Archive for the ‘Fundraising’ Category

Taking the long road

Screen Shot 2014-05-02 at 12.10.15 PMI first met Carrie and Tony Requist of U Grok It in February of 2012. We were hosting a DEMO event with VentureBeat and UGrokIt was one of a handful of companies that was chosen to come in and pitch. I remember the U Grok It presentation well for a number of reasons. For starters, Carrie and Tony are married. And living in Steamboat. Both pretty unusual for the startup world. And they were building a simple smart-phone based RFID reader with the idea of creating a consumer product that would allow individuals to easily and cheaply track their stuff – a problem I’m quite familiar with as I have an uncanny propensity to misplace things (there was much joking in the meeting about this, in fact).

I stayed in touch with them after that first meeting and occasionally Carrie would swing by Boulder on her way in or out of town to update me on the company’s progress. As many businesses do, U Grok IT took many twists and turns as they figured out how to turn their prototype into a production unit and honed in on what they eventually found was a much larger opportunity – providing a enterprise class (but still smartphone based) RFID reader that was an order of magnitude cheaper and significantly easier to use than the special purpose units that had been on the market relatively unchanged for the past 15 years. All this while scrapping funding together on an almost continual basis.

I was impressed – mostly with their scrappiness but also with the progress of the idea and the business. And as I sat listening to the latest update about a month ago I finally had the right mechanism through Foundry’s FG Angels syndicate to actually support them and the business.

I wrote a post a while ago about the 10 year entrepreneur that described the often long, less celebrated journey typical of most entrepreneurs as they built their businesses (contrasted with what sometimes is glorified in the tech press). The story of UGrokIt’s funding is in the same vein. Perseverance in the business and in continuing relationships pays off. I’m excited to be working with Carrie, Tony and the entire UGrokIt team.

May 2nd, 2014     Categories: Company Creation, Fundraising    

The 4 Keys to a Successful Angel Investment Strategy

With the increasing popularity of angel investment sites such as AngelList and CircleUp more and more people are making investments. I love this trend and have a longer form blog coming on the subject – which I think is massive positive force in the startup ecosystem. But this post is much shorter and to the point.

I often get asked what my thoughts are on angel investing. Here are what I think are the 4 keys to a successful angel investment strategy:

1) Take a portfolio view of angel investing- put aside a pool of money and plan to make 10 or more investments. One-offs simply don’t make sense in this market (too much alpha)
2) Be willing to lose all your money (and assume you will) – mortality rate at the angel stage is extremely high
3) Be passionate about either the team, the idea or both. You should be in love. Angel investing is about emotion, not logic.
4) Don’t reserve/follow. Your job is to put in seed capital. The company’s job is to grow the business and find new capital. They either do this and are successful or don’t and you write it off. I don’t think it’s wise to play the pro-rata game at the angel level.

April 22nd, 2014     Categories: Fundraising    

Just say NO to that large fundraise

I wrote a post a few years ago about using your lack of funding to your competitive advantage. The basic gist was that all businesses act within constraints and that the discipline that can result from having less money that a competitor – if you embrace it – has the ability to sharpen your focus, avoid the temptations of distraction and be more thoughtful about how and when you spend the precious cash that you have.

I was reminded of that post recently when engaged in a debate about how much money a company should raise. The knee-jerk reaction is often “as much as they can!” And while that might sound satisfying, it’s often not the case. At Foundry we’ve been fortunate to be involved with a number of businesses that have taken advantage of the ability to raise a war-chest of cash. And when you’re going big, and have reached proof points where you can now spend money with a specific plan in mind (and the metrics to back it up) this often makes sense.

But not always.

Much less is talked about the null case. Those companies that could raise larger round but opt not to. We’ve had a number of those in the portfolio that are – by the nature of having not raised a eye popping round – much less talked about. While a whole lot less sexy and certainly not as buzz-worthy, NOT raising a large amount of capital very often makes as much (or more) sense than raising “as much as you can.” A few thoughts on why:

– For companies that are cash flow positive and already growing about as fast as they can keep up with (yes – there are plenty of these businesses around and yes – adding more cash doesn’t always equate to more growth) there’s often simply not a compelling need to over-raise.  Think growing at the right cost vs. growing at all costs. One optimizes spend and trajectory. The other wastes money.
– Large rounds bring new investors and a different investor/board dynamic which can be a challenge to manage, especially for a fast growing business
– Importantly, those new investors and their large piles of cash bring with them lofty exit expectations. Often times companies are better served raising a smaller amount of money from existing investors to keep all of their options open – especially as they transition from start-up to mid-stage. I’ve watched this literally kill a company.
– Large balance sheets beget large spending (see my post I referenced above on being scrappier than your better funded competitor). The world is littered with companies that raised too much, then spent too much. And while you can certainly keep your discipline with a large balance sheet it’s pretty easy to get off track.

More than anything, its important to note that there’s a choice here. One isn’t better than the other – despite the market perception. Make your own choice and don’t get caught up in the hype.

March 25th, 2014     Categories: Fundraising    

Handling rejection

Update below with the final email in the chain where the entrepreneur apologizes (and talks about some challenges around fundraising that led to his frustration).

I just tweeted about an unfortunate email exchange I just had with a company founder, but 140 characters isn’t enough to really do the matter justice. And more important than my venting (and to be clear this post is definitely part that) is the real issue that many entrepreneurs face about how to handle a “rejection” email from a potential funder. This is an example of how not to do it.

I pride myself on answering all the legitimate emails that I receive (punctuated by the point that it’s 8:24 on a Tuesday night and I’m sitting here at my desk doing just that). I think this is getting more common amongst VCs, but I do hear from a number of entrepreneurs that they send notes off and get nothing back. I figure everyone who emails me their plan is really excited about what they’re doing and deserves a response. Sometimes it’s a quick no, sometimes it’s more extensive if I have an idea that I think is worth sharing back.

From the entrepreneurs perspective I can understand the frustration of hearing that the idea that you’re so excited about isn’t something that whoever you emailed wants to hear more about (and I can relate – Foundry raised money from investors and got plenty of “no’s” before we managed to pull together a syndicate of fund investors). But the reality is that not everyone shares your passion, not everyone is at the right time in their fund, not everyone has time vs. other things their looking at to take a closer look, etc. And with most firms having some kind of focus, there are plenty of ideas that simply fall outside of a firm’s investment bounds. And, of course, the math makes it hard as well. At Foundry we see something like 5,000 business plans every year of which probably 500 or more are clearly plans that will get funded by someone. So there is no lack of really interesting things to take a look at. But there is a lack of time and money. In our case that means making about 8 new investments a year (give or take). I’m sure many firms have a similar funnel.

Nonetheless, handling a rejection is important. Done well it can keep the door open to further engagement (I’ve had plenty of companies that I’ve turned down drop me notes with updates on their progress and asking me questions or advice) and can sometimes lead to a later investment (we have a company in the Foundry portfolio that we (I) turned down that we funded several years later). I strongly believe in the “no assholes” rule and try to live my life by it.

Below is the exchange in question (personal details redacted), posted in all its glory. Ironically in this case it looks like this is someone I gave some advice to about a prior business plan (I don’t remember the details – it was one of thousands of these sorts of emails that I have responded to over the years). Oy!


Howdy Seth,

Our social site based on privacy never went anywhere.

We were right about the privacy stuff. But no one cares. Oh well, win some you lose some. I’m proud we did it, no regrets.

Check out our site:

We make money, been around a long time, our customers love us.

There’s a big opportunity we need help with (not sure if that’s the right lingo or not).

Any interest?


My initial response:

Sorry that the [redacted] idea didn’t take off. It’s hard to get people interested in a new social networking idea these days (even those who say that privacy is important). Good for you for moving on to something else.

.[redacted] is definitely novel, but doesn’t really fit our investment focus (see Big opportunity is definitely the right lingo (and what you’re searching for…).


And then this is what I get back:

Howdy Seth,

Be honest.Did you even look at the site?

Just worked out a deal today that leads us into one of the two largest captive auto lenders and one of the three largest banks in the US.

But you’re not interested.

Go see the movie “Twenty Feet from Stardom”.

Then get that funding is more about who you know, pedigree, etc., than anything. Get how many talented entrepreneurs there are out there, that don’t make it. For no other reason, then they’re on the outside looking in.

One of these days, I’m going to write about it.

I could have a cure for cancer, you wouldn’t give us a dime. Because you don’t know us, you don’t anyone who knows us, and in my case, I’m too old.

You know how you could make the planet a better place? Start telling the truth to people.

I’m not angry, at least you were kind enough to reply.

Be cool.
or just be.

Obviously it totally pissed me off (thus the tweet and the rant here). This was my response:

I’m debating whether to answer or not given the tone of your email. But I didn’t want to let your belligerent, tactless note pass. I did look at the site – and you have no reason to rudely call me out on having not done so. If you looked at our website you’d understand why this isn’t a fit for us ( – we’ve written extensively on what we’re interested in and what we’re not). And yes – if you had a cure for cancer we wouldn’t be a good target for you because health sciences isn’t in our investment focus (which, again, you would know had you done any research on us). We get over 5,000 business plans submitted to us each year (and fund about 8 new ideas). That’s why we’re so deliberate about what we’re interested in (and good at) and what we’re not. We have entrepreneurs of all ages and “pedigrees” (whatever exactly that is). And have funded people we’ve never met before or who don’t have 1 degree of separation with us. You can believe otherwise if that makes you happy. But there’s no need to be an asshole about it.

Good luck with your idea and with your life. I’m sorry it has left you so bitter and angry.



Postscrip below. Final email from the entrepreneur below. Felt that I owed it to him to include it here.

Yes, rejection sucks.

Yes, I have feelings about VC’s that are…real for me and plenty of others.

For me, they come from how I grew up, poor. They emanate from coming into the tech world in 1988, the hard way. From being turned away at the door so many times, because I didn’t go to Stanford, didn’t come from the right family, didn’t have the right friends.

All these years I’ve financed my business with SBA and bank loans. So has everyone I know. So I don’t know anyone in the venture world, neither does anyone in my circle. You have no idea, how hard it is, to break into this world of yours from the outside. Nowadays, it’s just impossible. Throw in that I’m 54 now…

There’s discrimination in the tech world now. The tech world makes those on the inside richer, and it keeps those on the outside — there. It never used to be that way and yes, I’m angry about that. I need to deal with it.

No one talks about that the chances of getting funding if you aren’t in the know (went to the right school, worked for the right founder, know people in the VC world), are older, are slim and none. Instead, the VC’s have websites that create a false sense of hope. It’s bs and no, I’m not going to apologize for the truth.

That’s what you should write about. That’s, what no one writes about.

But I do apologize for making you wrong. You do what you do. I need, to deal with it.

Go see the movie. I drove two hours to see it. Background singers and entrepreneurs on the wrong side of the tracks, are on the outside looking in, have so much in common.

You’re right, I got anger.


July 23rd, 2013     Categories: Fundraising    

How much should a start-up CEO make?

I was asked this question at a talk I gave to the recently graduated TechStars Boulder class and thought it deserved wider dissemination than to just the group in the room at the time. This is a loaded question and while there are many variations I do actually think there are some general norms that are followed in most cases. So here goes with some guiding principals and then below that some numbers. Keep in mind that I’m talking about Seed and Series A stage businesses.

Pay yourself as little as you can. Cliché, of course, but true. At the seed stage the modest amount of money you have raised is best spent on product and attracting initial customers than it is on paying yourself. This advice is generally true across the organization. It’s also true that generally founders and early employees own a large portion of the business at this stage and as a result, business progress at this stage disproportionately benefits founders. So the trade-off is most beneficial to the founders and employees – including the CEO.
Don’t starve. There’s no sense in paying yourself so little that you can’t live or will be overly stressed about paying your bills. Seed stage investors are sympathetic to varying life conditions and you don’t need to tighten the belt so much that it ends up distracting you from your focus on building a great business. Some founders are happy to live in their parent’s basement and take almost no money; others have families or student loans, etc. and can’t work for minimum wage.
Have an open conversation with your investors about what you need. As is typically the case, you should be as transparent as you can with your investors on this topic and have a open dialogue about compensation.
Map out a plan. As part of this open conversation be clear about what your expectations are going forward and what milestones might trigger incremental compensation (raising a larger round, getting product into the market, hitting a certain revenue target, etc.).

So what does this all translate to? I think market (and this seems to be true whether you’re in San Francisco, New York, Boulder or somewhere else) is that companies that have raised $1M or less tend to pay their CEO between $75k and $125k (skewed very much to the low end of that scale – companies that have raised less than $500k tend to top out at $75k for CEO comp). Companies that have raised between $1M and about $2.5M tend to pay their CEOs around $125k. Companies who have raised above that amount skew up from there. Not science, but these observations are based on a sample size in the many hundreds.

August 22nd, 2012     Categories: Company Creation, Fundraising, Uncategorized     Tags: , ,

The future of your past (our investment in Mocavo)

It’s funny how things have a way of working out. I wrote recently of our experience with SEOMoz – from initial meeting a few years ago to finally investing in them earlier this month. Today we announced our investment in Mocavo – a genealogy search platform that provides users with the best tools available to find information on their ancestors. More specifics on the business in a minute but the year long journey from TechStars to Foundry investment is worth noting.

I first met Mocavo at the start of last year’s TechStars Boulder. I liked founder Cliff Shaw a lot and appreciated (although at the time didn’t share) his passion for genealogy. When he asked me to mentor them through the program I thought it was a pretty safe bet. “Sure thing Cliff,” I said at the time, “there’s zero chance that I’d invest in a genealogy site, but it would be fun to work together!” Through the summer I held to that party line.  Cliff and I kept meeting regularly even after TechStars (Cliff knows my soft spot for sushi and would regularly invite me to the Mocavo offices for brainstorming sessions with the team over take-out). But over the winter the lightbulb went off on what a big idea Mocavo really is. I had known that genealogy is a huge (and growing) market but was beginning to realize just how novel the tools that Mocavo is bringing to the market are. And the pent up demand in genealogy circles for better access to content, better tools for sharing this content and better ways to bring offline content (the majority of historical content still resides offline). And how passionate genealogists are about their pursuit of family history and as a result how much time, effort and money they spend in their pursuit.

Launched in March of 2011 (although their paid features only launched a few months ago), Mocavo has seen great growth in visitors to its site, searches on its platform and information indexed in its search engine. The company isn’t out to replace existing genealogical tools – it’s here to augment those tools and provide an overlay social experience that is natural to genealogy. I couldn’t be more excited to be working with the Mocavo team (along with Cliff, I’ve gotten to know Richard, Andy, Ryan really well over the last year).

Welcome to the future of your past!

May 16th, 2012     Categories: Foundry Companies, Fundraising     Tags: , ,

The Seed Signaling Problem That’s NOT Being Talked About

There’s been plenty of chatter over the past few years about the potential pitfalls for entrepreneurs taking seed money from VCs. This includes a recent and very thorough overview of the issues by Elad Gil which I’d highly recommend reading, even if you’re already familiar with the issues around seed financing (and in particular the so called “party round” where everyone takes a piece but no one takes the lead).

I’ve noticed something recently that’s a bit of the flip side of the same problem that everyone is talking about but that I haven’t seen mentioned yet. I’m seeing an increasing number of Series A pitches where a company has at least one venture investor in its seed, the business is very clearly doing well and where the entrepreneur is simply not pursuing their existing institutional investors for money (note: please give me a little credit here for knowing the difference between an entrepreneur not pursuing money from their existing investors and their being told by their investors that they’re not interested; I’m talking about cases where it’s either pretty clear that the business is seeing excellent traction or where we’ve actually been able to confirm that they’re trying to go around their existing investors).

You could call this the VC seed signaling problem.

A VC throws some money around into a bunch of different seed rounds assuming they’re buying optionality for their Series A. But by essentially ignoring these seed companies some investors are showing them that perhaps they’re not the value added VC that they claimed to be. I’ve heard a variation of this themea number of times in the past few months. Entrepreneurs completely disappointed with the lack of attention they’ve received from their seed investors and as a result choosing to either try to keep them out of their Series A rounds or minimize their participation (most have received pro-rata rights as part of their seed investment so sometimes this becomes a negotiation – again, clearly evidence that these entrepreneurs are indeed telling the truth on this subject as their seed investors try to negotiate for more participation in the Series A).

I find this pretty amusing. At Foundry we view seed investing the same way we view all of our investing – we believe that we’re in this business to add value to the entrepreneurs and companies we back regardless of the capital we have invested (great post from Brad here explaining this in more detail). Clearly that view is not held across our industry.

April 23rd, 2012     Categories: Fundraising, Startups, Venture Economics    

Exit Numbers – $100M is rarer than you think

Fred Wilson put up a post today that grabbed a slide from a recent presentation Mark Suster gave at a Founder Showcase event. The chart (and Fred’s post) back up with numbers the qualitative argument I was making in my recent post on Pattern Recognition (I wish I had these data when I wrote my original post!).

In my post I argued that while there is plenty of talk about a handful of high flying companies (Zynga, Twitter, Facebook, etc.) that vast majority of venture back companies can expect significantly more modest outcomes. In fact history suggests that a majority won’t even return invested capital to investors. All this talk about the stratospheric valuations of this small group of companies however has investors fundamentally misjudging the chance that their latest investment will do the same. As the chart from Mark’s presentation clearly shows, not only is it the extreme exception for a company to hit the kind of valuations that are getting all of the press attention but even hitting the $100M mark is rare. On some level I think we all know this, but seeing the numbers in black and white really puts a exclamation point on exactly how rare it is. And as Fred points out (as did I in my prior post), investing in early stage companies at the kind of valuations that are prevailing today is a losing bet…


June 22nd, 2011     Categories: Company Creation, Fundraising, General Business     Tags: ,

Preparing an effective executive summary

Today’s guest post comes from Ted Rosen, a partner at the law firm Fox Rothschild. How to write an effective company “teaser” is one of the most common topics I’m asked about by entrepreneurs and I think Ted has some excellent thoughts on how to prepare a company summary that hits the right points but isn’t so long that you’ll lose your reader’s attention (or make them abandon the summary before reading the important parts). Ted really nails it in the piece below. I’d especially call out “jargon free” and “keeping it simple” – the inverse of which are probably the two most common traits of poorly formed executive summaries. As always, I welcome comments, ideas, suggestions, etc. You can reach Ted directly at


By: Ted D. Rosen, Esq., Partner Fox Rothschild, LLP

An effective executive summary — also known as a “teaser” — is a crucial tool that helps entrepreneurs catch the eye of venture capitalists and other sophisticated investors. Those venture capitalists and investors have the money that could make the difference between the success and failure of your fledgling business, but they tend to be bombarded with business plans to the point that they could not possibly read all the information they receive from business owners seeking financing.

A well-written business plan is also crucial, but it is generally premature at the start of the courtship — the right tool at the wrong time. A clear, concise, well-written teaser is an initial sales document and therefore the tool of choice to get a business owner from the start of the process to the point where an investor needs the more specific information that a business plan contains.

As legal counsel to many emerging companies, I have read hundreds of teasers and am all too often taken aback at how poorly they present the companies’ initial case for funding. Owners of such businesses and their advisors must package the business and present its compelling story in such a way that it increases the likelihood of success in a capital raise.

As with most communications, business owners seeking capital should focus at least as heavily on the venture capitalists’ expectations and desires as their own. A well-written teaser describes for a prospective investor the three main benefits that the business offers its customer base, in descending order of importance. From that, a prospective investor can weigh the likelihood of robust sales and revenue — crucial elements in the decision whether to fund. (An effective follow-up document, the business plan, will mirror this format with greater detail of the competitive benefits a company offers.) 

For each benefit to the marketplace, the teaser should describe what customers’ needs are met by the business’ products and services; touch on whether the business model is sustainable and how revenue will be generated; and discuss why customers will pay for what the company offers. Opine on whether the company offers must-have or nice-to-have products and services. Does the company solve some crucial problem for its target customers? Don’t exaggerate on any of these points and generally avoid unsupportable superlatives — the best, the only one of its kind, or self-serving phrases such as game-changing or life-altering — because savvy venture capitalists will see through that gambit quickly. Support your claims by providing supporting research — past performance, for example, or clients’ testimonials and studies that buttress your claims.


As with any pursuit, there are some rules of the road to follow. I have observed over the years what tactics work and which ones fall short. Many of these suggestions may seem obvious, but they are worth repeating because following them should result in an effective teaser that might catch the eye of your next investor.

In clear, concise, jargon-free language, write a reader-friendly summary that an executive in any industry can grasp. Besides describing the benefits of your goods to your customer base, explain clearly the revenue model and value proposition; include information about your market, its size and demographics so investors can judge the scale of opportunity; pricing issues and competition. Investors know that virtually all companies have competition, so trying to convince them that you don’t will damage your credibility from the outset. You should explain why you have or perceive a competitive advantage over your competitors and why you believe you will maintain that advantage, but avoid puffery and bluster.

Your management team will probably be of great interest to investors, so describe the people, their qualifications and their track records. Make projections, but make them realistic. State how you intend to use the proceeds of the capital raise, but keep that broad and flexible. Finally, state clearly how much you are seeking to raise and how you arrived at that figure.

Employ KISS twice: keep it simple, stupid and keep it short, stupid. Avoid highly technical writing because at this early stage, investors are trying to get a big-picture snapshot of your company, not what kind of alloy you use in your widgets. Technical writing will turn off an investor if he doesn’t understand the teaser, which should appeal to a broad base of venture capitalists, not just those intimately familiar with your industry. So too will excessive verbiage; keep the document to four pages at the most.

Write in an active voice, not the passive. Be realistic, but avoid negativity of any kind. Avoid empty adjectives that carry no substance. And avoid the spell-check land mine; triple-check spelling and formatting. Venture capitalists have so many teasers and business plans — and underlying businesses — to choose from that they are likely to discard those that appear sloppy.

Finally, avoid the temptation to use a power-point display to supplant or accompany a teaser. Power-point presentations tend to be too long and, frankly, too dull for most investors’ patience levels, particularly at the early stages of the relationship.

September 28th, 2010     Categories: Fundraising, General Business    

Has convertible debt won? And if it has, is that a good thing?

Paul Graham, founder of Y-Combinator, sent out a tweet on Friday saying: “Convertible notes have won. Every investment so far in this YC batch (and there have been a lot) has been done on a convertible note.”

It’s an interesting data point on Y-Combinator companies, but is this truly a macro trend? Have convertible notes really won?  And if so is that good for start-ups? Good for investors?

I think the answer to these questions are that 1) it’s not at all clear that this trend is as definitive as Graham suggests; 2) it’s a mixed bag for entrepreneurs (more positive in the short run, potentially negative in the long term); and 3) it’s clearly not a positive trend for early-stage investors.

First a quick terminology recap (skip this paragraph if you’re already familiar with convertible debt vs. preferred equity). The most common forms of investment in early stage business are convertible debt and preferred equity. Convertible debt is exactly that – debt which is convertible into equity at some later point in time (or is paid off). Typically this conversion is at a discount to the next equity round (to compensate the debt investors for their risk) and sometimes carries warrants (same rational) or a cap on the equity price that the debt converts into. Historically convertible debt has been easier (and therefore cheaper) to put in place. Preferred equity is stock which carries with it certain rights (preferences) in terms of how and when it gets paid back and a handful of other items that relate to the control of the underlying business.

Also, before I jump into this let me state that I have the view that, like many things involving start-ups, there’s a balance between what’s good for investors and good for entrepreneurs (there’s a symbiotic relationship between the two). I believe in cutting fair deals with entrepreneurs and don’t at all subscribe to the belief that an investor should try to obtain harsh control or preference terms (almost all of our investments at Foundry have a 1-times preference multiple and are non-participating; see this post by my partners Jason and Brad for more details on what these terms mean if you’re unfamiliar with them). Paul himself said in a March 2009 article: “When you hear people talking about a successful angel investor, they’re not saying "He got a 4x liquidation preference." They’re saying "He invested in Google." And I believe that’s true, although as you’ll see below, I also believe there also has to be reasonable compensation for the risk that early stage investors are taking. We should all be so lucky as to find the next Google, but one’s investment strategy needs to be geared to finding the next Mint or

Has Convertible Debt Won?

I asked this question to a number of angel investors (all with institutional angel funds or running Y-Combinator like programs) and the results were mixed. Interestingly there seems to be  a real split between the coasts. While all of this year’s Y-Combinator investments have apparently been structured as convertible debt, that’s not the case with other programs. While some are clearly seeing a heavier weighting to convertible debt than to equity, one east coast based program I talked to told me that fully 100% of their companies who had received funding had done so in the form of equity.  Of the super-angels I talked to, several reported that “all” or “almost all” of their initial investments were currently being structured as convertible debt with one (again, east coast-based) exception who reported only 5-10% of their deals were structured as debt. It’s hard to say where in the country the line shifts from equity to debt, but it’s clearly a much stronger trend out west than on the east coast (at least the northeast which was where the firms/programs that I spoke to on that side of the country are located). To be clear, any west coast trend by definition is trend, given the skew of investing to that geography (and by far the majority of the so-called super-angel investors are west coast based).

The trend that Paul is pointing out appears to be taking place, but is less than definitive (and much less so than I expected). 

Now on to by far the more important question – Is this trend a good one for entrepreneurs and investors?

Traditionally convertible debt is used for initial funding rounds that are smaller in size, where the financing isn’t substantial enough to cover the greater legal costs of a more traditional seed equity round, where the investor base lacks a “lead” to price and negotiate terms, or where the financing size is such that all parties agree that not enough money is being raised to put a stake in the ground around pricing. As I noted above the conversion terms typically contain a discount to the next financing round and – according to the super-angels I talked with – also almost always contain a cap on the price at which the equity can convert at later. Both these terms are designed to bound the risk that the convertible debt investors are taking in not pricing the round – they’re investing in an debt-like instrument with equity like risks.

Entrepreneurs like convertible debt for some obvious reasons. For starters, it can be much quicker to put together a convertible debt financing, so more of the capital being raised goes to the operations of the business, not to the lawyers (this clearly benefits both the entrepreneur and investors). Importantly it also puts off the valuation question to a later date and tends to shift at least some risk from entrepreneur to investor (I’ll talk about why this is in the next paragraph below). Interestingly however, with the increasing number of seed financings we’ve also seen a decrease in the complexity and cost of equity seed financings such that they more resemble in time and cost convertible debt structures (both Y-Combinator and TechStars have model seed docs up for those wishing to further streamline the process). As a result I believe some of the perceived difference in time and cost are disappearing and less relevant to the debt vs. equity debate.

It’s the question of terms that’s key to the investor side of the equation and where I believe the convertible debt trend starts to fall down. In the investor’s best case scenario, the convert terms reflect the current market value of the business (specifically, the cap appropriately prices the equity value of the business at the time of the debt investment). However the investor hasn’t actually purchased equity and has opened themselves up to an easier renegotiation of their terms by a later investor (who, almost by definition, wields more power at that time than the original angels, assuming the company actually needs to raise capital). More likely, however, the convert cap reflects a premium to the current fair market value of the business. One super-angel I talked to told me that while a year ago these caps “approximated what I’d pay in equity” that they’re now “33% higher than what I’d normally agree to pay now.”

I have no doubt that the convertible debt structure has the effect of raising prices for early stage investing. Within some reasonable range this isn’t a huge problem – early stage valuation ranges move up and down with the markets – but in larger increments (which we’re seeing now) and viewed in the light of angel investing economics, these changes in early stage valuation may be problematic.

Traditional venture investors average up their cost basis in a company and “protect” their ownership over time by investing in subsequent rounds. Often, angel investors don’t participate in future rounds (or if they do, they do so at a much less meaningful percentage of the round) meaning that their initial buy-in forms the basis for the majority of the shares they ultimately own in a company. Ironically, the trend of companies raising less capital actually enhances the importance of the initial round buy-in (both because that initial buy-in becomes less diluted meaning the first round price was that much more important and because even if an angel wants to buy up more in later rounds they’ll have less of a chance to do so; I also believe that along with the trend of companies raising less capital we’re also seeing earlier and somewhat smaller average exits – also enhancing the value of initial round buy-ins as fewer investors are truly swinging for the proverbial fence). I’m a big fan of the rise of the so-called super angels – I think they’ve been great for the overall entrepreneurial ecosystem and I’d like to see them continue to thrive.

So how is this trend bad for entrepreneurs?

Clearly in the short run this trend is positive for entrepreneurs because it has the effect of both deferring an often difficult conversation (around valuation) and ultimately increasing early stage company values and as a result decreasing entrepreneur dilution (by the way it’s also good for Y-Combinator, TechStars and other similar programs since the shares the program gets of each company act as founder shares in this financing equation). And I have no doubt that there will be many entrepreneurs who benefit from this trend. But it’s not clear to me that it’s sustainable (just as it wasn’t a decade ago). Ultimately investors need to be compensated for the risk they take in making their investments. With capital being relatively fluid (and the angel markets being finicky) as companies run into trouble, as valuation caps begin to be disrespected, as overall return profiles decrease because of higher early stage prices, money will flow out of the asset class. And ultimately this doesn’t benefit entrepreneurs either.


If you’re a long time reader of this blog you’ll know that I don’t like superlatives and I don’t like sweeping generalizations. I don’t think convertible debt is bad and I don’t believe as famous angel investor David Rose has said that “Smart Money’ doesn’t invest in convertible debts. Period.” Different situations call for different capital and financing structures. That said, a broad market trend towards convertible debt has implications that I think are bad for the overall early stage investment ecosystem.

I look forward to a healthy discussion in the comments below!

Quick disclosure note, I’m a personal investor in TechStars and from that end actually benefit (at least short term) from this trend. As an angel investor I’ve participated (this was prior to raising the Foundry Group fun) in convertible debt structures, including several very positive outcomes.  I’m also an investor in several angel funds that are in the middle of this market. Foundry itself rarely (which is to say never to date) structures a first round as convertible debt.  

August 30th, 2010     Categories: Fundraising, Venture Economics