Tag Archives: Venture Capital

Term Sheet Purgatory

There’s a lot of advice about (1) how to attract VCs, and (2) how to negotiate a venture capital term sheet. Both sets of advice tend to ignore the gap between an investor’s expression of investment interest and your startup’s receipt of the term sheet. I refer to this waiting period as “term sheet purgatory.”

Term sheet purgatory can seem like is an eternity for a startup, although it may last from one week to over one month. Usually, the investor is just prepping the field to make the investment. While progressive discussions with an investor about the investment are fine and most revolve around pre-diligence matters, sometimes these discussions shift towards the pre-money valuation and investment amount. And this has potential negative consequences for the startup.

It can be a mistake to arrive at a consensus with your investor on pre-money valuation & investment amount before receiving the full term sheet. Terms like the option pool, liquidation preference, and board composition are just a few other investment terms that have a meaningful impact on your startup. You’ll feel real solid about that $6,000,000 pre-money until you receive the term sheet and it specifies a 25% option pool, 1X participating liquidation preference, and an investor-favorable board.

Of course, you can re-negotiate the pre-money and/or investment amount, but it still makes for potentially awkward conversations and/or feelings of mistrust. Neither is a good way to kick off your relationship with your future investor. (Even worse, a startup may feel like they can’t re-negotiate because they’ve already “agreed” to those numbers.)

Thus, if your potential investor continues to verbally discuss investment terms with you, consider asking for the term sheet.

Even if you are comfortable negotiating verbally on one facet of your startup’s capital raise and blindly on the rest — what’s the point of talking about the color of your corsage if you haven’t received a (non-binding) invitation to the dance?

Request that all key terms of the investment are laid out in front of you in the form of a term sheet. This may be the quickest way to get you out of term sheet purgatory and avoid negative consequences along the way.

Interview with Mike Brown Jr. of AOL Ventures

I had the chance to chat with Mike Brown Jr., Founder and Partner at AOL Ventures, a few weeks ago. I’ve known Mike for a few years now and during the conversation I asked if we could turn the chat into a formal interview for this blog. He graciously obliged and the following Q&A about AOL Ventures and “Corporate VC” is an excerpt from that conversation/interview:

Give us the background on your fund and what you guys are up to?

Sure – AOL Ventures is the VC arm of AOL, focused on early stage investing in consumer internet businesses. We formally launched the fund in January of this year and are a small team of investment professionals supported by some great Senior Advisors and the entire AOL family.

Overall, we focus exclusively on investments where we can add the most value, blending our personal expertise with some element of parent company involvement. We’re broadly interested in a bunch of different opportunities within the consumer web, and tend to focus on Seed and Series A investments in content, advertising, mobile and local spaces in the US of A.

What stage of startups are you looking at and what do you look for initially?

We’re a small fund with $30M of committed capital, so we focus on Seed and Series A opportunities. Typical investment amounts at the Seed level range from $50k to $500k and from $500k-$3M at the Series A level.

Other than the standard things, we like to play around with a working prototype at the Seed level and like to see some key inflection points met if you are looking for Series A funding. We also tend to focus on repeat entrepreneurs but are not opposed to funding first time founders who have significant domain expertise.

Have you invested in any startups thus far?

We’re just through our first year and pleasantly surprised with where we’re at – Rather than single anyone out you can see a full list of our announced portfolio companies and other relevant investment information on CrunchBase. (CrunchBase Profile for AOL Ventures)

What are you not looking for and/or what is a bad way to pitch you?

People email me sometimes and say, “if we only had AOL’s traffic we would be huge!” I get it, but that’s not a logical investment thesis for us to deploy capital against. We’re not looking to be anyone’s 80% customer and we frankly pass on a lot of entrepreneurs who have unrealistic expectations about what they want out of the relationship with us (it is a marriage after all).

We are not really interested in anything other than consumer Internet, so it’s not good to send me your telecom idea or new consumer electronics device that you need to raise money for. Later stage opportunities are also out of the mandate of our fund.

I’ll make a point here – we are not opposed to getting emails from people seeking partnership opportunities and recognize that this is a product of where we sit. By virtue of our gig we are highly accessible to the external world and also know almost everyone or can get to anyone within our parent company. If you think there is a relationship that doesn’t make sense from a funding standpoint but might be interesting to AOL, Inc., we’re happy to make the intro and they are definitely open for business. Feel open to approach us and don’t be shy.

How active or passive is AOL Ventures in deals?

That really depends on how involved the entrepreneur wants us to be. We tend to be passive-active in nature and will help when asked, but most of our entrepreneurs honestly like us to get pretty involved.

During the investment process we really try and hone in on exactly what the entrepreneur wants out of the relationship and what are the specific tasks that we need to accomplish to help them take the company to the next level. If these align with our own abilities and we feel we can meet the expectations then we’re happy to get involved.

Do you look at portfolio companies as future acquisition targets?

Not really. While we definitely understand that AOL is a large media company and acquisitive, we’re not really involved in those discussions. Remember we’re a minority investor in early stage companies, so the best we can do for our companies is present options for them – at the end of the day those decisions are up to the entrepreneur and the company board.

What’s the difference between Corporate VCs and Independent VCs and how is AOL Ventures similar/different?

Assuming a Corporate VC is operating a traditional fund vehicle and not just investing off of the balance sheet (probably the first real difference), I would say the most recognizable difference is in the single vs. multiple LP structure. Corporate VCs tend to have their parent company investing in their fund whereas Independent VCs tend to have multiple LPs (like endowments, pension funds, etc) investing in their fund. In addition to the nuts and bolts of things like governance, investment committees, etc, also being different Corporate VCs have also tended to be more strategic in nature, making investments in companies that have significant strategic value (and potential BD or M&A synergies) back to their parent company.

Note that this is a broad generalization and I’ll caveat it by saying that with the emergence of models like Intel Capital, Steamboat Ventures, Comcast Interactive Capital, Genecast and new players such as us and Google Ventures, the model of non-strategic Corporate VC is also starting to play a meaningful role in the early stage ecosystem.

In terms of our day-to-day, I would say there isn’t much difference. We think and act like any fund from a sourcing, diligence, execution and management of investments standpoint.

Where do you see corporate venture as a meaningful piece of the ecosystem?

That’s an interesting question. Historically I’d say that corporate venture has been most meaningful at the later stages of a company’s life cycle but that has primarily been product of fund sizing and strategic mandate of the corporate funds. I’d say it’s a relatively new phenomenon that corporate venture funds play in the early stages of a company’s life. While I am a believer that corporate venture can also be meaningful at the early stages, the fact is that it is largely unproven and pretty new in the overall game.

Corporate VC generally has gotten a bad rap – what are some of the things that you think you need to do to be successful?

Haha, who said it has a bad rap?! In all seriousness though, I think there are a few key issues that we looked at from the outset and felt needed to be in place to make this model work effectively.

First and foremost, we have carry in our fund and share in the upside if we earn a financial return for our LP. I don’t think many Corporate VCs operate this way and we feel it creates a lot of mis-alignment with entrepreneurs.

Second, we operate autonomously with a small investment committee (3 ppl) and separate governance structure. We’ve written a check as quickly as 72 hours (obviously not ideal but we have done it). We believe in the ‘quick yes / quick no’ philosophy and we’re not out to waste an entrepreneurs’ time. We co-invest with people we know and don’t ask for any egregious terms above and beyond the lead investors terms.

Third, we tend to only invest in situations where we can add measurable value and really give entrepreneurs that unfair advantage they need. The perfect deals for us are those where we can blend our personal expertise and value-add with a flavor of parent company involvement and value-add.

Thanks Mike!

Series A Startup CEO Salary

A startup’s Series A financing shouldn’t be a large liquidity event or salary payday for the startup’s founders. While a startup typically receives millions of dollars in a Series A, if too much of that $$$ flows guaranteed to the founders, various incentives get out of whack.

Not all startup founders understand this tenet.

Case Study

Earlier this year, this issue presented itself when a client was the lead investor in a Series A round of about $2MM at a $4MM pre-money. The term sheet was pretty much a done deal, when the startup’s CEO demanded a salary of $25,000. Per month.

My client countered with a reasonable startup CEO salary, but the startup’s CEO didn’t back down from his $300,000/year figure. You can guess what happened to the deal.

In addition, here’s an example of how a startup CEO’s huge salary didn’t help his startup: CEO’s $500,000 Salary Burns Startup Into Fire Sale.

The Importance of Startup CEO Salary

The startup community focuses most of the term sheet discussion on liquidation preferences and anti-dilution, but startup CEO salary is nonetheless an important issue. According to Peter Theil, Startup CEO salary is a predictor of a startup’s success:

“The lower the CEO salary, the more likely it is to succeed.

The CEO’s salary sets a cap for everyone else. If it is set at a high level, you end up burning a whole lot more money. It aligns his interest with the equity holders. But [beyond that], it goes to whether the mission of the company is to build something new or just collect paychecks.

In practice we have found that if you only ask one question, ask that.”

If a startup CEO’s post-Series A salary is too high, he or she may not have a true sense of urgency to implement and/or create shareholder wealth.

This doesn’t mean a startup CEO must continue to make Costco runs for ramen noodles. But if the startup’s CEO gets a huge salary, the startup CEO could likely view his or her equity stake as “house money” (i.e., even if the startup fails, the CEO won’t feel too bad because he still received got a hefty salary).

Furthermore, a demand for a high startup salary can signal that you don’t believe all those things in your investor pitch.

Austin Ventures to Invade Dallas on 2/24

Austin Ventures is holding their “AV Entrepreneur Hours” in Dallas on Wednesday, February 24.

AV Entrepreneur Hours is a chance for early stage entrepreneurs (particularly those in the internet and software space) to dictate casual conversation with the VCs from Austin Ventures in a casual environment. AV plans to have 10-12 slots for quick 20-30 minute chats with entrepreneurs.

To learn more about AVEH in Dallas and/or sign-up, check out AV’s post about it here.

Thanks for coming, AV. (And thanks for the tip about the event, @mdavis)