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Do You Really Want to Raise Money From a Venture Capitalist?

Freaking Heck's picture




 

By Chris at www.CapitalistExploits.at

When I was much younger everyone, myself included, wanted to be a hedge fund manager. And who could blame us. After seeing the kind of houses these folks lived in, any sensible bloke with aspirations of ditching the 30-year old Fiat for a Porsche wanted a hedge fund of their very own. They clearly brought only wonderful things to those who had one... except maybe Raj Rajaratnam.

A near mythical status was attributed to these God-like people, hedge fund managers that is. Even the excessively rotund, cabbage-faced geek, with the hygiene of a garbage bag would find himself swarming with girls should he let it slip that he indeed manages a hedge fund.

Today a similar status seems to have descended like a blanket of fog over venture capitalists. Like the aforementioned hedge fund managers, they're largely misunderstood. Fog does that. It makes things... well, foggy.

A conversation I had with a couple of entrepreneurs shows the thickness of the fog.

The conversation went something like this:

Me: So how are you financing this?

Founder: We've raised some family and friends money a few months ago and now we're looking for VC money.

Me: Why VC money? Why not angel money? (this is a very early stage company which is nowhere near being ready for VC capital)

Founder: Well VCs have a lot more money than angels, and we don't want to waste our time with angels. We're going straight to the top.

Me: The top of what?

Founder: Well VCs are it really. They've at the top. I mean they've got to where they've got to by being really good. No, we need VC money.

Me: Really? What do you believe they're going to bring you that angels can't?Founder: The expertise we get from VCs is going to help us a lot.

Me: Really, how do you figure that?

Founder: Well, VCs have more money, they have more contacts and they can get us strategic relationships.

Me: So you're expecting them to be quite active in your business?

Founder: Yes.

This sort of thinking is complete horseshit and I told the founder so.

Companies have different capital requirements during their life-cycle, but as I mentioned last week, it is an entrepreneur's job to identify the most efficient and attractive source of capital at any given point in the company's life-cycle.

The gentleman mentioned above had an extremely early stage business. Just a few months old, and not much more than an idea. What he needs is pre-seed capital which almost never comes from VCs as the amounts in question are very small, often only a few hundred thousand dollars. He would have been better off sourcing angel money for two reasons:

  1. His business was not yet mature enough to take to VC money, and
  2. He needed additional help in his company on the skill side. This would most likely be easier for him to get from an interested angel investor who could join the board, than it would be from a VC fund.

The problem, I realised, that this entrepreneur faced, was that he didn't understand the nature of what venture capital was, and had lumped venture capital together with anything related to private funding.

The trouble is if you don't understand the person you're trying to raise money from you land up wasting both parties time.

And furthermore, when the time does come and your business is at the stage where it needs to secure venture capital you can pretty much write off the VC you pitched earlier; he's already had a bad experience with you since he realised you never did your homework before talking to him.

I've always felt that the relationship between entrepreneurs and investors is or should be that of a partnership. Those funding your business are partners in your business and as such you should educate yourself about who they are, what their motivations are and what they can and cannot bring to the table.

Who, Then, Are Venture Capitalists?

Perhaps let's look at the structure of a typical VC fund as this will shine some light on the subject.

What takes place is that a bunch of smart, and sometimes not so smart guys, and sometimes gals, get together and form a company with the objective to get filthy stinking rich and they intend to do this by investing in exciting early stage ventures.

These guys are called the General Partners (GPs) and in order to leverage what they're doing, they take in partners who wish to co-invest. These partners are passive and called Limited Partners (LPs) and they are usually charged 2% of capital and 20% of the carried interest, which in the industry is commonly known as 2:20.

VC Fund Structure

The more money the GPs can raise from Limited Partners the better for them. More capital means more fees and returns. For example, a VC fund with $1 million under management that generates a 2x return will only earn the GP 20% of $1 million or $200,000.

On the other hand, a GP with $100 million who earns only 6% will earn $1.2 million or 20% of the $6 million, not to mention the 2% of fees, which on a $100 million fund amount to $2 million. Assets under management (AUM) are therefore super important to VCs.

What Does This Mean to You As a Founder Looking to Raise VC Money?

It means that your company should be large enough to be investable and it means that as an entrepreneur you need to understand who you're talking to.

As an entrepreneur, right NOW may very well be THE best time to raise money because there are those who are throwing it out like a lolly scramble at a 5-year-old's birthday party.

VC Throwing Money

All that said, VCs are going to protect themselves. They understand they are investing in a risky asset class and will limit those risks as much as is possible. They're going to demand liquidation preferences, maybe even 2x, and they're going to take board seats.

Realise also that VCs, evil as they may look, are not their own boss. They answer to the LPs, and if they answer to their LPs and you take their money, you now do as well. Oh, and remember, LPs are often made up of pension funds, endowment funds, funds of funds and the like. As such LPs tend to know about as much about your business as they do about the city of Ouagadougou... not so much.

What do LPs want?

Exits.

If LPs want exits it means your investor want exits. Now that sounds a bit like stating the obvious but realise that one of the biggest risks behind venture capital is the lack of liquidity and there will be a push for liquidity whether you the founder like it or not.

Everyone wants to eventually see liquidity. This is why companies will IPO even if it means, like in the recent case of Square, the valuation is lowered.

Case Study

Consider for a moment some of the VCs in Square who got in at the Series E financing. Many invested with a 1.3x ratchet. Some elected to waive the ratchet and they're staring at losses as a result, but many did not. It's the VCs who are making money and the difference comes out of, you guessed it, founders' pockets.

 As an entrepreneur it's important to know this early on when you're taking VC money. Maybe you're OK with that and you still walk away very rich, and maybe you don't. It all depends on how much dilution you've already taken on and how much you can still take, and the size of the opportunity you're hunting and how you execute on that.

Accretive dilution is fine and everyone is happy to see it, but as you can see VCs cover the downside and that means that someone has to pay for that protection. That someone will be staring you in the face every morning as you brush your teeth.

Now Jack Dorsey is still the largest shareholder owning over 24% of Square and we won't be crying for him. Remember, this is one of the success stories.

What is important to understand is that as a founder it's entirely possible to end up in a situation where your interests are no longer aligned with those of your shareholders.

It can happen where your VCs want that trade sale, or IPO, and you as a founder don't. Maybe you've incurred too much dilution and a trade sale or IPO at the market price, based on your equity, means that VCs with a 2x liquidation preference make money, and you, after working 100-hour workweeks, losing your marriage and friends, after mortgaging your home, end up with nothing. Yep. Nada. Zilcho. It happens. I'd rather it didn't happen to you.

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Sun, 12/06/2015 - 03:04 | 6882417 Fed-up with bei...
Fed-up with being Sick and Tired's picture

So, I think, HMMM who are these guys writing this piece?   I went over to their website and they are identifying themselves as "Chris and Mark" and are offering no last names!   So, I click on every link within the site and again, I might be missing it but NO LAST NAMES.  Click on the DISLAIMER BUTTON and it says, hilariously, "do your diligence."  That is a mockery as these guys are not even disclosing the very first piece of any interchance, "WTF IS YOUR FULL NAME, SIR??"

Sat, 12/05/2015 - 19:20 | 6881290 AMPALANCE
AMPALANCE's picture

So I have a unique design that is a vast improvement over what is currently available both in practicality and from a price point of view, something farmers and even gardeners could use to save them time and money. I'm building the prototype right now, and if it works I'll build 10 or so and start testing them. A patent is upwards of $8,000 and this may be at best a cottage industry. When asked why I didn't call Shark Tank, I replied I was not willing to give 10 or 15% of my idea away. He just look at me funny and walked away. People really have no clue. 

Sat, 12/05/2015 - 20:13 | 6881497 STP
STP's picture

A Provisional Patent would cost you less than half that and provides the same protections.  The good, find a good patent atty to help you out.  I've got a pretty good one).  The bad:  it's only good for a year, but if you can launch it, in that time frame, the money may be there to get the regular patent.  As far as Shark Tank, pfft.  I wouldn't buy one out of ten products that they've featured there.  If your story is not interesting enough, they won't even bother contacting you.  Ask me how I know.  Best of luck to you!

Sun, 12/06/2015 - 03:07 | 6882421 Fed-up with bei...
Fed-up with being Sick and Tired's picture

I think that  PPA is worth about the amount of the paper one burns applying them on...A PPA is a costly worthless effort.  If you cannot raise the capital on a NOVEL IDEA, one that NO ONE ELSE has ever offered the market, and you have kept this idea a SECRET, then you will FIND THE MONEY to afford a true patent.

PPA IS A TIME waster.  Don't ask me why I know.

Sat, 12/05/2015 - 20:50 | 6881630 AMPALANCE
AMPALANCE's picture

Thank you, I was thinking about building it, testing it, provisional patent then croudfunding on kickstarter to see what kind of interest I could generate. That should make a Patent reachable or tell me if no-one will pay for it.

Sat, 12/05/2015 - 19:07 | 6881241 AMPALANCE
AMPALANCE's picture

Long Death Spiral Finacing.

Sat, 12/05/2015 - 16:37 | 6880791 cheech_wizard
cheech_wizard's picture

Venture?, I swear I read Vulture...

 

Sat, 12/05/2015 - 15:52 | 6880650 pitz
pitz's picture

Most startups used to be almost fully funded by the engineers that started them.  In an era when engineers made enough money to comfortably own homes and were in enough demand to return to their previous jobs in industry if their startup plans failed, the startup culture flourished.  As did the broader economy.

But with the VCs these days, the startup culture is a giant mess.  Wholly and completely nonsensical ideas are funded, while plenty of stuff simply isn't funded.  The employees have very little upside or skin in the game so they don't work as hard (and many are treated horribly if they outlive their immediate usefulness).  Basically put, having "financial" guys in charge of this, as VCs, has created an absolute disaster of an economy.

Hopefully the 'flush' that will certainly be applied to the tech sector is severe enough that the VC fantasies are forever wiped out and engineers can be allowed to create real value for themselves and the economy. 

 

Sat, 12/05/2015 - 13:39 | 6880249 InnVestuhrr
InnVestuhrr's picture

I can tell you from my own experience as co-founder in 2 high-tech startups what the VC will bring you:

1. Their buddies, whom they trust to be their obedient agents, implementing any orders given without challenge and without regard for the success of the company, and whom the VC reward with undeserved unearned power and ludicrously high undeserved unearned salaries, bonuses and stock options.

2. Oceans of internal political strife conflict and intrigue as a result of the scumbag pseudo-managers brought in under #1.

If I did another startup, I would do ANYTHING to get funding for it, including narcotics trafficing, smuggling contraband, big robbery take-downs, etc rather than take 1 cent of VC funding if the VC funding includes giving ANY control to those parasites.

Sat, 12/05/2015 - 13:19 | 6880178 STP
STP's picture

And get this, the Startups have a 75% to 90% failure rate!!!

Some VC guy told me, about my product, that "Tesla is going to do that" and I challenged him on that too, like they haven't even made a profit yet.

There's 234 million light vehicles and trucks, with an average age of 11.2 years old and they ain't all Tesla's, that's for sure.

Sat, 12/05/2015 - 12:12 | 6879891 Dr. Bonzo
Dr. Bonzo's picture

None of these cunts are even the least bit interested in building an actual product that will enrich your life. They're all just piling onto the latest casino scam dressed up in a pretty suit and tie. Venture capital. LMFAO....

And go running to the Fed crying foul when it all blows up in your face right? Better yet, become a mouthy 28-yo wunderkind who got lucky on a fucktard website and start pretending you're King fucking Solomon and lecturing the rest of us.

My posterchild for venture capitalists is that Ellen Pao crackwhore. Ticket punching aspring elitist tart. Harvard... MBA... law school.... tick off all the elitist boxes... go work in some venture capital shithole... turns out aside from her eidetic memory she can't even give a decent blowjob while she's fucking her way to the top... gets fired... courtesy of her drama queen persona and elite ticket punching gets hired at Reddit... then shows what a true commie powermongering social justice warrior cunt she really is.... fires top Reddit staffers then announces shes going PC on Reddit....pfffff..... venture capitalist. Doesn't understand the company; it's culture, it's customer base, nothing. So what was the basis of hiring her again? Oh right. She was a professional student for 20 fucking years. The Wright brothers actually BUILT something. Thomas Edison BUILT something. Henry Ford BUILT something. What the FUCK did Ellen Pao ever fucking BUILD????? Venture capitalists. Hipsters make my balls itch with their bullshit. Sit in a fucking classroom for 20 years commiting other people's horseshit to memory she's crowned "venture capitalist" and basically demonstrates she's nothing but an aspiring get-rich-quick hack. BUT... no... our aggressive masculine male orientated tech industry did her in. LMFAO. Here's the really funny thing. Ellen Pao is just a patently obvious hack, she's representative of an entire generation of fucking hacks, MBA fucktards and venture capital morons climbing over eachother to get that brass ring first. Don't hold your breath for a better mouse trap though. Pfffff......

The fucking Chinese are going to eat our fucking LUNCH because of you fucking morons. I swear to god.........

Here, an old truism updated for our new age.... venture capital... the last refuge of a scoundrel.

Sat, 12/05/2015 - 13:32 | 6880224 JRobby
JRobby's picture

Dr. Bonzo has correctly identified the Psychotic Faction surveyed for above.

"My Boy works in finance, you should see his boat!"

Sat, 12/05/2015 - 13:21 | 6880174 STP
STP's picture

From recent experience, this is absolutely accurate.  They don't want useful and they sure don't want to cater to the masses, but only the shallow needs of the affluent and the elite.

There's a gazillion repetitive Apps that they're funding.  Parking Apps, Shopping Apps, Grocery Delivery Apps, Pet Apps.  Some grocery delivery app in London, got $1.5 million for funding, it's called 'deliveroo' (how cute!).  And another called 'FanCred' is a place for Sports Fans, to help you capture your favorite moments as a sports fan.  And there's another, for providing a 'safe place' for High School Reunion members.  It's really fucking pathetic.

Yet, when you come up, with a really useful product for the working class, you get to see the real stupidity of the VC crowd.  If you look at their 'Team' tab, none of them, have ever gotten black grease under their fingernails, while changing their own oil, unlike the scores of millions, that do just that.

I have three Major Corporations, including a division of Snap On Tools, providing me with all the vehicle service data, all the consumables and even tires on single virtual business card.  All my working class buddies love it, as I have a hobby shop in an industrial center.  But what do I hear from the VC crowd "It's not a fit for us".  Like, you don't want to make money?

One of the VC firms has a bunch of limited partners, that were all Automotive powerhouses.  Penske and a whole host of automotive ex-Presidents, VP's and the like and they have some 28 year old, nitwit woman, who knows nothing, asking me on the phone "What happens if you uplift a passenger vehicle to a commercial vehicle, what happens to the insurance?"  And I'm thinking WTF?  I've never heard of that?  She gave me, the "It's not a fit for us" answer.

 

Another VC firm, had some Asian guy, who said in his bio, that he's 'intensely dedicated to finding solutions to the problems of everyday people'.  And he turned me down.  I called him out on his lie, because my product would help the everyday, guy who changes his own air, oil and fuel filters, who shops for his own tires, who replaces the wipers on his wife's car and is sick of looking up the maintenance info, repeatedly for the three cars that they have in the family.

The CarInfoCard will fly one of these days, I just got to find someone in the VC crowd, who gets it.  Unfortunately, as mentioned, the only thing they know about their cars, is what the service guy at the dealership tells them.

 

Mon, 12/07/2015 - 23:35 | 6891723 herkomilchen
herkomilchen's picture

 

I just got to find someone in the VC crowd, who gets it.

This article just explained why you are looking in the wrong place.  VC's don't fund businesses in the idea stage, angels do.  You need angel funding.

Look beyond formal angels and create your own informal angels.  If your product is as great as you say, you should have no problem fashioning a mock-up, prototype, or demo and a killer sales pitch that gets potential customers excited.  They can then become your angel investors via heavily discounted advance purchases or standard equity stake investments. If you can't sell potential customers on the concept now, you couldn't have sold them on it after you blew a bunch of VC money.

Same with suppliers and employees.  If they all agree you have an obviously lucrative business idea, they'll accept dramatically reduced rates for their services and deferred payments in exchange for a piece of the action.

If your idea is only appreciated by real people running real small automotive businesses, then target those people.  Try to get $1K-$10K each from 50 of them.  Invite them to see how you run your current business, buy them dinner, walk them through your plan to make them money.  Give them promotional consideration or preferred partner status simply for investing.  Put all of them on your advisory board.  Invest them emotionally in the excitement of the business's birth and growth.  Have all your current business partners and customers vouch for your integrity and character.

There are a lot of ways to skin the funding cat.  Let that task be the first of the long line of entrepreneurial challenges to come that you'll need to be able to think out of the box to solve.

Sat, 12/05/2015 - 16:53 | 6880837 hongdo
hongdo's picture

Real world?  Whats that?

Sat, 12/05/2015 - 17:24 | 6880933 STP
STP's picture

LOL!  That's the world with an old stained Proctor and Silex coffee pot on the counter versus a Keurig machine with the cute little cups.  The world, where you're supposed to get your ya-ya's in reality and not digitally.  Big difference between Mario Kart and a Shifter Kart that has a Kawi 250 two stroke and six gears to pound through an five seconds or so.  Now you're doing 80 mph+ and the corner is coming up fast, real fast. 

Even what they drive tells us all about most of them.  They don't have a fucking clue about what goes on, underneath that big plastic cover under the hood.  They'd have trouble telling apart a butt plug, from a spark plug.   They've never touched nothing but the key and the steering wheel.  Unlike my 1974 Corvette Stingray, where I've had my hands in, on or around every single inch of that car, inside and out.  It doesn't even hava an idiot light!   You'd better be looking at the gauges like a man, knowing what's normal, oil pressure, coolant temp, ammeter and the vacuum gauge mounted where the clock used to be.  And rowing the gears on a Borg Warner Super T-10 four speed, with a big old heavy duty clutch for the occasional drag strip run (and of course, getting your ya-ya's on in a quiet area...).  Best of all, there is no buzzer, chime, bell, beeper, robo voice or gong, bitching at you, just for opening the friggin door.

That's liviing, by golly.

 

Sat, 12/05/2015 - 11:15 | 6879792 Open_outcry
Open_outcry's picture

I network with VC's as an outsourced service provider for start ups. This piece is accurate. What is missing, and more telling for this investment space, is that only $4Bill in new VC funds were raised in Q3 '15. While that may seem like a lot, it is down from $10Bill in the previous quarter. Valuations had become ridiculously high and are now contracting. Fewer successful IPO exits. It seems like the air is coming out of the VC bubble.

Sun, 12/06/2015 - 00:06 | 6882123 pitz
pitz's picture

What knd of 'exits' were they really expecting when most 'start-ups' have little more in assets than a couple coffee makers and boxes of pizza pockets? 

Sun, 12/06/2015 - 10:01 | 6882866 Gordon Freeman
Gordon Freeman's picture

They should call them "Tart-ups"...

Sat, 12/05/2015 - 10:56 | 6879759 illyia
illyia's picture

Nice piece. Quite useful, actually.

Thanks

Sat, 12/05/2015 - 12:36 | 6879753 Graph
Graph's picture

Be it a tired waitress, who still manages to muster a smile while serving you and makes your day, an engineer who designs bridges and airplanes, productive (producing something that you can touch!) business owners, and just about anybody making a honest day of work: THEY HAVE NO CHANCE in a society where this psyho and his ilk are allowed to operate.

There is a diferrence of driving a Porche which is a natural product of your skills, and a Porche that becomas a GOAL (to obtain at any price), which I gather is a meaning of life from asshole's musings!

Sat, 12/05/2015 - 13:28 | 6880213 JRobby
JRobby's picture

Which Psycho?

Perhaps narrow it down? Which Psychotic Faction?

“what a horrible loutish planet this is. the dominant species consists of sadistic morons, faces bearing the hideous lineaments of spiritual famine swollen with stupid hate. hopeless rubbish.”
? William S. Burroughs, My Education: A Book of Dreams

Sat, 12/05/2015 - 13:58 | 6880292 Graph
Graph's picture

If asshole asked if he would like to be Jaimie D. or Loyd B. he would have said:

"HELL, YESSS!" THAT (Gekko, God-like) Faction!

Thanks for correcting my typo. You could have gone  further w/ Porsche. as well :)

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