Raising Capital (8): Eyes Wide Shut... Welcome to the Masked Ball

(click on photo for the video of this scene)

This is part of my Series' on Venture Capital and Entrepreneurial Culture.

Over the years it’s been real privilege for me to mentor friends and acquaintances of mine who at one point or another in their careers have decided to make the leap into the start-up game.  I happened to have had the particular advantage of starting early and so carry with me the proverbial scars on my back and psychic black-and-blue marks so reminiscent of the trade.  It’s these same lumps that I always hope to help first-time entrepreneurs avoid.

Perhaps the most valuable counsel I can ever give to someone occurs right around the time they begin to raise capital to fund their company. This may well be the most vulnerable point of all in the life-cycle of a start-up for many reasons. One wrong move can literally mean the difference between success and a world of pain. Here’s truly where lack of experience, even in the smartest of people, can mean sheer disaster. I’ll start with the most important rule of all:  

You need to know who you are dealing with.

Through no fault of their own, first time entrepreneurs fresh out of school, an academic lab or who have worked for years at big companies generally have no concept of the cast of characters that populate the early-stage ecosystem. If you have just emerged from this sort of cocoon, you no longer enjoy the invisible “protection” your old position or firm’s name provided and hardly realize how vulnerable you are.  Essentially, you’ve arrived at a sort of Masked Ball, eyes wide shut, with no concept of who is around you.

Inevitably you will run into certain masked characters that may appear in any number of guises. Their firm might have the words “Capital” or  “Ventures” in it, or they may say that they are part of a “group of investors”, and they will talk about the many startup companies they have “worked with”. Certainly they will discuss how much they would like to help you with your funding needs. But beware…

You may be in the midst of being initiated into the shadowy world of the “broker-dealer”, the “investment banker”, the “middle-man”. At some point you may well discover that he has no money to invest in your company whatsoever. Instead, he will want to “help you” raise capital for a fee, taking a percentage of the money raised for himself and perhaps a retainer and warrants to boot. It’s perfectly legal and I will say that there are indeed some reputable people operating in this business. But these are few and far between.

Jason Calcanis and Fred Wilson have recently published some posts, (here and here), describing yet another masked character on the scene- namely, the type of angel group that charges extremely hefty fees, (thousands of dollars), to entrepreneurs who wish to pitch them.  This is definitely a character to avoid.  Another type that needs to be vetted carefully is the one who tells you he's got a bunch of shell companies on the bulletin board stock exchanges and that with a flourish of his cape he can take your company public with a reverse merger. Warning bells should go off immediately.

The bottom line is that although there are some notable exceptions, most of these masked characters generally do not have your best interest in mind and I have both witnessed and been told of dozens of situations where unwitting entrepreneurs have been victimized by them. My advice is simple. If you are trying to raise capital for your start-up, ask around first, do your homework and talk to half a dozen or more entrepreneurs with funded startups about their experiences. Also, try to find a good mentor while you’re at it. In every community there are reputable angel investors, legitimate angel groups and of course a handful of early-stage venture firms that have money to invest if they like what they see.

Notable News: "Read All About It"

1) Bo Peabody (WPost) “Twitter.org?”

2) John Tozzi “Smart Grid Will Spur Energy Entrepreneurship”

3) The Deal “Angel Investors Fly to Quality”

4) Scott Anthony “What Baseball Can Teach Us About Innovation”

5) Reuters “Angel Investor Makes A Mint”

Notable News: "Read All About It"

1) Silicon Alley Insider "Working Hard is Overrated"

2) VentureHype "Ready to Become an Angel Investor?"

3) WSJ "Where Twitter Ranks in Venture Funding History"

4) VentureBeat "Green Investing Bounces Back From Recession"

5) Larry Cheng "Who is the Venture Capitalist's Customer?"

Notable News: "Read All About It"

1) WSJ "America's CTO Challenges Tech Sector"

2) NYTimes "Twitter Confirms New Funding"

3) D. Shah "12 Facts About Entrepreneurs That May Surprise You"

4) This Is Going To Be Big "Retraining Wall Street"

5) Scott Anthony "My Best Innovation Advice? Be Promiscuous"

Google Acquires University Spin-off ReCAPTCHA

This is part of my Series on University Entrepreneurship.

 Another success story in the annals of university spin-offs hit the wires today. 

Hearty congrats to MacArthur Genius Luis von Ahn and his colleagues at Carnegie Mellon School of Computer Science. Their spin-off company, ReCaptcha was acquired today by Google. You can find Google’s announcement here and additional information here. 

The company came up with a clever and effective variation on traditional CAPTCHAs by using words scanned from old books and archives that computers find difficult to read.  In fact, more than 100,000 sites are currently using this technology. Google will go beyond this initial application however and intends to use the technology to greatly improve some of its own text and archival scanning projects, including Google Books. 

For Part Fifteen in in this Series, click here

The “X” Factor in Business

 

This is part of my Series on Entrepreneurial Culture.

Much as it has with most other sectors, the economic downturn has taken its toll on the early-stage ecosystem.  Many angels have curled up into fetal position for a while, a good number of VC funds are simply running on fumes and lots of startups are having a difficult time getting traction and are consequently running out of operating capital. By necessity people keep up appearances but plenty of old hands out there know what the deal is. There’s no getting around it- it’s just been tough.

I won't descend into cliché by expounding upon the inevitable “silver-lining” or the “positives” in all this. I will simply say that I have observed that a by-product of these trying times has been a sense of clarity imposing itself almost everywhere. Everything has become very basic in that so many early-stage companies are simply fighting to survive and to get through all this. Entrepreneurs are in hard-core bootstrap mode, the universities and the city are pitching-in trying to do their part, and the local entrepreneurship communities are congregating and banding together like they never have before. There’s something absolutely special going on in this city and I’ve been heartened by it. In my work as an entrepreneur in the university space and as an angel I have the privilege of meeting and working with dozens of entrepreneurial teams each year and the camaraderie and enthusiasm so many of them possess in the face of all this is inspiring.

There’s something else that has been reinforced to me in all this. It’s what I call the “X Factor” in business. When someone in a university lab for example, makes a shocking scientific breakthrough in an area with a large commercial market- it is as if there were never such a thing as a recession. The sun suddenly emerges in full force and the dark skies are a distant memory. Investors and entrepreneurs get on planes, trains and automobiles from near and far and converge in full force- money is suddenly plentiful, the absence of a management team is a mere detail and the future is unlimited. The somber story-line I’ve painted in the paragraphs above (and that the media repeats ad-nauseum) is suddenly rendered meaningless.  When Vinod Khosla decides to raise a couple of new clean tech funds, again, the mainstream narrative is eviscerated and he raises over one billion dollars with a wave of his hand. Similarly, when the likes of an Andreessen feels it’s his turn, a cool $300 million plus materializes for his new fund.

My message in all this? Simply that nothing is as it seems. That the “new story” can be written at any time, by anyone, regardless of the conventional mainstream narrative or the state of the economy. If you’ve got a me-too company or an incremental improvement on a product that already exists, or if you’re not fully committed to the venture- well, it’s a safe bet that convention will apply. But if you’ve got something magnificent, something bold and clever and possibly disruptive, well then… you may yourself be that “X-Factor” and if so, anything is possible.

For Part Fourteen in in this Series, click here

Launching Your Company: Send Lawyers, Guns and Money? Or Do It Yourself!

This is part of my Series on Entrepreneurial Culture.

The classic Warren Zevon refrain, “Send Lawyers, Guns and Money”, could very wellepitomize the attitude many first-time entrepreneurs take on when launching their companies.  In fact, I’m asked the question, “Which lawyer should I hire?” so often that I decided to share my quick thoughts on this matter.

In my opinion you actually do not need a lawyer. What you really need is a successful serial entrepreneur to be your mentor. She or he can help you not only with incorporation but with all the other issues you’ll be facing as you launch the new company.

In a nutshell- hold your fire and save your money.

Nowadays it’s a breeze to incorporate online and there are services such as Legal Zoom and others that remove any need whatsoever for engaging counsel.  Furthermore, standard Operating Agreements are widely available and figuring out whether to start an LLC, an S Corp or a C Corp or what state is best suited for your newco basically involves a two minute conversation with your mentor.  To pay a lawyer a handsome retainer and hourly fees to help you with any of these issues is a complete waste of money in my opinion.

If you don’t have an experienced mentor to help you and absolutely insist on hiring a lawyer, please remember that these services are a commodity. You should only work with reputable, respected lawyers that primarily work with start-up companies and who are well-regarded in your local entrepreneurial and investment community. If you go elsewhere you will most likely be shelling out thousands of dollars for the usual rigmarole. Reputable counsel will help you set things up inexpensively and will be a resource that is available to you as you grow your company.  Their value will manifest itself once you actually have a revenue-generating business and are perhaps raising your first round of institutional funding. 

I of course welcome you to share your thoughts and experiences on this topic.

Google Translate is Awesome

I recently found out that some folks in Asia have been using Google Translate to read my blog in their language. What a remarkable tool this is. Seeing a screen shot like the one below which translates my blog post on the five myths of raising capital into what seems like Japanese is also quite humbling.

Mourning Angels: What Went Wrong With Your Investment? (Case Study #1)

This is part of my Series on Angel Investing.

Some readers of this blog who are interested in getting involved in angel investing recently suggested I do some case-studies as part of this series. I agreed and thought we ought to start by examining some typically negative scenarios that one inevitably confronts as an angel. Hopefully these case studies will stimulate some questions and further discussion from which we all can learn.

Eventually we'll work our way back to the core issue at hand: your own judgment of other people’s capacity. (See my earlier posts on this topic here and here).

(**Disclaimer: These case studies are not modeled after any person or any company in particular- they are designed for illustrative purposes only).

CASE STUDY ONE:

So you hear rave reviews about this guy long before you meet him. The people raving about him are actually some customers of his whom you’ve known for years and respect and who have successful businesses of their own that have benefited greatly from his product. You meet him. He needs some growth capital. He’s an industry veteran, a go-getter, knows the business inside and out, knows how to stretch a dollar and generally checks out at first glance. You and your small band of angels analyze the business and perform your supposed due diligence.  Things look good actually and he’s in talks with a potential acquirer. After a month of analysis and discussion, the investment gets made. 

In the beginning all seems fine. There is some initial growth, some promising leads, but after about 18 months you all realize that nothing is happening. There is no growth and the acquisition talks have broken down long ago. There is also very little communication lately.  You hear that he’s borrowed some money recently and is having trouble paying it back. You fly out to visit him. He’s friendly, but seems evasive, a little down.  He’s gained about 15 pounds since you last saw him. Now what?

QUICK ANALYSIS:

He may have got caught up in other things. He may be having marital problems. He may have made some personal investments in other areas when the going was good but then the market tanked. Remember- as an Angel, you are probably not on the Board and you are a minority shareholder.

             Q: So what are your options?

             A: Welcome to Angel Investing. You have none.

Questions for Discussion:

• So what could you have done differently? Would a convertible note have helped rather than a traditional equity investment?

• Did you really know this person? Did you make reference calls?

• During diligence did you ever meet his family, see his home, see how he lives, what his hobbies are, etc.?

• What does due diligence mean to you?
  

Let's discuss this case study and the questions I've raised.  Looking forward to your thoughts and comments.

For the next post in this Series, click here.