VC Day

It has been a while since my last post on June 11th, which I wrote as I was heading over to Poland to watch Euros soccer.  The soccer trip was great.  I did not manage to stick with my “delete all email” plan.  I had my wife’s iPad with me, and could not resist the urge to keep up on a few matters.  And it was not really possible to only see those “few” matters on email.  But, that consumed not more than about an hour a day, and having the iPad allowed me to easily talk with my family.  So, I guess I failed my own test, but the trade off of seeing my kids and wife was worth it.

The trip was great.  The best “fan base” award goes to the Irish fans who are completely nuts – they know their team is not good so their expectations of winning are low.  Instead they dress up in their country’s colors and endlessly party.  Fun all around.

This has been my first full week back.  On the way to the dentist this morning (starting to feel like a Brad Feld wannabe with sharing too much personal information), I thought about what a crazy week it has been.  Then I realized it was completely typical.  Highlights:

1.  Met with 5 new companies/entrepreneurs to talk about their companies.  Some meetings in person, some on the phone.  All interesting and I have no good idea yet if any will be worth follow up.

2.  Dealt with some mind numbing details surrounding the winding down of a portfolio company that was just sold in a stock for stock transaction.  The issues dealt mostly with managing tax payments to the government on income deemed earned by management team members on receipt of the buyer’s stock.  That is never a fun exercise – receiving non-liquid stock and having to pay tax in real dollars based on the value of the stock.  I want to stress that being able to deal with lots of boring details is a skill set that a good CEO needs.  It is not a process to embrace, but a necessity.

3.  Spent a day at a board meeting for Launch NY, a non-profit initiative.  Launch NY hopes to bring the JumpStart model (northeast Ohio) to upstate NY.

4.  Been working feverishly to get a new investment deal closed.  Documents flying back and forth, lawyers working hard, etc.

5.  Had a great call with the founders of a company (in which we have not invested) and a potential new board member for that company.  I was lucky enough to be able to make this introduction; this call was part of our due diligence process and also a way to really help out the founders, both of whom I like a lot.  Hope this goes somewhere and we get more involved.

6.  Met with the head of eLab, a student incubator here at Cornell.  I am chairman of eLab, and we are moving it to the next level of service.   Lots of politics to navigate.

7.  Dealt with (and continue to deal with) a sticky business situation that I cannot share details about, but it has consumed many hours of time.

8.  Had a weekly call for one of the CVF companies.  The CEO holds these calls every Friday and opens them to every board member and COO.  Really a fabulous and pretty painless communication tool.  Not for every company, but good to consider.

9.  I am on the boards of 5 CVF portfolio companies, and have communicated with every CEO multiple times this week.  3 on both phone and email and all 5 on email.  Lots of time, lots of issues, lots of successes and lots of problems to solve.

I know that I have left stuff out.  My point though for sharing all this is only to illustrate the incredible variety of issues/highlights/problems that VCs deal with day to day, every day.  Call us lucky.  Call us crazy.  Both exciting and tiring.

Have a great weekend.

Clear Communication

My VC partners (one in particular) make fun of me for being extremely literal.  If you don’t phrase a question or statement the right way or with clarity, I have a tendency to get confused and ask questions.  I actually think this comes from my years of practicing corporate law.  After all, if your lawyer cannot state things clearly, you have problems.  I guess I just like overly clear communication.  I also like overly open communication.  While I think that most people like clear communication, some are more open to open communication than others.

This might seem a bit petty and obvious, but trying to be very clear with communication is good practice.  But I am convinced that some purposely practice unclear communication.

Here is an example that made me laugh yesterday.  My partner and I were emailing back and forth about how to characterize an exit transaction where we received stock of a private company for shares in our portfolio company (often called a private to private transaction).  My partner wrote “Show the comparative exchange rate then……”  And I wrote back “What is a comparative exchange rate?”  Showing return multiples in a private to private transaction can be challenging.   We ended up simply writing “CVF received $XXX,XXX of Company ABC stock on $YYY,YYY dollars invested.”    To me, that is clearly showing the return based on the current value of Company ABC stock.  I still don’t know what a comparative return multiple is.  Moral of the story:  use simple straight forward language whenever possible.

One more tip for clear communication:  when emailing a bunch of thoughts on a topic, try listing them out with numbers (1., 2., 3., etc.).  It makes it way easier to read and way easier for the reader to actually respond as they can just respond inline in the original email.   People who email with me often see numbered lists.  I get some grief about it sometimes like “you are being too direct”.  Well, better direct than misunderstood.

If you have some tips on clear communication, pass them along.

When to Bring Up Valuation

If you want to scare off VCs, start your pitch with “we are looking to raise $X at a pre-money valuation of $Y”.   Stating how much you want to raise is fine and recommended.  In fact, even better to state how much you want to raise and how long that amount will last.

However, stating a desired pre-money valuation early in the process is not a good idea.  Here is why.  There are typically just a handful of pivotal terms in a VC deal and they fall into 2 categories:  control terms (like special voting rights for the Preferred Stock and board seats) and economic rights (like liquidation preferences, anti-dilution protection, whether the preferred shares are participating or not, and………pre-money valuation).

In my view, starting off a VC relationship by diving into perhaps the most critical economic term is kind of like, well, moving too fast on a first date.  The good discussion will happen, but give the relationship a while to mature first.  Seriously, pre-money valuation is a function of many things (team strength, size of market, IP, hotness of sector, etc.) that will not all be readily apparent at the beginning.

So, my suggestion is to not bring up pre-money valuation unless (i) asked by the VC or (ii) the relationship has matured to a point where you can sense that a term sheet is likely.  If a VC asks for your input early on in the process about pre-money valuation, be skeptical and careful in your response.  If you give an actual number and it is too high, you have just given that VC a reason to say no (as in “why do I want to deal with an entrepreneur whose expectations are out of whack with my reality”).  Instead, I suggest something like this:  “We expect a valuation commensurate with our state of product readiness and company maturity.  We look forward to discussing that in more detail when your interest level merits”.

Answers to the question that I think are likely unproductive (again, I am talking about early discussions when you are building the relationship), include:   “$6.5mm is expected to buy 25% of the company”.   That is saying exactly what the expected pre-money valuation is.   Or, “Our post-money of our Series A was $10mm”.   No question that a pre-money for the Series B might be above $10mm, but it all depends on a bunch of factors that need time to flesh out.

Bottom line:  valuation discussions too early in the VC relationship game are a huge distraction and will likely backfire on you.   The exception is when you have a ton of interest (the VCs are just crawling over you).  That demand will accelerate the relationship building and the valuation discussion.

Startups Paying Bonuses…..an Oxymoron??

I am a huge believer is paying bonuses when a company can afford to pay them.  And there lies the issue.  How do you define “afford”.  I like to define it as having positive cash flow at year end to cover the payments.  Positive cash flow in this context = profit.

With that definition, here are some things that would not qualify:

  • “Hey, sweet, we just closed a $3mm Series A”
  • “We rock, we just signed an agreement with the largest distributor in the country!
  • “Sweet!!  We just got FDA approval for a new drug”
  • “Guess what – it is end of year holiday time!”

I hope you sensed a little bit of sarcasm in my text tone.  But yes, I have heard these and more.   Closing a Series A has nothing to do with profits; the investors want the $$ used to build a business.  Signing a large distributor has nothing to do with profits until you start selling lots of product (hopefully at a hefty profit) to the distributor.  Likewise for FDA approval – start selling the drug.  And holiday time, the biggest offender, has nothing to do with profits  and everything to do with emotion.

Motivating the team is obviously key.  Do bonuses motivate?  In general, it is hard to say that they don’t at least help to motivate.  So, at startups its is critical in my view for the CEO to set the tone from the beginning in terms of when bonuses can be paid.  If the team knows from the beginning that bonuses derive from profits that will serve to manage expectations well.  I think of the bonus mentality as an evolution that the CEO controls.

[just pushed “publish” instead of “save”…..sorry….here is the rest]

With respect to holiday time recognition the evolution might look something like this:  Year 1, holiday party.  Year 2, holiday party with $30 Starbucks gift cards.  Year 3, holiday party with $100 Apple Store gift cards.  Year 4, holiday party with $2000 cash bonuses (assuming profits exist to cover them).  Again, the expectation management is the critical component that must be managed from the top.

With all this said, I am 100% fine with paying a one-off bonus regardless of profits to a particular team member for an extraordinary effort.  For example, perhaps the head of bus dev did such an amazing job getting that big distributor signed up that the board decides to pay a “thank you” bonus to this person (despite the fact that the bus dev guy’s job is to get such big contracts signed up).

Look forward to your comments.

No Mess (Employment Agreements)

I thought it might be useful to start a blog series on stuff that VCs don’t like to see.  I know, some of you are laughing right now thinking “that will be an endless series…..”   I will pick random topics, but if you have any ideas, please let me know.

Today’s “No Mess” topic relates to restrictions on firing people.  Put simply, VCs like to see boards of directors that have maximum flexibility to terminate employees.  This relates to all levels of employees (not just senior execs).  Here are some examples of things that result in unattractive restrictions:

1.   Employment agreements:  if possible, avoid putting the phrase “employment agreements” and word “VCs” in the same sentence unless of course the sentence is “VCs really don’t like employment agreements.”   Employment agreements typically confer a severance payment to the employee (for example 3 months salary), and that means $ out the door (in other words an unattractive restriction).  Employment agreements, if they do exist, should always condition the payment of severance on the receipt of a written release from the employee and ideally an agreement not to compete as well.

2.  Employee handbooks that provide for severance:  I once ran into a situation where a startup company had an employee handbook (not all small startups have those, but this one had about 150 employees) that provided for 2 weeks severance upon termination for all employees.  Yikes.  Again, an unattractive restriction.  I know, I am sounding callous.

The general rule is that employees are “employees at-will”, which means that they can be fired any time (except for reasons related to a protected class like race, religion, sex, national origin, etc.) and can quit at any time as well.  An employment contract alters the “at-will” norm as does a handbook that provides for severance.  Again, it might sound a little callous, but these provisions cause problems often.

As the Godfather might say “Make sure that you can get rid of people without a mess.”

Enjoy the weekend.