Dogpatch charges rent in other locations outside the Bay Area. The program is an optioning scheme for polaris to identify more dealflow trends and opportunities with less cash. It would be like movie studios having free offices for screenwriters.

However, I do like the way they look at it as "open source" entrepreneurship.

Dogpatch charges *a lot* for desk space in SF, and it really is a "frat house for startups". If you want to start your company in a frathouse, then it may be a good choice. However this is not for everyone.

From extensive experience on this matter, EIRs are ...mostly... bad news. The benefits of undrstanding are overshadowed by the reality of idea theft, solicitation, etc. Just my $0.02.

I disagree strongly with one of your points - betting on the horse and not the jockey. I am running my second medical company (first was a biotech, second is a medical device). From these experiences and seeing countless other companies operate I am convinced that the people are the absolute most crucial part of a company. The technology is a distant second. The reason is because things never work as originally planned. NEVER. You need people who are scrappy, creative, inventive, and able to adapt and overcome. I completely understand why VCs bet on jockeys and not on horses.

Carl - Other than complaining about the current "system" what are you doing to change it?

FULL DISCLOSURE HERE... I dated a woman whose brother in law was an EIR and I only know of two other EIRs.

Respectfully, I agree with the first poster. EIR are often glorified principals that are there looking for ideas themselves. They are often VCs, without power, or money. And they are often -- not always -- first time entrepreneurs themselves.

AND THEY DO NOT SIT ON BOARDS. Too transient, inexperienced, bitchy.

Take Barney Pell, for example. He was one of the founders of PowerSet -- another Google Killer! He DID have one company under his belt, where he made no money for his first investors -- Carol Sands and her collected idiots. After a rocky time back at NASA, he became and EIR -- I believe in Menlo or Sequoia.

At PowerSet he blew a LOT of smoke up peoples' butts. And I mean a LOT. He was asking for $32.5Mil pre-money from his ANGEL round. After several years of chaos, he was demoted to CTO and was forced to sell for $100M to Microsoft.

As an aside, I like NYTimes. In fact, I am subscribed to their daily email. But when it comes to articles on entrepreneurship, they are really poor. Read WSJ, or for an international view FT.

I would Absolutely LOVE to hear what other "publicly available" publications people read. Should we start a separate thread on this?

#2 (gorilla44): Regarding your view that people are the most important part of a startup and the technology is a distant second:

Warren Buffett quote: "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact."

and

"You should invest in a business that even a fool can run, because someday a fool will."

I agree you need people who are scrappy and adaptive and can find the idea, but you still need the "idea". Without the idea, there is no sustainable, growing business. My first company was acquired by a larger, successful company that had mediocre products and management, but it was a great business: the money just poured right in because we owned something in the customer's mind that the customer wanted, and we gave it to them at a profit, over and over again.

To Gorilla 44, post 2

Okay, we can agree on the need for good management.

1) My point is a simple one. Good management is built around a great idea. Groups of "great management" who are just hanging around looking for a good idea is an "urban myth".
They don't exist, in a vacuum.

Start with a great idea and add one great manager. He can do the rest and the entire effort is based on a project which will be worthy of their time and devotion.

Let none of us remember the pet foods dot com fiasco, where VCs backed a great group of guys with (as I remember) 50 million.

What a great demonstration of the virtue of backing the jockey that project was.

2) When a VC supplies the management, the situation is already defective. Any manager who is "VC compliant" and accepts the VC termsheet, is NOT, repeat NOT, great management.

He is a whipped dog, ready to roll over and wet himself whenever any VC lifts a knuckle.

You want "scrappy, inventive, creative, etc.".....?

The best of them come for a great idea.

3) I am not complaining about the system at all. I merely point out that a certain situation was allowed to obtain where the focus shifted from producing great companies to obtaining VC money.

The fault lies in almost every entrepreneur - he should look in a mirror.

as far as what I am doing to change it ... two things.

a) I conduct myself with the discipline to bootstrap my own projects and do not solicit defective money.

b) I have been writing emails to friends of mine about a thing I call a SCC - a seed capital corporation.

I will open one up once a certain current project of mine is brought to a boil.

I will give you one clue as to how it works. There is no "2 and 20". But there is a "50".

The management people with whom I am dealing, will pay their own salaries, car leases, etc.

But we want a very much larger share of the carry. The answer is to put back, in place, the only incentive that matters ...

Never make your profit out of the other fellows in a deal, but rather ...

make your profit out of the success of the project.

A private jet is what you get when you win, not when you play the game.

best wishes

VCs are idiots because they think entrepreneurs are idiots and insist on terms that only idiots would accept. A good jockey will have stables of horses to choose from, putting on a different hat and going with whichever one is appropriate for the given track and rain. Sometimes if the environment is right, the horses win treasure and gold, other times if not as bright, will do other stuff instead. If they eventually get greedy enough, they'll realize they're nothing, loosen the terms to appropriate levels, and then maybe they'll get a little closer to understanding the ability to see all the value hidden in plain sight. But if they could do that, they wouldn't need to be LPs lackeys, would follow their own inspiration, and the rest of the entrepreneurs are back at square one. So, best to understand their situation, practice preventative damage control, keep all interactions with such realities to a bare minimum.

To ANonEMouse2 # 3

You have nailed it.

Grab the dirt. Get the underlying ground, via IP (patents) if you can. then find the jockeys.

Putting "Willie the Shoe" on top of a broken down donkey will never win you the Kentucky Derby.

But even my dead grandmother has a shot at winning that race on top of Secretariat. Just strap her on, and kick that mule ... watch him run.

The idea is the dirt, the underlying foundation.

Learn it, love it, live it.

best wishes.

To Ted #3

To express your post another way ....

An EIR without a great idea is like aloud mouthed eunuch.

Did I get that right?

:)

best wishes

Carl - I'm not trying to attack you. I just think that it is wrong to say that all VC is bad and that all entrepreneurs need to avoid it.

The important thing is that when an entrepreneur deals with any potential funding source they need to understand that source. VCs are ruthless, professional money managers whose job it is to get the maximum return for themselves and their LPs. Some may be able to ride the 2% management fee for a fund, but the best VCs do provide a strong return to their LPs and are able to raise new funds.

I am curious to learn more about your seed capital corporation? Can it work for a biotech or med device company that needs to raise tens of millions of dollars before their product can hit the market?

Riding Secretariat... that's the dream!

As I see it, you and The Founding Member and Georges at The Venture Company are covering all the bases:

Carl Wimm: disciplined bootstrapping, entrepreneur maintains control, bottom-up innovation (ala Microsoft), ignore VCs unless they truly bring something to the table on your terms;

The Founding Member: work directly with VCs, create rating system driven by Founders and real entrepreneurs, share information between real entrepreneurs to encourage better deal-making and company-building and better VC behavior;

George van H. (The Venture Company): work the layer about VCs, i.e., the LPs; train the LPs on what better venture investors should look like and how they should behave; train entrepreneurs to make better deals; re-analyze the whole structure so that maybe, someday, big venture investments by savvy capable venture investors confidently supported by LPs can be made again. After all many successful, large venture investments have been made and have paid off.

It's great to see all this innovation in the business of funding innovation, good luck and best wishes.

Matthew O'Keefe

to gorilla44 - post 9

My thanks for your comment that your contributions are not a personal attack. I appreciate the spirit and am motivated to contribute back.

The first point you make is one where "you nailed it".

"when an entrepreneur deals with any potential funding source they need to understand that source."

My contributions to this forum have been slanted to putting up views of VC to enable more understanding among entrepreneurs for the time when they approach them. (BTW the dating post is great - I have printed it off and will keep it for reference).

On the second point ...

"VCs are ruthless, professional money managers whose job it is to get the maximum return for themselves and their LPs" ....

Take the word "professional" out of this statement and we agree. ... how many comments have we heard that VCs don't understand, either the project or the process.

How about this version instead ....

VCs are ruthless and relentless managers of other people's money, in pursuit of their own rewards (and, once in a while, those of their LPs), one of whose almost mandatory tricks is to dilute founders to near nothing, both as to equity and control. The effect of even one dollar of VC money is turn the project inside out, where the sole focus now is that of the exit, always on the best terms favoring the VC.

Now ... that nails that statement.

I have written many times that if you get into bed with a VC, know what you are doing and what sort of experience you will have.

The third question - The SCC. Here are the essential elements of it.

You have to de risk the project.

Is the market enormous?
Can you own the underlying dirt (Patents, patents, patents ... three levels deep)
Can you demo it - people need to be taught and shown
Can you find the right people. (I rarely accept an inventor as a business manager)
Can you deliver it in a non castrated structure? (are you a deal maker or a deal taker)

You know medical and bio , better than I ever could. How long would it take (and how much would it cost)to answer those questions in your domain?

best wishes

TO AnonEMouse2, post 10

As you have pointed out, several people are working on things to overcome the "lead blanket" and cloven hoof of the VCs.

Since the old VC model is so defective and dangerous for just about any project, a new model has to be found.

I don't know anything about George van H and the venture Company. I do, however, appreciate the pointer and as a consequence of what you have written, will make it my business to learn what I can from this man and his contribution.

I do know something about the Founding Member. Adeo is quite a fellow.

His work, not only on the web site, but also on his Founder's institute, is something that all 13,000 of us would do well to learn. The FM has his approach and it is a good one. It solves many issues, addresses many problems, exposes many pitfalls, proffers solutions, etc.

Has he got all the answers, ... perhaps not. But he can, in the space of a short time, get novices fairly functional and competent.

My SCC is designed to approach innovation from a different POV. Does it offer "all the answers", perhaps not. But, it need only offer those answers required for its own approach.

Ultimately as innovators, we have to start viewing ourselves as professionals. We are "pros".

We have to understand the obstacles to innovation and the opportunities. We have to understand that to be true innovation pros, we need to act as the "freest men on earth".

We have to understand that our goal is to deliver innovations in good order to the market, all the while assuring that the fruits of that innovation are delivered to the founders and the management team.

In time, we can view this process almost like art. The process itself is beautiful and good, in and of itself.

best wishes

I agree that VCs and IBs are different to some extent, but that "extent" is highly firm-dependent. Some VCs are really entrepreneurial and some are not. Some IBs are moderately risk-oriented and others are not. That's all good because the market needs an entire spectrum of funding options.

What's bad for everyone is the deliberate misrepresentation made by a number of VCs and LPs who claim to be what they are not.

What REALLY should be done regarding tax rates is quite simple: only those monies that are actually transferred to companies to grow them should be taxed at the lowest capital gains tax rate. Any income derived from the rest should be treated as ordinary income or some intermediate rate between W-2 and the lowest capital gains tax rate.

This modest step alone would provide an incentive for limited partners (LPs) to choose only those VCs that put the vast majority of their investment money into an actual company versus using it for overhead. Otherwise, their tax situation would not be nearly as attractive.

This modest step would also encourage VCs to make better investment decisions and encourage them to reduce the "2" of the "2-and-20" rule.

It's like choosing a charity: is the majority of the money really going to help people in need or is it merely for advertising and fund-raising efforts? Efficiency in this important space is essential and this step would do a lot to improve it.

>The correct statement is

>Certain VCs will "interview" entrepreneurs who start new companies >from the ground up.

>But "work with them"????? Hell, even Angels don't do it that much >anymore.

They "interview" entrepreneurs, find out what they have and then turn their ideas and inventions over to their portfolio company until ...
Check out this story about why Agami shut down mysteriously
http://www.indusbusinessjournal.com/M...%3A%3AArticle&mid=8F3A7027421841978F18BE895F87F791&tier=4&id=57350E0A348D4E338A2C68208221E12E

KPCB was an investor of Agami.

Amen!!

One of the few VCs I have worked with over the years who actually does add value to a company sees this as problematic to the industry. In his words, if we have to pay ordinary income tax it becomes a much less attractive career option.

That may be a very good thing as a shakeout of those VCs who are only in it for the capital gains rate taxation and the ability to make money vs. those truly entrepreneurial VCs who enjoy starting new ventures would take us back to the 70's and 80's and get rid of the B-school types.

It is very hard to argue that someone who puts nothing at risk (VCs) but manages someone elses money should receive capital gains treatment. When they have run your company into the ground and put you out of job, they just turn to their next portfolio company or investment, while the entrepreneur, who has risked everything, is out in the cold and the LP has lost a boat load of money.

TO Duffer, #4

Taxation is almost not the issue.

Like bankers who get 50 million bonuses for destroying a financial system, VCs who get cap gains, are viewed as undeserving.

The financial model (banking) is going to change and so will the model by which funds are brought to innovative projects.

Both changes will be painful because so many sectors have been spoiled by easy, undeserved gains.

but it will come.

best wishes

The Founder Institute is considering a variety of locations in Europe, Asia, North and South America. The next set of semesters will likely be announced in April, 2010, assuming that all goes well with the launch of Singapore, Paris, Los Angeles, and Denver.

If you are interested in leading one, just click "Feedback" on the Founder Institute site at the bottom.

http://www.FounderInstitute.com

Well said. This is exactly what I'm feeling. The defintion of Angel/VC capital seems to have radically changed to the point where there is no capital doled out unless there is virtually no risk.

To # 1, Livu

Actually, it seems to be a natural progression. Immigrants to a country work real hard, their children go to high school and get good jobs, their grandchildren get into universities.

Soldier to merchant to artist, in three generations.

VC to mezzanine investor to participating lender, in two evolutions.

So .... assuming it is natural, it is incumbent upon us to know the process.

We all went to the Angels, starting 10 years ago, when VCs matured into third level investors.

Now the Angels have evolved into mid level investors.

That means it is time for a new layer to emerge and appear.

It will be some sort of small fund, expertise laden, start up specialist.

And that is where we go.

For those of you who have not gone to the Founding Members presentation on how he is leading one such charge ...

let me highly recommend it.

Inventive approach, dedication to the art and very flexible in its methodology. Adeo has some really good ideas.

I am not saying he has all the answers. BUT he has a good set of them, which are internally consistent in and among themselves.

After you see his preso, you can decide whether some or all of his ideas are "your cup of tea".

But as innovators, we have to be thoughtful as well as action oriented.

Since a large portion of TheFunded is in the Valley, some thought should be given to

a) setting up a series of presentations in the Valley - invites to TF members only
b) video taping all of them
c) making the videos available as downloads for us to go through on our own time (and place, if we are located in the Maldives).

best wishes

It's interesting that venture investing has become a sort of specialist-driven, high risk form of technology picking. A core problem was the move in the early '80's away from have venture partners who had strong experience actually building good companies - operational experience. SO today many VC's have no actual operating experience and really aren't positioned to provide relevant advice. So they are now simply playing the odds rather than trying to actively drive growth and development of strong businesses. Experience has shown that having real entrepreneurs spend time helping entrepreneurs build their companies results in a higher percentage of wins in a VC portfolio. The question is when/if the investor class will begin to demand that VC's have that experience of having to meet payroll... IF they do then I think that you will see a real restructuring at the early stages of venture investing.

To: carlwimm
Where can the "Founding Members Presentation" be found? And is there more from Adeo?

Thank you

to woodsmit

All questions to Adeo should be posted as such:

Dear FoundingMember (Lord of the Valley, Protector of the Poor, Defender of the Faith) ....... I humbly submit my question.

Adeo is very good about answering such questions directly. As he runs the Entrepreneur Workshops and Program, this is a subject very close to his heart.

best wishes.

Carlwimm, part of my pessimism (which is quite contrary to my nature) is due to the fact that I'm located in a region (upstate NY) which consistently lags the rest of the nation in supplying the various fuels that encourage entrepreneurial endeavors. So while I can appreciate and agree with the cyclical nature of what you're suggesting, I have to temper my eternally optimism with the reality of our geography.
This is by no means an isolated situation, but the somewhat glacial pace of change remains quite frustrating. As a hometown guy that wants to be a part of a rust belt town resurgence by growing a sustainable business, I always lament the lack of local progression within the local business community that either holds us back or forces us to take our ventures elsewhere.
(Scuse my rant, trying to post coherently while doing my best to manage a beckoning bottle of Merlot)

To Livu

These days, as long as you have broadband, less than 2,000 dollars of equipment keeps in touch with everything you need to do.

From anywhere. I reach people in 7 countries on a regular basis, working on a number of projects. I even spend the winter in a country with no tech entrepreneurial spine at all.

It no longer matters. The right people can be found worldwide for whatever you need.

The more interesting question is what is going to happen to places like the Valley when innovation can come from anywhere at any time.

best wishes.

I agree new models will emerge. My collegues and I have been working on a few.

Valuation is a function of how much capital you need, opportunity size, the strength of your team, exit opportunities and a whole bunch of factors that are not based on revenue.

You would be much better off if you wait till your 1st revenue is coming in. Not just signed.

A reasonable value expectation for a Canadian SaaS business at your stage is between $1.5M - $ 3M pre-money.

So, at the high end, if you raised $1M at a $3M pre you would sell 25% of your company 1/ (3 + 1).

I'm in Canada, so if you have more questions just ping me (mark@startupcfo.ca).

There is a lot out there on this but I usually recommend to clients at your stage of development that they use convertible notes to avoid the whole valuation discussion at this stage of your development.

I've been through this a few times here in Canada. Happy to help. Ping me at: bradmarshall75@gmail.com

I agree that a convertible note is preferable at this stage

I agree with Mark on all counts -- re. expected valuation for a Cdn SaaS company and especially re. the importance of waiting until you have revenue in hand. The funding climate is still skittish (especially here in Canada) and you'll have a hard time getting either angels or the few remaining active VCs in the country on board if you are pre-revenue (I'm a founding member of the largest Canadian angel group, and a twice-funded CEO, so I've seen this from both sides).
Cheers and good luck.
--Richard

Speaking again as a Canadian

Valuations are done by outside valuation firms. You odn't negotiate it, the way you seem to be able to do in the USA.

But as I have posted elsewhere, here is the trick. For the purposes of a CPC or other CAD public company, there are some things to know about the effects of a valuation.

Suppose the valuation firm says your deal is worth 5 million dollars.

1) If the assets are "real" - cash, bonds, real estate, machinery, inventory, - then you get a "real" notation on that part of the valuation.

The shares you get for that portion might be free trading and not restricted.

2) But if a portion of the deal is not "real" - things like patents, goodwill, etc. - then a notation is made that this valuaiton is theoretical (I forget the word they use).

That means those shares are restricted and may be canceled if certain performance standards are not met. The terms of that are set by the supervising authorities, not by you or the broker.

Now .... this is matched against the value of the company you are vending into.

If there are 5 million shares outstanding (restricted and free trading) and the share price happens to be 1.00 - because 1,000 shares last traded ... the entire company is deemed to be worth 5 million - without question.

The fact that there may be only 500,000 in the till and nothing else does not enter into it.

The game is rigged to value up the pubco and value down the project being vended in.

Why ? well, quite simple. The brokers and their friends own the exchange in Canada and they own the pubco.

You are a supplicant, entering their domain.

Valuation companies in Canada are well known because they will have done 50 valuations for the exchange - and they know what is acceptable and what is not. You won't be able to influence them much. You take what you get.

That is why I prefer the US route - where the business of becoming reporting is between you and the SEC. The 15c211 is between you and any broker - limited to that transaction.

Easier and cheaper to "roll your own".

And if the TSE is so important, after you are listed in the USA, you can much more easily apply for a co listing on the TSE.

Best Wishes

Please keep in mind that an investor will get a position on a board (or two positions). Let's say you will raise $1M and will sell 25% of your company as someone suggested. After you will pay the lawyers, and all kind of fees (some of it back to investors in various forms), the amount will be a bit smaller. I do not know who are on your board now, but the moment you will get an investor their loyalty (especially the independent board member and all consultants that now work for you) will be with the investors, simply because they pay the bills (even if you will be signing their checks) and can potentially provide them with jobs in the future. I hope you do not expect to get the money without the performance milestons? You will have to sign for them. The terms of the agreement will be clear enough to explain what will happen to you, if the company will not perform according to those milestones. There is one thing, that may or may not be clear in that agreement. This investment will be a loan with your personal guarantee. In case, if it will not be clear, do not expect your company lawyer to point this out to you, because he is not your personal lawyer. The point that I am trying to make is that your situation may be a bit more complicated than it looks to a consultant, or I maybe too naive to believe that the consultants do not know better.

To Jetskier:

The premise of Michael Greeley ... "There will be fewer firms, fewer venture capitalists, by this time next year," is nonsense.

He defines a VC as someone who has no stake in any particular technology and product and just functions as kind of a moneylender for other people.

How did the VCs control that conversation????

Every start up ... which has a founding member that injects his own money is a venture capitalist. Every start up that risks personal and private equity has a VC or multiple VCs on board.

Restricting the definition to the moneychangers does all of us a disservice.

The focus on the moneychanger contribution to venture and to capitalism is misguided, to say the least.

The Founding Member has plans to introduce 1,000 companies this year that are start ups through his Founders Institute. They are all VCs.

Change the terminology. The moneychanger portion of the CaptilistVenture sector is dying.

That I can accept, as it is the truth.

BW

@carlwimm, normally I agree with your analysis but you are taking an enormous leap here. The article in question is 144 words long, not near enough analysis to bring the battle cry of "socialism" into it. I read it as starting up a company is hard. Any neophyte looking at today’s environment would conclude that it’s harder now. The founders institute is a private resource, kudos to them; they are doing the right thing, a win for everyone. Since you have brought government in to the equation, I'll bite.

Countries success depends upon innovation and growth. It is in a government’s interest to provide a fertile ground for this innovation and provide resources to those with the ideas. Teach them, foster them, and nurture them. If left to the devices of investor and corporate elites there will be a skewed result in the favor to where the dollars reside. That said, in itself is bordering on extremist because we all know that it’s not that cut and dried. We could expand the debate over “trickle down” vs. “empower up” but I choose not to go there.

There must be a partnership between the ones with ideas and drive (startups), the ones with the money (investors), and the ones with a social interest (government). Too rosy a picture you (may) say? The system is broken in a number of places: the greed of VC and ineptitude of government are the culprits of my choice to blame. Let’s continue to spend our resources to fight a war and see how that effects the economy.

To wade into the realm of socialism on thefunded is a fool’s argument. I don’t mean to cut you down but the argument needs to go in another direction. I just think you are on the wrong path. Thanks for getting me riled up on a Monday Morning.

Yes. Luck is a big part of it, and unfortunately I haven't felt too lucky recently.

Desire leads to an idea or vice versa. this is a long way from start up. Most people espousing 'start ups' are clueless as to what they take. Some just barrel along and make money and suddenly that are a bona fide start up. Others get trapped in elaborate strategies. ADVICE IS # 1. Capital is # 2.

Where in the world do you find footing to make the leap from the idea that young people have innovative ideas but don't act on them, to causality in 'socialist ideas to overtax the productive'? Having hired dozens of interns over the last decade+, consider the trends spawn from the capitalist free market that I see fueling this current generation of under performing workers.

The cost of higher education has skyrocked, with universities and the financial institutions with which they collude chasing deeper pockets (parents). The last two decades have seen an onslaught of marketing and lobbying focused on creating a culture that believes that parents must save and pay for higher education. Financial instruments have been pushed on consumers encouraging parents to save money for their children's education with some slight tax advantage, legislation put in place by financial institution and educational institutions lobbyists. Colleges now compete to put the nicest climbing walls in their rec centers, the biggest flat screens up in their student centers, confident that parents will pay the bills as students relax between classes.

The last five interns I hired from the local top 3 engineering school had no idea how to work, having sought a job for a resume builder, I must presume. One called me from a beach in Germany telling me he would not be to work that week. The intern I hired from a local community college this year is putting himself through school, needs the internship for tuition, and is brilliantly productive. With that work ethic, he has a good chance at future success, under 'socialist taxation' or not.

@carlwimm, I suggest you look elsewhere to target your anti tax politics.

Blame it on Obama and his lack of interest in entrepreneurs...

Yes, all Obama's and Socialism's fault. The previous 8 years had nothing to do with the current climate. The recession is his fault. The lack of entrepreneurialism is his fault. I think Global Warming might be his fault too.

Increased vocational training, inexpensive technology, and low-cost freelance labor make it easier for people to start businesses. However, complex regulations, poor entrepreneurial training, and a challenging operating climate make building world-class technology companies difficult.

TheFunded Founder Institute set out to (1) identify strong entrepreneurs through a quantitative testing model, (2) provide these entrepreneurs with the best training available to build a technology company, and (3) ensure that the graduating entrepreneurs have the proper incentives and support to succeed.

Hopefully, this will lead to increased number of high quality technology businesses formed over the next five years.

I agree that @carlwimm makes a huge leap from the article to the "socialist idea to overtax". But there is a correlation here that I believe rings true.

@chas123 touches on it directly: this new generation of workers have an "entitlement" mentality the precludes them from doing what is necessary to get the job done. In some cases (like the kid calling from a beach in Germany to say they weren't going to be into work), there seems to be an outright disdain for responsibility, accountability, and ... err ... work.

And why shouldn't there be? The last four administrations have done as much as they can to assure the upcoming generations that it's "not their fault." Whether that be in the form of guaranteed student loans (it's not your fault education is expensive), the minimum wage (it's not your fault you have fewer skills than the average broom stick), or countless social "benefit" programs (it's not your fault you're a woman, a minority, transgendered, incarcerated, poor, an orphan, an indian, etc.) And if that weren't enough, the endless battles against those who have succeeded (against all odds, in some cases) should drive the point home clearly: "If you succeed, it's entirely your fault, and we're going to make you pay for taking advantage of the rest of us."

No - I think @carlwimm's leap may have been great, but the chasm he crossed rings true nonetheless.

Really? we have to listen to tea-bagging dumbassery here as well. Using socialism as a straw man is starting to get pretty old.

Uhhh... what's hard about this: increasing taxes on the fruits of people's labor leads to... less labor.

Re: comment #6: I really wish I had this web site, opportunities like the Founder's Institute, blogs like Paul Graham's and the training his team does, etc. It's just incredibly valuable in and ultimately worth millions in terms of better deals, higher chances of success, etc. So Thank You Founding Member and all the smart, experienced people who post to this web site!

It might be more relevant to talk to people who *actually* have been working with young entrepreneurs to understand the problems they're facing.

20 years ago, a startup meant 3-5 years of effort to get to profitability. This meant you could refine, rework, and refocus your business - you would become a better entrepreneur through the experience, and that was *valued*. If the startup did not succeed, it wasn't held against you - on the contrary, you might end up doing due diligence for your investors or starting another business or teaching.

This is no longer true. Startups are not focused on profitability, but instead of flip-ability - offloading a spin job for mucho bucks to some cash-heavy company for the eyeballs or some such (and this is true even for software / hardware businesses, crazy as that sounds). Since you've got a short timeframe to dumping the biz, the experience earned, the "business character" you acquire - wisdom, patience, fortitude, guile - is discounted since it's all due to "luck or lies".

So what's this mean for the unsuccessful entrepreneur? No second chances for one. Either you're lucky and get another gig, or you're not and you're all the way out.

Is it any wonder young people don't want to commit themselves? Since most startups don't work out as home runs, entrepreneurs who earn their first command and show resilience and initiative aren't promoted to the ranks of funded veterans - they're just losers without a future. And since one funded company looks very much like another nowadays (innovators are not welcome), is it any surprise that even young people are thought of as commodities?

So go ahead, train these guys (most of them are guys BTW). But when you're only looking at one-shots and luck instead of building businesses (hey, read the NYTimes for what equity firms do to "real businesses" - they mine them out, destroy their value and wreck their market, but it's OK because the pirates did OK), loyalty and determination and character get in the way of a quick buck.

Doesn't sound "socialist" to me - just sounds like the short-term greed of a smash-and-grab anarchist using capitalism to destroy our nation instead of build it. Think about it.

tp # 7, richardluck

you nailed part of the the issue that I refer to as 'socialism" .... the entitlement mentality is part of it.

But there is something worse. When you learn that your whole life will be played out with your lips glued to the teat of mother government, you develop a passivity that is really the crux of the issue.

Passivity is a state of mind that is encouraged naturally by a system that turns over the individual to a collective.

The description of socialism as just a system of income redistribution, is a weak, limp definition.

As start up CEOs, we have to face the fact that we are not, by nature or nurture, passive.

Every start up tries to make a difference. Every start up tries to stand out. Every start up is individual.

And every one that we start up, starts out in salute to Woody Allen's famous statement....

80% of life is just showing up.

This is not a tax issue. I made the point that in a collectivized society, people turn out as "non starters", because the hurdle to become a self starter is too high for a drone to leap.

To # 5, hexellent

Pointing at G Bush (the last 8 years) and letting the current "White House Wonder" off the hook as being not so bad by comparison, misses the issues as well.

The USA started to lose its status as a Republic in the early 1900's, when it , among other things, started to become an imperial power, brought in the "great leveler" of income tax , destroyed solid money with a central bank, etc.

Now all the USA has is a democracy.

Every president since the early 1900's has contributed to the problem,... some more and some less.

The rugged individualist of the early 1900 has given way to the sinecure supper club.

What I wrote in the post is true. Society produces drones, in super abundance.

I am glad I was never one of them.

best wishes

Just my opinion, but I think there are more appropriate forums for this type of discussion, these off topic conversations dilute the premise of thefunded.com

to # 12, Livu

respectfully and forcefully disagree ... that there are other forums

What other resource do we have if not the "start up mentality" in great quantity?

Whatever damages that supply, whatever constrains that supply, hits at the heart of what we do.

If we can't discuss it as entrepreneurs, on an entrepreneur forum, then where ...

economicsophistry.com
meaninglessblog.com

or perhaps we should confine our discussion to the "free speech" zone, always located 6 miles from where the President and the others who do affect our lives, happen to be.

best wishes.

@matthewokeefe -- lame, lame, lame -- so if you are taxed you rather be homeless and sleeping on the streets.

@carlwimm -- and what is wrong with socialism? sure beats Bush's fascism.

To # 14, liberal

Actually fascism and socialism have the same basic objective in mind ... subjugation of the individual to the collective.

Don't believe me ... look up how and from what the term fascism derives.

And in my opinion, it doesn't much matter what material your chains are made of.

best wishes

@carlwimm: just to clarify my first post: my recent experience with the fund leads me to conclude that it's a wonderful resource for identifying well defined and discrete ways for us, the entrepreneurs, to move our businesses forward.....particularly in the area of finance. It's not that I want to pretend that macro economic pressures and issues fail to exist, but rather that if the user base of thefunded sinks into the deep underlying factors that led to the present situation, we'll lose our grip on the direct and concise 'toolbox' of info that we have now.
Best wishes to you too, we all need it. (not responsible for spelling and grammatical errors, posting from an iPhone while consuming my share of Corona)

to # 16, Livu (and the Corona)

:)

You make a very good point.

Forward, always forward.

Recessions, though, also have the opposite effect: The force people with good ideas who had been sitting too comfortably in corporate jobs and lost them to act, and they significantly cheapen the cost of labor, they increase the supply of talent, and they test all the companies for real strength, whittling down the playing field in favor of the fittest, a form of entrepreneurial natural selection.

We as Entrepreneurs and CEO's are just more thoughtful now. I have at least 3 or 4 ideas in my head and I am running my company now for the past 5 years. I just need to think things through and am not interested in just putting up a web site and say advertising will generate revenue. I have seen so many companies that are nothing more than web site and no idea of their business model. I am interested in a real business model that will enable launching a company that can start generating cash right away. It has more to do with how to build it in phases and not do it the old fashioned way where you just build it and hopefully money will come. I want a very agile development where each increment generates cash. It takes time to think it through but execution, once started, will be rapid.

great catch

I cut and pasted this into a file so i could re read at lesiure.

CW

I'm running my second medical device startup and it is the same - one big, crazy roller coaster.

Seriously?

Uhm, if you aren't already reading Paul Graham essays, WTF are you reading?

It's a great essay, but I'm surprised that people who are interested in startups aren't reading Paul already...

Live and learn

By his own admission, Paul Graham writes code wearing nothing but a towel while hanging around 20-something boys. He writes popular essays that say exactly what techies want to hear... nothing new here. Move on. The real world is out there and knows nothing of this insular, artificial, self-agggrandizing world. Step away from the computer and have a look at the real world sometime.

Further to my own post

I just thought of something

we (the CEOs of TheFunded) can't be the only ones reading this article. The NY Times is not there just for us.

what happens when prospective LPs get hold of it?

I wonder what answers the up and coming VC funds are going to have?

Why are we beating this dead horse? What is the point? Isn't there more important issue to talk about anymore?

I agree with both #1 and #2. The article is good to distribute to build awareness of the real state of affairs in "VC-land" (#1's point). It's also important to focus on moving forward and getting good companies access to capital so that they can be properly funded, respond to market needs and grow to generate returns (#2's point). Both objectives are useful.

As I have mentioned in a few posts, private equity (PE) is one "way out". It's difficult, time consuming, requires dedication and discipline but PE is available and can provide the equity required for an enterprise to grow.

I have been asked to start an open discussion on this approach which I may do at some point. My previous posts, however, summarize an approach to getting PE that can work. I'll "cut and paste" one here for convenience:

As I have posted before (please forgive the repetition but I am trying to help out here), Private Equity (PE) is available. People are starting to agree that using the VC as an intermediary is not working out too well.

Of course, securing PE takes a lot more "bucket and shovel" work, but so what? If that's what you need to do to be successful, then get started. Complaining about the VC situation does not further your business very much so please do that for recreation, but never lose focus on why we are all here.

For what it's worth, here is a bit of a "tutorial" & my personal experience with securing PE:

\PE is very "geographically sensitive". So, what works where I am at (Cleveland, OH) may not work where you folks are at. Having said that, I'll tell you what I did and you can alter the process to suit local conditions.

Anyway, to get started, I got involved with various networks where the rich folks "hang out" & socialize. I did this through friends who were already a part of these "social networks" (BTW, these were not Linkedin or Facebook or any of that sort of "kid stuff", of course). These were more like professional organizations, social fundraisers, etc.

Since I was already known as a former professor, engineer and entrepreneur, I had a "head start" in meeting some of the key people - and I used that. Anyone can start this process with their own set of contacts & friends and using whatever relevant experience that they may have.

BTW, my first company (started in 7/88, sold in 5/99) was entirely self-funded, it operated in the black and made the top growth list a couple of years in a row. That helped with establishing my credibility.

Regardless of that success, I still continued to practice & refine my pitch. I am always working hard to improve in any way that I can. I worked with key friends in these organizations who introduced me to the COIs (Centers of Influence). They, in turn, took my pitch to individuals who they felt would have an appetite for an investment. That allowed me to inherit the "trust umbrella" of existing relationships that spanned decades - essential to success.

Over a period of about two years, individuals came forward to hear the pitch and a portion of those (about 70%) invested. The average level of investment was about $50,000. Most recently, we picked up another $360,000 during the past 2 months. We are also starting to attract "senior debt" with a convertible option as "back-end" protection.

This was a process and took a lot of time & effort, but it was worthwhile. The people who have invested have a deep, personal connection to what we are about and so they act as COIs for potential investors and - more importantly - potential customers.

This process can be repeated elsewhere. It is very hard work so do not get discouraged. It's all a matter of finding folks who can make the introductions. Look at your own databases and see who may be a candidate to jump start this process. Also, do not be afraid to "do the ask". If you do not ask, you will never get.

The bottom line is to have (or get) a great story and know how to tell it. That is essential.

That is all great, Dr. Steve, but your tale reminds in many ways me of the stories i hear from 22-year-olds who dropped out of MIT because Paul Graham threw $8,000 at them... your personal experiences are not generalizable. The prerequisites alone are daunting... Ph.D, high-growth prior company, professor, engineer....

i appreciate your effort but do not see how these anecdotes are any more actionable than the advice of 20-somethings who won the MIT-imprimatur lottery.

That is all great, Dr. Steve, but your tale reminds in many ways me of the stories i hear from 22-year-olds who dropped out of MIT because Paul Graham threw $8,000 at them... your personal experiences are not generalizable. The prerequisites alone are daunting... Ph.D, high-growth prior company, professor, engineer....

i appreciate your effort but do not see how these anecdotes are any more actionable than the advice of 20-somethings who won the MIT-imprimatur lottery.

Regarding #4/#5 - you raised a good point which is worthy of a response. So, here are some pragmatic tips/hints/concepts:

1) If you are 22 and still an undergraduate then stay in school and graduate. Taking "$8,000 from Paul Graham" to drop out of school and start a business is taking far too great a risk. Just don't do it. There's no backup plan. Never jump out of a plane without a reserve parachute.

2) Use whatever "tools" that you have. In this context, "tools" means academic currency (e.g., degrees, certifications, licenses, etc.), work experience, professional contacts, personal contacts, rich uncles, the bank of mom & dad, etc. These are all "tools in your toolbox". You must use them collectively to be successful. If you do not have them, then actively get them via personal effort (that's what I did - please keep reading). Yes, it's very hard work!

3) You do not need an advanced education (e.g., Ph.D./MD), but you had better not be a drop-out because all that says is that you could not complete a project / task. That does not look good to anyone. Would you write a check to someone who could not even get out of college or high school? If they can't do at least that much what are the odds of them succeeding in a new business?

Yes, I know that Bill Gates did that but please recall that he was blessed with two very unusual parents who were both phenomenally well-connected - and he (and they) used those connections very well. That was one of his "tools". In sharp contrast to Bill Gates, I didn't have that luxury (although my parents gave me the most important tools of all: discipline and motivation). I had to start building my own reputation because I could not leverage another's. If you are in that situation, then that's what you will have to do as well.

So, if you cannot leverage mom & dad (or "Uncle Bob") then you had best start generating your own reputation for hard work, discipline, intelligence, etc. You must have this in order for someone to invest in what you are attempting to do. That sort of reputation has to come from somewhere. You can't "come to the table" empty-handed and expect a business deal. You accomplish this in part by school, training and working in your field. You've got to pay your dues.

4) You have to put yourself in a position to manage risk by both design and by effort. If you do not have any so-called "raw startup funds" (e.g., $10,000, $20,000) then get a job, live cheaply and save those funds. It's not that hard, but it does require significant personal sacrifice. So what? That's the price of starting a business. BTW, that's exactly what I did. I worked, lived really cheaply, saved and then got started at age 28 in 1988. i also put myself through private schools (including four years of high school, undergraduate, graduate, etc.). I paid 100% of my high school & college expenses (tuition, books, etc.) by being a janitor. I still clean quite well, as my wife (and my current employees) will readily admit!

I bring this up only to illustrate the level of planning and sheer sacrifice that is normally required to make a lot of money. BTW, I lost several girlfriends during that time because they loved the "wine and dine" but had little or no appreciation for the sheer amount of work that it took to achieve success. This is the level of sacrifice that I am talking about. It is not easy and you have to make choices and (especially) live with the consequences. I regret none of it.

5) You have to be willing to go out of your way to meet people and talk to them about what you wish to do and to listen to them about what they do. Personal contacts are at the core of any successful startup (e.g., Bill Gates & Microsoft through mom & dad) so do not ignore them. These contacts must be nurtured (for all you EE geeks, that means periodic RAS & CAS signals) and that will take time and effort. Lots of time, especially. So, get started.

6) Look for opportunities that are "leverage-able" (= reusable). As an example, I got a consulting gig to do some research on electro-forming drums. I completed the project (and got paid) but I also generalized the software to what I really wanted to use it for which allowed consulting funds to, in effect, "jump start" my first business. The customer got what he wanted, I got paid and also ended up with something usable for my business. There are a LOT of those opportunities out there - you just have to be creative.

7) Folks, there's simply no "fast track" here. Yes, there are tall tales of great successes but these are dwarfed by the real stories of people like you and I who "crawled through glass" and slogged it out. In fact the stories of "instant success" are a lot like teenage sex: many claim to be doing it, few people really are doing it, and the stories of success are mostly wild exaggerations.

As always, I welcome further dialog.

That RAS and CAS comment is funny.

Dr. Steve - that's more like it. That's how I did it. To start my first company I had a couple of thousand dollars to my name, and knowledge. The basic rule was that I had to make more money every day than I spent. This made for some long days and some very worried times, but it worked out.

Didn't mean to spoil the thread with an anecdote... this is going in the right direction now - general principles applicable to anyone, not anecdotes about individual "success" that can't be replicated by others...

What the VCs' tax bracket has to do with their success?! VCs will survive. Specially the good ones. And the bad angle groups, who are a revolving door for destruction of value and capital.

What is killing VCs are 2 things:
1) long term to exit -- used to be 2.5 years, now it is 7.5. Since RIO is compounded, this is a big one. But even otherwise, a 30% return in 2000 is now 10%.
2) lower exit prices.
Both 1 and 2 are results of SoX. The M&A's know the IP option is off the table, so they can wait and offer less.
3) deflation in the technology space, means entrepreneurs do not need the money! Look at Zoho. As for contacts, that is fo the top VCs. The third tier ones and the angel groups are useless.

Believe me I used to work for Angels' Forum, and they destroyed more companies, than you could imagine. Unfortunately, there is always a fool that would join the group, as they lose a ton of money each and leave later -- a revolving door of failure.

Re: Comment #6 from Dr. Steve:
Bill Gates' parent's network had absolutely nothing to do with his ultimate success -- just as your parent's network had nothing to do with your success, Dr. Steve :-)

Since this is a thread started by Carl Wimm, the God of bootstrapping, of course I have to add that Microsoft is *the* bootstrapped company for the ages. Bill Gates never took a penny from his parents nor from a VC (ok, he took a few penny's from an investor long after he had become cash-flow positive and he took the money totally on his own terms). He and Paul Allen wrote a basic interpreter that worked across the myriad microprocessors of the day (late 1970's) and built a functioning business that was well positioned when the Goliath of the day (IBM) made it's move into PC's. Bill Gates was relentlessly obsessed with maintaining control of his company, dominating markets, and writing good software. Sucking up to ignorant VC's working for dysfunctional partnerships was the last thing on his mind.

to # 10 mathew.okeefe

the last two sentences of your post are worth re posting

Bill Gates was relentlessly obsessed with maintaining control of his company, dominating markets, and writing good software. Sucking up to ignorant VC's working for dysfunctional partnerships was the last thing on his mind.

make a list of the points in those two sentences.

Learn, them, live them, love them.

BW

Thanks. Great article. And congrats to innRoad (described on page 2) for sticking it out.

@carlwimm: While I totally agree, you can't build a consumer electronics company on revenues, nor an electric car company, nor a medical device company, nor a... There are thousands of big ideas that genuinely need capital to get off the ground.

There are many ideas that can be and should be bootstrapped as well, such as Web 2.0 businesses with a premium model. Many of these businesses are funded because they show legitimate "traction." Venture capitalists are taking very safe bets and starving capital intensive new ideas on the whole.

Here is my challenge to the venture community: make one risky investment in Q4 2009. Show the world what the "venture" really means.

I agree with #2; if anyone knows of a business where capital requirements are zero I'd like to hear it.

Carlwimm - great. many thanks once again.

to # 3, Lionel

perhaps, as the 11,000 start up CEOs on TheFunded continue to work, we will be like the old samurai.

Every day of our lives will be spent, sharpening our skills ... a little faster, a little smoother, always more precise.

in the end, one of us will attain 'start up enlightenment" and put a deal together, with no capital whatsoever.

The heavens will open, the angels will sing in chorus, all of mankind will exult in triumph, and ...

the gatekeepers (we all know who they are) will writhe in the dust, wailing to no one's ears and gnashing their teeth.

best wishes

Excellent article. I espouse to the "bootstrap" method. Build it and the $$$ will come.

to ALL

I should have stated that even attending the VC funeral is now, "not worth the candle".

It is a waste of time.

All of our 11,000 CEO eyes should be cast in one direction.

what is the replacement?

Where do we go for our new model.

Where do we find the funds to blast the obstacles that bootstrapping may not get us past?

Here is a Blog that talks about the future of VC and where we go from here

http://www.venturecompany.com/opinion...-entry-id-263

To carlwimm- Great posting. I think you should start a new discussion under: "Now that we know the VC model is shattered, Where do we find the funds to blast the obstacles that bootstrapping may not get us past?"

I think this would help the rest of us to get feedback on other "avenues" for funding than bootstrapping.

This is a very problematic issue, because the engine of innovation has been the flow of capital to entrepreneurs, whether fairly valued or not. That flow looks to broken for the foreseeable future, probably to the better if a substitute will arise.

I think the key is evergreen types of venture funds, backed by major corporations that will benefit from new technology, and from philanthropic investors who see others benefiting from technological advance in either green technologies, exchange of information, or better health care.

The 10 year cycle of venture funds and the need to ensure a return to LPs, while taking a substantial cut for VCs, is a major evil in the current mess.

The LP community doesn't think (or care) that VC takes too big a cut vs. entrepreneurs, but, rather, that both groups take too big a cut and/or fail to grow the pie.

These numbers are as much a repudiation of The Funded as The Funders.

To #4 Duffer

"Evergreen types of venture funds" --- not a bad idea

how does one set this up?

to # 5, John Kessler

A quote from your post "that both groups take too big a cut and/or fail to grow the pie"

Let me get this straight. LPs take 80% of the VC gross - which can be 80% of the project gross.

So LPs are taking 64% of it all and "both VCs and the entrepreneurs take too big a cut".

Did you do the numbers before you wrote the post?

and "fail to grow the pie"

How many VC funded companies had entrepreneurs that would have liked to continue building the company only to be told, "it is time to sell because we want to close this silo in our fund".

How many entrepreneurs have been told that they "failed" because they could not make a 20 egg omelette with 3 eggs.

Here is the "collective outcome" that VCs fell into. They got to like the "2 and 20" and, of course, on 500 million the "2 and 20" is much nicer than on 20 million.

Now with 500 million, you can't do 500,000 dollar deals. and 500,000 deal are EXACTLY the deals a VC should be doing, if there is any "venture" left in Venture Capital. And then a 2 million dollar deal after that, two years later.

A project needs a stream of funds, and in time with its own progress:

50 to 100 initialization capital
150 to 400 proof of concept, IP generation, corporate org
1,000,000 productization
5 million commercialization

Instead we get this crippled system of 25,000 each from 20 angels and then 30 million from "Mr. Big Stuff".

And let me point out, the 30 million from Mr. Big Stuff is considered the prize because everyone in the deal starts earning a real salary, has a cute secretary, a lease car and a nice office.... almost like a real company.

Okay ... let me be serious

The mismatch between what the funding sources can supply (and how they want to supply it) and what entrepreneurs need is the key to this.

Since entrepreneurs are where the rubber meets the road, I have to suggest that it is the funding sources that have to adapt.

Let's be clear, VC is in the toilet because the underlying investments suck. VCs just allocate capital, they don't create (or destroy) value. They are gate keepers.

I haven't seen any data on returns of bootstrapped companies, but anecdotally they don't seem to be particularly good.

I keep hearing the refrain mentioned here that "entrepreneurship is the engine of innovation" but the scoreboard would appear to indicate that the engine is struggling. I don't think this is a crisis of capital...frankly I think it's a crisis of innovation. There aren't sufficient great companies. If there were, capital would find them.

That's my $0.02 anyway.

To #8: Huh? No data on "bootstrapped" companies? Try Microsoft for starters, and a whole host of others. Chipolte restaurants started because the founder there wanted a fast-food restaurant that was a cash cow to fund his "real" high-end swanky restaurant, so he designed a cheap interior, had the cooks do the serving, kept the menu simple, and differentiated on quality ingredients (Chipolte spends 30% of revenue on ingredients, which is unheard of in fast food). Eventually Chipolte got McDonald's to fund their growth, because as the founder said: "McDonalds was the only potential investor that cared about the food and mission; everyone else talked returns and exits."

Carl Wimm: combine your bootstrapping emphasis with your emphasis on finding a large corporation that considers your technology critical, and *there* is your alternative funding model. It worked for Microsoft (ala IBM OEM deal) and Chipolte (see above). And keep up the great posts, always a pleasure to hear what you have to say and what you are thinking!

Nice article. The dream, however, is far from gone.

Folks, we can argue "process" all day but results are what count. So, if the VC model is "messed up" or "broken" or whatever you choose to call it, then look elsewhere for funding. Let the VCs do the explaining to their LPs of where the money went. The market is weeding them out.

As I have posted before (please forgive the repetition but I am trying to help out here), Private Equity (PE) is available. People are starting to agree that using the VC as an intermediary is not working out too well.

Of course, securing PE takes a lot more "bucket and shovel" work, but so what? If that's what you need to do to be successful, then get started.

For what it's worth, here is a bit of a "tutorial" & my personal experience with securing PE:

PE is very "geographically sensitive". So, what works where I am at (Cleveland, OH) may not work where you folks are at. Having said that, I'll tell you what I did and you can alter the process to suit local conditions.

Anyway, to get started, I got involved with various networks where the rich folks "hang out" & socialize. I did this through friends who were already a part of these "social networks" (BTW, these were not Linkedin or Facebook or any of that sort of "kid stuff", of course). These were more like professional organizations, social fundraisers, etc.

Since I was already known as a former professor, engineer and entrepreneur, I had a "head start" in meeting some of the key people - and I used that. Anyone can start this process with their own set of contacts & friends and using whatever relevant experience that they may have.

BTW, my first company (started in 7/88, sold in 5/99) was entirely self-funded, it operated in the black and made the top growth list a couple of years in a row. That helped with establishing my credibility.

Regardless of that success, I still continued to practice & refine my pitch. I am always working hard to improve in any way that I can. I worked with key friends in these organizations who introduced me to the COIs (Centers of Influence). They, in turn, took my pitch to individuals who they felt would have an appetite for an investment. That allowed me to inherit the "trust umbrella" of existing relationships that spanned decades - essential to success.

Over a period of about two years, individuals came forward to hear the pitch and a portion of those (about 70%) invested. The average level of investment was about $50,000. Most recently, we picked up another $360,000 during the past eight weeks.

This was a process and took a lot of time & effort, but it was worthwhile. The people who have invested have a deep, personal connection to what we are about and so they act as COIs for potential investors and - more importantly - potential customers.

This process can be repeated elsewhere. It is very hard work so do not get discouraged. It's all a matter of finding folks who can make the introductions. Look at your own databases and see who may be a candidate to jump start this process. Also, do not be afraid to "do the ask". If you do not ask, you will never get.

Great post. Dr. Steve, thanks for the input.
To fnazeeri, NO COMMENT!

to # 10, Dr. Steve

great comments

do you have any other suggestions, such as other general directions that we all could use to further the discussion.

My ears are pealed.

Also, to fnazeeri re: Comment #8:

Since Carl Wimm originated this thread I'll just quote him:
"3) VCs have invested in too many good ideas and have lost their shirt.
Nkannan, nkannan, nkannan.
The truth is that VCs have a certain kind of deal they need - which has nothing to do with venture or investing.
And people game the system. They dress up their deals to look just like the VC template.
And so, VCs spend 50 million on pet foods dot com (and other "good" ideas)
Every idea looks good going in. No general ever started a battle he knew he would lose.
VCs lose because they fail to see the flaws. But wait a minute. The VCs are supposed to be the experts.
They are supposed to see the flaws. Other than that, you could just use a dart board - and save the 2 and 20."

Most VC's either don't give a damn about innovation, or have to deal with the screwed up way VC is now organized and are hamstrung in trying to make innovation happen: see

http://www.venturecompany.com/Opinion...

Most VCs care more about their IRR's and looking good to the other partners so they can stay in their positions for a least one more year to collect that 2%. Probably a good idea since 90% of them are going to be out on the street looking for jobs within the next few years, so they'll need the money.

Even Mike Moritz thinks VC is broken (and has been for 20 years)...

Entrepreneurs are bootstrapping and trying via grit and determination to make things happen, and are out building great companies right now. They aren't waiting for VC's or LP's or the government to fix the problem. The stupidity and (short-sighted) greed of most VCs today makes it really almost impossible to build great companies with 99% of them.

I'm all for this; Is there a community online that focuses on bootstrapping, as thefunded focuses on VC? Our business, superfluid.biz, is a b2b barter exchange that effectively optimizes sweat equity, so the more bootstrapping, the better for us.

Carlwimm (@ #7), peace dude.

Point is, you gotta get > 1.5x just to get the LPs back to even. Here's a rough example. Let's say $10m of LP cash is deployed over 5 years. $1m to the 2% annual skim to the VCs. $9m to the company. Let's say founders, employees, etc. own 25% at liquidity and the directors have cut themselves another 5%. To get the LPs $10m back, the company has to return almost $15m (70% of $15m) = $10.5 - 20% x $1.5 = $9.2. That's > a 1.6x'er on the $9m invested. My doesn't reflect time value of money, preferences, etc. But you gotta say it's though to make money for the investors even if the money is well deployed.

Lately I've been thinking more about debt models, or to be precise, models that pay more back earlier to the money and rely less on the ultimate liquidity event to deliver return. Less involvement in governance but also much more incentive to pull the plug after a year or so if the benchmarks (covenants) aren't being hit and since money flows back quickly the managers have every incentive to generate cash and pay down that debt and there's less need to own as much of the company.

What do others think?

To # 15, JonKessler

The first thing that leaps off the page at me - when I use your calculations - is that when you take VC money, you are down 33% from jump street.

If you need to return 150% just to break the fund even - and ....

then you need to show them a "10 bagger", so that they can get even with all the pet foods dot com deals they have made - because the only deals they could get that fit their pre cast model were the "lemming deals"......

Yikes

it is worse than even I thought.

In reference to the debt model - as an alternative to the equity model - that has all its own problems, including the one where .... when the debt is called, you lose everything if you can't write them a cheque.

Here is a different take.

The real issue is the Funding Gap.

That is the distance between "love money" and Conventional funding.

And I come back to the entrepreneur. If he runs his deal so that the Funding Gap is large, he must turn to VCs - and they know it.

If he runs his deal in a way that creates a Funding Gap - especially a big one - then he runs the VC gauntlet.

I prefer to obsess on the things needed to close or eliminate the Funding Gap. In the short and medium term, this is harder to do.

But in the longer term it is the right thing to be doing.

To JonKessler

You quick numbers don't include the probably liquidation preference. Even at 1X, those venture investors get their $9M back before reverting back to common and taking their 70% of the remaining $6M ($4.2M). That's a total of 13.2M- so even with a 1M skim- their actual return in that scenario is about 30% (much better than break even).

The venture money just isn't there right now. At least I've not been able to find it. That means continuing with individual angels, pounding the pavement and making do with less- be efficient and minimize burn rates. Ultimately, those of us that *survive* on less will suffer less dilution.

I too have been thinking about this funding gap. If the funding gap can be minimized- then debt may be the right option. I'm starting to explore this now as we are getting closer to receiving orders.

to # 17 abright

concentrating on eliminating or minimizing the funding gap is the RIGHT thing to do, and I applaud that focus.

thinking that you can take on debt is dangerous. It is never danergous when things are going great.

It is deadly, deadly, deadly if things go wrong and the debt gets called.

Then someone else is running your project unless you can write a cheque on that day and pay it off.

equity cannot be called. It rides the bumps down as well as up.

my best wishes

I think you can change the process or transparency all you want and nothing will change if it's continued to be an overcrowded market run by ex-bankers/fund managers with wannabe entrepreneurs for their industry guidance. Get some experience and wisdom to drive the investments and things would change. But the only people that are capable wouldn't get close to this until it's been obliterated, less idiot competitors with fat wallets.

BTW

VCs cannot comment on the Funded. So ... even if you pull this Gordian Knot apart, no one will ever know.

so send me an email .... carlwimm@gmail.com

if you are a VC and you have an answer.

I have an inquiring mind

Who knows, I might even write something nice about you .... heaven knows, a VC needs all the friends he can get these days.

It's largely a thinning out of the VC ranks. Aren't the top 10% doing okay? Many firms had a herd mentality, fell in love/invested with "me too" startups and are now struggling with those portfolio companies. The surviving VC gene pool should be smarter and more fit going forward. New firms without any existing portfolio companies (aka baggage) should also perform well as markets start to improve.

The only thing the charts prove is that we have been in a recession in 2008 and 2009. Surprise, surprise!

Also, it is not the sole responsibility of VCs to fix this. Arguably, entrepreneurs should take responsibility for providing better returns for the money that we take from VCs. Fortunately, I believe that will happen on its own as the economy improves.

to # 3, monish

I think you miss my point. So ... let me restate it here, for greater clarity.

We see VCs as being the domino that can't fall over, the place that the "buck stops". NO matter what happens in the world outside, a VC is always there, always impervious to the issues of life and living.

But it is not true.

VCs are not the "prime movers". They are more like real estate agents, than real estate owners or developers.

It is not their money.

The purpose of those charts was to illustrate that the "VC emperor has no clothes".

He can't make arbitrary investments. He is beholden.

If BIll Gates wants to invest a billion in a business to make snow skis from whiskey barrel staves, he can do so. He needs to answer and explain his actions to no one. He is not beholden.

But a VC is. He is just a middleman, an agent, a hired hand.

He may be dealing big numbers, but that does not change who and what he is.

Being beholden, he must do, at some point, with the real money people exactly what he requires you to do, when you kneel before him.

In the movie business and the VC business, you are only as good as your last deal.

The money for movies comes from someplace other than Hollywood. The money for VC deals comes from someplace other than the Valley.

The movie producers and the VCs are powerful gatekeepers. But the lesson is that when you deal with one of those people, you are dealing with the logic that the money people throw out.

The movie producer/VC cannot be influenced by your logic, if it is not already the logic he is listening to.

So, IPOs are important. IPOs are the exit. The nature of the exit determines the nature of the entry.

If you seek VC money, remember the old ditty about the "hip bone is connected to the thigh bone ... etc.).

"The Fund is connected to the exit, the exit is connected to the entry ... etc.), everyone .. clap your hands together in rhythm.

Daphne Zohar's article was nicely written and made some great points. I would amplify her comments and suggest that the "VC makeover" is already underway, simply due to market forces.

As an example, the former founders & key players at Steris Corporation (the well-known makers of infection prevention items) have started a new company, called Cardinal Commerce. They are funding it entirely with private equity because their experience with VCs at Steris was less than stellar.

Likewise, my company has already turned down VC offers and we have been successful at going directly to private equity. In fact some the private equity players in Cardinal Commerce are the same folks that have invested in us.

Private equity is simply easier to manage. Further, it has no "VC overhead", e.g., management fees, board positions, liquidation preferences, VC family members in search of a sinecure, etc. The valuations are better and you end up with a group of motivated and well-connected people who become actively involved in helping the business succeed. Finally, you know that you will not be "sold off" just to deal with other issues that the VC has unrelated to the progress of your enterprise.

I recommend that all entrepreneurs at least explore this option before agreeing to any VC deal.

I agree with your point Dr. Steve.. but finding wealthy private investors is a challenge by itself.. any suggestions there?

In my experience VC's like many other people have too many people that just have no idea what they are doing. I am working self-employed for many decades. I had VC partners asking me "who would ever listen to radio on the Internet". These are people in charge. And these people were hired by other people even more in charge.

A business is a very complicated ordeal. It is simply impossible to introduce this within 5 min. That's why it's called a pitch. It means nothing but what car are you driving, what shoes are you wearing and are you looking good. This is a complete joke.

Venture Capital will never work. The few times it did work were accidents. When I approached VC's regarding a new search engine - that was the time of Yahoo, Exite and Lycos - I heard them saying "Not a new serach engine". Welcome to Google's world. It's like playing the Lottery. Sometimes people win.

Venture Capital is like the rest of the economy - it's needs a new start! No repair is possible.

This is a fatalistic approach but it is really bad out there - for everybody.

well just take a look at Bessemer partners and their Anti-portfolio list.. it tells you what they made of in terms of knowledge (technical and market).. the list of companies that they passed on investing is shocking for a vc that been around since 1919.. http://www.bvp.com/Portfolio/AntiPort...
so these are the kind of ppl founders dealing with.. and I agree to your point on 5 min pitch.. I can explain a business in basic materials in 5 mins but a high tech business with a market trend that is getting impact by so many dynamic factors is very difficult to explain in 5 mins..

@#2 - As I mentioned in a previous post to an open discussion/letter, "PE" (Private Equity) is very "geographically sensitive". So, what works where I am at (Cleveland, OH) may not work where you folks are at. Having said that, I'll tell you what I did and you can alter the process to suit local conditions.

I got involved with various networks where the rich folks "hang out" & socialize. I did this through friends who were already a part of these "social networks" (BTW, these were not Linkedin or Facebook or any of that sort of "kid stuff", of course). These were more like professional organizations, social fundraisers, etc.

Since I was already known as a former professor, engineer and entrepreneur, I had a "head start" in meeting some of the key people - and I used that. My first company (started in 7/88, sold in 5/99) was entirely self-funded, it operated in the black and made the top growth list a couple of years in a row. That helped with establishing my credibility.

Regardless of that success, I still continued to practice & refine my pitch and I worked with key friends in these organizations who introduced me to the COIs (Centers of Influence). They, in turn, took my pitch to individuals who they felt would have an appetite for an investment. That allowed me to inherit the "trust umbrella" of existing relationships that spanned decades - essential to success.

Over a period of about two years, individuals came forward to hear the pitch and a portion of those (about 70%) invested. The average level of investment was about $50,000. Most recently, we picked up another $300,000 during the past four weeks.

This was a process and took a lot of time & effort, but it was worthwhile. The people who have invested have a deep, personal connection to what we are about and so they act as COIs for potential investors and - more importantly - potential customers.

This process can be repeated elsewhere. It is very hard work so do not get discouraged. It's all a matter of finding folks who can make the introductions. Look at your own databases and see who may be a candidate to jump start this process. Also, do not be afraid to "do the ask". If you do not ask, you will never get.

Daphane Zohar tries very hard to be reasonable but the weight of reality bears against her.

Here are her comments (and my comments)

1) Daphne says, "stop devouring entrepreneurs".

That is like asking a wolf not to eat meat. The short term imperatives of the current VC setup does not permit the VCs NOT to eat entrepreneurs.

Under the current regime of LPs, VCs and promises made, a VC cannot "nibble" he has to gorge.

There is no in between.

Good idea but wishful thinking. It cannot change unless VCs change how they set up their funds.

2) Daphne asks "Has the industry really reached such a low point that the only way to get good returns is by financially engineering out the founders".

Gee, is that really a question that anyone still asks??????

I don't want to suggest that I am a cynical brute and Daphne is an idealistic naive but .... come on.

When you make promises like ... we can get 30% returns on 500 million... in a world where there are 3,000 VC firms who have the same size fund and the same promises .... who are you kidding??

People are buying Treasuries at a 2 or 3 % return in the trillions. Why would they do that if, magically, there is a parallel market where 2 or trillion can earn 30%.

Let me state this as emphatically as I can.

There is NO WAY this can be true. Somebody is, at the very least, mistaken.

BTW, I do not believe that the VCs are successful in lying to the LPs. Neither of them is so naive that they actually believe it is possible to deliver 30% on trillions of capital every year.

My belief is that both parties know the real score. There are some really desperate people out there and, in exchange for some money, you can take everything they own, except for 5%.

The VCs are saying, "let us do the dirty work. You can keep your hands clean as we take full advantage of these people."

The LPs are saying, "Don't tell me what or how you are going to do it. Just get it done and send me the money".

3) Daphne says "The third example of venture fumbling is the VC-controlled board"

Again, I differ. You HAVE to have a VC controlled board.

You must ensure that made some serious inroads into someone else's deal, that besides all his written promises, that it all falls your way.

What better way to do it than to control two things, the company and the money. The founder's prime role in a VC deal, besides working 22 hours a day for next to no return, is to be the scapegoat in case everything goes wrong.

"Hey", says the VC, "it wasn't our fault that this deal cratered. Yes, we know we had the bank accounts and the Board, but the failure is really all John Smith's fault."

4) Let me quote again from Daphne - who seems to be a nice Lady.

"Without entrepreneurs there would be no venture capital industry, but the opposite is not true. In a world with no VCs, entrepreneurs would bootstrap, work collaboratively with strategic partners, and create new models to finance their companies. Entrepreneurs have creativity and perseverance. They will continue to create innovative companies and make money for those investors who really are great partners to them"

I am not sure that she got the irony of what she just said. The first statement is "without entrepreneurs, no VCs" .... BUT

it is not true to claim the inverse... "without VCs, there will be no entrepreneurs".

The truth is that entrepreneurs don't need (and should not want) VCs. And the good ones know it. The good ones live it.

So what kind of entrepreneurs are the VCs dealing with, if not the good ones.

5) Let me conclude by differing with Daphne's last comment that the VC industry needs just a little "surgery to get rid of some unattractive features".

Daphne seems to be think of the "unattractive features" as being something non essential, like a wart on someone's big toe. Just a little cosmetic snipping and all will be right with the world.

Daphne could not be more wrong.

I don't believe that any of the current VC population can be rescued, in fact.

The ones who worked well 30 years ago and made great companies with 250,000 here and 500,000 there have all been corrupted by their 5 million funds going to 2.5 billion, where the "2 and 20" ( or 2 and 30 , in some cases) is so rich that having the fund is all that matters.

The ones who joined later, started out rotten and stayed that way.

I actually don't blame the late comers so much. A bunch of MBA, young puppies ... they really don't know any different. If one recognizes that their intellectual attainment is equivalent to a rock in one's garden, one can ignore them.

The older guys, however, cannot and should not be forgiven for converting to the Dark Side of the Force. They knew what it was like to make a difference and for whatever reason, sold their souls for 30 pieces (or 300 million pieces - it is just a number, their souls are bought and paid for).

You will not reform this industry. You have to kill it.

Instead of a scalpel to excise some warty tissue from a big toe or two, bring in a guillotine.

Send the trolleys to every VC castle and chateau and gather the "nobles". Let them contemplate their lives as they trundle to their fate.

Let their jury, if they wish to ask for one, be those entrepreneurs whom they have so ably "VC'd". I would trust in that judgment.

Before a new industry that can truly enable innovation to proceed, can arise, the old one must be dismantled.

And so ... the noble VC is led to the table, the blade is raised, the drums roll and the cackling entrepreneurs stop their knitting and look up,...

One small slice for VCs, one giant slice for Innovation.

You have my best wishes.

I suggest a slight modification: 'Take their $s (if you can get them), take the advice with a grain of salt.' At times I've got good advice; at other times, seriously dumb comments. You have to filter it.

I'd agree with the first comment. You can get some good advice from VCs but they definitely won't know your business like you will, and the may not have industry experience. VC's primarily work for their investors not for the entrepreneurs so it is their job to pick wise investments more than to run companies. That's our job.

So true ... I like the 'grain of salt' part

It's all about the term sheet. The rest? Well, a lot of it would probably be more useful for extra buoyancy at the New Mexico balloon festival.

+1 on comment #2.

How is this bad??

This person :
* realized they knew less about a subject than they thought they did
* decided getting the knowledge was more important than saving their ego
* thought about who they knew that might:
* have more knowledge,
* have better knowledge,
* not treat them like an idiot
* provide insight.
* chose YOU to help them.

So my questions to you:
* Did YOU treat this request to be the guru (teacher) to this ex-VC as an honor?
* Did YOU look on this request a way to expand your network?
* Did YOU treat him with kindness and consideration ( the way entrepreneurs on this site claim they want to be treated?)
* Did you treat this as a two-way street, where he can teach you as well? Like maybe more insight into:
* the VC mindset and pressures?
* which VCs are in trouble?
* what VCs said privately about your company and YOU so you can correct those issues?

I was telling a medical student on Friday that if she can decide to not "label" annoying people in her life; if she can decide to be friendly (not friends) to the people that she interacts with -- hands down she will be better than 90% of everyone else out there.

For me and my company, that is our goal.

What is your goal?

to "liberal":

Not to rain on your lecture, but ...

I think the original posting was intended to underscore the silly situation often encountered when the VC is busily pontificating and issuing edicts against the better judgment of the entrepreneur in the trenches.

I think the posting was intended less as an indictment against a particular VC but more as a recalibration of all-too-common VC - Entrepreneur roles.

@anonymou$ --

Maybe and I hope so! (p.s. I am avoiding VCs for all the reasons why the original poster is )

Wise Old Etruscan Saying:

"Money makes a man popular, not wise".

To the point of "taking their money and not their advice"....

think about what you have just written.

Since VCs pride themselves on being experts - and they tell the LPs exactly that - you have to take their advice.

For the benefit of the LPs, the VC has to look like he is controlling the situation. That means that any VC money will come well larded with buckets of VC wisdom.

That none of it applies... that some of it could be counter-productive... that it is a complete waste of time and actually endangers the new enterprise by burdening it with reports, consultations, meetings and other activities normally done nude , in a circle, with a bunch of your friends .... matters not at all.

VC doubloons come well mixed, in a pile of VC droppings.

Suck it up, VC money takers, before you suck it in.

Now back to your naked VC

Life for him, without the cocoon of the VC world will be painful. He will have to learn what we have had to learn. It will be worse for him because he first has to "un learn" a whole lot.

Pain, pain and more pain.

But to quote Sakini (Marlon Brando - Teahouse of the August Moon)

Pain makes man think;
Thought makes man wise;
Wisdom makes life endurable.

You all have my best wishes - including the Naked VC

For what it is worth, I have taken a company public, I have sat as Chair of the Audit Committee of another public company (I oversaw the Sarbox implementation), and I have worked extensively with Wall Street

While I am clear that Sarbox is not the biggest reason why there is a reduction in IPO's, I am equally clear that Sarbox is needlessly and pointlessly a big reason for the reduction in IPO's.

to # 9

I also have taken several companies public. SarBox is not an issue.

the lack of IPOs is simply because Fear has trumped Greed.

The lack of an exit thus hampers the usual route a VC can take.

Once a VC gives you his money, he is passive. He may dominate your board but he is sitting back, drinking coffee and telling you what to do.

And a lot of those "orders" come in the form of "you have 6 apples, now make a 20 apple, apple pie."

IPOs succeed because the brokerage house buys stock for its customers at 10 dollars (an example) because it knows it can resell them the next day at 15 dollars. (Of course the stock the borkerage house gets, is free).

If the market place will offer you 2 dollars (and it is a "maybe" at that) while you want ten dollars, then there are no IPOs.

You can always do an IPO, just cut the offering price by 95%.

Sorry to be so harsh. But you have to see that the IPO market is just that, a market. And for every seller, there has to be a buyer.

The clearing price IS the market value. Just lower your price until you have people lined up to buy.

to #10. Your logic is flawed.

You say the IPO route isn't an issue ... just drop the price, even by 95%.
But if the price drops below what's available in the M&A market, then - whoops! - there's no IPO happening - ever - for that company.

The underlying and most important issue is whether the IPO route offers a superior value option to startups (vs. M&A) so as to sustain the IPO market. And in this case, the hurdle costs of SarbOx do sometimes make a difference.

to #10, anonymou$

I don't understand one statement you made ..

But if the price drops below what's available in the M&A market, then - whoops! - there's no IPO happening - ever - for that company.

Do I read this right. If you drop the price that you are willing to take below what sellers are willing to offer, then there is no IPO????

Of course, you have an IPO.

SarBox

When you have a start up company that you have controlled from day one and where you have made all the decisions and written all the cheques, there really isn't a Sarbox issue, if you tell the truth.

You hit upon the more important point. The IPO route (upon which VCs depend) has a price to offer you. But so does ... going it alone, selling out, merging, whatever?

Of course you are going to pick the one that is best for you.

If your comment is really an observation that reads something like ...

"the costs of an IPO are 250,000 in cash up front (which we don't have) and 12 months of time (which we can't spare), all to get 20% of what we really think the company is worth" .. and ... we have 4 alternatives that yield more money, with far less work and much quicker.

Then I agree

IPOs are not worth it.

Sarbox is not the issue. An IPO is a bundle of hurdles and inconvenience, Sarbox being just one - and not the biggest one.

This is an interesting concept on how to better align incentives. Successful companies with Investors that are not adding value can remove their influence while leaving them with upside. The presence of a "Preference Redemption" places pressure on Investors to behave better.

Maybe there is a smart way to structure it. The ability to purchase the preferences through a "Preference Redemption" could only be implemeted after a two year proving period. The investor would sell back their board seat, liquidation preferences, redemption rights, and protective provisions for 1x or 1.5x their original investment, being left with common stock.

Interesting.

I don't think this idea would "create any big world-changing technologies and businesses spinning off lots of jobs and regional economic benefits", or solve VC's systemic investment aiIs. But I would set that conversation aside and agree that IF you could get VC's to agree to this, it would make economic sense for the business entity.

The two tricks are finding the smart way to structure it (as the previous post states), and persuading the VC that it is in the best interest of the business.

Hey, if the startup is generating cash and growing nicely, the VCs will be foolish to upset the management team and waste their energies for some sort of sadistic pleasure of controlling or firing the founders. You do not have to redeem at all. It is a waste of cash to redeem the preferences. It will be far more productive to invest back and grow the company.

Basically, whoever provides the marginal dollar of cash for operations, controls the company. If it is investors then they will do so. If you get the marginal dollar from your customers then your customers control the company. You would rather have the customers controlling than the investor. Remember, you can control your Board, but customers ultimately control you and your Board. Get more paying customers and keep them happy.

You can always go public and the bankers will do your dirty job of forcing all preferred holders to convert to common without any buyout. Or you can force a sale, if you are hell bent upon getting rid of preferences.

I really don't think any VC would voluntarily give up a liquidation preference. In any event, the mechanism already exists within typical VC preferred stock. Upon a majority (or other threshold) consent of (a series of) preferred stock, the (series of) preferred stock will typically convert to common stock. I suppose you could pay the preferred to convert, but I'm not sure if this would ever happen as a practical matter.

Caution. There may be tax ramifications depending on the way you involve common stock. That may cause tax headaches down the line, esp. for employee option strike price and other considerations.

"f the startup is generating cash and growing nicely, the VCs will be foolish to upset the management team" I think VCs have every inclination to rock the boat of a successful startup. See the discussion under "Former VC Perspective" http://www.thefunded.com/funds/item/5858. Meddling VCs trying to gain more control is one of the major putoffs for taking their money in the first place.

"the mechanism already exists within typical VC preferred stock" I don't believe any existing "voluntary" mechanism for reverting preferred shares to common really works. There should be a mandatory way that the founders could force it.

@Yokum: Getting a majority of Preferred shareholders to convert to common is a protective provision necessary for Preferred shareholders to "out vote" common shareholders as a class in drastic situations, such as a blocked merger or management team removal. Preferred shareholders would never convert to common unless a serious control issue was looming.

Structured redemption rights to "reclaim" the Preference is a great idea. First, you will start to place an economic value on the preferences, bringing more transparency to the process. Second, it will encourage better investor behavior.

This is one of the hardest areas I've encountered.

When you take VC money you're signing up for a homerun. VC's need companies to return the fund with a five year timeframe. I've done the economics thinking "I'd be different" but that is the way the math works.

Problem is when it turns out the company isn't a homerun, but its not a flameout what do you do??? Its called a "lifestyle" business which could be great from the founders perspective if managed correctly but its HORRIBLE from the VC perspective.

Getting rid of the preferences doesn't work. They have to be liquid and the only thing worse than illiquid preferred is totally illiquid common. You have to buy them out with terms you can both afford. This is better than the alternative which is bring in management with no ownership that wants to swing for the fence but if its not a business than can leverage capital in the right way, you're done for.

Ironically, even though VC's use the term "lifestyle business" as a derogatory term, all good VC businesses are in fact "lifestyle"

Illiquid common? You got your marbles back and can bet on any other startup you want. In fact, if you get a lot of these deals buying your preferences back, you can scale infinitely. You have no money deployed. There's no limit to the number of shares in multiple companies you can own, if you don't have any cash tied up in any of them. This method of investment definitely scales. Then you can live with a less than 10X return, since your investment in any particular company is $0. You are not limited to just 10 investments per fund. If you pick only companies that buy your preferences back, you could have 100 companies in your portfolio.

There is a reason all VCs want Preferred Stock. It comes with preferences. If you are a minority investor in a company where you don't work and the majority holders do work and the stock doesn't trade you have absolutely no power whatsoever.

You have to remember a typical VC fund dissolves in 5 to 7 years....and you should look because if the VC is in their third or fourth year for that fund that shortens that timeframe.

VC's can't just take their money back and hold on to it for new investments. They must give it back to their investors......and giving their investors illiquid common stock isn't going to work.

So they would want to sell their stock. Trying to sell common stock in a private company would be very hard.

Thanks for p[osting this.

AShah's comments to the NYTimes article cannot be denied - they are a first person, sitting in the room, real observation.

Wonderful

Great posting!

ThanX!

What if a successful startup generating cash could pay back the investors and have their preferred shares revert to common - with no preference items? This way successful companies could continue to be run and controlled by the founders increasing odds of success. VCs would have their money back and no longer at risk reducing need for careful control. They would still have their percentage ownership stake and funds available for investing in the next startup.

Right now, investment terms are so crappy that startups are chasing smaller ideas that require no investment and no VCs, and generate cash and achieve sustainability for the founders quickly. But they don't create any big world-changing technologies and businesses spinning off lots of jobs and regional economic benefits. We are all poorer for it. Right now VCs are forced into highly controlled, heavy investment "big ideas" and "long shot big bets" that invariably run into problems, lose their founding teams and fail.

If successful startups generating cash could buy back the preference items from their investors, they would know that they have a path to retaining control over their startup baby. And VCs should welcome having a capable team that is motivated to have their startup generating cash quickly. Their own "entrepreneurs in residence" could not do it any better. More entrepreneurs would be willing to take those bigger chances, and VCs would have their ownership at reduced financial risk.

If this post does not tell everyone what the real world is like, nothing will.

Great classification system. However, I don't believe any VC fits into the partner category. You're lucky if you get a parasite... most are pathogens.

Just to be balanced, let me communicate the views of some of my VC contacts that I respect, arguably the dark side.

Entrepreneurs fall into these categories from the POV of VCs..

1) Pathological solipsists: Most entrepreneurs are so sure of their own ideas and abilities that they are impervious to any and all questions regarding viability or the business merits of the ideas. If love is blind, entrepreneurial self-love is doubly blind, which is essential for their work and also can undermine success.

2) Contempt for VCs: Entrepreneurs view VCs as middlemen adding little value, but LPs view them as fiduciaries who will work hard to find and invest their money in ventures with high probability of success by sifting through thousands of opportunities presented by eager entrepreneurs

3) Entrepreneurs assume automatic value creation: Typically entrepreneurs assume that their unique products, services, or ideas will create value by their compelling benefits they ostensibly offer. Not so. Value creation is not automatic and it takes incredible effort to create sustainable and growing revenue streams and do so profitably. VCs have invested in too many good ideas and lost their shirts and thus are skeptical.

4) LPs should cut out parasitic middlemen like VCs: Not really. LPs need dispassionate middlemen who are not in love with one or two ideas and who will go over a cliff clinging to their business plans. LPs depend on VCs to search and sort among infinite opportunities for investments. Entrepreneurs, by their very nature, are incapable of such a role as they are romantically involved with their own ideas.

In sum, some entrepreneurs are great value creators just as some VCs are great identifiers of potentially successful ventures. We need both of them to create new industries, wealth, and prosperity for the foreseeable future.

@nkannan --

I agree. Every day an entrepreneur should look themselves in the mirror and ask if the best thing for their company is to replace themselves. This is true even without investors.

However, I disagree with you about the value of VCs from the perspective of the entrepreneur. Why as an entrepreneur should I care at all about the VC-LP love fest? That will not affect how well my company succeeds. Nor should I care about how jaded a VC is because of past bad experience UNLESS they use that experience to help MY company avoid a pitfall. In which case they are a PARTNER or PRODUCER.

Maybe a jaded VC should take that as a sign that it is time for a career change.

In the meantime, it is really hard to feel sorry at all for anyone driving a Porsche and living in Atherton. Cry me a river... Boo-hoo.

Less than 1% of the VCs in the US live in Atherton or similar towns. They get wealthy by making their portfolio companies succeed. They have a vested interest in your success and they are under pressure from LPs.

I do agree that many of the VCs should go find something else to do. At a minimum get some real world experience.

First, great classification system.

Of the four institutional investors in the company, I have one Partner, one Parasite, one Pathogen, and one kinda completely harmless investor who looks around for direction. Need a P to describe this sort of investor - maybe Puppet? So, as long as I keep the Puppet aligned with the Partner and manage the Parasite, the Pathogen's efforts to derail the company fall on deaf ears.

wow, @nkannan, thank you for your comment, and boy, do your contacts fit the mould perfectly!

Notice that my classification is based on how much value the various groups bring to the table, while the VCs comments are based on entirely superficial and mostly psychological things. Does it really matter what an entrepreneur thinks about the VC, or the VC's relationship with the LP? Is being passionate, really a pathology?
Isn't the only pathology here the extreme insecurity and frailty of the VC egos?

It's funny how in the world of pro-sports GMs are a lot more mature about these things? It is assumed that most top athletes think that they can always win. Is that a knock on them? Have you heard a GM or a coach complain that such and such athlete is too sure of his abilities. You take that for granted and try to make decisions based on talent and skill, not on some superficial psychoanalysis.

And what about appreciation? Do you ever hear an athlete credit the suits in the front office? Publicly it's: God, my teammates, the fans, sometimes the coach. Privately, it's probably: me and God. So what? What matters is winning. How petty and unproductive would be if GMs rated players, based on "respect for the suits". Would anyone - owner, fans, media - tolerate such GMs even for a month?

to Krassen:

It is an old theme on my part, posted here in public and in private, but once you understand a VCs money, once you understand that a VC is completely imprisoned by the promises he has made to his LP, you understand that a VC can NEVER be a producer.

He has to be a parasite, or is he is really not very good, a pathogen.

To Nkannan:

Let me go over your comments and perhaps you can see what it is that you have really said

1) The Entrepreneur as solipsist.

This cannot be a complaint. What do you ever want to have to do with an entrepreneur who is not totally convionced of the rightness of his cause.

The filter for a VC should be to kick out any entrepreneur who is not a fanatic about his project.

If he is a cynic, hire him as another VC.

2) Contempt for VCs

Let me get this straight. The universal feeling of all entrepreneurs who deal with VCs is contempt .

Of course, they are all WRONG.

There is an international conspiracy of entrepreneurs, Bilderbergers, Trilateralists and bankers to feel contempt for VCs.

Rubbish.

If the feeling is uniform, then it must have a good reason for being so.

If the VCs just want a touchy feely, self actualization experience ... take a pill.

If they are serioous about being investments proffessionals that do what a rpofessioanl must do. Take a look at the criticism seriously.

VC, heal thyself.

3) VCs have invested in too many good ideas and have lost their shirt.

Nkannan, nkannan, nkannan.

The truth is that VCs have a certain kind of deal they need - which has nothing to do with venture or investing.

And people game the system. They dress up their deals to look just like the VC template.

And so, VCs spend 50 million on pet foods dot com (and other "good" ideas)

Every idea looks good going in. No general ever started a battle he knew he would lose.

VCs lose because they fail to see the flaws. But wait a minute. The VCs are supposed to be the experts.

They are supposed to see the flaws. Other than that, you could just use a dart board - and save the 2 and 20.

4) Parasitic middlemen.

Actually most LPs should not be in the venture business at all. Their blue blood approach to money management is 4 generations removed from wealth creation.

Wealth creation belongs to the men with "face", not the faceless. Wealth creation belongs to men with character, not the amorphous salary man.

Whether created or made, the man who is destined for wealth creation is the only one who should be trusted with it.

Bureaucrats, pension fund mangers and widows at country clubs need excitement too, of course. Let them play bridge and have tea parties.

How many VCs would sleep in an office for a year, not knowing if one year or twenty years would be enough to make the difference.

Entrepreneurs are explorers and, as the saying goes, "explorers have to be prepared to die lost". (and poor and disgraced and alone).

I have no complaint about LPs. Let them spend their days chasing waiters around for more ice for their G and Ts.

But do not presume to be "one of us" just because you have so much money that you can invest in something of which you know nothing.

The difference between "them" and "us" is not money or lack of it. The difference is that we believe, "they" cannot.

5) Why did you write this posting

Nkannan - this was a puff piece posting, written by VCs, but submitted by you.

Do try and remember that the web site for "Sycophants for VCs" has a much different URL.

Wow, best post in a while.

Re: ECCE-O's Puppet: I agree that Puppet is another descriptive and large category. I've worked with many puppets, many parasites, a couple of pathogens, and one partner. The Partner is on my board today, I feel fortunate.

Re: CarlWimm: I don't think Krassen ever intended to classify VCs as Producers. I've certainly never met one in that category, although many would rate themselves as such!

Finally, Adeo, give serious thought to adding this rating system to the VC partner ratings on TheFunded.

Keep it up guys and girls, this is great summer reading!

Carl Wimm: great post! Never really thought of building a business as "exploration" but that is exactly what it is and what I've been doing. And I second the last post, great summer reading on TheFunded this year.

@carlwimm

I would like to pin this on my office door "Wealth creation belongs to the men with "face", not the faceless. Wealth creation belongs to men with character, not the amorphous salary man."

I have always believed that humility is the character of a man with "face" whether in our relationships with ourselves or with others.

Adding on that, I do believe there can be a healthy relationship between VC's and the rest of us. Its starts with us understanding the risks investors take to believe in us and investors understanding the sacrifices we make when we chose to do what we do.

For us, we should never be afraid to fail and to change. For the VC, you should never be afraid to risk and evolve.

Mr. Smith - I wish all posts were as lucid, thorough and objective as your post. Thank you for taking the time and effort to write this post

If you have not done so, you should expand upon these points in a blog format, or the like, if you care to share more of this information with those who really need to hear it.

Item #2 rings very true to my experiences. First, or early in investors have a lot of power over the direction of the company by how they represent themselves and their level of interest in having additional investors "welcomed" into the company, or treated has trespassers.

I just closed a company last month because of this. First in guys refused to have anything to do with new investors. It was obvious. I still had enough control over the situation and let them know to play nice or I will walk away and close the company.

They decided to call me on this, so I resigned as CEO, then got a majority vote to dissolve the company, closed it and walked away by following the legal rules in our operating agreement to do so.

I have since started a new company and went back to the interested investors, who were not welcomed in the prior company, and have begun raising money. Almost a million dollars in start up capital was lost, but the ego in these guys got the best of them.

Thanks for shedding light on how things really work behind the scenes.

Terrific, thorough post. VC's can absolutely force a sale, and as the post points out, there are multiple tools they design into the term sheet to ensure this.

Excellent rundown of the methods of gaining and exercising control over important decisions such as forcing a sale. I was a senior VC officer for a bank owned venture group. In these cases, our investments often followed bank loans from our parent bank which included security interests in all the assets of the company. While the bank often had views different from ours as equity holders, when they were parallel and big changes needed to be brought about, the bank's leverage over the company was immense through its loan and security documents. In those cases, there was no pretense by the bank about the leverage that was exerted. I managed our VC portfolio averaging about 30 to 40 companies at a time. Of these, about 20% (a guess after all these years) also involved our bank. Of these, I sat through or was directly involved in about 15% of the joint lending/investing deals in which we arranged for buyers of companies or changed managements. That doesn't count the ones we arranged on our own when there was no bank involvement. These experiences eventually led me to leaving the VC industry and becoming an entrepreneur, with the foreknowledge not to let these consequences happen to me. About 20 years later I co-founded a healthcare company. One VC liked us so much they agreed to fund all our needs. Sounded good until we need our next round of capital. They walked us right up to 2 days before a payroll we couldn't make without their funding and they "persuaded" the Board to fire all top management (including yours truly) and accept their new money at dilutive terms such that old shareholders that owned 75% of the company before the financing owned less than 1% after the financing. What goes around from my early career (which didn't seem capricious at the time) came around in later days where the VC's actions seem egregious and capricious. Bruce G. Rossiter, CEO, Zoom Sales and Marketing.

Great post that any entrepreneur should read when engaging with VC.

My personal experience has been that the most unscrupulous of VCs not only use these methods themselves, they often attempt to conspire with other investors or prospective investors to find ways to achieve their goals. In our case they took method #2 to the extreme of sabotaging our efforts to raise the capital we needed to fill $20M in purchase orders we had in hand. The temptation to take control of the company just when it was headed to be a huge success and eliminate the founder was so great that they actually told other VCs not to invest the amount that had been negotiated, put in a minimum amount, get a seat on the Board and help take over. They then offered a “special price” (without Board approval) to the other firm if they would cooperate. To the credit of the other firms, they saw a dysfunctional greedy Board member and ran for the hills. We know all this because they ultimately caused the demise of the company, lost their investment (and everyone else’s) and we are now suing them and have their e-mails to the other firms to prove the breaches of their fiduciary duty. In my present company, I would close the doors before I would let VCs get close to a controlling position.

This one simple rule applies.

If you take VC money, it is all about the VC and his "needs".

They are always in first place.

And there is nothing and no one in second, third, fourth or fifth place. If you are lucky, you might be in sixth.

Great post and very informative comments. As new to the site, I am learning a lot with your experiences. Thanks a lot. Looks like a game of sharks this VC game. I would bet for having a good shark in my team :) to be prepared and have a good defense.

To Adelante:

I am not sure that you have it right. There is no good defense against sharks.

Once in the shark pool, you are shark bait. A shark only knows three things (From "Jaws") It swims, it makes little sharks and .... It seeks shark bait in order to eat.

There is no point to jumping into the shark pool in order to defend yourself from being eaten. You cannot accomplish anything else since the shark is only capable of eating you.

The only viable choice to make is the first choice you must make.

Do I jump into that pool or not. If you are not in the pool, you don' t have to worry about sharks.

Let me abandon the metaphor.

Since the odds of getting VC funding are 1 in 3,000, why bother.

Spend the time that you would spend in 2,999 worthless, boring, frustrating meetings ... dealing with people who are not interested in you or your project ... spend that time on making your project work.

The best defense against the sharks is to ignore them. Find ways to do everything you need to get done within the resource net you have at hand.

Waste not one penny of your money and not one second of your time, chasing that ice castle.

I know, I know, I know.

Wouldn't it be nice to win the lottery, get 5 million of VC funding, get a 6 million dollar earmark and just not have to struggle, struggle and struggle some more on mundane stuff like paying rent.

When you face the truth ... that you seek that "5 million dollar lapshot" because you just want it easier for a while, not because your project can't work without it,.... you can buckle down, finish your project (you can always find a way) far sooner.

Interesting post. Definitely an eyeopener and confirms the Golden Rule--He who has the gold, makes the rules!

I think that carlwimm's response is particularly poignant. We've been struggling with whether we should attempt to dive into the "pool of sharks" or just get our heads down and make what we are doing work.

We are two years into a business that has been funded by the founders to date, and without the 08 Q4 meltdown would have been on the road to profitability. As a result things are tighter than we'd like. Bringing in outside money will make things easier and probably speed up our growth, expansion and acquisition goals. But the resources (our time building the product and sales) diverted to find that money and the strings that will come attached to it as outlined above make VC funding a not so attractive option.

Mr. Smith, I've done an analysis of the distribution of Amazon proceeds to Zappos shareholders, based on information in the Amazon SEC filing, coupled with details on liquidation preferences for each Zappos series of preferred that are contained in Zappos' articles, on file with the CA Sec. of State. These are at http://wac6.com. Basically, I found that Sequoia is going to do better on the Amazon sale than it would have without its liquidation preferences (which were 4x in the penultimate round, but both of its investments were designed to target a value of $24/share, in Zappos currency, before the preference went away). No redemption rights in the articles, however.

TO SPLEVY

There are actually 4 golden rules, not just one. The one you quoted is number 3.

The most interesting thing about all four rules is that you can judge a man and his intentions by which of the 4 he lives by.

Rule 1 - the Biblical rule

"Do unto others as you would have them do unto you."

pretty simple, pretty straightforward and a good guide for life.

Rule 2 - The Wall Street Rule (and the Washington rule)

"Do unto others BEFORE they do unto you."

Again simple and straighforward, but ..... yuck .... what a way to live.

Rule 3 - The VC rule

"He who has the gold makes the rules".

Basically it is an attempt to fix the poker game by making the game nly about who has the money.

Great technology, great project, great idea, .... who cares, ....

I have the money - please fall down on your knees and worship me.

Rule 4 - the CarlWimm rule

"He who makes the rules, gets the gold".

You either control the tendrils of life or they control you.

Your call. Best of luck to all of you in whatever you choose.