Friday, June 19, 2015

Racism and entrepreneurship

My Twitter stream in the last few days has been filled with outpourings of outrage about the killings of 9 people at the historically black church in Charleston, South Carolina.

What does all this have to do with the previous blog posts which have been about some technical aspects of convertible debt and crowdfunding?

The broader vision of many people involved in the activity of creating, launching and funding startups is that in some way we're all contributing to making the world a better place. We're also contributing to supporting opportunities of individuals to realize their dreams as founders and employees and customers, helping contribute to something of value in their lives.

All of this effort of humanity to better and better itself is horribly hindered by the threads of racism that still exist in our society.

Today the Wall Street Journal published the most amazing--amazingly horrible--article that says that these killings weren't about racism. It states that the institutionalized racism "identified" by Dr. Martin Luther King no longer exists.

The default that we are left with by the WSJ is that this young man was either (a) troubled or (b) evil. If you're secular you choose (a) and if you're religious you choose (b). But oh no, racism had nothing to do with it.

Of course he was troubled. But that doesn't mean that he didn't latch onto a culture where racism is prevalent. You have only to look at the statistics of both the number of African American's killed by their neighbors in their communities, the number of African Americans killed by police in comparison to the ratio of whites killed, and any one of many other statistics to see that the threads of racism are still wound tight within this society and within many of our institutions, warping all of our actions in bigger and smaller ways.

Does that mean things aren't better today than they used to be? Of course not. But to suggest we've washed our hands of racism, that we efficiently disposed of that ugly thing that Dr. King "identified" is mindbogglingly naive, blind, insensitive and well, racist.

Again, why does this matter in the context of entrepreneurship? Because to solve the world's problems or even simply provide great value to customers, you have to draw upon the best of people. You can't draw upon the best of people with deadly threads still wound around all of us. And so, in some way, all of our efforts suffer and many things are brought down. One of many things that is brought down, hindered, is the effort to better ourselves through invention, innovation and entrepreneurship.

Wednesday, June 10, 2015

the careful march forward of so-called crowdfunding rules

A while back I did a post that included a flow chart which was intended to give some guidance to entrepreneurs about the then new crowd funding rules. Recently the SEC approved additional regulation in its ongoing effort to implement the provisions of the Jobs Act. I've been asked by some entrepreneurs how this affects them. For early stage entrepreneurs it does not and it doesn't change the flow chart that I produced. Although nothing I write should be considered legal advice, I still think that flow chart is a useful tool. But here's an additional summary of the crowd funding rules.

Starting June 19, 2015, companies will have a new way to raise money from both accredited and unaccredited investors. These modifications to Regulation A, sometimes refered to as "IPO-Lite", allow a company to raise up to $50 million in growth capital. For early stage entrepreneurs, the operative word there is "growth". This is not something that companies raising a seed or A round should worry about. You aren't doing either an IPO or even a "lite" IPO. It might be something to consider at some point in the future but not at the early stage. Although the regulatory burden has been reduced, it's still not for a startup. If you want more information on this, Michael Raneri has been publishing some helpful articles in Forbes and other places.

The above is referred to as "Title IV" of the Jobs act, modifying Reg A. My flow chart refers to "Title II" which relates to the modification of Reg D. Those modifications went into effect in September 2013. The SEC took the old Reg D, the rules under which most entrepreneurs raise equity, and split it into two paths for entrepreneurs to raise private capital.

One path is 506b of Reg D. Under this rule entrepreneurs can not talk in public about raising capital. In other words, you have to be certain that you only talk with accredited investors not the general public. This is the old Reg D. Even though in the past people tended to talk publicly about their fundraising--in business plan competitions, for example--it really wasn't allowed. The modifications to Reg D clarified the regulations and essentially says that if you want to talk publicly--again, defined as an audience that may include unaccredited investors--you have to follow a new variant of the 506 rules, 506c.

The new Rule 506c of Reg D does allow you to talk publicly about raising capital ("general solicitation") but as with 506b, you can still only take in money from accredited investors. Why would you not always use 506c? The reason is that the reporting burden is significantly greater for the entrepreneur and places the onus on them, not the investor, to verify that investors are accredited. It is this rule that has opened up opportunities for general solicitation--crowd funding--from through platforms like AngelList. There's a good explanation of all this on the AngelList site.

What we haven't got to yet is regulation from the SEC allowing you, as an early stage entrepreneur, without the expense and time of Reg A, to take in money from unaccredited investors. This "real" crowdfunding is still not available.

Tuesday, June 02, 2015

some important thinking on convertible notes and liquidation overhangs

Two blog posts on convertible notes popped up recently and I thought I'd detail them a bit more in my own language. But you might be better served to just jump over to Brad Feld's post "The Pre-money vs. Post-money Confusion With Convertible Notes" and Mark Suster's post, as well as a further post, The Problem in Everyone’s Capped Convertible Notes by José Ancer.

The issue being discussed is a problem that has resulted from the use of convertible notes as investment rounds in and of themselves instead of as bridge notes to the next financing round, which is how they were originally intended. If a convertible note is used as a bridge, there is relatively little increase in value between the notes and the next round. But if a convertible note or notes stay in play for a longer period of time--say 12-18 months--then in the ideal case scenario, the value of the company has grown significantly. The problem is a feature in most convertible notes where the holders get an increased liquidation muliplie upon conversion if the valuation cap on the notes is exceeded.

Here's how it works.

Let's assume...
  • you're an entrepreneur who has issued $500k in convertible notes to investors
  • the convertible notes carry a $2.5MM valuation cap
  • new money invests $1MM in a Series A at $1 per share
  • the Series A is participating preferred with a 1x liquidation preference
Scenario 1

In our first example, we'll say that the next round investors invest at a pre-money valuation equal to that $2.5MM cap. New money would get 1,000,000 shares in Series A stock ($1MM * $1 per share) and the convertible note holders, upon conversion, would get 500,000 shares in the same Series A ($500k at $1 per share, ignoring interest in this example). The post-money would be $4.0MM. The new money gets 1x participating liquidation preference. In other words, regardless of what the company sells for, everyone with Series A gets $1 per share back on top of their participation on a pari passu basis with Common Stock holders.

Here's what the cap table looks like:

Common Stock: 2,500,000 shares or 62.5%
Series A (new investors): 1,000,000 shares or 25%
Series A (former convertible debt holders): 500,000 shares or 12.5%

If the company sells for $4.0MM, Series A would get $1.5MM out, and then get their pro rata portion of the remaining $2.5MM (37.5% in this case). This sort of participating preferred is pretty standard--almost every single one of the deals we at Long River Ventures have ever done has this feature.

If the company sells for $10MM, new investors get $1MM, note holders who are now Series A get $500k, and then both share in the remaining $8.5MM with Common.

If the company sells for $20MM, the Series A would get out their $1.5MM and then their pro rata portion of the remaining $18.5MM.

With me so far?

Scenario 2

Now let's assume that the $2.5MM cap comes into effect because next round investors think the company has done really well and are willing to invest above the cap set in the convertible notes. Let's assume that next round investors invest not at the $2.5MM cap but at a $10MM pre-money valuation. Let's assume they still invest $1M in a Series A and still get shares at $1 per share. They would get the same 1,000,000 shares as in the above example, but much less of the company. The convertible note holders wouldn't get 500,000 shares, they'd get 2,000,000 shares--remember, they have a $2.5MM cap and the valuation was $10MM. Therefore, they get 4x the shares in the first example. As an entrepreneur, you may not like that but that's what you signed up for.

Here's what the cap table looks like:

Common Stock: 10,000,000 shares or ~77%
Series A (new investors): 1,000,000 shares or ~8%
Series A (former convertible debt holders): 2,000,000 shares or ~15%

What you don't realize you signed up for is the same thing on the liquidation preferences.

Let's also assume the 1x participating preferred liquidation preference also holds in the second example. Just like in the first example, new money would get $1MM upon liquidation regardless of the company selling price, and then get their pro rata portion. However, the convertible debt holders would get a 4x liquidation because these liquidation rights are written on a per share basis, not on the amount of money invested. In other words, they are guaranteed to pull out $2MM off the top on their original investment of $500k.

If the company sells for $4.0MM, new investors get their $1.0MM back, note holders who are now Series A get $2.0MM back, and then all share in the remaining $1MM (pro rata of Series A in this second example is 23%).

If the company sells for $10MM, new investors get $1MM, note holders who are now Series A get $2MM, and then both share in the remaining $7MM.

If the company sells for $20MM, new investors get $1MM, note holders who are now Series A get $2MM, and then both share in the remaining $17MM.

Compare this second $20MM example with the same example above. The difference between $18.5MM and $17.0MM after payment of preferences is where the liquidation overhang lies.

To keep the illustration simple, I didn't include the discount on the next round that convertible note holders are also likely to get. In most cases, there would be a discount on the next round as well as the valuation cap so they would do a little better than this example. If you think that convertible debt holders get enough recognition for their risk in that discount and with the valuation cap, and that the liquidation overhang is overreach, go to the above blog posts for some solutions to this problem.

Thursday, April 02, 2015

USAIR...old school and not in a good way

USAIR ("now part of the new American Airlines") is going to have to change their ways or someday they'll fail.

I always try to fly Southwest Airlines because they never have change fees and the customer service people and in fact all their staff are in my experience always nice and helpful.

But flying on USAIR ("now part of the new American Airlines") into DCA instead of Dulles or BWI is too convenient to pass up. So when I travel down to Washington, it's not on Southwest. I was reminded again today of why that's risky.

I had booked a flight down and a flight back about two months ago but realized a week or so before my trip that I should be taking an earlier flight. Easy thing to do on Southwest but not USAIR. It was cheaper to buy a new one-way leg than suffer the change fee and rebook that new outbound flight. Thinking I was doing the right thing, even though there was no economic incentive to do so since I wasn't getting a refund, I went onto the USAIR ("now part of the new American Airlines") website and canceled the outbound portion. I swear, though I don't have the screen shot, that it did strike-through font on only that portion the trip.

When I went to take my return flight I wasn't able to find my reservation. Calling USAIR ("now part of the new American Airlines") I learned that my whole flight had been canceled. When I explained that I'd just canceled the outbound portion, they told me that was impossible and that indeed even they couldn't do that in their system because it was a round trip flight. I was forced to I buy a new  return ticket on a later flight at a price 3x my original ticket. No refunds, no apologies, no sympathy. And of course I had to book online because booking via the person with I whom I was speaking would have costs an extra $35.

None of this would have happened on Southwest, not the original change fee, nor the subsequent problem with the cancellation of my ticket, nor the entirely unsympathetic customer service person.

And if I'd booked my flight in USAIR in two steps, one outbound and one inbound, instead of in one transaction, the cost wouldn't have been any higher but their system could have handled my changes, I think. This is perhaps the most annoying part of the whole thing.

For a business traveler to encounter a business that doesn't seem to want my business, in this day and age in the United States, is increasingly old school and not in a good way.

This unpleasant experience was offset slightly by my Kimpton hotel stay. I know it's silly, but I find it gratifying to get a $10 credit on the well stocked room minibar just because I'm on their free rewards program. Every person at Kimpton I've ever encountered is just so nice. And the moment I checked out I got an email telling me I'd been upgraded to next tier status.

I wonder if whoever is managing the new American Airlines realizes how old they really are.

Thursday, March 26, 2015

Meet my assistant, Clara. I wish she could change her name and gender.

I just signed up for the new virtual assistant service by Clara Labs. It's a service that helps manage setting up appointments, using a virtual assistant named Clara Lovelace. I'm currently in the 14 day trial period.

You're instructed to write e-mails as if Clara is a real person, cc'ing "her" on your replies to requests for calendar invites. Your virtual assistant will then process the back and forth of setting up either an in person or phone call and put it on your calendar. I've used it now four times. The first two phone calls were set up perfectly. Clara is now in the process of scheduling an in-person meeting for me and another phone call. I'd guess that using this service has easily saved me 30 minutes if not more in the last 48 hours. It's very very good so far and I think worth the money.

But I have one problem.

With the basic service--which isn't cheap at over $100 per month, as much as Salesforce for example--you can't choose the name of your virtual assistant. It's always Clara Lovelace.

Several problems with that.

First, it's female. If I had to choose, I'd choose a male name because. Assistants are always female. If you can easily make a choice, why not address the gender in balance, at least perceptually?

Second there's that name. First person I talked with about this, a very high level tech industry CTO who hadn't heard of the company said, "isn't that a porn name?"

Of course "Lovelace" refers to Ada Lovelace who is the creator of the first computer algorithm. But I would bet that the average person would as easily see it as a reference to Linda Lovelace, with all of those porn star connotations that being a Lovelace in that context creates. And is it an honor or a slight to make a "daugher" of Ada Lovelace an assistant, especially in the context of ongoing conversation about diversity in the Silicon Valley workforce where this app will get its first traction? Was any of this discussed at Y Combinator where Clara Labs was launched?

So, I'm of two minds about the identity produced for me by having a virtual assistant named "Clara Lovelace" and keeping up the conceit with my email correspondents that this is actually a real person, or at least not telling them it's a virtual assistant. If a real person applied for a role as an assistant and they happened to have that name would I not hire them? Or course not. But it's annoying that I'm forced to think about these issues when some simple additional code could allow me choice. You can choose the name of the assistant with the higher level service, but that's 3x or so the price.

Third, because "it" is a "her" it makes me glance just ever so slightly in the direction of Joaquin Phoenix and I just don't to even have a hint of going in THAT direction!

Again, I don't want to take away from the fabulous effort of this startup. It has proven itself to be a great product, at least in these first few days. But I had to raise these issues.

Friday, January 30, 2015

Definitions of seed funding: a perspective beyond software

The inimitable Jason Calacanis has written a blog post called "Official Definitions of Seed, Series A, and Series B Rounds". I always enjoy Jason's posts and he holds a special place in my heart for declaring a war against angel groups that charge startups to pitch. But this "official" definition should really be the official definition of seed funding for software startups.

Jason says that in 2015 the stages are as follows
  • Pre-funding: You talk about your idea, you build a prototype & launch an MVP.
  • Seed Round: The funding necessary to get product traction.
  • A Round: The funding necessary to scale your product.
  • B Round: The funding necessary to get founder liquidity, build groovy headquarters, and make competitors give up (or not start in the first place). 
Yes, but ... if you're a regulated healthcare technology company you can't launch an MVP until regulators says so. If you're a certain type of science or engineering company, your pre-funding has to be grant capital from the Federal government. And many a STEM company is going to require at least A round funding before they can start any sort of sales.

Our venture fund, Long River Ventures, seed funded a company called Convergent Dental, making a product which we believe will replace the dentist drill. They sped through the prototype and regulatory process but their MVP came on the back of A Round funding. Now they're scaling with their B Round, delivering sales month after month but far away from any kind of founder liquidity that Jason says characterizes B Round.

I'm working with some truly special researchers coming out of the Center for Sustainable Materials Chemistry. Startups coming out of this center will owe their genesis to our tax dollars, through Federal government funding via the National Science Foundation. It would be brilliant if they could launch an MVP just based on this money and SBIR funding. But depending upon the particular spinout (and there are three so far and two in the works) it's going to take them an A round before they get any kind of product traction. With my colleagues at ecosVC, we're helping them move forward as fast as possible, teaching them techniques for market/research iteration but science can only be pushed so fast.

Finally, the science and engineering teams that are funded by VentureWell, the organization where I serve as Senior Advisor, for the most part can't follow Jason's trajectory. They are making engineered products, about half of them medical. These students are dedicated, passionate, work cheap, come from both big name and lesser known universities, and are determined to get their products into the hands of customers. But it's a disservice to them if we tell them they can always follow the easy paths of those who I like to refer to as their slacker peers such as Snapchat and their ilk. 

VentureWell also runs the NSF I-Corps program. Using Steve Blank's Lean Launchpad program, it helps NSF funded researchers learn the customer discovery process. It pushes them as hard as possible to get to an MVP as soon as possible. But again, science can only be pushed so hard and in some industries, where a bad MVP can actually kill people, not merely crash a web browser, the path is longer and harder.

Thursday, January 29, 2015

Louisville accelerator for agriculture companies

I spent the last four days in Louisville, Kentucky helping lead the last of three sessions of an agriculture technology accelerator. This is the sixth time I've been to Louisville to lead such a session and the fourth such program I've either led or co-led.

The accelerator was a program of Village Capital, an organization that has a truly unique approach to educating entrepreneurs and selecting companies for investment. It took place over three 4-day sessions (October, November, January). I also helped lead a similar program in Louisville in summer 2013. The organization for which I'm senior advisor, VentureWell, collaborated with Village Capital to teach the program. Four of our teams (from NSF I-Corps, which we manage, and from our E-Team grants program) were part of the cohort of ten. One of the ten was from Kentucky and the rest from around the country--Georgia, California, Washington, Arizona, Colorado etc.

The unique approach of Village Capital is to commit $100,000 to the cohort and have the cohort members themselves--the participating companies--choose which two companies, at the end of the cohort, best merit funding of $50,000 each. Each of the first two sessions, and at the beginning of the third session, there's a peer-ranking process completed. After the ranking is completed, peer companies have to articulate the reasons behind both the positive and negative scores they gave to their peers. This helps surface areas where the companies have to do better at explaining their business model, or areas where they simply need improvement. On the last day--in the case of this program, that was yesterday--the peer selection process becomes real, that is it results in the award of investment funds.

I'm more convinced than ever that this is a great driver for business acceleration. It produces a tremendous opportunity for iterative learning and challenges companies to understand how to think like an investor. Surprisingly, it also results in an incredibly collegial cohort rather than a "survivor-type" experience. Because the companies are adjacent but not competitive they can be of great value to each other. Sure they're competing for the final investment, but it's not enough money to drive them crazy, just enough to make them serious.

The companies in the cohort were as follows:

Agribotix: actionable intelligence for precision agriculture using drone derived scans of farmer fields.

Apitronics: site-located weather stations for more accurately and inexpensively monitoring diverse environmental factors – such as temperature, moisture, and humidity – within the microclimate of a farm field.

Farm-X: residential farm kits and larger scale farm monitoring and analytics.

FIn Gourmet: Kentucky grown wild-caught fish processed into surimi products.*

Growcentia (NSF I-Corps graduate). Natural plant growth stimulant result in bigger plants with smaller environmental impact through healthy soils

Iron Goat (VentureWell E-Team). Robotic hay harvester and pelletizer.

IUNU. Greenhouse lighting that is 30% more efficient than LEDs, with tunable light spectrum to improve plant growth.*

reNature (VentureWell E-Team). Super space and time efficient aerobic digester.

TekWear. Hands-free data capture and note-taking for farmers.

Wildsense (NSF I-Corps graduate). Wireless, underground water monitoring with a five year life--no digging up the sensors every year.

* These are the two peer selected companies but truly a tremendous and highly investable cohort overall.

If you're interested in seeing the companies, they'll be doing a fourth session in at UC Davis on February 20 and 21. Contact Candice at VilCap.

Sunday, November 23, 2014

"Most of you will fail, disrespected, impoverished ..."

Nassim Taleb's vision from his book Antifragile for an address to the nation on National Entrepreneur Day:

"Most of you will fail, disrespected, impoverished, but we are grateful for the risks you are taking and the sacrifices you are making for the sake of the economic growth of the planet and pulling others our of poverty. You are the source of our antifragility. Our nation thanks you."

Thursday, June 26, 2014

Value Propositions

Our VentureWell value proposition video. I scripted this in late 2013 and we produced the final in early 2014. I just reviewed it again and realized, hey, it's pretty darn good!