October 19th, 2009
Many entrepreneurs planning their first software startup get stuck on funding and ownership issues. Here are some simple rules of thumb that may help you reframe an issue:
- Revenue, especially break even revenue, is never dilutive of your ownership.
- The right co-founders, while dilutive, substantially increase your chances of success: they give you a smaller piece of a much more valuable pie.
- Paying customers are real proof that there is demand for your product. Getting funded is proof that an investor thinks there will be demand for your product.
- A software startup in 2009 normally doesn’t need more than 10-25K to get started, if the founding team can provide the bulk of the labor to develop and market the first version of the product.
- If the founding team cannot provide the bulk of the labor to develop and market the first product, think about adding co-founders not seeking funding.
- If you need a salary from day one of your software startup don’t seek investment. Instead keep working at your day job, save your money, lower your burn rate, and work on your startup part time. This is hard.
- Your most important investors are your spouse, friends, and family who will provide you with emotional support on the entrepreneurial roller coaster.
- Professional investors don’t want control of your business, they want a return on their investment.
October 11th, 2009
Jason Calacanis has gone a little bit off the dial on “why startups shouldn’t have to pay to pitch angel investors” but he is nonetheless correct that you should not pay large fees to potential investors for consideration or the right to present.
Our focus is helping bootstrapping technology startups but we do get startups at the Bootstrappers Breakfast who ask whether they should “pay to play” as well as those that have. I have yet to meet anyone in a startup who was happy with the outcome after paying a large fee to present. And by large I mean more than $100. There are a number of pitch preparation groups in Silicon Valley (e.g. VC Task Force, SDForum VC Funding SIG, SVB Competition, Under the Radar, Launch Silicon Valley) that are worth exploring before you write a large check to an Angel group in hopes of getting a larger check back.
The Angel Capital Association issued some guidelines in 2008 you should bear in mind (bolding added to body of text):
ACA Guidelines on Charging Entrepreneurs Fees for Applications and Presentations
In 2008, ACA recommends that angel groups charge entrepreneurs no more than nominal fees for applying for and/or making presentations for angel capital and that all fees are fully disclosed, ideally appearing on the group’s Web site. The fees should be no more than a few hundred dollars for applications and no more than $500 for presentations. Transparency to entrepreneurs is of utmost importance, so full information about fee amounts and what the fees are for should be included on the group’s home page and/or other prominent portions of the site and other important promotional materials. Angel groups should also provide a consistent program of high quality coaching, preparation and feedback to entrepreneurs participating in screening and presentation activities.
These guidelines match the practices of the great majority of ACA member groups, based on a 2008 survey. About two-thirds of responding members charge no application or presentation fees, and the other third mostly charged nominal fees. [...]
ACA is an inclusive association that welcomes membership from any angel organization meeting the application criteria, but it does not endorse the practices of any group that levies large fees and/or does not forthrightly explain its potential fees to the entrepreneurial community.
Let me give an example from a Silicon Valley Angel group that I am familiar with: The Angels’ Forum. Here is what they say on their FAQ page for how they are different (bold added):
- We are a small, stable and committed investor group with long history of investing together and low turnover. TAF only has 1-2 openings per year for new angels members.
- All of our deals are reviewed and the due diligence is carried out by the angel investors, not by consultants looking for business opportunities.
- Investments are always made via a single investing LLC. This not only simplifies the entrepreneurs’ process but also protects our investing members’ privacy. The aforementioned TAF LLC will often lead the A round and be instrumental in bringing in venture coinvestors.
- Entrepreneurs are not charged any fees to present, we don’t have “success” fees or any other fees for that matter.
- TAF only invests in Northern California headquartered companies in order to devote sufficient attention and resources to the management and encourage their success.
Sometimes engineers feel that it would be more efficient just to get all of the possible investors in one room, make a single presentation, and get an answer right away. It’s somewhat similar to the challenge of finding early customers, the presentations are entirely different and the negotiation dynamics are different, but the process of improving your presentation is very similar. In fact someone asked this question on a mailing list I am on:
Ask yourself which is better:
Scenario A): Spend 2 weeks preparing biz plan/ppt/talk and $3,000 to present to 40-50 angels
Scenario B): Spend 20 weeks and $1,000 (coffee/lunch/gas/printing) and talk 1:1 with 20-30 angels
If you get feedback from each (or most) of the 20-30 angels on an individual basis that you use to improve your plan and your presentation then the 20 weeks is well spent. It’s not clear from your hypothetical situation whether you are able to make progress on your business in the absence of funding, but assuming that you can taking a retail approach (selling one by one vs. “wholesale” trying to sell all of them at once) allows you to improve your presentation and increases your odds for success substantially.
Look at it another way, let’s say that there were still two or three things missing/wrong from your presentation to the group of 40 Angels, what are your chances of being able to approach them again once they have heard you once. What are the odds that you will get feedback from more than a handful of them in a group setting? Talking to 40 at once seems more efficient of your time but it has a much lower chance of success than 20 or 30 sequential presentations–providing you take the time to get feedback and improve your presentation as you go, if you give the same presentation to the 20th as you gave the first you are wasting your time and the time of your potential investors.
Update Mon-Oct-12: following up on a comment left by Benjamin Kuo on an earlier post by Jason I came across two good posts by Joe Platnick of the Pasadena Angels, (I have highlighted some key quotes from each).
- “Angel Investors – Do They Charge Fees?“
- “The best Angels make money the old fashioned way—working with entrepreneurs to generate investment returns upon exit“
- “Some reputable Angel organizations charge a nominal fee (~$50-100) to submit a funding application. The intent here is not to use this as a money making opportunity, but to provide a filter or sincerity test for the entrepreneur and to reduce the number of poor and incomplete business plans (aka junk) that get submitted.”
- “Friday Random Ramblings“
- “These pay-for-play scams remind me of the “modeling agencies” that charge people for representation, acting lessons and to have their headshots done.”
- “Beware of for-profit angel groups based on a franchise model–as those are typically the ones that charge companies. If they don’t make money the old fashioned way and exclusively through investment returns, then they aren’t worth talking to.“
Brad Feld, a VC with the Foundry Group, weighed in on this topic August 24, 2009 with “An Angel Investor Group Move That Makes Me Vomit” offering some key points to consider”
- “I’ve personally made around 75 angel investments during two periods of time – 1994 – 1997 and 2006 – 2007.” [For details read the full post].
- “I give you this background so that my statement below has some credibility. I think it is grotesque that an organized angel investor group would charge an entrepreneur to present to their members. “
- And many of the members of organized angel groups aren’t actually angel investors. I’d like to suggest that to “qualify” as an angel investor, you have to have made at least one equity investment of at least $25,000 in the past 12 months. If you haven’t done this, you can’t call yourself an angel investor.
Update Tue-Oct-13: Jason Calacanis has posted a follow-up in “and now for some smoking guns (or part two of angels that charge)” that has a number of sourced comments on the problem. Worth reading, it’s written in a more temperate voice.
Update Tue-Oct-20: Bob Crimmins left some very insightful comments on a Keiretsu Forum member’s website; here are some key excerpts but the whole set of his comments are worth reading:
“While I don’t fully understand the inner workings of Keiretsu, what I think I have learned thus far is 40%- 50% (huge numbers) of the startups that pay significant fees to Keiretsu get no funding.”
“In fact, I believe that Keiretsu’s incentives would be more properly aligned if they did have a stake in the outcome of the startups they represent. As it is, they have no incentive to ensure that every startup they put in front of their cadre of investors has a better chance than a coin flip of getting funded. [..] For example, Keiretsu could only take fees from startups who actually get funding, i.e., a success fee.”
“I would support a pay for performance model where the angel aggregator group only gets paid if they are successful in making a good match between their investors and the companies they charge fees to–no funding, no fees. Charging, say, a 2% – 4% success fee is utterly reasonable and in this scenario, the angel group has it’s incentives aligned with the startups and the investors, i.e., to make successful matches between entrepreneurs and investors.”
Update Tue-Oct-20 (more): Deborah Gage at PE Hub reports that “Keiretsu Forum to Drop Fees For Early Stage Startups” part of their Keiretsu Forum Thread.
Williams said the change is not a response to the recent attacks on the fees launched by investor Jason Calacanis [...] but have been in the works for several months. Keiretsu also has no plans to drop fees for other entrepreneurs.
December 5th, 2008
I was still mulling over the implications of yesterday’s briefing by Nate Burgess when I came across “Prediction: Angel investing in 2009 will be up?” by Alexander Muse on the Texas Startup blog. Briefly his thesis is:
The angel investment market hovers around $12 billion each year. I predict that the turmoil on Wall Street will actually improve the ability of startups to access investments from angels. The logic is fairly simple, wealthy individual investors no longer trust Wall Street, but they still need to invest their capital. [...] With the failure of the major brokerage houses investors may start looking locally to invest their capital. They may seek out ventures in their own backyard where they can exercise some level of control and oversight.
More and more angels I know have been moving more and more funds out of their brokerage accounts and into their bank accounts. [...] The lack of professional private equity will only increase the opportunities for angels to make great investments and their access to greater percentages of their own capital will mean startups will get more.
I have come to a different conclusion.
The current worldwide economic recession is lowering the wealth of many current and would be angel investors. Exits are driven primarily by acquisition. Companies who are potential acquirers are for the most part opting for expense and headcount controls in response to this recession. This means that acquisitions will be driven primarily by market consolidation objectives and not a desire for strategic advantage. This will drive acquisition prices much lower and make venture/angel investing less attractive. As ugly as the stock market has become, minority equity investments in private firms are not at all liquid and routinely subject to complete loss. I cannot see Angel investment growing next year.
This does not mean zero. But Angels can sit on the sidelines in a way that VC’s cannot: the VC’s have raised funds for the purpose of investment and are accountable to their limited partners for the management fees they are collecting, while Angels are investing their own funds and are only accountable to themselves (and spouses).
Update Nov-10 Susan Campbell did a follow up “Interesting Finding on Venture Investment in 2009” referencing these dueling predictions and citing first half 2009 results compiled by University of New Hampshire Center for Venture Research report “Angel Investor Market Declines in First Half 2009“
September 17th, 2008
Update Tue-Sep-23: Sold Out, No Walk-ins. We will offer it again: you can sign-up to be notified of upcoming workshops
We just finished our last rehearsal for next Wednesday’s (Sep-24) “Financial Modeling for Startups” workshop we are doing jointly with Nathan Beckord of Venture Archetypes. I think it will be a good lunch and learn opportunity (of course I am biased).
The workshop attempts to offer an approach for modeling your start-up that spans bootstrapping and developing a business plan that merits investment. Nathan addresses the first question that many entrepreneurs have about developing a financial plan: Why Bother?
- A good financial model is an operating plan and roadmap for your business…sales targets, hiring plan, marketing, etc…
- A financial model is a framework for thinking through key assumptions regarding growth rates, pricing, costs, etc
- A good financial model is a mark of credibility and can help convince investors of the overall potential of your opportunity
- A well thought out financial model gives you an idea of how much money you need to raise and when, as well as overall ROI.
It’s an interesting mix of topics that address the needs of teams that are bootstrapping and want a roadmap as well as teams that are preparing to seek outside investment:
- Philosophy of Modeling: Top Ten To-Do’s
- Getting Started: Revenue Build-Up
- Cracking The Pricing Code
- Prospect’s View of Cost
- Product Mix Strategies
- Forecasting Expenses
- Hiring Plan Hat Chart
- Roll It Up and Analyzing It
- Adjusting Forecasts for the Real World
- Pitching the Numbers
It’s only $20 if you sign up by tomorrow and includes lunch. It’s Wed. Sept. 24 at 11:30 to 1 at Plug & Play, more details and registration here: http://www.skmurphy.com/services/workshops/financial-modeling-for-startups-080924/
December 1st, 2007
- Whenever you are planning to take an investment from someone the calculation you have to make–and that they should agree with–is will you be able to satisfy their return on investment requirements. So, maintaining a certain level of ownership, while very important to you, will matter less to them than how much and when you plan to pay them back.
- You also need to be very clear as to why you need the money. In particular, your need to keep the business operating or to be paid a salary are not compelling. It’s best if you can present a plan for accelerating an existing business based on proven success and a clear understanding of the market.
- Take careful notice that the terms and conditions that come with a financing (in particular liquidity preferences) and have your own attorney review them. They can often have a much larger impact on how much money you put in your pocket when your (former) business (goes public or) is acquired than the percentage of common stock you own after the first round of financing.
Our focus is on helping teams that are bootstrapping find early customers and early revenue, enabling the possibility that they build a business that deserves investment. So we bring a set of biases to fund raising questions. Four other sources of good information you should consult–in addition to your own attorney–would be
May 3rd, 2007
Are you trying to raise venture capital? If so, the Plug and Play Tech Center Expo is the place to be. The full day agenda included presentations from thirty-one companies to a panelist of investors from Norwest Venture Partners, Menlo Ventures, Foundation Capital, Amidzad Ventures, and Mohr Davidow Ventures. The Expo consisted of two parts; the presentation room and the conference room. Since the investors can only ask questions during the presentation, the conference room allows attendees to walk the show floor and speak with the presenting companies at their demo tables.
My overall thoughts and comments on the presentations:
It was obvious that most of these presentations were unrehearsed. It was shocking to see so many entrepreneurs stumbled over words, read word for word off their note cards, and speak completely on the technology. Overall, I felt with a little practice and more organization in the flow of their key points, many of the presentations could have been much better. However, from the entrepreneurs perspective; how do you know if your presentation needs improvement? One resource we highly recommend is Peter Cohan’s book “Great Demo!“ It is an outline for giving compelling presentations.
The reason why we stress the need for entrepreneurs to practice, practice, practice is because of the bigger picture. You do not get a second chance to make a first impression. Nine out of ten times, the investor is interested in you and not the technology. Besides understanding the market opportunity, the presentation allows investors to evaluate whether or not you would be easy to work with. If you can not clearly state the problem you solve, the value you bring to your customer, and confidently speak to strangers, it will be hard to obtain a second meeting. Remember the object of the pitch is not to sell them on the spot. It is to get the next meeting.