Up and Running:

Over the weekend I got an e-mail question that I’m going to answer here on the blog. I decided to answer it here because it’s the kind of thing a lot of people ask. It’s related to a common misunderstanding about intangible value and business investment:

Question: How do I determine my experience as a part of my investment in my startup business?

Answer: Your experience is vital, critical to your new business, and it should, I would hope, make you successful. But it isn’t on your books as dollars or any other currency. You’re going to use it to create your business and give value to your customers, to make what you sell something that your customers want to buy. Your experience will be an important part of how you decide, if you have partners, who owns how much of what, and who does what.

But–and this is important–it doesn’t go into your books. It isn’t startup investment. Let me explain.

This is frustrating until you see how it works, and it can be a bit off-putting if you don’t like terms such as “debit” and “credit”; but really, it’s very simple. Bear with me, please.

According to standard financial convention, your investment has to be counted as dollars.

In the background, you have double-entry bookkeeping.

Don’t worry, you don’t have to learn debts and credits, so just look at this example.

Here’s what happens with a $100,000 investment. For every dollar you enter into your books as investment, there has to be a dollar entered into a bank account. Accountants call this a T drawing, and it is very simple:

Notice how “experience” doesn’t fit into the financials. Without depositing actual money in the bank account, you don’t have anything to enter as investment. The amounts on each side of the line have to sum to be exactly the same.

Startup investment doesn’t necessarily have to be, in all cases, money deposited. You can use cash equivalents in some cases, such as the following example:

The assets on the left add up to $2,570, which is credited on the right as investment. In this case, as a founder you’re contributing your personal assets to your company and crediting the value as startup investment. You can see the assets in question–the desk, chairs, computer and so on–and as this transaction is booked, they now belong not to the founder who invested in them but to the company. No money has changed hands, but assets have, and the need for two counterbalancing entries is satisfied.

In this case, too, “experience” doesn’t fit as investment. You can’t assign a dollar value to experience, and it can’t be an asset because you can’t package it up and sell it.

Summary: Off the Financials Values

This is one good example of how you have to work within the system of established conventions for financials.

Most companies at startup have the value of the founders’ experience as part of what makes them go. Without experience, you have nothing to sell.

This is something worth getting used to. A lot of the values in business end up outside of the core financials. Experience is one of them.

I’ve just added AskTheVC to my blogroll. It’s full of thoughtful answers to serious questions asked by entrepreneurs about details related to getting financed by a venture capitalist. If you are one of the Ready to Fly startups looking at VC deals, it’s a great resource. Brad Feld and Jason Mendelson have real VC experience and take time to explain.

As a reminder, this is not for everybody starting a business, just for a few thousand high-end ventures having founder teams with strong track records and real prospects for very high growth and exits to liquidity. Venture capital is not for the corner bar or the dry cleaner or that restaurant you want to start.

If this is for you, you already know who you are. If you have to ask, then you probably aren’t a candidate. Don’t worry, there are plenty of other routes to startup financing.
From the “About” on that blog:

Brad and Jason have been working together since 2000 when Jason joined Mobius Venture Capital, a venture capital firm that Brad co-founded. They started writing together on Brad’s Feld Thoughts blog in 2005 with their Term Sheet series. After several other series about issues facing venture capital-backed companies, Jason and Brad decided to start AsktheVC. Brad and Jason, along with three other partners, have recently founded a new venture firm, the Foundry Group located in Boulder, Colorado.

We’ve started this blog to discuss relevant issues in the venture capital and entrepreneurial ecosystem. As you may know, we’ve spent a lot of time over the past three years writing about venture capital and entrepreneurship on Feld Thoughts. We’ve had great feedback regarding our regular posts on matters that effect people in our industry, as well as our blog series on topics such as term sheets, letters of intent and 409A. We’ve also had a lot of fun and learned a lot from the questions that people have asked us. We’ve decided to put more focused effort into regularly addressing these questions. Brad will still blog about venture capital and entrepreneurship, and we’ll occasionally cross-post between blogs, but we’ll begin to use AsktheVC to address the steady stream of questions we are now getting on a daily basis from entrepreneurs around the world.

You can expect the same thoughtful and honest opinions that we’ve always had. We will also tackle bigger issues in a larger format than a single post. Our goal is that this blog becomes a broadly used informational source on venture capital and entrepreneurship. To achieve this, we welcome (and encourage) questions from anyone reading this and hope that “meaty” questions lead to better and more relevant content for our readers.

I’ve referred to their answers and used them several times, so it’s about time I mention the blog itself.

You’ve heard of Moby Dick and the one that got away? How about 20 really bad investments? This list, posted today on insideCRM.com and compiled by its editors, is a reminder of what burn rate really means, with a hint of what valuation once meant (traffic, not sales; notoriety, not fundamentals). It’s also a an excellent illustration of why venture capital firms aim for deals that look like they can deliver 100X returns–because there are a lot of losers along the way.

My personal favorite, Webvan, ends up as number three on this list. I was hoping for Webvan to succeed, because I hate shopping for groceries, and some of my family members were customers. Then they bought thousands of white vans and warehouse facilities, and crashed.

This company that once had about $800 million in venture capital ended up with $830 million in losses, with about $40 million on hand.

Number one, Amp’d Mobile, apparently decided to focus on people who didn’t pay bills, or so it seems from the description. I thought it had died because of the apostrophe in the name, always a bad sign.

While other mobile providers check for an ability to pay bills within 30 days, Amp’d let it go to 90 days and marketed to these risky customers. It has been reported that 80,000 of the company’s 175,000 customers were unable to pay their bills.

I won’t spoil the suspense, though, go read the list. And remember it the next time you want to complain that VCs are too focused on fundamentals.

Thanks to Ask the VC for catching Rick Segal’s More favorite VC phrases, an amusing phrase book routine for dealing with venture capitalists. Segal mocks five common phrases you’ll learn to hate when and if you start really dealing with venture capital.

Which reminds me of two must-read Guy Kawasaki posts, along the same lines:

• Top 10 Lies of Venture Capitalists: which is actually nine lies plus as amusing explanation for number 10.

• Top 10 Lies of Entrepreneurs: including several of my personal favorites, “patents make our product defensible” and “all we have to do is get 1% of the market.”

Somewhere in the midst of these phrase book thoughts is the fact that when VCs are talking to entrepreneurs, “yes” means “maybe” and “maybe” means “no,” but that’s not included in these lists.

Two things come together for me today, both related to the real world of financing startups with home equity.

The first of the two is the following comment to my blog post Q & A: Investment: Size Matters over at the bplans.com blog:

…along with a partner are starting our own wedding consulting business we were home based for 5 years but now we are expanding to a building. We are both investing $100 000, my question is how much do you think a bank would loan a new business?

The second is Homeowners Feel the Pinch of Lost Equity in yesterday’s the New York Times. That story isn’t about borrowing to start businesses, but it is about borrowing off house equity:

But now, in an ominous portent for the national economy, Mr. Whittey has grown tight with his money. His home is worth far less than it was a year ago, and his equity has evaporated. And like many other involuntary adopters of a newly economical lifestyle, he can borrow no more.

“It used to be that if I wanted it, I’d just go and buy it and finance it,� Mr. Whittey, 33, said. “I’m feeling the crunch, and my spending is down significantly.�

The Whitteys and others like them are at the center of deepening worries that the economy is headed for a substantial slowdown, possibly even a recession, as the artery of cash from Americans borrowing against the value of their homes has sharply narrowed.

These two come together for me with the reality that so many startups are financed by home equity. The real answer to the first question above, “how much would a bank lend me,” is that the bank will lend you about as much as your house equity would support. That’s an over simplification of course, the real detailed answer would be more complex than that, but it is the executive summary.

One of the steady streams of experts’ answers that we see all the time in the world of starting a business is that the bank won’t loan you money for your business idea unless you have collateral. It’s illegal. The law makes banks protect their depositors by not allowing them to speculate on your great new business unless you have collateral to pledge. And collateral means that if you don’t pay back the loan, you’re going to lose the collateral, which in the context of this discussion means you can lose your house.

And that takes us to the second part of this post, which is that as house equity loses value over financial problems, that affects startups that are being or might have been financed by house equity.

I say it a lot to entrepreneurs: don’t bet the house. But a lot of us do, anyhow. I’ve been there myself, with multiple mortgages and lots of credit card debt to start a company, but I don’t recommend it. Do as I say, not as I did.

Ouch! Move to the Valley? I doubt it, and I voted with my feet over a decade ago when I moved Palo Alto Software to Eugene, OR. But Rob May’s insight on how getting funded is like dating is right on target. From The Irony of Raising Money for a Startup:

Raising money is really an odd process to go through, because everyone who has been through it tells you “this is the way it really is…” yet all of them finish that sentence differently. People tell you it’s about the team, not the idea. Then someone else tells you it’s about the idea first and the team second. People tell you to just make up your numbers because everyone knows you can’t predict the future anyway if you are doing something really new. Other people tell you that your numbers really do matter. I think it’s really like dating - finding someone who wants what you want is much better than trying to change someone who you like, but wants different things.

My advice to would-be entrepreneurs remains the same… move to the Valley.

The second to last sentence is golden.

Angel investment is down slightly, according to a new study.

I’ve always had trouble describing angel investors because they seem so hard to define. Somewhere between the high-end friends and family investment and the low-end venture capital you have the angel investors. They’re mostly individuals, but they frequently group into venture groups. Back in the early Silicon Valley days we used the phrase “doctors and dentists” before “angel investors” became more popular.

Today’s National Dialogue on Entrepreneurship weekly newsletter reports on the University of New Hampshire angel investor report for the first half of this year. Investments are down slightly, both in number of deals and total money invested.

Both deal size (down 4%) and the number of investors (down 10%) also dropped. Finally, the number of deals (24,000) is also a slight dip (down 2%) from 2006. Angel investors are still America’s largest source of seed and start-up capital, but even angels are beginning to look at later stage deals with more dollars going to post-seed stages. Finally, the study contains some interesting demographic data. Women now account for 13% of angel investors, while minority angels make up 5% of the total.

Before you become discouraged and despondent, your venture, your effort to raise capital and your relationship with real or potential angel investors isn’t determined by these larger numbers. You still have the same deal as you did last week, when the members of the Angel Capital Association were reporting an increase in quantity and quality of investment proposals. These are different sources, with different conclusions. There are still several hundred thousand angel investors around.

For the full information, you can download the Center for Venture Research’s “Angel Investor Market full report.

So it looks like things are getting much more interesting for Mike Glanz and hireahelper.com, the subjects of my recent post Is There a Catch 22 of VC Funding. The founder at www.thefunded.com noticed the flurry of comments and my post here (which he called “mainstream media,” not bad for the second week of this blog’s existence) and featured “the debate” on the main page.

The comments to Mike’s open letter go from don’t “whine about it” to “the reason is you … be prepared to change your assumptions” to “get a seasoned VC lawyer” and on. Several agreed with something I wrote, that perhaps getting the VC money isn’t the best thing for that company now. That is the old “be careful what you wish for” routine, which is overused, but that is because it so often fits.

The thread highlights management track records. Mike described his team as “two small business owners and a couple whiz kids.” Several people suggested recruiting at least one experienced team member who has been with a successful startup funded by venture money. “You need a bankable name on your team. Just be prepared to give up a lot of control and % of net in return.”

Others suggest aiming more strategically at getting less money now and pushing the venture further up the chain later, after proving the concept and the team.

And of course the “VCs are sheep” motif comes up as well. One person says “VCs are like visionary sheep. Only one of them has the guts and the vision to try something new and then the rest follow.”

Most interesting, perhaps, is that the stir seems to be giving him better leads to getting a real hearing, and some good advice, and possibly some strategic angel money to push his venture forward. Whatever works! I’ve asked him to keep me up to date, and I will post when I hear more.

-Tim

According to Mike Glanz, of www.hireahelper.com, there’s a Catch 22 of venture capital financing: you can’t get venture capital (VC) money without a track record, but you can’t get a track record without getting VC money first.

I don’t agree with his underlying point, but I like the way he puts it:

I’m stuck. Not stuck like a truck in the mud, with wheels spinning and no hope of ever going anywhere. But stuck like I would envision being stuck in a pool of pudding. … That’s the best way I can describe trying to get VC with no prior experience raising capital. Pudding. I read everything, forums (like startupping), blogs (avc.com, venturehacks.com etc), articles (wikipedia), how-to’s (howstuffworks, business2.0, Inc) and write letters and emails to anyone I can think of to help me make a connection, offer advice, or even (dare I say it) make an introduction.

Where am I? Almost the same place I started.

I don’t know Mike Glanz, but I’m rooting for him. I like his letter, which he published as an open letter to the community at the Venture Capital review site www.thefunded.com (an excellent resource, by the way).

The open letter goes on to compare his company’s frustrating lack of success with VCs, apparently despite a good-looking launch, to another (unnamed) company’s deal that got $10 million for 50% equity.

The only difference, he says, is that the other company has an executive from RealMedia, and his doesn’t.

So what are your thoughts? Am I stuck? I’ve spent 4 months trying to get intros to VC’s. I’ve sent off the packet and even got great positive feedback on it, but here’s the bottom line. If I don’t know someone, then someone better know me. Since neither are the case, we’re stuck dealing with apathetic Angels, while Mr. Yahoo gets all the big money for his next big flop.

At this point I say stop. Hold on here. Your point is that it doesn’t seem fair? Who said this is about fairness? VCs are not responsible for offering equal opportunity to entrepreneurs. They aren’t judging a school venture contest. They are investing other people’s money. That’s their job, not being fair to newcomers. And they don’t do well at their job unless they choose the best possible deals, obviously guessing as they go.

Of course it’s a Catch 22, because people who have been there before are a better bet than those who haven’t. Mike describes that other team as “Mr. Yahoo” and his team as “2 small business owners and a couple whiz kids with high ambitions.”

I’m touchy on this point because through the 26 years I’ve been watcher of and consultant to venture capitalist, and guidance counselor for entrepeneurs, I’ve heard way too much “VCs are sharks” and not nearly enough of reality. Most of the big VCs are placing money entrusted to them by larger organizations including insurance companies, college funds, and so forth. Not that the source of the funds makes a difference, but it is a reminder that what they are supposed to do is maximize the return while maintaining a decent relationship between risk and return.

The Catch 22 that Mike notes is quite common, throughout life, not just in venture capital. Try getting a job as a journalist without experience, for example, and you’re at a similar dilemma: “How can I get experience if nobody will hire me without experience?”

Futhermore, there are ways around the wall.

• One of my personal favorites is bootstrapping; not always possible, not always a good idea, but when bootstrapping is good, it can be very, very, good. Of course Mike’s business plan might make a great case against bootstrapping, and I haven’t seen the plan, so this is just as an example. Still, with that as a caveat, he says in the letter that his startup sold $4K, $7K, $14K monthly its first three months, and it has $100K in the bank from friends and family investment. Doesn’t that sound like they could just go for it, then, make it $28K next month and $54K the following; does it really need $10 million? What’s that for, a SuperBowl ad? Build the sales, make it happen, don’t worry so much about what “Mr. Yahoo” got. Go get your own without having to convince venture capitalists. Just convince users. For the record, I’ve seen this happen before. I’ve been on the board of directors when it happened. It’s not a bad way to go.
• Strengthen your team. Hire somebody who has the experience the VCs want, offer that person equity, listen to his or her views, absorb the know-how and experience that the VCs want.
• Mike’s letter is discouraging about angel investors but maybe there’s an intermediate option, angel investors who have some future clout and credibility with VCs.

Anyhow, like I said above, I disagree with the sentiment about implied fairness, but I’m also rooting for this to work out because I liked his letter. The best revenge is living well. Forget the VCs, Mike, make a ton of money and then tell stories about how you did it without them.

-Tim

Marc Andreessen is one of the top ten entrepreneurs in the world, co-founder of Netscape, founder of OpsWare (which Hewlett-Packard bought last month for $1.6 billion), Ning, and other ventures. He has an eight-part analysis of startups on his blog.

1. Why not do a startup: He talks about the roller coaster, hyperspace, etc. I posted Apples and Oranges as a comment on this one. Marc is talking only about the high-end, prestigious, venture-capital backed startups, which are only about 6,000 companies a year, compared to 650,000 new companies.
2. When the VCs say no: How to review and revise your plan, and keep going.
3. But I don’t know any VCs: Then develop contacts, read blogs, work on it.
4. The only thing that matters: Product/market fit. This is a particularly strong section, boils it down to a very important essence. I posted Market Fit as a summary of this one.
5. The Moby Dick theory of big companies: Don’t wait for the big deal from the big company, it might take forever and then never come anyhow.
6. How much funding is too little? Too much? You need enough to get to product/market fit. What to do if you can’t raise enough, how to keep going.
7. Why a Startup’s initial plan doesn’t matter that much. I posted a rebuttal of this one on Planning, Startups, Stories. I think it’s too easily misunderstood. The initial plan has to change, be revised and reviewed, but you can’t do that if you don’t have a plan to start with.
8. Hiring, managing, promoting, and firing executives. This is very strong on the less obvious part, how to manage executives, and how and when to fire executives, and is a good general review that applies to most companies regardless of size.

So this is a collection of thoughts from somebody who’s been there. And he’s put a lot of thought into it to. Of course his thoughts reflect his own point of view, that of somebody who has been right at the top of the pyramid, remarkably successful. After coming off of Netscape, he was in a position to venture capitalists competing to offer him investment for other new companies he wanted to built. That is a built different from the norm, and it shows up in some of his opinions.

-Tim

Sorry. There’s no free lunch. And there’s very little free government money for you to start your business.

You’ve probably seen Matthew Lesko on television. He’s the guy with question marks all over his sport coat who talks very fast and offers free government money. Sometimes he throws bills in the air. Free government money to start your business. He shouts examples.

You can go to his site if you want — matthewlesko.com — and buy his information. Or you can go to a number of competing sites and buy their information about free government grants. Do a Web search and you’ll be deluged.

If you look carefully, you’ll see that Matthew Lesko and his imitators (let’s give him credit, at least he’s an original) don’t sell government grants and don’t give away free money. They sell information. The best of them — which, for all I know, is presumably a short list starting with Mr. Lesko — probably have valid information to sell. The worst of them are scams, laughing at you, calling you sucker, getting your money and giving you very little in return.

The grant information sellers are not necessarily lying and cheating and stealing, at least if they give you decent lists, but just don’t think a list means that it’s worth your time to start applying for things, or that you’ll actually find things to apply for. Many people have had similar experiences with businesses that sell scholarship information for kids applying to colleges: you pay your money, you get a lot of information, but you still end up working the scholarship through the schools.

Okay, yes, it is possible, but grants are extremely unlikely. Subsidized loans are much more common, but that’s not free money. You have to pay it back, although usually at an attractive interest rate. And you can’t get a subsidized loan for the full startup costs, just a portion. So unless you’re the target of some government objective (like developing under-developed inner city areas, some post-disaster objectives, or sometimes social objectives) then do follow up, but don’t get your hopes up.

To follow up on this, my recommendation is first find your nearest Small Business Development Center (SBDC). There are about 1,000 SBDCs in the United States, funded by the SBA, states, and local higher education. They know how to help you get started and they are surprisingly economical. After the SBDC, contact a local bank, preferably one you already deal with, and start asking questions. Then try with your Chamber of Commerce, and city and county governments. With all of these, expect that the first person you talk to won’t know, but ask that person, each time you talk with anybody, who will know. You’ll get more useful information that way than by buying lists.

You should also browse the SBA’s website at www.sba.gov. And, by the way, you can get a list of SBDC addresses at www.bplans.com/sb/.

It should be pretty obvious that governments don’t give away startup money that easily. Think about it. That’s tax money.

- Tim