December 2005 Archives

More Detail on Venture Fund Structure

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After a meeting with another lawyer, we got a deeper glimpse at the structure of a typical venture fund:

There is a General Partnership LLC which contains all the managers of the fund, and any other Special Limited Partners. These people generally run the fund operations.

A Limited Partnership also exists, of which the General Partnership LLC is a General Partner. This Limited Partnership also contains all the investors of the fund, but investors are only limited partners and generally do not participate in active management.

Then there is a management entity, typically a corporation or LLC, which hires all the operations people that do work for the fund. This is hired by the Limited Partnership. This management entity pays all payroll and infrastructure costs.

The Limited Partnership then goes and invests into new businesses. It is basically the venture fund itself.

Profits on investment flow in three directions.

There is a management fee that goes to the management entity, and then there are the profits, which go in two directions - to the investors, and to the General Partners LLC.

A typical deal is "2/20", where there are 2% management fees off invested capital, and 20% profits that go to the General Partnership LLC for identifying/managing/creating the opportunities. The other 80% profits go to the investors as return on their investment.

BANKABLE

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Someone paid me the best compliment yet.

After describing who we were and what we were trying to do, this person, a prominent person in the business/venture community said we were BANKABLE. That means on our abilities and our ideas alone he thought we could raise money.

I think this goes to show what a confluence of factors can bring:

1. Personal brand - Gotta have a great brand. This is built over years of success and positive relationships.

2. Great idea - Our plan of attack is new in the venture space. It hasn't been popularized yet. So we're the first in many eyes. And our feedback has been that they like what we're doing.

3. Timing - the venture community is ripe for change in the way it's doing its work. We're approaching it differently, creatively, and uniquely. So we gain positivity for being different and unique.

We have gotten some really great responses so far. I hope we can keep this going....

The next factor to work on is to have actual deals in our pipeline. It would greatly enhance ourselves in the eyes of the venture community and really help with us getting some funding. Stay tuned.

Money is the Root of All Evil

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Money has the unbelievable capacity to turn everyone into the virtual opposite of what they are now. No other force I know of can make a person do a complete 180 degree flip.

I've heard stories now of friendships being destroyed, of family members making incredible demands, families being broken - the list goes on. All of these stories have been in context of starting businesses.

I've personally experienced an episode where a partner didn't pay up his share of a business despite claims to the contrary and I've now had to exit that business. I've lost an opportunity and a friend.

Somehow in our society, money is some kind of magical force in our lives. It is the path to freedom, to getting things done, and also to nightmares and headaches beyond belief. We are programmed like this from the day we are born - to succeed, to go to school and make money, to buy things, to gain pleasure from buying things, to want more, to have more - as if money is going to solve all our problems by having more.

So therefore, when people are asked to commit actual money to a venture - that's where the adventure begins or ends.

When you have skin in the game, you're committed like nothing else. Because in our society, it's not acceptable to commit one's life (you succeed, you live - you fail, you die). So you commit the next best thing that has a similar perceived severity in one's life - your cold hard cash.

Yes, that cash that you slaved over. That you worked years for. That you equate to other things which give you status. Status to attract a mate. To elevate you in society in the eyes of others.

Without which you are a nobody. You can't eat. You have no roof over your head. You don't have a mate. You suck.

So what have I learned:

1. No partners are truly committed unless they have put in some substantial level of cash. $100 is not enough. We're talking at least $1000, if not much more.

2. Don't start any work until the money shows up in the corporation's bank account.

3. If it doesn't show up, just cut loose as fast as possible. It ain't worth the headache to chase it down no matter what the opportunity is with this partner.

4. I've learned to let go of the cash I put in any venture myself. You need to have that mindset that this money is gone and I may never see it again. Because if you don't have that attitude, you'll always be nickel and diming everything and you'll miss opportunities because you're not willing to spend to generate more cash.

5. Money ain't everything. There are way more important things in life than money despite what's been burned into our brains by our immigrant-have-nothing-hiked-50-miles-in-the-snow-to-school-every-day parents. For them, it was very much about making money and surviving. We're past that.

6. Depending on externalities, like what money can buy, for happiness is an undependable road fraught with disaster. Work on your internal abilities instead. In the end, when you've left the poker table and you've lost your shirt, you're still left with yourself and you better be ok with...YOU.

OK I'm diverging and giving you life advice when I should be talking about entrepreneurship. Sorry.

A few more business things I've learned:

7. DO NOT BE GREEDY. Be patient. There will always be time to make the next thousand, million, billion. Whatever. We all were greedy through the internet bubble years and look what happened to all that wealth. Take the time to build your business, your credibility, and do it step by step versus trying to make that last one killing. Why would you want to put all your eggs in one basket?

8. Working with friends and family adds another huge level of complexity, commitment, and obligation if you're doing business with them. You can much more easily walk away from strangers if you don't get along with them in business. Trying to walk away from friends and family can be hugely stressful, emotional, and/or impossible. It's like a breakup or divorce of huge proportions. You should be aware of the pitfalls and make sure you set expectations with your friends/family you're doing business with or taking money from. Most likely, friends/family won't be experienced in this type of thing and are not used to losing money.

Institutional money, however, is different. They are professionals, and are used to losing money all the time - not that I'm saying you should lose it ;-).

Make your call if you're going to work with friends/family and beware the consequences.

Trust

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After talking to many of my entrepreneur friends, one big topic always comes up - Trust.

They always ask:

How do you know your partner?
How long have you known him?
Have you worked with him before?
How do you know he/she will deliver?

And the list goes on and on. Questions upon questions. Some of which I do have answers and many I don't have answers for, dependent on whom it is we're talking about.

It seems that just about everyone has gotten burned in their past lives in such business relationships. And unfortunately, I haven't pinpointed any reliable way of knowing how to trust someone completely unless you work with them for a long time. And even then people can betray your trust.

So if you have to work with someone for a long time, then how did you start in the first place, given your lack of knowledge about this person?

At one time, you would have trusted family members. But I don't think that is a safe criteria to go by either. Your aunts, cousins, brothers, even your parents, can betray your trust in these matters.

I've heard stories of best friends becoming non-friends when they enter into business together.

I've heard stories of people starting businesses under the euphoria of hope of making tons of cash, but only to end their business relationship in a haze of hate for the other person and how it was absolutely hell working with them.

It is really unfortunate that so many people can't get to some basic level of doing what they say they will do, and if they can't, then just saying so. I think this is the core of trust. You need to be straight with your business associates as to what you can't and can do, and what you are willing and not willing to do. Too many people hide behind some facade of passive-aggressive fear of failure and false pride and refuse to just be honest and clear with others around them, as well as with themselves.

I've already had an encounter where I had trusted someone, only to find out that this person could not be trusted and actually lied to me at the end. I got out as fast as I could but still I lost a lot of cash. Well, what can you say- entrepreneurship comes with risk.

And so it is with trust. Trust comes with risk and yes you need to minimize the risk associated with trust. So I try to do better in listening to my intuition, read up on how to tell if someone is lying to me, do some reference checking to see what others say. But somewhere along the line, you need to fish or cut bait. You make a call and either it works out or it doesn't.

I think the key thing here is to know that trust is not without risk, and that even after doing everything you can to maximize your trust in a person, you can still get betrayed. The object lesson would be to minimize the exposure of your assets to such risk, to be able to let go of your investment if it goes sour, and to always learn and try again.

The worst thing you could do is to retreat into some cave and never trust again...

Track Record and Your Personal Brand

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VCs and investors like to see entrepreneurs with a great track record. It makes them more likely to invest in you versus somebody with no track record. These are:

1. Number of businesses started, and even better a number of wins (versus losses).

2. Ever increasing amount of money raised in subsequent ventures.

3. Great references, other entrepreneurs who love you, as well as investors.

4. You and your team have worked together in the past and thus, have shown the ability to have a successful working relationship.

It really makes you think about your own brand and how people have felt about working with you. I have met people with little or no brand and they are having a dog of a time finding funding in a time when it seems like money is flowing again. And I have met people with incredible brands who get money or are called back for subsequent meetings.

Structures for Venture Funding and the New Dirty Word

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So first, the new dirty word in the world of venture investing is...INCUBATOR.

We learned this from a meeting with a law firm who had setup 24 of these over the internet bubble years and saw EACH ONE OF THEM FAIL. In general, what happened was that they built out way too big infrastructures and hired too many people, which caused their downfall when expenses got too high and not enough money came back in.

So now there is bad taste in investors' mouths regarding incubators and their failure to bring returns on their investment.

We had started calling our little project an incubator, but now we're looking for another name.

But we found out that this was still important to discuss, in the context of structures for venture funding.

INCUBATOR MODEL:

People give you money, you build out huge infrastructure to house entrepreneurs and the theory is you share resources from office space to CPAs to internet access to etc. and something good will come out of it.

Apparently, even though there are no existing incubators left alive, the activity is still being quietly pursued within many venture firms, under the guise of such things like Entrepreneurs-in-Residence (EIRs).

So the other models to discuss are:

SERIAL LLC MODEL:

You setup an LLC which is the vehicle through which funds flow, and this LLC is owns an interest in the target business. You are a member and a manager of this LLC, and the investor(s) are other members but not managers. The managers collect a fee for directing and managing the funds, and typically participate in the upside of successful ventures.

BLIND POOL MODEL:

This is the traditional venture capitalist model. You collect funds, and have no specific business to invest in but you have the ability to go looking.

HUNTING LICENSE MODEL:

Another variation, this one generally doesn't give you any funds to start with but investors basically hire you to go looking for businesses for them. You get paid expenses and salary and start prospecting. You also get commitment upfront from the investors that they will participate in businesses you deem worthy. But the investors here do not put money into any vehicle upfront.


Interesting to hear the structures being used for this kind of work. Lots to learn still over the next few months....

Things That Attract Users and Make Them Stick

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Last night, I had a dinner meeting with some entrepreneurs and we were talking about how to make users stick to a website from a community standpoint. These points were:

1. Socializing - satisfying the need for humans to connect with other humans is great attractor for people to stick around. They communicate, meet, make friends, etc.

2. Sex - once you get Socializing, then the next natural extension of that is wanting to meet for dating reasons or sex.

3. Competition - somehow, enabling people to compete against one another and make them feel better than others by winning contests, acquiring more goods or power, is something that people like. There is the prestige factor of feeling and being better than others.

4. Fame - along with competition, if you can increase one's opportunity for fame when they win, then there is a natural desire to keep competing and retaining that fame and being on top. It's all about bragging rights to your friends and strangers....

5. Fortune - this was one we didn't discuss, but I just thought of. Allowing people to make money out of their activity, or acquire real or virtual wealth, helps keep people on the site. Reward for activity and participation only makes people want to participate more. As in the real world, the pursuit of wealth is on many peoples' minds.

The Five Most Important Things for Investors to Know

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From a lawyer who specializes in venture fund creation - the five most important things that investors want to know at a minimum, when investing with you:

1. Length of time that your fund will be in existence.
2. Carry, ie. 15 or 20 points?
3. Management fee, ie. 2%? 4%?
4. Distributions, or how do they extract cash?
5. Structure, ie. Delaware LLP

Heard from a Venture Seminar

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Some really great thoughts from a Venture seminar:

1. "Own the Need" - get your target audience (ie. the investor or fund) to internalize the problem that your product or service will solve. If they don't get it, they'll never fund it.

I see parallels with this concept and what I believe in what type of product/service I should and should not work on. I truly believe that there are products and services that I am the wrong person to work on, even if user experience and design principles are very universal. Some things just don't resonate with me, and they don't have a specific place in my life or serve any purpose or need of mine. Because I can't or have not internalized it, I can only take this kind of product so far.

Now I also believe that this has little correlation of whether this will be a successful product in the marketplace. The world is full examples of people building stuff that I would never use or I have no affinity for, and yet they are viable businesses.

So this is like getting your investors to "own the need". If they don't feel some affinity for it, you'll never get their support or cash.

2. Lead then with marketing vision - Once you get them to "own the need" then show them how you'll take it to market and win over users.

3. Convert the toughest accounts - If you can win their respect and support, the other accounts will follow.

4. Avoid lifestyle companies. By lifestyle, they mean that there are entrepeneurs out there will have, on the surface, a great idea, but are only there to take your money and support their expensive lifestyle. Bad for investors because they don't really care about the business, but only for their own needs....

Entrepeneur Meeting!

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So far, I've been hearing that funding is really prolific right now in the Valley. But not for everyone...

Here is a guy who has been experiencing trouble getting funding. He attributes it to:


1. He's not part of the old boy's network in silicon valley. not known to VCs.
2. Hasn't had a previous company attempt, whether successful or not.
3. No personal brand to fall back on. Yahoo's brand carried a lot of weight but going independent is rough.


Some thoughts, learnings, and advice:


1. Don't work with any entrepreneurs who have an overinflated sense of self worth or demands. They'll just be trouble later.
2. Gotta be hungry. Experiencing hunger motivates and drives success more than anything.
3. Contributing money derives commitment. Without appearance of money from all parties, you're not really committed.
(We had a long discussion about how money changes people, and how people can change dramatically)
4. "Psycho partners" - what psycho means is relative to the eye of the beholder, but one can experience a lot of different sides of someone else's personality when doing business with them and when money is involved.
5. New entrepreneurs don't know how hard it is to start a business. it takes way more work than people realize.
6. Doing business with friends and family is tough. Always threat of losing friends and family, and there is an added sense of responsibility and seriousness when involving friends/families.
7. Take money when you can get it. It's harder than you think to raise money. worry about spending it later. better to have more money than none.
8. Don't worry about dilution now. Establish credibility, relationship, and get money over arguing about ownership.


VCs want:


1. "Big idea" and huge returns for their money, not just small returns.
2. "Lying" - or maybe exaggerating the truth about returns and goals versus being straight and telling it like it is has worked better for him in getting VCs excited.
3. They like big balls and vision. Don't want people with small outloooks.
4. Like founders and engineers in the same office. Don't like remote offices as much.

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This page is an archive of entries from December 2005 listed from newest to oldest.

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