Investors Focus On Management Teams
Bill Warner Sunday, June 07, 2009
All said and done, when raising money, the most critical hurdle the entrepreneur has to leap over is gaining the confidence of the investors. You can have the most attractive market, with the most innovative and competitive product or service, but if the investors do not believe that you can execute your business plan, they will walk. Read more about this perspective at Startable.com.
What investors look for
With respect to the management of the company, including the CEO and the other main players, investors just simply have to believe that you have the right team. This is often a very delicate judgment they make, sometimes with clear facts and sometimes on gut feel. The management team has to “click” with the investors, or it’s over. Here are some of the things they are looking for:
- Start-up experience
- Relevant industry experience
- Management team has worked together before
- Successful exits where they made money for investors
- Superior communications ability
- Demonstrated ability to build a team
- Establishes great working relationships with partners and customers
- Clear understanding of the business model and how to achieve it
Create the right management team
Entrepreneurs have to be very diligent in pulling together the best management team possible. It’s the most important set of decisions they make. Make sure you are getting the kind of people that can take you substantially down the path to success and have the skills that are needed to get there. Investors pay a lot of attention to entrepreneurs that have made them money, or at least have made money for other investors. Nothing speaks stronger than past success. Keep that in mind and try to assemble a team that has proven they can get the job done.
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Venture Capital Firms Declining
Bill Warner Friday, June 05, 2009
The National Venture Capital Association just reported that the number of venture capital principles has declined by 15 percent since the end of 2007. These are the folks that do the due diligence on investment opportunities and make the investment decisions within venture capital firms. The number of venture capital firms has dropped by 13 percent. Take a look at the WSJ article that gives the full details.
Massive Exodus
Some of the best of the best are heading out the door. Large firms like Sequoia Capital and Bessemer Venture Partners, along with smaller firms like Atlas Venture, Advanced Technology Ventures and VantagePoint Venture Partners, have lost partner level people. This is all a natural outcome of the decline of the venture capital market, and is why we are seeing new business models emerging.
The underlying problem with venture capital
For most of its recent history, venture capital deals have been structured with the requirement for a big payout upon exit, based on an initial public offering (IPO) or acquisition. IPO’s have nearly dried up to nothing and acquisitions have suffered a tremendous decline over the last year or more. As a result, venture firms are left holding onto investments that have no viable way to achieve liquidity in order to pocket their returns.
On top of this, with the rapid economic downturn at the start of the Obama administration, the institutions that fund venture capital have had to back away from this asset class. These institutions have lost up to 40 percent of their value, with some recovery recently, but have been in the mode of selling off their venture investments. Some have even had to withdraw their capital commitments to some venture firms. This has also put the brakes on venture firms that need to raise more money.
The dilemma for venture capital
If a venture firm has recently raised a fund, they may have a chance to get through this economic downturn, assuming it recovers sometime next year. To survive, many are simply protecting the best companies in their portfolios, and are making few if any new company investments.
If a venture firm is nearly out of money, they are going to have a heck of a time raising a new fund in this market, and are faced with simply going out of business.
An unwanted outcome
Despite what you read, this is not a natural evolution of the venture capital market. This is a forced outcome as a result of the economic downturn that has now nearly destroyed the venture capital business. This all goes back to the fundamental causes of the bank failures that was driven by mismanagement, government meddling and oversight failures.
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Venture Capital Correcting Valuations
Bill Warner Monday, June 01, 2009
Venture capital firms are finally making corrections in their valuations in response to the downturn in the economy late last year. Read about the details in the WSJ, but this decline in valuations represents an adjustment to the value they place on their portfolios and to any company they are considering for new investments.
The adjustments are not uniform
The sharpest decline is occurring with later stage companies whose valuations declined about 43%, dropping from a median of $56.1 million in the fourth quarter to $32 million in the first quarter, all of which is pretty comparable to the decline in public markets last year. The median for the third quarter was $64 million. Likewise, their limited partners have felt the squeeze as well in that their portfolio values have dropped a similar amount.
Second round companies had a similar drop from $16.1million in the fourth quarter to $10 million in the first. But, first round companies faired well by rising from $6.6 million in the fourth quarter to $7 million in the first, but usually show less volatility to changes in the public markets.
Venture firms are buffering their pain
In the first quarter, 57% of all venture rounds were done by the current investors, giving them the chance to tamp down the pain of the write-down thus protecting the fund’s performance. New investors would be much more likely to want a more aggressive reduction in valuations.
Good and bad news for entrepreneurs
Entrepreneurs of start-ups that are going for their first venture round should expect valuations that track consistently from the last two quarters. Unfortunately, this is a bad time to have to go out to raise later stage VC money. The company will probably be faced with a down round where the company’s value is less than what it was at the time of the last round, and it’s all due to the economy. The hard thing to swallow is that even if the company performed well and met all its milestones, it still will get punished with a lower valuation.
If you need the money though, you have to do it. This is where tightening the belt and conserving cash pays off.
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Find the Right Angel Investors
Bill Warner Monday, June 01, 2009
Entrepreneurs need to take care to choose angel investors that are going to add value to their business in addition to the cash infusion. Believe it or not, there are some bad choices of angels. The trick is to avoid the angels that might cause you some problems in the future.
Bad Angels
Just because they can write you a check, doesn’t make them your best choice for a business partner. Entrepreneurs need to take a deeper look into the background of potential angel investors and find out who they really are. Here’s what you need to avoid:
- The predator – is an angel who is going to take full advantage of the economic situation, the entrepreneur’s need for money, and perhaps the entrepreneur’s lack of experience and construct a deal that is so one-sided that the entrepreneur is left out in the cold. In addition, they will have the tendency to take you to court when the going gets tough, knowing that you cannot afford to defend yourself.
- The rookie – will waste your time with endless due diligence and meddling in your business that he may not be worth taking the money. He is more of a drain on your time than a help in moving your business forward.
- The ex-executive – is a former high level corporate executive that has an ego as large as a barn and not a lot of experience in start-up companies. They have an attitude of being superior to the entrepreneur and will often lead the entrepreneur down the wrong business path.
- The meddler – takes up your time by requiring too many controls on the entrepreneur and the business. In addition, they may actually take a management role in the company just so they can see what is going on.
- The dullard – is perhaps an angel that just doesn’t have the savvy required to run a business, and has never done so. They got their money from stock options or inheritance and want to try something new. They will waste your time.
- The broken angel – has tapped out with too many loses, or is awaiting exits. This angel will take up a lot of your time but never actually make the investment.
- The broker – is quite common. They make you believe they are investors with a syndicate of investors they lead, but they are really people that want to make retainer and success fees off of the entrepreneur. It is rare that they add value to an angel deal, and most real angels don’t want to have anything to do with them.
What to look for in a good angel
The angels you want bring considerable business value and are the kinds of people with whom you want to have a long term relationship with. The value comes in various forms:
- Deep knowledge of your industry
- Relevant and successful business experience in your market
- Influential position in your community and industry
- Industry contacts that can turn into customers or partners
- Solid management and leadership wisdom to coach you through tough times
As you search for angel investors, look for the ones with the wings that can really take you to where you need to go. By all means, make sure you have your attorney create the investment documents. That way, you know they are right.
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Venture Capitalists Open a Stock Market
Bill Warner Wednesday, May 27, 2009
Last week I wrote about angel investors becoming super angels and replacing the role of the venture capital firms in investing in early stage companies. Well, venture capitalists are not standing still. With institutions backing away from venture investing and the IPO market drying up, venture capital firms are rethinking their strategies. Take a look at what Tim Draper is doing to reposition his firm. However this comes out, this is all good news for entrepreneurs who need to raise early money.
A New investment entity
Draper is corralling money from other private equity firms and high net worth individuals to create what he calls an exchange for trading shares in early stage companies.
In addition to being an informational network for investors and companies, the exchange provides a facility for matching investors with companies and a platform for actually buying and selling company shares. It’s a private stock market, giving investors the opportunity to invest in high potential companies and getting some early liquidity in lieu of an IPO.
Although this is not a new idea, it is the first time that an exchange has been pulled together for venture capital.
How this helps entrepreneurs
The exchange provides a service for entrepreneurs to raise money for their ventures, while at the same time offering investors a new way to get a return on their investment short of an IPO or acquisition.
This service doesn’t quite reach the pure start-up in that the company has to have at least $20M in revenue to enter the exchange. Nevertheless, this is a good thing for these companies in that they will have another viable opportunity for raising capital.
Launching in September, this will be a grand experiment worth following. Stay tuned as this evolves and see how other venture firms deal with this dilemma.
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Super Angels May Replace Venture Capital
Bill Warner Friday, May 22, 2009
Here’s a slant on the angel investment world that you may not imagine. Those angel organizations that view this down economy as an opportunity to get some really good deals may be introducing a new model of angel investing that could replace the role venture capital firms play today. Read about this in Spenser Ante’s article in Business Week.
What’s new?
Here’s the idea and premise. Instead of raising huge amounts of money in venture funds, which many claim is a broken model because the IPO market is nearly dead, raise much smaller funds. Every wonder why you read so much about the health of IPO’s? VC’s need them to get the multiples they require to make their deals whole. The new premise is to raise smaller amounts of money and invest much smaller amounts in many start-ups looking for much smaller but more predictable exits.
The aggregate should be more positive exits but at much smaller values. The idea is that the overall returns will be greater than the very high risk opportunities that VC’s engage in today.
VC’s are too big
The issue may be that VC firms are just too big. They have to place so much money in any single deal that they are almost destined to fail because the exits will not be lucrative enough. It has nothing to do with the recession, but everything to do with a basically broken business model. Some VC’s are seeing the light and going back to their roots of investing in start-up companies with small amounts of money. The difference today is that many companies can be started with a whole lot less money than we were seeing in the late 90’s and early 2000’s.
Why this might work
Well, the proof of the pudding is not yet seen. An entirely new model of venture investing may be emerging; one where VC firms invest in a lot more deals at the start-up stage with a lot less money per deal. This is placing a lot more bets on much riskier opportunities. Stay tuned as this model emerges.
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Angel Investments Decline In Recession
Bill Warner Thursday, May 21, 2009
In its most recent Angel Group Confidence Report, the Angel Capital Association (ACA) reported that 2008 average angel group investments were down 9 percent from 2007. They did point out that many groups actually increased, seeking opportunities while valuations are depressed.
Why did investments decrease?
We are all familiar with the impact of the economic downturn. As institutions backed away from venture capital investments, angel investors also become much more cautious and selective. They too took a big hit in the markets. The reaction of angel groups has been to be much more selective about making investments in new companies. This has led to the decline in average angel investments. In addition, they circle the wagons and protect their portfolio companies. Knowing that their companies will need help as it became unlikely to be able to raise VC money, the angel groups have to carry more of the water.
What does it take to get their attention?
It’s not all gloom and doom. Entrepreneurs that have a great business idea should not shy away from approaching angel groups. They should really get familiar with what valuation and terms to expect in this market before they approach them.
Angels will be looking for well thought out business models that will get substantial sales traction quickly. The less money needed the better. Many web based businesses have that characteristic. It is important to portray a realistic and near-term exit strategy; the shorter the better. The management team matters even more. Gather an outstanding group of people who have both the technical and business wisdom to grow the business.
What does the future look like?
Well, I am afraid it is going to be more of the same, and perhaps a little worse, in 2009. But, again, don’t let that stand in your way as entrepreneurs. Put a whole lot of discipline in your business planning and execute smartly. Nothing beats a company that knows how to get to market. Be one of them.
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Buckle Up For New Valuations and Term Sheets
Bill Warner Wednesday, May 20, 2009
The market downturn has certainly put the damper on the view of risk by angels as well as VC’s. I keep reading that there is plenty of money out there, which is true, but the problem is that there is actually less money than last year. The personal wealth of angels and the portfolio value of foundations and institutions are considerably less by 30 to 40 percent. This puts a lot of pressure on their willingness to take on new investments.
Term sheet shock
As entrepreneurs go out with their investor stories, the lucky ones get to see term sheets that are unbelievable. See Ty McMahan’s article in the WSJ. The rest have to keep looking. The term sheets bring a new dose of current reality:
- Valuations that are up to 50 percent lower than this time last year; start-ups could pretty much negotiate a 2 to 3 million dollar valuation last year, but now, you can expect to see 1.5 to 2 million, sometimes less
- Dominant board positions for investors
- Significant control of money spent through strict covenants
- Tamping down of executive salaries
- Option pools carved out of founder’s shares
- No recovery of past founder expenses or deferred salaries
Entrepreneurs need to show maturity
It has always been the case that entrepreneurs have to show that they have a mature understanding of the equity market. Entrepreneurs that have unrealistic expectations and are not willing to negotiate and compromise will fail to get any money. However, today’s equity situation is a shocker for even the most mature of entrepreneurs. We are in a deep buyer’s market and prices and terms are very much in favor of the investor. If you need the money, this is the way it’s going to be for quite awhile.
Before you approach investors, get an update of your understanding of the market and be prepared to deal with this new reality.
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Number of Start-ups is Declining
Bill Warner Tuesday, May 19, 2009
According to the TechCrunch database, the number of start-ups in the first quarter is down considerably. Keep in mind that this is only a subset of all US start-ups. With unemployment increasing, there is an increasing number of companies overall that are starting in the US. Most of them are not seeking private equity financing.
Venture capital financing is down
This certainly tracks with the reduction of angel and venture capital investments for the first quarter. Although, the reduction in venture financing was felt less for companies needing B or subsequent rounds of financing. This too is proof that venture firms are focusing on their current portfolios by protecting those companies that have the best chances of success.
Other indicators
Their data also shows that start-ups are starting with fewer people and with less money. This can be attributed to belt tightening as well as the increasing number of web based companies that need far less money to get started. M&A is way down for the quarter, with none of the major companies announcing an acquisition.
All of this is perfectly predictable, but the reality is here. Nevertheless, if you are planning on starting a business, go for it smartly.
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Give Your Business a Stress Test
Bill Warner Tuesday, May 12, 2009
Hey, here’s an idea. If banks can undergo a stress test, you might want to consider doing the same thing for your business. This might be worth your time if you do it with the objective of determining if you can withstand the worst of economic situations.
Determine the stress on your business
Start by making some reasonably pessimistic assumptions about your industry and market segment. Don’t be ridiculous, but make assumptions that represent the worst case you can realistically imagine. For example:
- Assume your market segment growth is flat or even down year to year; whatever is indicated by the changing trends in your industry.
- Make assumptions about the cost of goods and services, all of which will have an effect on your gross profit.
- Project what might happen to prices, especially if you see new competitors emerging or the possibilities of price reductions by your current competitors.
- Assess what will be changing about your customer’s purchasing behavior. Will the sales cycle be longer? Will the need for your products and services survive budget cuts?
- Take account of what is happening in the legislative and regulatory world. Will changes in government subsidies affect your business or your customer’s business? Will tax increases affect you or your customers.
Calculate the changes in your financial outlook
Any of these stress factors will have an effect on your ability to do business and need to be reflected in your financial forecast. Express these stress factors quantitatively so that you can reflect them as changes in your Excel spreadsheet assumptions that drive your financial forecast:
- How will marketing productivity be effected?
- What will happen to sales productivity and closure rates?
- What changes will have to be reflected in your cost of marketing and sales?
- Will there be changes in your assumptions for operating expenses?
- What changes should be made to prices over the next couple of years?
Perform what-if analysis
With your new assumptions, update your financial forecast spreadsheet and let Excel determine what will happen to your financials over the next 18-24 months.
- Will your gross profit still be viable?
- Does your expense structure still work?
- Are you profitable?
- Do you maintain a positive cash position?
Determine required actions
With your completed stress test, make some judgments as to what you need to do to assure your survival if your pessimistic assumptions become reality. You may find that you need to make certain changes now or at least determine contingency plans that could be executed if the situation requires them.
- Should you raise money to pull you through the tough times?
- Are their cost and expense actions you should be taking right now, just to strengthen your financial position?
- Will you be able to realistically cut costs and expenses further if times get tougher? Create a plan for such actions.
- Should you take preemptive action on prices now?
- Do you need to reduce staffing now?
Be totally objective
We are talking about your business, so be bluntly honest about your market situation. This is not a time for unfounded optimism. Be optimistic about your chances of survival, but be realistic about what challenges you face. If you are, you will come up with actions that will save your business. By taking action now, before a disaster hits you, you are giving yourself the maximum chance of winning.
