Team, Team, Team

You all likely know that most VCs consider the management team to be the top measure of potential success of the venture.  This post is not about that point, at least not directly.

I want to instead focus on the importance of the entire team (not just management) and the importance of making sure that the team can play together.   I am going to use my past weekend’s soccer experience as an analogy.

I organized and played on an Over 40 soccer team this past weekend in a small tournament in Ithaca.   There was no Over 50 bracket or I would have played in that!   So, there were 4 total teams in the Over 40 bracket.  Two teams from Ithaca (one of which was mine) and then one team from Vermont and one from Binghamton.  You are going to have to trust me that no matter how in good shape you might be, playing 4 soccer games in one weekend when you are over 40 means that you can barely walk come Monday.  Advil turns into candy.

When organizing the team, I managed to get this one guy who is an exceptional player – better than anyone else on the team.   I will call him Jim for purposes of this post.  On Saturday, we tied both of our games (against Vermont and Binghamton).  The catch was that Jim could not play on Sunday.  I knew this going in.  And to make things even more interesting, Vermont outplayed us and we literally tied the score on a questionable call that resulted in us getting a penalty kick, which Jim converted.   Time ran out and we tied 2-2.  Vermont team was pissed, but that is soccer.   We knew that the top 2 teams in the group would play for the championship Sunday afternoon.

Well, you guessed it…..the top 2 teams were mine and Vermont.  Vermont wanted revenge, clearly.  We were without Jim.  I was a bit concerned.  But we ended up playing exceptionally well – better without Jim!  We won 2-0.  It was kind of unbelievable.

Relating back to startups – it is not good to rely on one person.  Not the CEO, not the head of engineering, not the head of sales.  You get the point.  Playing together as a team is the path to the best results.  CEOs who don’t realize this will often get fired or just fail.  I think one of the primary roles of the CEO is to make sure that the team dynamics are as good as possible and get the entire company pulling in the same direction.  This is not to say that there cannot be stars on the team, but it is WAY better if the stars end up rotating around.  The larger the group of people that feel like they contributed to a win, the better off the company will perform.  And the successes will keep coming.

My entire Over 40 soccer team all felt that they contributed – we only had one sub for our last game so that is an understatement.  Team play captured the championship.  Make it happen!

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If it smells bad, it probably is

We all live in a world of conflicts.  I am particularly sensitive about conflicts due to the roles I have at Cayuga Venture Fund and Cornell.  I think that everyone should conduct business in a way that will not provide fodder for an unsavory newspaper article.  All the recent press about Theranos is a great example of this.  Regardless of your views on situations like Theranos, it is likely that some of what you might read in the newspaper is true.

You might call me naive, but my approach to competing accounts of juicy situations is that there is probably some truth in both sides.  This applies to all sorts of situations, be it feuding companies or feuding people.

So, this morning my wife forwarded me an article on Hampton Creek, “Hampton Creek Ran Undercover Project to Buy Up Its Own Vegan Mayo”.  Now, my wife loves Hampton Creek Mayo, but even this one caught her attention enough to forward to me.  Furthermore, the company’s CEO is a Cornellian (yes, I knew him when he was a student).  The article claims that Hampton Creek had a systematic program of having its employees and contractors literally buy lots of product off store shelves thereby inflating velocities (i.e., how fast a store sells a given product typically measured in units/cases per week) and effectively overstating sales.  Hampton Creek has raised millions and millions of dollars from VCs and wealthy investors……and this is not the type of press that any investor wants to see.

Without saying much more, this type of practice would and should produce a media frenzy.  I am picturing myself in the management meeting when this idea first came up. “Hey, let’s buy up lots of product under the guise of quality control.”  Kind of ridiculous.  Ok, not “kind of”, just ridiculous.  Note:  for all I know, the company’s board of directors approved the plan.  I have no idea.

And I have no clue as to the merits of the press’s coverage or the company’s position.  I have only read one article on this.  The lesson though is simple:  if some plan or proposed action leaves a bad taste in your mouth then don’t do it.  Chances are it will back fire.  Said another way, if something smells like rotten mayo, then don’t eat it.

I believe that being transparent and dealing with people who are transparent is a proven road to overall success and achievement.  Sometimes I am overly direct and have been criticized for it.  Yet, trust is a fundamental pillar of relationships.  If you sense any pang of distrust in someone you are dealing with then trust your own instincts.

In the meantime, go buy some mayo!

Yes, I am still kicking!

Hey everyone, it seems like forever since I added a new blog post.  And this one is going to be brief to boot.  

Things have been incredibly hectic mostly in a good way.   At Cornell, at the beginning of June we opened our new eship space on campus called eHub.  And our eHub location in Collegetown is opening in about a month.  The construction has been time consuming and so has been working out the kinks of the facilities.  At Cayuga Venture Fund, we have been making a bunch of new investments, which is always time consuming.   Never a dull day.

Now I am going to be a little “Brad Feld-ish”, which means a bit overly personal.  Over the past months we renovated a lake house here in Ithaca and have been busy renting it.  And my dear dad passed away over Memorial Day weekend.  Lots on my mind.

In short, my brain has been full up.  But things are settling down so I hope to get back to regular postings very soon.  Thanks!

Rule 409A – Again

I first wrote about Rule 409A back in September 2011.  Here is the post, which focused mostly on how 409A valuations are used for stock option purposes.  BTW, I continue to think that as applied to private companies 409A is a terrible rule.  And I think that early stage companies should take the risk and not use 409A valuations.  As companies move to later stages and have meaningful revenues and profits then 409A valuations begin to make more sense.

I would like to add another Rule 409A thought.  Here goes:  please do NOT think that the 409A valuation has any bearing or meaningful relationship to how a VC will value your company.   Said another way, a 409A valuation is meaningless to how VCs negotiate pre-money valuations for their investments.  The 409A valuation is not based in VC reality.  Sure, you might say that VCs have warped senses of reality.  I can understand that!  Regardless, don’t dig yourself any credibility holes by trying to use the 409A valuation as a negotiating tactic.

To repeat what I wrote in my earlier post, I think that 409A valuations routinely work to the detriment of employees.  Stock options prices for startups should be as low as possible.  The government would end up collecting more tax on successful exits and the employees should be delighted to pay more tax on their larger gains!

Thanks, and enjoy the weekend.

Convertible Debt – Qualified Financing Triggers

I recently dealt with a tense situation regarding the “Qualified Financing” trigger in a standard convertible note financing.  For background, convertible debt documents typically provide that the debt will automatically convert into a future0 Qualified Financing equity round.  And that conversion is typically at a discount to the Qualified Financing equity round price.  Here is an example of actual language from a promissory note:

“Upon the closing of a Qualified Financing, the principal and accrued interest of this Note shall be converted automatically without the consent of the Holder into securities of the same class or series as are issued in the Qualified Financing. The number of securities to be issued in such conversion shall be determined by dividing the sum of the then outstanding principal amount of this Note and all accrued but unpaid interest thereon by the Conversion Price.  The “Conversion Price” means an amount equal to eighty five percent (85%) of the price per share paid by the investors in the Qualified Financing.”

It is extremely straightforward – here the discount was 15% to the Qualified Financing price.  (Sometimes, though not in this example, you will see a valuation cap built in too so that the debt holder gets the better of the discounted price of the valuation cap price. I suppose I should do a post on valuation caps too at some point.)

Here is the definition of Qualified Financing from the same promissory note:

”    “Qualified Financing” means the issuance of equity interests (or debt securities convertible into equity interests) in the Company to investors prior to the Maturity Date (as the same may be extended) in one or a series of related transactions, the principal purpose of which is to raise capital, which transaction or series of related transactions result in the Company receiving gross proceeds of not less than $700,000 (inclusive of the principal amount of the Notes that will convert into equity in connection with the consummation of the Qualified Financing).”

Typically you set the Qualified Financing trigger to be a meaningful amount of NEW equity financing so that the convertible debt is converting in a financing that will give the company some meaningful cash burn runway.  That is the whole premise behind having the conversion be automatic.  If the company is successful in raising the equity round that gives it some breathing room and runway, then the debt automatically converts and everyone is happy.  Goal accomplished.

I have used the word “typically” a few times in this post.  I am now going to use it again.  Typically, in the definition of Qualified Financing the amount of the outstanding convertible debt notes do NOT count towards achieving the Qualified Financing threshold as it is NEW cash that gives the company the breathing room and runway.  In the definition above the threshold is $700,000, which would give the company meaningful time to achieve its next set of milestones and set it up for additional capital raising if required.   Now, I hope some of you see the problem in the definition above.   It uses the word “inclusive” as opposed to “exclusive”.  I underlined “inclusive” in the definition.  In all the convertible debt deals that I have done (probably 50 or more), I have only used the word “inclusive” once.  And I honestly do not know why on that one occasion I agreed to it.  Mental lapse?  Maybe!  I actually think what happened is that when we advanced the first promissory note we were highly confident that the Qualified Financing was not far off so that including the note amount was okay because the note amount was small (like $100,000).   Well, the Qualified Financing got delayed and delayed and delayed…..and the amount of convertible debt grew and grew and grew as more debt was advanced to support the company prior to a Qualified Financing.

Ultimately, the amount of the debt approached the $700,000 Qualified Financing trigger amount.  We could not advance more than the trigger amount – that would be nonsensical and put the noteholders in a very bad spot.  The resulting conversations were awkward, but the solution was easy.   Just amend the notes to change “inclusive” to “exclusive”, which is incredibly normal anyway.

Lesson learned.