State of Startups 2016

First Round Capital just released its State of Startups 2016.  It is chock full of interesting stuff!  No need for me to recap it here.  Just view it for yourself.  Here is the link.  Thanks!

PS:  2 prominent team members at First Round Capital are Cornellians (Bill Trenchard and Howard Morgan)!


Calling BS

Vanity Fair recently published a expose on Theranos.  It is worth reading.  Like a mini “page turner” novel.

It reminded me of one of my personal themes in investing:  “if you don’t understand the technology then don’t invest.”  The understanding can definitely be acquired.  In fact, I rarely understand the technology when we first meet with a company.  But over our months of due diligence the understanding grows.  And sometimes my partners’ understanding is a good proxy.  BTW, understanding does not mean being an expert.

So, how about these words that Vanity Fair wrote about Elizabeth Holmes, the CEO of Theranos:  “She took the money on the condition that she would not divulge to investors how her technology actually worked, and that she had final say and control over every aspect of her company.”   All I can say is OMG.   Are you kidding me?  Who would invest into a black hole and control freak?  Not sure what else to say.  Granted that this is all hearsay.  I have no proof that this is what actually happened.  All I will say is that if you get whiffs of this type of attitude you should run the other way.   And now that I think about it more, we actually did get caught in a similar situation once, but by no means as blatant.  It is not working out well!!

The Vanity Fair article also offered up an interesting synopsis of venture capital:

“It generally works like this: the venture capitalists (who are mostly white men) don’t really know what they’re doing with any certainty—it’s impossible, after all, to truly predict the next big thing—so they bet a little bit on every company that they can with the hope that one of them hits it big. The entrepreneurs (also mostly white men) often work on a lot of meaningless stuff, like using code to deliver frozen yogurt more expeditiously or apps that let you say “Yo!” (and only “Yo!”) to your friends. The entrepreneurs generally glorify their efforts by saying that their innovation could change the world, which tends to appease the venture capitalists, because they can also pretend they’re not there only to make money. And this also helps seduce the tech press (also largely comprised of white men), which is often ready to play a game of access in exchange for a few more page views of their story about the company that is trying to change the world by getting frozen yogurt to customers more expeditiously. The financial rewards speak for themselves. Silicon Valley, which is 50 square miles, has created more wealth than any place in human history. In the end, it isn’t in anyone’s interest to call bullshit.”

My reaction that synopsis, which definitely made me chuckle:

  1.  The white men comments are true.  Change is happening at a slow pace.
  2. Good VCs typically do know what they are doing, but some are so full of themselves that they come across as very pompous.  But most VCs I deal with are good people with lots of brain power.
  3. Most companies I see are not working on meaningless stuff.  But we focus on upstate NY!!
  4. There is nothing wrong with a “Change the World” CEO as long as they are realistic and focus on building a big company that will make money.
  5. VC is definitely about making money.
  6. It is in EVERYONE’S interest to call bullshit.  Please do just that all the time!


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.

Analyzing Startup Job Offers

I often get questions about startup job offers.  So I figured best to write some points down and provide some resources.  Here are some key points:

  1.  Evaluating an offer for a VP and higher position is much different than evaluation an offer for a position below a VP.
  2. Titles also don’t (and should not) mean a heck of a lot.  This is my personal view and others definitely disagree.  But if you are title “crazed” in your startup job search, I think you are misguided.  Said another way, if I were interviewing you for a job at a startup and you were title crazed I would never hire you.  Job performance is job security.
  3. VP and higher positions are outright entitled to understand exactly the percentage ownership of the company their equity package represents.  Equity packages are either stock options or restricted stock.  Lower level positions are often not tied to percentage ownership.  I think ok to politely ask for this information for lower level hires, but don’t be alarmed when you don’t get it.
  4. VP and higher positions are often given change of control acceleration on their equity vesting.  Lower level position are not typically given that.  So don’t embarrass yourself by insisting on it if you are applying for a position below VP.   Might be ok to politely ask for it, but expect the answer to be no.
  5. The key question from my perspective is “Am I being treated fairly compared to others at my level inside the company”.  If others at your level have change of control acceleration, then you should as well.

So, here are some good links.  I am not guarantying that all the information in the links is fully consistent with what I wrote above, but that is ok.  I think almost all of it is……