The past few years have seen a balancing of the playing field between investors and entrepreneurs, one of the many manifestations of this trend has been a site launched by Nivi and Naval, called VentureHacks.com. HipMojo.com sat down with one half the terror twins to learn more about the venture, what exactly is a venture hack and what entrepreneurs and VCs can take away from it.
Q - Tell me about your and your colleague’s background?
A - I (Nivi) am an entrepreneur-in-residence at Atlas Venture. I’ve worked with startups in roles from Vice President to Inventor, including Songbird (Sequoia), Grockit (Benchmark), Kovio (Kleiner), and Newroo (MySpace). On the venture capital side, I’ve also worked with Bessemer and one of Softbank’s funds.
Naval runs Hit Forge, an early stage fund which offers friendly seed capital and viral marketing help for social networking and Facebook application companies. He has worked with startups in roles from Founder to Advisor, including Epinions (Ebay), XFire (Viacom), Vast.com, and Mercantila. He has also invested in half a dozen companies as a VC including Scintera, Neopath, and Technorati.
Q - What’s the concept or big idea behind VentureHacks.com?
A - We show entrepreneurs how to negotiate better deals with their investors. At best, first-time entrepreneurs negotiate sub-optimal deals. At worst, they negotiate awful deals. And they don’t know how their first deal will affect the rest of their chess game with investors.
This isn’t surprising—investors play this game once-a-day while entrepreneurs play it once-a-lifetime.
Startups have one chance to raise money right. You can fix almost any mistake in a startup—if you hire the wrong guy, you can fire him. But you can’t fire your investors. You can’t fix bad investment terms.
We level the playing field so startups can do this critical job right.
Q - What’s the biggest mistake entrepreneurs make?
A - In the context of a financing, entrepreneurs focus on valuation when they should be focusing on controlling the company through board control and limited protective provisions. Valuation is temporary, control is forever.
The easiest way to maintain control of the company is to create good alternatives while you’re raising money. If you’re not
willing to walk away from a deal, you won’t get a good deal. Great alternatives make it easy to walk away.
You create alternatives by focusing on fund-raising: you pitch and negotiate with all your prospective investors at once. This may seem obvious but entrepreneurs often end up meeting investors one-after-another, instead of all-at-once.
Focusing on fund-raising creates scarcity and social proof which close deals. Focus also yields a quick yes or no from investors so you can avoid perpetually raising capital.
Q - What’s the biggest mistake VCs make?
A - The biggest opportunity for venture firms is differentiation. Firms compete for deals, and differentiation is the only way to compete.
Most firms offer the same product: a bundle of money plus the promise of value-add. And the few firms that are differentiated don’t communicate their differentiation to entrepreneurs effectively. Y Combinator is one example of differentiated capital with excellent marketing communications.
It’s ironic that firms which thrive by investing in game-changing businesses have barely differentiated themselves, let alone changed the rules of their own game.
Q - All factors being equal: should entrepreneurs accept VC or angel money?
A - There is no typical VC or angel. Instead of pitting VCs versus angels, consider the perceived pros and cons of each and pick the best investor.
Angels are perceived to have less money, invest for fun, make their decisions quickly, and not ask for control. VCs are perceived to have more money, invest as if their careers depended on it, make decisions slowly, and ask for control.
You’re looking for an angel or VC that has follow-on capital, supports companies in tough times, invests like his career depends on it, makes decisions quickly, and doesn’t ask for control.
Q - Is there really such a thing as dumb money?
A - If smart money is money plus the promise of value-add, then dumb money is just money. Dumb money sounds bad but it’s what entrepreneurs primarily want from investors: money.
Some angels, venture funds, and hedge funds provide money and get out of the way—they’re somewhat “dumb”. But there’s very little money that says “our primary responsibility is to provide capital.” And there’s too much money that thinks “smart” means “we know how to run your business better than you.”
Before you raise dumb money, you need to determine whether the investor can provide his pro rata in the next round, whether he will support you if the company is going sideways, whether you trust him, whether he has impeccable references, et cetera. But these are the same questions you need to ask before you raise money from
anybody.
Wherever you raise money, you should raise it as if your investors were dumb money, i.e. just money. In other words, unbundle money and value-add. Get money on the best terms possible and get value-add on the best terms possible.
Whether you want advice or introductions to customers and recruits, you can buy it for a tenth of what most investors charge. A hand-picked advisor or independent director will only ask for 0.25% - 2.5% of your company. He will be more aligned with you than an investor because he will own common stock. And he won’t have conflicting responsibilities to his venture firm, other venture firms, or limited partners.
Smart and dumb investors will add value. To decide if you should pay for it, ask yourself whether you would add an investor to your board of directors/advisors if he didn’t come with money. If the answer is no, you should treat him like dumb money. If the answer is yes, you can subtract some dilution from his proposed investment because he
offsets the cost of a value-add director or advisor. But if the investor ends up not adding value, you can’t fire him like you can fire an advisor or director. You can only hope to ignore him.
Instead of looking for value-add from an investor, first look for money-add and second, look for someone who is humble, someone you trust, someone who will treat you like a peer, someone who shares your vision, and someone who is betting on you, not the numbers.
Q - Do you get any slack from VCs?
A - No. Smart investors like educated entrepreneurs.
Q - What does it take to be a successful entrepreneur?
A - Successful entrepreneurs delight their customer, execute relentlessly, and enjoy lots of luck. Like porn, you recognize great entrepreneurs when you see them and you get better at recognizing them every day.
Q - What does it take to be a successful investor?
A - Successful investors have access to capital, great dealflow, good judgement in picking companies, and, in competitive markets, the competitive advantage to win deals.
Q - Your website claims, “We’ve raised $100M or so in financing from firms including Sequoia, Benchmark , August, and Bessemer . We’ve also invested another $20M in about 12 companies.” So the question is: Who really has it tougher? Entrepreneurs or VCs when you consider their predicament: in other words, VCs have to actually make their investments
worthwhile; whereas entrepreneurs ultimately pitch to people who’s job it is to invest money?
A - Entrepreneurs and VCs both work hard before and after an investment.
Investors are typically personally wealthy and draw a very comfortable salary from their management fees, in addition to their potential carry in a portfolio of startups. Entrepreneurs are often strapped for cash and fully invested in a single startup.
The premise that investors “make their investments worthwhile” is incorrect. Companies make themselves worthwhile. In theory, investors prefer investments that require no work, have no risk, and have a tremendous return. In practice, investors are part of the team that makes a company a success or failure.
Q - Finish the sentence: The top VC in the world is…?
A - It depends on the startup’s market. And we avoid applauding or criticizing individual firms on Venture Hacks.
In general, the best firms don’t care what anybody else thinks, don’t take up your time with a lot of diligence, never pull out their Blackberries in a meeting, and don’t ask dumb questions.
They make decisions quickly, show up to meetings on time, pay attention when you speak, let management run their companies, treat entrepreneurs like peers, and conduct themselves with humility and trust.
I will give a shout out to Atlas Venture and their General Partner Jeff Fagnan who is crazy enough to support me while we write Venture Hacks. They don’t agree with everything we say but the whole firm is very entrepreneur-friendly. And a shout out goes to Naval, my Venture Hacks partner, and his Hit Forge fund—I’m lucky to be working with him and I recommend him to any entrepreneur.
Q - Naval gained notoriety from his lawsuit, did that help or hurt VH?
A - Neither. It’s a non-issue for us. The plaintiffs in the suit included 3 founders and 50-odd employees—it wasn’t “Naval’s lawsuit”. Since then, he has raised money from venture firms for several startups and for his Hit Forge fund—he has plenty of good VC relationships. Thanks for the opportunity to clear this up.
Q - What’s your biggest accomplishment?
A - I prefer contribution over accomplishment. Accomplishment is about me, contribution is about customers. I’m happy to have contributed to promising startups like Songbird and Grockit.
Q - Why should entrepreneurs check out VH?
A - Entrepreneurs can get a better deal by following our advice. Even companies with great exits can benefit from a better deal because a better deal makes more employees rich.
Fund-raising advice is abundant but mostly bad. Entrepreneurs usuallyget their advice from other entrepreneurs who are inexperienced, investors who are biased, and lawyers who know how to do things right (legally) but don’t know the right things to do.
There are a few people in the world who know the fund-raising game cold and we’ve been lucky enough to learn from some of them. Now we’re open-sourcing everything we know. I’ve learned a lot from my partner Naval, serial entrepreneur
Jim Pitkow, Jeff Fagnan at Atlas Venture, and Jorge del Calvo at Pillsbury Winthrop.
Q - Is the VC industry doomed?
A - No. Venture capital under management is increasing and VCs are a critical part of the startup ecosystem—I’m grateful they exist.
The rate of innovation is increasing and that innovation needs capital to get in customer’s hands. Capital invested in startups is going to increase, not decrease.
It’s wonderful that you can start a web-based software company with little capital. But after that early stage, even these companies need significant capital to reach their customers and beat their competition.
VC is not doomed but it is changing: see Y Combinator, Idealab, Hit Forge, Squid Labs, and others.
Q - Sell to a biggie or raise VC? what do you recommend?
A - Sell if an acquisition dramatically changes the lives of the founders and the early team. You can use an earn-out at the acquirer to capture some of the potential upside of raising money.
If you raise capital, you risk your current value for a chance to capture your future value. If you sell your company, you capture your current value, do your time at the acquirer, and then create future value at your next company. What’s the difference between creating future value at your current company and your next company?
One alternative to an acquisition is to cash-out some of the founder’s shares so they have enough money in their personal bank accounts to feel comfortable with the risk of building a bigger business. I’m guessing the Facebook founders have been cashed-out to some degree—but that’s a guess!
Q - Is VH a peripheral, tangent occupation or do you have bigger plans for it?
A - We’re always looking for ways to serve entrepreneurs. Our Term Sheet Hacks are a good start.
I want to invite your readers to “cold call” us if they’re starting a company and have questions, need introductions to investors, need help negotiating a term sheet, et cetera. We can’t help everyone but we can
certainly help the most promising companies—you can reach us at nandn@venturehacks.com.
Q - You’re a good man, thanks again for your time and keep up all of the good work at VentureHacks.com.
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