Last week, for just the second time ever, I passed on an investment opportunity because of the terms of the deal--both the price and the legal structure of the agreement. It was a company whose product I believed in and whose founder I liked, but a firm lobbed in a term sheet at a price 33% higher than what I had offered using a very light agreement meant for a much earlier stage company. This was a company that had successfully bootstrapped itself to real revenues, employees and cashflow and I thought it deserved the structure of a going concern, not a flier.
At first, I thought I was making a mistake. After all, I understood that when these types of deals pop, the initial price you pay tends to matter very little--and it matters much more that you're in the deal versus not. I remember back in the Union Square Ventures days when we had an internal debate over the price of the first round of Indeed. A billion dollars later, it didn't much matter.
Then, I read about the idiotic comments made by a co-founder of Rap Genius...
which is not long after the recent debacle at Github...
and then there's the nightmare at RadiumOne...
Founders. Run. Amok.
And even when they're not disrespecting murder victims, creating hostile work environments for women or literally beating women, they're running amok in other, less violent ways...
...like raising over $300 million, flaunting the epic winning, only to watch the whole thing go up in flames, like at Fab...
...or sticking your head in the sand while fraud occurs on your platform, like the way Indiegogo watched Healbe Gobe get torched in the media. They even tried to change their Terms of Service in the middle of the alleged scam.
No wonder people are questioning where the boards of these companies were.
Founders. Run. Amok.
Three of the aforementioned companies have taken investments from Andreessen Horowitz--probably the hottest firm on the planet right now. They got that way due in large part to a very public founder friendly stance.
Perhaps they need to rethink that "back the founder at all costs" mentality. Perhaps we all should.
I certainly have.
When I saw this term sheet where another firm clearly fell over themselves to get enough money into this deal, going against anyone's better judgement with a thin set of terms and a high price, it vaulted the founder into a tremendous power position in the company's dynamic. No one from the firm leading the deal will join the board. The whole deal was optimized to avoid distracting the founder too much from the world of building the company.
I hate to break it to anyone, but the creation of a board, the building of a strong legal base, and, to take it a step further, tedious little things like values statements and human resource policies, are all the work of building a real company. Terms that hold founders accountable make them better founders and company builders.
It ain't all coding, selling, and raising money, people.
Ok, does getting one over on investors term-wise mean this founder is going to go out and start beating people up, harrassing people, etc... No, probably not.
But it's all part of the environment we're creating.
Is it really surprising to anyone when we talk about "party rounds" as financing strategies we've created companies with unprofessional environments and founders behaving irresponsibly?
Fundraising isn't just a "distraction". Finding and negotiating with investors is a serious part of the process of creating a company. It's an opportunity to outline a vision for the kind of environment you want to create and the impact on the world you want to make--and a chance to seek out and properly align incentives with the best potential partners you can get.
Treat financings like an auction and you're going to get a bubble and a lot of bad behavior. Treat it like the creation of a partnership and you'll build a lasting entity built on values.
And as investors, we need to keep doing our job. We shouldn't be telling founders how to run their companies--but we should hold them and ourselves accountable to really high standards. We shouldn't bend just because someone appears to be a high flyer. We need to make sure that there are sound and thorough management practices in place at the companies we work with--and that all starts with the very first piece of paper you pass across the table...
The Term Sheet.
If we've seen anything so far, the more term sheets are built simply to win deals--the more we'll see inflated founder egos believing that what they've built up to that point is amazing, needs no help, and that their creation changes all the rules.
Rules have a funny way of snapping back again, if you hadn't noticed. Rules like respect. Rules like checks and balances.
Sign a term sheet that you feel doesn't respect the contribution you can make as an investor and one that doesn't respect the company building process, and you'll likely, unintentionally, create a founder that believes they are above a lot of rules.
I treat all my founders equally. I ask them for terms that acknowledge how much more work they have to do in order to fulfill their potential and ones that involve me directly in company building process. That might be a board seat, or at least an observer right. It will certainly involve market pricing. If I lose a deal, I'll lose a deal--but I have a feeling, in the long run, some of those high fliers are going to get undone by the same lopsided dynamics that created the first term sheet.
I could spend a lot of time writing a long diatribe about what it means to create a brand, or I could just show you three videos that Tinybop, a company I seeded in 2012, made as part of the marketing for their new app, Plants.
Consider the bar raised... As a biased investor, I not-so-humbly submit that this is the most creative thing any startup in New York City has ever produced as part of a launch:
If the Bloomberg story is right, all three of these companies are now worth about $10 billion. I don't know about you, but I'm pretty sure I'd rather own Uber than all of the crappy Dollar Tree stores or a peanut butter company.
Plus, I'm more of a almond butter guy anyway.
I don't totally understand why people get obsessed with valuations--especially given that the complete lack of context around a deal. There are so many factors that play into valuation that the big headline number is completely meaningless.
First off, if I buy one billionth of your company for a dollar, does that mean your company is worth a billion dollars? Technically, that's exactly what it means, if you price your company's shares on the value of the last trade. That doesn't seem reasonable, though, does it. When does that become meaningful? At 1%? 5%? I'm not totally sure.
What about if you think about how much money the person writing the check has? When Apple bought beats for less than 2% of its cash, do you think they were really paying that much attention to the price? Think about what you could buy for 2% of the cash in your bank account.
If the investment in Uber was $500 million put in by a middle east oil family who has $50 billion in assets, is 1% even meaningful for them?
And what return are they seeking? If I'm looking for a 10% annual return, what I could be saying is that Uber is going to go public in three years at a valuation of about $14 billion. That doesn't seem particularly unreasonable. If I was looking for a 30% annual return, and I invest. I'm saying that Uber is going to be worth $22 billion in three years. That's obviously a bigger future.
We don't know the terms of this deal. If the company is getting preferred shares, they're also the first money out--so they don't need it to be worth $10 billion to get their return. Maybe there's a dividend that starts kicking in. You don't know.
Plus, there's the question of why someone is making that investment. Do they just want to be an investor in Uber because they think it's cool. Maybe it's General Motors, and they want all of the Uber drivers to use Cadillacs, in which case, they might recoup their investment back on increased sales.
Or maybe it's a mistake... and a bad idea.
At the end of the day, who really cares? I mean, what does it matter?
Does the valuation of one company mean we're in a bubble? No. I mean, it's got real revenues and they're growing rapidly. Is it likely to completely implode and be worth nothing? Doubtful.
It would be great if valuation made us debate whether Uber is just a cab company or the future of all transportation. That's an intelligent conversation.
Randomly opining on paper numbers... that doesn't really do much for anyone.
Two years ago I started a fund. For the fund to be viable, it had to be at least $5 million, but somewhere in the neighborhood of $8-10 million would have been perfect. Thankfully, that's what I raised--$8.3 million.
So how does it work? How does one make money raising a venture fund of this size? Not easily, let me tell you. The benefit comes in the upside, and it's very back end weighted. If you're looking to make a lot of dough in the short term, microVC isn't for you.
Here's how it plays out:
I have a 2.5% management fee. Most larger funds have a fee around 2%, but when you're this small, you need a little bit extra to keep the lights on. It's only a little bit of a performance drag, though, because management fees act like a loan. You charge your limited partners this, but you have to pay it back before you start taking a cut of the profits. It's more "borrow" pay than "take home" pay. If the fund is a disaster, you don't have to give it back, but I plan on being successful, so I still think of it like a loan.
That means I have a total budget of a little over $200,000 to run the entire operations of Brooklyn Bridge Ventures. Over time, when I raise the second and third fund, those fees will ramp down in the out years, but I'll still have two funds worth of management fees to run with. That's a big help. You're running pretty lean when you're on your first fund.
I take a salary of $100,000, while healthcare and other HR related expenses like add up to another $16k on top of that. You can look at this two ways. On one hand, this is probably less than your average associate makes. Now that I think of it, it is, in fact, less than what I made as an associate. I hear that partners can make $300,000 on up to a million dollars at a big fund, and that's before their cut of the upside.
It's also probably less than most funded CEOs are making--or certainly less than your average software developer.
Meh. If I was optimizing for cash, I would have been an investment banker a long time ago.
I don't have any kids. I live in the hinterlands of Bay Ridge, Brooklyn, and so my overhead isn't that high. My nine year old car is paid for and I put more mileage on my bike anyway.
And, if you really want to put things in perspective, I'm pretty sure this is more than my parents ever made combined. So, no complaints here.
By second highest expense is the administration of my fund to various types of professional services. My fund administrator, who I'm sure is doing me a favor because I've known them forever, is charging me around 20k. Tax prep is another 12k.
Legal is lumpy. The creation of the fund was charged to the assets of the fund itself, and outside of that, I really don't have a lot of legal work that needs to be done. I send out my own term sheets and review docs myself--especially since I'm in sydicated rounds. When a bigger fund is in a round with me, they're going to look at the legals, too--so I'm generally fine with whatever they go for. If I was the only one in, I couldn't do it that way. Plus, when I look at my risks--is the risk that a legal term will shoot me in the foot or that these two founders and a prototype run this business into the ground. My expected value of legal term haggling is near zero over the long term, so I'm not going to spend a lot of time and effort on it. Still, one should probably budget at least 10k annually just in case.
Ok, so now, very quickly, we're down to about 50k of budget after doing all the must-dos. I have a desk in a co-working space--that's $5k a year. I have a terrific part time assistant and she does a max of about $800 of work for me a month. I wouldn't be able to run my fund without her, so that's $10k well spent.
That leaves about $2500 a month all the other random stuff--website, Mailchimp, paying for breakfasts, bike flat tires, travel, conferences, etc.
And that's that.
The upside, on the other hand, is pretty amazing, in my mind.
Back of the napkin math on the upside.
The fund's dollars are used both for investments and for administration--so lets's say I wind up putting about 85% of the fund to work in actual investments. That's about $7 million. If all I do is double it, that's $14 million of returns. Subtract the $8.3 million of initial capital with all its fees and stuff, and you've got about $6 million of gains. That's a little over a million dollar gain for me personally. If you want to think about it simply, for every "x", or multiple of return, that's another approximately $1.4 million. A fund that returns three dollars for every dollar of capital invested would be a $2.4 million return for me. Four times return is $3.8 million, and so on and so on, and that's just one fund. At some point you're five or seven years down the line and your cut of the profits starts coming in more smoothly, because in any given year, your seven year old investments are getting sold, going public, etc. So, ten years from now, investments I make three years from now might be exiting. Some may take longer, some might exit in a shorter amount of time.
The most important thing, though, is that I have a chance of making a million dollars doing something I love. To me, that puts me in the 1% of the 1% of life. Can I buy a majority stake in the Mets? With these economics, doubtful, but you'll never see me complaining about money, or frankly, anything about my job. I feel very lucky to be doing this.
I don't drink. I mean, I consume liquid, but all of those liquids are non-alcoholic.
I'm not Mormon.
Nor am I an alcoholic.
I have no real moral issue with reasonable amounts of drinking--and actually quite envy wine enthusiasts. It seems like a neat and interesting hobby. I just really don't like the taste. Otherwise, I probably would drink wine. The taste of alcohol, to me, is akin to what kids think of cough syrup.
On top of that, there are lots of aspects of my life that reinforce the not drinking thing. I'm a bike commuter, so I'm essentially always driving, and I wouldn't trade one drink for one half second of taxi door reaction time.
I do, however, spend lots of time in situations where alcohol is consumed. I play lots of team sports and go to a lot of tech networking events. In fact, I do a lot of networking in general.
When I was in my 20's, it was a little bit more of an awkward issue, maybe even more so than in college. In college, you could be out at a bar and everyone was too drunk to notice whether you were drinking or not. In your 20's, you're in slightly smaller groups, and so it's more obvious. Dating presented an issue... because if I wasn't having a glass of wine, was I being judgy? Was I an alcoholic?
Over the years, I've come up with a ton of little ways to duck the issue. People will ask me if I want to have a drink for professional purposes, and I'm always turning it into breakfast or lunch. Someone will come up to me at an event and put a beer in my hand. I'll thank them and then eventually regift it to someone else. It's never really been a big deal.
What is interesting to me, though, is that in the conversation around gender and tech, that alcohol doesn't come up more often. It's a huge factor in problematic situations, but we tend to look at alcohol as some kind of sacred cow--where seriously discussing whether or not it should be part of our environment isn't really ever on the table.
That's why I found Jeff Atwood's "What Can Men Do?" so interesting. This is the first time I've really seen such a bold stance taken on it:
"I think it is very, very unwise for companies to have a culture associated with drinking and the lowered inhibitions that come with drinking. I've heard some terrifyingly awful stories that I don't even want to link to here. Men, plus women, plus alcohol is a great recipe for college. That's about all I remember from college, in fact. But as a safe work environment for women? Not so much.If you want to drink, be my guest. Drink. You're a grown up. I'm not the boss of you. But don't drink in a situation or event that is officially connected with work in any way. That should absolutely be your personal and company policy – no exceptions."
It's really hard to argue against his logic with anything other than the lack of alcohol making things "less fun". It does, however, highly correlate with bad decisions. I know of a partner at a VC firm who literally needed to sit a founder down and have a discussion about the reputation they were building around their "epic" happy hours. While it may have made that founder seem fun to their summer interns, it certainly wasn't scoring any points with potential experienced talent that might want to work for the company.
Even if it's not that extreme, perhaps alcohol just isn't so fun for everyone. I recently spoke to someone who was the first hire over thirty at a startup. He told me that one of the things he was told was that on Friday afternoons, they play drinking games. He told me the last time he played a drinking game was probably ten years ago and he'd rather forget that experience, but not partaking made him feel like he didn't fit into the company's "culture".
It's true. If you don't want to drink, you aren't exactly made to feel like you fit in. I can't tell you how many bottles of wine I've been handed as a judge or speaker for things--which is weird to me in itself, because I feel like that's part of my job. If you knew I was an alcoholic, would you still send me one? I'm not, but I could be if you don't ask whether or not I drink. The assumption is just made. It's fine for me. I just regift, but it's all part of the death by a thousand cuts.
A lot of people think that unless you have a big sign on the front door that says "No women!" or "No one over 30!" or "No black people!" that means your environment is welcoming--especially if you say it is. However, they never stop to examine all of the subtle little ways in which people are made to feel like they aren't part of the norm.
For companies, I think if you're serious about building a welcoming, diverse environment, you need to think seriously about what the presense of alcohol means and its effects on a situation. Should companies outright ban alcohol in the office or at work events? If it's not at least on the table for you to consider, then you're not taking this stuff seriously enough.
For individuals, I suggest that whatever decisions you make about how you spend your time and what activities you partake in, you should be very conscious and deliberate about your choices. Don't just drink because everyone else is having one--and keep in mind the increased potential for bad decisions, things that shouldn't have been said, or awkward/uncomfortable situations around your personal life. From what I've experienced, if you're confident in yourself and you own your actions, good things can happen. It's not an accident that my circle of tech friends tends to be more health conscious, sporty, and the type of folks who generally don't regret or forget the night before--and instead can be found cycling at 7am on a weekend.