angel investors

Three Things That Kill Early Stage Companies

Scout Ventures, , , , 2 Comments

As a VC, we spend a lot of time thinking about where we want to invest our money.   Last night, I was with my friend Pedro Torres-Pincon who recently presented “How to Build an Investment Thesis”  providing good insight into determining how and where you decide to invest your money.

But writing the check is the easy part.    The real challenge in entrepreneurship is to build a meaningful and sustainable company.   To that end, one of the things we like to discuss at Scout with our founders is how to avoid the pitfalls that can kill an early stage company.

(1) Don’t run out of money.    I know this seems like a simple rule but it’s amazing how many entrepreneurs under estimate how much time and money they will need to build their business.   In most case, we see financial projections that too aggressively forecast revenue growth, while underestimating the cost of building a scalable product.    The other issue that tends to crush entrepreneurs is not allocating enough time to raise the next round of capital; fundraising is time consuming and requires a focused effort.    So beware – forecast more conservatively and budget more time to raise your next round of capital.

(2) Don’t make a bad critical hire.   We often invest very early in a company when they haven’t hired all their critical team members.  In many cases, our capital is being used to expand the team and help the founders grow their vision.  If the Company hires a rock star then everything will get much better, but if they hire a dud then the Company is sure to suffer.   The two areas that are most often affected are  technology and sales.    If the company is in the process of building a new product and their new CTO drops the ball, then it’s almost impossible for the company to meet any of their deadlines or achieve the metrics necessary to secure the next tranche of capital.    Likewise, if the Company hires a revenue generator like a VP of Sales and they fail to achieve their revenue goals, it’s often a devastating blow to the company’s forecasts and thus also hurts their ability to raise additional capital.

(3) Avoid bad investors.   The early stage landscape is much different today than it was when I started in this industry as there is more seed stage money than ever before.   Accredited investors are jumping into early stage investing with angel groups, accelerators, and equity crowd funding platforms like SeedInvest. This coupled with significantly lower barriers to entry means that it’s easier than ever to start a new company and raise a small amount of capital. The resulting increased competition among early stage companies has created a shortage of follow-on funding as described by Josh Kopelman of First Round Capital.    But more hazardous than the shortage of Series A capital, is the impact inexperienced investors, often from other industries who are looking to dabble in venture as an alternative asset class, can have on an early stage company.    The worst case scenario for a young entrepreneur is to get lured by an investor who is offering capital but wants to add terms and provisions inconsistent with standard early stage venture rounds.    These terms vary greatly but the most dangerous are the right to ask to get paid back, asking for too much control and/or the need for the investor to consent to future financing, etc.    It breaks my heart when a young team is crushing it only to have a disgruntled early investor call their $100,000 note – which represents a significant chunk of operating capital.    Smart money is always the best way to go.

Three Things That Kill Early Stage Companies

Is venture capital under attack?

Scout Ventures, , , , , , 1 Comment

I am an early stage technology investor.   It’s what I love and I wouldn’t want to do anything else.

And with the job title of VC comes a few primary functions:

(1) Be great at finding, cultivating, and investing in amazing entreprepreneurs building disruptive companies.

(2) Successfully raise money for our funds from high net worth individuals/angel investors, family offices and institutional investors.

(3) Build profitable companies by providing advice, mentorship and access to our network.

(4) Have exits and distribute money to investors.

While that sounds pretty straightforward, it’s not.  It’s really, really hard and very few firms build enduring brands that survive multiple boom and bust cycles.   At Scout, our goal is to build a great firm that lasts.

Recently, there have been a lot of discussions about what value VCs really bring?   The discussions focus on two key areas: (1) Performance and (2) Access to Deals.

Unfortunately or perhaps fortunately, venture capital as an asset class is under attack. Organizations like the Kauffman Foundation are questioning the returns and structure of the industry arguing that most fund managers don’t beat the public markets and still charge management fees and carry.   In Kauffman’s May 2012 report “WE HAVE MET THE ENEMY… AND HE IS US” they state that they believe smaller funds (less than $400M) with partners that consistently beat the public markets and invest 5% of their own money are the right firms to back.

Furthermore, the very closed nature of venture capital is changing drastically with the emergence and expansion of accelerators, incubators, co-working spaces and online platforms.  Historically, VCs differentiated themselves through their “proprietary” access to the best deals.   But in recent years, entrepreneurs are experiencing an unparalleled level of access to potential investors through online platforms like SeedInvest and Angelist.   Additionally, accelerators and incubators have become masters of the overly produced “Demo Day” where I actually saw a pitch with dancers in silver sequenced dresses. Regardless, entrepreneurs and investors have many more ways to more effectively connect in person and online.   Again, another argument that VCs no longer have their unique closed access to deals.

While this might seem like a good thing, I’d argue that the more experienced, smart money is and will always be more valuable than money from some finance guy that thinks he is going to write 5 checks and find the next Google.    Often these investors have no idea how to value a start-up, how to structure a deal (equity or convertible debt) and more importantly they have no experience building early stage companies.  They simply lack the skill set and required experience.

The people with that experience – VCs.

Now, I definitely think there are some amazing entrepreneurs that sell their companies and become valuable early stage investors, but they are the exception.   Most angel investors simply are not that sophisticated and can’t add the same value that Fred Wilson can add.   Fred is one of the most knowledgeable and successful VCs and he spends a ton of time educating entrepreneurs and investors alike.    He can do that because of his years of experience as a VC.

Almost everyone knows that people are the key to making early stage companies great.  A common mistake that kills early stage ventures is hiring the wrong key people.   If you need a CTO, then obviously hire someone with technology and management experience.   If you need a great VP of Sales, then hire someone with a track record of building a sales team and growing revenue.

This seems obvious, right?

Then why wouldn’t the same hold true when entrepreneurs need money and guidance to build their company.   If you are looking for an investor – it has to be more than money.    You want someone with the experience and track record of building successful companies.  VCs have a tremendous amount of experience in building teams, building products, scaling businesses, securing subsequent rounds of financing, access to potential customers, partners and potential acquirers.

I am definitely not saying that I love VCs, because their are plenty of assholes in VC.   But if you are fortunate enough to attract a VC with a good reputation and track record – you should figure out how to get them involved with your company.

We can make a difference.

Is venture capital under attack?