February 2007 Archives

MOOOOOOOOOO!!!!!!

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One day, I saw someone handing out these small photographic cards with their contact info on the other side. They were photos that this person had taken and I thought it was a great idea to meld photography, or life imagery, with a personal identity system. I was hooked. I had to make some too! Enter Moo.com .

Moo.com allows you take photos from flickr or bebo and make cool business cards out of them. These can be from pictures you have uploaded into your own account, or they can be semi-randomly selected from the gazillion photos on either service.

I took some of my own favorite shots and uploaded them into flickr. Then I went to Moo.com and they have a great interface for selecting which pictures you want, cropping them, setting up the text on back, and the ordering them.

For one batch, the result wasn't that great; they sometimes don't print so well. However, my second batch came back really cool and you can see them in the picture above. The second batch was a personal business card and I just ordered another batch of business cards, with candid photos from all the startups I work with on the back.

I love the way they make printing these cards so easy. It's also an interesting way of expressing yourself (or your business) through the use of photography, a lens into the world through your own eyes. Something to share, something to tell your own story with.

I can't stop ordering these cards!

By some fortuitous circumstance, I met these guys at FlipperNation:

FlipperNation is about 2 guys who are trying to make it rich by flipping houses. The episodes show their misadventures at flipping their first house and all the strange people they deal with around house flipping like other realtors and contractors. It's really great stuff and I can't wait for the next episode.

What was really interesting about my meeting with them was that it got me thinking about the state of video content today in the world of the Internet, interactivity, and declining TV viewership. As I wrote my first email to them, giving them some feedback on what could make their internet video show better, I thought about the ways that some video outfits were getting really creative at leveraging the Internet and interactivity to engage the viewership in ways that was not possible in the days before the Internet.

Passive TV consumption is waning. Users are getting more sophisticated and want something that involves and communicates with them rather than sitting there like drones and just receiving.

My first encounter with interactivity aligned with a TV show was way back around 1999 when "Who Wants to be a Millionaire?" was the big thing, and they rigged this Internet game that played along live with the TV show itself. You could play against other players who also played along, and winning gave you points which could land you on the main leaderboard. It was incredibly well orchestrated, and it must have been a nightmare to manage as it needed to coordinate with the current live showing in 4 time zones.

Another example of using the Internet is with Sci-Fi Channel's Battlestar Galactica where, between seasons, they shot a whole series of shorts that connected the last episode of the previous season with the new upcoming season, and showed them on their website. It was a way to inexpensively engage viewers while the new season was being prepared, but yet keep them interested and wanting more as the story line unfolded. Also on the website are podcasts, additional commentary, images, interviews with the stars - Sci-fi Channel did a great job of filling out the blanks for curious fans to consume, whereas in pre-Internet days this information was impossible to see.

FlipperNation already had employed some of these types of ideas. They have employed guerilla marketing such as getting on MySpace and each character has a page as well. Their website includes a whole bunch of content related to real estate and the art of flipping houses. They have an email address where you can submit your house to be on the next episode of FlipperNation. We brainstormed on many more ideas at our meeting yesterday, extending on the usage of the Internet, engaging the viewership and keeping them humorously hooked.

I think FlipperNation has legs. They are now looking to sign up with a studio and go big. I will be watching them and hope one day I can say, "I knew those guys when they were nobodys, and now they're somebody!" That's show biz!

Swimming with the Sharks: Part I

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Last week I had a meeting with a friend turned entrepreneur. We talked about the company he was forming and it sounded really interesting, interesting enough for me to put in some early money into it. We then moved to talking about possible angels who would fill out a first funding round.

These were angels who were also individuals very prominent in the area of business he was going into. They were definitely going to be helpful in building the business and be able to make the chance for success much higher.

Since he was my friend, he also told me what these people were like. They are very money focused. And they will do anything to maximize their gain, potentially at the expense of others.

I thought about this for a moment. At first, I thought what could happen if I were to invest early, probably into a convertible note, and then convert to the preferred series? Aren't I protected by preferred rights?

Then it dawned on me what could happen. Let's say the preferred round closes. Then a few months later, the board is faced with the other angel investors proposing to change their own rights. They propose changing them so that they can, upon majority vote of the shareholders, buy out any shareholder. My friend who will undoubtedly be on the board of directors may oppose this, knowing why this is being proposed, which is to squeeze me out. He tries to defend me but then the angels apply leverage in that they could make life much more sweeter to him and his business if he agrees to the change in rights. My share in the company leaves me no leverage at all. I have not put enough money into the company so that I can defend myself in this proposal through vote alone; I don't have enough share in the company.

In this scenario, the vote passes with my friend/entrepreneur bowing to the needs of the company and the next vote is buying me out, perhaps with a bit of profit, perhaps not.

There is a possible solution. That is to propose that I go in with my seed money and demand a board seat. This should protect me for at least one round of funding, but after that I will probably need to relinquish my board seat in favor of whomever is coming in with subsequent rounds of funding. I do not know if my friend would agree to this or not, or if I would even want a board seat. I am thinking on this some more...

Early stage angels are definitely in a tough position when we come in early, and often with small amounts of money relative to the cash coming in for later rounds. We take the most risk, but yet we are left with no leverage later on, as the needs of the company outweigh shareholder need.

SunshineNYC: Office Space for the Geek Cool

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I really love this office space operation in Manhattan, Sunshine Suites, this one at 419 Lafayette near Astor Place:

The tree branches around the conference rooms is a bit freaky. Makes you feel like they are going to reach out and grab you. Don't have a meeting here while on drugs!

It's only about $400-$500/month for a desk. You get a phone, internet connection, unlimited usage of xerox and fax. And it's decorated in New York chic. The entrance to the floor looks like the W Hotel. There is even sexy house chill music playing in the bathrooms to relax you when you...well...you know...

EastMedia: Ruby on Rails in the Big Apple

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I just bumped into these guys in Manhattan: EastMedia:

Really cool bunch of guys and really good at Ruby on Rails. If you're looking for a small development shop in NYC, you should definitely check these guys out.

Legal Help is Showing a Depressing Pattern

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So far, my scorecard for legal help for startups and investors has been pretty dismal.

Let's see. The stories go on:

An LLC agreement costs $6000 to create but upon dissolution of the LLC the agreement has ambiguous terms on who owns what and causes tons of issues upon dissolution. Note that an LLC agreement can be created and filed in about $1000.

A term sheet is created by a new associate who is new to Silicon Valley and barely has any experience in startups and financing. He tries to snow an investor during a call to defend his terms and the investor, who happens to be seasoned and coached by his really good lawyer, refutes every point made by associate, who concedes at the end of the call that investor was actually experienced and compliments him.

The night before the first investor meeting, a lawyer totally flakes on entrepreneur and doesn't have a term sheet done! It arrives around midnight the night before and there is no time for review at all.

Entrepreneur asks for term sheet, and lawyer delivers one. Investor reviews and finds provisions that have no meaning whatsoever to the current deal. It is obvious that lawyer cut and pasted from a previous deal term sheet and didn't bother to review and check for relevance to current deal, costing everyone in time and legal fees.

Entrepreneur asks for advice from lawyer on what to do from a financing standpoint, and gets almost no worthwhile advice whatsoever. Friendly investor guides entrepreneur through all the possibilities and helps develop a financing strategy.

Investor asks lawyer for help on looking at startup term sheet and gets back worst case scenario response on the whole thing. Investor initially gets cold feet, but quickly realizes that this particular lawyer is the most conservative, worst case scenario lawyer in the world, and investor realizes that risk is a part of life for the early stage investor and that this lawyer isn't the right person to advise on early stage investments. If investor had listened to this lawyer, investor probably would never make any investments at all and would rather sit home and stuff money in mattress.

Legal help is crucial to both the entrepreneur and investor. It doesn't matter that the legal help sits in a big expensive firm or a smaller shop. Why can't we find good, dependable, and experienced legal help?

In the last few months in working with financings, I have gotten to know the Convertible Notes versus Preferred Equity issue very well. As an angel investor, I am constantly thinking about maximizing my money and I don't have the cash to play the field in a broad, diversified way to not care about this issue like some larger angels. Thus, knowing when to take a deal or walk away is part of the game, and certainly financing terms are part of that decision.

Again, I reference Josh Kopelman's post on Notes and Preferred Equity and think it explains many details well. I'll talk about this topic with his thoughts and some of my own in mind.

Why would I be OK with a Note?

The terms must be good.

Often Notes have no anti-dilution provisions or special provisions that help us in case the next equity financing does not occur. They seem to be hastily drawn up and many details are left out. I have walked away from Notes that didn't have enough good terms in there.

They are mostly unsecured, so I'm OK with that. I know that I'm dealing with an early stage startup and they have little or no assets at this point. What would I do with 1/10th of a PC?

I also want to make sure I am not locked into a particular Next Equity Financing by default. I want to have the ability to back out if company conditions change.

If they require an auto-conversion provision in their to the Next Equity Financing, then I want them to insert a minimum on the money raised, to ensure that they don't do something screwy.

In truth, I don't pay much attention to the interest rate return for early stage startups. This is usually a make or break time for them. If they don't get the Next Equity Financing, then often the company will tank and I won't get any interest payment or my money back yet. I do just make sure it is in range of other Notes I've seen which is about 6-8% per annum.

There is a Preferred Series financing imminent.

Most Notes are used to gain cash to continue company operations just prior to a first Preferred Series financing. My goal is to always get share of a Preferred Series. If I know there is one coming soon, then I'm OK with a Note knowing that I'll convert in a few months. Time is minimized between the Note and the Preferred Series and there is a less of a chance that the company valuation will change dramatically, causing loss in ownership share from when I invested and when it converts.

Why would I NOT be OK with a Note?

There is no Preferred Series in sight, or I am not confident it will happen soon.

If the Note is being raised, but they have nebulous plans for raising the next Preferred Series. I won't do it. The risk of it dragging on for a long time is there, and the more time that drags on before I gain actual ownership in the company, the more chance that it goes not in my favor. The valuation could go up (meaning I convert to less ownership than I originally thought), the company could go under with not enough funds, or I mayjust get paid back and not reap any benefits of having ownership in the company, if the company starts gaining revenue. The company need not be going under for you to not gain the benefits of investing in a company.

Or they may SAY they are going for Preferred Equity fund raising, but I get the feeling they will drag their heels or avoid seriously doing it. As soon as I get some intuition that this is true, I won't do it.

This is a second (or beyond) Note they are raising.

This begs many questions. Is the company trying to be greedy and not give up any ownership? If so, they can build their company on other people's money then. I want to maximize return and getting interest rate return on my money is not the way to go.

Or you have to wonder why this is yet another Note. Why do they need another Note? Why haven't they raised their Series A? Or what is wrong with them that they can't raise their Series A? Many Notes are written vaguely that the Note will convert to Next Equity Financing. They may actually want to convert the last Note holders to the terms of the second Note which may be less favorable to them!

Unfavorable Terms.

Although this may seem like a given, it could mean that the company opportunity is really good, but the Note terms are not.

Terms always take care of the worst case scenario and nobody wants to see them come into action. But sometimes, the terms are there and you can't change them. I've already had a case where I wanted to change the terms but the entrepreneur did not because the current terms were already approved by the lead investor, and he did not want to scare the lead investor off. But, it was obvious that the lead investor didn't really read the term sheet carefully because some of those terms were bad even for him.

By the way, I think this happens frequently in the Valley. There are so many large investors that when they invest, it is a small amount for them but large enough to make them lead investor. But they go through so many deals that they don't seem to be spending time on the terms at all. I've heard from one person that they just write off investments that get diluted to nothing or fail, and employ diversified investing across many different investments and hope that a few make it big to cover the many that return little. Very frustrating for us smaller angel investors.

Always be ready to walk away no matter how good parts of the deal looks...

Investors are not aligned with interests of the company in building value.

Clearly stated in Josh Kopelman's post, it makes sense that as investor I want the valuation kept as low as possible so that I convert to as high ownership as possible. But my model is to help entrepreneurs as much as possible. So if I end up helping them and sign up as advisor, but feel that a Note they may be presenting may not be in my best interests, I may end up not investing at all.

Why I like Preferred Series.

I have ownership in the company.

I gain immediate ownership in the company and this point is not nebulous, as in the situation of the Note.

Generally, preferred terms are pretty favorable to me.

There will be provisions for voting, company control, preference in paying back, potential dividends, etc.

I am aligned with the interests of the company.

Once I have ownership in the company, I can freely and without reservation help the company build value, as my own value in the company will also grow.

Why not Preferred Equity?

Not many reasons to not jump into an investment if Preferred Equity is offered, assuming all other factors are positive.

Sometimes, there is a gotcha in the terms.

Potentially the terms could be not quite right. This happened once where the voting rights were not favorable to the Preferred Series Angel round. I caught this at the eleventh hour and thankfully the entrepreneur agreed to a change in the docs to make this more favorable. Otherwise, our terms and rights could have been wiped out without us having any say in it! You always need to review the terms no matter what and I would do it with a seasoned lawyer who has done many financings before, and hopefully from the perspective of company and investor.

Caveat Emptor - "Let the Buyer Beware" - words to live by and in the investing world you have to dig into every little detail in every deal. It costs more in time and money, but it keeps me out of trouble.

The Amazing Pace of Change at My Alma Mater, Yahoo!

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I just found the email that detailed the re-org at Yahoo! from Sue Decker, head of the new Advertiser & Publisher Group. It's posted at Techcrunch:

Text of Email to all Yahoos, Techcrunch

I have been out of Yahoo! since Sept 2004, and in 2+ short years, I see:

* Lots of EVPs and SVPs. They used to make you run the gauntlet before making even VP.

* I only recognize about 6 names in the email out of about 15. The influx of new people is staggering at the higher levels. Where did all the people I knew go?

* The company is organizing in a very "large company" way. The changes were in the making while I was still there, but now they are extended more.

* Valleywag's post about slightly less kneeling before Zod is a bit cutting, but it does make a point. I am not sure that splitting engineering (and by the way I heard through the grapevine that my old user experience group is reporting into the product teams now too) is going to be good for the company in the long term.

To me, companies always undergo cycles; they try things, they work or don't work, and then they go back to try old things, and then they work/don't work, and then you're back to trying stuff you tried before. I suppose it's one way to keep the world off balance to distract you from other possible issues with the company.

In reading my last post, one may start to think on why either method may be more or less desirable to an entrepreneur seeking to raise cash.

Why a Note?

It is Cheap.
Early stage startups typically have little cash to spend. Closing a Note allows them to bring in money in the cheapest possible way. Preferred Equity will cost them 10 to 20 times more.

It is Fast
Often startups need cash as fast as possible to fund short term operations. A Note closing can be accomplished in as little as two days.

It is Unsecured
For early stage startups, every Note I've seen has been unsecured. If the company goes under, there is no obligation to pay the Note holders back. It could be secured by assets, but generally for early stage startups it is not. Why would you get paid back with 1/10 of a PC?

Maximum Flexibility
In the case of early stage startups, we talk most often about a Convertible Note which Note holders want to convert to some version of stock in the company. Depending on how vague the language of conversion is, a startup could convert the Note holders to common stock, to Preferred Equity, or even to the terms of another Note. There is the potential for maximum flexibility on the part of the company as, in theory, it could convert to anything if they word it right. Another aspect of flexibility comes in next financings. For instance, with a Note, valuation for the company has not been set yet so there is freedom to adjust. It also means there are no preferred shareholders and could be more attractive to certain large investors who want more control in the company.

It is Low risk
The Note holder often has an interest in helping the company and getting in on the ground floor, and they can be generous with the payback period and the terms. Assuming the company either gets to a place of generating money or raising more, a Note of this type can be paid off prior to the due date, or converted to preferred in the financing, in which case the Note turns into equity and expunges the debt.

Why not a Note?

Not many reasons to not use a Note first, from the company perspective.

It misaligns helpful investors with the company.

The startup may have some investors whose contacts you want to leverage, or who are actively giving you help. By executing a Note, the startup creates a situation where the investor is not incentivized to help the company. If the company grows in value, and since Note holders don't have actual ownership in the company yet, then Note holders gain smaller share of the company when the Note converts. Helpful Note holders want to help, but they will see their potential stake in the company if they help drive the valuation of the company upwards.

But read on for some thoughts on Preferred Equity.

Why Preferred Equity?

It aligns the interests of helpful early stage investors with the company.

In Josh Kopelman's blog post about Bridge Loans vs. Preferred Equity, he explains it well. Once investors jump into a preferred series where they have actual ownership in the company and feel good about building value with the company, as their own value in the company increases with whatever value they build.

It rewards early stage investors with their support of the company.

Early stage investors have the riskiest position. They go invest in a company early, and often they get their stakes diluted by subsequent investments until they get nothing back. This seems grossly unfair for people who supported the entrepreneur at such an early time when there is barely no clear value built yet. With a preferred series raised with the earliest investors, they are rewarded for giving their support early on and the preferred equity will most likely resist dilution with the proper provisions.

It attracts investors.

Like with the previous item, preferred series are just more attractive to investors simply because you gain immediate ownership of the company and not have to deal with potential uncertainty of Convertible Notes. Entrepreneurs can increase their chances of getting more investment by offering this early on. Many investors are gunshy of Convertible Notes and want ownership immediately.

Why not Preferred Equity?

It's expensive in time and money.

You spend more money executing the paperwork, and there is a lot more paperwork to do. This may be too much for an early stage startup to bear financially.

It could deter future investors.

Venture funds don't like to have others in potential control of the company. They want it all. Other preferred shareholders could present a problem here as they may have preferential voting rights, perhaps even a board seat. Also, preferred equity terms often have anti-dilution provisions which prevent future financings from grabbing a larger stake in the company.

Operationally, it adds a bit more complexity.

Now a preferred shareholder elected board member may be present, so there may be another voice in the operations of the company. Potentially, other large directional moves by the company may require the preferred shareholders to agree via vote.

Still not an exhaustive list, but some thoughts I've picked up along the way. More interesting thoughts in Part III from the investor point of view, coming up next!

Convertible Notes versus Preferred Equity, Part 1.5

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Oh one other quick word.

When I started dealing with term sheets in both Notes and Preferred Equity, I strove for understanding. I went in thinking that this was an orderly process and that there were standard contracts for this sort of thing.

The one thing I learned is that NOTHING IS STANDARD.

Terms are written purely on whatever the entrepreneur and the investor(s) want. Yes, there are standard things like interest rate payments or anti-dilution provisions, but as for what interest rate to pay or which type of anti-dilution provision of which there are many...all up for grabs.

So if anyone tells you their term sheet is standard in the industry, don't believe them. Everything is negotiable, so just say, "Thanks I'll take a look and get back to you."

Onwards to Part II...

Convertible Notes versus Preferred Equity, Part I

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Just recently the issue of Convertible Notes vs. Preferred Equity came up with an entrepreneur. It was an interesting discussion and caused me to think deeply about both types of financing methods and why entrepreneurs and investors may or may not like either one.

In this Part I post, I describe what I've learned about Notes and Preferred Equity. This is by no means exhaustive or even showing that I'm an expert in this, but I choose to state what interesting information I did dig up over the many months I've been doing this angel investing stuff.

Characteristics of Notes:

1. They are cheap. I just heard a quote from a law firm that, after terms were set, you could close a Note at about $1000 in legal fees.

2. They are quick. You can close a Note in about 2 days, assuming everybody gets their cash transferred in. If you need cash in a hurry and the other larger financing round is going to take more time to close, then the Note can give you cash in the short term very quickly.

3. The paperwork is minimal. Only one document is required, which is expanded from the term sheet and spells out the terms of the Note in exhaustive detail. Investors sign that, the money is transferred, and you've got cash.

4. At early stage, many companies have little assets. Generally, for early stage startups, Notes are unsecured, meaning they are not backed by the assets of the company. So if you go under, you are really under no obligation to pay investors back.

5. It keeps options open for the next equity financing. Valuations may change and the Note doesn't cause any potential issues with Preferred Equity ownership prior to the next round of financing.

6. Negotiation on terms is possible, increasing time and cost to close.

7. Notes, or convertible notes, are basically loans to the company. The investor doesn't own any part of the company, and there is a promise to pay back the loan with interest. The convertible aspect means that at some point, generally when the next financing occurs, the money you invest would convert to the terms of the next financing. Sometimes it's spelled out as to which financing it is, and sometimes it is not.

Characteristics of Preferred Equity:

1. Preferred equity holders gain actual ownership in the company.

2. It locks in a valuation for the company at time of closing.

3. They are more expensive than Notes to close. A recent quote, after terms were set, would cost about $10,000 to $20,000 in legal fees to close a Preferred round (versus the $1000 of a Note closing).

4. Preferred Equity rounds take longer to close. They may take up to 3 weeks to finalize everything (versus as little as two days for a Note).

5. There is more paperwork involved. A Note involves only the expanded Note document. A Preferred Equity round involves a Stock Purchase Agreement, Investor Rights Agreement, filing of changes in the Articles or Certificate of Incorporation, potentially a Voting Agreement, and other supporting documents and changes. After all the paperwork is signed, a Preferred Stock certificate is sent to each shareholder.

6. It will require an official board meeting resolution to approve, and recording of minutes.

7. Negotiation in terms is possible, increasing time and cost to close.

8. Preferred Equity may cause issues in further financing rounds as follow-on round investors may desire more ownership and/or control in a company and may be deterred from investing by the fact that there already are Preferred Equity owners present.

9. Preferred Equity holders get preferential treatment as defined by terms. These can be things like, in case of company liquidation, they get paid back first, or anti-dilution provisions, or special voting privileges, or the ability to select a board member to represent their interests.

In Part II, I look at Notes versus Preferred Equity from the entrepreneur point of view. Part III will look at Notes versus Preferred Equity from an investor point of view.

The First Investor Meetings!

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A potentially scary moment is when you get into your first investor presentations. One of my startups is doing that right now. So before the meetings, I tend to send lots of comments to prepare them. Here are some of them:

1. You will be presenting a term sheet. Most VCs will present their own and I am sure it will be investor friendly. See item 2 below.

2. VCs may tempt you by closing quickly and shoving a term sheet in your face, hoping that the positivity and amount of money will sway you into signing right now to get the money. See item 3 and 4 below. My advice is to never sign anything especially in the emotional euphoria of a positive meeting. I would shop around first and make them compete against each other if possible on terms.

3. Always be ready to say 'Let me think about it.' Don't accept anything too quickly.

4. Don't let desperation cloud judgment. Ever. And it's corollary (see item 2 above), don't let euphoria cloud your judgment either!

5. There may come the option to skip the note if a VC you like wants to close quickly. Be ready to address this as an option, and hopefully a positive result for both you, the VCs, and us angels. By positive I mean that we all invest in and get stakes in the series A. Negative results would mean us angels may get squeezed out.

6. Make the note close between 250K and 400K. Keep the option open to close sooner if you think it's a good idea, or to extend fund raising to grab the extra 150k for a total of 400k. Don't just close on 250k if you think you've got it. You may be able to get the full 400k if you work a little harder and a little more time. Remember item 3 above.

7. VCs may want part of the note. Especially if you're giving a discount. They may demand to write into the note the right of first refusal to invest in the series A of some percentage. I would recommend not letting them do the full amount, but say up to some percentage like 50%.

8. VCs may attempt to squeeze us angels out to gain a higher percentage of ownership of the company. Being an angel, I will only ask that you do not let this happen for our sake.

9. VCs may demand a board seat. This is probably ok, but make sure you select the board member VERY CAREFULLY. You should get along with this person, like them, and want to work with them. Getting rid of a board member is not like firing an employee. You will be stuck with this person for a long time. Choose carefully and wisely.

10. VCs will undoubtedly ask for a huge percentage of the company. I would only say that a smart VC should never un-incentivize an entrepreneur by taking huge stakes in the company and dropping the entrepreneurs ownership to near nothing. It's a dumb move and unnecessary. I would say you could get away with 25-40% depending on the situation.

11. VCs may like the idea so much they want to give you more money. Be also very careful of taking too much money. It will affect valuations, ownership percentages, and also exit strategies. Now venture funds are huge with cash; they want to deploy more whenever possible. Don't let them tempt you into taking too much!

Other stuff:

1. Be prepared for the due diligence process. It involves getting a huge amount of paperwork delivered to potential investors. Get it all organized and ready to go now, and thankfully you haven't been in operation very long or else the paperwork could be immense.

It's always an exciting process to present your ideas and business to potential investors. It is unfortunate that there are so many sharks out there and trying to not get eaten is the name of the game.

One of the coolest things I've seen is when one of my startups gets their first site or application up and running. VoxPop has been busting their butts getting their first two promotions up:

EW.com Presents the 79th Annual Academy Awards: Pick the Winners

WCBS Newsradio 880 Presents the Yankees Decade of Dominance Tournament

Incredibly well done and designed. Their contest engine is working nicely and the front end design is beautiful. Check them out and enjoy!

Learn more about VoxPop on their site...

Guardian Angel

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The other week one of my entrepreneurs jokingly referred to me not just as an angel (as in angel investor) but as a guardian angel. I laughed.

But it's also got some real serious undertones.

The more I meet entrepreneurs, the more I realize that there are real BIG holes in their knowledge. This is even more apparent with first time entrepreneurs. Even I had big holes in my knowledge base regarding investing and startups when I started David Shen Ventures, LLC.

How did I learn? I tried to find people to sit with me and talk with me. But so many of them are all busy and I also found out that a coffee or lunch is just not enough time to go through everything and have it sink in. I tried looking for books, but many were too generic to be useful. I did find a series of really expensive books on venture funds but they were very complex to read and took a while to figure out what they were talking about.

I eventually paid my lawyer for about 1.5 hours to sit down with me and go through some example financing docs. I made notes on these complex term sheets and other paperwork and then I could go back later and review what I had heard and written down. One funny thing was that when I met with my lawyer, he actually brought on another lawyer whom he partners with in financial deals. He was probably the most conservative, worst-case-scenario lawyer I had ever met; I almost quailed at giving my money to anyone after talking to him! But I also learned that early stage startup investing is not for the risk averse and that you can't get the same security as for other more established companies in later stages. Still, that 1.5 hours was not enough time to let everything sink in, but I had a better base to draw from.

Then I started reading some blogs about venture funds. I especially like Josh Kopelman's blog and I find his posts about investing in general to be really informative. This brought more knowledge in but still didn't complete the picture.

It was when I started doing a few angel investments when I really started to hit my stride. Arguing for terms was one of the best ways to firm up in my mind what risks there were in a particular deal. So many details all intertwined: valuation now and in the future to achieve a given return, percentage company owned, future return, squash prevention (or preventing dilution), notes versus preferred series. I always carry a calculator with big buttons with me at all times to punch in numbers and make sure my mental calculations are correct. I am getting more and more proficient and arguing from at least the point of view of a knowledgeable angel investor.

Now think about the new entrepreneur. Not much cash. No exposure to the financing world for the first-timers. I was willing to pay for some of my education with my lawyer (I just thought of it as educational expense) but others can't afford that. So what do they do? Where do they find help?

As advisor, I feel compelled to help them. And I don't mind as many meetings as it takes to get them educated. With this particular entrepreneur, I have had meetings weekly, many email exchanges, and also sat in with them on presentations. We talk about everything. The presentation, what to talk about, financing strategies, the usual company strategy stuff that I advise on (product, user experience, advertising, etc.), everything.

Before presentations, I email them for things to watch out for, and remind them to mention this and that. Post-meeting I email them again and give them one person's objective view on how it went. We go over the financing strategy and explain to them some of the details that are hard to understand if you haven't done it yet. I give them strategic advice on the pros and cons of doing financing one way or another, and how investors will react to certain terms. I give them example term sheets and show them what terms can look like, and what investors like and don't like and why.

I make myself available to them because I know there is no one else that is willing to spend that much time with them. And while I give them information, I try not to make the decisions for them; I make sure they have as much information as possible so they can make an informed decision and not one that has blind spots.

So from angel (investor), I became guardian angel. I keep them out of trouble as much as possible and in many cases I'm the only guy doing it.

How ridiculous is that. In our world, we seem to have major problems finding mentors who will give their time and expertise to others. If you don't have the connections and relations, then it gets even that much harder to find someone who is willing to help you. I for one hope to change that with my entrepreneurs. It is my belief that whatever knowledge I give them will give them a greater advantage over other companies who are still in the dark.

FanLib Moving Up: Beverly Hills 90212

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Companies grow up. They need to expand. FanLib is hiring like mad and has moved to Beverly Hills. What's with the pig and balloon in the elevator?

Yet Another Startup: Thank God for IKEA

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Yet another startup setting up in San Francisco offices. A nice space right near the CalTrain station!

I think that SF startups would have a hard time finding furnishings if it wasn't for IKEA being so close by. It's so cheap to outfit an entire office! They really exemplify the concept of disposable furniture; if it breaks, you just go buy another one. When you're done, you can just toss it.

The Power of Referrals

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Just recently, I've been thinking more and more about the power of referrals as applied on to Internet businesses.

Think about Digg.com. I "digg" an news article, so I hit the "digg" button and it gets tossed onto the Digg.com list. Because I "digg" it, I am essentially referring it those who subscribe to the Digg feed of news articles. In aggregation with the crowd's opinions, as well as with some newly discovered editorial color on top of it, my referral could get sent to the those who like the Digg referral style of consuming news, as a way of uncovering interesting news.

On NYTimes.com, I just learned that they consider the number of times a story is emailed a better measure of popularity than just the number of clicks to read a story. If you think about it, calculating most popular based on clicks can have a self-fulfilling prophecy aspect to it; those on the most popular list are seen by more users who click on them more, and those stories inevitably stay on the most popular lists longer than they should. But, if you think the number of times a story is emailed, then you realize that if someone were to think this story is great, then they're going to refer it to friends. It's an added metric on top of how many times the story is read and helps fine tune out of self-fulfilling prophecies.

A new site I was just introduced to works on the same referral principle: downfly.com. It is a simple application which allows you to post a link on the site and it gets "passed" to your social network. Every now and then, I'll get an email from the system that sends me links that get passed to me. As I use it more, I find it to be entertaining, a great way to discover new sites, and I also get to see what people in my network are thinking about and consider important enough to pass down their social network chain. But as I become a "passer" of links, I can't help but think about what I'm passing and why and the ramifications of passing. I want to pass good links, not junk. I don't want to waste peoples' time by passing stupid links. I think about the value they're going to get and make sure they get some from whatever site/link I'm passing them. I also can't help but think about what they think of me as they're receiving my link passes. That would be something interesting to implement is a feedback system that allows people to easily comment or feedback on the stuff they're getting, as a mechanism to see if I'm doing a good job or not.

I see this referral aspect also in my advising/investing business. I see part of my job eventually is to help my early stage companies raise funding. I also see part of my job is to utilize my network to bring them valuable business partnership opportunities. But I told myself long ago that I need to build trust in my referrals to these folks. Investors don't want to keep seeing junk from you; they'll never take your call if you keep wasting their time with lame businesses. Potential business partners don't want to see junk either. I think deeply about whether there is true value in a partnership with someone before I introduce them. I don't want to make frivolous introductions, again because I want to continue building trust in my network that when I refer somebody to them, that I'm not doing that randomly, and that 10 times out of 10 it will be something they should look at.

Look at the effects of referral:

1. You the referrer have a desire to bring value to the receivers of the referrals. This altruistic notion forms the basis of the positive effects and power of referrals.

2. You think heavily on what could be interesting or valuable to them, so you're careful at referring things to them. Thus, you as a referrer need to get to know your receivers at some level to know what could be interesting to them. If you don't know them well, your referrals could have a negative effect on you as the referrer as your referrals could be perceived as random or junk. They may ask you to stop. Refer effectively by getting to know your receivers.

3. Successful or valuable referring can have positive effects on your reputation. It builds trust in your receivers of the referrals that you are giving them something valuable. It also builds trust in the thing you're referring, like a website, or business opportunity, or news story. It was checked out by the referrer, whom you trust, and thus you have a tendency to trust it more too.

4. If they like your referrals, you may get value back, in the form of good referrals or otherwise. If there is some measure of how good a referrer you are, like a ratings system, you can gain in reputation in a visible way. That rating is value to referrer, as is other things.

5. Referrals can be a better measure of popularity and "this is valuable or good" based on all of the above, and helps remove self-fulfilling prophecy effects of other forms of popularity measures.

6. You refer poorly, or annoyingly, and people will shut you off. Trust is lost, and thus reputation is lowered. And also they will lose trust in the thing you refer. As an entrepreneur, make sure you get referred by someone who is trustworthy as a referrer, and not somebody who has low or potentially low trust amongst the people you're trying to get referred to. This can be very hard to determine who is trustworthy as a referrer and who is not, so tread carefully.

7. The system which enables referring effectively can use this as a viral marketing tool to gain more customers or users.

As I think on the effects of referral, I am going to try to employ it more often in thinking on product strategy with my companies.

On Being an Advisor

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When I talk to entrepreneurs about working with them, I make it a point of saying that my business is based on the assumption that they will have a better of chance of success if I am actively helping them versus if I'm not. Therefore, if I invest in a company, I require them to make me an advisor. And yes, it's also a form of investment protection for me since I'm watching over my money by being involved.

One might think that if I were to invest, that the advisorship wasn't necessary. I would be tied to the company through the investment and the ownership that comes with it, and probably care greatly about the company's progress and help when I can. In some sense it's true.

But I have already come across cases where even though people SAY they want my help, they really don't. They just want my money. One way to test that, besides watching my intuition about these things closely, is to see if they will sign me up as advisor.

When they do that, they need to be willing to compensate me for the advisorship. Since I deal with early stage internet companies, often pre-funding, I told myself long ago that I would not ask for cash payment like a consultant. Many people who do what I do will ask for consultant hourly fees to work with a company as an advisor. But I cannot. An early stage startup barely has cash already; to drain them of whatever little savings they may have could cripple or destroy the company. I would rather that they take that cash and build the business. In fact, I don't think they would sign me up if I were to ask for cash. So I ask for options to equity, vesting over my term which is typically between a year to two years.

If they are willing to give up some of their options pool for me, then that is definitely a good sign that they are actively seeking my help since they are giving up some form of payment to me. It's not 100% reliable, but there is nothing better than seeing a company give up something like cash or equity to ensure their engagement in you; they're giving up valuable options that they could give to someone else like an employee, but instead they are giving it to me, so they better utilize me and get their money's worth!

Being an advisor also clarifies my involvement in the eyes of outside world and within the company. I don't want to be perceived as a bothersome investor, who keeps sticking his nose into the company's business. With me, I'd be bugging people about product strategy, the user experience, and online advertising all day long. Without a statement of purpose like "David Shen is our advisor and he will help us in X, Y, and Z", it becomes that much harder to communicate and reinforce why I'm hanging out with the company. I believe with that clarity comes acceptance that my advice will be given, and that they should listen. If they aren't ok with that, then issues would come up during the advisor signup process in which case maybe it wouldn't make sense for me to get involved with the company, if they don't perceive my help as valuable. By the way, this has happened already.

It also clarifies in my mind what I'm supposed to do every week. If I'm signed up as advisor, I have an obligation to help them since I want to earn my options. If my term is over, then I can mentally shift and focus on the other companies whose terms are still on-going.

So is my help going to continue after the term? This part is still a bit undefined since my business is so new. A few thoughts on this:

If I'm an investor, I'll always be around until I exit the investment. To what extent I am involved depends on the state of the company at the time of end of my advisor term.

I always tell people that by the end of my term, my goal is to teach you everything I know, help you get people in place to permanently take on what I have brought to the table, and bring on any relationships you need through my network. Generally, I think one year terms are too short to do this, but 2 years is a bit beyond the point of finishing this task. So somewhere between 1 to 2 years is where I think I'll accomplish those goals (it's very uncommon to do 1.5 year terms even if I think it fits my mental timeline of when I'll finish my goals). For that reason I like 2 year terms better than 1 year, or else I think that the chance of not accomplishing those goals is high and if my advisorship does not get renewed for another year, then I'll feel like my job with them is unfinished. So theoretically, if I do accomplish all that, then you'll have people and relationships in place to do everything I helped you with, and only need minimal involvement from me post-advisor term.

I believe that when people see what value I have brought to them during my advisor term, that they will keep me engaged after my term ends. But I can't keep shepherding them in their tasks; they need to be able to function effectively by themselves since I'm not an employee. And thus it's critical that they hire great people who can do all the things I helped them with, and I will be helping with that aspect as well.

However, if they really want to lock-in my involvement post-advisor term, they should renew my advsior contract and we'll keep going officially.

So far, being an advisor has been a rewarding experience. As I do my work, I am pretty active and aggressive at checking in and seeing opportunities and throwing ideas over to the entrepreneurs. I have found that they have really appreciated it. Anecdotely, I am finding that I am outpacing most, if not all, of the other advisors that they have brought on. I find this to be an interesting revelation. It seems to me that traditionally most advisors are only called upon very sparingly. Perhaps it's because I'm an investor in some of these companies that I care more and want them to succeed; but I also am pretty regular in checking in with companies which are quiet at the moment.

Because of my seemingly extra effort, some of them have offered to find some way to thank me beyond what compensation we've agreed on. While I appreciate it, I do not expect it. The satisfaction I get in helping these entrepreneurs, seeing my help get them to success, getting caught up their energy and excitement for their company and product, being a part of the celebrations of closing their series A funding or their first $1 MM of revenue - it's ample reward to know that I am part of that and that my help is being actively utilized, appreciated, and validation that my help is worth it.

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