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VC's Try and Go Half Way.

TheFunded.com Open Letter

Posted by carlwimm on 2010-02-28

PUBLIC:

Another article in the NY Times

http://www.nytimes.com/2010/02/28/tec...

The idea is that a VC firm is going to try and bridge the gap between VCville as it exists now and entrepreneurship, which is what they need and cannot easily find, if at all.

You can all read the article for yourselves but here are my observations:

1) Since the "big huge fund", "living la vida loca at 2 and 20", all investments must be 20 million before we can be interested" model of VC is, by definition, an entrepreneurial non starter, ...

my first recommendation is to never go to a VC firm unless it has at least one E.I.R.

My reason is that, according to the article, you have someone who is at least partially entrepreneurial who sits during the presentations and then during the partners meetings.

Not only do you have a shot with an EIR that you could never have with a finance geek, but the VC firm itself might be influenced, at a Board level, by EIR musings.

Without an EIR, my first guess is that the Board meetings are and can never be more than an echo chamber - and quite useless for start ups.

2) do recognize that one EIR in the house (or 3 EIRs in the case of Austin Ventures) only gets you part way.

But ... as I said in point 1, half way is a lot better than "no way".

3) The best illustration of the limits of this approach come in the same article.

This one is subtle.

The article says " Silicon Valley legend abounds with tales of wild success sprouted from a garage where a pair of geeky unknowns toiled away" etc. etc. Then it names some Valley pairs.

Here is the subtle point. The pairs of geeks conglomerated around an idea (as did Gates and Allen, when they left Harvard to go to Albuquerque).

In other words, dear "two and twentiers". There is an answer to the eternal question, "which came first, the idea or the geeks".

Answer - the idea. The geeks coalesced around the idea. They became great business partners around an idea. They may have been friends before but they focused once the idea was in hand.

Trying to get some "geek groups" happening without a focusing idea is the wrong way around.

The EIR model is better than nothing but ... "a walk to first base is not a home run".

4) let me get this straight ....

15,000 a month for 6 months, offices, clubby lunches, etc. all to sit around and "muse" ......

Let's call this 25,000 a month in real or in kind - that is 150,000 dollars.

Do you know that you can substantially de risk an idea for that kind of money.

(and probably completely de risk it for double that)

So ... why don't the VC partners - who see themselves as doyens of the Valley - take 3 million (out of the 500 million that is happily creating the "2 and 20" for themselves) and start 20 new ideas.

Hell - go crazy. Start 40 ideas. that would cost 6 million.

How to finance that - in the first year of the fund (and in no other year) take 6 million out of the 10 million that the VCs want to take for themselves via the "2 and 20" on a 500 million fund - and start 40 crazy ideas.

After "living poor" on 4 million for a year, the VCs can live it up on the 10 million a year after that for the next 9 years.

Here is a possible new aphorism for VCs,... "a little less "2" in the beginning means a lot more "20" down the road".

5) Summary

I salute the VCs that want to get out of their closeted, echo chambers.

BUT - and it is a huge "but" - the premise of the VCs that you bet on the jockey and not the horse, is not correct.

The first bet is on the horse, boys and girls. You can always put on a better jockey later, once the horse has shown some promise.

Eventually, when VCs want to be of real use again, they will have to go to a "bet first on the horse" model.

The real value of a VC will be a) his stable of jockeys - which he can use to improve and smooth the path, after the horse/idea shows some promise ... and b) a warehouse of oats - after all, you don't keep Secretariat and Seattle Slew on a diet of weeds and crab grass once they demonstrate the possibility of a triple C.

best wishes.

Posted by Anonymous on 2010-02-28 10:45:21

From extensive experience on this matter, EIRs are ...mostly... bad news. The benefits of undrstanding are overshadowed by the reality of idea theft, solicitation, etc. Just my $0.02.

Posted by gorilla44 on 2010-02-28 14:27:34

I disagree strongly with one of your points - betting on the horse and not the jockey. I am running my second medical company (first was a biotech, second is a medical device). From these experiences and seeing countless other companies operate I am convinced that the people are the absolute most crucial part of a company. The technology is a distant second. The reason is because things never work as originally planned. NEVER. You need people who are scrappy, creative, inventive, and able to adapt and overcome. I completely understand why VCs bet on jockeys and not on horses.

Carl - Other than complaining about the current "system" what are you doing to change it?

Posted by Ted on 2010-02-28 14:51:46

FULL DISCLOSURE HERE... I dated a woman whose brother in law was an EIR and I only know of two other EIRs.

Respectfully, I agree with the first poster. EIR are often glorified principals that are there looking for ideas themselves. They are often VCs, without power, or money. And they are often -- not always -- first time entrepreneurs themselves.

AND THEY DO NOT SIT ON BOARDS. Too transient, inexperienced, bitchy.

Take Barney Pell, for example. He was one of the founders of PowerSet -- another Google Killer! He DID have one company under his belt, where he made no money for his first investors -- Carol Sands and her collected idiots. After a rocky time back at NASA, he became and EIR -- I believe in Menlo or Sequoia.

At PowerSet he blew a LOT of smoke up peoples' butts. And I mean a LOT. He was asking for $32.5Mil pre-money from his ANGEL round. After several years of chaos, he was demoted to CTO and was forced to sell for $100M to Microsoft.

As an aside, I like NYTimes. In fact, I am subscribed to their daily email. But when it comes to articles on entrepreneurship, they are really poor. Read WSJ, or for an international view FT.

I would Absolutely LOVE to hear what other "publicly available" publications people read. Should we start a separate thread on this?

Posted by ANonEMouse2 on 2010-02-28 15:31:52

#2 (gorilla44): Regarding your view that people are the most important part of a startup and the technology is a distant second:

Warren Buffett quote: "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact."

and

"You should invest in a business that even a fool can run, because someday a fool will."

I agree you need people who are scrappy and adaptive and can find the idea, but you still need the "idea". Without the idea, there is no sustainable, growing business. My first company was acquired by a larger, successful company that had mediocre products and management, but it was a great business: the money just poured right in because we owned something in the customer's mind that the customer wanted, and we gave it to them at a profit, over and over again.

Posted by carlwimm on 2010-03-01 12:51:25

To Gorilla 44, post 2

Okay, we can agree on the need for good management.

1) My point is a simple one. Good management is built around a great idea. Groups of "great management" who are just hanging around looking for a good idea is an "urban myth".
They don't exist, in a vacuum.

Start with a great idea and add one great manager. He can do the rest and the entire effort is based on a project which will be worthy of their time and devotion.

Let none of us remember the pet foods dot com fiasco, where VCs backed a great group of guys with (as I remember) 50 million.

What a great demonstration of the virtue of backing the jockey that project was.

2) When a VC supplies the management, the situation is already defective. Any manager who is "VC compliant" and accepts the VC termsheet, is NOT, repeat NOT, great management.

He is a whipped dog, ready to roll over and wet himself whenever any VC lifts a knuckle.

You want "scrappy, inventive, creative, etc.".....?

The best of them come for a great idea.

3) I am not complaining about the system at all. I merely point out that a certain situation was allowed to obtain where the focus shifted from producing great companies to obtaining VC money.

The fault lies in almost every entrepreneur - he should look in a mirror.

as far as what I am doing to change it ... two things.

a) I conduct myself with the discipline to bootstrap my own projects and do not solicit defective money.

b) I have been writing emails to friends of mine about a thing I call a SCC - a seed capital corporation.

I will open one up once a certain current project of mine is brought to a boil.

I will give you one clue as to how it works. There is no "2 and 20". But there is a "50".

The management people with whom I am dealing, will pay their own salaries, car leases, etc.

But we want a very much larger share of the carry. The answer is to put back, in place, the only incentive that matters ...

Never make your profit out of the other fellows in a deal, but rather ...

make your profit out of the success of the project.

A private jet is what you get when you win, not when you play the game.

best wishes

Posted by Anonymous on 2010-03-01 14:02:16

VCs are idiots because they think entrepreneurs are idiots and insist on terms that only idiots would accept. A good jockey will have stables of horses to choose from, putting on a different hat and going with whichever one is appropriate for the given track and rain. Sometimes if the environment is right, the horses win treasure and gold, other times if not as bright, will do other stuff instead. If they eventually get greedy enough, they'll realize they're nothing, loosen the terms to appropriate levels, and then maybe they'll get a little closer to understanding the ability to see all the value hidden in plain sight. But if they could do that, they wouldn't need to be LPs lackeys, would follow their own inspiration, and the rest of the entrepreneurs are back at square one. So, best to understand their situation, practice preventative damage control, keep all interactions with such realities to a bare minimum.

Posted by carlwimm on 2010-03-01 14:12:09

To ANonEMouse2 # 3

You have nailed it.

Grab the dirt. Get the underlying ground, via IP (patents) if you can. then find the jockeys.

Putting "Willie the Shoe" on top of a broken down donkey will never win you the Kentucky Derby.

But even my dead grandmother has a shot at winning that race on top of Secretariat. Just strap her on, and kick that mule ... watch him run.

The idea is the dirt, the underlying foundation.

Learn it, love it, live it.

best wishes.

Posted by carlwimm on 2010-03-01 14:14:11

To Ted #3

To express your post another way ....

An EIR without a great idea is like aloud mouthed eunuch.

Did I get that right?

:)

best wishes

Posted by gorilla44 on 2010-03-02 14:55:34

Carl - I'm not trying to attack you. I just think that it is wrong to say that all VC is bad and that all entrepreneurs need to avoid it.

The important thing is that when an entrepreneur deals with any potential funding source they need to understand that source. VCs are ruthless, professional money managers whose job it is to get the maximum return for themselves and their LPs. Some may be able to ride the 2% management fee for a fund, but the best VCs do provide a strong return to their LPs and are able to raise new funds.

I am curious to learn more about your seed capital corporation? Can it work for a biotech or med device company that needs to raise tens of millions of dollars before their product can hit the market?

Posted by ANonEMouse2 on 2010-03-02 22:09:10

Riding Secretariat... that's the dream!

As I see it, you and The Founding Member and Georges at The Venture Company are covering all the bases:

Carl Wimm: disciplined bootstrapping, entrepreneur maintains control, bottom-up innovation (ala Microsoft), ignore VCs unless they truly bring something to the table on your terms;

The Founding Member: work directly with VCs, create rating system driven by Founders and real entrepreneurs, share information between real entrepreneurs to encourage better deal-making and company-building and better VC behavior;

George van H. (The Venture Company): work the layer about VCs, i.e., the LPs; train the LPs on what better venture investors should look like and how they should behave; train entrepreneurs to make better deals; re-analyze the whole structure so that maybe, someday, big venture investments by savvy capable venture investors confidently supported by LPs can be made again. After all many successful, large venture investments have been made and have paid off.

It's great to see all this innovation in the business of funding innovation, good luck and best wishes.

Matthew O'Keefe

Posted by carlwimm on 2010-03-03 10:44:16

to gorilla44 - post 9

My thanks for your comment that your contributions are not a personal attack. I appreciate the spirit and am motivated to contribute back.

The first point you make is one where "you nailed it".

"when an entrepreneur deals with any potential funding source they need to understand that source."

My contributions to this forum have been slanted to putting up views of VC to enable more understanding among entrepreneurs for the time when they approach them. (BTW the dating post is great - I have printed it off and will keep it for reference).

On the second point ...

"VCs are ruthless, professional money managers whose job it is to get the maximum return for themselves and their LPs" ....

Take the word "professional" out of this statement and we agree. ... how many comments have we heard that VCs don't understand, either the project or the process.

How about this version instead ....

VCs are ruthless and relentless managers of other people's money, in pursuit of their own rewards (and, once in a while, those of their LPs), one of whose almost mandatory tricks is to dilute founders to near nothing, both as to equity and control. The effect of even one dollar of VC money is turn the project inside out, where the sole focus now is that of the exit, always on the best terms favoring the VC.

Now ... that nails that statement.

I have written many times that if you get into bed with a VC, know what you are doing and what sort of experience you will have.

The third question - The SCC. Here are the essential elements of it.

You have to de risk the project.

Is the market enormous?
Can you own the underlying dirt (Patents, patents, patents ... three levels deep)
Can you demo it - people need to be taught and shown
Can you find the right people. (I rarely accept an inventor as a business manager)
Can you deliver it in a non castrated structure? (are you a deal maker or a deal taker)

You know medical and bio , better than I ever could. How long would it take (and how much would it cost)to answer those questions in your domain?

best wishes

Posted by carlwimm on 2010-03-03 10:59:38

TO AnonEMouse2, post 10

As you have pointed out, several people are working on things to overcome the "lead blanket" and cloven hoof of the VCs.

Since the old VC model is so defective and dangerous for just about any project, a new model has to be found.

I don't know anything about George van H and the venture Company. I do, however, appreciate the pointer and as a consequence of what you have written, will make it my business to learn what I can from this man and his contribution.

I do know something about the Founding Member. Adeo is quite a fellow.

His work, not only on the web site, but also on his Founder's institute, is something that all 13,000 of us would do well to learn. The FM has his approach and it is a good one. It solves many issues, addresses many problems, exposes many pitfalls, proffers solutions, etc.

Has he got all the answers, ... perhaps not. But he can, in the space of a short time, get novices fairly functional and competent.

My SCC is designed to approach innovation from a different POV. Does it offer "all the answers", perhaps not. But, it need only offer those answers required for its own approach.

Ultimately as innovators, we have to start viewing ourselves as professionals. We are "pros".

We have to understand the obstacles to innovation and the opportunities. We have to understand that to be true innovation pros, we need to act as the "freest men on earth".

We have to understand that our goal is to deliver innovations in good order to the market, all the while assuring that the fruits of that innovation are delivered to the founders and the management team.

In time, we can view this process almost like art. The process itself is beautiful and good, in and of itself.

best wishes