What is upgradeable Series A preferred stock?

作者：Yokum

Occasionally, I see a new provision in a term sheet, which keeps things interesting for me. I’ve decided to call this type of Series A preferred stock “upgradeable” (after recently realizing that there are economy class plane tickets that aren’t upgradeable despite having system-wide upgrade certificates). The term sheet provides:

The Series A Preferred shall also be convertible into any future series of Preferred Stock (the “Future Preferred”) under either of the following circumstances: (a) if such conversion is approved by the Board or (b) if such conversion is in connection with a future Preferred Stock equity financing in which the Company’s fully diluted pre-money valuation is greater than the Company’s fully diluted post-money valuation immediately following the Series A Financing contemplated by this term sheet (a “Future Financing”), in either case, on a one-for-one basis (subject to anti-dilution adjustment) at the option of the holder; provided however, if such conversion is in connection with a Future Financing, that the holder may convert into shares of Future Preferred only in the event that all of such shares of Future Preferred received by the holder upon conversion are sold to an Approved Investor (as defined below) no later than 90 days following the first closing of the Future Financing at a price per share no lower than the price per share at which the Company sells shares of such Future Preferred in the Future Financing and, provided further, that such Approved Investor is not an affiliate, family member, or related party of the holder. For the purposes of the preceding sentence, “Approved Investor” means (1) a bona fide institutional investor, or (2) any investor who has invested at least $1 million in the Company. For the avoidance of doubt, any conversion into Future Preferred in connection with a Future Financing that does not result in a sale of such Future Preferred to an Approved Investor on the terms set forth above shall be void, and such Future Preferred shares shall be deemed re-converted into Series A Preferred Stock automatically and without further action on the part of the holder.

Basically, this is a variation on Series FF stock that I have previously written about.  Instead of the stock being issued to founders, the “upgradeable” Series A stock is issued to early investors.  If the early investors want to sell their stock to investors in a later financing round, the Series A stock is convertible into the later round of preferred stock.  This is helpful for early investors who may want liquidity prior to the sale of the company or an IPO.  Assuming the Series B is sold at $2 per share and the Series A was sold at $1 per share, the Series B investor typically would not want to pay $2 per share for a Series A stock with price-based rights (i.e. liquidation preference) at $1 per share.  Of course, allowing an exchange of stock with a lower liquidation preference to a stock with a higher (and potentially senior) liquidation preference is detrimental to the holders of common stock.

I have seen somewhat similar provisions in the past in a slightly different context. In early stage Series A financings, some investors have tried to eliminate certain provisions, such as registration rights, from the standard documents to decrease the complexity and length of typical financing documents. However, these investors want the benefit of rights given to future investors. For example, I have seen a term sheet provision that provides for “most favored nation” status.

When the company raises a Series B financing, the terms of the Series A shall be amended to be at least as favorable as those granted to the Series B.

The problem with this provision is that it is not precise enough.  For example, one might interpret this to mean that price-based provisions (such as liquidation preferences) would be upgraded.

As an alternative, I have used the following term sheet provision in seed stage Series A financings where the investors received a Series A preferred stock with a liquidation preference and no other rights.

If the Company grants registration rights, information rights, rights of first offer, price-based antidilution protection, protective voting provisions or other similar rights to new investors in a subsequent financing involving the sale of additional series of Preferred Stock, the Company will use reasonable efforts to extend such rights to the Purchasers on the same basis granted to new investors. The Company also agrees to use reasonable efforts to provide that holders of greater than 400,000 shares of Preferred Stock will receive any rights customarily having minimum stockholding requirements.

In any event, I wouldn’t be surprised if more sophisticated early-stage investors that want to sell their stock prior to a sale of company or IPO started started asking for “upgradeable” preferred stock.

Should you take VC money or Angel money?

作者：Dan

I meet with a lot of entrepreneurs, and invariably this question always comes up in one form or another.  I think I have a pretty good perspective on this because I’ve been on all three sides of this question: 1) a professional VC, 2) an angel investor and 3) an entrepreneur facing this question for my own business.

There are both pre-investment issues and post-investment issues to this question.   Post-investment is a lot more nuanced and maybe I’ll tackle it in the future, but not right now.  The pre-investment issue can be summed up very simply:

Raising angel money is like trying to find a date on Hot Or Not.  Raising venture money is like trying to find a life partner on eHarmony.

If you’re "hot" (like this picture of Miss America 2008), you’ll very quickly get lots of dates / investors. 

You may not ultimately like the dates you get, because they only like you because you’re "hot", and if you stop being hot they move on pretty fast.  And always remember that different people find different looks "hot", like this picture of a New Guinea tribal woman doesn’t appeal to me but I’m sure it does to New Guinea tribal men.

If your business is something that people well-schooled in the industry and market you are going after would find really exciting, AND you have the time and patience to spend a lot of time getting to know each other (because it will take a while),  then you may be better off going after professional VCs who know your market and are looking for long-term relationships (i.e. submit your profile on eHarmony).  For example, Tina Fey’s humor, intelligence, style and looks aren’t for everyone, but they sure do work for me (which I’ve fully disclosed to my wife!)

Food for thought when picking an investment route….a fun way to think about a serious topic!

NOTE: I fully disclose that I’m plagiarizing this concept from someone else, but I can’t remember where I heard it so I can’t give appropriate credit, so Thanks to whoever said it first.

作者：Mark Davis

Since entering the venture capital field, I have observed how other VCs approach the business. Tactics and practices vary greatly and some are better than others.

I have tried to identify venture capital best practices. There is more to the business than picking winners; the nuances of interacting with and supporting entrepreneurs are potentially more important. While I have found that there are dozens of small processes that are exemplary, the principles that make a VC effective and poised for long-term success can be boiled down to a top ten list. Although exceptions always exist, these ten guidelines appear to be the guiding light for how the best VCs interact with entrepreneurs. I believe that these rules are worthwhile for entrepreneurs to be aware of, as it is my hope that they will set the bar for their expectations.

Top Ten Ways In Which The Best VCs Interact With Entrepreneurs

1. Be respectful of entrepreneurs and their efforts – remember that they are changing the world.
2. Handle sensitive information carefully.
3. Be forthcoming if you are evaluating competitive opportunities.
4. Be honest about your intentions.
5. Respond as promptly as possible.
6. Help entrepreneurs when possible regardless of whether or not you intend to invest.
7. Ensure that entrepreneurs share in the upside.
8. Be an active board member.
9. Pursue the exits that are best for everyone around the table.
10. Support the entrepreneurial community.

More broadly, these guidelines address three potential VC short-comings that are commonly cited by entrepreneurs: arrogance, inconsiderate behavior and selfishness. The best VCs avoid these behaviors like the plague, and they do it for good reason; in the long run, it makes them more successful.

The all-stars of VC understand that the entrepreneurs are the stars of the startup show. This perspective keeps actions that could be perceived as arrogant in check. With this mindset, these VCs know that egos are unjustified and, very often, destructive. Simply being respectful can make life for entrepreneurs easier and can enable a type of board room collaboration that yields the most productive outcome.

As I mention in my post, The Venture Police: Reputation, VCs needs to be considerate in order to develop the kind of reputation that attracts the best entrepreneurs. Being considerate means a few things. First, it means stating intentions up front. For example, VCs who are looking at multiple opportunities in an industry need to inform entrepreneurs of that fact. Second, responding to entrepreneur emails in a timely fashion is also important. Responsiveness is part of being a team player – fundraising is a stressful process that does not need to be complicated for no reason. Furthermore, responding to emails is the same courtesy afforded to nearly everyone in business – entrepreneurs deserve the same respect. I have found that a quick “no” is always appreciated – like everybody else, entrepreneurs want to know where they stand. While promptly responding isn’t always easy for VCs when their email inboxes are being bombarded, efforts to be responsive appear to be appreciated.

Lastly, even when VCs don’t plan to invest, trying to selflessly help entrepreneurs is a noble pursuit – this goodwill gesture not only helps a VC’s reputation, it is the right thing to do. Helping an entrepreneur can increase the odds that a new service makes it to market, that new jobs are created and one person gets a little bit closer to realizing a dream.

The best VCs appear to understand that being perceived as arrogant, inconsiderate and selfish can damage their reputation and future deal flow. As a result, they go to great lengths to avoid these perceptions. Ultimately this unique alignment is one of my favorite aspects of the VC role – it’s in a VC’s best interest to be a good guy.

Guy Kawasaki, the guy behind Art of the Start, has some video clips with tips on raising venture capital for early stage startups.  He takes 15 minutes to deliver his "top 5" tips:

1. Make sure VC is right for you.  Most deals are suitable for VC for reasons that have to do with VC and not the company. 
2. Capture attention in 15 seconds. There’s a long story about Hot-or-Not to deliver this point.
3. Offer a "clean deal."  Don’t give the VC an easy reason to pass (in the first meeting).  Avoid lawsuits, nepotism, IP issues, etc. 
4. Pitch in PowerPoint.  Great quote: "not using PowerPoint is like joining a Haiku contest and then saying ‘I don’t want to be limited by 5-7-5.’"
5. Drill a lot of holes.  Go after a bunch of investors…at the end of the day all money is green

Bonus tip: ignore all of the above if your business is lightning in a bottle and growing faster than you can scale.

几点建议：

１. 调研他的公司和他曾经投过的ｄｅａｌ

２. 用他易于回复的方式和他联系（如一封合适的ｅｍａｉｌ）

３. 用一个奇特的吸引他注意的方式来联系.

４. 在第一次联系中把他们关心的问题都说清楚

５. 明白融资是需要不断付出努力的，而不是一次即可成功

……

Q:  Everyone tells me the way to approach a venture capitalist I don’t know is through a friendly introduction from someone who already knows that VC. But what happens if I don’t have the connections to get that introduction? Am I screwed?

A:  (Chris) Every entrepreneur who has raised venture capital has heard it a thousand times—the best way to approach a venture capitalist is via a warm introduction. Venture capitalists invest in people as much as they do in technology or business ideas, and having some connection (even if it’s indirect) is immensely helpful to the VC in determining if that entrepreneur is someone he wants to invest in. The logic also continues that VCs are generally bombarded by requests for meetings, so a warm introduction helps an entrepreneur’s request float to the top of the list.

Unfortunately, as you’ve pointed out, sometime you don’t have the luxury of relying only on warm introductions. That doesn’t mean you can’t or won’t be successful in approaching a VC on your own, but I think there are ways to improve your chance of success.

Here’s my advice to entrepreneurs on what to do and what not to do when approaching a venture capitalist cold.

Do… Research the VC, his/her firm and their investments. If you’re asking a venture capitalist to take the time to read your business plan or take have a call with you, then you owe it to him to take the time to understand who he is and what kinds of investments his firm makes. It’s a waste of everyone’s time if you cold call a VC for funding for, say, an artificial heart valve startup when that venture firm’s web site makes it clear they only invest in software companies. By researching investments that the venture firm has made that are relevant to your opportunity (and by mentioning that research when appropriate), you show the VC that you’re serious, thoughtful and have done your homework. Successful fundraising usually isn’t a game of large numbers (i.e. the number of VCs you send your executive summary to); it’s about being smart about who you reach out to, understanding and articulating why you’re reaching out to them in particular, and having the appropriate follow through.

Do… Reach out to the VC in a way that makes it easy for a VC to respond to your approach. Out of the three primary options—USPS mail, phone and email—I think email is by far the best way to make the initial approach. VCs are notorious for their hectic travel schedules, packed calendars and odd working hours. The cold email approach saves you time and makes it easy for the VC to quickly assess whether your opportunity is one that merits pursuing. Regardless of how you decide to approach VCs, make sure they provide all of your contact info (including email and phone number) so they can re-connect with you in whatever way is best for them. Believe it or not, I have actually received business plans (via USPS) where the only contact information provided was a postal address. I can tell you firsthand that the more options you give a VC for reaching back to you, the more likely you are to actually hear back from him.

Do… Be specific in your approach about why you’re approaching that VC and what you’d like to accomplish. I think it sets the interaction off on the wrong foot when I get an email or a phone call from someone and I have to prompt them during the dialogue to get to the heart of why they reached out to me. Conversely, I really respect it when someone cuts straight to the chase and tells me what they’re looking for and why they think I’m the right person for them to reach out to. It not only tells me the entrepreneur knows what he wants and is confident enough to just ask for it, but it also gives me a sense of where that entrepreneur is coming from, whether he’s done his homework and whether his interpretation of the situation matches my interpretation.

Do… Provide the VC with enough information during the initial approach to allow him to qualify that you and your opportunity are interesting. While “dark and mysterious” may work in the dating world, being coy or secretive in the initial approach to a VC usually backfires on the entrepreneur. I’ve been on the receiving end of emails and voicemails that say nothing more than “I have a really exciting idea for a company and would like to arrange a meeting with you at your office next Tuesday.” While I think most VCs like to be accessible and will generally try to return all credible messages they receive, in most cases an attempt on the entrepreneur’s part to create a sense of intrigue will backfire and cost him or her credibility. If you do leave a message or send an email, give the VC enough information for him to determine whether it’s of interest to him.

Do… Recognize that successful fundraising is usually a series of small steps rather than one large step. Most entrepreneurs wouldn’t expect a venture capitalist to read a business plan and immediately write a check to the entrepreneur. Similarly, it’s unlikely to expect that you can pick up the phone, cold call a VC and immediately have that VC spend a couple hours on the phone going through your entire presentation. Nor should you expect that you can cold email a VC and get him to have lunch with you without his having pre-qualified that your opportunity is interesting. Your primary goal when you first cold approach a VC is simply to determine whether he has any interest in your opportunity. That’s your only ask during the initial approach: “Does this sound like something that might be of interest to you or one of your partners?” And all you have to do is provide just enough information for the VC to be able to respond. Assuming there’s an expression of interest, you can proceed with the dance called fundraising.

Do… Follow through when you make your outreach and be gently persistent. I’m amazed at the number of letters and emails I get in which the entrepreneur concludes by saying “I’ll call you next week to follow up and see if you have any questions” and where I never actually get that call. If I get a credible email or letter, I generally will close the loop regardless of whether the entrepreneur calls me, but if the initial contact promises follow through, then not doing so costs the entrepreneur credibility. Likewise, I don’t think most VCs consciously try to test entrepreneurs’ persistence, but our travel schedules, busy calendars, and existing portfolio demands sometimes create a backlog. Gentle persistence in following up can be what keeps you at the top of their minds.

Don’t… Try to make idle chitchat as a prelude to your “ask”. We’ve all had those telesales calls where an anonymous sales person tries to engage you in pleasantries about the weather, how your weekend was, or whether you think <insert sports team here> can make it all the way to the Super Bowl, etc. I don’t know of many people that enjoy it. If you don’t already have some sort of a personal connection to the VC you’re calling, the first cold call isn’t the time or place to try to force that connection. If you assume that you will only get a finite amount of time from a VC in your initial approach (it’s a safe assumption), spend that time wisely on making your case why your opportunity is a great fit for that VC, not on trying to make witty banter.

Don’t… Name drop, try to create a false sense of urgency, or raise a lot of hype unless you can back it up. Venture capitalists exchange emails, have phone calls, and meet with lots and lots of people. Most can smell when you’re trying to bull-shit them, and the only thing this does is make them more wary.

Top 10 VC Objections (And How To Overcome Them)

比如，市场太小，团队太差，阶段太早，规模太小。。。。。。

都可以找到相应的应对措施

Someone asked a question about this on TheFunded and here’s (my expanded) response.  First, let me say that the reason VCs come across as entirely pessimistic is because most companies that come in to pitch in reality don’t measure up to their claims.  Their objections are an imperfect process for testing the claims.  It’s tough on both sides.  So anyway, here is my list of the top 10 VC objections and some tips on how to overcome them:

10. We think your market is too small (or will take forever to mature). Dealing with this feedback from a VC has mostly to do with understanding the constraints of venture capital.  You can either broaden what you consider your target market, explain why you see the market as bigger than they do or go talk to a VC with a smaller fund.
9. You are too early stage. This could be real feedback or it could be a platitude.  VCs usually develop a comfort zone with a particular stage of company, but all but the most adventurous shy away from companies where the product is not yet in the market.  Most VCs like to see some revenue and depending upon the industry they maybe want to see close to $1MM in revenue for early stage deals.  Respond to this one is tough, because you are where you are.  Best thing to do if confronted with this is find out where their comfort zone is and potentially come back when you reach that (I’ve actually seen that result in funding).
8. The valuation is too high. This usually means the VC thinks your company is okay and they might consider investing if you were giving it away at a couple million pre. It also can be used as a platitude. Sometimes it’s a reference to companies that have raised a lot of money and have to do a flat or down round because they’re running behind plan/expectations.
7. You are too late stage. This is really a variant of #8.  Any early stage VC would love to own 20% of your late-stage business.  This typically happens in Series B rounds or Series A rounds where the CEO/founders have an existing track record of success.
6. Google/Microsoft/Yahoo/AOL is already (or about to or could) do this. This is a push back on competitive landscape and your relative positioning.  The key to thwarting this objection is to have more market knowledge than the VC you’re talking to (which is an uphill battle given the information flow they get).  You have to do your homework.
5. We think your projections are unrealistic (or alternatively: you have no business model).  If you haven’t spent enough time preparing your financial model, you can get caught flat-footed.  Best thing to do on a financial model is to be very conservative.  You want the VC commenting, "Oh, I think you’ll get customers faster than that."  There are also a lot of comparables out there so no need to reinvent the wheel.
4. We’d like to see more market traction before moving forward. This is typically a blow-off or a legitimate variant of #9.  A close cousin of this one is when the VC says, "we’re interested, but we need to know who else is interested to know if we’re really interested."  If you get that response, you’re wasting your time…just get up a leave.
3. Company is a "feature" or "product" but not a business. This is really a variant of #10.  Best thing to do is to try and step back and take a broader view of the opportunity and what it could be.   
2. You have to ask yourself…what about India and China? I’ve only gotten this objection once.  It’s a dumb question so it’s hard to give advice on how to respond.  Maybe just make a reference to snoman.
1. B- or C-level team. Actually, Most VCs won’t tell you this and instead you get one of the other platitudes.  That makes it one of the hardest objections to respond to.  I think the best way to overcome this is not to say that you have an A-level team (if in fact you don’t) but rather to say something along the lines of, "here’s our staffing plan for success…"

Overall, the best policy is honesty and candor. In fact, your best bet is to address these objections before they come up. And if, for example, a VC asks if the market may be too small you can respond, "you are probably right, but here’s what would have to be true if that were not the case…"  You want to turn it away from a "in-order-for-me-to-be-right-you-have-to-be-wrong" conversation.

孙正义的演讲全文在互联网上很容易找到，而演讲的PPT，笔者用照相机拍下一份，笔者不敢独享，现将每张PPT附上孙正义的演讲辞，奉献给大家。

孙正义的PPT很长，我分为三篇个部分，分别是：

《我看好无线互联网》

《软银和巴菲特的不同》

《软银和谷歌的异同》

上篇：《软银的愿景》

一、 远大的理想才能获得大成功

孙正义19岁的时候，有很多想法，他列了一张25个理想的单子，这个单子描述了他要建立的企业是一个大型的新型企业，这个企业就是后来的软银。

孙正义：成功不会在几年内就降临，它需要多年的努力。建议每个人都准备好自己的清单，来做好选择你的人生该怎样走，然后全心全意做你决定好的事情。99%的人走一步看一步，所以他们只能取得一般性得成功；而在很早就树立愿景的人，往往会取得更大的成功。

树立一个近期目标只能获得有限的成果，孙正义建议大家树立长久和远大的理想（愿景），创业企业需要愿景。

二、 软银的远景

软银有两大远景：一个是最大的移动互联网公司；另外一个是亚洲最大的互联网公司

孙正义称软银现在是世界第二大互联网公司，该图是他将软银、雅虎和亚马逊和谷歌做的比较

三、 软银的发展历程

从这张图看出，软银从最初的商业、印刷、门户到后来的宽带，最近软银开始涉足移动业务。两年前，软银花了200亿美元收购了日本一家手机公司，和当时那些电信巨头相比，这是一家很小的公司，几乎每个人都认为软银会在这在这个这个市场上搞杂，甚至选入困局。孙正义凭借自己的激情、软银的远景以及争第一的目标，这个曾经的小公司现在已经占有了一半的客户和50%的市场份额。

软银的业务

该图显示的是，软银旗下的公司和控股的公司，阿里巴巴、淘宝、校内、猫扑和千橡，软银都有投资。

        KDDI、NTT是日本有名的电信公司，跟这些其他的电信业巨头来说，软银本来是小公司，软银两年前投入了两百亿美元的投资，收购一个小的手机公司，当时是日本的第三大移动公司运营，跟其他的竞争对手比，软银收购的是最小的一个手机公司。在这两年发展过程中，在新用户增长过程中，软银得到的新用户数量是最多的。

四、 移动互联网将成为趋势

我们再来看看人类的历史：17世纪，人们互相竞争，去获取新的材料。比如说像农业材料、食品、金属、药品等等；在18世纪直到20世纪，人们都在竞争能源来进行工业革命，石油、天然气、电力帮助他们进行工业的变革；在21世纪，我想主要的竞争领域就是为人们获取信息，信息的获取是21世纪的人们竞争的一个东西，那么人们想更快的获取新的信息，以更大的深度，更广的广度来获得这个信息，然后再来传递这个信息，分享这个信息，这样人们可以互相分享这个信息，然后进行更好的沟通。所以我的关注点是信息获取，也就是网络业务。

互联网已经从PC向互联网转移（该PPT不全，只照了一半，全部的英文是 FROM PC TO MOBILE）

手机的速度，在过去8年间已经增长了375倍。手机处理器速度增长如此之快，使他将成为一个真正的互联网工具。

孙正义在日本有一个雅虎移动门户网站，这个门户访问量在过去两年里面增长了100倍，在音乐下载方面，在手机上下载数量也比电脑高出10倍。

音乐下载方面，手机是

PC

的11倍

社交网络也已经可以在手机上实现。一年之前，访问最大的社交网络MIXI，电脑还占到了90%的访问量，但现在却不足40%，其中60%是从手机访问社交网络。

移动设备中来自语音的收入的比例正在变小，在欧洲和美国，第三代手机的基础设施也就是3G，目前，大多数的欧洲公司以及美国已经渗透率是20%，在日本渗透率是30%，在日本已经有3.5G，超越了3G，所以从手机上面接入英特网，已经非常的便利非常的高速。

日本的3G技术处在世界首位

五、 软银看好亚洲市场

谷歌和软银的市场对比

谷歌是在美国取得了成功，但是我要制造亚洲得成功，我要和你们在一起制造亚洲的成功。和你们在一起，我们将会凝聚亚洲的力量，然后去制造全球得成功。就像我说的，软银的愿景，我们的愿景就是在亚洲发展移动网络，希望我们能够把这一件工作一道做成，我希望能够帮助年轻的中国的网络企业家。

孙正义在现场展示手中的3g iphone

Reasonable pre-money valuations for startups

On Thursday I was chatting with a seed-stage company from Dallas.  The founders have raised approximately $250,000 and are closing in on their beta release.  They are in the market for $2-3MM and are getting ready to start visiting venture capital firms around the country.  They asked me for advice on what pre-money valuation they should ask for.  They began talking about discounted cash flows and market comparables and my head began to spin. My advice: I suggested that if an investor asked them about valuation that they simply suggest that ‘valuation isn’t as important to them as finding the right partner.’  Then turn the question around, ‘based on your experience, what would you think was a fair valuation range?’  After meeting with several investors I suspect you will have a very good idea what the ‘market’ will bear for a deal like yours.

Of course, no one ever listens to my advice, so here are some things to think about:  The operable word, valuation, in the phrase ‘pre-money valuation’ is really a misnomer.  Typical angel or venture capital investors aren’t really attempting to determine ‘value’, but instead they are attempting to determine ‘price’.  This is an important distinction.  Consider the value of crude oil versus its price today - they have little in common.

David Berkus’ valuation method as described in Winning Angels suggests:

• 
  

  Sound idea = $1MM to company’s value

• Prototype = $1MM to company’s value

• Quality Management Team = $1-2MM to company’s value

• Quality Board = $1MM to company’s value

• 
  

  Product rollout or sales = $1MM to company’s value

The Ottawa Capital Network has an interesting explaination of price versus value:

More casually, “value” is what something is worth and “price” is what you get for it. Here are some of the reasons why the two results may be materially different:

• Fair Market Value is calculated in a “notional” market, while Price reflects the real world;
• Fair Market Value assumes equal negotiating ability between the parties, while Price is affected by different negotiating strengths;
• Fair Market Value assumes both parties have equal knowledge, while Price reflects differences in information or assumptions;
• Fair Market Value assumes there are no “special purchasers”, while Price may reflect the influence of a purchaser that has a unique incentive;
• Fair Market Value assumes neither party is under compulsion to transact while, in reality, vendors are usually under some financial pressure to sell, and one or both parties are acting on emotion; and,
• Fair Market Value assumes there are many buyers in the “notional market”, whereas in reality there are often only a few that often confer.

Notwithstanding this important distinction between “value” and “price,” most discussions on the topic inherently use the term “value” to refer to “price.”  Just remember though, all discussions on value really refer to price – i.e. what you can get for your company, not what it is worth. With the higher risks inherent with earlier stage companies, the valuation methodologies are much more subjective than the methodologies used for Later Stage companies.

According to VentureOne Research most seed stage pre-money valuations are between $2MM and $5MM with seed-stage investors receiving 20% to 30% of the company for investments between $500K to $2MM.  The Ottawa Capital Network explains how valuations are determined:

Given the relatively few possible outcomes, Seed Stage investors typically use very simple valuation methodologies. Some of the reasons for a more simple approach include:

• The final pre-money valuations will be within a narrow band and will be more affected by negotiating strengths than “mathematical” determinations
• Many Seed Stage investors recognize that much of the company’s business plan and product concept will likely change over the next few years
• With so much “uncertainty” and perceived risk, Seed Stage investors typically rely on more “intuitive” or subjective valuation models and support their subjective views with reality checks (i.e. due diligence) in a few key areas
• Seed Stage investors also recognize that, without a lot of substance in the companies upon which to do meaningful due diligence, they should be able to reach an intuitive assessment relatively quickly.
• Many Seed Stage investors recognize the “subjective” nature of their Seed Stage investment decisions and expect a high “mortality rate.” To offset this exposure, most Seed Stage investors are prepared to invest in one or two more financing rounds for the more promising investees.

Here are a few “data points” supporting the above summary observations:

• MIT Entrepreneurship Center: Research Findings February 2000: Seed stage technology ventures were typically US$500,000 to US$3 million. Pre-money valuations greater than US$5 million required an extraordinarily compelling story.
• The Tech Coast Angels: Website: “we look for pre-money valuations below US$5 million”, Presentation March 2002: “sweet spot” for investing is a pre-money valuation of US$1.5 million to US$3 million.
• Sand Hill Angels: Website: invest US$250,000 to US$2 million at a valuation of less than US$5 million.
• New Jersey Entrepreneurial Network Angels: Presentation: Valuation of US$1 million to US$5 million, for 20% to 30%
• Winning Angels, Amos/Stevenson (Noted Book): Most Angel investors want pre-money valuations between US$2 million and US$5 million, with US$2.5 million as the “sweet spot”

Convertible Debt: Valuation

As I noted in my post, Converitble Debt:  Mandatory Conversion, a savvy reader sent me an email about my post, Convertible Debt:  Delaying Valuation.  I thought our exchange was worth sharing.

He wrote: I saw your comments on convertible debt and had a couple of questions for you about a convertible note with a “mandatory” conversion:

• As you mentioned, convertible debt is a way to postpone valuation until the next round. But what if the convertible note has a mandatory conversion at a certain price after three years? Is valuation still “postponed”, or is the conversion price stipulated for three years down the road an indicator of present value?

It is common for notes to include a pre-determined max conversion value to reflect the maximum potential current valuation. In my opinion, you are right - while the conversion is delayed investors ultimately are buying assets at the price that is appropriate when they invest the capital. Sophisticated investors do not want to put money at risk now only to buy shares at the higher future valuation that likely reflects a lower risk profile. As a result, entrepreneurs and investors should be careful to think about this conversion price as a measure of current valuation. Otherwise they may encounter some of the challenges that companies face when they are overvalued.

Ultimately investors vary how they structure investment vehicles. Unfortunately, some are better than others about creating advantageous structures. As a result, it’s worthwhile for entrepreneurs to know enough to sanity check investment structures.

How Many Deals Should Be Needed To Return A VC Fund?

Fred Wilson has another excellent post up titled Venture Fund Economics: When One Deal Returns The Fund.  He continues his expose on how VC funds work and builds his thoughts in this post around the statement:

"Every really good venture fund I have been involved in or have witnessed has had one or more investments that paid off so large that one deal single handedly returned the entire fund."

I’ve been a partner in several venture funds and am or have have been an investor (LP) in around 25 VC funds since 1995.  I reach the same conclusion as Fred on slightly different data - every successful venture fund that I’ve been a part of in any way has had at least one deal that effectively returned the fund (I’m changing the assertion a little as I’m including the funds where there were several deals that each returned at least 75% of the fund.)

In 100% of the cases where there wasn’t at least a deal that returned 75% of the fund, the fund was a loser.  I can’t think of case that I’ve been involved in or seen the data from a situation where this hasn’t been true (I’m sure this is at least one case, but my assertion would be that it’s an outlier.) 

Fred explains it well, but the meta-message is that you have to have at least one home run in a venture fund (where home run is defined as returning at least 75% of the fund) to have a successful fund.  For tech VC funds, this is relatively easy to get your mind around for funds under about $300m.  Once you start getting into higher numbers (say - $1 billion funds), you quickly realize that to return $750m on one deal, you have to own 20% of a company with a value over $4 billion at the time you exit.  That doesn’t happen very often.

Fred’s conclusion is also right on the money as it’s not about just stepping up to the plate and swinging for the fence.

Some will read this and suggest that our business is all about swinging for the fences. But I don’t think so. There are hitters in baseball, the best hitters in fact, that hit balls out of the park when they are just trying to make good contact. That’s how you have to do it in the venture business. You try to make 20 great investments and you work with them closely in hopes that four years in you have six or seven that have home run potential, and after ten years, you maybe hit one or two out of the park. If you try to hit every one out of the park day one, you’ll strike out way too much and the fund won’t work out very well.

Fred is doing a superb job with this series.  If you aren’t already a subscriber to his blog, what are you waiting for?