Tag Archives: Private Equity

Why VCs Won’t Sign Your NDA

Plain and simple: just don’t do business with people that you don’t trust. Once the genie is out of the bottle…

Why VCs Won’t Sign Your NDA

Written by Audrey Watters / May 10, 2010 7:30 PM / 7 Comments

There are several important documents you’ll want to have ready when you meet with potential investors. Your mission statement. Your founding team’s resume and responsibilities. A business plan.

But most investors agree: they do not want to sign an NDA.

While non-disclosure agreements are designed to protect your ideas, asking potential investors to sign an NDA is generally seen as unnecessary and unwise. Most VCs point to the following reasons for avoiding NDAs:

1. Trust. Potential investors are not your competition, and asking them to sign an NDA is often interpreted as a sign you don’t trust them. As professional integrity is important to VCs, requiring an NDA is generally seen as a violation of business etiquette.

2. Legality. An NDA is a legally binding document, and as such, it’s something people will refuse to sign without having a lawyer review. Most investors are unwilling to accept the risk of litigation should they hear about a similar concept – and it isn’t a stretch to assume that investors are weighing multiple pitches with similar or related concepts. Furthermore, an NDA means the investor is restricted from mentioning you, your idea or your project. And chances are, as an entrepreneur, you do want your investors to talk about you.

3. Ideas. Good ideas are dime-a-dozen. As Andrew Warner argues, “Ideas are worthless. It’s your execution of those ideas that will be valuable. Besides, this idea that you’re so proud of now will probably change completely as you build your company.”

There may be times in which you should require a non-disclosure agreement. As Anil Dash recently wrote on this subject, “Now, I’ve had clients ask for an NDA, which makes perfect sense, and I might ask contractors working for me to do the same. Or some big companies just have a boilerplate NDA that they throw in front of people as a matter of course. But for individual entrepreneurs who just have a good idea and big dreams, it’s easy to be misled into thinking that walking in the door with a fancy legal document makes you look professional or ‘serious’.”

Whether or not you ever consider an NDA, it is advisable in the early stages of forming your business that you share your ideas and plans with people you trust. And if you are approaching someone as a potential investor, it’s important that relationship be build on credibility and integrity, not on a legal document.

via Why VCs Won’t Sign Your NDA.

China grew >10% in 2009; about to surpass Japan

While getting gas (petrol for our international readers) this morning, I heard on NPR (National Public Radio) that China released it’s numbers this morning. Their economy grew by over 10%! There was a discussion about whether China would beat-out Japan in 2010 to be the #2 economy in the world; the US being #1. Well, I have to say: not bad for a bunch of communists. Oh, did we all forget? One consistent thing that I hear about China is that things happen gradually. So I’m wondering when their form of government will catch-up to their economy.

Now you may ask yourself: how did the Chinese do that in 2009—the year of pain and intense pucker-factor? Well, their Government pumped $1.44 Trillion (with a capital “T”) into their banks which in turn pushed it into the hands of the consumer and small business. Hey, didn’t we do that in the US? Why yes; yes we did. Except that the US banks horded the cash and kept a tight lid on credit. So, small businesses (which really fuel the economy and have the greatest affect on unemployment) still can’t get any credit, which means that they have diminished working capital and are stuck in survival mode. Also, this morning on the TV I saw a snippet with my idol Warren Buffet . He said that the current US “Stimulus Package” was like “taking 1/2 a Viagara” and that now we need to do the rest. Man, I love this guy!

In the interest of full disclosure; I have owned Berkshire-Hathaway for over 15 years.

Banks Hording Cash as of July 2009

Angel Investors – The Good, Bad and Very Ugly | Dr. Earl R. Smith II

Here is another blog about start-ups, PE/VC, and entrepreneurship that I thoroughly enjoy. I would like to share it with you. Dr Smith has a wealth of info and his reader’s comments are also very useful.  Please go to his site and read the comments.

Angel Investors – The Good, Bad and Very Ugly

Posted by Dr. Earl R. Smith II



There is a tendency among entrepreneurs to chase money wherever they find it. The pressure to find the financial resources so necessary to build a business can be over-mastering. Most of the time the partnerships which form between founders and angel investors are productive but, in a few cases, I have seen it turn very destructive. Companies that should have realized success have been held back by investor partnerships that have severely limited their potential or, in some cases, doomed them to failure.

Look Beyond the Checkbook

It may be hard to be discriminating when you are in the heat of the ‘money hunt’ but the sins of omission you commit while chasing investors can return ten-fold to destroy any chance of success. The problem become acute because of the incredible range of circumstances, experience and interests that angel investors bring to the table. Their having money to invest in not enough. You need to understand their basic motivations and what is driving them to act as an angel investor. You also need to understand that all investment money is not the same. Some money will help you succeed while other investments will be a poisoned pill that will reduce your chances of building the business you envision. Here are some ‘sacred cows’ that you need to slaughter:

  • Angel investors are in it for a return on their investment: Well, how can you argue with that? You would assume that the primary driver is always a return on investment. But, as you will read further on, that is not always the case. I know angel investors who are simply bored and looking for something to do and others who are frustrated CEO-wannabees. For some investors, it is all about a return but for others the return is secondary. You need to sort these two groups out. Do not listen just to what they say; it is what they do that is important.
  • They have money they; must be smart: This is another fallacy. Some of the dumbest and most self-destructive people I have ever met are wealthy. I have found only a weak correlation between wealth and intelligence and a slimmer one between wealth and wisdom. Many a destructive hubris has been built on a fat bank account. Investors have an important role in start-ups but pretense, omnipotence or omniscience can warp an investor’s understanding of that role. Smart investors play their part in a highly professional and constructive manner. Seek them out; they are most likely the winners you want to associate with.
  • They have been successful in business so they will know how we can be: Past success is not always a good indicator of wisdom going forward. In fact, great success can be counter-productive when they decide to work with start-up companies. I know one investor who continually regales his CEOs with stories of how he ran his company. Of course, the company was running over one hundred million annually when these stories took place. The CEOs, wanting to emulate his success, take steps that are entirely premature. The result is wasted resources and a dysfunctional corporate culture. Past business success is not a good indicator of professional performance as an investor. Remember, you are seeking an investor, not a shadow CEO.
  • They will become my close personal friends and advisers: Not a good idea; the correct focus of investors should produce a tension in the relationship with management. If you want a friend, buy a dog.

The Bad and the Very Ugly

The problem with writing about angel investors is that they come in an amazing variety. I have met lots of them and there is always something different about each. The ease of entry into the field may have something to do with it. The only real entry requirement is wealth beyond current needs. That’s all it takes to become an angel investor. There are no educational requirements, courses to take or certifications to merit. Only a bank account and a decision to ‘invest’ are required to hang out a shingle and open up for business. Watch out for the following:

  • The Shadow CEO: I have met investors who purposefully pick weak or inexperienced CEOs to work with. Their real agenda is to run your company from the back seat. These investors are very intrusive and will push you to make decisions and commit resources that will put your company at risk. They are mostly successful entrepreneurs who have built and sold a business. In the process, they have lost touch with the necessary energy levels and passion that is essential to building a start-up into a going business. Mostly they remember the later stages of their company and the extended staff they had. Then they turn the CEO into a kind of executive assistant and attempt to run the company by proxy. Most of the companies in the portfolio of this type of investor remain very small. They generally have very complex Excel spreadsheet projections and poor records in meeting them. Stay away from the Shadow CEO; they are very dangerous investors.
  • The Crazy, Rich Uncle: This is probably the most dangerous type of angel investor because they are so easy on the management team. They are mostly retired and living comfortably. Their mission in life is to ‘give back to the younger generation’. A clear indication of this type is the total lack of performance metrics and a weak statement of expectations. They can be very seductive to entrepreneurs but there is a dark side. Without stiff set of performance metrics, the company can develop a culture of permissiveness. That will feel good until the money runs out. A key indicator of this type is the feeling that the amounts of money involved are, at least initially, not sufficient to cause them concern. The expenditure patterns are not carefully monitored and discussions do not turn serious until the money is spent and the wolves are at the door. As an entrepreneur, you need to seek out investors who will be hard on you; insisting on strict performance metrics and precise definitions of roles. Take the easy way out and you will be in for a ride to nowhere with a crazy, rich uncle. Sure you will enjoy the ride but, in the end, you will be let off the bus in the middle of nowhere with a tarnished reputation for failure.
  • The Gaggle: Remember the old saying about a camel being a horse designed by a committee? These gaggles are fond of that kind of engagement. The investments that they make are very often selected in a very casual way and supervised fairly loosely. The problem comes as the group itself is very loosely organized. Different participants might have significantly different understandings of what it mean to be an investor and what that status entitles them to. The can range from complete indifference to total immersion in the management of the company. This situation can result in lots of pulling and pushing of the management team without an overarching strategic vision. Investments should be made based on clear and concise understandings codified in a detailed investment agreement.
  • The Bottom Feeders: You will meet some investors who are really only interested in your intellectual property. They ‘drag the bottom’ of the entrepreneurial community looking for weak teams with good ideas. Mostly they insist that their funding be used to develop the technology rather than developing revenues. Once the money runs out, they regretfully inform management that they are closing the company down and talking the intellectual property as compensation for their investment.
  • The Lead Broker: I have seen these lead brokers promote themselves into central roles in companies without putting much of any of their own money on the line. The net result is that the bulk of the investor group gets involved without much direct knowledge of the business or the management team. In one case, such a broker put together an investment in excess of one million dollars without making any investment of his own. He still managed a seat on the board and a dominate role in the management of the company. Be particularly careful of the broker who can invest but does not. This situation can turn nasty if expectations are not met. Finger pointing and recriminations can come to dominate the relationships among the investors. This could seriously damage chances of follow-on investments by the group.

The Good

Good angel investors always take a highly professional approach to the process and their portfolio companies. They generally focus in industries that they are familiar with. It is a good idea to avoid angel investors whose portfolio companies do not fit a close pattern. The best angel investors will often forgo the option of claiming a board seat and, instead, insist that an independent board member with professional experience be appointed. Beware of investors who seem to see investment in your company as an opportunity to enhance their reputation by sitting on yet another board. Here are some positive things to look for:

  • Success Breeds Success: There are angel investors who have the knack to help their portfolio companies thrive; while others seem to doom them to failure or stagnation. I know of one angel who specializes in little deals and has a well developed ability to keep them that way. Other investors seem to have the opposite skill. Their companies grow and prosper. It is a good idea to do some diligence on the track record of the investor. Go with the successful ones even if the deal terms are less generous.
  • The Investment Agreement: There ought to be a detailed investment agreement agreed to before any funds are transferred. This agreement should be very specific when it comes to the roles and responsibilities of each party. The best agreements provide for an earn-in by management based on performance. It also sets the ground rules for further investment. Good angel investors will require this as a matter of course. The worst ones will simply require a term sheet and then write a check. Remember that the absence of planning is the road to failure. Think of the investment agreement as a strategic plan for the relationship.
  • Strategic Agreement on Roles and Responsibilities: Good angel investors will insist that the roles and responsibilities for each party be very well understood from the very beginning. These roles will be codified in the investment agreement and specify the actions that each party will be able to take under a range of possible outcomes. Although such an agreement can complicate initial negotiations, it will help greatly when performance does not meet expectations and realignment become necessary.
  • Use of Proceeds: I have seen investors write rather large checks without insisting that there be an agreed upon use of proceeds. You can imagine what happened then. Entrepreneurs initially like the freedom to simply take the money and spend it as they see fit. But, more often than not, this leads to waste and spending on things that do not connect directly to the success of the company. One company, upon receiving funds in this way, spent a lot of the money on new laptops and cell phones with expensive service plans. They replaced very serviceable units. Another CEO kept paying his salary, even through results fell far below projections, and failed to pay suppliers. The result was a law suit that is almost certain to shut down the company. It is good business practice for the angel investors to insist on a detailed use of proceeds and for control over the spending of their money.
  • Insistence on Performance Metrics: As a CEO you should be insisting on performance metrics for every member of your team. That is just good management. Your investors should take the same approach. It may seem initially easier to deal with angel investors who are very lax about this, but it is far from best practices. I am not just talking about Excel spreadsheet metrics. They have to be much more detailed than that. Good performance metrics detail the responsibilities of each member of the management team and the way their performance will be measured. Everybody from the CEO to the receptionist should have a job description with metrics attached. And the metrics should be sufficiently detailed to drive evaluations based on performance. Performance should be the driver in determining both compensation and earned-in interest in the company. Performance metrics are a sign of a professional and productive organization. Start-ups with that culture have a much higher chance of success.
  • Focus on Governance Issues and Oversight: “Who’s minding the store?” If the answer to that question is “nobody but us entrepreneurs”, consider that a red flag. In the short-term, it may feel good to be free from oversight but, in the long-term, you are guaranteed to make more mistakes and waste more opportunities. The board of directors has a very important role to fill in any corporate structure and it is not just making sure that the investors get to a liquidity event as soon as possible. Good governance means overseeing the strategic planning process, dealing with issues of succession, audit and compensation, and providing for the protections and expansion of shareholder value. This fiduciary relationship with the shareholders is an important part of the corporate structure. Without it, management is under no effective supervision and the investment looks more like a roll of the dice than an investment.

Keep This In Mind

An angel investment creates a relationship that will help determine how successful you are going to be. Your skill in crafting that relationship is a test of how dedicated you are to the success of your company and team. If you take the easy way out, your chances of success will drop significantly. If you opt for the limp relationship with an inattentive investor, your prospects will suffer. Angel investors, the good ones, bring much more than money to the table. The good ones have helped their companies succeed and will help you do the same.

© Dr. Earl R. Smith II

via http://www.dr-smith.info/angel-investors-%E2%80%93-the-good-bad-and-very-ugly

PE Fundraising Hits Brakes

PE Fundraising Hits Brakes

Podcast: Listen to this article.

on 07 January 2010, 13:55

by Red Herring Staff

Private equity fundraising declined precipitously in 2009, according to a report, its worst year since 2004.

Industry researcher Preqin on Thursday reported that 482 funds worldwide raised $246 billion in 2009, down 61 percent from the $636 billion raised in 2008.

“Although investors are in a much clearer position now than at the start of 2009, the chances of a return to the fundraising levels seen in 2007 and 2008 are very slim, Preqin representative Tim Friedman said in a statement.

Particularly dismal, fourth-quarter 2009 saw only $35 billion raised, the lowest level since third-quarter 2003.

The biggest category of funding went to buyouts, raising $102 billion by 84 funds in 2009. The largest regional deployment went to North America, where 228 funds focused there raised $145 billion. That compares with 136 Europe-focused funds that raised $74 billion and 118 Asia and other world regions raising $27 billion.

LPs have seen lower investment returns and have less money to commit to funds, according to the Preqin report, and that isn’t expected to change anytime soon unless the exit market improves.

via PE Fundraising Hits Brakes.

What’s the right amount of seed money to raise?

More words of wisdom from cdixon.org – chris dixon’s blog

What’s the right amount of seed money to raise?

December 28th, 2009

Short answer: enough to get your startup to an accretive milestone plus some fudge factor.

“Accretive milestone” is a fancy way of saying getting your company to a point at which you can raise money at a higher valuation.  As a rule of thumb, I would say a successful Series A is one where good VCs invest at a pre-money that is at least twice the post-money of the seed round.  So if for your seed round you raised $1M at $2M pre ($3M post-money valuation), for the Series A you should be shooting for a minimum of $6M pre (but hopefully you’ll get significantly higher).

The worst thing a seed-stage company can do is raise too little money and only reach part way to a milestone. Pitching new investors in that case is very hard; often the only way keep the company alive is to get the existing investors to reinvest at the last round valuation (“reopen the last round”). The second worst thing you can do is raise too much money in the seed round (most likely because big funds pressure you to do so), hence taking too much dilution too soon.

How do you determine what an accretive milestone is? The answer is partly determined by market conditions and partly by the nature of your startup. Knowing market conditions means knowing which VCs are currently aggressively investing, at what valuations, in what sectors, and how various milestones are being perceived.  This is where having active and connected advisors and seed investors can be extremely helpful.

Aside from market conditions, you should try to answer the question: what is the biggest risk your startup is facing in the upcoming year and how can you eliminate that risk?  You should come up with your own answer but you should also talk to lots of smart people to get their take (yet another reason not to keep your idea secret).

For consumer internet companies, eliminating the biggest risk almost always means getting “traction” – user growth, engagement, etc. Traction is also what you want if you are targeting SMBs (small/medium businesses). For online advertising companies you probably want revenues. If you are selling to enterprises you probably want to have a handful of credible beta customers.

The biggest mistake founders make is thinking that building a product by itself will be perceived as an accretive milestone. Building a product is only accretive in cases where there is significant technical risk – e.g. you are building a new search engine or semiconductor.

Now to the “fudge factor.”  Basically what I’d recommend here depends on what milestones you are going for and how experienced you are at developing and executing operating plans. If you are going for marketing traction, that almost always takes (a lot) longer than people expect.  You should think about a fudge factor of 50% (increasing the round size by 50%).  You should also have alternative operating plans where you can “cut the burn” to get more calendar time on your existing raise (“extend the runway”). If you are just going for product milestones and are super experienced at building products you might try a lower fudge factor.

The most perverse thing that I see is big VC funds pushing companies to raise far more money than they need to (even at higher valuations), simply so they can “put more money to work“. This is one of many reasons why angels or pure seed funds are preferable seed round investors (bias alert:  I am one of them!).

via What’s the right amount of seed money to raise? cdixon.org – chris dixon’s blog.

5 Great Blogs For Funding Advice

5 Great Blogs For Funding Advice

Written by Dana Oshiro / January 5, 2010 8:00 PM /

Photo Credit: Flickr user Alistair and Andrew Magill

The best advice we can give you is to know your audience. You don’t try to sell booze to pregnant women, you don’t make God-jokes in Utah and you don’t get a term sheet without tailoring your pitch. Investors are already blogging about what they want from potential portfolio companies, so if you’re looking for funding you should be reading their blogs. While we know there are plenty of useful investment-related blogs, here’s a list of five to get you started.

1. BOTH SIDES OF THE TABLE, @msuster: Investor, entrepreneur and blogger Mark Suster is a partner at GRP VC and recently created Launchpad LA – an incubator for Southern California-based companies. Suster has an 11 part series on what makes an entrepreneur successful and it’s a great primer for first time startup founders.

banknotes_jan10.jpg2. PAULGRAHAM.COM: Best known as the co-founder of YCombinator, Graham and his partners revolutionized the investment model. The entrepreneur popularized both the incubator-style program model and the term ramen profitable to describe lean startups. To look at what Graham is interested in, YCombinator publishes Requests for Startups on an ongoing basis.

3. A VC, @fredwilson: Perhaps one of the most well-known blogger/VCs, Fred Wilson is a principal with NYC-based Union Square Ventures. He has a 15-year track record and some of his investments include Twitter, Disqus and Etsy. Wilson is an avid blogger and offers insightful commentary on emerging tech trends as they happen.

4. VENTURE HACKS, @venturehacks: Run by startup advisors Babak Nivi and Naval Ravikant, Venture Hacks offers great advice for early stage startups. The two have raised more than $100 million dollars for companies like test prep site Grockit and open source music company Songbird. With connections to major firms such as Sequoia, Benchmark and Kleiner Perkins Caufield and Byers, the duo’s blog also features guest posts from top-tier VCs.

5. VENTURE BLOG, @ventureblog: August Capital’s David Hornik is a former lawyer who has celebrated successful investments in Evite and PayCycle. During the winter of our financial apocalypse, Hornik was one of the first investors to offer a hopeful message to startups. Entitled Innovation Doesn’t Take a Vacation in an Economic Downturn, Hornik’s post inspired many to continue in their pursuit of great products.

via 5 Great Blogs For Funding Advice – ReadWriteStart.

Options on early stage companies

I enjoy following Chris. He has included a Black and Scholes calculator in his original posting.

Options on early stage companies

August 18th, 2009

“I believe that what I’m about to say is accepted by venture capitalists as fact, even trivially obvious fact, yet very few entrepreneurs I meet seem to understand it.

An option on a share of stock of an early stage company is (for all practical purposes) equal in value to a share in that early stage company. Not less, as most entrepreneurs seem to believe (and god forbid you think “the VCs have the option to put in more money” is economically advantageous to you).

Here’s why. Black and Scholes (and Merton) won a Nobel prize for inventing the Black-Scholes model, which was the first model that somewhat accurately modeled options pricing. Using this model, and making a few reasonable assumptions (the option is “near the money,” the maturity is sufficiently far away), the key driver of an option’s value is volatility (in fact, if you listen to option traders talk, they actually talk about prices in “vols”). In public markets, options are usually priced at some fraction of the share price. This is because public stocks under normal circumstances have volatilities around, say, 20% (at least they used to 10 years ago when I was programming options pricing algorithms). …”

Continued at Options on early stage companies — cdixon.org – chris dixon’s blog.

Start-Up Tool Kit – Term Sheet Creator

Start-Up Tool KitOrrick's Emerging Companies Group is a leading advisor to start-ups, with more than 700 emerging company clients in the United States, Europe and Asia. The group features lawyers in nine offices around the globe, including more than 100 lawyers in our Silicon Valley office.Orrick's Start-Up Tool Kit is a comprehensive set of resources designed to aid start-ups and their founders on the journey from the “garage” to the global marketplace.Use our Start-Up Tool Kit to memorialize agreements with co-founders or potential investors, understand the terms and terminology of key legal documents, and network and learn business strategy and the latest industry news.

via Orrick – Start-Up Tool Kit – Term Sheet Creator – Start-Up Forms Library – TOTAL ACCESS Events.

A Sad Truth re last year’s financial crisis

Interesting perspective…it’s not your Daddy’s stockbroker anymore…

A Sad Truth re last year’s financial crisis
October 14, 2009
Op-Ed Contributor
Wall Street Smarts

“IF you really want to know why the financial system nearly collapsed in the
fall of 2008, I can tell you in one simple sentence.”

The statement came from a man sitting three or four stools away from me in a
sparsely populated Midtown bar, where I was waiting for a friend. “But I
have to buy you a drink to hear it?” I asked.

“Absolutely not,” he said. “I can buy my own drinks. My 401(k) is intact. I
got out of the market 8 or 10 years ago, when I saw what was happening.”

He did indeed look capable of buying his own drinks – one of which, a dry
martini, straight up, was on the bar in front of him. He was a
well-preserved, gray-haired man of about retirement age, dressed in the same
sort of clothes he must have worn on some Ivy League campus in the late ’50s
or early ’60s – a tweed jacket, gray pants, a blue button-down shirt and a
club tie that, seen from a distance, seemed adorned with tiny brussels

“O.K.,” I said. “Let’s hear it.”

“The financial system nearly collapsed,” he said, “because smart guys had
started working on Wall Street.” He took a sip of his martini, and stared
straight at the row of bottles behind the bar, as if the conversation was
now over.

“But weren’t there smart guys on Wall Street in the first place?” I asked.

He looked at me the way a mathematics teacher might look at a child who,
despite heroic efforts by the teacher, seemed incapable of learning the most
rudimentary principles of long division. “You are either a lot younger than
you look or you don’t have much of a memory,” he said. “One of the speakers
at my 25th reunion said that, according to a survey he had done of those
attending, income was now precisely in inverse proportion to academic
standing in the class, and that was partly because everyone in the lower
third of the class had become a Wall Street millionaire.”

I reflected on my own college class, of roughly the same era. The top
student had been appointed a federal appeals court judge – earning, by Wall
Street standards, tip money. A lot of the people with similarly impressive
academic records became professors. I could picture the future titans of
Wall Street dozing in the back rows of some gut course like Geology 101,
popularly known as Rocks for Jocks.

“That actually sounds more or less accurate,” I said.

“Of course it’s accurate,” he said. “Don’t get me wrong: the guys from the
lower third of the class who went to Wall Street had a lot of nice
qualities. Most of them were pleasant enough. They made a good impression.
And now we realize that by the standards that came later, they weren’t
really greedy. They just wanted a nice house in Greenwich and maybe a
sailboat. A lot of them were from families that had always been on Wall
Street, so they were accustomed to nice houses in Greenwich. They didn’t
feel the need to leverage the entire business so they could make the sort of
money that easily supports the second oceangoing yacht.”

“So what happened?”

“I told you what happened. Smart guys started going to Wall Street.”


“I thought you’d never ask,” he said, making a practiced gesture with his
eyebrows that caused the bartender to get started mixing another martini.

“Two things happened. One is that the amount of money that could be made on
Wall Street with hedge fund and private equity operations became just
mind-blowing. At the same time, college was getting so expensive that people
from reasonably prosperous families were graduating with huge debts. So even
the smart guys went to Wall Street, maybe telling themselves that in a few
years they’d have so much money they could then become professors or
legal-services lawyers or whatever they’d wanted to be in the first place.
That’s when you started reading stories about the percentage of the
graduating class of Harvard College who planned to go into the financial
industry or go to business school so they could then go into the financial
industry. That’s when you started reading about these geniuses from M.I.T.
and Caltech who instead of going to graduate school in physics went to Wall
Street to calculate arbitrage odds.”

“But you still haven’t told me how that brought on the financial crisis.”

“Did you ever hear the word ‘derivatives’?” he said. “Do you think our guys
could have invented, say, credit default swaps? Give me a break! They
couldn’t have done the math.”

“Why do I get the feeling that there’s one more step in this scenario?” I

“Because there is,” he said. “When the smart guys started this business of
securitizing things that didn’t even exist in the first place, who was
running the firms they worked for? Our guys! The lower third of the class!
Guys who didn’t have the foggiest notion of what a credit default swap was.
All our guys knew was that they were getting disgustingly rich, and they had
gotten to like that. All of that easy money had eaten away at their sense of

“So having smart guys there almost caused Wall Street to collapse.”

“You got it,” he said. “It took you awhile, but you got it.”

The theory sounded too simple to be true, but right offhand I couldn’t find
any flaws in it. I found myself contemplating the sort of havoc a horde of
smart guys could wreak in other industries. I saw those industries falling
one by one, done in by superior intelligence. “I think I need a drink,” I

He nodded at my glass and made another one of those eyebrow gestures to the
bartender. “Please,” he said. “Allow me.”

Calvin Trillin is the author, most recently, of “Deciding the Next Decider:
The 2008 Presidential Race in Rhyme.” This piece appeared in the NY Times.

Company Math vs VC Math

Eyeopening to see the demands and expectations of this industry.  It’s boomed in the past decade and performance expectations have not been adjusted.

Company Math vs VC Math

“Fred Wilson has a great blog post today entitled The ‘We Need to Own’ Baloney. In it he discussed the fact that many VC’s apply arbitrary ownership thresholds to investments. I couldn’t agree with Fred more – but I’d take it even further. This is not just limited to ownership requirements. Rather, VC’s often impose “VC math” on companies in three areas:

  • The amount VC’s “need” to own
  • The amount VC’s “need” to invest
  • The return VC’s “need” to generate certain exit returns

These “requirements” are a direct result of the mathematical model that venture funds are optimized for.  And as fund’s have gotten larger, their math has gotten more difficult.  We’re now witnessing the conclusion of a “10 year experiment” where money invested in venture funds has exploded and fund sizes have more than tripled in size.  A decade ago, 75% of all venture funds raised were under $100 million.  In 2007, fewer than 25% of all venture funds raised were under $100M.  And I don’t think it’s a co-incidence that VC performance has fallen off a cliff during this time period.  Indeed, we’re approaching a point where the 10-year return in venture capital is negative.  Paul Kedrosky recently authored a paper for the Kauffman Foundation which discusses this in great detail and proposes that the venture industry needs to be “rightsized” — and suggests a 50% reduction.  It’s a great paper — but if you don’t have time to read it, the money chart is below:


Fred Wilson has previously written about the VC math problem — but he approached it from the macro/industry perspective.  I agree, and think it’s even more scary when you look at it from a micro/fund perspective.  Take a $400M venture fund.  In order to get a 20% return in 6 years, they need to triple the fund — or return $1.2B.  Add in fees/carry and you now have to return $1.5B.  Assuming that the fund owns 20% of their portfolio companies on exit, they need to create $7.5B of market value.  So assume that one VC invested in Skype, Myspace and Youtube in the same fund – they would be just halfway to their goal.  Seriously?  A decade ago, any one of those deals would have been (and should have been) a fundmaker!

As a result of this new math, VC’s end up super-focused on the longbets (or moonshots) and frequently remove optionality for mid-tier exits.  It has, as Super LP Chris Douvos has written, become a game of finding the next Curtis Sharp.  It is because of the challenges of “VC math” that First Round Capital chose to raise a relatively small fund — allowing us to continue to make initial investments that average $600K.

I understand the importance of aligning one’s time and capital to the upside opportunity, and recognize that there is some minimum threshold of ownership that is required for a VC to commit the time and attention to an opportunity.  Does it make sense for an investor to spend the time and join the board of a company they own 2% of ?  Probably not.  However, the difference between 25% and 20% ownership — or even the difference between 20% and 10% — should not prevent a VC from investing in a promising opportunity.

It is the same “VC math” which drives a VC to seek to deploy a larger amount of capital into a company.  (Often taking a capital efficient company and helping it become capital inefficient).  And it is the same math which sometimes creates a lack of alignment between a founder and a VC around exit opportunities.  I have previously written these issues when I discussed the “unwritten terms on a term sheet“.

A company’s outcome should drive VC returns.  When VC’s required returns drive company’s outcomes, it’s a recipe for trouble.”

via Redeye VC: Company Math vs VC Math.