This link has been bookmarked by 115 people . It was first bookmarked on 11 Jul 2006, by Daniel Jomphe.
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06 Aug 16
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A typical startup goes through several rounds of funding, and at each round you want to take just enough money to reach the speed where you can shift into the next gear.
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conflicts with investors are particularly nasty.
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Competitors punch you in the jaw, but investors have you by the balls.
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And if trouble with investors is one of the biggest threats to a startup, managing them is one of the most important skills founders need to learn.
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Another way to fund a startup is to get a job. The best sort of job is a consulting project in which you can build whatever software you wanted to sell as a startup. Then you can gradually transform yourself from a consulting company into a product company, and have your clients pay your development expenses.
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This is a good plan for someone with kids, because it takes most of the risk out of starting a startup
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To be a startup, a company has to be a product business, not a service business.
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By which I mean not that it has to make something physical, but that it has to have one thing it sells to many people, rather than doing custom work for individual clients.
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Custom work doesn't scale.
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Fear of failure is an extraordinarily powerful force. Usually it prevents people from starting things, but once you publish some definite ambition, it switches directions and starts working in your favor.
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You won't have it driving you if your stated ambition is merely to start a consulting company that you will one day morph into a startup.
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An advantage of consulting, as a way to develop a product, is that you know you're making something at least one customer wants. But if you have what it takes to start a startup you should have sufficient vision not to need this crutch.
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Angels who've made money in technology are preferable, for two reasons: they understand your situation, and they're a source of contacts and advice.
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The reason is that investors need to get their capital back. They'll only consider companies that have an exit strategy—meaning companies that could get bought or go public.
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There are few large, private technology companies. Those that don't fail all seem to get bought or go public.
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If your competitors offer employees stock options that might make them rich, while you make it clear you plan to stay private, your competitors will get the best people.
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One of the dangers of taking investment from individual angels, rather than through an angel group or investment firm, is that they have less reputation to protect.
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The best way to find angel investors is through personal introductions.
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the angel asks his lawyer to create a vanilla agreement, and the terms end up being whatever the lawyer considers vanilla. Which in practice usually means, whatever existing agreement he finds lying around his firm. (Few legal documents are created from scratch.)
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When a company is only two months old, every day you wait gives you 1.7% more data about their trajectory.
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But the investor is already being compensated for that risk in the low price of the stock, so it is unfair to delay.
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If an investor knows you have other investors lined up, he'll be a lot more eager to close-- and not just because he'll worry about losing the deal, but because if other investors are interested, you must be worth investing in.
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It's the same with acquisitions. No one wants to buy you till someone else wants to buy you, and then everyone wants to buy you.
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The key to closing deals is never to stop pursuing alternatives.
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When an investor says he wants to invest in you, or an acquirer says they want to buy you, don't believe it till you get the check.
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And we think it's better if startups operate out of their own premises, however crappy, than the offices of their investors.
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The fact that the deal terms are standard doesn't mean they're favorable to you, but if other startups have signed the same agreements and things went well for them, it's a sign the terms are reasonable.
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Seed firms differ from angels and VCs in that they invest exclusively in the earliest phases—often when the company is still just an idea. Angels and even VC firms occasionally do this, but they also invest at later stages
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So seed investors usually care less about the idea than the people. This is true of all venture funding, but especially so in the seed stage.
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When a startup reaches the point where VCs have enough information to invest in it, the acquirer should have enough information to buy it.
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More information, in fact; with their technical depth, the acquirers should be better at picking winners than VCs.
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VC firms are like seed firms in that they're actual companies, but they invest other people's money
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and much larger amounts of it. VC investments average several million dollars
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So they tend to come later in the life of a startup, are harder to get, and come with tougher terms.
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VC firms are organized as funds
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VC firms that have been doing badly will only get the deals the bigger fish have rejected, causing them to continue to do badly.
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As a result, of the thousand or so VC funds in the US now, only about 50 are likely to make money, and it is very hard for a new fund to break into this group.
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In a sense, the lower-tier VC firms are a bargain for founders. They may not be quite as smart or as well connected as the big-name firms, but they are much hungrier for deals.
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This means you should be able to get better terms from them.
Better how? The most obvious is valuation: they'll take less of your company. But as well as money, there's power. I think founders will increasingly be able to stay on as CEO, and on terms that will make it fairly hard to fire them later. -
The most dramatic change, I predict, is that VCs will allow founders to cash out partially by selling some of their stock direct to the VC firm. VCs have traditionally resisted letting founders get anything before the ultimate "liquidity event."
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The disadvantage of taking money from less known firms is that people will assume, correctly or not, that you were turned down by the more exalted ones.
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So the more confident you are, the less you need a brand-name VC
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the lower-tier firms' biggest fear, when chance throws them a bone, is that one of the big dogs will notice and take it away. The big dogs don't have to worry about that.
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when a VC offers you a term sheet, ask how many of their last 10 term sheets turned into deals.
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If you get a call from a VC firm, go to their web site and check whether the person you talked to is a partner
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It's the partners who decide, and they view things with a colder eye.
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VCs generally write it into the deal that in any sale, they get their investment back first. So if the company gets sold at a low price, the founders could get nothing.
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Some VCs now require that in any sale they get 4x their investment back before the common stock holders (that is, you) get anything, but this is an abuse that should be resisted.
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Another difference with large investments is that the founders are usually required to accept "vesting"—to surrender their stock and earn it back over the next 4-5 years. VCs don't want to invest millions in a company the founders could just walk away from.
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Financially, vesting has little effect, but in some situations it could mean founders will have less power.
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If VCs got de facto control of the company and fired one of the founders, he'd lose any unvested stock unless there was specific protection against this. So vesting would in that situation force founders to toe the line.
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The most noticeable change when a startup takes serious funding is that the founders will no longer have complete control
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In a typical VC funding deal, the board of directors might be composed of two VCs, two founders, and one outside person acceptable to both.
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The board will have ultimate power, which means the founders now have to convince instead of commanding.
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Like angels, VCs prefer to invest in deals that come to them through people they know.
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So while nearly all VC funds have some address you can send your business plan to, VCs privately admit the chance of getting funding by this route is near zero.
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In fact, I would strongly advise against mailing your business plan randomly to VCs, because they treat this as evidence of laziness. Do the extra work of getting personal introductions. As one VC put it:
I'm not hard to find. I know a lot of people. If you can't find some way to reach me, how are you going to create a successful company?
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One of the most difficult problems for startup founders is deciding when to approach VCs. You really only get one chance, because they rely heavily on first impressions. And you can't approach some and save others for later, because (a) they ask who else you've talked to and when and (b) they talk among themselves. If you're talking to one VC and he finds out that you were rejected by another several months ago, you'll definitely seem shopworn.
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So when do you approach VCs? When you can convince them. If the founders have impressive resumes and the idea isn't hard to understand, you could approach VCs quite early. Whereas if the founders are unknown and the idea is very novel, you might have to launch the thing and show that users loved it before VCs would be convinced.
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If several VCs are interested in you, they will sometimes be willing to split the deal between them. They're more likely to do this if they're close in the VC pecking order. Such deals may be a net win for founders, because you get multiple VCs interested in your success, and you can ask each for advice about the other.
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Two-firm deals are great. It costs you a little more equity, but being able to play the two firms off each other (as well as ask one if the other is being out of line) is invaluable.
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The average founder is smarter than the average VC.
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every negotiation is unique.
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Stage 1: Seed Round
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Since most startups are in competitive businesses, you not only want to work full-time on them, but more than full-time.
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The phrase "seed investment" covers a broad range. To some VC firms it means $500,000, but to most startups it means several months' living expenses.
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There's only common stock at this stage. They leave 20% as an options pool for later employees (but they set things up so that they can issue this stock to themselves if they get bought early and most is still unissued), and the three founders each get 25%.
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When you have five months' runway left, how soon do you need to start looking for your next round? Answer: immediately.
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It takes time to find investors, and time (always more than you expect) for the deal to close even after they say yes.
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For a startup, cheapness is power. The lower your costs, the more options you have—not just at this stage, but at every point till you're profitable. When you have a high "burn rate," you're always under time pressure, which means (a) you don't have time for your ideas to evolve, and (b) you're often forced to take deals you don't like.
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Every startup's rule should be: spend little, and work fast.
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If you have to choose between spending time on the demo or the business plan, spend most on the demo. Software is not only more convincing, but a better way to explore ideas.
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Stage 2: Angel Round
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Now the group is looking for more money: they want enough to last for a year, and maybe to hire a couple friends. So they're going to raise $200,000.
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The angel agrees to invest at a pre-money valuation of $1 million. The company issues $200,000 worth of new shares to the angel; if there were 1000 shares before the deal, this means 200 additional shares. The angel now owns 200/1200 shares, or a sixth of the company, and all the previous shareholders' percentage ownership is diluted by a sixth.
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In reality the angel might be more likely to make the investment in the form of a convertible loan. A convertible loan is a loan that can be converted into stock later; it works out the same as a stock purchase in the end, but gives the angel more protection against being squashed by VCs in future rounds.
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Maybe the angel pays for his lawyer to represent both sides. (Make sure if you take the latter route that the lawyer is representing you rather than merely advising you, or his only duty is to the investor.)
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An angel investing $200k would probably expect a seat on the board of directors. He might also want preferred stock, meaning a special class of stock that has some additional rights over the common stock everyone else has. Typically these rights include vetoes over major strategic decisions, protection against being diluted in future rounds, and the right to get one's investment back first if the company is sold.
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Some investors might expect the founders to accept vesting for a sum this size, and others wouldn't. VCs are more likely to require vesting than angels.
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I should add that vesting is also a way for founders to protect themselves against one another.
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It solves the problem of what to do if one of the founders quits. So some founders impose it on themselves when they start the company.
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The angel deal takes two weeks to close
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The point after you get the first big chunk of angel money will usually be the happiest phase in a startup's life. It's a lot like being a postdoc: you have no immediate financial worries, and few responsibilities. You get to work on juicy kinds of work, like designing software. You don't have to spend time on bureaucratic stuff, because you haven't hired any bureaucrats yet. Enjoy it while it lasts, and get as much done as you can, because you will never again be so productive.
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With an apparently inexhaustible sum of money sitting safely in the bank, the founders happily set to work turning their prototype into something they can release.
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How much stock do you give early employees? That varies so much that there's no conventional number. If you get someone really good, really early, it might be wise to give him as much stock as the founders.
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The one universal rule is that the amount of stock an employee gets decreases polynomially with the age of the company. In other words, you get rich as a power of how early you were. So if some friends want you to come work for their startup, don't wait several months before deciding.
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Step 3: Series A Round
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Armed with their now somewhat fleshed-out business plan and able to demo a real, working system, the founders visit the VCs
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VCs are like high school girls: they're acutely aware of their position in the VC pecking order, and their interest in a company is a function of the interest other VCs show in it.
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A term sheet is a summary of what the deal terms will be when and if they do a deal; lawyers will fill in the details later.
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By accepting the term sheet, the startup agrees to turn away other VCs for some set amount of time while this firm does the "due diligence" required for the deal.
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Due diligence is the corporate equivalent of a background check: the purpose is to uncover any hidden bombs that might sink the company later, like serious design flaws in the product, pending lawsuits against the company, intellectual property issues, and so on. VCs' legal and financial due diligence is pretty thorough, but the technical due diligence is generally a joke.
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The due diligence discloses no ticking bombs, and six weeks later they go ahead with the deal.
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it's unlikely that the VCs would keep the existing numbers of shares. In fact, every bit of the startup's paperwork would probably be replaced, as if the company were being founded anew. Also, the money might come in several tranches, the later ones subject to various conditions—
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And of course any VCs reading this are probably rolling on the floor laughing at how my hypothetical VCs let the angel keep his 10.3 of the company.
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In the real world, VCs regard angels the way a jealous husband feels about his wife's previous boyfriends. To them the company didn't exist before they invested in it. [9]
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The founders are required to vest their shares over four years
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If there's one thing all startups have in common, it's that something is always going wrong.
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Many startups—even successful ones—come close to running out of money at some point.
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In the startup world, closing is not what deals do. What deals do is fall through.
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Why? Partly the reason deals seem to fall through so often is that you lie to yourself. You want the deal to close, so you start to believe it will.
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The reason is that it's such a risky environment.
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People about to fund or acquire a startup are prone to wicked cases of buyer's remorse. They don't really grasp the risk they're taking till the deal's about to close. And then they panic. And not just inexperienced angel investors, but big companies too.
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And so in starting a startup, as in any really bold undertaking, merely deciding to do it gets you halfway there. On the day of the race, most of the other runners won't show up.
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Consulting is where product companies go to die.
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So starting as a consulting company is like starting out in the grave and trying to work your way up into the world of the living.
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If "near you" doesn't mean the Bay Area, Boston, or Seattle, consider moving. It's not a coincidence you haven't heard of many startups from Philadelphia.
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I've omitted one source: government grants. I don't think these are even worth thinking about for the average startup. Governments may mean well when they set up grant programs to encourage startups, but what they give with one hand they take away with the other: the process of applying is inevitably so arduous, and the restrictions on what you can do with the money so burdensome, that it would be easier to take a job to get the money.
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VCs regularly wipe out angels by issuing arbitrary amounts of new stock. They seem to have a standard piece of casuistry for this situation: that the angels are no longer working to help the company, and so don't deserve to keep their stock. This of course reflects a willful misunderstanding of what investment means; like any investor, the angel is being compensated for risks he took earlier. By a similar logic, one could argue that the VCs should be deprived of their shares when the company goes public.
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One new thing the company might encounter is a down round, or a funding round at valuation lower than the previous round. Down rounds are bad news; it is generally the common stock holders who take the hit.
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Some of the most fearsome provisions in VC deal terms have to do with down rounds—like "full ratchet anti-dilution," which is as frightening as it sounds.
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Founders are tempted to ignore these clauses, because they think the company will either be a big success or a complete bust. VCs know otherwise: it's not uncommon for startups to have moments of adversity before they ultimately succeed. So it's worth negotiating anti-dilution provisions, even though you don't think you need to, and VCs will try to make you feel that you're being gratuitously troublesome.
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21 Sep 15
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06 Dec 14
Jordan GoldmanVenture funding works like gears. A typical startup goes through several rounds of funding, and at each round you want to take just enough money to reach the speed where you can shift into the next gear. Few startups get it quite right. Many are u...
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17 May 14
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16 Apr 14
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mitzvahs
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scrape
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relatively
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astounding
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pork-barrel
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renovate
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favorable
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jack up
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confers
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vicious
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exalted
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skim off
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scour
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huge coup
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The most noticeable change when a startup takes serious funding is that the founders will no longer have complete control. Ten years ago VCs used to insist that founders step down as CEO and hand the job over to a business guy they supplied. This is less the rule now, partly because the disasters of the Bubble showed that generic business guys don't make such great CEOs.
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transom
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pecking order
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appalled
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fleshed-out
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and inscrutable
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acutely
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tranches
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adversity
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wicked
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[6] I've omitted one source:
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grants
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arduous
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inane
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[9] VCs regularly
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casuistry
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deprived
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being gratuitously
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25 Mar 14
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17 Jan 14
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multi
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Another way to fund a startup is to get a job. The best sort of job is a consulting project in which you can build whatever software you wanted to sell as a startup. Then you can gradually transform yourself from a consulting company into a product company, and have your clients pay your development expenses.
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he trouble with co
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The contacts and advice can be more important than the money. When del.icio.us took money from investors, they took money from, among others, Tim O'Reilly. The amount he put in was small compared to the VCs who led the round, but Tim is a smart and influential guy and it's good to have him on your side.
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The disadvantage of taking money from less known firms is that people will assume, correctly or not, that you were turned down by the more exalted ones. But, like where you went to college, the name of your VC stops mattering once you have some performance to measure.
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lower-tier firms are much more likely to pretend to want to do a deal with you just to lock you up while they decide if they really want to.
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Two-firm deals are great. It costs you a little more equity, but being able to play the two firms off each other (as well as ask one if the other is being out of line) is invaluable.
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The concept of "standard" is a useful one when you're operating on a small scale (Y Combinator uses identical terms for every deal because for tiny seed-stage investments it's not worth the overhead of negotiating individual deals), but it doesn't apply at the VC level. On that scale, every negotiation is unique.
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They all ask the same question: who else have you pitched to? (
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24 Aug 13
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01 Aug 13
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10 Sep 12
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14 Mar 12
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There are few large, private technology companies. Those that don't fail all seem to get bought or go public. The reason is that employees are investors too—of their time—and they want just as much to be able to cash out. If your competitors offer employees stock options that might make them rich, while you make it clear you plan to stay private, your competitors will get the best people. So the principle of an "exit" is not just something forced on startups by investors, but part of what it means to be a startup.
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If someone pays $20,000 for 10% of a company, the company is in theory worth $200,000.
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Some angel investors join together in syndicates. Any city where people start startups will have one or more of them. In Boston the biggest is the Common Angels. In the Bay Area it's the Band of Angels. You can find groups near you through the Angel Capital Association.
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A big-name VC firm will not screw you too outrageously, because other founders would avoid them if word got out.
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In many startups' lives there comes a point when you're at the investors' mercy—when you're out of money and the only place to get more is your existing investors.
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The best way to find angel investors is through personal introductions. You could try to cold-call angel groups near you, but angels, like VCs, will pay more attention to deals recommended by someone they respect.
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Investing in startups is risky!
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If an investor knows you have other investors lined up, he'll be a lot more eager to close-- and not just because he'll worry about losing the deal, but because if other investors are interested, you must be worth investing in.
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The key to closing deals is never to stop pursuing alternatives. -
you have to keep looking for more investors, if only to get this one to act.
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Seed firms are like angels in that they invest relatively small amounts at early stages, but like VCs in that they're companies that do it as a business, rather than individuals making occasional investments on the side.
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Till now, nearly all seed firms have been so-called "incubators,"
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Seed firms differ from angels and VCs in that they invest exclusively in the earliest phases—often when the company is still just an idea. -
Angels and even VC firms occasionally do this, but they also invest at later stages.
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The problems are different in the early stages. For example, in the first couple months a startup may completely redefine their idea. So seed investors usually care less about the idea than the people. This is true of all venture funding, but especially so in the seed stage. -
Seed firms and angel investors generally want to invest in the initial phases of a startup, then hand them off to VC firms for the next round.
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Google has been aggressively pursuing this route, and now Yahoo is too. Both now compete directly with VCs. -
When a startup reaches the point where VCs have enough information to invest in it, the acquirer should have enough information to buy it.
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VC firms are like seed firms in that they're actual companies, but they invest other people's money, and much larger amounts of it.
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VC investments average several million dollars. So they tend to come later in the life of a startup, are harder to get, and come with tougher terms.
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VC firms are organized as funds, much like hedge funds or mutual funds. The fund managers, who are called "general partners," get about 2% of the fund annually as a management fee, plus about 20% of the fund's gains.
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of the thousand or so VC funds in the US now, only about 50 are likely to make money, and it is very hard for a new fund to break into this group.
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In a sense, the lower-tier VC firms are a bargain for founders. They may not be quite as smart or as well connected as the big-name firms, but they are much hungrier for deals. This means you should be able to get better terms from them. -
I think founders will increasingly be able to stay on as CEO, and on terms that will make it fairly hard to fire them later.
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The disadvantage of taking money from less known firms is that people will assume, correctly or not, that you were turned down by the more exalted ones
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Another danger of less known firms is that, like angels, they have less reputation to protect. -
The second or third tier firms have a much higher break rate—it could be as high as 50%.
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when a VC offers you a term sheet, ask how many of their last 10 term sheets turned into deals.
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If you get a call from a VC firm, go to their web site and check whether the person you talked to is a partner.
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Odds are it will be a junior person; they scour the web looking for startups their bosses could invest in.
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The junior people will tend to seem very positive about your company. They're not pretending; they want to believe you're a hot prospect, because it would be a huge coup for them if their firm invested in a company they discovered. Don't be misled by this optimism. It's the partners who decide, and they view things with a colder eye.
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Because VCs invest large amounts, the money comes with more restrictions. Most only come into effect if the company gets into trouble. For example, VCs generally write it into the deal that in any sale, they get their investment back first. So if the company gets sold at a low price, the founders could get nothing. -
Another difference with large investments is that the founders are usually required to accept "vesting"—to surrender their stock and earn it back over the next 4-5 years. -
If VCs got de facto control of the company and fired one of the founders, he'd lose any unvested stock unless there was specific protection against this. So vesting would in that situation force founders to toe the line.
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The most noticeable change when a startup takes serious funding is that the founders will no longer have complete control. Ten years ago VCs used to insist that founders step down as CEO and hand the job over to a business guy they supplied. This is less the rule now, partly because the disasters of the Bubble showed that generic business guys don't make such great CEOs. -
In the seed stage, the board is generally a formality; if you want to talk to the other board members, you just yell into the next room.
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. In a typical VC funding deal, the board of directors might be composed of two VCs, two founders, and one outside person acceptable to both. The board will have ultimate power, which means the founders now have to convince instead of commanding.
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As long as things are going smoothly, boards don't interfere much. The danger comes when there's a bump in the road, as happened to Steve Jobs at Apple.
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Like angels, VCs prefer to invest in deals that come to them through people they know
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VCs privately admit the chance of getting funding by this route is near zero
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he did not know a single startup that got funded this way.
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As one VC put it:
I'm not hard to find. I know a lot of people. If you can't find some way to reach me, how are you going to create a successful company?
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One of the most difficult problems for startup founders is deciding when to approach VCs. You really only get one chance, because they rely heavily on first impressions. And you can't approach some and save others for later, because (a) they ask who else you've talked to and when and (b) they talk among themselves. If you're talking to one VC and he finds out that you were rejected by another several months ago, you'll definitely seem shopworn.
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So when do you approach VCs? When you can convince them. If the founders have impressive resumes and the idea isn't hard to understand, you could approach VCs quite early. Whereas if the founders are unknown and the idea is very novel, you might have to launch the thing and show that users loved it before VCs would be convinced.
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Two-firm deals are great. It costs you a little more equity, but being able to play the two firms off each other (as well as ask one if the other is being out of line) is invaluable.
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The concept of "standard" is a useful one when you're operating on a small scale
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A lot of startup founders say they started the company without any idea of what they planned to do. This is actually less common than it seems: many have to claim they thought of the idea after quitting because otherwise their former employer would own it. -
Some of the founders in a startup can stay in grad school, but at least one has to make the company his full-time job.
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We'll suppose our group of friends start with $15,000 from their friend's rich uncle, who they give 5% of the company in return. There's only common stock at this stage. They leave 20% as an options pool for later employees
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how soon do you need to start looking for your next round? Answer: immediately.
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It takes time to find investors, and time (always more than you expect) for the deal to close even after they say yes
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if our group of founders know what they're doing they'll start sniffing around for angel investors right away.
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of course their main job is to build version 1 of their software.
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For a startup, cheapness is power. The lower your costs, the more options you have—not just at this stage, but at every point till you're profitable. When you have a high "burn rate," you're always under time pressure, which means (a) you don't have time for your ideas to evolve, and (b) you're often forced to take deals you don't like.
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Every startup's rule should be: spend little, and work fast
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what they're going to do, why users need it, how large the market is, how they'll make money, and who the competitors are and why this company is going to beat them.
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If you have to choose between spending time on the demo or the business plan, spend most on the demo. Software is not only more convincing, but a better way to explore ideas. -
While writing the prototype, the group has been traversing their network of friends in search of angel investors. They find some just as the prototype is demoable. When they demo it, one of the angels is willing to invest. -
they want enough to last for a year, and maybe to hire a couple friends. So they're going to raise $200,000.
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The angel agrees to invest at a pre-money valuation of $1 million. The company issues $200,000 worth of new shares to the angel; if there were 1000 shares before the deal, this means 200 additional shares.
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In reality the angel might be more likely to make the investment in the form of a convertible loan. A convertible loan is a loan that can be converted into stock later;
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Maybe the startup can find lawyers who will do it cheaply in the hope of future work if the startup succeeds. Maybe someone has a lawyer friend. Maybe the angel pays for his lawyer to represent both sides.
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He might also want preferred stock
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Typically these rights include vetoes over major strategic decisions, protection against being diluted in future rounds, and the right to get one's investment back first if the company is sold.
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In practice this turned out to be good, because it made us harder to push around.
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vesting is also a way for founders to protect themselves against one another. It solves the problem of what to do if one of the founders quits. So some founders impose it on themselves when they start the company.
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They pay him the smallest salary he can live on, plus 3% of the company in restricted stock, vesting over four years.
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If you get someone really good, really early, it might be wise to give him as much stock as the founders.
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the amount of stock an employee gets decreases polynomially with the age of the company.
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Perhaps they need to spend a lot on marketing, or build some kind of expensive infrastructure, or hire highly paid salesmen. So they decide to start talking to VCs. They get introductions to VCs from various sources: their angel investor connects them with a couple; they meet a few at conferences; a couple VCs call them after reading about them.
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They find the VCs intimidating and inscrutable. They all ask the same question: who else have you pitched to? (VCs are like high school girls: they're acutely aware of their position in the VC pecking order, and their interest in a company is a function of the interest other VCs show in it.)
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Due diligence is the corporate equivalent of a background check: the purpose is to uncover any hidden bombs that might sink the company later, like serious design flaws in the product, pending lawsuits against the company, intellectual property issues, and so on
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VCs' legal and financial due diligence is pretty thorough, but the technical due diligence is generally a joke
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Here are the terms: a $2 million investment at a pre-money valuation of $4 million
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In fact, every bit of the startup's paperwork would probably be replaced, as if the company were being founded anew. Also, the money might come in several tranches, the later ones subject to various conditions
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In the real world, VCs regard angels the way a jealous husband feels about his wife's previous boyfriends. To them the company didn't exist before they invested in it.
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Some startups could go directly from seed funding to a VC round
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Many startups—even successful ones—come close to running out of money at some point. Terrible things happen to startups when they run out of money, because they're designed for growth, not adversity.
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In the startup world, closing is not what deals do. What deals do is fall through. If you're starting a startup you would do well to remember that. Birds fly; fish swim; deals fall through.
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So if you're a startup founder wondering why some angel investor isn't returning your phone calls, you can at least take comfort in the thought that the same thing is happening to other deals a hundred times the size.
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First-rate technical people do not generally hire themselves out to do due diligence for VCs. So the most difficult part for startup founders is often responding politely to the inane questions of the "expert" they send to look you over.
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02 Jan 12
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you mix together your business and personal life; they will probably not be as well connected as angels or venture firms; and they may not be accredited investors, which could complicate your life later.
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Much of the value of a startup consists of that tiny probability multiplied by the huge outcome.
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consulting project in which you can build whatever software you wanted to sell as a startup. Then you can gradually transform yourself from a consulting company into a product company, and have your clients pay your development expenses.
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you trade decreased financial risk for increased risk that your company won't succeed as a startup.
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To be a startup, a company has to be a product business, not a service business.
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that it has to have one thing it sells to many people, rather than doing custom work for individual clients.
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To be a startup you need to be the band that sells a million copies of a song, not the band that makes money by playing at individual weddings and bar mitzvahs.
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Fear of failure is an extraordinarily powerful force.
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they understand your situation, and they're a source of contacts and advice.
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exit strategy. Younger would-be founders are often surprised that investors expect them either to sell the company or go public.
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So the principle of an "exit" is not just something forced on startups by investors, but part of what it means to be a startup.
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But in a newly founded startup, the valuation number is just an artifact of the respective contributions of everyone involved.
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Startups' valuations are supposed to rise over time.
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One of the dangers of taking investment from individual angels,
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s that they have less reputation to protect.
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The best way to find angel investors is through personal introductions
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10 Dec 11
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30 Sep 11
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21 Sep 11
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To be a startup, a company has to be a product business, not a service business. By which I mean not that it has to make something physical, but that it has to have one thing it sells to many people, rather than doing custom work for individual clients. Custom work doesn't scale. To be a startup you need to be the band that sells a million copies of a song, not the band that makes money by playing at individual weddings and bar mitzvahs.
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26 Feb 11
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10 Jan 11
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15 Nov 10
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21 Feb 10
updmcbss: you mix together your business and personal life; they will probably not be as well connected as angels or venture firms; and they may not be accredited investors, which could complicate your life later.
The SEC defines an "accredited investor" as someone with over a million dollars in liquid assets or an income of over $200,000 a year. The regulatory burden is much lower if a company's shareholders are all accredited investors. Once you take money from the general public you're more restricted in what you can do. [1]
A startup's life will be more complicated, legally, if any of the investors aren't accredited. In an IPO, it might not merely add expense, but change the outcome. A lawyer I asked about it said:
When the company goes public, the SEC will carefully study all prior issuances of stock by the company and demand that it take immediate action to cure any past violations of securities laws. Those remedial actions can delay, stall or even kill the IPO.
Of course the odds of any given startup doing an IPO are small. But not as small as they might seem. A lot of startups that end up going public didn't seem likely to at first. (Who could have guessed that the company Wozniak and Jobs started in their spare time selling plans for microcomputers would yield one of the biggest IPOs of the decade?) Much of the value of a startup consists of that tiny probability multiplied by the huge outcome.
It wasn't because they weren't accredited investors that I didn't ask my parents for seed money, though. When we were starting Viaweb, I didn't know about the concept of an accredited investor, and didn't stop to think about the value of investors' connections. The reason I didn't take money from my parents was that I didn't want them to lose it.-
The advantage of raising money from friends and family is that they're easy to find. You already know them. There are three main disadvantages: you mix together your business and personal life; they will probably not be as well connected as angels or venture firms; and they may not be accredited investors, which could complicate your life later.
The SEC defines an "accredited investor" as someone with over a million dollars in liquid assets or an income of over $200,000 a year. The regulatory burden is much lower if a company's shareholders are all accredited investors. Once you take money from the general public you're more restricted in what you can do. [1]
A startup's life will be more complicated, legally, if any of the investors aren't accredited. In an IPO, it might not merely add expense, but change the outcome. A lawyer I asked about it said:When the company goes public, the SEC will carefully study all prior issuances of stock by the company and demand that it take immediate action to cure any past violations of securities laws. Those remedial actions can delay, stall or even kill the IPO.
Of course the odds of any given startup doing an IPO are small. But not as small as they might seem. A lot of startups that end up going public didn't seem likely to at first. (Who could have guessed that the company Wozniak and Jobs started in their spare time selling plans for microcomputers would yield one of the biggest IPOs of the decade?) Much of the value of a startup consists of that tiny probability multiplied by the huge outcome.
It wasn't because they weren't accredited investors that I didn't ask my parents for seed money, though. When we were starting Viaweb, I didn't know about the concept of an accredited investor, and didn't stop to think about the value of investors' connections. The reason I didn't take money from my parents was that I didn't want them to lose it. -
has to be more than small and newly founded to be a startup. There are millions of small businesses in America, but only a few thousand are startups. To be a startup, a company has to be a product business, not a service business.
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With angels we're now talking about venture funding proper, so it's time to introduce the concept of exit strategy. Younger would-be founders are often surprised that investors expect them either to sell the company or go public. The reason is that investors need to get their capital back. They'll only consider companies that have an exit strategy—meaning companies that could get bought or go public.
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Consulting is where product companies go to die. IBM is the most famous example. So starting as a consulting company is like starting out in the grave and trying to work your way up into the world of the living.
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20 Nov 09
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01 Jul 09
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17 Nov 08
Michel BauwensVenture funding works like gears. A typical startup goes through several rounds of funding, and at each round you want to take just enough money to reach the speed where you can shift into the next gear.
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08 Nov 08
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15 Sep 08
Gary EdwardsVenture funding works like gears. A typical startup goes through several rounds of funding, and at each round you want to take just enough money to reach the speed where you can shift into the next gear. .... Y Combination founder Paul Graham explains the many issues and considerations involved with funding a startup.
Few startups get it quite right. Many are underfunded. A few are overfunded, which is like trying to start driving in third gear.
I think it would help founders to understand funding better—not just the mechanics of it, but what investors are thinking.yc vc entrepeneur entrepreneurship investment startup angels
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two reasons: they understand your situation, and they're a source of contacts and advice.
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The contacts and advice can be more important than the money.
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the concept of exit strategy
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Another concept we need to introduce now is valuation.
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Some angel investors join together in syndicates.
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One of the dangers of taking investment from individual angels, rather than through an angel group or investment firm, is that they have less reputation to protect.
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What kind of anti-dilution protection do they want?
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Fair or not, investors do it if you let them. Even VCs do it. And funding delays are a big distraction for founders, who ought to be working on their company, not worrying about investors. What's a startup to do?
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The key to closing deals is never to stop pursuing alternatives
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Seed Funding Firms
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Seed firms differ from angels and VCs in that they invest exclusively in the earliest phases—often when the company is still just an idea.
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seed investors usually care less about the idea than the people. This is true of all venture funding, but especially so in the seed stage.
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Seed firms and angel investors generally want to invest in the initial phases of a startup, then hand them off to VC firms for the next round. Occasionally startups go from seed funding direct to acquisition, however, and I expect this to become increasingly common.
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Venture Capital Funds
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In a sense, the lower-tier VC firms are a bargain for founders
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Better how? The most obvious is valuation: they'll take less of your company.
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Another danger of less known firms is that, like angels, they have less reputation to protect.
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lower-tier firms are much more likely to pretend to want to do a deal with you just to lock you up while they decide if they really want to.
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It's the partners who decide, and they view things with a colder eye.
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Because VCs invest large amounts, the money comes with more restrictions.
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Another difference with large investments is that the founders are usually required to accept "vesting"—to surrender their stock and earn it back over the next 4-5 years.
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Every startup's rule should be: spend little, and work fast.
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prototype
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skeleton business plan, addressing the five fundamental questions
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An angel investing $200k would probably expect a seat on the board of directors. He might also want preferred stock, meaning a special class of stock that has some additional rights over the common stock everyone else has. Typically these rights include vetoes over major strategic decisions, protection against being diluted in future rounds, and the right to get one's investment back first if the company is sold.
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vesting is also a way for founders to protect themselves against one another. It solves the problem of what to do if one of the founders quits. So some founders impose it on themselves when they start the company.
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The one universal rule is that the amount of stock an employee gets decreases polynomially with the age of the company. In other words, you get rich as a power of how early you were.
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Step 3: Series A Round
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Due diligence is the corporate equivalent of a background check: the purpose is to uncover any hidden bombs that might sink the company later, like serious design flaws in the product, pending lawsuits against the company, intellectual property issues, and so on. VCs' legal and financial due diligence is pretty thorough, but the technical due diligence is generally a joke.
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Deals Fall Through
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But the most unrealistic thing about the series of deals I've described is that they all closed. In the startup world, closing is not what deals do. What deals do is fall through.
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Partly the reason deals seem to fall through so often is that you lie to yourself.
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The reason is that it's such a risky environment.
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Consulting is where product companies go to die. IBM is the most famous example.
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full ratchet anti-dilution
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So it's worth negotiating anti-dilution provisions, even though you don't think you need to, and VCs will try to make you feel that you're being gratuitously troublesome.
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08 Aug 08
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06 Aug 08
Ben GodfreyPG's overview of how the typical startup funding process works, the different rounds etc. Has a simple example of how that might work, without real world troubles.
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29 Aug 07
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08 Aug 07
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03 Jul 07
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Gareth Stackreally good explanation, not just of sources of funding, but of the breakdown of shares in a startup, and how this changes with additional rounds of funding
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