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3 posts from April 2012

April 30, 2012

Activist Seeds - The Latest, Subtle Trend in Seed Investing

When I entered the VC business 10 years ago, I tried to keep thinking about venture capital as a business, where the key focus area was on meeting the needs of our target customers -- entrepreneurs and limited partner investors.

In the case of entrepreneurs, those needs have changed radically in these last 10 years.  The surge in seed investing over the last few years has been well-reported and analyzed.  With advances in cloud computing, open source infrastructure, development tools and general "Lean Start-Up" techniques, entrepreneurs need less capital than ever before.  And when entrepreneurs' needs change (i.e., requiring less capital), smart investors adjust to meet those new needs.  Hence, the rise of angels, super-angels, incubators, accelerators, micro-VCs and VC-led seed programs.

But as the "Great Seed Experiment" (as my partner, Michael Greeley, calls it) matures, a new trend is emerging.  Entrepreneurs are beginning to learn the difference between what I'll call Passive Seeds and Activist Seeds.  And entrepreneurs are learning that the difference between the two, although somewhat subtle, matters greatly.

Passive Seeds are when a VC invests a small amount of money (for a $200-500M mid-sized fund, typically $250k or less, for a large $1B fund, perhaps $500k or less), to achieve a very small amount of ownership (typically less than 5%) to simply create an option to participate as a more meaningful investor in the future.  Passive seed programs get most of the press attention because of their sheer volume.  

When you ask venture capitalists about their seed programs, many will brag about how many seed investments they have made (20-40 per year is not uncommon) and how wonderful it is that so few of them "graduate" to become series A investments (perhaps 10-20%) because it shows how discriminating they are.  Other characteristics of passive seeds are that one or two of the partners can make the decision to invest, rather than requiring the entire partnership to approve, and the due diligence is very light.  Additionally, in a passive seed round, VCs don't mind if 3-5 firms participate, as opposed to more tyically 1-2, and each VC partner can juggle a dozen passive seeds at any given time.  Sometimes there are more VC investors than employees in a passive seed!

But entrepreneurs are starting to wise up.  The conventional wisdom has emerged that Passive Seeds from VC investors are bad for start-ups and entrepreneurs.  VCs who make passive seeds are not typically engaged enough in the business to add meaningful value.  Further, they send a bad signal to the funding market when they don't invest in the Series A, thus creating inappropriate leverage on the entrepreneur at the time of the Series A decision.  

Seed investor/venture capitalist/entrepreneur Chris Dixon has written extensively about this issue, and I couldn't agree with him more when he declares, based on his discussions with experienced founders, "there is no room for debate" on the issue.

Activist Seeds VC investors are a different story (which Chris acknowledges, although uses different language).  From the VCs perspective, an activist seed is when the firm commits the full time, resources, and energy into the investment that they would do with a Series A.  From the entrepreneur's perspective, they truly want to raise less capital because of all the positive Lean Start-Up trends noted below, but want the active involvement of a value-added VC firm.  

An activist seed from a VC is typically more like $250K-$1 million and the ownership is closer to 8-10%.  The full partnership approves an activist seed and the due diligence, although abbreviated, is thoughtful and serious.  The firm gets to know the business and the entrepreneur better and thus makes a deeper commitment in making the investment.  

The conversion rate of an activist seed into a larger Series A is more like 50-75% and each VC partner dedicates as much time to an activist seed as he/she does in a larger Series A.  In short, an activist seed is nearly identical to a Series A, just smaller, slightly more streamlined, and informal - all appropriate for the stage of the business and the requirements ahead.

So next time you are discussing a seed round with a VC firm, figure out if their firm's philosophy is activist or passive.  At Flybridge, we firmly believe in activist seeds (two nice examples recently in the news are Crashlytics and ZestCash).  Different firms have different approaches.  Make sure you find out which is which, and make sure it's a fit for your needs.  Here are a few questions you can ask yourself to distinguish between the two:

  • Was the entire partnership engaged in the investment decision process?  Did I meet with and pitch to the entire firm?  This results in a greater sense of commitment and shared ownership. 
  • Did the VC open up her network and make a few value-added introductions to prospective talent, customers and business development partners?  Again, this is an indication that the VC is willing to add value along the way and be more active than passive.
  • Was the due diligence process rigorous? Do they seem to really understand my business and the subtelties around what it takes to win?  Did they ask tough questions, check my personal references to get to know me better, put me in front of prospective customers?

Absent these elements, you are at risk of taking money from a VC that views you as "an option" rather than "an investment" - not a place a hard-charging entrepreneur who needs as many friends on his/her side as possible wants to be!

April 12, 2012

The Bar Has Gotten Higher

chin up bar

When I first entered the venture capital business 10 years ago after being an entrepereneur, my partners warned me that "my bar" for new investments would get higher over time.  In other words, the criteria to make a new investment - clearing "the bar" - would get more strict with time as I developed more experience and saw more things.  I found this to be very true, and the notion that investors get wiser and more selective over time has become common wisdom in the industry.

But there's something very new going on in the last few years - something very striking.  Simply put, the collective bar of the investment community to fund young companies has recently gotten higher - much higher.  

The entrepreneurs I speak to are feeling it every day.  When they pitch their new idea to investors, they are told to build a prototype first.  When they build the prototype, they go get customers.  When they get customers, they are told to show engagement metrics.  When they show engagement metrics, they are told to run some monetization experiments.  When they run monetization experiments, they are challenged to prove scalability.  Maybe I have Passover on the brain this week, but it's like investors are putting entrepreneurs through a nightmarish version of Dayeinu, where no matter what they achieve, it's never enough (speaking of Passover, if you haven't seen this Jon Stewart clip of Passover vs. Easter, it's a must.  I'll wait.).

Why is the new investment bar so high today?  Isn't there plenty of euphoria and "animal spirits" to go around with the IPO market returning, marquee acquisitions (e.g., Instagram at $1 billion) and the impending, earth-shattering Facebook IPO?

I believe this new phenomenon of an extraordinarily high bar is an outgrowth of three related forces:  (1) the Lean Start Up movement, which has trained entrepreneurs on capital-efficient start-up techniques; (2) the plummeting cost of experimentation and the cloud, which allows entrepreneurs to rent infrastructure that allows them to develop prototypes and pilots much cheaply than ever before; and (3) the proliferation of social media, which allows entrepreneurs to read innumerable books and blogs to educate them on building start-ups and effective fundraising.

These three forces have led to a major increase in the collective "Start-Up IQ" of both entrepereneurs and VCs, while at the same time putting in their hands inexpensive tools to progress with their ideas.  Thus, if you are an entrepreneur, your competitors - not necessarily market-based competitors but simply other entrepreneurs who are pursuing capital - are that much more sophisticated and advanced than ever before.

A great example of this is Crashlytics, a compay we led a $1 million seed round along with Baseline last year and then a $5 million Series A, which was announced this week.  At the seed round, the two entrepreneurs (who are in their mid-20s and, like many young entrepereneurs today, wise beyond their years) had already both been successful serial entrepreneurs, had completed a customer discovery and development process with 20 application vendors and had built an alpha product.  In other words, before they had raised a nickel, they had made as much progress as a $10 million funded Series A start-up circa 1999 or even 2004.  They had achieved initial customer validation and identified a precise experiment they were going to run with the first $1 million - whether they could get broad adoption for their crash reporting tool.  Indeed, they crushed their milestones.  By the time they had spent half the $1 million and were ready for a Series A round, they had over 500 organizations using the product across tens of millions of devices.

Crashlytics is a special company run by special entrepreneurs, but their story isn't unique - it is playing out across the world as more start-ups are more sophisticated in their approaches and achieving more with less.  That's generally a good thing for everyone.  But it does mean the bar has gotten higher, much higher comparatively speaking, to raise money.

And in the spirit of sharing more information to help entrepreneurs raise their game, below is a presentation I gave as part of a Skillshare class I delivered at Harvard's i-Lab with a few tips on raising capital:

How To Raise Your First Round of Capital

 

April 06, 2012

Now That The JOBS Act Has Passed, Immigration Reform Is Next

Yesterday was a pretty special day.  Not only did I get to attend the White House ceremony at the Rose Garden for the passing of the JOBS Act, but I got to see one of our CEOs featured as an entrperneurial hero.

I have written in the past about the JOBS Act and its importance, so I won't repeat that here.  The president was on point in his remarks (see the video I took below), pointing out that his job is "Fighting every day to make sure America is the best place on earth to do business."

 

But the coolest thing for me was seeing our portfolio company CEO, John Belizaire of FirstBest, standing next to the president on he podium as exhibit A of the kind of entrepreneur we should be celebrating in this country.  John's parents were Haitian immigrants who arrived in America with nothing.  John worked hard as a kid, fell in love with technology and software, and after a stint at Intel decided to start his own software company at a young age with a few friends, called The Theory Center.  After a few years, he successfully sold it to BEA for over $160 million.  He stayed on as an executive at BEA for a few years and then started another company with his same team called FirstBest, which we invested in.  The company recently raised a $10 million growth round and is revolutionizing the front office of insurance companies.  I loved seeing John up there on stage and hearing his story of participating in a roundtable and meeting the president beforehand (see picture below):

John's story, like many others, is playing out all over this country and this world.  It makes me glad to be doing what my partners and I do - trying to help more John Belizaires achieve their dreams.

At one point, Naval Ravikant of AngelList and I were observing that we need to marshall the same energy and resources behind the JOBS Act for the next big agenda item for the entrepreneurial community:  immigration reform.  Stay tuned.