Archive for May, 2008

Empathy With My Clients on My Second Anniversary

May 30th, 2008

June 1 marks the two year anniversary of starting my solo law practice. Recently a friend asked if it was what I expected, and it has taken me until now to think about how to really answer the question.

The answer is yes and no (you expected something different from a lawyer?).

Yes, the work itself is what I expected. I do more or less the same thing I did when I worked in larger law firms- a mix of (i) brand-new startups focused on getting off the ground and raising money and (ii) later-stage companies concerned with negotiating and signing revenue-generating deals as efficiently as possible.

The no has to do with the structure of the business itself. Working for yourself means wearing lots of hats.  The other day someone called and asked for the “billing department”, which interrupted the “maintenance department” in the process of changing a light bulb in my office, both of which stopped the lawyer from doing the actual work of my business- advising companies and negotiating transactions.

I knew that part intuitively, but experiencing it firsthand is totally different. I have advised startups and company founders for ten years now, and having been through the startup process myself I have a *far* deeper understanding of how hard it can be to juggle all the balls that need to stay in the air to keep a business running.

So to all my past and present founder clients- nice job keeping it all going, and keep up the good work!

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How Much Money Do I Need from Investors?

May 29th, 2008

This is one of the hardest questions to answer. There is no “right” answer to be sure, but here are the considerations.

1) Raising money costs both time and money. It takes time away from other things (it is not uncommon to see revenue dip during a financing since attention is focused on the investment instead of sales), so you don’t want to do it often. Legal costs are also considerable.

2) On the other hand, raising money involves dilution. You don’t want to raise too little because you don’t want to have to do it all over again soon. You don’t want too much, either, lest you dilute your ownership more than necessary.

One rule of thumb is to seek enough cash to last 18-24 months. This allows a decent amount of time in between financings, both so that no one needs to think about the next round immediately- and so that everyone can get a sense of where the business is headed before diving into another set of negotiations.

All of this is really preamble to a fascinating hint of a different model I saw this morning. Sapphire Energy announced a $50M “open checkbook” financing that allows the company to draw as much money as it needs to commercialize its technology rapidly.

What does this mean and how is it different from a standard financing? At first blush it sounds more like “venture debt” where a company takes a line of credit from a bank and agrees to repay it in cash and/or equity, but Sapphire’s investors aren’t known for making those kinds of investments.

I am going to poke around a bit and see if I can come up with some more information on the terms of the financing. What was the valuation? How is management/founder dilution calculated? Is it less if the company doesn’t need all $50M over a set period of time? What if Sapphire needs more than $50M?

Truly new investment models are rare. It will be interesting to see what this one actually looks like.

P.S.  Sapphire’s business sounds terrific as well.  A highly scalable crude oil-like substance from algae.   Neat.

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Preferred Stock and Risk Apportionment

May 27th, 2008

I wrote a post on Gigaom over the weekend that covers the basics of a VC investment term sheet. A couple of the comments wondered whether preferred stock screws the founding team by definition. Another comment there answered the direct point pretty well (preferred stock is just part of the process). Fred Wilson’s post from this morning covers the philosophical angle as well and is worth reading as a complement to the mechanics I spelled out.

To paraphrase him- and dig under the surface of his comments a tiny bit- a VC’s job is to take risks, and so is a founder’s. The founder takes a chance with his idea and livelihood. The VCs risk someone else’s money- and in the process her own livelihood as well, because if none of her investments pan out she is going to be looking for a new line of work.

The VC may also be very active in a business, but not on a day-to-day basis. Ultimately, a VC’s job is to give an entrepreneur some tools to build a company, but the VC has only so much control over how (and how well) the tools get used.

Preferred stock helps line up the relative risks given all of these factors. As a friend of mine put it even more simply, preferred stock offers a mechanism to ensure that if things go poorly, morale runs low and everyone starts to wonder when to throw in the towel, the people actually running the company on a day-to-day basis will feel more pain than the investors.

Sometimes this is enough glue to keep the whole thing together and sometimes it isn’t. I have seen cases where a company has failed and investors have given up some of their liquidation preference so that founders can get *some* cash back. I have also seen preferred stock terms used to enrich investors at founders’ expense. There is no magic about any of it. Cheating and fairness are a function of the people involved; preferred stock is merely the framework on which the VC investment process is built.

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Same Issue, Different Worlds

May 22nd, 2008

There has been a dust-up in certain corners of the Internet recently over Twitter’s alleged failure to deal appropriately with interpersonal conduct on the site. The relevant tweets have been removed, so none of the facts are easily verifiable. To summarize the story quickly, though:

*social media consultant Ariel Walden complained to Twitter that she was being stalked and harassed on Twitter by a specific user.

*Twitter declined to take action several times over several months, citing a desire not to filter content appearing on the platform, and also saying that the alleged conduct did not, in Twitter’s mind, violate the site’s Terms of Use.

*Twitter recently made several public comments on the matter, including one to say that it is reviewing its Terms of Use to more clearly say that it will not actively monitor content.

I spent a little time looking at this and came away interested much more in the issue as a study of human behavior than anything else. Specifically, comments on Twitter’s official blog post contain nothing but glowing praise for Twitter’s approach. In contrast, the thread on Twitter’s support forum is filled with nothing but condemnation of the company. Literally in each case- the comments are 100% pro-Twitter in one venue, and 100% pro-Walden in the other.

Is there a point to this? Possibly not, except that even within Twitter, finding “community” depends on how you turn the coin- look to the official outlet and find Twitter diehard supporters; look to the support forums and find a completely different view. Fascinating.

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Two Great Videos from Someone Who Hates Video

May 21st, 2008

This post may serve to show that I am both (i) late to the party and (ii) inconsistent. When asked I will not hesitate to say that internet video bores me, and yet here I am posting two that I found terrific.

I am late to the party because the first one comes of out SXSW, a whole two months back. Apparently there was a spoof business plan competition panel there where people competed for the coveted prize of “worst website ever”. (Side note: I would have nominated AOL at basically any time since about 1994 and will vigorously defend that position, while acknowledging that it also cost me the chance to make a bunch of money in the 1990s.) The video is great because the guy spends five minutes explaining a business without ever actually saying what it does, and I’ve seen people do the same thing in real life too.

Merlin Mann’s Worst Website Pitch (the embed code for this isn’t working. Sorry.)

The second video comes courtesy of Brad Feld’s blog and lists numerous people who either failed miserably several times or were doomed to failure by teachers and others, and then went on to be extremely successful. It’s a useful reminder that life goes up and down- there is no linear path to success.[youtube Y6hz_s2XIAU]

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Social Entrepreneurship and Alphabet Soup Corporations

May 18th, 2008

There’s the C corporation that most people are familiar with (what you get if you don’t specify anything else) and the S corporation that is tax free but doesn’t allow preferred stock. Both of these names come from the sections of the IRS tax code that describes them.

Add now the B corporation. The “B” stands for “beneficial”. It doesn’t have special tax rules- instead the intent is to tell people clearly that the company considers benefit to its employees, the general public, the environment etc. along with shareholder profits.  The organizers have developed a community of B-corp adopters, and it includes a bunch of “green businesses” but also a couple of big law firms, a skateboard manufacturer and a handful of software companies.

The challenge of socially entrepreneurial companies is that they can do very well, get acquired or obtain outside capital and/or management, and the core principles can get diluted. The B corporation process doesn’t prevent this from happening, but it does make loud and clear that social good is a core element of the business.

So how does one become a B corporation? First, one must fill out a survey. A passing score means that one can take the next step of amending the corporation’s Bylaws and Articles of Incorporation to state the social purpose(s) clearly. I haven’t done it yet, but I am going to take the survey as it applies to my own business.  I hope I score well!

There is nothing magical about any of this.  It can all be changed or abandoned completely.  It is, though, a way to tell the world what your company cares about strongly.  That can be good for the company, good for business and- one hopes- good for the world.

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Near-Perfect Summary of Angel Financings

May 7th, 2008

Todd Vernon is the CEO of Lijit and wrote a post this morning that covers all the bases in angel financings.

http://falseprecision.typepad.com/my_weblog/2008/05/angel-financing.html

I won’t rehash the whole thing, but will comment on a couple of points.

Todd’s analysis of the different types of angel investors is very insightful.  In my ten years of experience advising startups, the family investor class is the most common type, but the companies that are unable to broaden their investor base beyond that seldom succeed in raising further money.

The analogy to burning cash is a good one, though I usually use winning the lottery to make the same point.  Startup entrepreneurs should be aware that at least on some level investment in a brand-new company offers about as much hope of return as lighting cash on fire, or spending $25,000 on lottery tickets.  No one makes that decision lightly.

I mostly agree with Todd about convertible note financings, with a couple of qualifiers.  First, no company should offer convertible notes if it doesn’t intend to convert them.  Todd seems to say that some people might undertake note financings intending to pay them off in cash rather than equity.  That is a terrible strategy and borders on abusive.

Second is that I have done successful note financings.  In almost every case the Note investor(s) are also participants in the equity round and are using the Notes as a genuine bridge so that the company can get some cash while completing the steps to a larger investment.  Notes usually come with warrants or other discounts from the equity round so there can be tension between the Note investors and the equity investors.  Having the same people on both sides of the deal helps immensely to smooth that out.

Good post Todd.  I am going to send a lot of clients to read your summary.

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Chinese Family Carbon Footprint from NPR

May 5th, 2008

There is a lot of talk, of course, about the facts that (i) the U.S. has the highest per-capita (and overall) rate of CO2 emission in the world, and (2) that China is catching up quickly.  This podcast from NPR puts some facts to the story.

NPR previously profiled a family in North Carolina that worked hard to reduce its CO2 output and succeeded in getting itself well below the North Carolina average.  For contrast, NPR then profiled an “upper middle class” family in Beijing with a 3 bedroom apartment, a car and a house in the country that makes no real effort to conserve.

The result?  Excluding air travel, the North Carolina family trying hard to conserve and the Beijing family that doesn’t are basically even on CO2 emissions.  The American family travels more and farther by plane, so factoring that in put the Chinese family in the lead (in the best sense) by a wide margin.

This kind of data, even though anecdotal, is really fascinating.

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