Monday, March 29, 2010

Should I Shop This Term Sheet?

You've been working hard. You have a product, it's getting traction. You've been getting some interest from various VCs. And then, voila, you've got a term sheet. Now what?

I know that for many folks in these difficult times the answer is going to be -- where do I sign. Maybe you only have one investor seriously looking at your company. Maybe you could really use the cash. But there are some companies that have the luxury of competing bidders. This comes up time and time again and it is a very tricky area.

On the one hand, you have established conventional wisdom that comes out firmly on the side of "don't ever shop" a VC term sheet. It is considered bad form. You could lose what you've got. It makes the VC feel like they are nothing more than money to you. If you had played the game correctly, you would have already orally agreed to all salient terms, so there should be nothing for the VC to improve upon. Etc.

On the other hand, what if there are some terms that you would like to see improved upon? Or, more important, what if you really clicked with a different VC and would prefer for that VC to be the one that you are going to be married to for the next 7 years? Well now you are in a pickle.

In these types of situations, I have generally counseled folks to follow the following protocols. (And, interestingly, I listened in on a "panel" at SXSW where Justin Fishner-Wolfson a principal at VC shop, the Founders Fund, agreed with this protocol on almost all points. So there is certainly not unanimity among VCs on this issue.)

Shopping term sheets is ok. But only under certain limited circumstances.

First, you should never show an actual term sheet. That really is bad form. Rather, you should orally convey that you've got an actual signed term sheet and let the other firm know one of two things -- either they are your top choice because of personality fit and if they come up with a ball park offer you will go with them, or they are in the ball park but if they can improve on one or two key terms, then you will go with them.

Second, you can only go back once. It cannot have the appearance of an auction or feel like you are playing different investors off against each other for incremental improvements in terms. Remember, VCs talk to each other. A lot. Chances are quite good that they will catch on to you if you are doing multiple round trips.

Third, only ask for things that you really care about. Pick two or three (or one) term(s) that really matter to you and ask for improvement. Don't quibble about silly things like number of demands in a registration rights agreement or number of days notice you need to give on the right of first refusal. Stick to what really matters to you, explain that the competing investor gave better terms in that area and ask for the improvement.

Fourth, if the VC concedes to your request, then you should accept their term sheet. It is NOT ok to then go back to the first VC and ask for further improvement. Etc.

Finally (and most important), never shop an "oral" term sheet. Another word for an oral term sheet is diddly-squat. If you don't have it in writing, it doesn't exist. Just because a VC told you that they "feel really good about getting you a term sheet soon", it does not mean you have a term sheet. Trust me, VCs talk. They will figure it out if you are shopping something you don't really have. And then you really will have nothing.

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Wednesday, March 24, 2010

Six Things Not To Do When Pitching for VC

Here are six common sense pitching tips I gleaned from various SXSW discussions. Hope they come in handy.

1. Leave the jargon at the door. The folks that you are pitching have to hear dozens of pitches a week. A buzzword that sounds hot to you, sounds obnoxious and stale to them. Keep it simple and just explain why your business model is great.

2. Ask everyone for advice, but DON'T take it all. When you are fleshing out your business, you should bounce it off of as many smart people as you can. Potential investors. Potential mentors and peers. Potential employees and co-founders. Potential drinking buddies. Who knows where you will gain insight. Generally, you shouldn't worry too much about someone stealing your idea. In the consumer-facing internet space, just about every company has at least three clones out there somewhere. (Obviously, in some sectors where IP is paramount, you should disregard this advice, e.g. Life Sciences, Cleantech, etc.). What will make you successful is your team and their ability to execute on the idea, iterate quickly and pivot when necessary. More feedback is better. But, don't feel the need to incorporate everything everyone says. Show your founders intuition and filter the good from the bad. The only thing worse than a half-baked idea is a pitch deck suffering from feature bloat. Which leads to ...

3. Keep your pitch short and sweet. Don't let it get longer than 20 to 30 minutes and 10 to 15 slides. If you feel like you need more than that, then consider the possibility that you need to learn more about the essence of your business. Work on refining it.

4. Don't make unrealistic projections. Everyone needs to do a TAM analysis of some kind or another. And it is incredibly tempting to find a $50billion market and say to yourself, hey, if we only get 3% market share we will be doing $1.5billion a year in revenues. Sweet. Let's be honest here -- that just simply isn't going to happen. And your potential investor knows this. It is much more impressive if you can do a bit of research and leg work to develop your market from the bottom up. You can still come up with some pretty wild projections, but at least you will have established the metrics against which you should be measured.

5. Please don't argue with the person you are pitching. You aren't going to convince them. They don't like it. Really, no one wins here. If you disagree with a point someone is making, let them make it, respectfully disagree, maybe give a cogent counter example, and then agree to move on. You can still have a successful pitch -- and, in fact, you can use the disagreement as a reason for an additional touch. In a few days, you can contact the person you disagreed with and supply them with strong evidentiary support for your position. Data and proof will overcome most doubts. Also, by following up you will show good qualities to the investor, like follow through, sticktoitiveness and initiative. Arguing just irritates people.


6. Don't get hung up on the pre-money valuation. Too many entrepreneurs meet their waterloo over valuation at the A round. Not only is this shortsighted with respect to future rounds, but it may very well cause the entrepreneur to miss other important issues in the current round. With respect to future rounds, keep in mind that you will suffer much more dilution in a down round if the current valuation cannot be sustained, than you will by doing a reasonable pricing now and a much higher pricing in 18 months when you are raising 5 to 10x the capital. With respect to the current round, keep in mind that the base pre-money valuation is only one of several key terms. If you force an investor to raise the pre to a higher level than they are comfortable with, they will just adjust other, more opaque, terms to get their pound of flesh elsewhere. For example, they could increase the size of the option pool, take a multiple liquidation preference, take participating preferred or take an accruing dividend. As a founder, you may very well be better off with a lower pre-money valuation, but with plain vanilla preferred stock terms and a small option pool.

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Tuesday, March 23, 2010

Back From SXSW, Alive and Kicking

Now that I've been back from SXSW for a few days, I've had some time to catch up with my backlog of work and emails and collect my thoughts. I met a lot of really interesting people and learned a lot (though typically not by attending the official panels). I am sorting through my notes and will refine them into a few posts over the next couple days. I'm looking forward to posting again! Click Here to Read More..

Thursday, March 11, 2010

Deep in the Heart of Texas!

Am I the only one that has an urge to test this every time I arrive in Austin?

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Wednesday, March 3, 2010

Life Before Google



Thanks to Shoebox Blog. Click Here to Read More..

Tuesday, March 2, 2010

4 Thoughts on How to Get Funded by VCs

Last week at the Southeastern Venture Conference, I listened to a panel called "2010: State of the Venture Market." The panelists (Jack Biddle from Novak Biddle, Bob Hower from ATV, Dan Marriott from Stripes Group, and Lou Volpe from Kodiak) ranged pretty widely across the venture capital landscape and touched on some great insights for emerging growth entrepreneurs. Below in bold are 4 quotes that I found particularly interesting with my thoughts following.

1. "You need a big idea." -- Bob Hower.

This may seem obvious. Why start an emerging growth company if it is not based on a big idea? But it seems that almost every day I am approached by an entrepreneur with an idea that is just obviously not big. Maybe it is a great feature for another product? Maybe it is a neat app that few would actually pay for? Maybe it is a niche product that people would pay for, but there aren't that many people in the niche? Nevertheless, what these concepts have in common is that they do not have BIG potential. By big potential, I mean they do not have a chance to achieve massive scale or massive profitability. The thing about early stage venture capital is that for the VCs business model to work, they need to see returns of not 3x or 10x but 20x or 50x. That is because out of 20 portfolio investments, VCs anticipate that only 2 to 5 will be successful. (YMMV depending on the VC.) The typical VC is not interested in a 3x exit with a high likelihood of success. He is really looking for the homerun and the 50x exit. Consequently, every company he backs must have that home run potential. If you are really just a feature or a niche product, my guess is your TAM is not going to get a VC that excited.

2. "I need to know that you're not just making it up -- you need a single objective data point." -- Jack Biddle

In a word -- you need TRACTION. Your big idea is all fine and dandy, but can you prove that it works? VCs in 2010 are just not investing in two guys with an idea sketched out on a cocktail napkin (likely over cocktails). They need data points. Now, this doesn't mean that they need to see profitability or even revenues. But it does mean that they want to see that you have something that people are interested in using. Can you show adoption? Can you show a nice upward trend in hits? New users? Retention rate? Or some other metric that accurately captures why your idea is great? In a technical field, do you have your patent? Have you successfully completed Phase I clinical trials? Etc. The point is, you need to give your VC a hook to hang your idea upon. Just one single objective data point ...

3. "You have to be able to sell for a valuation that has no rational relationship to your earnings power." -- Jack Biddle

This is similar to the "big idea" requirement, but is more nuanced. What this is really getting at is "what is your secret sauce"? Is it a hot new technology? Is it a rock star team? Is it a revolutionary now business model? How can you justify to a buyer that they should pay a 12 or 18x multiple on EBITDA when competitors are selling for 7x? How do you justify a $3B pre-money valuation when you have not earned a single cent but you have traction that is through the roof? These mysteries are what make working with emerging growth companies such an exciting opportunity. And the perceived presence or lack of a "secret sauce" will often prove the difference between finding VC funding and not.

4. "Immediately out of the chute [an early stage company] will have international operations, whether in India or China, etc." -- Lou Volpe

A great reminder of the globalization of all things. Not only should you be looking overseas for crowdsourcing, coding and design assistance, but you should be watching your space overseas to see what competitors are up to. For many, it is no longer possible to say "we'll build market share in the US for 3 years, then head to Europe, and then maybe Asia later this decade." By later this decade, Asia will already have lapped you if you are not paying attention.

One last bonus thought that I think brings the VC capital raising process home:

"This is all about money and the money chases returns." -- Jack Biddle


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Dividends and Preferences by Hank Heyming is licensed under a Creative Commons Attribution 3.0 United States License.