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THE ENTREPRENEURIAL BIBLE to VENTURE CAPITAL This Page Intentionally Left Blank the ENTREPRENEURIAL BIBLE to VENTURE CAPITAL THE ENTREPRENEURIAL BIBLE TO VENTURE CAPITAL This page intentionally left blank THE ENTREPRENEURIAL BIBLE TO VENTURE CAPITAL Inside Secrets from the Leaders of the Startup Game ANDREW ROMANS New York Chicago San Francisco Athens London Madrid Mexico City Milan New Delhi Singapore Sydney Toronto Copyright © 2013 by McGraw-Hill Education. All rights reserved. Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permis- sion of the publisher. ISBN: 978-0-07-183036-2 MHID: 0-07-183036-7 The material in this eBook also appears in the print version of this title: ISBN: 978-0-07-183035-5, MHID: 0-07-183035-9. All trademarks are trademarks of their respective owners. Rather than put a trademark symbol after every occurrence of a trademarked name, we use names in an editorial fashion only, and to the benefi t of the trademark owner, with no intention of infringement of the trademark. Where such designations appear in this book, they have been printed with initial caps. McGraw-Hill Education eBooks are available at special quantity discounts to use as premiums and sales promotions or for use in corporate training programs. To contact a representative, please visit the Contact Us page at www.mhprofessional.com. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. —From a Declaration of Principles Jointly Adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations Author’s Note Under no circumstances should any material in this book be used or considered as an offer to sell or a solicitation of any offer to buy an interest in any individual company or investment fund managed by Andrew Romans or The Founders Club.Any such offer or solicitation will be separately made only by means of the Confidential Private Offering Memorandum relating to the particular fund to persons who, among other requirements, meet certain qualifications under federal securities laws and generally are sophisticated in financial matters, such that they are capable of evaluating the merits and risks of prospective investments. TERMS OF USE This is a copyrighted work and McGraw-Hill Education and its licensors reserve all rights in and to the work. Use of this work is subject to these terms. Except as permitted under the Copyright Act of 1976 and the right to store and retrieve one copy of the work, you may not decompile, disassemble, reverse engineer, reproduce, modify, create derivative works based upon, transmit, distribute, disseminate, sell, publish or sublicense the work or any part of it without McGraw-Hill Education’s prior consent. You may use the work for your own noncommercial and personal use; any other use of the work is strictly prohibited. Your right to use the work may be terminated if you fail to comply with these terms. THE WORK IS PROVIDED “AS IS.” McGRAW-HILL EDUCATION AND ITS LICENSORS MAKE NO GUARANTEES OR WARRANTIES AS TO THE ACCURACY, ADEQUACY OR COMPLETENESS OF OR RESULTS TO BE OBTAINED FROM USING THE WORK, INCLUDING ANY INFORMATION THAT CAN BE ACCESSED THROUGH THE WORK VIA HYPERLINK OR OTHERWISE, AND EXPRESSLY DISCLAIM ANY WARRANTY, EXPRESS OR IMPLIED, INCLUDING BUT NOT LIMITED TO IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE. McGraw-Hill Education and its licensors do not warrant or guarantee that the functions contained in the work will meet your requirements or that its operation will be uninterrupted or error free. Neither McGraw-Hill Education nor its licensors shall be liable to you or anyone else for any inaccuracy, error or omission, regardless of cause, in the work or for any damages resulting therefrom. McGraw-Hill Education has no responsibility for the content of any information accessed through the work. Under no circumstances shall McGraw-Hill Education and/or its licensors be liable for any indirect, incidental, special, punitive, consequential or similar damages that result from the use of or inability to use the work, even if any of them has been advised of the possibility of such damages. This limitation of liability shall apply to any claim or cause whatsoever whether such claim or cause arises in contract, tort or otherwise. Contents List of Contributors and Interviewees xi Foreword by André Jaeggi xiii Introduction 1 1 Start Me Up! 3 Why Now Is a Great Time to Start a Company, Be a Venture Capitalist, Be an Angel Investor, or Invest in a VC Fund 3 BranchOut: The Textbook Case Study for Superb Angel Advisory Round and VC Funding 7 Add Angel Dignitaries to Your Series A VC Round 10 Why Entrepreneurship Is Becoming Increasingly Important and Why Angel Investing and Venture Capital Are Here to Stay 11 Getting Started 12 We’ve Got to Start a Company 13 When to Start Up? 14 2 Angels, Mortals, and Super Angels 17 The “Startup Cambrian Explosion” 18 Ron Conway, Super Angel 20 Accelerators 22 v CONTENTS vi Tech Stars and the Rise of Accelerators 24 Online Funding Resources 28 Crowdfunding: Everything You Always Wanted to Know but Were Afraid to Ask 28 Practical Ideas and Advice on Raising Angel Funding 35 How to Recruit and Negotiate with Advisors 37 Convertible Note Versus Priced Round 37 Valuation Ranges for Pre-Money Caps on Seed-Stage Convertible Note Financings 40 Don’t Raise Angel Funding at Too High a Valuation 41 Raising Angel Funding 41 Steve Jobs Rated by His VC 43 The Team Means Everything 44 A Balanced Team 44 Recruit a First-Class Team Contingent upon Funding 51 Choose Your Investors Wisely 52 Building Blocks of Pre-Money Valuations 53 Pitch Lawyers before Pitching Angels 53 Legal Fees for Startups: Fixed Pricing 55 Legal Factors to Consider When Choosing an Angel Investor 56 Smart Angels Flock Together 57 Pledge Funds 58 The Importance and Art of Networking 58 Never Turn Down a Smart Strategic Investor 59 3 How Venture Capital Works 61 Understanding VC Titles 66 To the Victor the Spoils 67 The Stock Market and Venture Capital 69 Where Do VCs Get Their Money? 69 Why Are VCs So Arrogant? 71 CONTENTS vii Old School Venture Capital: Pitch Johnson on the Early Days of Silicon Valley 72 Romans Five Forces Venture Model: Incentives Are Not Aligned 77 Corporate VCs 79 Family Offices 80 The Difference between Venture Capital and Private Equity 81 A Perspective on the Difference between VC and PE 83 What About Venture Debt? 85 This Is Not Your Mother’s Venture Debt 86 Pick the Right Partner the First Time 89 Questions You Should Ask Your Venture Debt Partner 90 Venture Debt Terminology and Term Sheets Revealed 91 Why Venture Debt Is an Attractive Asset Class 95 Fund of Funds 96 More Than Matchmakers Between GPs and End Investors 97 4 What to Bring to the Dog and Pony Show! 103 Business Plans 103 Executive Summary 105 Investor Slide Deck 105 Financial Model 106 Characteristics of the Best Spreadsheet Models 109 Investor Control Schedule 114 Demo and Video 115 The Pitch 116 Five VCs Explain What They Really Think About Your Pitches 118 5 Practical Ideas and Advice on Raising VC Funding 121 Getting on the Radar of Your First Choice VC 121 CONTENTS viii How Should an Entrepreneur Approach Negotiation of the Key Terms? 123 How to Negotiate with a Venture Capitalist 124 Don’t Tell VCs Which Other VCs You Are Talking To 127 Confidentiality: No NDAs or Secrets in the Fast Lane 128 Bridge Financing 129 Living from Round to Round 129 Employ an Army of Interns 130 Customer Financing 130 Dual Tracking 132 Venture Fratricide 132 6 Corporate Governance:Who’s The Boss? 135 The VC That Wanted a Board Seat 136 Engaging the Board of Directors 140 Making Your Board Work for You 146 7 Company Building and Growing Value 149 Distribution Versus Product 149 Skype: Where is Your Button on Kazaa? 150 Facebook: The Balance Among Product, End User Experience, and Advertising 151 MySpace: Pimp Out Your Contacts 153 YouTube: How to Extend Beyond Your Domain 156 The Marketing Myth 157 The Blackmail Business Model 159 The Nine-Year Overnight Success 160 Just Grab the Bird and Lower Yourself Out of Those Clouds 161 How to Come Up with True Innovation That Drives the Rest 162 Picking a Name 163 CONTENTS ix 8 Which Way to the Exit? 165 M&A Is the Most Likely Positive Outcome for Most Entrepreneurs 165 Practical Ideas and Advice When Selling Your Company via M&A 165 Three Kinds of Business Buyers 170 How Instagram Secured a $1 Billion Valuation 172 Advice on the $300 Million Sale of Adify 173 How Liquidation Preferences and Carve Outs Play in Exit Scenarios 174 How to Smoke Out the Serious VCs in Your Syndicate 175 Large Trade Sales of Private, Venture-Backed Medical Device Companies 176 Acqui-Hire Early Exits:VCs Versus Founders 176 Several Perspectives on Acqui-Hires 185 Seek Truth in Facts: Statistics on Venture Exits 186 Fund Physics: Expect Improved IRRs from Smaller Funds 188 9 Do We Need All These Lawyers? 191 What Are the Key Terms in a Term Sheet? 192 No Time Like Right Now to Settle a Legal Dispute 198 Dumb Licensing 200 Letting a Licensee Get Out of Control 201 Sometimes You Have to Go Downhill to Get to the Top of the Next Hill 202 It Is Better to Be Lucky Than Good 203 10
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