Startup Toolbox

Jay Parkhill November 10th, 2006

It doesn’t really break any new ground, but here is an interesting calculator that shows how Charles River Ventures’ QuickStart program might work.
The calculator is set up to demonstrate returns, so you can plug in different numbers for the amount of the QuickStart loan, the amounts of each subsequent fundraising round, and the exit valuation. The calculator then spits out the return to the founders and each set of investors.

This is interesting, but pretty long-term and hypothetical. I would be more interested to see a calculator that shows the effect of the QuickStart loan on a company’s cap table. E.g. how much of the company can founders preserve for themselves by using a QuickStart loan instead of a larger funding round?
I have done a million of these for my clients and thought I could try to add to the general base of knowledge here. I have no idea how to make an HTML calculator, but here is an Excel file that does the job.

The scenarios can get very complicated, but the basics could be expressed pretty simply. The main variables are:
*amount of initial loan
*amount of Series A round
*valuation at time of Series A (or percent of company sold for Series A funds)

The calculator could then spit out alternative cap tables showing founder/investor ownership percentages. One column would show ownership structure under the QuickStart model and the other would show the ownership assuming a larger VC financing. The value of the smaller, earlier financing should become readily apparent.

I made a couple of assumptions in the calculation, esp that the “VC funding” route would be for 1/2 the amount of the QuickStart Series A, and at 1/3 the valuation. Reasonable minds may disagree on the numbers, but the concept is that the target company would not need as much money in an earlier VC funding, and that the valuation at which the money comes in would be significantly lower.

• Financings , Securities , Startups

Jay Parkhill November 1st, 2006

With all the talk about the venture model being “broken”, it is interesting to see at least one fund addressing the issue head-on. Charles River Ventures has announced something like a quick-and-easy bridge loan program with its new QuickStart plan. While the plan may be more marketing than anything else, as described below, I think it represents a significant change in the way VCs are looking at their portfolios.

The basic idea is that it costs much less to build a product than ever before. Josh Kopelman cites a figure of $500k-$1M, though in some cases I think it can be far less than that.

Given the lower costs, many companies just don’t need a $2.5M round, at least not until much later in the process. QuickStart is designed to get $250k to companies in the form of bridge loans. The investment can go forward with consent of only 2 of 5 CRV partners, so presumably the funding can happen faster as well. The net benefit, then, would be less dilution and less time spent chasing the investors, allowing entrepreneurs spend more time building a product.

On the other end of the investment, IPOs are few and far between and M&A exits command a much lower valuation than most VC firms need to generate solid IRR on $5M - $20M investments. Firms simply have too much money to invest and too few highly profitable exits to build their reputations on. QuickStart seems like a way for CRV to hedge its bets by seeding more companies earlier and seeing which ones sprout.

There are certainly problems with the QuickStart model, as pointed out by Josh and others point out.

The biggest ones are interlinked. As VC investors, CRV is expected to take an active role in the business. With numerous small investments, though, it is not clear how easy it will be to do this. Further, since CRV also intends to invest in later rounds, it may have some incentive to keep the valuation low in order to improve its conversion rate for the bridge funds.

In the end, of course, none of this is really new ground. VCs have invested in seed/bridge rounds for a long time and will continue to do so. QuickStart may be nothing more than CRV’s existing internal policies given a name and a marketing pitch. The fact that an established firm like CRV felt it needed to do it, though, speaks volumes about the current investing climate.

• Financings , Startups

Jay Parkhill September 21st, 2006

The National Venture Capital Association maintains a set of “standard” transaction documents for venture financing. The documents are interesting, perhaps especially for businesses that aren’t familiar with the process and don’t know what to expect for transaction terms.

At the same time, the limitations of presenting a single set of documents as “standard” become quickly apparent on review. There are multiple alternatives offered for most of the key terms with no indication of what circumstances lead parties to settle on one or another set. East Coast/West Coast differences within the investing community lead to further alternative sets of terms.

It is useful to see a range of sample terms, but what is even more interesting is to see how often these terms get used. VentureOne’s Deal Terms Report collects this data. I haven’t seen the report, but it would be fascinating to compare its data to the NVCA terms and see, for example, the average number of investors joining the Board of Directors in a Series A financing, or the percentage of financings where founders gave personal reps & warranties.

The other interesting thing to note is that the California State Bar Association’s Corporations Committee has published a set of adaptations to the NVCA forms. The forms are published in pdf, which makes them hard to compare easily with the NVCA’s Word documents, but the adaptations generally reflect (i) wrinkles in California law that may bear on transaction terms, and (ii) a feeling (typifed by Wilson Sonsini’s letter to the Committee) that the documents skew toward investor-friendly provisions.

The WSGR letter points out that most law firms have their own sets of form documents and asks whether another set of forms is beneficial. I agree that law firms and investors certainly have access to plenty of forms (such as the set I have generally worked from), but most entrepreneurs aren’t interested in paying money for a set of professional-reference tools. Good work to the NVCA for making its forms publicly available, and to the Corporations Committee for providing its comments and adaptations. Transparency and public discussion are good for business.

• Financings

Jay Parkhill September 14th, 2006

In the course of my legal career I have worked with a number of companies on the “venture capital track” as well as many that don’t fit the VC mold. Many clients come to me saying an infusion of capital would be a huge boost to their growth plans, and asking what they need to know about the process.For some businesses venture capital investment makes sense, while for others it doesn’t. Here are a few key questions company principals should consider before trying to raise money:

• Do we need investors or customers? Bear in mind that raising money from venture capitalists can be a 6 month or longer process, and very time-consuming along the way. If you could bring in a customer with the same effort, would this bring your goals within reach?

• Are we ready to get married? The best investors bring to a company not just cash, but also experience, business acumen and a strong network of useful relationships. On the other hand, you will be required to consider their interests as shareholders in addition to your own as you guide the company. This may sound a lot like getting married, and the analogy is quite good. Do the benefits of getting hitched to your investors outweigh the added responsibilities you will take on toward them?

• What is our exit? VCs look to get their money back, with a healthy return, in 6-8 years (more or less). For the uninitiated, this means selling the company or going public- buying out investors from revenue won’t work. Will your company make an attractive acquisition target or IPO candidate down the line?

• Can we give up control? There are companies of all stripes where the founders have retained control over the long term. At least as frequently, however, the people skilled at starting a new business are not the ones equipped to build out and sustain the company over the long term. Are you prepared to step aside when the Board decides it is time for new management?

Of course, this is only the first step in the long capital-raising process, but addressing these questions can help companies figure out if venture financing makes any sense for them. If any of the questions above give principals significant pause, then it probably makes sense to look closely at alternative ways of bringing in capital.

• Financings