The Game of Innocence

 (From thefunded.com: http://thefunded.com/funds/item/2374 )
Aspiring entrepreneurs be warned. Venture capitalists will provide money for your idea, but they often walk away with most of the value, especially if you are not careful. Like an amateur sitting at a table of professionals, the cards are stacked against your success, so be prepared. Know the game.

Here are some anecdotal facts. There are five times as many people working in venture capital as there are CEO’s that are funded each year (~16,500 vs ~3,000). The average venture funded CEO is fortunate to make 1/10th to 1/20th the return on exit as the venture capitalists. Just the legal fees on a later stage deal will run $50,000 or more per party involved, and the venture capitalists always flip the bill, directly or indirectly. Who do the lawyers work for again?

No matter how nice, no matter how fair, and no matter how genuine a venture capitalist appears, you are being out-smarted, out-lawyered, and out-maneuvered the second you sit down and ask for money. The first step in winning is to understand their motivations: (1) control, (2) risk, and (3) opportunity, in that order. Let’s take a look at all three.

The entirety of a venture investment centers around control, and control takes many forms: control of the board, control of the voting, control of the investment capital, and, most importantly, control of the management. Venture capitalists are “control freaks,” and the psychology of control is embedded in nearly every aspect of the deal legal structure. Assume that most financing terms, from Board meeting frequency to protective provisions have some origin in control, and analyze them as such. Ask yourself: in good times and in bad, how do these terms affect my behavior as a CEO? For example, did Google really need to have 14 Board meetings in one year… ever?

Venture capitalists are excellent at managing risk. It is assumed that at most venture investments fail, but approximately one in ten succeed. Following this simplistic logic, a venture capitalist would need to make at least $10 from every $1 invested in a success to recover from the 9 losses. Now, not every deal is a total loss, but a lot are. Complex protections are inevitably put in place. Let’s look at a common scenario: a company receives $10 MM for 50% of the stock in a participating preferred with a 2x liquidation preference. The company sells for $25 MM right after the investment. How much does the founding team make? Nothing. The “50%” is legalese.

Venture capitalists are not very good at spotting opportunities, or they might have better odds than 1 in 10. However, they are very good at “managing” opportunities as a result. Here are some examples. Venture capitalists do not say “no” (for risk of losing an opportunity). They postpone meetings until you are achieving success, and they flock around markets with success stories. Ever wonder why a venture capitalist calls you out of the blue asking about your company? It’s probably because a competitor is succeeding. Every wonder what “demonstrate traction” actually means? It means a nine figure IPO or liquidity event in your sector. Your dream is just potential, and you will be held on the sidelines until “the time is right” for the venture capitalists to make money.

The irony is that the venture capital behavior is largely a response to other abuses by CEO’s. At this point, however, the venture capitalists have gone too far. The opportunities in building a venture funded start-up are gone for the great entrepreneurs. It simply makes more sense to go it alone.

You can quote me without attribution.

On Big Companies and Startups- Jano Banks

I came across this video forwarded to me from a colleague in the sates. It’s a bit long, and I never heard of Jano Banks before, but it was actually a pretty good speech. He speaks honestly, and really gives good insight into the differences between working for big companies or startups. He has worked for some famous bigger companies, like Apple, and is currently running a small startup called Radiient.

I especially like how we touched on the subject of real life problems that bootstrappers face: mortgages, feeding your family, stamina, team building, fund raising, etc.

Enjoy,

-I

Bootstrapping Tip #1- Never Roam

I’m going to start off the tips with this little gem:

If you’re bootstrapping it, and you’re on a trip in a different country, NEVER roam with your cell phone.  It will always be cheaper to buy a local SIM and pay local rates.   And if you find yourself traveling frequently to a certain country, it could even be cheaper to get a SIM with a line (as opposed to a pre-paid SIM) and use that every time you visit that country.  Either way, roaming will kill your budget unexpectedly, and is not good for any company that is bootstrapping it.

-I

Randy Komisar of KPCB on working with VC’s

I figured this video would appropriate for the first blog post- a short overview of the early stage of the VC process. Many of our clients who are first time entrepreneurs are totally clueless as to how to start the VC process, and end up making some fundamental mistakes. This includes:

• Blind/cold sending of materials to every VC firm under the sun,
• Asking VC’s to sign NDA’s,
• Not preparing the appropriate materials, or
• Not preparing materials properly
• And many others!

He makes certain things sound very easy, like having a reference connect you to a partner at a VC firm. Not every entrepreneur has these kinds of connections, and this shouldn’t limit the success of the idea. This is also something we offer as a part of our consulting services- we open doors for people who have great ideas, and are lacking a network of proper individuals. I would argue that this is a bigger problem in Israel than Silicon Valley. Granted both are communities where most of the players know each other, Israel is a smaller community and has the aura of a closed club, making it very difficult for new or first time entrepreneurs to break in. (A post about this topic, Israel vs. Silicon Valley is coming soon).

Enjoy the video- provides some good tips when you get to that point. But remember, there is a lot of work to do to even get to the point where you are properly approaching a VC firm. And props to iinovatecast.com , they have some great podcasts on their site- check it out.

-I