Rob started up by asking how many people in the room had started a company in the last 5 years, and about 80% of people raised their hands. He then asked how many people would be starting one soon, and I think teh other 20% raised their hands.
Rob and Jeff then went over their companies portfolios, and they were impressive lists of some of Web 2.0′s biggest success stories and companies that look to be future successes.
They then moved into the “Ten Points”:
- The Idea
- The Team
- The Company
- The First Money
- The Pitch
- The VC Process
- The Funding Process
- The End of the Beginning
- The Growth
- The Exit
Rob: What value are you creating? There are “can dos” and “should dos”. There’s a lot of stuff that can be done, but should it be?
Jeff: There are often changes from the early stages in the idea, but the value has to be there.
Jeff: At the end of the day what market are you going to serve. Why will they care? Then we can figure out how narrow or broad that market should be. You can go for a lot of users where you try and get a few cents from each user, or go narrow and try and get a lot of value out of each user.
Rob: You need to think through if you’re creating a new market or serving an existing market. It’s harder to create a new market, but it can be more valuable if you can do it.
Jeff: In a time where it’s so easy to build features and enhancements, if you’re going to do something that’s already been done, you need to be 100% better, not just 10% or 20% better.
Rob: You need to go after scale and speed. Different kinds of money will be interested in different growth rates.
Rob: Failure cheap and fail fast. The quicker you can get to the point to figure out if it’s going to fail or not is the best. You can move on to the next thing while burning less cash in the process. We often like to invest in experienced entrepreneurs. Investing in a first-time entrepreneur can be like paying tuition.
Jeff: You learn more from failure than success. You can still believe in your idea, but the money is going to need to know when they should get out.
Rob: You need to gain our confidence that we can believe in you and your team. At the end of the day we’re betting on you.
Jeff: We will be your friend, but we’ll also kick your ass. One big question I get a lot is how to bring in the right people for positions. How do I find a CTO? How do I find a great salesperson? We can help as a VC, but you also really need to get out there and network and find people.
Jeff: Question from the audience about how you start finding people while protecting your idea. Basically, you can try to get people to sign NDAs, but in the real world that doesn’t work. As an investor I never sign them. You can do background checking to see what their reputation is like, but if your idea needs that protection it’s basically too easy to copy.
Rob: There isn’t much secrecy anymore. I’ve been involved in companies that we tried to keep quiet but people would come up to me and say they heard I invested in such and such company, when I didn’t even think they should know about it yet. Secrets just don’t say that secret now.
Jeff: The idea of the unique idea is not really true. The “rule of 3″ is good. If you see one company working on something, it means three really are. If you see three companies working on something, than nine really are.
Rob: A great gut check is when you have to go through the trouble and cost to incorporate your company. Paying a few thousand dollars and doing the paperwork is a good early gut check if your idea is good and if you’re serious about it.
Jeff: Make sure you setup properly, get it legally protected and setting up in the standard format is important. A venture capitalist wanst to invest in a C corporation incorporated in Delaware. Use a real lawyer instead of one of those $500 services. They just send you the paperwork and you’ll have to pay $50k to fix the problems later.
FOUNDER EQUITY SPLIT
Jeff: How do you split up founder equity? The debates about how to split up equity need to happen and should happen early. Is it evenly split? Does the tech guy get the majority because he built the idea? Does the business leader get the majority because they will lead and be the CEO in the future?
Rob: From our point of view, the risk and dynamics are best with a fewer number of founders. We like two founders better than eight.
Jeff: At the same time, single founder companies make me nervous. It’s a lot of stress and it can be lonely to make decisions. My favorite is two people, one tech person and one business person is a nice mix.
Jeff; Audience question if there’s been any trends in how equity is split. There are no particular trends, I just like it explained to me why it is what it is.
Rob: There’s definitely a 50/50 pattern in two-person companies.
Rob: Does location of the founders matter in an investment? It can, but it’s just a factor. It usually doesn’t make or break a decision, but it’s considered.
Jeff: I like to have the founders within an hour’s drive. It makes it much easier to meet that way.
MAIN VS SIDE JOB
Rob: I get a lot of people who want funding so they can quit their day job. Get in line. If you don’t have the passion to quit your job and go after it, it’s likely we’re going to have problems.
Jeff: We expect you to take the risk, get out of your comfort zone, and put your skin in the game. The other problem, if you invent things in your spare time and have signed and IP agreement with your employer, it may technically belong to your employer. You can either quit your job, or get a formal letter from an employer saying they have no claim on your idea.
They displayed a graph of valuation levels and money required, and what types of funding sources match those levels.
THE FIRST MONEY
Rob: What is the right amount? We’re often giving them money to get to the point where they can raise their next round of financing. We try and figure out the run rate and when that success point is and how long it will take to get them there.
Jeff: The usual first round/angel funding is around $1M.
Rob: There are plenty of companies who may give you $2M or $4M to reach that next funding point, but it’s probably not going to be us.
Rob: So how do you find and choose investors? Check all their websites and blogs, and ask around.
Jeff: How do you choose between these people? Find the ones who will really work with you to build the company. They’ll give you access, help you network, and they fit with your goals.
Rob: Just to explain dilution really quickly. Let’s say there are three founders who each own a third of the company. We say the company is worth $3 million today, and we invest $1 million. So now we and the founders own 25% of a $4 million company.
Jeff: Additionally, we usually ask that the options pool for future employees is set up pre-money. This means that we may ask that 20% of the company is set aside for options. So there is dilution from the investment and the options pool.
Rob: In the seed round you check to see if the idea is feasible. Risk is high and valuation is low. When you hit the beta phase, the risk is lower and valuation is higher. When the model is definite and proven, the risk is low and valuation is getting really high. It happens really quickly now. Getting customer acceptance used to take a few years, and now it takes 3-9 months to figure out.
The Funding Process
2. More pitches
3. Due diligence
4. More pitches
5. Partner’s meeting
6. Termsheet issued
7. Terms negotiation
8. More due diligence
9. Legal docs negotiation
10. The funding
11. Money in the bank
12. Get to work
Oren Michaels from Mashery
Oren: In my case, raising money was a little different for Mashery because I had already built some relationships with these investors. The people who will invest in you need to know you. They aren’t investing in your idea, they are investing in you. So they’ll ask, why you? Why should we invest in you?
Oren: After I left Feedster I talked to Josh Kopelmen who wanted to meet to see what I was doing next. We took a small amount of money in the beginning because we didn’t have a team or hadn’t done much. We gave up a chunk of the company to get money so early, but getting it going quickly was something we needed to do.
Oren: We didn’t worry too much about valuation or getting the perfect deal. We had to get going quickly so that was the most important thing.