Making your venture more fundable by removing potential red flags

This is another question I have had to deal with and have got asked in the past. How do you structure a business, or hire or develop a startup in a way not to turn off the VC’s at a later stage. You have to consider the cap table, the business location and structure, the team, the investor base and many more things.

Do not start-up without considering the long term objectives of the business and its funding path – in other words consider all the issues for the life of the business at the start, as far as you can, and then get going.

As you go along try and make sure you minimize issues and actions that will lead to problems when it comes to funding at each stage. In particular, VC’s are very sensitive to all manner of issues and will pass on a deal that takes too much effort to "clean up".

I read an excellent and funny piece that deals with this in detail on infoChachkie.com, where he refers to the issue as "deal hair".

Shining, Gleaming, Steaming, Flaxen, Waxen

Deal hair, just like the real thing, comes in a variety of colors and styles. Some of the most common types of deal hair include:

Junky Capitalization Table – A hodgepodge of small investors that could cause potential headaches for management and/or institutional investors.

• Nair Solution – Repurchase as much stock as is practical and convert any remaining preferred stockholders to common stock status.

Untenable Bridge Terms – Convertible debt terms that are prohibitive to an institutional investment, such as large discounts and/or warrant coverage that dilutes the intuitional investor’s investment.

• Nair Solution – Marginalize the relative dilutive impact of these terms. For instance, a discount of less than twenty percent is usually deemed reasonable. In addition, converting warrant coverage to non-participating status will also enhance your adVenture’s fundability.

Band of Brothers – Friends, family, former roommates and other unqualified people occupy senior management positions.

• Nair Solution – Replace such mis-hires with strong-willed, independent executives who have relevant, successful track records.

IP Confusion – Questionable ownership of key intellectual property, including non-exclusive licenses, potential infringement of a third party’s technology and/or inappropriate use of open-source tools.

• Nair Solution – In most failed adVentures, the only asset of value upon dissolution is the underlying intellectual property. As such, it is paramount that investors can unequivocally evaluate its veracity.

Legal Landmines – No matter how frivolous, lawsuits will seriously chill investors’ interest.

• Nair Solution – As noted in Roping In The Legal Eagles, it is generally advantageous to fight nuisance lawsuits to avoid becoming known as easy mark for unscrupulous lawyers. However, when fundraising, it is more appropriate to expeditiously resolve any litigation (potential or otherwise), rather than expend energy convincing a skeptical investor that your legal issues are without merit.

Geographic Dispersion – Significant physical separation of Core Team.

• Nair Solution – During an adVenture’s early days, virtual teams are often viable. However, as a company accelerates its growth by deploying its institutional funding, the Core Team cannot afford to be handicapped by disparate locales. As such, the Core Team should be prepared to relocate to a central location within a reasonable period after obtaining funding.

Way Outsourcing – Outsourcing core competencies.

• Nair Solution – Identify the areas of your adVenture that are critical to its success and internally develop the necessary levels of core competency. For instance, technology startups should maintain key development resources in-house, rather than relying exclusively on third-party, contract labor. If your business model is predicated on superior online marketing expertise, do not utilize consultants to craft and execute your online marketing initiatives.

Double Agent – Problematic agency issues, such as high salaries, non-entrepreneurial perks (car allowances, exorbitant travel expenditures, etc.), side businesses and/or cross-ownership of related businesses.

• Nair Solution – The addition of disciplined, experienced investors to your adVenture team will require you to run your business with a focus on creating long-term value. As such, eliminate any unconventional forms of compensation or other potential areas of Agency conflict before you are forced to do so by a prospective investor.

Before you seek investment capital, do what you can to make your adVenture smooth and shiny, with no nicks or cuts. Although judicious use of metaphorical Nair on your adVenture will help your fundraising efforts, it is often also necessary to unequivocally acknowledge the remaining deal hair. It should be shampooed, conditioned and styled in the most attractive manner possible. Trying to cover up deal hair with a cap and deny its existence is not a viable strategy. If you remove and groom the hair on your deal, there will be no doubt as to “Who loves ya baby?”

See the full article here: http://www.infochachkie.com/nair/

Even more advice on presenting to investors…preparation is key

You must know what they say about the 5 P’s, preparation prevents “piss poor” performance!

THE PREPARATION PROCESS:

Identify the 3-5 key points you want the audience to remember. These will inevitably be the key points of the investment case. Build the presentation (or meeting) around these points.

Limit the amount of information you give an audience, so that they don’t have any difficulty identifying the key points.

Start with a strong statement, after which all your comments should reinforce the opening. The strong start should provide a theme for the presentation, which can be pulled together by reference to it at the end (e.g. “I said right at the start….”). That start may be your key message, or the reason why they should listen to your story.

Back up key points with evidence in the form of facts and figures, but also use examples, analogies, metaphors, anecdotes and success stories to bring issues, especially abstract areas, alive and make them memorable. Every-day examples are best. Use just enough evidence to provoke interest in and discussion of the key point. That way the Q&A discussion is more likely to be centred around what you said i.e. the key points of the investment case you want them to agree with and remember.

In general, look through your notes/script, once created, to see what visuals are needed. Visual aids should reinforce and clarify your message, not lead the presentation. By using visual aids to illustrate a point made by the speaker, the audience will see who is in control and gain a more positive impression of you the management team. If using slides, make sure that there are some blank slides in the presentation, to ensure that the audience’s attention returns to the speaker.

If you are writing a script (only suitable for use with larger audiences, make sure it is written in spoken not grammatical English. Keep sentences short and snappy and break them up with dots ( …. ) to encourage conversational delivery. Use contractions such as “we’re” rather than “we are” and avoid literary, weak words such as “however” and “therefore” – use “but” and “so.”

All audiences have limited attention spans. Short presentations are better than longer ones. A maximum of twenty minutes is a good guide.

 Close dramatically. Summarize the key points and end on an upbeat note by referring to your strong start and reinforcing – conversationally – the investment case.

The current economy…the Silver Lining

With every cloud comes a silver lining…right!

I am glad I am not alone in this thinking and this week a friend and my US lawyer John Montgomery sent me and others in his circle an uplifting memo that I thought I would post here.

In summary, we learned well from the last downturn and the VC community is responding well – well in this case means getting back to basics, working with portfolio companies to reset expectations, preserve cash and not carrying “dead wood” that prevents fresh capital getting to early stage companies.

Here’s what John says in his uplifting memo:

The Venture Capital ecosystem has reacted swiftly and decisively to the current economic downturn. The alacrity of the collective response bodes well for the ecosystem, especially for early stage companies. With the right perspective, down markets provide tremendous opportunities, and, as Benchmark highlighted at the end of its memo to its portfolio companies, the best companies get built in down markets.

We are bullish and confident that many great companies will emerge from this recession as well.

This downturn is very different from the last one, which was like a slow motion train wreck. The NASDAQ peaked in April of 2000 and began a slow decline. Everyone hoped that it was just an inventory correction that would only last for a quarter or two.

We here at the epicenter of the Internet bubble were all in denial that the party was over. It was way too much fun while it lasted. After it was over, we funded unviable businesses for far too long, keeping them on life support and thus denying capital to new businesses that were better recalibrated for leaner times.

This time, the VC community has done the entire ecosystem a favor by quickly telling its portfolio companies to go to their bunkers, focus on the essentials, preserve cash and cut burn. We have been very impressed with how quickly portfolio companies are responding. The missives from Sequoia, KPCB, Benchmark and Foundation have been particularly effective and have provided excellent thought leadership and guidance for the ecosystem.

The topics of the day at almost all of the board meetings we’ve been
attending recently are (i) immediately rightsizing headcount and (ii) redoing the 2009 budget and operating plan. Many of our clients have gone through this painful process already and will be done with implementation by Thanksgiving or 12/31/08 at the latest.

Now you would be well advised to get a great lawyer like John who has his finger “on the pulse” of the VC community if you plan to raise any funds. In addition, John really believes in giving back to the community and runs regular useful meetings, seminars and opportunities to meet the investment community. learn more about his company here: www.montgomerylawgroup.com

What Compensation Should You Give Your Team, according to the VC?

I found this useful feedback to a question I often get here, Matt McCall of Draper Fisher Jurvetson Portage Venture Partners lays out a useful set of numbers he thinks are correct as a VC for 2008.

I thought I would lay out historically the average benchmarks with some caveats. The first caveat is that these numbers will be skewed more towards an early/expansion stage company versus a start-up or late stage companies.

The second is that with conditions worsening, a lot of companies are going to need to ask employees to take across the board pay cuts (usually in exchange for some equity) to stretch the runway out. The third is that these are non-founders stats. Founders will have much higher equity and lower salary. The fourth is that each situation is different, as is each employee, so there are trade-offs between salary and equity.

• CEO (non-founder)
  Salary $180-200k, bonus $50k+, equity around 5-7%
• CMO
  Salary $150-175k, bonus $50-75k, equity around 2%
• COO/CFO
  Salary $150-$175k, bonus $50k, equity 1-1.5%
• VP, Sales
  Salary $150k, bonus tied to sales (usually in the $50-75k+ range), equity of 1-2%
• Other VP spots
  Salary $140-150k, bonus $25-50k, equity 0.75-1%
• Director and below
  The market will dictate these. Directors usually in the $110-130k range, key programmers in the $90-120k range, controller in the $50-80k range depending on experience.