Recently in Angel Investing/Venture Funds Category

Over the last few months, I've spoken to a number of investors who work in the early stage startup space. It seems that many of them have come to the same conclusion I had in my earlier blog post, Angel Odds vs. Venture Odds, which was that they really had to go broad in investing to try to find those few Google super-investments to generate the bulk of the fund's returns.

The numbers they propose are staggering: 50-100 investments over the life of a fund! If 100, that's 20 investments per year if spread out over 5 years (typical life of fund). Some of them may even try to front load the investments, exceeding the 20 and perhaps going up to as much as 30-50. That's about 1 investment accepted, negotiated, gone through due diligence, lining up a wire, and docs signed and delivered every 2-3 weeks. If you've ever invested, you know how difficult that process can be.

Some thoughts on this, from the perspective of working on the measly 16 investments I've done over the last 3.5+ years:

1. Investor management of this number of startups will be challenging. What will it mean to have 20+ startups emailing you for help, meetings, introductions, advice, etc? Time management will be very difficult.

Entrepreneurs will have to be prepared to find ways of capturing dwindling time slices of the investors, and working hard to deserve more time. By deserving more time, I mean it is natural that the more successful startups will get more time as they have the best chance to return the most money to the fund.

2. Investor teams will need to increase, but paying for them may be difficult as early stage funds are typically smaller in size, and thus management fees collected will also be proportionally smaller.

3. It will be interesting to see how the money being moved around can be optimized. Typically capital calls are made to limited partners when an investment happens. If there are a lot of capital calls, making and collecting a huge volume of capital calls can be a lot of work on the fund personnel and limited partners. Capital calls may work differently for these early stage funds.

4. In this world of proliferating me-too products, it may be impossible to not invest in startups which overlap in plan. Many investors and entrepreneurs worry about their plans being discovered by competitors or near competitors. This is why we don't like investing in startups who are competitive to one another. But if they are investing in 50-100 startups, I wonder how they avoid competitive conflicts? Or should they even care?

5. Can 50-100 quality startups be found in one area even if it is in the Bay area, the startup capital of the world? It may be that going far afield will need to happen in order to find quality startups. This will strain time commitments for investors to travel and keep tabs on investments far away. It will also mean entrepreneurs may only get as much help as they can remotely.

6. Entrepreneurs should be prepared for what I call "survival of the fittest" and "ruthless culling". Given the limited attention time of the investor in the face of overwhelming numbers, entrepreneurs need to work extra hard to prove they deserve more investor time. The best will get more help, and get follow on investment. Those that do not get follow on investment may find this is a detriment to them getting more money.

Entrepreneurs will have to get over the fact that while they think they are the coolest kid on the block, in the face of being in group of cool kids, their own coolness will be the norm and therefore commonplace and they will have to find ways to be even cooler than their peers. Being commonplace in a group of equally cool kids could mean neglect as the even cooler kids get more attention and help.

Despite all this, I firmly believe this is the way to play the early stage startup game from an investor point of view. It is the only way to raise the probability that they will find the Google super-investments that will create the oversized return of the fund.

I went to Dave McClure's Startup2Startup last night and we listened to Mark Fletcher recount his current startup commandments. Mark has had a great history in startups, having built ONElist back in the day which merged with eGroups and got acquired by my old alma mater Yahoo. Then he built Bloglines which sold to IAC in 2005. Now he is working on another startup called SnapGroups, which got announced and was supposed to launch last night, but unfortunately also came out with a nasty bug and kind of stifled the launch..!

One of his slides had to do with startup business models, which was more in the area of talking about startup business building strategy than just strictly revenue models. For his 3 startups, including his current one, he listed his startup strategies (me paraphrasing here and imperfect memory at work):

ONElist: Raise lots of money (~$46MM), grow big fast, hire a lot of guys, dominate the market before anyone else, go IPO

Bloglines: Raise a bit of money ($200K), hire small team, build great product, flip it.

SnapGroups: Spend as little as possible ($6K) using lean startup methods, outsource everything, work on something he's passionate about, no exit strategy to shoot for.

It was a trip back in history for me, as I came into the startup world via Yahoo, and lived through the times as Mark had. What was amazing to me was the difference in strategy given what was in vogue at the time.

During the dotcom boom years, it was just build as fast as possible and get huge before everyone else, and then go for IPO. This of course didn't work anymore after the dotcom bust, and the introduction of Sarbanes Oxley which basically killed the IPO market even as it attempted to fix the bad accounting problems and protect the shareholder. Also, the excesses of the dotcom era were completely gone, and also gone with it the ability to IPO on little or no revenue.

Then along came the post dotcom bust years and it seemed that the M&A market for startups heated up. So now it was cool to get a bit of investment, and then build something that a Yahoo or Google wanted, and then get bought. At this point, we saw that it was getting cheaper and cheaper to launch web products, and over time, a lot of people jumped on the flipping bandwagon.

Soon, flipping became tough also because it was easy to copy somebody else and now the market was flooded with me-too products. Everybody called on the corporate development teams of the Googles and Yahoos of the world and it became impossible to get their attention. They didn't want to hear about you if you were too small; they only had so much time and only could focus on those opportunities that yielded the largest results for them. Yeah you thought you were cool, but against that kind of competition you weren't cool enough.

Somewhere in there, along came Ycombinator who proved that you could build something with so little capital and get it launched that it started being copied everywhere. Also, the world shifted to providing so many outsourced services and resources that you could build something by using other peoples' servers, open source code, and even excellent coders from other parts of the globe. Other companies would do the heavy lifting on commoditized services while you could focus on the core differentiator of your service.

Enter the economic downturn of 2008 and now M&A was difficult because major companies were pulling back to conserve cash and survive. They were also questioning their M&A strategies prior to this because they were buying startups for huge sums of money but wondering where all that hockey stick growth had gone to, after destroying the incentives of the brainchilds of the startup by making them rich and then watching them leave. Flipping became not so easy.

College kids couldn't find jobs any more; nobody was hiring. Plus, they keep hearing from their peers that working at large corporations sucks. Enter also the rise of a ton of resources like Ycombinator to jumpstart tech startups in a number of locations. Starting up became the in-thing and now we see tons of people trying to do this in a super cheap, fail fast, be adaptable way.

Despite the obvious indicators, I have found that entrepreneurs still are sticking to last era's strategies. Mark was smart; he watched the market and then built quickly to exploit the advantages of the era he built in. But today, I still meet entrepreneurs who are building to pre-dotcom bust year concept of building users fast and then thinking they can raise money later!

Even investors are stuck in last era's strategies. The consequence of raising ever larger funds meant that they were hoping for the huge deals that were present in dotcom boom years, but now that strategy doesn't work so well with the IPO market so slow and the presence of large enough startups worthy to put that much capital in so scarce. They add in the fact that initial capital requirements are so low, that often they find great startups who don't need or want their enormous amounts of cash.

I also changed my investment criteria. Many startups I funded before the 2008 economic downturn still had dotcom boom year or flipping strategies, and had burn rates to match. But then as we crossed into 2008, I started seeing that either strategy now created enormous downside risk of failure, and so had to now go for startups who were smaller, followed the lean strategy, and looked seriously at producing revenue sooner than later.

Mark's message was incredibly insightful, which is that this world is a constantly shifting place, and that you have to be nimble enough to switch strategies when the world changes on you. You also have to be observant enough to know when to make those changes, and not get locked into past views which may not be valid in today's world.

Being an advisor is tough. It's all about influence. None of the entrepreneurs I work with have to do anything I say and it's all about convincing them that something I say is worth listening to and executing on.

I had breakfast with my life/executive coach yesterday to catch up and she mentioned she was working on how to be a more effective influencer. In doing some research on the topic, she found that it is actually more about personal charisma than just straight intelligence and knowledge. For example, she related to me that smiling a lot and charm have a great effect on whether you are successful at influencing somebody or not. So it's a lot like what effective salespeople are good at, which is using their personality to charm you while you inadvertantly hand over your wallet!

Towards the end of my tenure at Yahoo, I managed to land into two roles that were all about influence. The first one involved getting all the product teams to revamp their site designs to implement larger more monetizable display ads. The second role involved implementing worldwide a more disciplined and quality oriented product development process. Both required me to become a salesman and evangelist, two things I was definitely not. But I learned about how to get things done via influence and how much I still had to learn.

If you've ever worked in a role where you had to get things done with influence, you will agree with me that it can be very frustrating. Nobody ever reports directly to you and so you can't force people to do anything. They may even agree with you at a meeting but then when everyone walks away from the meeting they go back to doing their usual thing and not what you asked them to do. In fact, I had even vowed that if I were ever to take another permanent role, that I would only do it if I had direct control of the team and my destiny.

But here I am, thriving as an advisor to 20+ startups over the last 3.5 years and enjoying my work solely built on influence.

A lot of entrepreneurs look to me to give them the answer. In fact, in times past I have delivered an answer but I have found problems with this approach:

1. The answer is often "my" answer but not the entrepreneur's answer. This is because, given my experiences and expertise, that I would tackle the problem in a certain way and because it was me executing, I could probably make something out of it. However, if an entrepreneur doesn't have similar experiences, then they have a greater chance of failure.

2. The early stage world is incredibly random and I have often found answers that I would not have done but yet have been successful. So what exactly may seem an answer today may quite often not be where you end up.

3. There are often many answers to the same problem. Again, back to point 1, what may be the answer for me may not be the answer for you.

This is why I hesitate to throw an answer out there unless someone is smart enough (like yesterday!) to ask the right question, which is "if this were you, what would you do?" This is important to frame the answer correctly so that the questioner realizes that my answer to the question is more about me than him. If I were the entrepreneur, this is how I would do it - but you're not me!

My approach has morphed to a more "throw ideas out until one sticks" method, basically putting so much out there until something resonates with the entrepreneur and team.

This resonance is very important. Everyone comes to the table with strengths and weaknesses and all the experiences they have. Thus, whatever idea they run with has to be something they are resonant with and can run with because they will be the ones living with it day and night to make something worthwhile out of it. I am only there intermittently but can't direct them every minute; it's their project so they have to own it through and through.

The unfortunate side effect of this is sometimes I can sound vague or perhaps even dodging their question of "what should I do next?" I have found over the last 3.5 years of advising that my biggest help to startups is to guide them like a teacher, teach them general concepts and help them translate them to whatever they are doing now, and to help expand their thinking as a lot of entrepreneurs tend to get very myopic in what they are doing and have a hard time keeping track of innovation outside their own project. So instead of providing them with "the answer", I provide them with ways to look beyond themselves and perhaps find an answer for themselves within that process.

OK I should build IKEA furniture more often. Spending the last 2 hours building a new dresser from IKEA meant that my mind kept drifting back to The Ultimate Product and why it makes me feel uncomfortable when the Ultimate Product doesn't match what the entrepreneur is actually building.

I think it means the probability is high that they will need to pivot at some point because they are off target from the Ultimate Product. While pivots are a fact of life for entrepreneurs, the problem for me is at early stage where I invest.

Most entrepreneurs only plan to last for a year on their current fund raise to my chagrin. If only they had planned to last 2 years, it would mean that they have time and money to pivot. But they will die before they can because they will run out of money and begging for more isn't going to work in today's funding climate.

So if they are, in my mind, off target from their initial mission and the resulting Ultimate Product, the chance of pivot is very high and they will be out of funds by the time they realize that what they are building isn't going to be widely accepted by consumers and can't pivot. Thus, if they don't plan on lasting two years, it makes me not too confident that they will last long enough to get somewhere stable and growing. As an investor, this doesn't make me want to invest...!

Do I believe this is a certainty, that if they aren't quite on target to what I think is the Ultimate Product that they will surely pivot? Of course not. I recognize that I could be wrong, and that a better product than the imagined Ultimate Product could arise which also satisfied the consumer/market need. I think this is all a probability game and I'm just trying to increase the odds of success. This is definitely something the entrepreneur needs to weigh as well, especially if they are off target from the known Ultimate Product.

The other day, I met with an entrepreneur and we talked about his project.

He first stated his mission, and then dived into his product and service and how it worked. As he talked about the various features his site had, how users would interact with the product, and what would happen when they did, my brain was actually split. Half my brain was following what he was saying, and the other half thought about his initial mission statement. As his talk went on, my brain halves began to diverge.

The second half of my brain was constructing the ultimate product to his initial mission statement. The ultimate product is the product that completely satisfies the users' problem as defined by the mission statement.

When my brain halves diverged, I was unfortunately very uncomfortable at this point. This is because what the entrepreneur was describing was not the ultimate product, but in fact something different. At this point, I stopped the entrepreneur in his description about the product and we talked about the ultimate product.

I detailed it out and walked through in the ideal case, what that was, and how it would work. But it was unfortunately different than what he was describing. It was one of the reasons why I felt uncomfortable in supporting him in his project, because his product seemed to be enough off the path to the ultimate product that there were more than necessary barriers to getting there, when it seemed to me that there were more direct paths to the ultimate product.

I think it's a worthwhile exercise to construct the ultimate product for a given need, and then see if you can get there via your startup's evolution. If you can imagine the ultimate product in your mind, I think it can give you guidance on how to build it. But if you don't know what that is, how can you know if you're on the right path to get there?

Last night I went to yet another great dinner hosted by Dave McClure at the hip Clift Hotel in SF. It was a precursor to a conference series on social marketing called SMASH Summit. If you follow Dave, you'll know that he is big on the fact that marketing and design in startups are key elements for success, and that most startups don't do either well.

SMASH is an acronym standing for Social Media And internet Strategies and Hack-tics. A bit forced, but the concept is pretty cool.

Speakers included Matt Cohler of Benchmark, Rashmi Sinha CEO of Slideshare, Stew Langille from Mint.com, and Jeremiah Owyang of Altimeter Group. It was a great round up of information presented, showing the various ways folks are using social media marketing.

Last night's dinner was actually a preparatory step to a one-day conference series Dave is going to put on both in SF and in NYC. After dinner, the tables had a discussion on what they have done in social media marketing and the goal was to generate some possible topics for discussion at the SMASH summits. As official notetaker, I wrote down some ideas and listed them below, so that you will get a possible taste for what you may see at the SMASH summits:

Marketers that work for sites that are democratic - how do you tell what succeeds or fails with the crowd?

How to gain trust for novice social networkers for social marketing?

How do you manage novices facing more technically savvy social media users? Ex. forum users ragging on novice posters for not knowing a tech solution.

How to use our customer base who are more technically savvy to support call center people?

How do you use cross channel communication?

How do you connect developers with passionate customers?

What's better than focus groups? What do you use instead?

How do you overcome corporate/executive fear of talking to your customers?

How do you track/prove ROI of social media? Ex. We only have anecdotal evidence of more sales via positive social media response.

What metrics of social marketing are important?

Panel idea: Bigger companies' overall experiences with implementing social marketing/media (success/fail stories, case studies, techniques, etc.)

Panel idea: Experiences with integration of old school organizations with new social media (more specific than previous: talk about organizational difficulties and how to solve, how to win over the old regime, how to deal with people protecting their turf, etc)

Where does social media belong in the organization?

I'm looking forward to checking out the first SMASH summit for great discussion on these topics and more!

I saw this great post by Steve Blank: Make No Little Plans - Defining the Scalable Startup the other day and tweeted out a quote that I thought was very important to me:

A lot of entrepreneurs think that their startup is the next big thing when in reality they’re just building a small business.

His post talks about the fact that many entrepreneurs that create web businesses want to be big, but in fact only create something that is small. There is nothing wrong with this; the world needs lots of small businesses, and even those on the internet. The post also offers some hints and tips as to how to create something that grows large.

When I tweeted, the tweet also showed up on my newsfeed where some of my Facebook friends commented. I thought that the comments there were a nice addition to my previous post, The Rise of Small Business on the Net, and thought I'd post them here:

Me: "A lot of entrepreneurs think their startup is next big thing when in reality they’re just building a small business." http://ds.ly/8PXB19

Friend 1: Depends what you call small. A lot of room between a hardware store and Google. :)

Me: a small biz is one that makes a decent amount of revenue for its employees and is a nice sustainable business, but not much more than that. there is not hyper growth but just nice, recurring revenue. there can be a big spread of revenue that could qualify for this, like from a few 100Ks to even low millions.

The issue is that it is unfortunately a dangerous place for angel investors to be, because the biz is too small to be acquired at a large multiple of its value, or even to be noticed by the big guys. We can't easily get our return on investment from companies like these.

However, that is not to say that these biz shouldn't exist. I think it's a healthy evolution from the storefronts we see on our streets to the virtual storefronts of the internet. not all biz need to go IPO or make a billion bucks from an acquisition for them to have a reason to exist.

Friend 2: Do angels build in other means of acheiving ROI? For instance share of revenue+ebitda over time after a certain agreed to time horizon?

Me: not traditionally, but i have been thinking about applying something like this to startup investing. it's almost like investing in a restaurant or some other kind of cash business.

however, another problem exists where the entrepreneur is batting for the moon and of course they always think their idea will be the next google, even when we can see ... See Morethat it will only grow so big. thus, they are unwilling to accept terms that are not the usual startup investing type terms for investing.

i do think about this every day though, and hope that a solution does present itself. or we just suck it up and try to only pick the ones we think have the best chance for being google-like, or near-google-like, and we just write off the others that we can't get our money out of, even if they are nice small businesses.

Friend 3: For some reason I think there must be a sweet spot for investors that focus on smaller tech businesses or even projects. I'm thinking about investments in tech analogous to those made by restaurateurs, real estate developers, etc. Where capital requirements are low and return is performance based not exit based.

Me: I call this the Rise of Small Business on the Net http://ds.ly/7X5JM5 and think that there is something here, but just not quite clear yet. in the old days, banks would be the lenders to such businesses, but banks are way too conservative to invest in internet businesses, and with the economy the way it is, they are even less so.

While Steve's post (and many others) focus on encouraging the entrepreneur to think bigger (even I ask about the world domination plan and more on why), I have not heard much about the plight of investors who end up involved in a startup which becomes more like a small business than the scalable, world dominating startup we all would love to find. Steve does mention those who are OK with flipping startups, but some are simply too small to even flip.

I'd love to hear more about this from others who are thinking about this.

Dave McClure posed to Jeffrey Veen and me an interesting question over Twitter which was:

WHY aren't there more consumer internet VCs w/ graphic design skills?

This is something I've been thinking about for quite a while now. When I started angel investing and advising startups, I discovered that pretty much I was the only design guy out there angel investing, or at least that I could find. By that, I mean someone who worked in design in the industry, then switched careers and became an investor full time. For me, I felt that it was a specialty that would make unique in that I could help startups in the area of design and user experience.

However, I had always thought about why there weren't other design folks out there doing angel investing. Here are the reasons I came up with below. Note that I lump together the design disciplines of visual design, interaction design, and user/usability researchers.

1. There just aren't that many designers out there, relative to other disciplines. Anybody who has tried to hire designers knows that it is super hard, harder than hiring engineers which is already hard. Think about how many students graduate with design degrees; the number is incredibly low compared to the number of computer science graduates coming from engineering schools. This makes the probability of finding designers who become investors very, very low.

2. Now, take the very low number of designers out there, and meld that with the probability of experiencing a windfall of cash. This windfall of cash can be from any source, like a large inheritance, or winning lotto, or being an early person at a startup who had a mega-exit. Any of these cases (and others) is of extremely low probability. So again, low number of designers melded with low probability of windfall of cash to enable angel investing results in a super low possibility of this happening at all.

3. Of the people we meet in general with a lot of cash, who really wants to angel invest? I have queried some of my affluent friends and they're just not into it. Some of them don't want to, some don't feel the least bit qualified to do it, some know nothing about it and aren't interested in it. If this is true, then if we take the low number of designers who also have enough spare cash to angel invest, those who feel like investing in startups results in another very low number.

4. Knowing a bit how the venture fund industry works, I've been told that it's super hard to join up with a fund. It's not like applying for a regular job. Commitment at a fund can be a number of years, ranging from 5 to 10. Thus, adding someone to a fund's staff takes a lot of deliberation as it is not good for someone to leave a fund's team in the middle of a fund's life. A fund's pool of money is often raised on the fact that there is trust in a team to invest their money properly. If that team is disrupted, it could cause investors in the fund to pull out. Pulling from a limited pool of possible candidates, and the very low probability that any of them have any sort of design background results in just about nobody joining up with funds who are also designers.

5. If you look at who are typical venture fund partners, they are most likely ex-business people or ex-entrepreneurs. These seem to be the favorite candidates for becoming investors as they have experience in managing investments or acquisitions, or have worked in a startup and have some knowledge in startups and how to spot other good entrepreneurs. Designers are more likely to NOT have experienced these conditions and generally are not specifically looked for when a venture fund is recruiting for partners.

6. As one path to gaining successful experience as an entrepreneur, resulting in a potential windfall of cash to enable them to angel invest, designers might become a founder of a startup and grow it to an exit. However, most designers in pre-2002 days, were hired in later stages of a startup's life, thus limiting their potential return as their stock allocation and strike price are not as attractive as if they came into a startup much earlier. Therefore, even during the dotcom boom years, designers may have been able to reap in a lot of cash, but probably not enough cash to freely angel invest in post-2002 years.

If we expand the list to include design agencies, then there are design companies who invest. For example, Method Design did have an investment operation, and fuseproject is currently making small investments into some of the startups they encounter.

Still, individuals remain almost non-existent.

While all that may be true up to today, I also think that this may change in future years. For example, starting an internet company is a lot easier today than it was in years past. There is a lot more literature about entrepreneurism and general acceptance that entrepreneurism is an OK career choice. Also, it is possible to build something and not be a coder, which most designers are not. There are many inexpensive avenues to getting something built, and use of open source code and other hosted services make creating web businesses much easier.

Also, it is my belief that with the number of me-too products being so high, and the ease that one can create copycat products, design is finally becoming a true competitive advantage as core services are pretty much the same, but it is the user experience and design of the product that allows a me-too product to win over its competitors.

So going forward, we may see a bunch of designers who are part of startups from a very early stage, and thus can have enough equity to get them a substantial cash windfall upon exit, which can then result in enough spare cash to start angel investing. Over a period of time, if they get good at angel investing, then they may get noticed enough to raise their own funds, or join up with a venture fund.

When I first tried to raise a small fund back in 2006, I heard about venture fund odds on investments which was that for every 10 investments a fund made, about half would fail, 2-3 would return a little bit, and then there would be the 1 that would return everything that was lost on the failed startups and then some.

It seemed to make sense and also drove the original reason why I thought I should invest more often than not. If I put more bets out there, then theoretically I should have more chances to make my money back...right?

To date, I've made 16 investments and two exits. I invested more broadly than most angels, except for the super angels. But looking at the internet industry, the sad state of the economy, and the way early stage angel investing has progressed for me over the last 3 years, I have come to the conclusion that the one in ten odds for this biz doesn't apply to us; for us angels, it's more like one in 20, or 30, or even worse.

Why do I think this:

1. The economy sucks. Probability of exits is much much lower.

2. The economy sucks. Making money is harder. Paying consumers are harder to come by. Businesses are already slow in committing to pay for a service.

3. The internet is too crowded. Me-too products are all over the place, creating blur in consumers' minds, and making it harder to attract customers.

4. The internet is too crowded. Truly unique products and services are super hard to find now, so gaining a competitive advantage is tougher.

5. Too many small business opportunities on the internet. The probability of starting a great small business is a lot more likely. But finding a suitor with a small business is tough because it may not generate enough revenue to be attractive enough to be acquired.

6. Angel investors typically invest in the earliest, most risky time for startups. Venture funds (except for the early stage funds) usually invest after the very earliest money in. Once startups get to a size that is attractive to a venture fund, a lot of risk is taken out already; we don't have that luxury. We typically go in when there is just an idea, and maybe a prototype built, and occasionally a business up and running. We don't know if the startup will fail in a few months or not; there is no history that we can look at. With that kind of risk profile for our typical investment, it would make sense that their would be more failures in our portfolio than for a venture fund portfolio.

7. Those that survive have a high probability of needing additional rounds of funding for growth. If we can follow on invest, that helps a lot. But most of us can't do that. We may have enough capital to put one round of investment, but most likely can't invest more money in a subsequent round. Thus, dilution will limit our investment unless we get lucky and find a startup that does not require further rounds. The more investment rounds after the initial round, the more we get diluted.

So all this means that it's super hard to find that Google super-investment that makes back all that we lost and then some.

Solutions?

Ron Conway combats this by going super wide and doing more investments than we could ever hope to do. This increases the probability of finding a Google in his portfolio.

We could try to find more startups that are capital efficient, and that make money from beginning. Those that do not require a lot of cash to scale means they may not need another round. If they make money, then this also reduces the probability of needing more rounds of investment. Of course, companies like this are incredibly hard to find. Nor can we accurately predict what amount of money they will need later.

If we could follow on, this would help a lot. How about playing Lotto and winning a bucket of cash to play with?

Now, if more venture funds played in the early stage space, combining broad, early stage investment with follow on investments into the winners, this would seem to be a perfect combination. However, in thinking how many venture funds operate, it seems like there are problems with making this approach a success.

Any other possible solutions?

An interesting observation I've seen amongst early stage internet startups is that more and more of them are requiring closer to two years to get to breakeven. This is because of many factors, one big one being the fact that there are too many me-too products and that distribution is the number one problem facing entrepreneurs today. But also, many startups end up in someplace different than where they started. They may find that their initial theses is wrong and need to twist/turn/adapt into some other product to be successful. This also takes time.

I talked with an early stage VC and she mentioned that she had seen the same thing, which was a large percentage of them coming back for bridge rounds after working for about a year. We talked about the fact that they always seem to raise money for about a year or runway, but yet most of them just need a few months more to get to breakeven.

Even in my own startups, there are a number of them that "just need a bit more time." If only they had a bit more runway, if only they had a bit more cash, if only they could raise more....we are seeing that startups with mediocre metrics aren't finding it easy to raise cash so they are dead in the water, and soon to die in totality.

I talked with another investor about whether or not we should get more of our startups to raise more cash at the beginning. He actually was less of the opinion that we should demand startups find a way to last 2 years from the get-go. It was an interesting conversation and I think the difference in perspectives comes from the fact that I'm an angel investor with limited resources, and that this investor had far more resources to bring to bear on successful versus mediocre or dying startups. Also, given that this was my own money I'm investing, it was far more important to me than investing someone else's money. Strategically, it makes sense for them not to care as much. We already know startups will die; it's a ruthless culling process that startups experience. A professional investor can just move on and invest in the next big one, or invest in the winners in his portfolio. But given that my personal money is at stake, I care more about startups lasting long enough to make something with their businesses.

I've been tooting the "last 2 years" horn ever since the economy tanked. But universally I have been ignored. Remember that there are two levers to apply here: one is how much money to raise, the second is the burn. However, I never see anybody produce a 2 year plan ever. A host of reasons why not:

1. Entrepreneurs are unwilling to reduce their burn. There are a number of reasons for this, ranging from families that need support to those unwilling to reduce their lifestyles, to inability to hire people at low salaries.

2. Entrepreneurs are unwilling to go out and raise more. Yes, begging for money sucks and takes too much time and is not fun. Entrepreneurs just want to get back to work building.

3. Entrepreneurs are unwilling to take the dilution. They already have sold part of the company and don't want to sell more.

4. An investor assures an entrepreneur that they will give them more money if they need it. Entrepreneur decides to trust investor.

Great reasons all, but the reality is that a huge majority of startups are all taking 2 years to get to a good place. The marketplace for products and for investment is not like it was 2-3 years ago before the economy tanked. In previous years, you could go raise money on no revenue but a ton of users. Now it's near impossible. Second chances are hard to come by. Raising money on mediocre metrics is near impossible.

One last appeal: Entrepreneurs, do what you can to last 2 years. Expect it. Raise enough money and/or adjust burn assuming no revenue. It's become unfortunately the norm.

This last Thursday betaworks had our annual Betaday, where we gather our entrepreneurs, investors, and other luminaries and prominent folks from the industry to meet and greet and have lively discussion on issues facing us today.

It was held at the Hiro Ballroom at the Maritime Hotel. Swank mood lighting and hipster chill bar decor was found everywhere:

..as was the latest footwear fashions:

Before the festivities:

John Borthwick giving the opening remarks to full house:

Gary Vaynerchuk on how social distribution is changing media:

Is the Web page dead?

The death and rebirth of search:

Stowe Boyd moderating niche membership and birth of mass amplification:

A lively discussion on crowdsourcing:

Another fun packed, informative day with betaworks!

Just recently, someone asked me what it meant to "lead an investment round". This was my reply:

1. The lead is generally the one with most to lose, or the most money in. It's not always like this, but usually. Sometimes it ends up being the person who cares the most about the terms.

2. The lead negotiates the terms for the round.

3. The lead may or may not share the negotiation with the other investors. It depends on the situation. For example, a venture fund may not include angels' opinions in negotiating. OTOH I've invested with one fund where they did include all us angels in the negotiation.

4. The lead is committed to the round and will most likely put in money first. Other investors will typically follow the lead's move to sign the docs and transfer money into the startup's account. So it's a tremendous vote of confidence for investors who may be conservative or shaky.

5. The lead generally pays the lawyer fees associated with the negotiation unless it's specifically called out in the terms that the startup will pay all the lawyer fees (ie. negotiation + financing). The lawyer fees typically aren't shared amongst others like angels. There are exceptions like two big VCs may share some costs if they are working on the negotiation together from the investor side.

6. There is liability associated with being the official lead. For example, there have been rare cases where other investors have sued the lead investor where they may feel the terms weren't negotiated well and there is some bad financial result because of it. So you should be aware of this and be concerned about it if you lead.

7. The lead generally sits on the board of directors since being on the Board of Directors since it allows them to watch their money most closely, and having the most to lose they usually want to do this. Not all financings have investor representation on the board, especially at early stage. Once you get professional investors involved it will most certainly be the case.

8. Only experienced people should lead. Someone who has done this many times is much better than someone who hasn't. Experience gives you an edge in what to negotiate for and what to give on, and what really doesn't matter. Otherwise you may not know what you're doing. Even someone with a lawyer backing them up may not be enough; a lawyer will always argue for you first and so you have to know when that is appropriate and when it is not, meaning how investor friendly or company friendly do you want the terms to be and how to get there.

In the last few months, there have been a number of people whom I've tried to talk out of being entrepreneurs. I tell them it's really a test to see if, after hearing about how hard it is, whether or not they actually still want to do it.

There are many who are newcomers to entrepreneurism. I think this is great. But I think most of the newcomers underestimate what it takes to start a company and make it successful.

So I let it all out. I tell them how it requires some serious soul searching about what kind of person they are. You have to be natural risk taker. You must be willing to throw all caution to the wind, because you never know what's going to happen. You must be willing to throw away all levels of comfort in hopes of some huge gain later on. Are you OK with leaving your current job and its consistent pay, health insurance, and sense of direction in your life for a lot lower pay and the chaos that accompanies typical startups?

I talk about the time commitment. I talk about my early Yahoo days when there were just a bunch of us, and we worked our tail off for years. I talk about the long hours we spent building Yahoo back in the day, the stress, the do-everything-yourself mentality and the chaos of not knowing what's coming next. I tell them about the fact that relationships have broken up due to training for Ironman, which even at its peak, doesn't equate to time commitment spent at a startup and for a longer period of time. I go through the inevitable ups and downs that come with relationships and families of entrepreneurs; it's not an easy place to be when your work and family demands collide.

I make them take a hard look at themselves, and I also gauge their reaction to what I say. I can see it in their eyes and in their replies if they are unwilling to give it up. My intuition is running high in sensitivity as I sense whether or not they have what it takes to go the extra distance to be a successful entrepreneur.

Don't get me wrong; I am not judging what's good or bad, but only what's appropriate. I am not making a judgement call on whether you're a good or bad person if you have or do not have what it takes to be an entrepreneur. For some people, it's just not the right path to take. Yes it's disappointing, but I think we need to be realistic that entrepreneurism isn't for everyone. Or perhaps your life stage is now not the right time for a startup - for example, having a family and/or dependents, and/or a lifestyle which requires steady income may not make it appropriate for you to jump into a startup.

This is really important. We investors are betting on you to take our money and build something big with it. We are looking for those who are willing to do anything it takes to make something successful so that we all win, and that means sometimes driving yourself into the dirt and dealing with the stress of knowing that your bank account is about to run out and that if you don't do something fast/creative/better, you'll not be able to feed yourself or have a roof over your head anymore. This kind of passion/adaptability/drive for building a great company is what we're looking for.

If you're going to quit as soon as the risk is too high for your own personal livelihood, then it's best that we just don't start. It's not positive for either of us. Find an occupation that allows you to live the life you want, at the stage you're at now and be happy about that. Don't try to start a company on the assumption that you're going to just have the same kind of life you did when you worked at a bigger company.

One of the big problems I've seen over the last 3 years of angel investing and with entrepreneurs is that they will raise money and then compensation goes to near market levels for the people in the startup. They think that they can be in a startup and have their old lifestyle not be threatened. The reality is that startups are not a place where lifestyle can be guaranteed. This ranges from the "working lean and mean" philosophy (how can you pay yourselves market rates and still be lean?) to execution speed (you can't work at speeds seen in large organizations; you'll get crushed by other startups) to just the simple fact that the risk of failure is tremendous (you don't get the comfort of stability in a startup that you would get at a larger more established company; that's the price you pay for constant salary versus the chaos of a startup).

So if you pass my test, which is, after my whole tirade about the risks of startups and the downsides of what it's like to be an entrepreneur, you are still fired up about being one, then more power to you. Let's take this conversation further. But I am getting better at spotting hesitation, fear, and reluctance after hearing my speech. So let's not kid ourselves in being somebody we're not.

It's sexy being an entrepreneur. The rewards are great. The upsides are what everyone sees, and nobody sees the downsides. Dealing with the downsides is where the rubber meets the road and where you'll be tested sorely on whether or not you are a great entrepreneur. But if you're not entrepreneur material, you're not and that's that, whether it's your personality, life stage, or otherwise. You're not a bad person; it's just not for you and we should all just realize this, and not fool ourselves into thinking otherwise.

I was just talking to a new entrepreneur about a term sheet and I realized that trying to understand all those dang terms on a term sheet was super tough because of all the legalese there, and also it's hard to know the implications of terms if you haven't experienced them first hand. It took me 2+ years of investing to get to some basic understanding of the terms and I'm still not even close to being an expert at it.

Searching on Google, I found some excellent posts from Brad Feld that explains some of the basic terms in a more easily understood way. Here are links to them:

Information and Registration Rights
Anti-Dilution
Redemption Rights
Liquidation Preference
Drag Along Rights
Protective Provisions

A few years back I worked on a tiny startup that was attempting to jump on the affiliate marketing/blogging bandwagon. It was all the rage that people were making $100Ks per year just writing articles and doing a good job on driving traffic and purchases to marketers. It was a site about how geeks were cool because they were buying cool products, and so we would write about these really cool products and then drive affiliate traffic to places where you could buy them.

Our venture didn't get that far, but so many others' did. And the list is growing.

As everyone working on projects on the Net knows, the cost of building a business has dropped dramatically over the years. It started with blogging software which would could install on our own servers or use the hosted versions. Now, you can go out and find shareware for just about anything; stuff that would have cost a big company millions of dollars and a team of 100 to build in the past could now be found and deployed for a tiny fraction of that cost.

It's also easier to deploy web applications now. Previously you had to be a computer scientist to do so; now just about anyone can figure out how to deploy it, or using hosted versions just fill out a signup form and point your domain at it and you're off and running.

So now, just about anyone can throw up a website which has some advanced functionality. And people are doing it too. In the startup world, we see the internet has gotten super crowded over the last few years. Very few truly unique business/product ideas have emerged, and many are just clones of each other. Or once someone puts up a good idea, the clones emerge quickly because it's so easy and fast to put up a website. Thus, it's now less about the idea but rather how many customers you can grab and whether you can monetize that traffic to balance out your burn.

Thankfully, the internet crowd is enormous. Grabbing a small slice of that traffic and monetizing it effectively can mean a sustainable business that pays its employees a decent salary. In the past, we called these businesses microbusinesses or lifestyle businesses where a single person could make a decent living managing a website. However, in today's world, I call this phenomenon the rise of small business on the net.

Many startups we encounter have plans that we know can reach this stage. With great execution and effort, we can easily see many businesses growing to great small businesses. They will have revenue from several $100Ks a year to small millions. They have a small teams and all of them are well compensated for their work. All the employees will have great lives supported by this business.

The effort is comparable to opening up a storefront on your favorite street. In the old days, you'd go find a great physical location with lots of foot traffic. You go get a small business loan from your local bank and open up shop. Then you go and acquire customers and build your business from there. In today's world, you can do it on the internet without a physical location and tap into customers from around the globe.

From an investor's standpoint, we're finding that this creates a number of problems. Our model is dependent on finding those startups which will go big, much bigger than small business size, and find a way to return our investment with large gain through some mechanism like M&A or IPO. However, the ease at which startups can reach small business stage makes our job harder; we're seeing many businesses reach a certain level of growth and then breaking through that level is tough due to how easy it is for competitors to enter your market, and how hard it is to acquire the attention of users.

Some of us are thinking about change in the way we support some startups. I find parallels in the area of restaurant investing, where the investment is all about cash return and not ownership. What kind of restaurant would go IPO? Highly unlikely. But could we make 10-20% on our investment? Infinitely possible.

I wonder about how the structure of deals we do for internet startups might mimic restaurant investing. Instead of caring so much about ownership, perhaps we should find a way to get a healthy return on capital invested through cash flow, if the startup monetizes efficiently and does it well.

The problem with traditional investing in startups here is that these small businesses may never attract an acquirer and certainly the chance of an IPO is even more remote. Driving these small businesses to activities to return an investors' capital in that manner may take a healthy sustainable operation and turn it into something unsustainable and problematic as it reinvents itself to attract an M&A event or IPO. That seems dumb; the business is thriving and its employees well paid and happy - why destroy this?

I think the world of investing should think more about the rise of small business on the net. Many more businesses each day are showing up that are great sustainable operations supporting employees and their customers. They are never going to be superstar Googlesque success stories and we should not attempt to turn them into one. In today's crappy economy, the world needs more small businesses to show up to employ the masses and make them money. We as investors should find a way to invest in and help these companies to grow, and just be comfortable in the fact that they will never be Google but still can help us make a healthy return on our money.

I was just reading 10 Huge Successes Built On Second Ideas and it motivated me to write this post, as I've been thinking a lot about the fact that entrepreneurs often end up in a place very different from where they started. It's gonna be a bit random, but here's what I've been thinking about:

1. How we pick startups to fund.

Time and time again I hear seasoned investors talk about betting on smart people because smart people will adapt and twist and turn to make their journey worthwhile. It is less about what they're building, although that is what brought them to the investor in the first place. Rather, the bet is that the person is good enough to figure something big out of whatever it is they pitched you.

I guess it's just me, but I place more emphasis on the idea than others, as there are many smart people working on stuff that doesn't have a chance, and is almost certain to require...a second chance.

The problem I see is that money only goes so far, and second chances don't come by easily. Most people don't raise enough money to allow them to twist and turn later; they only have enough to get them to barely a market trial of their initial idea. That's why I push entrepreneurs to raise at least 2 years of capital now, while their attraction is hot. Trying to raise more money later on mediocre to poor metrics is next to impossible in today's market. Otherwise, the entrepreneur will have to (usually painfully) adjust burn to last them further into the future or...just die.

2. Helping startups change/enhance what they're doing now.

I was talking to a venture capitalist the other day who said that you had to bet on entrepreneurs who knew what to do whatever the situation, and that if you had to help them then this was a sign of trouble. I find this to be somewhat not true, as I've built my business on sitting with entrepreneurs and helping them shape their products. I've found out that even smart entrepreneurs appreciate you throwing them ideas and opportunities that they can use, especially when they are in a bind. Finding smart people is fine, but everyone needs help once in a while and it's the smart ones that know they need help and accept it.

It's happened a few times now, where startups are now figuring out what to do next. One has changed completely, and others are in the process of reinventing/rethinking what they started working on because it hasn't worked out as well as they thought it would. I find the more I insert myself in this process, whether I ply coach-like skills to help give them some process in reinvention, or I'm throwing a constant stream of ideas at them until something sticks, the faster they will get on a new and potentially better path before their money runs out.

3. Raising money is a tough process for second chances.

This is tough for a variety of reasons.

a. Dealing with existing investors can be difficult. Already you have some invested in your company. But yet, now you're out there raising more money to continue - if your metrics are mediocre, then this could mean a sideways or down round to keep working on your current idea, and you must take into account the fact that your investors already own a piece of your company, and now more money is coming in and ownership and control issues arise. They best condition would have been if they invested into a note without a cap, which I would never do, because then you have total control over what happens to them.

b. Raising money on mediocre metrics is next to impossible. If you've gotten to a point a year in and your growth is not so great with little or no revenue, it's next to impossible to get another set of investors to bet on your idea in today's economic climate. They often assume that your idea and/or team isn't right.

c. If you're working on a totally new idea that may be great, but you and new investors still have to account for the fact that there are existing investors already, and what kinds of ownership and control issues exist and how they will change. Potentially it could also mean some questions will arise as to why your previous idea tanked and if whatever those reasons were make you look bad, then it will be hard to raise more money.

4. Mentally it's hard.

Yeah it's tough as hell. You're all gung-ho on your initial idea, you've got your investors and everyone around you excited about where you started and now you gotta change. That sucks! And you often beat your head on the table trying to figure out how and where to go next.

As many smart people I've met, they have often shown that they are often not equipped to continue on these projects in the face of adversity. This is both situational and internal.

Situational means that they may have real life needs for capital, like a family to support. I say situational because dependent on their life stage, the situational needs may be completely different like, for example, during when the time they were just coming out of college.

Internal refers to elements of one's psyche to enable them to deal with the harsh realities of entrepreneurism and what it often takes to build a business. So being smart is one great metric, but it's not enough by itself. You need to be creative, adaptable, able to withstand change and adversity and find solutions in chaos. Many people can't do this. Over the last few years, I've noticed that many people think they can just start a company and it'll be an easy ride to Google style riches. Time and time again it's proven wrong to me, having been through it at Yahoo and watching countless startups now.

All I can say is second chances (or twisting/turning/adapting from their initial idea) are tough. I am one for doing a little upfront planning for having enough time to twist/turn/adapt as far as second or maybe even a third chance, since it happens very often. Raise enough money early in the process and create a plan to go for 2 years, assuming no revenue or progress. Be prepared for it mentally, celebrate when your initial plan pans out, and buckle down the hatches when you have to shift.

In the last few meetings with entrepreneurs, I've noticed I've been consistently asking about whether they have a world domination plan. But I think my request is being misinterpreted; of course, I have not helped since I haven't clarified what I'm looking for either.

I am reminded of when I ran User Experience at Yahoo and when we interviewed people, we would give them a test. This usually was an hour to create a new design for Yahoo Profiles. We would give them some paper, pencils or pens, and then leave them alone for an hour. After an hour, we'd come back and see what they came up with.

It's pretty amazing the variance of output that we'd see. Some people would have maybe one piece of paper done. Others would have a whole tornado of paper and sketches on them and on the white boards on the walls. The way people "fail" this test if they came up with just one answer and were adamant about that being the only perfect answer. That's not the point; the point is that it's pretty impossible to come up with a fantastic solution in one hour. We gave them the test to illustrate their design process. If they had a great process and could walk us through their thinking, then we knew they could get a fantastic solution if given enough time. Those with a poor process would typically come up with just one answer and settle on that, thinking it was final.

This is the same for when I ask for the world domination plan. It would be nice to get "the answer" but I think it's pretty unrealistic given the twists and turns that startups go through. Some give me "the answer", which is fine if it's in the context of something they're thinking about. Sometimes, though, there is a certainty in their belief that is scary to me; it almost shows an inflexibility in their thinking that they are shooting for this solution and you sense that they're going to bulldog their way to this answer even if it is the wrong answer.

It's also pretty amazing to see how many entrepreneurs don't even think about it. I ask them and there is a blank look on their faces. This is a problem. While that doesn't mean a decent business couldn't be built out of their idea, it could mean that it only grows to a certain point and then...that's it. Great for the employees of the company who get paid every day, great for the founders who work at the company and own lots of it and also get paid, but not so great for us investors whose money is locked in the equity of the company.

As an investor, I would much prefer that you have the frame of mind that you WILL take over the world in whatever area you're operating in and you're always thinking about how that would happen. I don't want to see a blank face like it was a new concept. I just want to hear that you are thinking about it either all the time or at least it's floating in the back of your brain most of the time.

Because it's then that us investors know that we have the best chance of getting our money back and hopefully making some on top of it. Smaller companies can be great companies, but many reach some midpoint where they may not be acquired because their potential seems limited and acquirers are also looking for big opportunities. Thus, our exit potential is also limited. When you're on a trajectory through luck and planning to world domination, then your options are much greater because everyone chases you and wants your world dominating characteristics added to their own. You could even go IPO - but not if you're not big enough.

World dominating companies are the ones we want to be involved in and it starts with the right mindset. Remember it's not "the answer" that I'm looking for, but rather that right frame of mind and that you're noodling on it day and night as you're building your company.

A while back I wrote about "me-too" products and that one of the biggest issues facing early stage internet startups is the lack of distribution to get their product out there. After going to Ycombinator yesterday, I, again, felt that similar feeling when I wrote my post many weeks ago.

I thought that some of these were really great, but most of them were much-improved twists on what was already out there. In this crowded world where people already have multiple ways of doing things, I thought it was a damn shame that many of these startups would fail not because they weren't better, but just because they could not get enough customer exposure before their bank accounts ran out.

Just the other day, I had lunch with a buddy of mine at a small publishing company and the topic of distribution came up again. We talked about how valuable the traffic they had on their site was to all these little startups who had none at all. From this conversation, an idea emerged.

Here's the idea, and it's one that is best executed by people who have traffic, like a Yahoo or a Google, or even a NYTimes.

Any of these companies and their like all have done venture investing. But it's been very much like a investor-startup relationship, which is we give you money and you go out to make something big out of it. To me, I think this should change. I think there should be a way to give both money and distribution. To an emerging startup, a firehose of traffic could be worth its weight in gold, in addition to the money.

Suppose at the bottom of every page, which is not worth very much to advertisers since they want to be at the top of the page, there was a row of links which was labeled, "New things to try:", or "Cool startups:", or even something more explicit like "Check out our new ventures:". Then for each startup you invest in, part of the deal is to gain a place in that row of links. You could have permanent placement, or rotating placement if there are more startups than link slots.

Then just let them run. I think you'd be surprised at the amount of traffic the bottom of the page can generate. Certainly, even 1000s of clicks per day driving to a new startup would be extremely valuable. At Yahoo, we did some exploration on placing links down there. At Yahoo traffic levels, they were driving a tremendous number of clicks to Yahoo products and services each day! But yet that space at the bottom of the page wasn't really being monetized otherwise, or of any use to users after the main content of the page had ended.

So why not give it to the startups you invest in?

Today, startups are in a fight for attention. The only way for most startups to get noticed, induce trial, and thus get true validation from the marketplace that they are better, is to point a firehose at them. SEO is too slow, SEM is expensive - what else is left - perhaps partnerships with companies who can give them exposure. But I think that while it is possible, it is a lot of effort to do a BD deal for distribution. As an investor, I would think that it would be easier to just give it them ourselves, right? If you can firehose your investments to show the world they exist, induce trial, really prove out their models, wouldn't that take a huge amount of risk out of your investments and increase the chance of a startup being successful? Of course it would also show whether or not you chose wisely or not....

So c'mon big media companies - work with your venture arms. Invest AND offer a firehose. These guys need it, and, aspirationally, we do want some of these products which ARE better than what we have out there now.

I believe the universe of internet businesses has become extremely crowded in the last few years. In the early days, you could come out easily with something new because there weren't that many competitors out there. Now, it's hard to find somebody who isn't working on something similar to what you're thinking about. So competition is fierce and many times you'll find entrenched competitors with a lot of product inertia and a great head start.

The other huge problem is on the consumer side. Consumers are deluged by new products and services all the time. They have overload and just keep to the products they know best, and need to have a really good reason to change and move from another service to a new entrant. We saw this first in the past with email addresses; Yahoo Mail users were hesitant to move because the cost of changing your email address was super high and thus user retention was very high. Now add what makes up our digital lives on services like flickr (all our pictures that we've uploaded for half a decade now), or facebook (our friends are all here, plus their interconnections), or linkedin (our business connections are all here, plus all their historical connections). The cost of moving has become so high because we've invested so much time and effort into those services and we don't want to redo that, let alone adding the cost of learning a new service.

As an early stage investor, I've found that this makes picking companies exponentially harder and it's a shame. I meet a lot of smart entrepreneurs with some really great ideas, but then I do some research online and find that there are others who are working on something similar or in a close enough space to be competitive. Then I start to get worried about their prospects.

You can find tons of books on the subject of competition and winning despite having entrenched competitors. In general, I have found that entrepreneurs are doing what they should be doing to attack a crowded market. These are things like (my thanks to Andrew Chen for helping me with this list):

1. Innovate on the product experience (ie. Posterous vs. Wordpress).

2. Business model changes, where you are going free (or freemium) for a product that's usually subscription (or fixed charge).

3. Changing the market where you're going long tail instead of hitting the larger market (ie. casual games versus hardcore games).

4. Change in distribution model, where you are delivering something as a service rather than a download, or bundled into an existing thing (ie. Facebook app) instead of a standalone thing.

5. Change in branding. An example is where you cater to an upscale prestige market or niche market instead of a mass brand, or vice versa like taking a niche product and making it available to the masses.

6. Create a business that is better, out of a larger part of another business (ie. Lefora created a message board hosting product for those who don't want all the bells and whistles of a full social networking product).

7. Innovate on design, which appeals to those who want a similar product but one that looks/feels better.

8. Offering more features on a product, or customization on product.

And the big, traditional way of taking a new entrant into a crowded market:

9. Mass advertising to gain broad awareness and induce trial and adoption of new product in face of existing competitors.

So I am not saying it's not possible to win against a crowded marketplace. My issue is with early stage startups: in order to win in a crowded marketplace, early stage startups often don't have enough resources to last long enough to compete effectively and win. While a lot of the above can be implemented, growth time is limited by whether or not you have enough capital and revenue to survive until you run out.

To me, if you're developing a me-too product, it's ultimately going to boil down to a marketing game more than in any other situation. You can develop the best product or service, but if nobody knows about it because they're busy using something else, then you're still dead.

So distribution for a me-too product is critical. In the past and present, large corporations could do this because they had lots of money to launch large advertising campaigns. They knew distribution channels and could insert their new product there. They had contacts in their market and it was straightforward to get word out that they had a new product even if it was similar to existing products.

As a new startup, you may not have those channels and contacts established, and certainly you don't have money to spend on advertising plastered on the Superbowl, magazines, online, and elsewhere.

However, once you finish your product using one or more of the strategies above, you need to jump to strategy number 9 as soon as possible and get it out to consumers. You don't have time to wait until people notice you; you need to get noticed.

Some possible ways of doing this:

1. Buy advertising. As an early stage startup, this is the least viable unless you somehow have enough money to do this. Lead gen advertising can be better than CPM based advertising as you'll be able to pay only on a referral, but still this costs money. Let's move onto cheaper alternatives.

2. Marketing that involves barter space. You trade something of value for advertising space on their side. Something of value can be advertising space on your site, or donation to their cause for charities.

3. Word of Mouth Marketing. Contact bloggers, magazines, users and get them to try and talk about your product. Getting in the NYTimes is a big traffic driver, as well as many other national circulation magazines. Online publications like C|Net and The Huffington Post can also be great. Twitter is also a great up and coming means for getting your word out.

4. Get distribution partners. Existing companies can add your product on their sites and can help you promote it. This is usually in deeper partnership such that it goes beyond just buying ad space. You look for exclusivity in contracts and features that your product has that enhance an existing company's product and prestige.

5. Viral marketing. This is a very hard avenue to execute, which is to start with a few users and then it blossoms outward to many. Determining how your product can be viral can be an elusive game and if you don't hit on it early, you could waste a lot of time tweaking and hoping that something you create will be virally popular and spread.

In working with a few startups, I am disheartened by the fact that the importance of distribution is still not well understood. The leading thought is that "if I build something great, then everyone will come find me." Unfortunately, that is rarely the case in this crowded marketplace, and most early stage companies don't have enough time to let people just wander around until they find out about the product.

They did not do enough work to go out and contact bloggers. They didn't go out and try to woo corporate partners to see if they would help them get their message out. They just waited for users to come and they didn't come in great enough quantity to support their business by the time their money ran out.

So don't let your product fail simply because you can't induce trial. Remember, you have developed a me-too product, one that users already have a solution for and switching costs and barriers may be too high for them to take action to look for a better solution. You need to get them to know that your solution exists, and attract them to try it out - and since you're an early stage startup, you need to do this ASAP to give yourself enough time to let consumer adoption grab hold and ultimately take off, all before your money runs out.

I love it when I hear entrepreneurs are working on a world domination plan.

I see a lot of entrepreneurs arrive with pitches that are limited in scope. They talk about how the world needs this function, how great it is, and how current products don't have these features. Usually, they really are great ideas. When we get to revenue, sometimes there is a plan and sometimes there isn't. But many of these revenue plans only seem to get to a few million a year at most. This may be a great small business, but for an investor, we need to ply our limited resources into those opportunities that will grow into huge businesses, and not just a million a year.

The need for a world domination plan is important to me. I want to invest in businesses that will grow into huge businesses, which will maximize my return on investment. I don't want to invest in businesses that will grow into small businesses, even if they are great small businesses. I only have time and resources to work on so many projects and need to maximize my efforts.

The plan needs to be believable to both me and the entrepreneur. It's not enough that I just believe it's possible; the entrepreneur must also believe the plan since he is executing it. If only I believe in the possibility, that's not good enough. To me, it's a form of personal deception; I see the idea, I see its potential, and it doesn't matter who works on it - it must build into a big business as I believe, right? It's not that simple even if I wish it was. I'm not the one executing the idea and doing all the ground work. The entrepreneur must believe in the idea and be able to do all that. If he does not believe in the idea and/or cannot execute it, it's going to fail.

Some people have enough resources to invest in experimental projects, meaning that there is no clear path to success at the beginning. I unfortunately don't have enough resources to deploy like that. Thus, I need to at least have some comfort that both the entrepreneur and I believe there is a world domination plan (and yes I know there is a great probability that this will change).

What is your world domination plan?

On Hacker News, someone posted that they could not find a good tutorial on becoming an angel investor. As I wrote in my previous post, "What I've Learned in Angel Investing, March 2009", there is practically no one to teach you or we're all too busy to hold your hand. So I thought I'd write a bit about starting out.

I thought about writing a whole tutorial, but I kind of backed off on that. I've only got about 2+ years of angel investing under my belt; hardly "expert" status on this topic! There are plenty of people who have been doing angel investing for decades and would be much more qualified to teach angel investing than me. However, I thought about what I could do to help budding angel investors start out and figured that I'd start by talking about whether or not you have the basic qualities for becoming a successful angel investor.

Don't Get Caught Up in the Glamour

Angel investing is glamorous. It's like sitting at the Monaco blackjack table that has a minimum of $10000 per bet. People look at you as if you're some rich celebrity. It's the same with angel investing. People think that you're going to make it rich as you go find the next Google and make a gazillion dollars. In fact, they think you are making a gazillion bucks even as they talk to you.

I would be the first to say that I get some attention for angel investing. But that's because they always hear about the great successes of venture capitalists and startups getting acquired or going public. They never hear about all the other startups that fail miserably, and taking investors' money with them down the tube.

So if you are thinking about becoming an angel investor because you think it's glamourous and you'll gain fame from it, I think that's fine but I can probably think of other less money-wasteful ways of gaining fame (for instance, join Twitter and challenge Ashton Kutcher to see who gets to 2MM followers first). Personally I would not become an angel investor because of this reason so don't get caught up in the glamour.

What is Your Reason for Angel Investing?

I think you need to think hard about why you'd want to angel invest. I would also suggest that you should have alternative reasons for angel investing beyond making money. That's because angel investing is probably one of the riskiest ways of making money and betting it all on this as an overall portfolio strategy.

So have other ways of gaining return from angel investing since there is a good chance you're going to lose all your money doing it. Feel good that you're getting something back from it even if the money doesn't.

My alternative returns from angel investing are:

1. I love hanging with smart entrepreneurs.
2. I love learning something new.
3. I love teaching and get joy from watching others learn.
4. I love being part of something growing.
5. I love the challenge of the process of startup and product building. I love the brainteaser aspect of trying to solve this problem.

You Need Money to Angel Invest

Angel investments range typically in the $25K-$100K range but can go lower or even much higher, upwards of $1MM. You can just do a few angel investments, or even one. But this substantially increases your risk of losing your money. To maximize your chance of making your money back and hopefully a bit more, you should consider that you need be able to make at least 10 investments to spread your risk.

Ideally you'd have a minimum of $25K x 10 = $250K to deploy. And the amount goes upwards from there depending on your target investment size.

Then, if you think about popular overall personal portfolio investment strategy, then you shouldn't have more than 2-3% in any one investment (ie. single stock) to mitigate risk. So is $250K (or whatever amount you are thinking about investing in total) only 2-3% of your overall personal holdings or less?

Remember, betting it all on angel investing is a dumb dumb dumb move.

Are You A Risk Taker?

In order to angel invest, you need to be comfortable with deploying huge sums of cash. You need to be able to do this decisively and without regret or anxiety.

If you are a conservative person, angel investing is not for you.

If you have anxiety about throwing large sums of money out there, this is not for you.

If you can't let go of your money emotionally, this is definitely not for you. You'll drive everyone crazy because you'll be so worried about losing your money and it WILL NOT BE A GOOD THING. Please PLEASE...just do us all a favor and don't angel invest.

Just Because You Like To Gamble, Doesn't Mean You Should Angel Invest

Angel investing is a lot like going to Vegas and gambling except for one important point. In Vegas gambling, the money is gone instantly; you have no recourse but to let go of the money at the moment it's gone. In angel investing, your money isn't instantly gone; if anything it can seem to drag out the loss process for an incredibly long and painful time.

Can you deal with that?

Do You Deal Well with Chaos and Uncertainty?

You might be a risk taker, but if you lose your head during times of great chaos or uncertainty, this is not good. Every startup goes through periods of high stress and low periods. As an investor, you'll probably be dragged along with those sentiments. I've lost my head once and blew up with entrepreneurs once, and learned my lesson that it just isn't productive. You gotta keep a cool head so that you can think clearly and strategize correctly.

Are You Disciplined?

Can you develop a plan and stick to it? Or are you tempted to toss your plan to the wind when something comes along so juicy you can't pass it up, even if it violates your plan?

I have found that sticking to your plan is crucial. It keeps you honest and focused. It also keeps you out of trouble. There is nothing wrong with altering your plan; that's not what I'm saying here. But once you figure out what is right for you, don't mess with it or else you'll get yourself in trouble.

Can You Exercise Tough Love?

As a parent, I often think about tough love with respect to my kid. The same applies to startups and entrepreneurs. When things are going south, somebody has to step up and say that you are heading south and something needs to be done. This can mean things like saying to the CEO that he needs to go, or closing down a startup because it's going nowhere. Anyone can say positive things during good times, but can you tell someone that something is really going bad and that they need to change/stop/leave?

Some of the hardest conversations I've had occurred beginning last year, when I began having talks about cutting burn due to money running out, and the lack of possibility of further funding. With the economy the way it is, I fully expect to see more tough conversations coming up.

An effective angel investor needs to be able to exercise tough love.

Are You Good at Saying NO?

Some people have this issue where they just can't bring themselves to say "NO". It's painful, it risks dealing with negativity coming from the other party, it's uncomfortable as you worry about hurting another person. It also feels bad being negative.

In angel investing, you MUST absolutely have the ability to say NO decisively and stick to it. Clarity is critical and wishy washiness sucks for everyone involved. If a deal is wrong for you, you just need to be able to say NO no matter how much an entrepreneur is begging, making you feel guilty or inadequate. Remember it's their job to sell you on investing in their company. Can you not fall for that and just say NO when you're supposed to?

Do You Have Great Intuition?

I run with intuition a lot. I listen to my gut and if something doesn't feel right, I just don't invest. I don't care what it is. If my gut just doesn't feel the least bit good about a deal, I just say NO. Intuition detects those things that are immediately obvious or things that are hidden. What is it about this deal that sets off the butterflies in my gut?

Intuition is that primal survival instinct that our ancestors and apes gave to us, but civilization just destroyed. We all know people with zip intuition; you know, the ones with seemingly no common sense whatsoever or always getting in trouble? Are you one of those people?

If you have a highly developed intuition, it will pay you in spades with angel investing.

Do You Have Something to Offer Startups?

I'm fond of talking about angel investing as a probability game. You always want to do a whole bunch of things that maximizes the chance that a given startup will succeed and return your investment with profit.

One of those is your money. That's easy.

The other is how you yourself can help. How can you help a startup you're investing in? Can you lend your experience to the entrepreneur? Your business contacts? Your ideas and creativity? Did you specialize in a particular area that you can teach? What else?

If you don't have anything to offer, then you should consider not angel investing, or at least not in the industry in which you have no experience to offer. Remember that you want to increase the chance of your investment's success always; why invest in something that has a lower chance of success? Why do people learn how to count cards to play blackjack, or at least learn blackjack strategy?

Are You Willing to Learn?

You should not be arrogant in thinking you know everything. I thought that by coming from Yahoo!, I could pick successful startups. And I was wrong. There will be a lot to learn, lot that you will not expect, skills that you will realize you do not have. To go into angel investing thinking that you know everything is only going to cloud your decision process. This is bad.

Following on the previous comment, you should be open to learning. If you are not receptive to finding out that others know more than you and learning from them, this is a big problem. You're going to think that with all your previous experience that you're going to be successful, and I guarantee you that you will miss the important finer points that will throw the odds in your favor and not against you.

Regarding Picking Companies

You have to be good at spotting opportunities. I have already said I have fooled myself in the beginning in thinking I was good at this, but then discovered there was much to learn beyond just the idea. Let's just say you have to be willing to learn and deploy intuition and objective measures for picking entrepreneurs and their ideas in order to be good enough at picking companies that you're not throwing money away.

Someday I may write more about what I've learned in picking companies. It's a tough subject with many moving parts. Suffice to say that if you somehow are good at this before you start, then it's a great quality to have. But if you don't have this quality or are unsure, then let's hope you learn because if you can't ever pick great startups, then you're toast no matter what. Go to Vegas and hang out with hot chicks at the $1000 Blackjack tables instead. At least you can hang with the hot chicks while throwing your money away.

Do You Have These Important Other External Factors?

Over these last 2+ years, I have found these external factors to increase the probability of success as an angel investor:

1. Your business contacts include those at companies which can result in strategically important partnerships or acquisitions.

Right now, one of the biggest problems that early stage internet startups face is access to customers, whether they are consumers or other businesses. If you know someone who can create a distribution deal for your startup, that would accelerate the growth of the startup, potentially past competitors who don't have those contacts.

Also, providing more opportunities for acquisitions is also strategically important. This can be as simple as just providing an exit for investors, but in times of economic crisis, it can become a survival lifeline for a business who is running out of money and options. Casting the net as wide as possible can only increase chances for a startup to be acquired.

2. You know and are trusted by other investors, either angels or venture funds, and can invest alongside others who will be helpful and advantageous to a startup.

Again, it's a probability increasing thing. The more helpful people involved, the better the chance of a great outcome. Thus, having experienced investor friends who will allow you to get into the deal is a very positive thing. If you're investing alongside not so helpful or experienced people, it just reduces the chance of success especially if you're in a tough situation, like running out of money and are looking for further investment or facing hostile competition or in need of strategic partnerships.

3. You have access to great dealflow.

This is always critical. If you don't have access to great deals, then why invest in only crappy deals? If you live in the middle of Montana and all the internet deal flow exists in Silicon Valley, how are you going to get included in those deals and/or pitched? There are probably a myriad of ways to access great deals: location, relationships, going to conferences and startup/entrepreneur gatherings - probably worthy of an entire post in itself. But this is a critical part of being a successful angel investor.

Last Important Attribute: LUCK

Are you lucky? Do good things fall in your lap out of the blue? Does opportunity knock for you more often than for other people?

As in all forms of gambling, being lucky gives you an edge over everybody and everything else.

If you are UNLUCKY, angel investing is DEFINITELY not for you.

Over the last 2+ years in angel investing, I learned a lot about myself while doing this. I also learned a lot from interacting with others and learning from them. Exhibiting these intrinsic qualities will enable you figure out if this occupation is right for you, and whether or not you'll be successful in it.

Endnote: Did I miss any essential qualities?

Paul Graham of YCombinator ran a great afternoon conference called Angelconf where he brought together a great afternoon of Silicon Valley angels to talk about how to become an angel. He then wrote a great blog post about it. I managed to watch a lot of it, although I was in NYC at the time and it was tough to watch the whole afternoon.

I was also impressed with Naval Ravikant's segment, which is posted on VentureHacks. Reading Naval and Nivi's post sparked some thoughts about angel investing in my mind, so I thought I'd talk about what I've learned, and my views on angel investing. One thing you'll notice is that many of the things I consider important are what others think are important, but there are definitely differences too. So angel investing can have individual differences between angels.

The Problem With Angel Investing Is...

There is no one to teach you. No one to hold your hand. At least until Paul Graham ran his Angelconf. Yes there are many blog posts out there, but there is no really good guide that leads through the topics in an orderly and easily learn-able manner. You get a lot of information piecemeal and you can't always tell what it's relevant to, or whether it's relevant to whatever deal you're working on now.

I paid my lawyer 1.5 hours of time to have him walk me through, explain, and let me ask him questions about term sheets. Even that was not enough. The ins and outs and subtleties of investing I had to learn on my own, and only by doing 10+ deals in the last 2 years.

Should You Be an Angel?

First thing is you need cash - $250k is minimum, which would put $25k into 10 companies. This gives you good diversification, and you get some good learning which would otherwise be missed by investing more sparingly. Investing regularly also gives you good market information. I now have a good picture into valuations for companies with and without revenue, as a reference for whether or not a deal is good or too expensive.

You can start out lower than $250k, but generally it is rare that entrepreneurs will let you put less than $10K into a company. You usually must have some sort of alternative attraction, like being a prominent business individual.

Starting out with more is always fine....but....the starting amount needs to not be your life savings! You're likely to lose it all in angel investing! If it's not your life savings, then mentally you'll also be better prepared, since if you can lose it all it matters trivially to your life.

Also do not invest with people who are investing what you think is a significant part of their life savings. There is a high probability that they will not be happy to lose it all and could cause no end of trouble to the entrepreneur.

What's your risk profile? If you're conservative, you shouldn't be doing this. Angel investing can be akin to playing the lottery or going to Vegas. Really.

Expect the ratio of 9 failures to one success. Naval thinks it's much worse, like 1 out of 20 or even 30. So you have to go wide to minimize your loss potential.

So it's hard to make angel investing profitable if it's just a hobby, ie. investing in a startup every once in a while, like one a year or less. Probability is far against it.

Do you have something useful to offer to your companies? If not, then your money is just dumb money and it is less likely you'll get included in great deals. Entrepreneurs look for people to be involved that can help them.

Discipline

Stick to your operating philosophy. Don't waver. For example, I don't do notes and have not since, or only under very strict conditions.

Intuition

If something doesn't feel right, don't invest. You may have a funny feeling about the entrepreneurs, the business potential, the deal terms, or something else. Trust your instincts.

Picking Companies is Hard

I thought that with all my Internet experience at Yahoo!, I could pick great startups. Boy, was I wrong.

Don't delude yourself in thinking you can pick a great deal every time. There are so many factors that exist in generating success. You can find total idiots who have made it big, and totally smart people failing miserably. Market conditions could also affect success rates simply because capital is not available or the market is not ready for a product like yours. Just because you think this deal is a great idea doesn't mean it's going to actually be one.

Also be wary of laying your own way of getting to success onto the idea but the entrepreneur has not bought into that. Don't fall into the trap of thinking this is great idea because you personally think it should be executed in some way but the entrepreneur is attacking it in a slightly different way. If he has not bought into it, it won't be done your way; it'll be done his way. But also remember that if you think of a great way to execute, it is possible that you are the only one who can execute it that way, meaning you have the business contacts, the experience, the thought leadership etc. The entrepreneur may not.

So if you love the idea and space, but hate the execution plan and think you have a better one AND can't convince the entrepreneur that you have a better plan, I would walk away.

Dealflow

I am lucky to be able to filter my dealflow by referrals.

Try to be friendly and useful to more experienced angels and VCs out there. They'll direct some great dealflow your way because they know you'll help load the odds of success in their favor.

I would caution you on investing in companies in industries you know nothing about.

I personally don't like to have an inbox full of proposals from strangers. I can't tell what is good and what is not. So build referral networks if you can.

Don't Be a Flake

Say you're going to do a deal or not. Don't be waffling in the middle. Nobody wants to invest with a flake who can't decide or is really just unwilling to part with his money but can't say so.

Branding Yourself

I started David Shen Ventures, LLC and it has become a slowly growing brand. People know me for being useful and many entrepreneurs appreciate, and can attest to, my usefulness.

People do think I'm bigger than I really am though. It's the risk of sticking the word "Ventures" on the end of your name. I'm just one guy, with an advising and investing operation and that's it.

Don't Refer Anything That You Would Not Invest in Yourself

This is brand building, which is to refer only great deals that you're personally going to invest in. No better validation can be given than if you vote with your own money. Don't get known for passing only junk that nobody else wants.

On the other hand, if for some reason you do want to help, be clear that you're not investing but think it's interesting. But don't do this often. Investors' inboxes are clogged enough with random deals that are coming from everywhere. Don't clog investors' inboxes further. So I would not do this very often at all.

Be Wary of How Many Deals You Can Handle at One Time

I went out very fast. It was fun, I learned a lot, but I also quickly throttled the process because advising too many companies at once was getting tough and I didn't want to short change anyone. I also started running short of available capital so be careful of putting too much money out there all at once.

In addition, I would be very disciplined in deploying the same amount of capital every time. Don't get caught up with the excitement of deals in the beginning and put more money in than what you planned. You'll run out of money faster, and also I guarantee that the probability of finding your google isn't any higher in the beginning than it is later on.

Pitches

I can't sign NDAs unless I get involved. I see too many pitches across many different internet industries and my business can't survive if I limit that.

The quality of referred pitches is much higher than randomly appearing pitches.

Be wary of being dazzled during a pitch, but be impressed at people who can be so dazzling. Always come back to earth after the meeting and take an objective look at the pitch when you're out of the mindcontrol ray that some great pitch people can point at you.

Let your intuition be your first guide, and then verify the rest: integrity/intelligence/energy of entrepreneurs, market idea, etc. If something feels wrong, don't invest.

Investing in More than One Company in Similar Business Areas

I generally try not to do this. I don't want to accidentally say something that one company is doing to another possible competitor. I also don't want to be accused of conflict of interest if I'm introducing one company to another for business development or M&A.

There are those who are willing to do this but I don't think it's a good idea for me.

Learning to Say No and Walk Away

You need to go into angel investing by having the courage and discipline to just get up and walk away. Every pitch will sound like a game changing next google opportunity for you. That's their job, to sell you the idea and get you to invest. Do not get mesmerized by that. Be objective in your decision and not emotional, and just say no. Don't be a flake and waver on telling someone yes or no.

By the way, it's easy to stress AFTER you say no. You feel regret that maybe you walked away from a great deal. In my experience, this is natural especially after a great attractive, sales pitch. Who can walk away from a hot woman who walks up to you, puts their hand on your rear end, and wants you to come home with her? Let me tell you; I have never regretted walking away from a deal. Remember your intuition - if it says no, it's saying so for a reason. Better to live to fight (invest) another day, then to get into a deal that may make you miserable later. Also, the probability of any early stage deal being successful is extremely low no matter how sexy the pitch is.

The Best Way to Say Yes

Don't just say yes. There are many first time entrepreneurs out there who think that when you say yes at the first meeting, they mean they have you. But that is not really true. It's only the first yes in a string of yes-es, which follow due diligence, checking references, checking the idea independently, or any other decision process items you may have. So make sure first time entrepreneurs understand that.

Do Not Skip Due Diligence

I ask my investments to give me a whole list of due diligence items. It's a good discipline to have and gives you a deep dive into the company. Luckily, early stage companies don't have much to dive into, but you can still see problems, like weird debt, or bad corporate structure. You may not want to invest if the entrepreneur is unwilling to clean problems internally.

Also be wary if the entrepreneur is unwilling to give this info to you freely and openly. This only sets the stage for how the relationship will be later on for other things.

I have walked away from deals in failing the due diligence process.

Trust

There has to be a large amount of trust no matter what all the business docs say. You have to see integrity in your entrepreneur and be able to trust that this person won't screw you later on, because business contracts still can't protect you 100%. Fundamentally, you need to trust the entrepreneur and he has to be trustworthy.

Be Wary of Business Guys With No Technical Partners

It's not that I don't think business only teams can make it big, it's just that in this day and age it's more expensive to run an internet business as just a business guy with an outsourced team, which results in increased burn and increased need of capital. And you have to ask why this person can't court another technical founder to help - is there something wrong here that you're missing?

Be Wary of Entrepreneurs Who are Building for Businesses They Have No Experience In

Most of the time the idea is great. But then I ask if they have any real world experience in the area they are building in and that's where I get them most of the time. I don't like it when people are theorizing about how a certain market is or isn't. They will most likely find problems that they have no experience tackling. It's better to find a company who has a veteran of the industry they are tackling so that they have at least have some first hand knowledge of what goes on in that industry.

I know that many would argue that entrepreneurs often need to adapt and dance back and forth a bit before they find their sweet spot. My only issue with this is that learning takes time and they may not have enough time to learn before their money runs out. This is especially relevant at the early stage where we angels often play.

Reputation is Everything

Totally agree here. Build your brand by being a good angel, useful and helpful to the entrepreneurs.

Learn the Terms, and Don't Just Trust the Entrepreneur to Treat You Right

I spent a lot of time and money, and doing a lot of deals before I could get a broader understanding of all the terms and legal speak of term sheets. It's tough to keep track of all that. It's also tough to understand the effects of all the terms in each situation. Experience helps you learn, and, unfortunately, making mistakes.

As I mentioned before, I asked my lawyer to help me understand the terms. But also get a good lawyer to review every term sheet for you and point out what is good and bad and explain why. I have found many angels to barely seem to care about the terms at all. They just "trust" the entrepreneur. I think this is bad. I think you should not fall into this kind of behavior and get a good lawyer to work with you on your angel investing.

If you can affect the terms to your favor, I would advise you to try no matter who is leading. I have also even been able to affect the terms AFTER the financing was over, so it never hurts to ask if you are the last one into a deal and you find something not to your liking.

Selecting a Good Lawyer

It's unfortunate but I have not met many lawyers who are experienced in the early stage. There are many who have done larger financings at later stages but not many who have done a lot at early stage. I can tell you definitely that there are differences. For example, there are terms that are just not appropriate at early stage but fine for later stage. You don't want to burden at seed financing negotiating over these kinds of terms, or waste money doing so.

Interview your lawyer for their experience in early stage financings. Get referrals from other angels.

Board Seats

In the companies I've observed, I think that taking a board seat should only be done if the person taking it can add value beyond that of just watching over the investors' money. I've seen some pretty ineffective board members and I've seen some that were amazing. The amazing part comes in when the company needs to be sold or needs business deals or needs additional funding. Board members with lots of industry experience and connections can make or break whether a company is going to die today or live on.

If you're just there to watch over the money, then i've heard horror stories of board members whose only mission was to protect the investors and not care what happens to the company.

How Much of the Company Should I Get After an Angel Investment?

Assuming you're not doing a note, I originally set my goal for getting about 1% of a company with a $50K investment. Before the current economic climate, I was seeing deals raising about $1MM on a $4MM pre-money valuation. This seemed like a reasonable benchmark at the time. But now times have changed a lot. The valuations have dropped quite a bit and now you can get more of the company for the same $50K. Still, I see many startups trying to raise money at pre-2008 valuations and I just pass on them because I know there are better deals around the corner. This where having a good finger on the pulse of seed financing can help greatly.

I Don't Do Notes

Sorry all, too many misadventures with notes, even those with caps. Read about my misadventures here. It's too risky and troublesome for me.

Assume You Lost the Money As Soon As You Invest It

Definitely you'll sleep better if you think this way. If you can't let go of your money, angel investing is truly not for you.

Matchmaking and Connections

Your job after you invest should be to go out and meet people who can help your startup. You should keep a rolodex of these connections and cultivate them, because you never know when any of your startups might need their help.

Don't be a passive investor and not help. You want to increase the odds of your startups' success, and not be dumb money.

Invest with Other Helpful Folks

When you have a group of well connected, motivated individuals you increase the chance that a company will succeed, as the other investors will apply their connections and expertise to the startup.

Never Invest By Yourself

Again, you can increase the odds of your startup's success by having a pool of helpful investors. If you invest by yourself, you only have yourself to help and the startup may need more than you can give. Incent others by including them in the deal. Forcing the entrepreneur to find other investors can also lend some more validation to the business idea.

Don't Invest in People You Don't Want to Hang Out With

Like Naval says, why would you want to give money to people you don't like or don't care about? Once you invest, you'll be involved for a long time. Remember that. You can't just walk away from an angel investment. There is no cash out and washing of your hands of a deal afterwards.

Make Sure the Company Raises Enough Money Before Sending Your Money In

I'm guilty of doing this for sure. You need to make sure a company can get enough money to survive before you put your money in. You don't want to just extend out when a startup will die by giving them a little extra money. You want to give them enough money to survive to a good place. So commit, but make sure the entrepreneur has other money committed and coming in before you give your money in.

Don't get entranced by the excitement of the business idea and want to see it started NOW, so you put your money in now thinking that it's going to be all right. It may not be all right. You may have just wasted your money on letting the company run a little longer and then it dies.

Angel Investing Return is Not About the Money

My return is not all economic. I find it extremely satisfying to work with young, smart entrepreneurs and sharing with them my experiences at Yahoo, and helping them with their businesses and products.

This also helps me to consider invested money as "already spent" and not stress about whether that money is coming back or not.

I also consider it a challenge to see if what I think will work for a company really works. Thus, I apply my expertise and advice to my companies and am gratified when they do work (and bummed, and learn a lot when they don't).

This is partly why I started advising when I invest. I get part of my return from working with the entrepreneurs. But I also want to make sure they really want my help and are not just telling me, then get my money, and don't bother to talk to me. By executing an advisor agreement, this really creates the commitment from the company that they do want my help and want to engage me in that way. I've also walked away from deals because they did not want my help like that. It's OK; remember...discipline to stick to your plan!

It's an Individual Thing

In listening to Angelconf, you'll find that most angels are consistent with many operating strategies. But then you'll see some who'll say one thing and another say something completely different on the same topic. A lot of that goes to what experiences they've had in the past, whether they were VCs before, or got burned on something in the past.

The important thing is that you need to figure out how you want to work and then stick with it (unless shown that you should change of course). Don't go and tell someone else that they should do something your way. Their way may work perfectly well with them and it can be dangerous to adopt a new way of operating if you're not able or ready to make it work that way.

How do I compare to other angels out there? Or to your own operations if you're an angel?

In the last few months, I've encountered at least 3 people who are thinking about incubating. On the one hand, it's amazing that the topic still comes up, but on the other hand, it's not so amazing.

Clearly the news about the spectacular failures of incubators during the last Internet bust hasn't deterred anyone from trying to build incubation operations. We can even find examples of incubation-type operations that are arguably working like Ycombinator and similar operations in other locales, like Techstars and LaunchBox Digital.

People keep wondering themselves why they can't just build stuff, and keep building stuff until something works. Or setup something like Ycombinator/Techstars/LaunchBox. It seems so cheap and easy to build a web site/service and get it out there. Why not just build lots of things quickly and try them until something works?

I believe the answer is YES you can. But before you do, I would point you to my two blog posts about incubation, which were gleaned from conversations from many incubator operations both personal and groups in the present and in the past. At betaworks, I took on the project of finding out as much as about incubation as I could, to inform betaworks about the best way to go about coming up an idea (or ideas), how to get them built, and set them up for later success. I then went out and talked to people incubating and distilled what I learned into these two posts:

Incubation 101
Incubation 201: Should You Incubate?

Words of wisdom/caution to those who want to do this:

1. Generally, professional investors run away from people trying to raise money into incubators, because of lot of them were around when the dot-com incubators all collapsed and they remember that. So calling whatever you're doing an incubator has been found to be a detriment to fund raising.

2. Find your benefactor, woo someone who believes in you and what you're going to do and has cash to fund your operation.

3. Be aware of destroying incentives that will hinder people from working their butt off on their projects. These are things like paying people full salaries and benefits, and not tying the ownership of the project deeply enough to the people working on them, among other things. Keep people hungry and motivated, that they think their entire future and life depend on the project they are working on.

4. Transferrance of an idea is SUPER HARD. Don't think it's easy to just be able to explain an idea to someone else and they will understand it as intuitively and viscerally as the idea originator.

5. Keep costs as low as possible. This will keep everyone's runway as long as possible. It will also add to the hunger.

6. Figure out what you're good at, and leverage that in developing the incubation operation. Paul Graham loves smart hackers and is really good at filtering for that. So Ycombinator teams are always composed of super smart hackers because his strategy is based more on having super smart hackers around than just the idea, because often times where you start is not where you end up, and smart people will find a way to success no matter what. What do you believe will generate success and how will your strengths help that strategy?

7. Following on 6., I would advise you not to compete with Ycombinator or any of the other incubator type operations out there. Don't call yourself Ycombinator 2.0 either in name or messaging. Only Paul Graham can pull off Ycombinator in the way he is doing now. Be yourself and build your own brand.

8. Out of respect for the kind folks who shared with me their knowledge and wisdom which cost them a ton of time and money in legal fees to figure out, I am not publishing anything about what I learned about company structure or legal matters. You should go find a law firm who has worked in this area before and they can help you figure things out. As a hint, some of that has to do with the SEC Investment Company Act of 1940.

I wish you well in your incubative endeavors. May you build something truly great!

Revenue is important. DUH.

It seems as though we forgot about that through the internet years. People were willing to put money into startups to build up a user base and put revenue generation second before that. They didn't have to deal with revenue because they knew that they could raise their next round based on tremendous usage and on the assumption that if you had a gazillion users, then you must be able to monetize them somehow.

That did work for many startups through the dotcom boom years, and even after the internet bust it still worked for many years, right up until the economy took a nose dive.

The world changed, and now that second round is just about non-existent.

So I, along with just about every other experienced investor out there, have started to demand revenue as soon as possible (better) or want to see it at the outset (best). We have turned away just about every early stage company that has no revenue or no firm revenue plan.

While we'd love to be optimistic and place a bet on a startup that only has user building potential, but no clear revenue plan, it's just too risky right now. Or, if the entrepreneur has not created a firm revenue plan, or does not plan to turn on revenue generation as soon as possible. Any of those are too risky for me right now.

Why? In the economic climate of today, 99% of the funding sources won't even touch a startup that doesn't have revenue showing, when they hit their next round. I've seen it happen multiple times for companies trying to raise money today. Thus, if you don't have your own source of cash (a.k.a. revenue), then you'll end up dying when you burn through your initial cash that you've raised. You just can't count on that next tranche of cash to appear when you need it most.

So in investing in you, I want you to survive. I want you to build a great business. I DO NOT WANT YOU TO DIE a few months or a year from now when you run out of cash, just simply because you put off revenue generation until the very end and it's too late to generate enough cash to support yourself. To me, that's a waste of not only my money, but of everyone else's money as well. Think about that if you're going to take your friends' and family's money. In today's funding environment, you might as well be tossing it out the door if you don't start revenue generation from day one.

Before the internet, startups were always created to make money. Entrepreneurs always thought about building businesses to make money from day one. And many of them would drive themselves into the hungriest state, risking their homes on additional mortgages and their relationships with divorce. Their unwavering belief in their business idea coupled by their need for cash to sustain their lives kept them going until some of the biggest businesses of today were built.

Somehow we lost that when funding sources were willing to bet on ideas that didn't have obvious monetization early on. It took the economy to dive into recession to bring this "create a business to make money" philosophy back into the forefront.

Perhaps it never should have gone away.

I'm only looking at startups with revenue or will turn on revenue from day one now, but I also wonder about what I will do when the economy recovers. Would I go back to placing bets on some ideas that may not have obvious revenue plans, or are generating revenue immediately? I think that we'll have to take a look at the funding environment and the startup ecosystem to see if we'll ever go back to supporting businesses like that.

In the last few weeks, I am amazed at how many people are completely unaware, oblivious, or uncaring of what is happening in the markets.

When you drive past malls, the parking lots are full. People are still out shopping! Maybe they aren't buying? At least they still aspire to buy even if they are not. However it seems that some people still are.

One of my startups, Ideeli, who sells luxury goods at 40-90% off, is showing great growth. I guess women still want their luxury goods even in a recession.

The other day I was catching up with a buddy of mine and I told him some of my companies are shutting down. He was amazed that this was happening.

Some startups I meet with still are in the mode of building for users and making revenue part of their future plans AFTER they raise their next round. I tell them that the investor community has completely stopped funding startups without revenue WHEN THEY SHOW UP at their doorstep. They look at me like I'm an idiot for asking about and pushing them to generate revenue now.

WTF??!?!

Ignorance? Obliviousness? Inertia of irrational exuberance still keeping spirits high? Or perhaps some things just haven't affected some?

It almost reminds me of when I was a kid growing up during the downturn of the 1970s. My parents dealt with the problems, but they never affected me directly. I never stressed about it, and nobody asked me to stress about it. Food showed up on the table, I went to school, still had clothes and toys. The world was all right.

I think some are like that. They have money. They have support. They still walk down the street to their Starbucks and buy coffee. Everything does seem normal in our little microcosms.

But if you take a look at the world beyond our immediate surroundings, it's a mess. The larger, global mess trickles down to creating a mess all the way down to affecting us. It's in all the news, and in our stock prices, our gas prices. For us in the investing biz, it's in how we think about building startups.

Sometimes I think people just don't read newspapers, or watch the news. Or maybe their larger view doesn't have enough experience yet to process all the macro effects and distill them down to micro effects, and finally down to those that directly affect each and every one of us individually.

I think that I was fortunate enough to be an adult through the 1989 downturn, the boom-bust of the internet through 2001, and now this one. It's a sobering thing to be hammered so many times and to viscerally have experienced their effects on us. I have learned to process broad data and bring them down to the individual level, and I have much more to learn.

I meet with my financial advisor regularly now and pump him for broad economic data, because he sees much more info than I do. We talk about how it affects my investments, but also about the broad economy both domestic and global because I want that data to process, so that I can strategize effectively in all areas of my life, including my startup investing.

When I think about how I get all my information, it's almost a full time job keeping track of all this information. So maybe I can forgive those who are ignorant/oblivious/irrationally exuberant because it's a lot of data to process, cutting across a lot of experience areas, and it's hard to understand if you don't have context or experience to pull it all together.

I can only hope that people do a more deeper dive in broader economic factors because it does affect us all, and we'll make better decisions about our lives, money, and work because of it.

And I can stop getting in arguments with people about why building for users isn't a good strategy now....(more on this in a future blog post).

A reporter asked me some thought provoking questions about the state of the world and whether Silicon Valley will play a large role in recovery and building new companies and employing tons of now-out-of-work people. I gave a rambling reply which also caused me to think deeper about how things are and my dissatisfaction with many things in the past, which I hope will be fixed. Since it was an interesting thought exercise for me, I thought I'd share it with you (with a bit more embellishment):

3% is the new 20%

Greed has played a large role in how broken the system is. I now say 3% growth is the new 20%, which means that expectations have been totally out of whack in the past. When I was at Yahoo, it was ridiculous to have investors continually push for 20% growth quarter over quarter, year over year. It's unsustainable. and when Yahoo fails at this, or any company for that matter, the investors knock the stock down. When the stock goes down, the investors get in an uproar and scream bloody murder, try to get rid of the current management team, cause a huge ruckus which is hugely distracting and doesn't enable a company to respond in the way that is best, which sometimes takes time - More time than investors are willing to give. The short term mindset of investors which drives the short term mindset of companies doesn't let any company plan effectively for the long term, but only for next quarter's earnings call.

Stock market driven by emotion

The whole stock market is driven by emotion which is really bad in general. Whatever happened to what I learned about stock investing way back, when the stock price was a reflection of the actual value of the assets a company had, not what emotion drives what we think it should be?

Is incremental innovation enough?

Lots of innovation is definitely in the form of incremental innovation but that is true in more established technologies. We see this in bulk on the internet, but on the other hand, we still see a lot of truly weird new stuff that nobody is working on before. I think a lot of people think they can merely do something better and that is enough to get to a good place, or become number one. the main problem is that users have services overload; ex. how many social networks do we really need?

This is a big problem for us internet startup investors. We see a lot of me-too products and while something may be truly better, there are so many factors out there that inhibit the establishment and growth of a me-too product, even though it's better. Users have lots of inertia in products they know; they learn, get used to them, then are unwilling to switch. Users also can't determine what is truly better or not - when two things work in the same industry or product area, users aren't going to spend time to dig into every new product's details to figure out which is better; they don't have time. In the past, large marketing campaigns to drive awareness could get a new entrant a place in the marketplace, but "firehoses of users" aren't easy to find or establish to get enough trial such that natural growth of users starts to happen.

Where's the next big industry creation going to happen?

If i were a betting man, I would say cleantech is the next big area for large scale innovation that creates big companies and factories, that employ a wide variety of skills and skill levels - it's an area that will require lots of capital to start and get going.

Internet tech only employs a certain type and set of skills - as a veteran of the internet and investor in the area, I still think there will be lots of innovation there, but it will come more slowly and the big returns will become more rare, but lots of smaller companies will pop up. It's still an interesting area and think it will be for some time. Capital requirements are virtually nil for internet startups now.

Statistics says that Silicon Valley can still drive a large portion of company creation and thus, help in the recovery

I'm biased. I live in the Silicon Valley and in living there, versus visiting elsewhere, I think that innovation and new business creation still happens a great deal in the valley. Why:

1. Even in the economic downturn where we'll see many of the venture funds die, the greatest concentration will still be in the bay area. No other region in the US can claim the sheer number of funds and greatest concentration of angel investors too.

2. The economic downturn will kill off many dumb ideas and leave the strongest to survive. This puts back a constraint on startups which had gone missing in the boom years: gotta make a great business that can make money. duh!

3. Still people flock to silicon valley to start businesses. This inertia isn't going to go away instantly. It would require many years of failure to reset this in peoples' minds that Silicon Valley isn't the right place to be.

4. Being in the Valley means you are surrounded by tons of other like-minded startup people. It would be hard to find some other place like this, except for perhaps NYC or maybe Boston (even those two would still be dwarfed by the sheer number of people in Silicon Valley). Everywhere else has a much much less dense concentration of people who can help you and who have done it before.

5. I personally still look at deals and those that kind of are sub-standard, I tell them (as does everyone else) to go back to the drawing board and come up with an idea that can make money. This kind of feedback is just one more iterative step in getting people to the right place.

6. So eventually some great ideas will make it through the filter, but you have to wait for time and effort to pay off. Statistics says that the greater number you have to play with, the higher the chance you'll get something new and big. With the sheer volume of stuff that goes on in Silicon Valley, that says to me statistically that you'll get a next big idea faster than in any other place in the country.

The next big breakthrough employing 1000s of people won't happen overnight

I doubt that any idea could move that fast and with the economy so down, it will be even harder to see a company grow to such size in those conditions, even those with some momentum. So in that sense, it may be that the government's massive infrastructure projects may be the ones that will employ a lot of people in the short term while the other companies fight off their investors by laying off people just so they can get their revenue numbers looking better.

What if we didn't layoff anyone and just waited it out?

What if companies didn't sucumb to the pressure - what if they kept paying people but were OK with zero profit? We all know we'll pull out of this downturn at some point - but we have to make a whole bunch of people suffer by laying them off just so a company can look good to investors. Again, the short term focus will weaken companies and place a lot of good, experienced workers out of work. OK OK I'm not totally correct because maybe some companies will make less than their expenses so they will no longer be break even, so maybe they should cut dumb projects and fat off their staff. On the other hand, we've seen time and time again where companies would layoff people in downturns, and then just re-hire them later during good times. We don't need them - we DO need them - this see-sawing back and forth costs people in time, money, and effort.

What if we just didn't fire them, made less or zero money, and just waited it out since we would have hired them back anyways?

Another thing I learned along the way: being loyal to a company is a thing of the past. A company exists for the survival of itself; if that means that people should be let go, it will do so in order to survive. It doesn't care about the people, even though it should. As long as the people help a company survive, it will retain those people. Anybody who doesn't contribute to its survival get cut. I don't see people having any say or power in this decision. Thus, we have to prepare and take care of ourselves in case it happens.

People are resilient, and will drive new business creation

In a downturn, people tend to be resilient. I read somewhere that during these times, people start their own businesses because they've been laid off, sulk for a while, then pick themselves up and go and start new sustainable businesses because now they are free from the corporate mess to do so, whereas they may not have felt that freedom before....?

Entrepreneurism is under attack

I agree generally with this statement. I think the capital mkts are closed, but only for a while. The evidence is that the recovery steps are taking hold but it will still be a few months before things are more back to normal. There will be a shake out in the venture industry. IPOs will still be tough until SAOX gets fixed, which I heard people are working on.

Education could use some serious improvement in the US. But still many kids come out of college wanting to do a startup instead of taking a corporate job. so while we essentially closed the doors to international talent, I think that there is plenty of talent ready and willing to go with just a little experienced handholding.

Basic research is declining I hear. People aren't encouraged to take science; they want to make the quick buck so they become stock traders. So less ideas come out that way, but still there are many untapped. I met a guy who had a line to the DARPA funded projects in universities. He raised a small fund to help these projects become real businesses. Real scary star wars stuff he was telling me about. Pretty cool.

The search for exits is a problem for the whole venture industry. Tt does foster this attitude of building a business for the exit and not for sustainability. This needs some re-thinking. I admit I even suffer from exit-itis as an angel investor. But we also need to figure out how investors can profit from supporting a company and being able to cash out their investment.

Silicon Valley downturn not as severe as other parts of the country..sort of

Still lots of wealthy people running around, although a lot of Valley companies laying off 1000s of people. And I think parts of the Valley are experiencing downturns but not all, as evidenced by housing prices, etc. Still, it's probably not as bad as other parts of the country. But as for contributing to the entire country's recovery, I think you'd have to make people move to the Bay area to look for jobs, or have those companies expand out to other states to get cheaper labor. One problem is finding skilled workers in the areas that high technology requires in other states. Sometimes, you just can't find those people there, or get people to move there because the quality of life is not what they want (who doesn't want to live in California haha?).

I read an article in Venture Hacks about American Apparel. This is the innovation that is required in the US; to stop throwing jobs out of the country and figure out how to do things here, so that we can employ Americans and pay them what we need to pay, but also do it in a cost effective manner to be competitive.

California is well poised to recover

I think California has a great chance to recover by itself: entertainment industry in southern California, tech and other stuff in northern California. As in other years, I think there will yet again be a migration to California to look for fortune, as companies get created and are looking for skilled people, and that will draw skilled people from states where jobs are lost.

Do you agree or disagree?

RENVY
[ren-vee]
noun, verb

-noun
A feeling of discontent or covetousness with regard to another startup's revenue, especially when you have none:
Green with renvy takes on new meaning when we're talking about money.

-verb
To regard with renvy:
I renvy company Y reaching breakeven; if only we had went for revenue from the very beginning, we wouldn't have to go beg for more money.

RENVIOUS
[ren-vee-uhs]
adjective

-adjective
Full of, feeling, or expressing renvy:
We at company X are renvious of company Y's $100 million dollars of revenue last year and are planning to take them out in beer pong on Friday night.

This startup vocabulary lesson was brought to you by the folks at Loudwater Labs.

The government has bailed out banks and mortgage companies, and it's most likely going to do something for the auto industry. How about my early stage internet startups who are also in desperate need of cash to survive through this economic downturn? Or...how about my all time favorite startup Pets.com?

Some teams from Seedcamp from London were in town this last week and I managed to get a private pitch session. Here is a video of uberVU pitching me, shot from a mobile phone:

uberVU - betaworks pitch from Vladimir Oane on Vimeo.

I don't look too good without makeup, do I?

This slide from the infamous Sequoia deck is one of my favorites:

Running lean is something all startups should practice at all times, even if they are profitable. Keeping costs under control is an art and a science and is even more critical when you're just starting out and don't have any revenues.

So add in our economic woes and in the short term, the death spiral becomes a high probability and high burn startups can't pull out of it, because funding has almost all but dried up. Venture funds are pulling back and getting super conservative; they have good reason too - the crappy economy does not allow startups with slow to prove business models to survive. At the early stage, it's even worse; us angels and early stage funds can't give a startup enough money to last out past when the bailout plan and economic recovery will begin. Early stage startups need enough runway to get to positive metrics so that they can raise the next round. If they can get to profitability, even better. However, if you try to raise money now and your metrics are average or not all that great, you won't get your raise.

Hence you enter into the death spiral and you're dead.

UNLESS...you reduce burn now. Do whatever it takes: layoffs, cutting salaries, removing non-essential services and perks. It's all about survival now and for as long as you can, to give you as much time as possible to get your metrics to a positive place. Activate revenue generation immediately; don't wait. Start getting cash in now and you'll be able to last even a bit longer.

And if you're starting a company right now, begin with good habits of running lean. Don't get into thinking you can run the company as if it were a bigger, more mature company. You can't. The bad economy exacerbates these problems.

It's times like these when you really find who truly believes in the company and the idea. If you need cash in your life (ie. have a family), you should seriously reconsider being in a startup. Startups need to run lean to survive; it means that there is a huge amount of sacrifice that its employees take on to really run lean. Those who are truly believe in the company and idea will stay no matter what it takes; they will not leave when you cut salary or perks. And they will work their butts off for minimal pay and equity alone. If you can't live in an environment like that, I would really urge you to look at what is truly important in your life before joining a startup.

Today we had our second Betaday at betaworks in NYC. It was at the Soho House, a posh movie screening house right next door to our offices in the Meatpacking District:

Looking forward to the next Betaday!

The economy is affecting everyone. But it's also interesting to see how it is affecting my angel investing strategy.

Like all other investors, I sent out my own doom and gloom email to my companies. Here is mine:

------email--------------------
Well, I should have been more closely following the blogs, but for some
reason missed this. Of course, you may have seen this already.

I am sure by now I am not the first investor to be telling you this. More
data from a presentation from Sequoia to its portfolio companies. Better
hunker down the long haul. This problem is now worldwide which means it
isn't just a local US problem. Thanks to some of our once esteemed
financial firms, we've now taken down the system worldwide.

Early stage is the most risky. It's where cash is very scarce, and you
don't have revenues yet. The problem is the economy is going to be
harshest on all you guys because in a good economy, you may not have
problems.

Make the hard decisions now before you're laying off people and in
survival mode. Extend your cash as long as you can and work as hard as
possible to get your metrics into a great place. VCs have cash to give,
but they will not give it to you if your metrics aren't anywhere but
great.

Also, the more you can find revenue that is not advertising based, this is
a good thing. Over and over again, the forecasts for positive advertising
spending have turned out to be wrong.

Read on and see the embedded pres:

http://gigaom.com/2008/10/08/sequoia-rings-the-alarm-bell-silicon-valley-in-trouble/

http://gigaom.com/2008/10/09/what-startups-can-learn-from-sequoias-doomsday-warning/

Thanks for listening...Dave
------email--------------------

The Sequoia deck was very enlightening and pretty much says it all. The world has changed; many early stage entrepreneurs are too young to have experienced as adults any economic cycles. I lived through the dot-com boom and bust cycle, and also the other one back in 1990 when the first Bush invaded Iraq. It's a sobering thing to have done so.

During the 1990 downturn, I was working on a Master's in Product Design at Stanford. I had completed a summer internship at Apple and managed to land a job continuing my work there, which allowed me to stay on as a full time employee and take a year off from school. The fall/winter of that same year, the US was into Iraq, beating back forces bent on invading Kuwait. Shortly thereafter, the economy goes downward. EVERY ONE of my fellow students in my Master's program did not get a job for OVER 9 MONTHS after graduation the following June. I was incredibly ecstatic and thought myself super-lucky that I had a job, and one that didn't lay me off thankfully.

During the dot-com bust, I was at Yahoo and we came through it with a stock that was down to 9 bucks and laying off 1000s of people. If you've ever laid off people, let me tell you it SUCKS. First there are all the planning meetings beforehand, behind closed doors to see who would be let go and who would stay. Then the big day comes; everyone is supposed to wait in their cube until the whole process is over. You just sit there and wait, in anxiety, wondering if you are going to be axed or not. When you go and get them, there is a mix of emotions: tears, fears, anger - you have to know how to deal with it all. This isn't about the people anymore; the corporation exists to survive for itself, not for its people. The harsh reality is that we're all expendable in corporate terms. No more IBMs with their plush retirement and pension plans, no more thanks for all the loyalty you've given the company for 30+ years. If you're not part of the solution, you're gone.

Personally I was also extremely lucky again. There were two things that pushed me through the dot-com bust in decent position. First, I was so freakin' busy at Yahoo that I did not deploy my personal funds into any stocks. Thus, when the markets crashed in 2001, I was heavily in cash. Geez. A bit of laziness saves me from a superb drop in stock market value. Second, I told my broker that whatever funds I did deploy, I did not want to be in PC manufacturers, ie. Dell, HP, etc. I told them that these were now commodity products and that these guys were going to get killed at some point in the near future. Little did I know that during the dot-com crash, these guys took down the value of many a fund, and because I told my broker not to buy these stocks, I managed to keep my stock portfolio breaking even, whereas other portfolios were heavily invested in these companies which just tanked at that crash.

Freakin' lucky bastard I am.

Now we're in another downturn. It's too early to tell what personal moves I'm going to make although I think about it every day and there is ongoing strategizing with my broker.

But it's effect on one part of my portfolio strategy has been growing clearer. Angel investing at the early stage is inherently risky. But now, the economy is going to make certain strategies even more riskier, and this is compounded by the fact that further fund sources are going to be even more conservative and picky on which companies they invest in. This means that whereas great metrics alone may have gotten you your next round, now it's not enough.

Early stage startups typically raise about a million. It lasts them for about a year. However, raising money in 2009 is going to be SUPER TOUGH.

Now my strategy has shifted to investing only in companies which are either generating revenue, or have businesses that naturally generate revenue from usage. That means no more exploratory forays into social networks or consumer companies that depend chiefly on advertising. As I said in my doom and gloom email, every positive forecast about advertising spending has turned out to be DEAD WRONG (kind of calls into question forecasting and research in general).

This economic downturn is a worldwide phenomenon now. All our economies are intertwined, and I'm sure many countries counting on the ol' faithful US to prop up their own economies were slapped rudely in the face. Guess what. Build up your own economy and make it great. Depending on someone else to do it for you is not working!

But it also means that we're going to take a long time to pull out of this. Early stage is super risky because we can't give them enough to survive long enough to prove out certain types of business plans. Only the ones who are generating cash from the get-go are going to be the strongest. Everyone else has a greater chance than ever now that they will run out of money before they can prove out their biz models. We don't know how long it will take to recover, and we don't know if the bailout plan will affect things quickly or slowly.

So I'm really only investing in clear revenue producing startups now. It seems to be the only thing that reduces risk. By the way, since the economy is way down, it just happens to be a great time to invest since prices will be really low; you just have to have cash to deploy.

This year's Ycombinator did not disappoint me in seeing smart, young people crank out new business ideas. But I was struck by the number of repeated ideas in this class's mix.

In past classes, Ycombinator participants came up with truly innovative ideas and prototypes to illustrate those ideas. They were really new and concepts that I had not seen before.

In this class, I saw many that were remakes of old ideas, either from previous Ycombinator classes or even just improvements on products/services that were already out in the marketplace. All of them were better though; their user experience was markedly better and most people agreed that the Ycombinator teams produced better versions of existing products.

It brings up the question of what I would call "follow on innovation," which is to take an existing idea and make it better and then customers should adopt the new product because it's better, faster, easier to use,....right?

One of my favorite business books is The Innovator's Dilemma by Clayton Christensen. The book describes the classic case study of the hard drive industry. Established hard drive manufacturers would create one version of it, and either be unincentivized to innovate on the technology or miss seeing the opportunity of a smaller hard drive. Smaller more nimble incumbents would develop a faster, smaller hard drive while the established manufacturers missed the opportunity to develop the newer versions for fear of cannibalizing their existing business. This happened over and over again as hard drives got faster and decreased in size.

At each stage, the existing company would somehow miss the opportunity to jump into that new space. They would research and research and find that no customers would ever want smaller, faster hard drives. Their financials would always say that the new product versions would cannibalize their existing businesses and create harm to their companies. They were smart people doing the right thing and that right thing told them they should not innovate and that there was no proof in the innovation being good for their bottom lines. Their own analyses created an opportunity for new incumbents to enter the market and steal large amounts of share from entrenched, already-established companies.

Here we see follow on innovation clearly overtaking existing, established businesses. If it can happen in the hard drive industry, couldn't it happen with one of these Ycombinator companies in the Internet?

In Digital Dreams: The Work of the Sony Design Center by Paul Kunkel, Sony's Design Center looks at their products through a life cycle from "sunrise" to "sunset". "Sunrise" is when the product is first introduced. The product is a completely new entrant to the marketplace. Competing products introduced into the marketplace from competitors compete on features and technology, and features are added until differentiation is no longer achievable through either features or technology. This is when the product starts crossing from "noon" to "sunset" and competing on design becomes ascendant.

Sony stops adding features as a main focus and starts creating new designs around the features and technology. Products are created in different forms and colors, appealing to every consumers' taste in the way it looks and feels versus on features alone. According to the book, it is heaven for designers because now they are the important resource to which product teams must turn for further competition.

For Sony products like the Walkman, "sunrise" to "sunset" takes years, if not decades. Physical product development cycles usually take about 6 months to a year to complete back then; now they are faster given advances in manufacturing technology and the lack of need to innovate on basic technologies. Still, they take a long time to plan and build and for consumers to buy and experience and, ultimately, replace to try a new product. On the Internet, products and services move from "sunrise" to "sunset" in a matter of months. The pace of innovation is incredibly fast and a high percentage of the basic technologies enabling a product or service can be implemented very quickly. Products rapidly reach that point at which design and the user experience quickly becomes a differentiator between competing services who essentially accomplish the same thing.

In the beginning of an Internet product, engineers' importance supercedes that of other disciplines. Basic technology must be developed, implemented, and tested. As other entrants emerge, they too develop similar technologies and then there are many competitors in a market where formerly there was only one.

As an internet product reaches "sunset", the user experience becomes more important. Basic technologies have been developed and now you need to deliver the benefits of those technologies as easy as possible. Retention of users comes from clear, simple designs and hard-to-measure metrics like branding and emotional satisfaction from using one service over another. It's the designers' dream time because their discipline comes to the forefront for product development.

Or is it their nightmare?

It's never as easy as saying that a great user experience is all you need, when other basic technologies have been developed, and all other things like marketing, funding, etc. are held equal. User experiences can be copied; they are near impossible to protect via patents. Branding can be mimicked. The more aggressive the design, the higher the risk that you attract some and alienate others. It also means that the more aggressive the design the more often you need to update the design because design can get dated and worn out.

And for early stage companies trying to enter into a market with entrenched competitors, you're trying to build a better product through user experience alone. You probably do have a better user experience when compared to your competitors, but trying to unseat a gorilla in a marketplace because there is so much inertia in current users is incredibly tough without a lot of resources.

As a person with a design background, I am a big proponent of design and its importance to product teams. But in looking at some of this last Ycombinator's products, I find myself wondering if a better user experience on top of a product that is already existing in the marketplace is good enough for it to compete and survive to grow to be a worthwhile sized business.

I intend on studying this further as I watch the current batch of Ycombinator companies and others attempt to gain market share through mainly innovation in design.

This has happened to me several times now. I've found an amazing lack of caring when it comes to negotiating terms amongst supposedly experienced investors. This is both among angels and venture firms. It doesn't happen every time, but it happens enough. I have also found that people who put the most money in have the most to lose, but yet don't step up to lead a negotiation on terms.

Why would this happen even with seemingly experienced individuals who have put up a large sum of cash for investment? Here are some reasons I've seen:

1. There is inherent trust in the entrepreneur. This occurs most in rounds with family and friends. Experienced individuals who jump into these rounds may not negotiate over terms and just sign whatever paperwork comes their way, on the assumption that the entrepreneur won't ever do anything to screw them.

2. Some investors have lots of money, but don't have enough knowledge on financing terms and their future implications. In my own experience, the only way I have learned (and that learning is burned into me) is to have done lots of deals and continually do them. Most angels don't invest that often and it's easy to forget how terms can affect their investment.

3. Some investors simply don't care. They just put money up for investment and they are totally passive, and are happy to be part of the deal and gain some sort of return later. They don't care about the details at all.

With 3, I believe that even at large sums of money, and this can be upwards of 500k-1MM dollars, this still is a drop in the bucket for their entire holdings and thus can afford to not care about the details.

Also, I think that for many investors, they are just doing it as a hobby and they are not serious about it. Thus, their level of care drops considerably on the details.

4. I have also seen investors simply avoid confrontation. They don't want to get into an argument over terms, so they don't start.

5. Some investors don't want to spend lawyer fees to deal with the terms. They don't want to spend anything extra and just want it done.

6. There is also something more serious, which is that if you lead, you could take on extra liability in case something in the terms causes the entire deal to go sour at some point. I've heard of cases where you could get sued for that. So investors get cold feet and avoid leading.

On some deals, I have pushed back on the terms because they weren't to my liking. I do that even when I go in at my very low investment level, and I am never large enough to be a traditional lead investor. Entrepreneurs often counter that their most experienced investor is OK with the terms and thus the terms must be acceptable. In fact, because the other investors have not spoken up, the terms get accepted by default.

I have to say that this is frustrating. I have met only one other investor who invests at my level and ALWAYS speaks up about the terms. Everyone else just follows whatever is happening and assumes someone else is dealing with the details.

The problem with the terms is that, unless a lead investor produces a term sheet, you're almost always given a term sheet that is company friendly. It will always favor the company and provides zero protection for investors from negative events.

My message to entrepreneurs is this:

You're probably doing the right thing from a negotiation standpoint in starting out with a document that favors you totally. But I would truly warn you against making the assumption that since an experienced investor(s) have reviewed it, that it is truly an acceptable document. As discussed before, there are myriad of reasons why an investor, or group of investors, are OK with what you produced. But bear in mind, that if you as an entrepreneur truly want to take care of your investors, then you should query your lawyer on why an investor might object to the terms set forth in the document that he gives you, so that you understand why we would have issues and the ramifications for us in the extreme cases.

By the way, a lawyer will ALWAYS produce documents that favor you initially. It's their job. If they are being a proper lawyer they will always seek to protect you and the company first UNLESS you specifically ask for a document that is more balanced. Also, NOTHING IS STANDARD. No matter what anyone tells you, it's true. In every deal I've worked on, the terms are always slightly different.

My message to investors:

First, following on the very last comment previous, NOTHING IS STANDARD. Don't believe it if someone hands you a term sheet and they say it's standard, in hopes that you will believe them and just accept it blindly. I've worked on many deals now and they are all different in small and large ways, with many of the entrepreneurs and their lawyers leading the discussion with "it's standard".

Second, hire a good lawyer and spend the money to have someone review the terms and explain to you the potential up and downsides of the terms. Too many horror stories abound where there was insufficient protection for investors and we've gotten squeezed out company ownership, cheating us of larger returns. As an early stage investor, we put up cash at the earliest stage and take the highest risk and it is my belief that we should be compensated for taking that risk early on. Without us, the entrepreneur would never have gotten anywhere.

Third, CARE ABOUT THE TERMS. Make sure someone good is negotiating on your behalf. Never assume that someone else is going to do it. If you're unwilling to do the negotiation, then at least make sure that there is someone who will do the negotiation. READ THE TERMS. Understand their implications to you and your money.

Fourth, we'd all like to work off of trust and a handshake, but I've already seen how friends can turn on friends in a business situation. It happens way too much for my taste. Thus, if we have a trusting business relationship, then there should be no problem putting that down in the terms. Be alert for when an entrepreneur gets upset at you implying that their trust is not good enough because you want it written down - to me, it's a sign of trouble. It's a psychological tactic to get at your good, trusting nature so that you won't require him to write it down. Don't fall for that. Walk away from the deal.

Last, do not be afraid to speak up regarding the terms either to the entrepreneur or to the lead investor. It's your money so take care of it! Besides, you never know if the entrepreneur might actually change something based on what you say; it's happened twice to me now where I'm on great terms with the entrepreneur and just asked nicely if we could make a change, and they did it.

You know what - if we all sat down and thought for a while, we can all think of at least one company that made it big all by itself, nice and viral like, without any help from anyone but users, and that first user was able to drag all his friends in, and then exponentially drag all their friends in as well, and so on, and so on. Pretty soon it became an internet dynamo, a dominant force on the Web and its founders made a gajillion bucks off it for practically doing nothing.

No advertising. No SEM. No SEO. No nothing. Just magic. Maybe a bit of accidental viral-ness, but nothing else.

The funny thing is, I've met so many entrepreneurs whose site growth strategy depends on this magic.

I listen to them tell me their idea, and sometimes their idea is pretty cool. Sometimes they've got the site up and their idea's coolness is actually reflected in what they built. I tell them I really like it and then ask them if they are going to start a company. Then the story gets murkier.

Each one tells me yes they really want to start a company. Each one has big dreams. Then I start asking them about how they're going to get the word out about their product. Then it's unclear. They say they want to put it up and see how it does.

Well....Okay.

I tell them do they intend on doing marketing, even some marketing on the cheap like reaching out to bloggers, or SEM, or something. As soon as the mention of spending more money comes into play, the answers get murkier and murkier.

I persist. I ask them why don't they go out and raise money and become a startup. Then they would have money to spend on marketing. They give a range of answers from not wanting to leave the comfort of their current job to fear of committing to something that might not work to "still thinking about it." Mostly, they got the site up and are just waiting to see what happens.

At this point, I have my answer at least (which is "no I'm not investing").

You know, it's hard to leave the comfort of where you are now. You're making money to support a great lifestyle, or a family. You are comfortable, and don't want to face the potential chaos of the unknown, let alone a startup and its challenges. You might even fail - god forbid what others might think of you, or worse, what you might think of yourself. You might fail, and end up with no money, no job and you bet it all on this one thing and now you might have....zip...nada....nothing.

So you say you'll just put it up and see what happens.

My thoughts to you are:

1. Growth by "magic" into an internet dynamo happens SOOOOOO infrequently that the chances of what you built doing that are so vanishingly small.

BUT - what you built might actually be useful and cool enough to grow into a decent sized business (or even a dynamo) IF you were to put some sweat and money into distribution and marketing so that users know you exist.

In absence of full commitment, you might as well be playing Lotto.

2. Since you won't fully commit, you're unfortunately not risk tolerant enough to become a great entrepreneur. No offense, and I don't say it as negative criticism. Not everyone is built to deal with the uncertainties of being an entrepreneur, and the chaos that inevitably ensues from running a startup and living on the edge of having no money. So just stay home, make your money, live your life.

And don't be delusional about the chances of your site which you just "put up" and are "watching what happens."

Way back when, I was happy to have encountered Josh Kopelman's excellent post, Bridge Loans vs. Preferred Equity, to which I did sort of a re-post but also added my spin on the subject in Convertible Notes versus Preferred Equity Parts 1, 1.5, 2, and 3.

Now that I've been out here for about two years angel investing, I've uncovered more reasons not to do notes any more. So much to learn but yet no one to learn from except to fumble about and get myself into trouble. Now I've firmed up my rule to never invest in notes. I *might* do a note with a price cap on it, but it is still not without potential future issues. Here are some more reasons why notes are awful:

1. It is possible that the company you invested in achieves significant revenue, enough to do one or both things:

a. The valuation will inevitably jump. So when you put in your money, you expected the valuation to be one value, but when your note converts, the valuation has gone higher and now you've taken all the early risk with your note investment, but have lost share in the company upon conversion.

b. The company has enough revenue that it may not need further investment. Or it can delay seeking investment. If the company does not need further investment, then you're in risk of just getting paid back and not obtain any share of the company. This can also happen if the delay in seeking further investment takes the next fund raise period out beyond when the note is due. Again, you could just get paid back instead of converting into equity.

It is possible to convert still, even if there is no conversion. But it depends on the entrepreneur and they are under no legal obligation to do so.

2. The valuation may jump anyways independent of revenue. Again, if/when you convert, the value of your participation will shift from where you originally put in the money, and it doesn't reflect the risk of your early investment.

3. The terms of the next equity financing are unknown to you at the point you invest. While it is easy to ignore this in the excitement of doing an investment into a note, any problems that may arise will come up later during the conversion process.

You would think that at conversion time some large and/or experienced investor would take care of negotiating the proper terms. In most cases, this is true. However, it is also possible that not-so-favorable terms may appear and seem to be proposed by seemingly experienced investors. The big issue is that you don't know what you're converting to with a note at the time you give up your money; then, if you don't like the terms, you're kind of stuck into accepting them because you can't get your money back. Unless you're leading the investment, you won't be able to affect them much. However, if you do get stuck in one of these situations, I would advise you to speak up about the terms; you never know when you'll be heard and someone might actually change the terms to your liking.

Notes don't align investors and entrepreneurs, and now I've discovered other reasons not to do notes...

Often I get asked by entrepreneurs to become advisor to their company and they take a look at my companies page and they wonder how I can handle so many companies at one time. Where does Dave find the time? Do the companies actually get enough support from me given that I am advising so many?

It's actually not so hard. Here's how:

1. I've found that advisor time commitment varies greatly from company to company. Some entrepreneurs use me as traditional advisors are used, which is to meet up once every month or quarter and give me an update and go through their plans and get my feedback. If all my companies were like this, I could definitely advise a ton more.

Others call or email me whenever they need something. I have many hours in the day and definitely can field calls or answer emails. Sometimes they ask for a site review or recommendations. This takes longer, but blocking out a few hours to do that isn't a problem.

Some have wanted meetings weekly for a while. The weekly meetings never last though; entrepreneurs are pretty busy and they get going on something and they don't have time to meet up any more. Or they learn enough or have firmed up plans enough to keep them going for a while and then they don't need my constant interaction.

2. Perhaps the greatest time commitment is just thinking about each company daily. I often have at least one (or more) of my companies swirling in my brain and I try to record any ideas down asap. If I am in front of my Mac, I'll open an email and just record the ideas in that; also, I have a small moleskin notebook that I carry around with me constantly to jot down ideas. Once I get all my ideas down, I check it over, do some rewrites, insert additional ideas that come to me on the fly, and then send it to the entrepreneur.

I like to get into the mode of a single company and its product and try to immerse myself in the product as a user, and the experience of needing/wanting that product. That enables me to really get into what I would want, and also what others could want in that product and where improvements can be made.

I multitask on this throughout each day, but sometimes I take some focused time and do this too.

Still, once a company receives these ideas and acts on them, they usually don't need further time from me for a while.

3. Another task I do for my startups is connecting them with potential partners and sources of capital (although definitely I do not bill myself as a fund raiser). This requires me to network a lot with both old and newly met folks. Thus hour long coffees and lunches are the norm and these take time out of my week.

Also, I write a lot of emails introducing my companies to these partners as well. Thinking about which partner to send the company to and also sending the email does take up time, but not all that much.

4. My favorite thing to say about advisor time commitment is that almost all companies need the most time at the beginning of our advisor relationship. There is a big spike in time and thinking from my side and also in interactions and then somewhere between 2 and 6 months later, that time drops to near zero, with little peaks of time to do emails and check-ins.

The rationale behind this is that the company is supposed to learn everything I tell them. They finalize their plans with my input and feedback. They take this knowledge and are off and running building their product. They don't need my interaction so much after this time because they have what they need from me.

This is one of my main goals: To transfer knowledge from my brain to theirs so that they don't need me any more. If I do this successfully, they should be able to function for a long period of time without my input. Over time, my goal over the term of my advisorship is to help them find resources that would manage what I help them with day to day. This is finding and hiring a great full time design resource and great product management resource. It can also mean finding/hiring a great sales program person as well, to help them monetize their advertising programs.

I've been advising for about 2 years now, so many of the companies on my companies page are off and running without further need of my help.

4a. One thing that I have consistently observed is that if my time requirements spikes again after the initial peak, the company is in trouble...so I keep watch for this and hopefully help prevent this from happening.

5. OK OK I admit it. Even working like the above, I still can get pretty busy in the short term. In fact there was a time when I thought I was overextending myself due to the pace of advisorship signups. So now I am very aware of the pace of companies I advise and have slowed down dramatically based on my current support load.

6. Next, I tell people I shouldn't be put on critical path for anything. It's not what advisors do anyways.

A lot of people ask me to be advisor, but really want me to do the design of their site for them. If they want this, they should either outsource their design or find a designer to hire full time, and not try to turn an advisor into a fake full time person. I think this is especially true in product design; in order to do a great job, you have to be immersed 24/7 with the product and team. It's hard to jump in and out or do it on the side.

If I'm not on critical path, that reduces time commitments from 24/7 to something much, much less and less frequent.

As advisor, I always tell people that I shouldn't be expected to be put on critical path for anything because we're both going to end up being disappointed and frustrated. Very bad!

7. Last, I love being involved in many things. It helps keep my interest level up and allows me to see the entire world of internet startups across the board, which is an advantage. I purposely try to get involved across a myriad of projects, across a range of areas.

It takes me out of being myopic into one thing, and allows me to help my startups by being broad in my thinking and not get too trapped into the details of one project. While this is important from an execution point of view, it doesn't help when you're helping to plan the strategies of these startups by not looking outward and seeing where the trends of the industry are going. Often I bring the broader view to my startups because they don't have time to look at it themselves. They're often too busy to do that. On the other hand, I want them to spend all their time executing and not get distracted.

I've really come to love advising startups. The connection with smart, energetic people working on cool new things is really great, and I enjoy helping broaden their vision and give them the help and knowledge they need to be successful.

Our subprime mess is very much underway and the economy is suffering from that and a host of other issues. When consumers feel the pinch, that means they buy less, and companies don't make as much money, and then they spend less on advertising and also on acquisitions. This is important to both startups and us investors: consumers spend less, so they are less willing to buy products and services from a company. Companies spend less and then they slowdown their advertising spend. Stats show that advertisers will maintain their online ad budgets when compared to offline budgets (woe to offline operations who are heavily dependent on advertising for revenue), but I can't help but wonder how much online advertising could have grown MORE if our economy wasn't so bad. Last as companies pull back and preserve cash, they will be less likely to acquire all these nice startups that we're working on now. Granted, the wiser and the more resourced companies will actually go on a buying spree, but they'll be after the startups at super cheap prices since they'll be lower performing towards the end of the year as revenues become tougher. Beware the corporate development folks who seem to slow down a bit; they're just waiting for you to go through your cash reserves and get to a more desperate place by end of year and snap you up at a discount!

When I meet startups, I am now telling them to raise more than they were thinking. I try to get them to run the numbers and to figure out how to survive until at least the second half of 2009, or further if possible. I want them to survive through the economic downturn and not be dependent on additional money until then. I tell them to expect that any revenue projections will be missed towards the end of this year, and advise them that if they try to raise money on poor metrics AND they have run out of money, they will have an extremely hard time doing it.

A lot of entrepreneurs are still coming to me with raising $100k-$300k in their plans. Then I try to convince them of the economic issues and that unless you can survive for 1.5 years on $300k, you'd better change the plan. Not all of them listen though. It will be interesting to see if I am right. To me, you should be at least $500k, even better upwards of $1-1.5MM, whereas in a decent economy, you could get by with $300k-$1MM.

Some of them only want to survive 6-9 months to get a prototype up and raise money on that. In a better economy, I would say that this is not a bad scenario. However, in today's world, I tell them that if they are getting traction on an idea in investors' eyes, that they should leverage that inertia and get more money now. If they build a prototype and are not gaining traction in a down economy, it's only going to show that you could not gain traction and investors be much less likely to participate as they look for positive metrics. It's much better to raise money on a beta and/or the idea and get as much money as you can now, and to plan on survival on minimal or no revenues for 1.5 years.

Another issue with the 6-9 month plan: August and the holidays. Running out of money by August really sucks for fund raising. This is because the venture community goes on summer vacation and it's nearly impossible to find someone to get a meeting. You have to wait until they all get back in September. Then you have about a two month window everyone gets distracted once again because it's Thanksgiving and then Christmas. From about mid-November to first/second week of January, the venture community goes on vacation, peoples' minds are on the holidays and families and not on funding you.

If you're an entrepreneur reading this now: raise more cash than you think, expect that any revenue projections you have will be missed, and try to plan to survive on minimal or no revenues until at least the latter half of 2009, and raise all that money now while you have investor inertia.

A little while back I sat with another experienced angel investor and the topic of gut feel came up, as it relates to angel investing.

It was funny for both of us that for all the analysis we can do on a new startup's prospects, that if our gut said no, we'd not invest. How interesting to use such a undefined force and feeling to make such a prominent decision!

After I left Yahoo, I resolved to develop and listen to my intuition more. I really searched down deep inside myself and really tried to become sensitive to the most minute feelings that emerged about anything. I trained myself to be acutely aware of the good and the bad, and those nagging feelings of doubt or uncertainty. Then, once I could identify those feelings, then I told myself that I would act on them and never ignore them. This is because in the past, I feel that I have ignored my intuition and this has resulted in me getting into some really bad situations.

When I meet an entrepreneur for the first time, my intuition is on high alert. I search my feelings as I hear them talk to me about their business. I not only attune myself to pitch he is presenting, but also to who he is. Is there elation on the idea or some nagging uncertainty? Do I feel this person is trustworthy or not? These and more.

However, what can stymie intuition in the world of angel investing is seduction. This is when the pitch and/or the person delivers such an incredible perceived opportunity that it's like seeing the hottest, sexiest woman walk into a bar and you just can't resist. You're hooked emotionally and you're already reaching for your checkbook. Somehow, the seducer has blown past all your defenses and even your intuition seems suckered.

This happened to me in a pitch not too long ago. The pitch was perfect. It was seductive. It claimed solving so many problems and the benefits and monetization were straightforward. The team was experienced and veterans of the Internet, so no problem on solving any kind of technical challenge. But I countered by saying to myself that hottest, sexiest woman is still a person despite what we perceive is her perfection, and thus means she can't be perfect since she is only human. Thus, for this pitch, however sexy it was, I refused to fall under its spell and viewed it with objective eyes. I brought my intuition back online and ultimately felt too uneasy about it to participate.

Walk away from that hot, sexy woman - hardest thing you can do sometimes.

Avoiding seduction is crucial. We have to train ourselves to not fall under the witch's spell and view the entrepreneur and the opportunity with objective eyes.

This brings back the clarity of our gut and intuition, which we must cultivate to make sure we are not doing something that we're not comfortable with.

In Blink by Malcolm Gladwell, he doesn't like using the word intuition but instead he calls it a form of unbelievably quick thinking. For me, it's both. It's both the gut, the emotional aspect of immediate, primal reaction to something, and the incredibly rapid thought that allows us to make an instantaneous decision. One is cultivated within ourselves and our feelings, the other via years of experience in dealing in a certain area of expertise.

What does it mean exactly when we pass on an opportunity via gut feel?

Just because we pass on an idea does not mean that we think an idea will fail. It might actually succeed. However, I do believe that it truly means that we are not the right people to be involved and that our gut is telling us that, given who we are, how we work, etc, that this project is not right for us.

For the entrepreneur that gets passed due to gut feel, don't feel bad. In the end, it will be better if we didn't work together. Go and be successful, but just with someone else.

My last post Incubation 101 went over basic concepts which I think are essential to the success of any incubation operation. Basically, I think that risk of failure increases exponentially if you don't follow these concepts in their entirety.

In this post, I want to bring out some subtle points mentioned in the previous post which refer to whether or not you SHOULD incubate at all. I assume that if you are thinking about incubating, that somehow you've reached a point in your career/life where you CAN incubate. But does it mean you should?

What are YOU personally willing to do?

Self-examination and knowledge is very important. You need to figure out exactly HOW you can contribute to incubation and the nurturing of ideas into businesses. Then you need to figure out what really motivates you and how you gain satisfaction, relative to the kind of participation you're willing to give.

Are you willing to jump back into the startup life of working 24/7?

If you're not in a position to go back to startup life, then you shouldn't incubate your own ideas. Remember, the idea originator has the resonance with the idea, and is best poised to take an idea to a successful conclusion. If you're not willing to do that, that's a clear sign you shouldn't incubate. Transferrence of an idea to someone else is nearly impossible and substantially decreases chances for success. Incubating at arm's length is still possible.

Do you have incredible, kick-ass product ideas and want to see them flourish?

This is better than having dumb ideas, or ideas that others are working on, or no ideas at all. You shouldn't incubate your ideas if you don't have great ideas to begin with. Again, maybe you should incubate at arm's length.

Being the "Guy at the Top"

The most dangerous thing you can do with incubation is try to be the "guy at the top" who directs things but doesn't get involved in the day to day of any incubated operation. You generate great ideas, and then hire a team to execute that idea, and then think you can sit back and watch the idea flourish, grow big, and you reap the benefits while being able to kick back and just manage it all.

Incubating Your Own Ideas

So you have great ideas and are willing to go back into the startup world. Incubation is a great way to figure out what to do next, if you have the resources to work on many things simultaneously. You will need to be personally involved in the day to day of each incubated idea, and you'll most likely max out at around 3-4 ideas, perhaps less.

Follow the principles in Incubation 101 and you'll do great.

Managing Incubation at Arm's Length

So you don't have great ideas, OR you aren't willing to put yourself back into startup mode regardless of whatever ideas you have.

My advice to you, is to let go of any notions that you be the "guy at the top" and find another way to help others with their ideas. Reorient your values and take great pleasure in watching others' flourish with their own ideas, but contribute in ways that allow you to be involved.

This can be through advisorships and/or investments. Provide value to your entrepreneurs as you invest money in their ideas and they will come to you for help. Create a positive relationship and you can gain some satisfaction in knowing that you contributed to the success of their idea.

Raise a venture fund and support people more through cash, if you aren't so helpful in other ways. Keep the incubated ideas and companies at arm's length as much as possible to maximize incentives and reduce your exposure to ideas that aren't going anywhere. Again, follow the principles in Incubation 101 and you'll minimize risk and maximize your chance of finding something great.

My Personal Experience

Back in early 2006, I attempted to raise a venture fund with an incubation component. I was having a hard time raising it, and ultimately this caused me to get involved with startups in a different way. Looking back, I was glad that I didn't fully realize the incubation operation as I think it would have gotten to a bad place.

In my self-examination, which happened much later, I discovered:

1. I was not willing to put my personal time into any one idea. This would have lead to a bunch of ideas run by me, the "guy at the top". This would have been a risk increasing move.

2. I really didn't have great ideas. I had some, but none that were earth shattering. I didn't have a way to generate great ideas but would have tried to execute some mediocre ideas, again increasing risk.

3. I realized I was much better at taking someone else's ideas and making them even better.

Thus, I am today at something-like incubating at arm's length. I feel that I have yielded a much better risk profile through my work with startups across a number of great ideas and entrepreneurs, and leveraging my personality preference for making an existing idea better versus coming up with a great idea myself. I also have higher personal satisfaction working in this fashion.

Read Incubation 101, do the self-discovery, and do incubation the right way for YOU.

Over the last few months, I spent some time interviewing a whole bunch of people about incubating businesses. It was very enlightening not for the information I uncovered, but the fact that it just brought to the forefront of consciousness things I already knew.

Incubation has had a bad reputation over the years, especially the large ones like IdeaLab and Internet Capital Group that raised enormous sums of money but didn't return nearly what they were supposed to. When I tried to raise my own venture fund 2 years ago and wanted to include an incubation component, I was advised unilaterally to not call it an incubator or else I would get nowhere fast! Investors had been burned way too much on the incubator model in the past to trust new ones.

Yet incubation is sexy. Generate new, cool ideas. Create new businesses. Find the next Google. Unbridled innovation, unlimited success! Wow!

If only it were that easy or certain. Incubation is really hard, but in my research I've uncovered some guiding principles which make incubation viable and possible as a strategy.

Here are the highlights:

Incubation works nicely for internet projects
Developing products and services for the internet has gotten so cheap and easy that invested capital can be very small relative to other industries.

Incubation is HARD
It's not easy to come up with a great new business. Attempting it is not for those wishing for a quick win. You have to be patient, focused, and be able to let go of projects that aren't getting anywhere or waste too much of your time and resources.

Go cheap
The less money you spend, the less money you need to properly incubate. Testing ideas as cheap as possible reduces overall investment. Don't invest a ton in infrastructure liking buying a pretty building and cool office furniture. Outsourcing can help with being cheap especially in the international marketplace for talent.

Build fast
Get your concepts out there fast and test. Being slow means competitors can get into a space before you can test properly. Also, the more ideas you can generate and test, the more chances you have of hitting on something worthwhile.

Fail and remove fast
If something is failing, close it down fast! Have the discipline to kill projects that aren't working. Throwing money at failing projects doesn't solve the problem either. The ability to let go of bad projects is extremely important. Otherwise, projects that are sitting around languishing just waste money and effort to keep afloat.

Go wide...Carefully
Risk is reduced if you cast your net wide of ideas to try. Throwing all your eggs into one or a small number of baskets increases risk substantially of failure. But go wide carefully, meaning don't stretch your resources too thinly.

The founder of an idea needs to go with that business
It is nearly impossible to properly transfer an idea to someone else. Trying to do so raises risk tremendously. To reduce risk, the person who comes up with an idea should stay with that idea, should that idea blossom into a business. This is because the originator of an idea typically has some intrinsic resonance with that idea as a business, and is the right person to build, innovate, and nurture it.

If you are not willing to take an idea through to its proper conclusion, my advice to you is to re-examine your life and what you want to do. If you're not willing to jump back into a startup, then I would tell you to just let others develop their own ideas and let go of your own. Take pleasure in nuturing others and their ideas into great businesses. Raise a venture fund and help others do well.

The team members also should go with that business
Shared resources developing an idea is a nice concept, but to reduce risk, as soon as an idea starts taking off, the development and product team should immediately be deployed on that project. Switching people on a project is hugely problematic and wastes time in education, learnings, and experience.

Any resources working in an incubator should be told beforehand that if they work on an idea, they can't just sit around and keep coming up with new ideas; they need to see the blossoming idea through to its conclusion. If anyone can't buy into that model, then they should find a job somewhere else.

Keep resources at arm's length
The more resources you can keep not on recurring payroll, the better. It's easier to remove people who aren't working out, or shut down projects. Hire the teams on projects that are flourishing to the corporations in which those projects reside.

Build a rolodex of resources you can deploy at a moment's notice. Find great people who are willing to give you great rates and can do great work.

Be disciplined in a process for evaluation
Set clear checkpoints for your incubated projects. If they do not reach basic minimum levels, then they should be shut down ruthlessly. Budgets, time, goals all can be used to create checkpoints.

Incentives are key
Nothing motivates people better than survival instinct and a life or death deadline. The survival instinct is activated when they know they're going to run out of money (like their salary, their means for eating and paying rent, etc.) if they aren't successful. The life or death deadline is activated when they know they're not going to get any more resources or help beyond a certain point. So they MUST be successful or else they're gonna starve.

On the other side of the coin, it is highly motivational to know that their success is also tied to success of their project in a large and singular manner.

Paying them a regular salary from the overall incubator pool is not motivating enough; it makes them too comfortable knowing that they could fail on any idea but still are able to go on surviving. It also severely reduces their urgency, knowing that they're still going to get a paycheck whether or not it launches today or 3 months from now.

Giving them large ownership in a separate corporation formed from their project is. Tying their salary to the separate corporation is even better.

Forming a separate corporate entity per project increases clarity in ownership and process
Keeping projects internally makes it difficult to track and assign costs properly to each project. When you have a separate corporation each with its own budget and resources, tracking becomes easier.

It also makes it clear who owns what part of what corporation, and how much of it. Keeping projects internally removes that fact as you're part of and being paid by the whole.

This clarity extends to funding as well. When an entity is running out of money, you have to take an official step to put more funds into that corporation's bank account, along with all the ramifications in doing so in ownership, and why you have to do so. It really makes you think twice about funding a business that may be faltering or flawed.

As mentioned before, when peoples' salaries are tied to the corporation, then incentives are highly aligned with the success of that corporation, and not blurred with the whole incubator.

Some ideas require a sustainability component to be fully tested
A recurring theme among internet products is that ideas can be launched quickly and once it's out there, people will come and use it, love it, and it will grow. Banking on an idea to grow organically by itself is a recipe for disaster. The problem is that not many ideas have the ability to do so. We often fool ourselves that by launching a new idea live, that people will just come and use it and it will be the next Google. It might happen, but probably won't. Then we get frustrated wondering why it isn't growing, and often end up thinking that the idea sucked and we should close it down.

However, it is deceptive to think that an idea which does not grow organically is a failure. The reality is that the idea might actually be good, but just requires people, time, money, and smarts to apply to it and then it might grow. Thinking through the sustainability of a launched idea and how that can be supported for at least some period of time is really important.

Incubation works great if you're personally trying to figure out what to do next
If you have some personal capital and want to find a new idea to work on, incubation could be for you. I've talked to a number of people who have employed incubation at a personal level successfully. Instead of working on just one idea, they launch 3-4 and work on all simultaneously. Each idea gets funding and their own team. At the end of the process, the most successful idea survives. The other projects are closed down or sold, and you become CEO of the surviving, thriving business.

It could work much better than working on singular idea and trying to determine if that idea is the right one or not. Or working ideas serially. Being serial takes up a lot more time than doing things in parallel.

Yes it takes a lot of time and effort, and requires a multi-tasking brain. But if you're a startup person, you're probably used to working like that anyways.

Find great startup people
Seems basic right? It's actually harder than you think.

Find creative, hard working, caffeinated people who are smart and motivated AND can take a project to a conclusion. Too many people float at the creative, idea stage and don't have what it takes to stay with an idea over time and develop it. Discovering people who are like this is very hard, so beware.

As mentioned previously, keeping them at arm's length makes it easier to get rid of inappropriate people. Be ruthless in culling people who aren't working out.

Young people are great. They can work for long hours, live cheaply, have almost no other attachments in their lives. They will try stuff because they don't know better, unlike us old, jaded, experienced people. They're not so great because they don't have enough business experience to know how to take a business further.

Build an idea with revenue generation on the mind from day one
If an idea is generating money, its ability to sustain itself grows dramatically. Creating products which bank on the free model and gain lots of users, but have no concept or plan for short term revenue, is great for people who have a powerful investor as backer and who is willing to fund growth beyond that point. For an incubator, I would say that this is not a good path to go down and substantially increases risk of failure.

Revenue generation sustains the incubation process
Following on the last principle, if you can find a way to generate revenue immediately, then the incubation process can be self-funded and sustaining, and opens up the ability to try new ideas without deploying more outside capital.

Good luck with your incubation efforts, and I'd love to hear how you're doing if you are going to incubate new businesses.

Over this last year, the topic of exploratory products versus utility products has come up so many times. And I've always felt uncomfortable with products that engage users because it helps them "discover" or "explore" something.

"Discovery" and "exploration" are always so alluring terms. Throughout human history, we've always envied the explorer. Christopher Columbus set out to discover the New World. Lewis and Clark went looking for a way to the Pacific Ocean. Neil Armstrong sets his foot on Lunar soil and declares, "That's one small step for man, one giant leap for mankind." Even watching Star Trek with the Enterprise on their 5 year mission to explore new worlds, we can't help but wish we were on the Enterprise alongside Captain Kirk and Mr. Spock. It sounds so wonderful, so romantic, and speaks to our ingrained cultural tendencies that achieving, discovering, and exploring makes us feel that blazing new territory like pioneers puts us out of the comfort zone and sets our senses afire, and takes us out of our normal, boring lives.

First, I think that there is a segment of the population with a natural "gene" for exploration. I personally know people whose first inclination every morning right when they get up is to go to click randomly on news articles or websites, like StumbleUpon or Digg, or Del.icio.us. They always do this before doing anything else.

Second, I think there are differences in the manifestation of the "exploration gene" based on age. Young people seem to engage in more exploratory behavior. But once young people grow older, they get more responsibilities, their time gets occupied by a whole bunch of things, their lives get so full that there is little or no time for exploration unless you have a natural "gene" for exploration.

To me, exploration is either an activity relegated to a small population relative to the whole, or one that does not sustain itself as a person ages. Given this belief, I think there is a tremendous amount of risk associated with products that depend on "exploration" and "discovery" as the main reasons why users would want to and/or continue using a product.

What's the difference between an exploratory product and a utility product?

Utility products are those which depend less on exploration and discovery as primary tenets. Instead, utility products work their way into our lives because they are essential and we gain continual value from our usage and interaction with the product.

Here's an example. News sites like NYTimes.com are utility sites. We consume news every day and find value from that by being informed. But they also introduce exploration to keep things interesting with their Most Emailed Stories module. But it's not the focus of the site; it's secondary.

Another example: StumbleUpon. I consider StumbleUpon a classic exploration site. You go there because you don't know what you'll find. You have to like discovering new websites and are ok with spending your valuable time doing so. But yet traffic over the last year has been dropping.

Here are the Alexa graphs for NYTimes and StumbleUpon:

Do you want your product's graph to look like NYTimes.com or StumbleUpon?

My basic tenet is:

If you want a chance at success, you must make your product essential from a utilitarian point of view. You can use exploration to make your product more interesting, but if you make exploration your main purpose, you'll reach a topping out point of users and potentially decline over time.

Is it a perfect rule? No, of course not. I am sure if we thought hard enough, we could think of some sites who are successful at employing exploration as their main purpose. However, I'm talking about risk reduction of failure and increasing the probability of success dramatically in my opinion. Wouldn't you want to reduce the risk of failure by a great amount?

It's a shame.

Every week I encounter entrepreneurs. Given that I look at early stage internet deals, a high percentage of them are first timers. And practically all of them have nobody to help them or walk them through the details of creating a new company and funding it.

It's a real shame.

I would be the first to say that I'm no expert on this. But I try to help as many people as possible. Yes, it takes a lot of time but I'm willing to give that time out, even if it's for goodwill and I only get a positive relationship out of it. I just hate seeing people either stumble around on their own or worse, get bad or imperfect advice.

Investors give you advice, but sometimes they aren't entrepreneurs and can't really know what it's like to build product and a company. Or you wonder if the advice they're giving you has their interests wrapped up in there, especially where funding is concerned.

Other entrepreneurs give you advice, but many of them are bitter with past experiences of investors and tend towards telling you how to do things in investor unfriendly ways. Or they have ways of doing things that they like and these may or may not apply to your situation.

Lawyers are supposed to give you advice, but they are only giving you advice that protects you, which is very company friendly. Also, many of them don't understand the different phases of a company's life cycle; they may have only done big corporate financings and have not done early stage. As your experience grows, the things that are important are different based on the size and stage of the company. It's frequently up to the entrepreneur to educate the lawyer on how they want to do things, with the lawyer supporting. But you can't educate your lawyer until you educate yourself. Oh, by the way, you have to pay lawyers to talk to them....

I'm probably one of the few people around who are schizophrenic and can wear both an entrepreneur and an investor hat; my model of advising and investing has helped me understand both sides of the equation. I also try to lay it all out and talk as broadly as I can about the implications of as many things on the table, both company and investor friendly and unfriendly. On topics in which I do not have experience, I say so and try to point them in the right direction.

Yes, my experience base is relatively low, but I am still willing to spend that time with entrepreneurs, because it sure seems like no one else is willing to. In general, I find mentorship to be severely lacking in the hustle/bustle of Silicon Valley...

One thing I've noticed about the startup funding eco-system is that everybody is out to get your money. Unfortunately, that means that you get both people with the good ideas and people with the not-so-good ideas. And it always seems that the people with the not-so-good ideas outpace the people with good ideas by a factor of 100 or more.

A while back I stopped going to the Tech Meetups and entrepreneur gatherings because whenever I handed out my business card and people notice the word "Ventures" in my company name, the emails don't stop. I get pitched by everyone. I even got pitched the other day on Facebook. At some point, I may need to remove my business name from Facebook!

It's too much. The deluge of emails coming in is too much to deal with. I hear it's the same at venture funds; they too are getting too many pitches and are trying to make sense of it all while not losing the opportunity to find that next big thing amongst all the not-so-good things.

Over this last year, I've pretty much switched to the referral model. It means that I never go to tech gatherings but only field introductions from people I know. It's slowed the pace of pitches considerably while filtering them in a much better way. After all, somebody you know isn't going to send crap your way; you have a personal stake in that referral being worthwhile and not a waste of time and don't want to jeopardize the relationship. If an entrepreneur is able to convince someone else that they're good/cool/savvy enough to be intro-ed to me, then I'd love to talk to them.

The same goes with venture funds. As I've gone out there and networked with them, I'm finding that we angels can play a great role in filtering for them as well. We can be a great first line of defense for them, sending only those that we feel good about to them and doing some of the leg work in finding hidden deals through our networks, which are often hidden and hard for outsiders to break into. I've also gotten referrals from venture funds on deals that were too small for them to handle, and also those that I've helped them check out. It works really well in both directions.

As the venture fund world evolves, I can see the relationship between venture funds and angels is going to grow tighter and more useful for both parties over time.

The last half of 2007 saw for me an acceleration of deal flow. I've spent numerous hours with a host of startups. I've passed on a few, gotten further with others. Most I've not gotten involved with, and the remaining few I've stuck with them through the process and told them verbally that I was committed, as long as other things fall into place.

Some of these deals have taken a long time to close on investment, or finalize my involvement. I find that as the weeks become months, that I am feeling a bit of fatigue on these deals.

I have heard this happening to other entrepreneurs where if they take too long, their investors just lose interest and don't want to do the deal any more, or just move on to other projects which are taking up their time. Now that I am toe-ing the edge of this fatigue on deals, I can relate to how these investors feel.

As an investor, I told myself I would not be flaky. When I say I am committed, I want to be just that and not be wishy-washy. I do not want to frustrate entrepreneurs and make them do extra work in chasing down investors who can't figure out if they want to do the deal or not but just stay in that grey zone; I want them to finish the fund raising part of their company building and move back into building the product and business. I have heard too many stories about investors who can't seem to just make a decision to say yes or no and don't want to be like that.

But now I feel some fatigue setting in, and start to ponder not just the fatigue aspects but also the reasons why it's taking so long.

We investors tend to like to pool our due diligence process by watching the reactions and analyses of other investors. So if an entrepreneur can't get the commitment of prominent investors in a short amount of time, then perhaps that is saying something about the project itself. Perhaps something is amiss; perhaps the entrepreneur's pitching skills need work, or the pitch itself needs re-work, or the business plan itself. Add to that other projects demanding my attention - I cannot help but feel that fatigue may actually pull myself out of commitment on certain projects due to my own wavering interest, but also the real reasons why it's taking so long to close on an investment round.

Now that I am experiencing this time lengthening process firsthand, coupled with my own fatigue on projects, I offer this advice to entrepreneurs, which is to close on investment as soon as possible, doing whatever it takes to prepare, make a great pitch, and herd the investments to a close date.

It's a bit like dating; if I go out with a girl many times and it doesn't seem to go anywhere, shouldn't I stop wasting time and move on to someone with whom a great relationship would develop?

So far, I've spent a little over a year angel investing. I've noted before that it's been a fun and rewarding educational process in learning how to angel invest. I've talked to people and got some great pointers, read some books on the subject, read some insightful blog posts, and leveraged my own Yahoo! knowledge in trying to figure out whether I should invest in a business or not.

I've also noticed that I've begun, and now attempting to prevent, a slow slide into "analysis ultra-conservatism." What exactly is this?

Just recently, I've started looking at a lot of deals and but invested in none. I felt like the frequency of my investments has dropped dramatically. Yes, there were many reasons why I did not invest and some of them were out of my control. But I also wondered if something else was at work.

As an angel investor in early stage internet companies, I know that high risk is part of the game. They all have not been in business long enough to show traction, and you need a healthy dose of faith in order to put money in them. Yet, I felt that I was thinking more deeply into a business now than I did before. For sure, I have more knowledge now; I have looked at a lot of companies, heard other peoples' objections and analysis, developed my own analysis process in what I like and don't like. It has definitely moved from an emphasis on liking the product and the team to many other business aspects. This is all good and makes me more seasoned. The bad thing is that the more knowledge I get, the more things I find wrong about a business and shy away from investing.

So, as your knowledge and experience grows, you get better at analyzing companies but as you get better at analysis, the list of problems grows and you start finding reasons to not invest, hence, the term "analysis ultra-conservatism."

A friend of mine once said something very insightful about early stage investing, which is:

There is always something f**cked up about EVERY early stage startup.

I find myself repeating this to myself over and over as I do not want to fall into the trap of "analysis ultra-conservatism." I cannot remain an early stage investor if I do. I know that it is a good thing to get more experience in analyzing companies and opportunities, but I have to remember my friend's insightful quote and stop myself from over-analyzing and becoming risk averse simply because an opportunity has faults in it. ALL EARLY STAGE OPPORTUNITIES HAVE FAULTS! I must remember to keep in mind that there will be faults and to decide on the positive factors that remain.

These last few weeks have been really hectic. For a while, it seemed like I wasn't looking at any new deals whatsoever. I resigned myself to working on the companies I had signed up with but also could see that my work with them was starting to taper off in an expected fashion.

But then it changed. All of a sudden, a flurry of new opportunities came down and I found myself meeting with companies every week. It actually got fairly hectic, meeting up with entrepreneurs and actually going through some due diligence processes with a few companies. But one by one they dropped off my radar. As they dropped off my radar for a variety of reasons, some interesting observations came to light about the way startups and investors strategize with each other.

The Entrepreneurs' Perspective

The most sought after entrepreneurs/startups get deluged by requests from angels to invest in them. Typically, they are also pursued by venture capitalists who also like what they see and want to participate. The availability of money to these entrepreneurs creates an situation where they can pick and choose the money they receive. I've seen them go in these directions:

1. They go directly for the big VC investment and skip angels altogether. Let's face facts: raising money sucks. It's time consuming, you get a lot of negativity from people who don't believe in you, and you'd much rather be building something than begging for money. So why not skip all the nonsense and just take the big money and go back to building your business and hiring people you need.

2. They take the VC investment but only bring on some angels who are either high value or friends. Similar to 1., they get the big money but only bring on those people they like or those angels that can help them later.

3. They delay VC funding to push up their valuation, and only pick a handful from the crowd of angels wanting in. The most bold of entrepreneurs who are on to a good thing will press their advantage by not taking big money now, which could mean they have to give up more of their company at this point, and wait to build their business a bit more which raises valuation for later and, thus, gives them a larger advantage for not giving up so much of their company later in exchange for a large VC raise. They instead raise a smaller amount (ie. $500k - $1MM) which gives them the ability to run for enough time to build their business to a more valuable state.

4. They want angels who are active investors and can bring value to their company. More and more I speak to entrepreneurs who only want angels who can help them in their business versus just bringing money alone. It makes sense; angels who can help are more motivated to help because they have skin in the game. It does make for a tough environment for those angels with only money to give.

5. They are limiting the number of angels and/or investors. Managing a lot of investors can be troublesome to entrepreneurs. Simply cutting all the paperwork (ie. stock purchase agreements, stock certificates, etc.) can cost more money. Collecting the money can be tough for those angels who are dragging their heels in transferring the cash into your account. Dealing with nervous investors can be a draw on resources as you need to respond to their requests for information and calming their anxieties about whether or not you're going to make money for them.

This all goes out the window for those entrepreneurs who don't have something hot enough to attract lots of investors.

The Investors' Perspective: Herd Mentality, Joining the Herd

As an investor, I want to get in on the great deals. Finding deals that are good but are hidden can be really tough. It's more often that there is a common opinion about a startup and that everyone wants to get a piece of the action.

I try to do my own due diligence. I also try to form my own opinion about a startup. But I do find it difficult to ignore what others' think about a company. Over these last few weeks, I've looked at bunch of deals where there was a large number of investors trying to get in. But I've somehow lost out on a number of them. Why was that? Some observations:

1. Herd mentality is inescapable. For some reason, when many people think you have a hot deal, then you tend to think so too. They must know something you don't, or you bank on someone else's expertise, or you just don't have time to do all the due diligence yourself. Thus, I tend to look more seriously at deals with lots of interest, even when I tell myself I'm going to be disciplined enough to do all the due diligence on my own.

2. The investor herd piled in, wanting to invest into a startup. It's a common scene around the valley. The hottest deals get shopped around the most popular and prominent angels who are all high value and high profile. They have lots of money and value to bear on a deal. But they also have their friends who come in on the deal. So a combination of being able to keep in an entrepreneur's mindset and haivng the herd not forget about you, thus keeping you in the entrepreneur's mindset, helps to get you into a deal...or not. I have not been really part of any investor herd before so it was literally impossible for me to stay in an entrepreneur's list of investors as they get deluged by a huge number of people and can barely manage the flow of communication. I know I've been dropped off investor lists because of not being part of a herd.

3. Joining a herd became a worthy goal. As I thought about reasons why I missed out on deals over these last few weeks, I started thinking about how I could join a herd. I don't like to bill myself as a guy who can do lots of investor intros now, but knew I could get there in a few years as I worked with more and more people. But now I think about the networking aspect more, and using entrepreneurs to introduce me to some prominent angels and VCs around the valley. Slowly but surely, I am starting to not be forgotten amongst the investor herds, which is a good thing. So far, I think a combination of personality and value has helped me stay in the mindshare of herds. I meet people and show them that I'm a cool guy and not a wonk, and that my experience can actually help a company that we may all be investing in, and things seem to be happening.

4. I am trying to standout in a herd. If you demonstrate that you can bring high value to the company, staying in the list of investors for a given entrepreneur becomes easy. I can sometimes stay in a deal where other investors with lesser or no value to a company beyond just cash get dropped. I have found a great variance in entrepreneurs in whether or not they find value in what I could bring to their companies. If entrepreneurs don't find value in what I bring, then the probability becomes much greater that I will get dropped from their investor lists.

5. I need to constantly follow-up on deals I want in on. In the past, I've relied on entrepreneurs to contact me when they're ready to talk investing. However, a number of them have dropped me simply because I didn't do my part to stay in their mindshare. Shouting loud via email or phone works well and helps a lot.

Lots to keep track of in the ecosystem of investors and entrepreneurs in order to not be forgotten amongst the herds of investors roaming Silicon Valley.

In working as advisor and angel investor to startups, I find that I can be schizophrenic at times. Three faces I wear, when dealing with entrepeneurs:

INVESTOR

Characterized by:
1. Paranoia about losing my money.
2. Saying "sell the company"; starts when my return crosses about 5x my investment, and becomes a yell when my investment hits 10x.
3. Motivated by what my terms say for Notes.
4. Recommending courses of action which generate a lot of cash for the company, which increases value of the company and thus my investment.

ADVISOR

Characterized by:
1. Recommending courses of action which build the company.
2. Seeking the best ways to create product and do business.
3. Balanced view towards generating revenue in the company versus building product, which can be at odds if, for example, we're talking about advertising and internet users.
4. Might recommend against selling the company given what I have seen when bigger companies absorb smaller companies.
5. Seeks the best employees and resources to do the job. Pushes those resources to build the company bigger and faster to exclusion of other things like sleep.

DAVE SHEN HUMAN BEING

Characterized by:
1. Tends towards recommending humanistic approach to treating employees.
2. Wants to grow employees, sees them as learning over time, nuturing them to be better.
3. Coaches people to balance life, work, and family. Asks what makes people happy and what keeps them motivated, encourages people to find this in the company.

If you've been in the startup game for a while, you'll know that these three faces I wear are often at odds with each other and conflict in goals. For example, how can I counsel people to balance work and life and go home at 5pm to make time for family when as advisor, I want these guys to work 24/7 because the startup needs it, and as investor, I want them to work so freakin' hard so my money isn't wasted?

When I start working with someone, one of the first things I tell people is that I can be schizophrenic. They always laugh and sometimes I can see that they don't get what I mean; the more experienced ones snicker and thank me for being upfront!

It can disconcerting to have a guy like me advising you to do one thing and then tell you to do something else in opposition to what I just said a while ago. It's because I do wear many different hats, and the forces within me struggle every day to push/pull me in several directions. It's a challenge to find a balanced answer, and I like the challenge of finding a solution that satisfies all of my three "identities". I just hope I do not drive any of my entrepreneurs nuts by my triple schizophrenic state...

I went to my first Ycombinator Demo Day this last Thursday. I wasn't sure what to expect, except for the fact that a whole bunch of startups created by near-college grads would be presenting their projects. I definitely wasn't expecting any well-thought out business plans but was hoping to see some really cool stuff.

After the event, much has been written about the companies themselves, and you can read about them at VentureBeat: The Ycombinator List and at TechCrunch: Ycombinator Demo Day: The Summer Class. There has been enough coverage about the companies, so rather than do that I wanted to write about something else regarding the Demo Day.

Usually when you sit through pitches, they can be relatively dry. You see lots of graphs and how big the market opportunity is and it's usually a more serious and professional presentation.

For Demo Day, I was pleasantly surprised that each presentation had a healthy dose of humor cleverly injected. I found myself chuckling at funny demos, laughing at jokes made at competitors' expense, and smiling to see them laughing at themselves. During one of the breaks between presentations, I stopped to say hi to Paul Graham (co-founder of Ycombinator) and asked him about whether or not he encouraged humor to be part of the presentations. He said they were actually more humorous during the dry-runs and that he actually pulled them back from being too over the top. I shudder to think what they were like before he pulled them back...!

Sitting through 19 demos for 3+ hours could have been a truly grueling affair. I am glad that the young graduates of this summer's Ycombinator class threw some humor into their demos and turning a potentially boring, lifeless afternoon into a more lively event.

I was just recommended this excellent book called The Four Steps to the Epiphany by Steven Blank. It describes a particular problem I've encountered with some of the startups I've met with.

Some of the entrepreneurs I've met with lead with the business opportunity. They say that the market is this big. They have charts and research to back that up. They show millions upon millions, if not billions of dollars spent in this market alone.

Then they present this product that fits into this market. They go on to say that we can attack this market opportunity by building a product to gather all these eyeballs, users, consumers, whatever and then sell this market to advertisers and marketers.

It always worries me when they lead with business opportunity.

Most likely what I discover after is:

1. The entrepreneur is not a model customer of this market. They have come upon this opportunity through research.

2. The entrepreneur has researched business opportunity but has not researched what customers want. While it may be true that marketers spend millions and billions of dollars trying to reach these consumers, the entrepreneur has not asked consumers whether they want the product he is building.

3. I often get a defensive response when I tell them this is an issue.

Which brings me back to The Four Steps to the Epiphany. Author, Steve Blank describes the Customer Development Model, which is an iterative method of figuring out what customers actually want, versus driving a business with financial projections and product development and assumptions that the product will be accepted by consumers. He argues that every successful startup runs by this model, and that running it by traditional product development models brings a huge amount of risk into whether the business will be successful or not.

Reading about the Customer Development Model brought me back to those meetings with entrepreneurs who are trying to build companies using traditional methods. Those meetings left me feeling uncomfortable and ultimately, following my instinct on these matters, I would often let the opportunity go. I am glad to be reading this book, because now it frames my uncomfortable feelings into a way of articulating them better.

As an angel investor, I want to reduce risk whenever possible. I find that when entrepreneurs resonate with the market and are building a product that they are target markets for, then it minimizes risk. This also means that you get extra passion for the product because the entrepreneur wants the product for himself, and you may reduce the need for external research to figure out what customers want, which reduces cost and time which could be used in building the product.

That's not to say that someone couldn't be successful if they don't fully or completely resonate with the product and are the target market. Success is a probability game and when entrepreneurs are themselves the target market and they resonate with the customers, then you stack the odds in your favor by a great deal.

When I started David Shen Ventures, LLC, I originally thought I could advise only or advise and invest. The latter would be a form of watching my investment by helping the startup in a formal fashion. I also thought that in certain cases, I might only advise but not invest.

So far, I have not invested in all of the companies I am involved with. In most of these cases, I just missed the opportunity to invest because I could not get in on the series A, or that opportunity had already passed. But there is the case where I could invest but choose not to.

Originally, I had just started up with entrepreneurs and signed up as advisor whenever the opportunity arose. I had not given much thought to points at which they would get to raise funds, but only to make my involvement formal by completing the paperwork. But now I am wondering about whether I should continue this method of operating or change it.

Why would I not invest but still advise?

One big one now is that I am coming to the end of my allocation of funds for this purpose in my budget. I had originally set aside some money out of my own pocket for angel investing as a means of diversifying my overall portfolio while making a new career out of it. I was planning to stop when I reached the end of that block of money and take stock of my operations and investments to see how I was doing. I near that limit now.

Another reason is that I have, at the time of this posting, 8 companies I am working with. Being an advisor allows me to increase the number of companies I am involved with, but potentially lower my exposure to investment in too many companies that I could effectively watch over as advisor AND be investor in. My model is to not be a passive investor at this point, but be active only (I may change this strategy later). But I do have A.D.D. and love to be involved in more companies than less, so I know I can sign up as advisor in more companies than I could be investor in.

But sometimes, I work with the entrepreneur a bit and just come to a point where I think I can help the company but my funds are better deployed elsewhere. It's a hard choice to make as you think you can help anyone, but sometimes you can and sometimes you can't help them in a way to make the company take off on a super positive trajectory.

That doesn't mean that the company has no chance (in my view) but just means that I can't help them as much as I'd like to be helping them, whereas for other companies I am adding a tremendous amount of value and seem to be making a huge difference in their trajectories.

So in deploying my own funds, I have to make that hard choice in deploying money in the companies with the maximum trajectories and me helping them. And not everyone is on the same slope of trajectory. It's a really hard to choice to make.

Recently, there was an unanticipated effect. Because I have decided not to invest, other investors have begun to ask why I have not invested. This is naive in my view, as they just assume I would invest in everything I'm involved in, which is not true.

Seeing as how I may not be able to fully explain my operational model to everyone, this unanticipated effect has me re-thinking about whether I should advise a pre-money company but not invest. I do not want to inadvertently reduce a company's chances for investment by putting doubt in other investors' minds about a company's prospects.

No particular solution comes to mind as of yet, but it is something I am working on more fully now. I may slightly change my operating model with entrepreneurs to not officially sign up as advisor until much later and until a lot of the business and product plan as been set. At this point, I can really evaluate whether I will feel comfortable investing and advising or just not continue my involvement. If I sign up as advisor too soon, then I may get myself in a situation where I am advising but when the first funding round comes, I decide not to invest.

Definitely connections is one of the most important parts of my involvement with startups. I introduce them to people I know in other companies for potential partnerships, I help them hire people (although I have to admit my record here is abysmal), and I try to meet more new people in case they may present opportunities for investment, partnership, or acquisitions later.

So I try to meet as many people as possible. But I've learned a lot about this introduction and meeting thing. Some thoughts about it:

1. In general, I try to meet as many people as possible, and as many as will meet with me.

2. I have discovered that it is impossible to meet everyone that you want to meet. It sucks but it's true. More on why in a sec.

3. Time is a so precious. Filling up your day with meet and greets is tough and it doesn't give you time to get your other work done. So I have to limit these kinds of meetings as much as possible.

4. Filtering becomes super important. As you can imagine, those with immediate purpose and importance come first.

5. Making introductions is also an important skill. Here is my process and thoughts:

a. I identify a possible introduction that should be made. In general, I try not to do more social type meets but want them to have at least a purpose. Think of it as a courtesy on peoples' time demands and not wasting them, and also it gives them something to talk about which will reduce awkwardness.

b. I hold my contacts close and don't frivolously make introductions. I am keenly aware of not creating an image where Dave Shen sends frivolous introductions around. That would reduce the possibility of someone responding to an introduction. My goal is to have a 100% response and connection rate, so I think deeply about whether to make the introduction or not.

c. Timing on the introduction has come up often. When to make it is important as you don't want to intro too early and want to do it when both parties are ready.

For example, if a startup is working very hard and if I judge their resources to be strained too far, I won't make another business development intro until they get more resources or some brain space frees up. The worst thing is you send them the intro and then nothing happens until much later. Or if the startup has nothing to show yet, then I don't want the intro-ed party to feel like it was a wasted meeting because it was too early to talk about their product since there was no demo.

d. While I do not bill myself as a fund raiser, the few investor contacts I do have are important to me. Asking for money raises the stakes of an introduction. Thus I will not make an introduction to an investor until I feel the company is at a place to put a really good foot forward. I do not want to make it unless they will look good at the meeting. If they look bad, then I will look bad for sending an unprepared company to that investor contact. I also won't make an introduction unless I have put my own money in. I feel it is the ultimate vote of confidence for a company when you have your own skin in the game. I do not want to come off as sending what may be perceived as random companies to them. There are plenty of people who are professional fund raisers who do this and do not have any skin in the game. I want to operate with bit more confidence than these guys.

e. I try not to deluge someone with introductions. For example, at a recent meeting with a media company executive, we discussed many of my startups who may be potential partners of theirs. He got excited about all of them. But I did not want to throw all the introductions at him at once for fear that he may not get to them, or they may get lost in email, etc. So as a courtesy to both introducees (is that a word?), I think about the tide of introductions racing at them and try not to overdo it, and space them out.

f. I always try to follow up on introductions. I want to see how they went, and pass feedback back to either or both parties. I also want to double check my introduction methods and make sure I am hitting as close to 100% response and connection rate as possible. I also want to address potential problems on the rare occasion that they occur.

6. Getting deluged myself with introductions is bad. If I meet someone who can intro me to several people, I tell them to slow it down a bit. I do not want to drop one or two because they get lost in email or from my brain. Sometimes, I am scheduling out many months and my calendar is super-important to me. As a personal goal, I try to get to 99% of my emails and always try to get back to those whom I say I will meet up with. I like saying I'll do something, and then actually do it. I don't like it when someone says they'll meet up with me but don't mean it. I intend to be as clear as possible, which unfortunately is really hard. Better to head it off with the introducer and be clear with them before they send the introduction email.

7. I have found there are many who are not what I would call socializers, which enjoy meeting for the sake of meeting with no particular goal for the meeting other than to connect. There are those who don't seem to meet anyone who does not have a particular purpose for them. Whether this is good or bad I cannot be the judge, as everybody has their own way of working and time demands.

8. I always confirm a meeting the day before. You never know when someone else may drop you off their calendar. It's always good to remind them that you're meeting with them, again as a courtesy and also it's a good time to remind them of why you're meeting.

9. By the way, I always space travel time between meetings. I try not to pack them so closely together time-wise. This also goes for how many of these types of meetings I can do in one day. Generally, I try to space them out across days as well. Going through a whole day of meetings with people you haven't met before is tough for a guy like me (call me an introvert with extroverted tendencies!).

10. Some people network solely for work purposes. There is almost no notion of personal relationship they build. You can tell by what they ask you about, what the conversation is about, and reasons for contacting you later. You never go out for a coffee with these people, or grab a brew. It's kind of cold, sometimes empty. It creates this feeling that you are only useful to them for one thing, which is business. I prefer to look for opportunities to create a relationship that goes beyond that of business only. I think this creates a richer relationship than just for work alone. If they know and feel you are a good person and you connect with each other at that level, I think you'll find that the relationship tends to work better and have more opportunities than less. Who wants to work with someone who isn't cool to hang out with?

Bottom line: introductions, connecting, and meeting are important parts of my work. I do my best to try and not waste the relationships I have built with these people, and create value with each relationship I have.

This is an impression of a "tough dog", as performed by entrepreneur whose determination is shown through gritted teeth and never failing optimism in the face of rejection, sleepless nights, and stress at starting a new company.

It's easy to give up. Retaining confidence, determination, and forward moving energy is super tough in the face of constant adversity. Rejection, business deals moving too slow, running out of cash, wondering when revenue is coming in, investors and partners beating on you, your staff is not working out and you need to fire them - the list goes on and on of things faced by new entrepreneurs.

But you can't give up. If you do, then you may never realize your dream of watching your company and idea flourish and grow. You need to learn that the world is going to constantly try to beat you down and you have to live with that, roll with the punches, and keep moving forward. There will be times where it will seem you've hit rock bottom, but only to fall even lower. You, the budding entrepreneur, need to expect this, prepare yourself, and keep saying to yourself that it will get better, and to drive towards making it better.

Because if you can't adapt, then maybe you shouldn't be an entrepreneur. You'll die of despair and never get anywhere. Know yourself before you embark in entrepreneurism.

Or...learn how to say:

GRRRR ROWRRR ROWRRR

It really works.

The other day, I met a guy who told me about a situation he was in where he was a consultant for a company who got in a legal dispute with another firm. Then he got tangled up in the lawsuit and got sued by the other firm and was forced to defend himself with his own funds because there was no clear indemnification in any contracting agreement.

At the moment, this guy is shelling out between $25K to $50K per month out of his own pocket to pay for legal fees. There is a soon to come happy ending though. It turns out that this guy was employed through another temp firm while working for the company. While indemnification was not explicit, it just so happens that employees are automatically indemnified via the California Labor Code (see section 2802) and is the same for pretty much every other state's Labor Code.

However, had this guy worked directly for the company without an official statement of indemnification as a consultant, he would have been really screwed. There would be no clear path for indemnification and thus reimbursement for legal fees.

Very scary. How would you like to pay out of pocket legal fees of $25K to $50K per month, and for months on end?

As soon as I heard this story, I called my lawyer and thanked him for being so adamant about indemnification.

In my journey to implement indemnification, here are my thoughts and discoveries:

1. Ignorance of the state's Corporation Code, especially with respect to indemnification, is common among the lawyers I've worked with. So they err on the side of company favorable tactics, which is to never give anything away, including indemnifying advisors.

2. Not knowing or understanding indemnification is also shared by investors and other entrepreneurs.

3. It's very much a worst-case scenario discussion. It's difficult to discuss sometimes.

4. Experienced entrepreneurs have no issue with it. They just assume they'll protect anybody that does work for them. It's natural for them to thank people who help them in that way.

5. By the way, all the Corporation Codes stipulate that in the case of an external person causing harm willfully to a company, the Code states that indemnification is invalid, even if a contracting/consulting/advisory agreement calls for indemnification. By the way, there is the case of unknowingly causing harm which is a huge grey area and would probably have to be explored on a case by case basis.

If you're interested, you can read about indemnification in the California Corporation Code or in the Delaware Corporation Code.

6. No matter what, I do not want to put my personal assets at risk for another company. It doesn't make sense at all.

7. I will definitely walk away from any deal that will not indemnify me as an advisor. It is a deal breaker.

Raising money is never fun. When the time draws near to a date at which you want to officially stop fund raising and collect the money, things tend to get pretty hectic.

So what happens exactly? And who is involved? What are things you should watch out for?

Let's say you created a term sheet X weeks or months ago. You've met with a whole bunch of investors and some of them say they will invest (usually we say "we've soft circled them"). The term sheet has been negotiated and potentially changed, and you circulate that back to each investor and finally everyone says they're on board and they're ok with the final term sheet.

And then, time draws near and you realize it's time to get serious and actually get the money. What happens?

1. In the financings I've done, the law firm project manages this process. They help circulate the documents, gather signatures, send reminders, etc.

2. The law firm has an escrow account where investors wire their money. As one entrepreneur I met put it, "The reason why you wire to an escrow account is to prevent us from absconding with your money (if wired into our own bank account directly) to the Cayman Islands before all the official paperwork was finished ."

3. The law firm takes the term sheet and expands that into official paperwork that spells out the terms in detail. The investors sign these documents and they make everything official. This paperwork is passed back to investors for review and signature.

4. Due diligence materials from the company are sent to each investor upon request (and I HIGHLY recommend that) to make sure everything is in order. Every company document is sent, every record, every contract - just about everything. Thankfully for early stage startups, there isn't that much paperwork to review. But imagine if you were to do due diligence on buying a company like Yahoo! or IBM. The due diligence alone would be staggering as you reviewed every contract, every patent, every legal dealing, every lawsuit - everything that could introduce risk into the investment. You don't want to miss something that could turn what appears to be a great investment into zilch.

5. The CEO devotes his/her entire life to the closing during the last 2-3 weeks before close of the financing. He calls every investor and double checks to make sure they are still on board. He fields any last minute questions. He assures investors that the close will happen and makes sure everyone knows to sign papers, wire money on time, etc.

6. Investors need to prepare the cash for wiring. This could take some time to prepare if the investor needs to sell stocks, or get out of other investments. They may need to give their money manager lead time to make sure cash is available. Even the wiring process takes time. I fax in requests the day before with wiring instructions just to make sure that they get in on time. If the money is being wired internationally, you have to be wary of the fact that it could take additional time, or the wiring may not even be accessible to that account from theirs. More warning is always better than less.

7. Signatures also take time to collect. The law firm project manages the collection of the signatures and makes sure that everybody has signed the right papers on the right lines.

8. After the money is collected and the paperwork signed, then the law firm gets copies of signed paperwork back to the investors and, if it is an equity deal, prepares stock certificates and sends those back to investors as well. Other paperwork that goes back to investors can include receipts for the money wired; one law firm prepared a huge notebook for me which had all the involved paperwork in it. Very nice!

9. Be prepared for high stress situations as the time draws near, the lack of sleep, distractions up the wazoo. You must remain focused and determined through the whole process.

So there are never problems, right? HA. What COULD happen:

1. At the last moment, one or more investors back out and you're left with less cash than you expected, perhaps substantially less.

2. Other investors backing out could cause even more investors to back out. It might be interpreted as a vote of no-confidence for the investors.

3. Some strange investors could keep saying they'll send you money, but it never shows up.

4. Unfortunately, I have also seen the law firm flake out which is REALLY BAD. All the more reason for the CEO to keep tabs on EVERYTHING and make sure it's all moving along.

All sorts of things can happen which can spoil your day. As CEO of a startup and going through this process, you should make sure your full attention is on this and be ready to adapt to changing, chaotic conditions - but rejoice when you get every investor that you say you got and see that money arrive in your bank account.

It's so funny when I hear people being so protective of ideas. (People who want me to sign an nda to tell me the simplest idea.)

To me, ideas are worth nothing unless executed. They are just a multiplier. Execution is worth millions.

- Derek Sivers, president and programmer, CD Baby and HostBaby

I just found this quote in 37Signals's book, "Getting Real", which is an awesome book on super fast Web development.

It says it all.

So far I've had a few entrepreneurs ask me to sign an NDA before talking about their startups. Each time, I politely decline. My main reason for declining is just what Derek Sivers says in his quote. Ideas are just that - they are just ideas. No substance, no solidity yet, but just words. Execution is harder than you think. Just because you tell me your idea doesn't mean I am going to go out and build it. In fact, I have no desire to build it. I recognize that it's your idea and that you are the best person to execute it, not me. And I don't have the time or desire to execute it, nor is it my business model to build stuff.

So in essence I am saying that there should be no fear about sharing ideas and that goes both ways. I don't mind throwing ideas their way as much as I like hearing them. I toss out ideas all the time and I don't look for monetary return because I know that 99% of the time, they won't be able to or have time or desire to execute on them.

But occasionally, they may find value in my ideas and actually do something with them and make their product stronger. That's a good thing. But most of the time, they'll need the originator of the idea to fully explain the idea enough to the entrepreneur so that they can internalize it and be able to execute against it. In that, I build value for my services and it helps sell my value to a startup.

Here are my thoughts about NDAs:

1. If I sign an NDA, then I'll be bound to not reveal any ideas from my interactions with them for the length of time designated in the NDA. While I have no problem signing one if I do work with them in official capacity, it is possible that I might end up not working with them. If I don't work with them, I could be hampered from working with any other company in the same space because I might inadvertantly reveal some bit of knowledge that could be taken as confidential by the company I signed an NDA with.

2. If for some reason I were to sign lots of NDAs, I would have to manage the NDAs which is a nightmare. I'd have to remember when each NDA started and when they would end. They could all have variable expiration terms. The chance of slipping up would be incredibly high which could put me at legal risk.

3. Negotiation of NDAs would increase my legal fees. There are mutual NDAs and one-way NDAs. There are those that go in perpetuity and those that end in 1, 2, 5 or any number of years. There is no standard NDA; the conditions are written based on the situation. I'd have to go through negotiation on every one.

4. If there is something you don't trust me enough to tell me, then don't tell me.

5. Trust is an essential part of my business. You gotta know when to keep your mouth shut and no piece of paper is going to help with that.

6. I have and will walk away from companies who require NDAs to hear about what they are doing. It doesn't matter how cool the company seems to be. It just isn't worth the hassle. There will ALWAYS be other companies and opportunities.

Rejection sucks. You spend umpteen hours on your deck, you go through trial runs and field criticism and incorporate feedback, you redo it again and again, you spend hours driving around to meetings, you brush your hair for the first time in weeks and pretty yourself up for the pitch. When you get there and start, you look around the room and the body language is clear:

What is this guy talking about?
This'll never work.
Where am I going to lunch?
This is a dumb idea.
I can't believe my partner dragged me into this meeting.
When is this presentation over?
I need to pee.
Way too many competitors. Why even touch this market?
Yawn.

And the list goes on. All from subtle and not-so-subtle bodily cues. Or overt vocalizations.

You throw your heart into the pitch and you wonder how these guys could be so blind! Why don't they get it?

At the end, they usher you out with a polite, "We'll get back to you."

Your heart drops. You walk out dejected. Nobody likes you. Everybody hates you. Self doubt creeps in. Life sucks. You grab a beer and drown your sorrows vegetating in front of Tivo.

You wish everyone could just see why your idea is so great. But it's just not so. I wrote about resonance way back and think it also applies to investors. They need to be able to feel the idea, to get their brains and hearts around it. And unfortunately, not everybody can resonate with every idea. It's just the way the world is.

So steel yourself for rejection. It will come and you'll see it a lot. Build your resistance to letting rejection take you down emotionally and energetically. Practice blowing it off so it doesn't wipe you out. Because it only takes ONE investor to resonate with you and your idea, and they will give you the cash to make it to the big time, and then you can say, "I told you so" to all the nonbelievers.

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.

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.

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!

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...

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.

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.

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.

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.

Three of the companies I'm working with are now approaching the fund raising process. Often with these entrepreneurs, there is a lack of exposure and experience to how the investor process works. Here is an (edited) excerpt from an email exchange regarding some details and expectations from the fund raising process, and about an upcoming meeting with a prominent angel investor:

I'm glad I broached the subject. Thanks for the detailed and insightful response, Dave.

DSHEN: I consider it my job as advisor to teach you as much as possible and get you up the curve as fast as possible to set your expectations correctly, to prepare you for the best and the worst, but also to have a really fun time at all this ;-).

What's a likely scenario in your mind?

* Send term sheet and 1-pager immediately

DSHEN: I think this is a good idea. It will help keep the mtg shorter and you and he can focus on his real questions.

* Meeting on Thursday

DSHEN: Present your deck, field his questions, pray for positivity.

* How many more meetings until we close a deal?

DSHEN: No idea. It will vary from investor to investor. Generally if you have a group of investors, you'll get a general "I'm in" and you should add them to your list. You'll always have to check back with people to make sure they are still "in". Sometimes they may drop out. This motivates you to close funding as soon as possible.

And lastly, we get our nice Preferred Stock certificate in the mail from your law firm a few weeks later.

* Dave, it is my understanding that if this investor is in, you're likely to close as well?

DSHEN: Actually my commitment to you is not dependent on that. I have already said that I would invest and now it's a question of exactly how much I will put in, and a final review of terms. Also, I will need the advisor agreement signed with you since that's how I operate, which is I require that I be an active participant (advisor) with any firm that I invest in, on the assumption that my help will raise your chances of success than without my help, thereby somewhat protecting my investment.

BTW, you'll find that some investors won't invest unless somebody else goes in too. A lot of people go on the opinions of others, especially those who aren't as good at evaluating companies in the internet space. Some won't go in unless you reach a certain threshold of dollars committed, also as a way to gauge others' confidence in you. Be prepared to deal with this in your fund raising travels.

* Would we close with just you two, or would we have to wait for other investors to come on board as well?

DSHEN: Most likely with a dollar amount of $1MM, you'll have to have other investors at the angel level. Unless you find someone who LOVES you and what you're working on, AND they are richer than you or I can imagine (there are a few people like that in the valley). You already have a small list of people who have verbally committed; ask your partner about that and I believe I am already in that list.

I understand that these things are not entirely predictable, but we still need to have a clear plan, with milestones and tasks, so we know what we're aiming a and so we can track progress and change our strategy when things don't go as expected, and so we can plan for our finances in the meantime.

DSHEN: Yes, hence my comment on setting a closing date. You should be doing regular check-ins, on progress and keeping a list of investors (ie. Contact info and contact progress (ie. Sent term sheet, no response, got warm response, referred me to his buddy, etc.), amount committed or not, did they refer you to someone else so you can thank them later, how did the mtg go?, were they assholes or not :-), etc.)

Last word on this fine cold NYC morning: find investors who are going to help you if you can. Taking non-helpful money is OK, but not as nice as getting someone involved in your company who has skin in your game and can also help your business, like leveraging their list of contacts. Sort of like when I invest, I am doubly motivated to help you than if I'm just an advisor.

Some other notes about investors:

We're dealing with a large sum of money. $10K, $50K, etc. are especially large sums of money for angel investors. You'll find that money changes people and there will be some people that will say they will give it to you and then pull out at the last moment. It's frustrating and you'll wish that people mean what they say, but be prepared to encounter some who won't be able to part with their cash, even if they insist that it will show up tomorrow.

If a few pull out, this could mean that you won't be able to close and you'll have to go back out and raise more money.

Keep the number of investors as low as possible. There will be people who can't stop bugging you about how their money is doing. This is also related to the previous point; this sum of money is a large amount of money and there will be people who will be overly paranoid about losing it. Experienced angels won't act like this since they've done this before, but the likelihood of it happening with unexperienced angels is fairly high. So keep the number of investors low; it will reduce the chance of this happening and reduce the chance of added distractions in keeping investors happy.

The fund raising process can be filled with frustration, consumer incredible amounts of time, and be extremely rewarding building your confidence and your rolodex with each meeting. Have a positive attitude through the whole process, don't give up, and have a great time with it.

As I started angel investing into startups, I began realizing that the amount I was investing gave me virtually no leverage to affect terms. The largest investor typically has the most power to affect terms, since the entrepreneur wants their money the most. They are more likely to negotiate and do what that investor wants than other small fry...like me.

One goal I have is to take the cash I set aside now and try to build it over the next few years to a point where I could be lead investor and really affect terms. This usually starts happening at around a $250,000 or more investment.

But I did find one place where I could actually affect terms without requiring large sums of money. First, I asked my lawyer to draft an example Series A term sheet. I also asked him to make the terms balanced towards investor and the company. This was an important point; many times now, I have seen investments go much quicker when the terms were more balanced. This is even true with my advisor agreement, which is neither overly advantageous towards me or the company. It reduces negotiation, and thus legal fees and time - both of which are desirable.

Second, I start advising these companies very early, even pre-incorporation. I help them in the process of defining their fund raising strategy, and give them my sample Series A term sheet. They love that. Otherwise, they would have to get it from their lawyer and that would cost extra cash. Instead, they present that to their lawyer who reviews it and is usually agreeable on basing their actual term sheet off mine. it would cost them extra cash to alter it later to the requests of potential investors, as well as costing money to go over it with their legal help to understand it all.

This is good because now I have a fair, balanced term sheet which I am investing in, rather than something created by the legal support. Given that most entrepreneurs are new to the fund aspect, and the fact that lawyers will most likely default to a company friendly term sheet to protect their client, being aggressive at presenting a sample term sheet which is balanced provides an opportunity to create a situation where I can actually affect terms and not be the lead investor.

Well, I finally saw it myself. Two friends of mine just raised venture capital for their startups on...a POWERPOINT.

Before this time, it was by rumor that I heard people were walking in with ideas and getting funding. No company, no corporation, no IP, no technology...nuthin! But getting $1MM to $4MM committed. And the rest of the world struggled along with their business plans and prototypes...

I tried to quantify what made these two people unique. Here are some thoughts:

1. They are both very persuasive presenters. Very good at pitching their ideas.
2. They were well-known to the venture fund. Both people had fund partners begging them to start something...anything...so they could fund it.
3. They had decent track records.
4. Both had high integrity, so trust is a factor. They were also very realistic about their prospects and didn't oversell or overcommit.
5. Both could attract talent amazingly well. While everyone else was struggling to hire, these two got committed employees with no company existing! So they were well-known and trusted to the people they got on board.
6. Of course their ideas were pretty damn good too. They were presented as very well thought out ideas and with an answer for all tough questions.

Sorry Microsoft, but I don't think Powerpoint had anything to do with their success. Too bad if that was all someone needed was advanced presentation software to get funding...!

As I wrote my last post, I just found this very amusing post, which has some element of truth to it:

The Venture Capital Aptitude Test (VCAT)

Take the test and see how well you do. I got 28 points, which means I should probably just stay away from being a VC and keep doing what I love doing, which is what I'm doing now...

Sometimes I get asked what it takes to be an angel investor. It also leads to insight into whether or not being a venture capitalist is the right career. While I am not an expert at either, I do have some observations from the many months I spent trying to raise a venture fund and now ending up as an angel investor. These observations are by no means complete or exhaustive, but for now I think they serve as one man's look into the world of investing in startups. These are the results of conversations, feedback, and personal thinking and experiences:

What Does it Take to be a Venture Capitalist?

Beyond that magical ability to pick companies/businesses/the next Youtube, there are a number of things to be aware of.

Investors need to trust you. They are handing you their millions of dollars and want to have maximal assurance that you'll not run away with it, make stupid or poor investment decisions, keep to discipline (which is what you sold them on investing in your fund), and want you to do better than the next guy.

If you've created companies and built them to success, that's a plus. But it's only one piece of the puzzle. Building a great company doesn't mean you can go and pick other companies that will win. Investors like to see that you have engaged in activities that show you can pick successful companies AND make lots of money from it. The 'AND' is important; just saying "I knew Youtube was going to be big" isn't the same as saying "I bet on Youtube when they are two guys in a garage, put my money in it, helped them with XYZ when they needed it, and saw the potential and put my own money where my mouth was, and made 10X on my investment."

How to develop a track record? Angel investing helps, as does working in investment banking or some other similar investment outfit. If you've worked with other prominent investors like in an angel network, that's great too. People who have invested alongside you and made money off your introduction of a company to them is a great trust builder. Experience as an entrepreneur also helps but not as much as (successful) investing experience. (Working in a previous venture fund helps a lot, but hey this paragraph is about whether or not you should be a VC in the first place.)

If you are thinking of joining a venture fund, they need to also trust you, see your commitment, and they have to like you and be able to work with you.

Joining a venture fund is not like taking a job at any other company. With a regular company, you can quit at any time and go to a new company. The commitment is typically 5 years, with potential to extend to 10 years if you still have companies in your portfolio that you have not exitted out of. This is spelled out in the Private Placement Memorandum (PPM) and is a condition for investors to commit. If you decide to leave the fund before the 5-10 years are up, this can, at a minimum, cause uncomfortable questions in investors minds as to the viability of the team they put their money in. It can, at a maximum, cause all the investors to bolt and your fund is left with nothing.

Therefore, venture fund partners want to know that you're in it for the long haul no matter what. It's pretty tough; 5 years is a really long time to commit. You'd really have to want to do it that long and the moment a partner smells wavering commitment, they'll back off you.

Since you're in it for a long time, you want to know that you can all work together and also must like each other. Again, 5 years is a long time to be hanging out with someone. You'd better all be drinking buddies as well as love working with each other to stand each other's company. That is why a lot of venture funds are made up of partners who have known each other for a long time and have worked with each other in the past. Investors like this also; they want to have assurance that the team can function together well and prevent an unrecoverable implosion of the team at some point in the future. They want to know that the team will exist long enough to make them money for the period of time they commit.

Lastly, almost all venture funds require the partners to put up their own capital. I've heard 1% is the norm, but I've also heard it can be higher as well. Doing some quick math - if your fund is $100 MM, you would need to put up 1% of $100MM which is $1 MM of your own cash. It doesn't have to come all at once; venture funds do capital calls when an investment is imminent. So the cash would come in portions as you went out and found companies to invest in. But over 5 years, you'd have to find $1MM to invest. All is not lost; a venture fund has many partners, so the 1% is spread out amongst all the partners. Still, it could mean many 100s of thousands of personal money to commit to the fund, in order to gain trust of the investors. How many people have that kind of cash lying around?

So after reading this, does the above apply to you in the positive sense, if you aspire to be a venture capitalist?

What Does it Take to Be an Angel Investor?

Simply put, being angel investor requires nothing more than cash. I don't think there is any other requirement than that. Of course, if you want to be GOOD at it, you'll need more than that. Read on..!

Things That Apply Both to Angel Investing and Venture Capitalists

Beyond those mentioned above, you will need to be able to pick companies well. The topic of picking companies is beyond the scope of this post, but no matter whether you're an angel or a VC, you have to do this well. You'll probably want to have some expertise in the area that you are picking companies in, like for me I work on Internet companies because that's what I know most about.

Having an extensive business network really helps. Connecting your entrepreneurs with the right folks will help from a company building standpoint, and even potentially on generating an exit at some point in the future. When you are calling on your friends or previous business associates, it works much better than going in cold. They already know you and there is a level of trust built already.

You also can't be risk averse. You need to be more of a risk taker and be able to get behind an entrepreneur, even when there seems to be no intellectual proof that it will be successful. Startup investing is not for the conservative soul; you'll drive yourself crazy if you are conservative by nature.

The Money Aspect

Here is where it differs slightly between venture capitalists and angel investors. When you are a VC, you are playing with other peoples' money; when you're an angel, you're playing with your own money. I say 'slightly' because in the case where you have to put up your money into the fund, then you'll also be playing with your own money as you invest the fund's money.

But with a fund, the bulk of the money you're investing is not yours. So if this is true, you need to feel some kind of fiscal responsibility to that money, and not feel that you can just take unnecessary risks with it. After all, these people entrusted you with their money on the assumption that you wouldn't just piss it away on stupid investments.

When it's your own money, other things come into play. I'll throw some out there which I think are important.

Most financial planners say that you shouldn't put more than 2-3% of your assets into any one investment. This ensures diversification minimizes the impact of any one investment in case of a downturn in that investment. In either case of whether you're committing money into a fund or designating it for angel investing, is that amount larger than 2-3% of your total assets? If it is, you are potentially taking too high a risk with your assets. Investing into these types of companies is not a sure thing. The potential is greater than zero that you could lose it all.

Still, it has been shown that statistically speaking, if you put money in 10 investments, about 6 will tank, 3 will break even or make back a little, and the last one makes back everything you lost on the previous 9 and then some.

Let's do some math: say you put $50K into 10 companies because you want to employ this diversification concept to maximize your chances of making money. That means you need $500K to do this. If we say that we don't want to commit more than 2% of our total assets, then our assets must be $25MM total.

Certainly this can be modified by many factors like are you a risk taker or not. Maybe then 2% isn't the right number but maybe 4 or 5% or maybe more. It definitely bears some thought into what kind of person you really are, and the comfort level you need with respect to your assets.

I think also that you need to be able to let go of that money. You need to be able to say that you will be OK if you never see that money again and just move on. If you cannot let go of the cash emotionally and intellectually, you'll be in a really poor mental state when your investments aren't doing well. Remember, that even if you employ the diversified/statistical method of investing, something like 6 of those companies will fail completely. I would not recommend you get into venture or angel investing if you're going to collapse mentally every time one of your portfolio companies dies. You'll go nuts and probably drive everyone else nuts around you. Because it WILL HAPPEN and you need to be able to deal with it.

You also need to have a healthy attitude towards money. Some people just can't. They assign way too much importance to cash in their lives. They can't let go of it, and they may do a Dr. Jekyll/Mr. Hyde thing on you. I've already experienced this once already in my life, and I have heard stories about many more. Friends, family all turning from loving people to the nightmares of your life. They will do things like hate you for losing their money, and never let you forget it. They will lie, cheat, steal - literally money does bring out the worst in people. Are you a closet Dr. Jekyll/Mr. Hyde with respect to money? If you are or even think you are, stay away from startup investing!

What's Your Real Motivation?

I am big on getting real insight into why I do anything. I want to really understand my motivations and feelings on it. So I think it is worthwhile asking yourself why you REALLY want to do this. If after all your inward analysis you still want to do this, then by all means go for it assuming the other stuff we talked about applies positively to you.

One big thing is to not delude oneself about the glamorous life of a startup investor. It ain't glamorous all the time and it takes a lot of work to do it well. And as much as you may say you want to build great companies, you won't be able to ignore the monetary aspect of it and how you're going to get your money out of the deal. Sometimes the two don't sync up exactly and you need to be ready to make a decision contrary to what you really want. You need to prepare yourself on the realities of what is going on here. Can you take your blinders off and really see what it takes realistically?

The Last Word

The last thing I'll say about whether you can be successful at this is: Are you a lucky person? By fate, or by creating your own luck (which I am big into - creating opportunities rather than just sitting back and hoping it will happen), I think luck plays a bigger role than people think. It is that slight edge you get by the will of the gods that will enable your video company to succeed, whereas the other 99 will not...

Really the Last Word

Don't create the 100th video company when there are 99 out there. But if your video company makes it big; then I would say you are lucky. Go invest more and call me to bring me into your next deal (haha).

I've learned a huge amount about angel investing over the last few months. It started with me sitting down with my lawyer and getting a brain dump of terms, term sheets, provisions of all sorts, talking about notes and preferred series: the list goes on and on. But it's all theory until you get out there and try to invest in something yourself.

I told myself I would try to be a sophisticated investor, meaning that I would spend the time (and money) to get every deal reviewed by my lawyer and I would make best efforts to read everything. It was the only way I could understand everything, which was to experience it in real time.

When I started looking at deals, many things emerged. Here are some of them:

It's the Wild West

There is no such thing as standard. All term sheets have similarities, but everything is different, sometimes subtly different. Every law firm has its own style and favored terms to present, and modify that by the entrepreneur or the venture fund and you get every kind of combination of terms you can think of. All I can say is that I'm glad to have my lawyer around to look at terms with an experienced eye, and I can only hope that over months (years?) I too can gain enough experience at looking at terms and their ramifications.

Law Firms Protect Their Clients

And that's a good thing. The law firms that startups hire will produce documentation that is always company friendly. Which usually means that it's not very friendly for the investor. The terms will inevitably have provisions that don't protect the investor at all. This confounds the process because sophisticated investors will always push back and alter the terms. If there is pushback, then legal fees will mount, as the process of negotiation goes back and forth on the terms.

The downside is that entrepreneurs are typically new to the financing aspect. They don't know enough to ask for more balanced terms when developing term sheets. They just take whatever the lawyer gives them.

I always push for balanced terms that favor neither investor nor company. In my limited experience, it has resulted in the fastest way docments get approved and signed with minimal fuss and cost.

Money Gives You the Lead Position

One thing I found out was that at the amounts I'm angel investing ($25K - $100K per investment), I am typically not the lead investor. That unfortunately means that I have little leverage to modify the terms; if I had put in more money, the entrepreneur is incentivized to negotiate with me and keep me happy in order to get my cash. If I am only putting in a small amount relative to others, or as a percentage of the total raise, then it is up to me to do my best in gracefully pushing for better terms.

Sophistication or Attention to Detail is Severely Lacking in Angel Rounds

During angel rounds, it is often the case that the entrepreneur went to their friends and family to get much of the money. These folks have cash, but almost always have no experience with terms and what is good and what is not. They rely solely on trust of their family/friend to not screw them when it comes to protecting their investment. When I arrive on the scene, it is often the case that a lot of the money has already been raised, and now we have a whole crew of people who have accepted the terms, albeit not fully understanding them, and now I have little leverage to ask for different terms because the entrepreneur would now have to go back to each investor and approve and sign off on changes. This will incur extra costs and perhaps even uncomfortable dialog between the entpreneur and family and friends (ie. you asking for my approval for better terms now...? why weren't they in there when I signed the documents in the first place...?).

Big Experienced Angels Mess Up the Process for us Little Guys

Another issue I have encountered is the prevalence of angels in Silicon Valley with large sums of money. Throwing $50K, $100K, even $1MM into a startup during an angel round is done without attention to terms. How do I know they aren't reading the terms? Because they invested in a company with investor un-friendly terms! And with the amount they put in, they could have easily negotiated changes in the terms.

Now that the entrepreneur has a big investor signed up, I show up with my investment and again I don't have leverage to change terms, even if they favor the big investor, because the entrepreneur doesn't want to go back and re-approve terms.

I asked around as to what these guys were doing. I found out that many have 40+ investments. With that many investments, it is impossible to keep their attention on any of them. And some of them are not experienced enough to know if a given company is good or not. Remember, this does not mean that they aren't smart; it just means that sometimes you're putting money in an industry that you may not have deep experience in. So they spread out their investments as much as possible in order to employ what I call the "Random Method of Investing". Basically, this means you employ the theory that has been proven time and time again by venture funds, which is that for every 10 companies you invest in, about 6 will tank, 3 will do about even, and the last 1 will make back all that you lost and then some. Now you can see the reason for 40+ investments. It's very much a passive investing operation.

My bet with David Shen Ventures, LLC is that I will improve that success ratio by being smart about the busineses I involve myself with, and I get involved with them to give them the benefit of my knowledge and experience. I am betting on an active investing operation and I hope to prove that this will be more lucrative than the passive route, as well as more fun.

Timing is Everything, But Not the Last Word

So far, in every investment I've done where I came in middle or towards the end of the round period, I generally have found that I lose leverage to change the terms. But I ask anyways. And it looks like dependent on the entrepreneur; often they will make best efforts to make changes or even make the change.

When I am at the beginning, I find that I can negotiate much better, even with my small amount going in. Over time, I hope to generate proof that going for funding with balanced terms results in lesser negotiation, less cost, and faster fund raising.

What's the Future?

I think the route that others have taken may be the best. And that is to employ enough capital to be the lead investor in the round, angel or otherwise, and to be able to effect change in the terms because you are bringing so much cash to the table. Definitely, I am not there yet; my hope that is David Shen Ventures, LLC will be successful over time to be able to make succeedingly larger investments to the point where I can manipulate terms to the benefit of both investor and company.

The concept of an incubator keeps coming up in my travels. Everybody knows about the big Internet incubators like IdeaLab during the Internet boom years. Lots of investors pouring money into these operations, big plans and huge infrastructure was built to support the development of business ideas, on the assumption that certain resources could be pooled together and shared to increase efficiency and cost. These were building space, internet access, servers, expertise - you name it and you could find it at an incubator in the late 1990s.

The spectacular demise of these incubators put a damper on the creation of new huge incubators. Even now, the lawsuits still go on where angry investors, having lost hundreds of millions of dollars in these investments, are litigating to get some of that back. When I started into this investing business, my ex-venture fund partner and I tried to form an incubator called Ignited Brains where we would employ inexpensive outsourcing to Internet ventures and try to let the marketplace decide on their viability. When we went out to get advice on our operation, we were met unanimously with negativity; incubators, we discovered, was a dirty word in the venture/investing community. Nobody wanted to have anything to do with us at all, which caused us to switch gears to try to raise a traditional venture fund.

As we worked on our traditional venture fund, we also discovered that incubators did exist in other forms. Some venture funds developed the concept of Entrepreneurs in Residence (EIRs), where entrepreneurs with a track record got office space and sometimes were paid staff and they were free to work on whatever projects they wanted. If they were on to something good, the venture fund would then finance it and off they would go. In fact, we had an "lab" in our venture fund which we would activate, with permission of the investors, to operate essentially as an incubator for our own ideas. Another interesting model came up with YCombinator where the two principals would get college students to work with them for 3 months and they would fund them for that time and help them get an Internet business prototype out the door. This is interesting to employ college students who have lots of energy, are super smart, and have skills to throw at a given problem. Another incubator model was tried by those who came through the Internet years with at least one large exit, and thus could fund their own ideas. Basically, they would get some of their smart buddies together, form an LLC or corporation, and work on an idea with minimal cash to see if they could get traction with it.

For me, I think I would have tried the last model, which was to take my own ideas, form a team, and run with it to see if it would work in the marketplace. Upon further thinking and research into this, I think there are limitations on this model. In short, my belief is that you can't work on many ideas, if they are your own AND expect them to be successful in the way you envision them.

The problem has to do with resonance with an idea, and transferring that resonance to other people.

First, an idea has to resonate with me. I must love the idea, understand it, and know how it could be successful. So naturally, I get how to make it work, what a target user might want from it, how to market it, etc. You might say I would be a natural to lead the business.

Herein lies the problem. You can only work on so many things so that they get enough of your time and benefit of your ideas and leadership. It's pretty hard to be CEO of one company, let alone 2 or 3.

And you can't rely on others to take your idea and run with it. That's where the transferrence of resonance comes into play. Since everybody is different, it is a very rare event, in my experience, to be able to transfer your own resonance with an idea to another person so that they feel it as deeply as you do. Without that shared resonance in others, they'll never be able to take an idea to the place you can take it to.

Over the years, in various jobs, I've tried to sell concepts time and time again. And I can't recall a single time that an idea survived longer than me driving it. As soon as I stopped working on an idea, it was impossible for the people there to continue work on it. I believe the same applies to incubators. In fact, I talked to an entrepreneur who actually launched a personal incubator with all his own ideas in it and he also had the same experience I had, which caused him to kill all the other projects and focus on the last two. Once he did that, the two are now flourishing, whereas previously they were actually languishing without his focus on them.

If someone can figure out how to transfer resonance to others, please let me know. Otherwise, are we ADD entrepreneur types doomed to only work on one or two things at a time?

I've been doing David Shen Ventures, LLC for about 4 months now and it's been a truly positive and educational experience.

Coming off the difficulties of raising my own venture fund, Chroma Ventures, which showed me that the current market was just too unfriendly to new fund managers, I leaped into the world of early stage internet startups on my own. With only pocket change, when compared to the mega venture funds out there, I tiptoed into the world of angel investing.

Big Education

Early on, I knew I had to learn everything as fast as possible. All this investor stuff was very new to me. I had learned some of it while trying to raise Chroma Ventures, but I hadn't gotten everything yet. So I enlisted my lawyer to sit down with me for about an hour and a half and just go through a whole bunch of financing docs and talk briefly about all the different ways people could screw you.

Lawyers can definitely be worst case scenario guys. They will scare the crap out of you on how you can be taken by everyone. It sure scared me, hearing all the stories of how people were cheated out of millions of dollars, and what happens if you invest on the wrong terms. I listened to all this and it could have made me run for the hills....but it didn't.

Investing in early stage companies, internet or no, is an inherently risky business. I like to think of it as better than gambling as you can personally affect the odds in early stage investing by making the right bets among other things. So you have to take some risks and be ready to lose that money. And sometimes, the investment terms aren't exactly the way you like them. I've walked away from terms that were just too risky. I've also invested in terms that were still risky to a point, but I thought there was a good chance of my risk being mitigated by other things. Basically, to invest in early stage companies, you have to be willing to lose a lot but hopefully win it all back on one or two big wins. (My advice here: if you're not a risk tolerant person, don't invest in early stage companies; you'll drive yourself and the entrepreneurs crazy.)

Learning about terms was one big education. I think I'm getting better at solo-ing on reading a term sheet, but still like my lawyer to go through it and get his take on it. Finding out what terms were company friendly and what terms were investor friendly was really enlightening. I had wished that it was all standardized, but it's actually the wild west of terms out there. Everything is done to personal taste so you have to read every term sheet carefully.

Huge Positive Response

As I went out there, I had no idea whether people would want my involvement this way or not. I already had met some folks who were doing the same thing I was doing: advising for an equity stake in the company. Many were actually paid as consultants to help their ventures. They also touted their contacts in the venture world so they could help an entrepreneur through the funding process. They seemed to be doing OK and had an active roster of entrepreneurs they were working with. But I had no idea on how to find these entrepreneurs.

I started by going to a Silicon Valley Meetup. I met some folks there but also realized that it was not such a good thing to advertise my status as an angel investor - too many people are out there working on stuff that won't ever make it - or they themselves are not true entrepreneur material. I didn't have time to field every business plan that came across my email, nor did I have time to check up on every person to see if they were on the level.

I also met with some ex-Yahoos who had started their own startups and they were plugged into the entrepreneur "underground" in San Francisco and Silicon Valley. This seemed to be a better route than going to the more public forums. Getting to know these guys personally and by referral was much better.

But then, once word got around to the ex-Yahoos around the valley that I was doing this, the response picked up. They all knew me and I knew all of them and thus I focused on a (thankfully) constant stream of referrals to entrepreneurs working on all sorts of stuff. Filtering by referral is much better; your own personal reputation is at stake when you refer someone to someone else!

I also noticed one other thing about the positive responses - they really needed my expertise in their fledgling businesses. Mostly this was in the areas of:

1. Internet user experience and design
2. Product strategy
3. Online advertising and the media world

I thought back to the people I met who were doing the startup advising thing professionally, and there were no people who were operating these particular areas - only in business strategy and engineering. And in talking to entrepreneurs, they lacked someone with experience to lead them in these areas. This was hard won Yahoo knowledge from the 9 years I spent there working on just about every type of product out there. Over the last few years, it has only been in recent years where Yahoos have started leaving, and the knowledge is starting to get out there. But even then, how would an entrepreneur find an ex-Yahoo if you're not connected?

Developing Criteria

It's nice to be wanted. Now how do I work with the companies? I had to develop a strategy for picking the right entrepreneur, company, and business to work on. I did not want to work on everything that came by and I wanted to see if I could do better than that.

First, I said to myself that my knowledge and experience could increase a company's probability for success than without. So if I was going to invest money, then they would have to involve me. I figured an advisorship was the best way to formalize that (rather than being a bothersome investor). No involvement, no cash. (NOTE: I don't invest in everything I work on. A lot of things have to fall into place correctly for me to put money in, and not all of those are in my control.)

Second, I had to develop a set of criteria to base my decision on whether or not to get involved. These are:

1. The team must consist of quality people. They must be trustworthy and I must like to hang out with them. I want to have a good connection with them, and I want them to want me to be around. If I don't like hanging out with these people, then I would be less inclined to keep bugging them on their product and company. The moment something doesn't feel right, I don't do it. (NOTE: Honing one's intuition is paramount.)

2. I wanted to work with people who geniunely wanted my knowledge and participation, and not just my money. I am trying to be super sensitive of any sign that someone is looking only to get my money and don't really care about my participation. That participation needs to work from both sides; a team needs to pursue my knowledge just as much as I want to help them with it. It's too easy for a startup team to get caught up in the day to day and not leverage their advisors. I am trying to avoid it as much as possible but know I will not be 100% perfect in reading entrepreneurs on this matter.

3. I need to resonate with the product. See my Resonance post.

4. I need to believe in it and see a future for it. If I can't see the future for it or don't believe in it, I don't think I should work on it. That doesn't mean that someone else couldn't take it to success; it just means I'm not the right guy.

5. I like certain types of projects more than others. See my What Do I Think is the Next Wave of Business for the Web? post.

6. The team number must be between 1 and 10. I have found that it works best when there are not people in place with skills similar to mine. See my The Sweet Spot Number post. If there is a number on the team greater than 10, a red flag automatically goes up in my head.

7. Generally, I like teams with track records than without. And I also like teams with very strong people in them. If you don't have smart, experienced, motivated people from the beginning, you'll be severely hampered very soon. Let's not start the project with sub-standard people, shall we?

8. I am starting to be a bigger believer in the distance rule for investing. I have increased that to encompass San Francisco from Silicon Valley, so instead of the 20 minute rule is more like a 50 minute rule. (Hey, I've got a Prius with carpool lane stickers so driving ain't so bad - heh). Right now, I am concentrating on companies in Silicon Valley/SF, Los Angeles, and NYC. While that may seem like the distance rule is a bit stretched with this list, I count the distance rule from my place of dwelling in each of those places, which I am in a lot for a variety of reasons.

My message to entrepreneurs is this:

1. You shouldn't put me on critical path. We'll both be frustrated as I don't have the time to take projects to completion on my own.

2. By the end of my advisor term, my goal is to find replacements for all the skills and knowledge I bring to your table. This can be either by the hiring of individuals or by the actual teaching of knowledge to you.

3. Use me to the fullest. I am available to bring along to meetings, evaluate vendors, evaluate products and services, etc. Just schedule me ahead of time and if I have time, I 'll make best efforts to come along and help you.

4. I only take equity as payment. I do not want to charge hourly and drain an early stage firm's bank account. Save that money for operations and product. Let's build the damn thing together and win big later.

That last message expresses my philosophy in working with entrepreneurs. I am not in it to make money in the primary sense. If I were, I would have continued trying to raise money for Chroma Ventures or tried to join up with another venture fund. I get the most kick out of seeing a company grow from nothing to something big, and hanging out with a bunch of really cool, determined, smart individuals to do it. It was what it was like back in the old days of Yahoo; just a bunch of buddies hanging out doing great stuff. I truly believe it is the formula for great success.

This morning, I had a meeting with someone at University Cafe on University Ave in Palo Alto. Being a little hungry for breakfast, I arrived an hour early to eat before my meeting arrived.

Sitting here in one of the more popular cafes in downtown Palo Alto, I scanned around the room just to check out who was there. It was pretty amusing.

There were the "blues" and the "not-blues".

The "not-blues" were people who looked to be Palo Alto residents, or those who worked in various businesses based in Palo Alto. They were dressed in a variety of ways, generally in jeans and very casual.

Then there were the "blues". It was pretty funny. Everybody else here had dark dress pants and a blue collared shirt. It was very obvious that a large population of the venture capitalists also came to University Cafe to have breakfast meetings. Talk about attack of the clones!

You know what - blue does look good. It is a cool color and has a calming effect, more to woo potential entrepreneurs and partners by having that trustworthy effect on people around you (little do they know...ha!). It must be a critical component of the venture capitalist how-to manual, under the chapter entitled "Venture Capitalist Dress Code."

Among VCs, blue is the new black!

...you must use the right language in your presentations. Find useful and essential Web 2.0 doublespeak here at:

The Web 2.0 Bullshit Generator

After you finish your presentation, you must have an official Web 2.0 logo. Forget that retro crap. Go 2006 with a true Web 2.0 design! Type your company name here:

Web 2.0 Logo Creator

Since I want David Shen Ventures, LLC to be truly a next generation Web 2.0 company, I am thinking of switching my logo to this:

But if I truly want to be Web 2.0, I must drop some vowels. So...

I am also thinking of switching my page design. So I tried this automatic page layout creator for Web 2.0 design:

Web 2.0 Generator

Check out my proposed new webpage design.

After doing this for about 4 months now and only really seeing maybe 5 investment term sheets, I am already seeing a huge variance in investor experience and/or attention to detail.

My lawyers are great. They are super-conservative and I joke to them about being worst-case-scenario guys. It is truly scary to hear all the crazy things that either have happened in the past or all the possible bad things that COULD happen. In their defense, that's their job which is to protect their client and keep me out of trouble, and in the course of that scare the daylights out of me by talking about possible disaster scenarios.

It is obvious to me that not everyone is employing their lawyers in the same way. Or maybe their lawyers aren't that good, or even stylistic differences in approaching financing changes the equation. Or maybe the company doesn't want to spend the money to do things right. Or the investor either doesn't want to spend legal fees or has no legal help at all.

In reviewing these term sheets, they range from being, "These investor terms are super-dangerous; I can't believe anyone would sign this!" to "WOW these are great balanced terms that serve both the company and the investor". I don't see the ones which are (most likely) initially given to companies which are totally investor friendly and screws the company.

For some of the more experienced investors, I see definitely a jockeying of position for control happening in subtle and not-so-subtle ways. It is the interesting interplay between company and investor, and if you have large assets coming to the table, the company definitely wants to bring that cash in. But either side exhibits differing levels of experience. Generally, I find the big venture firms having more leverage and experience, but sometimes they seem to sign early stage docs a lot quicker and with less attention to detail since less money is involved. When bigger sums of money are involved, then the real jockeying begins as negotiation for rights and control are passed back and forth.

Still, as I ask around, I find that there are many of the big VC firms that also operate haphazardly. I do not know all the reasons behind this yet, but it seems that time is a big limiter, as is cost for applying legal fees, and also experience, especially among junior partners trying to get a deal done.

In some instances, given that it's friends and family who are the angels, I think they operate on trust. They are relatives/friends of the entrepreneurs and give their support by putting up some of their own cash. They typically have little or no angel investing experience and probably not much legal help at all. So terms are not read or read and then not understood, and paperwork is signed on the assumption that the entrepreneur will not screw over their friends/family.

What can I say? I hate reading legal docs too. It's why I asked my lawyer to really simplify my advisor agreement. You can actually read the damn thing if you're not used to legalese, and understand what you're getting if you sign me up. Before that, it was really tough to read; lots of legalese and weird words like "hereunder". What the hell does "hereunder" mean? I see it everywhere in legal docs. Sheesh.

But I have forced myself to really read and understand term sheets and also the final expanded investing paperwork. As investors, I believe that we need to do this so that we can be prepared to defend why we're asking for term changes, and to not be afraid to push for changes even though we're not the lead investor. It is essential that we become experts in this and be good at reading docs, and not be shy about spending a bit on legal fees to keep us angel investors out of trouble.

When I tell people what I'm doing now, they always ask me about what I think is hot and upcoming. They always wonder what I think makes something worth looking into and potentially the next big hit in Web business. I guess they want to know the secret formula or something.

Sometimes I hate answering this question. It is almost like the question I always get asked in seminars when I present: What are your favorite websites and why? It seems that I always should have a ready answer in my pocket to give them. And sometimes it's hard. Hard to remember all the websites I surf to each day, or those that I encounter through referrals or friends, or hard to articulate why I like something or why I don't. So now I get into the practice of thinking more deeply about each website I go to and try to have some kind of answer to this question.

As I now must have for "What does Dshen think is hot on the Web and why?"

So I thought I'd write some of them down here so at least you can see what I'm thinking about these days:

1. I find the viralness and the spontaneous emergence of communities intriguing. Sometimes you can't predict when something will take off. The non-prediction aspect is both frustrating and invigorating; as business minded folks, you want to be able to say that this community will work and I can make money of it or not. The reality is that a lot of these communities take off on their own. It has been shown to me that the "put it up and see what happens" strategy works so well here. If I don't connect with a community or what brings it together, it doesn't mean that it won't be huge or work for others. Which brings me to my next thought...

2. It's all about the niches. The Yahoos and the Googles of the world have already taken care of the broad swaths of internet turf. But they are so huge that it's hard and not justifiable to attack niches. This is where I think smaller companies can do a great job at tackling niche markets and flourishing. With the internet lowering barriers of reaching people, small niches that were hampered by geography and other factors can all of sudden congregate and be powerful through the internet, which has no physical limitations. So communities of interest can form and be really huge.

3. In the future, the power will really be spread out to the people. I really like startups working on concepts which empower people. One big example is how MySpace is showing that the record labels aren't as necessary as they were years ago when there was no internet. Musicians can now effectively get their music out to the masses and make money without the marketing power of record labels. If the labels (and music studios, and other similar huge old world entities) don't change their thinking, they will all die a slow death. Throwing lawsuits at it will slow it down but my belief is that such movement of democratizing the old world is unstoppable and inevitable.

4. Equally important and relevant to me are the people working on it. I find there are two types of people. Those who are very open minded and those who are not. My belief is that the open minded people are more creative, more adaptable, and be able to accept new ideas and directions than those who are not. I try to avoid working with those who think their way is the only way and don't really listen to what I have to say, or what others have to say for that matter. In my 10+ years of working on Web products, I have been surprised so many times at what works and what doesn't that I've lost count. You have to have the ability to go with the flow and shift and adapt. Being too rigid brings a lot of risk, which brings me to the next point...

5. I see building applications on the Web has a huge probability game. Nobody is guaranteed for success but yet that shouldn't stop you from putting something up and seeing what happens. And whatever you do, you keep stacking the odds in your favor. You keep testing and adjusting. You find smart people to bring onto your team. You network continuously to make sure you get the best ideas possible. Keep stacking the odds in your favor and you may just find that someone who isn't doing this is all of sudden left in the dust.

6. A buzzword favorite. I like companies who work in the long tail (see book of same name The Long Tail by Chris Anderson) which is akin to giving the power to the people.

7. Another buzzword favorite. I like companies who disrupt old traditional ways of doing things. Those who take on big, huge, slow companies in big and huge industries by doing something in a different way that cuts costs and delivers better to their customers. Love it. Think iTunes to the music and TV industries.

Other stuff: Gotta be innovative, gotta be engaged with the Web. Being tenacious and never giving up. Unwavering belief in success.

That's it. Now to work on my favorite websites list haha.

In our talks with investors, it seems that angels are less interested in investing in venture funds. Mostly the reason seems to be that these angels are typically experienced professionals in certain areas and have enough knowledge to go direct into companies. They work with those companies, lending their expertise and contacts and help them grow, and later reap the rewards.

For them, there isn't a good reason to give up the carry that is paid to venture fund managers, or the fees paid yearly. They can get involved with the company and invest directly to gain the full reward of an exit.

Makes total sense for angels, but tough for us. This could mean many angels and angel networks will not be interested in us. Already I have contacted Band of Angels in Silicon Valley and they never look at venture funds....

We're in the midst of fund raising now. It's been an educational process.

Two weeks ago, we spoke with a placement firm which helps funds raise money from institutions. We were told that we are too small for institutions to be interested.

They apparently want to invest at least $10MM into a fund. This is because of their own size, which many institutions are now in the billions of dollars. It simply does not make sense for them to place money into another vehicle at less than that amount. They need to put larger amounts of cash to work, at one time.

The next constraint is that they want to be no more than 10% of any venture fund. This means that any fund they invest into must be at least $100MM in size.

With us at $25MM, we're too small for them. We're thinking about this as we continue our talks with other potential investors.

On my trip to Shanghai, I met a journalist working on a book about venture capitalists working now in China. It will be published in Chinese which kind of stinks since I can't read Chinese, and I can't wait until it gets translated to English. The journalist asked me what kinds of things a potential reader might be interested in, and I sent her a list:

1. What are the pros/cons of being in China?
2. What are the difficulties in working in China?
3. What makes it easy to work in China?
4. Where are the dollars being invested now? It would be great to show some stats, as they are extremely hard to get. As you interview the VCs, they might be willing to share an industry breakdown with you.
5. What are the current opportunities?
6. What are the trends?
7. What are the risks?
8. How is money extracted from China?
9. What are the corporate structures that enable foreign investments or ownership in China?
10. How does one deal with the chaotic environment, ie. Business climate, inconsistent legal/political system, etc.?
11. How does one deal with trust issues?
12. How does one become a VC in China? Are there legal and regulatory issues?
13. Is fund raising possible within China? Asia? Or does most of the money come from overseas?
14. Show case studies of successful/unsuccessful investments. How/Why did they succeed/fail?
15. Top 10 things to do to increase chances for success, Top 10 things not to do.
16. How do you deal with language issues?
17. What are the notable cultural differences to watch out for?
18. How receptive are entrepreneurs for help beyond money? Examples?
19. How would you characterize investors in China today? How would you characterize entrepreneurs in China today?

So much is a mystery to Westerners about China, similar to the days when I worked extensively in Japan building the Quicktake 100 for Apple with Kodak Japan and Chinon. Culturally, Chinese people are similar in many ways as they are different; it's the differences that sometimes confound Westerners who try to work overseas. The subtlties get tripped over, often with disastrous results.

And now, with billions of dollars going into China, the stakes are much higher. So many variables, and so many things moving so fast. Will the government institute legal systems to make it more stable to do business there? Will the currency be an attractor or a hinderance? Can the Chinese people emerge gracefully from their Communist roots and support capitalism? Can the people resolve the class differences between those who have and those who have not?

All questions to ponder, and to watch history in the making over the next few years, as we watch China emerge truly into the 21st century.

Seen on the onramp to 90, from Marina Del Rey, a sign stapled to a telephone pole:

Business Plans
Grant Funding
Business Funding
50K - 1 MM
Call this 800 Number

Which venture fund do you think this is?

My Hobby

In looking at all the new Web stuff that's out there, I am amazed at the diversity and also at the number of rehashes of old applications. I am beginning to get to know some of these entrepreneurs and trying to find out what their motivations are for building whatever it is they're working on. Some of them clearly have more defined goals in terms of problems they are trying to solve, what opportunities they see.

Others...don't have such clearly defined goals. You ask them some standard questions about business models and user retention, or scalability and it is clear that these issues have not been thought through yet.

But no matter what, there is huge interest and determination in working on these apps, and the passion is evidently there. Just like having a hobby.

So yes, these apps pass the hobby test. But they can they go beyond being just a hobby?

Because I can...

I suspect that some entrepreneurs build these things because they can. Because the world of Web 2.0 it is really easy to build some really complex applications and you don't need an entire team of engineers to do some very interesting things. You weld maps with some other app and get a new way of approaching the same problem. Never know if you'll come up with something totally disruptive and it takes off.

Certainly many build them also because they are trying to satisfy some need that they have. They see some specific problem in the world and they solve that problem. These can be services or parts of technologies, or even reinventing some old thing again.

Almost universally, they have this hope that they will make the big score by selling their little app to some big company and live the life of luxury forever.

Does the world need yet another Google Maps mashup?

Sometimes I wonder about creativity in this new Web 2.0 entrepreneurism. There seem to be multiple versions of almost every app out there. For example, one way to be "cool" is to do something interesting with Google Maps. So, yes, creativity in mashing-up maps with some other app, but creativity in services? It seems like people take the same service or some existing and redo it in their own image.

As a user, how I am supposed to distinguish between one app or another when they look almost the same? Sure, I could sit at every app and try it out for an hour, but I don't think I would spend my time to do that to figure out why something was better in some tiny but important way.

Money Making Hobby?

Some people make money off their hobbies. You do something you love doing for the sake of doing it, and then a business springs out of that. But many people have hobbies that don't make money.

The big question is: in the world of Web 2.0, how does one take their hobby and make the leap to business? On the internet, users can't distinguish if something they encounter on the Web is a "hobby" (in the context of what we're calling hobby in this post), or a real business. So that's one problem.

Another problem is that it's really hard to execute. Putting your website up is one level; staying in it, developing a business model, and keeping it going for a long time is another level.

I think the main goals of our venture fund will be to discover:

1. If this is a "hobby", can it become a business, and one that has big enough potential for us to invest in?

2. Does the entrepreneur have enough vision, experience, or potential to be able to evolve this from a "hobby" to a business?

Last night, I went to the Silicon Valley Meetup held at Draper Fisher Jurvetson (DFJ) in Menlo Park. These have become wildly popular following a New York Times article about the New York Tech Meetup, which was standing room only due to its new publicity.

I found the meeting to be an interesting group of people. I was only 1 of 2 venture fund folks there, the other person being the DFJ guy who donated the conference room. The rest of the people were all entrepreneurs and seemed to span the range of experience, from novice to those who had done many startups.

It started out by everyone giving a short introduction (which was when I found out I was 1 of 2 venture fund folks). Then they began the presentations. The 4 companies were very interesting and ranged from very early-test phase-virtually no users to more developed business plans and lots of funding. They are:

Meetro.com - a location based IM client
Zooomr.com - a location based photo sharing service
Rrove.com - a tagging service for physical locations
Prosper.com - a community managed service which allows individuals to provide lending capital to others

Some impressions of the meeting:

1. Why aren't there more VCs at these meetings? I need to ask around and find out why. Maybe they don't want to get inundated by entrepreneurs. Me, I like to build things and like to hang out with people with great ideas.

2. It was interesting to see what Web 2.0 has wrought. Lots of tools and functions to build but hard to define a business model.

3. Naming is a real problem. Rrove was an example of that. I am certain we'll see lots of names like that.

4. There seems to be many people attempting to be entrepreneurial these days. It's nice to see, but also I can see where the learning curve can be really tough without guidance and experience. I did find a whole bunch of resources for new entrepreneurs. I hope to hit a few of these to see how they operate - My thanks to Chris, an entrepreneurial engineer who sent me these, in his own words:

SVASE.org
This one is pretty good. I've seen entrepreneurs, angel investors and VCs attend these events. There's a StartUp-U group that helps entrepreneurs in different areas in the startup process.

eBig.org
This group has several SIGs and each SIG concentrates on specific areas. Since you’re into web opportunities for your fund, you may want to look at the Blogging & RSS SIG, Java SIG, Start Ups / VCs SIG and the Web Development SIG.

TVC (techventures.org/)
This one really helped me understand the Startup world. They have this one program made up of 6 events which helps entrepreneurs start their ventures. Entrepreneurs, angel investors and VCs attend these events. This group is funded by Lockheed and is more organized compared to the other groups in events. This has probably helped more than any other group and usually has a bigger audience than any other of the listed groups.

VC Task Force (vctaskforce.com)
This one seems to be popular in the VC world, I haven't attended any of their events because it's a little pricier compared to the other groups.

Stirr.net
This is a new one.

Very exciting time to be an entrepreneur now.

Today, my partner went down to Wall Street to meet with a banking buddy of his.

Somehow, he got wind of our venture fund, Neuron Ventures. And it's now the buzz of him and his Wall Street friends. Apparently, they are really excited about what we're doing and how we're doing it. Wonders of wonders.

Not sure why that happened. But I would think it's a good thing that the word is out about us and it could help us if, when we meet them, they know about us already and have already did their research on us.

Colleges - a place where our future generations emerge and develop the new and cool.

Nowhere is this more true than for Web products and services.

We, who have been through the Internet boom/bust years, are now in our 30s and 40s. We have fused the internet into our lives, but we did not grow up with it. We had to integrate it slowly, deliberately, and smartly throwing away old habits...or not. Sometimes we can't let go of the old ways of doing things because we're old farts.

On the other hand, the teens and tweens of today have grown up knowing only the Internet in their lives. They have used every bit of it and have no experience of life without it.

A growing belief is that this generation is really where the next generation Web products will emerge. They see and experience the Internet in ways that we are too old to know. And thus, they can see holes and opportunities in the spectrum of Web services that we can't.

We need to tap into this resource and nurture the next set of great entrepreneurs. College internships? Consulting gigs? Or even simple conversations? All of these and more can be utilized to really figure out what products and services will be necessary and vital for the future Net generations.

PPM= Private Placement Memorandum.

A long document describing what we're offering and what the terms are for investors. It's got a ton of legalese and some basic language too. We lucked out by hiring a boutique law firm in NYC who only works on venture funds. They also were able to put together a PPM which was very easy to read even though it has the usual disclaimers and such.

It took a little time to work this out. So many little details on what we are selling to potential investors, but I suspect that we took less time than most.

We wanted to be very standard and not do anything unusual which could raise uncomfortable questions amongst our investors. I figure this saved us a couple of weeks for sure.

In any case, we're done and ready to go sign up investors!

The other day I was talking to a entrepreneur friend of mine about how to get acquired by a Yahoo! or Google.

This person had noted that they had tried to get in many times to show something they were working on and could not. It wasn't their technology; I took a look at it and it was pretty cool on its own. But for some reason, Yahoo! and Google just would not give this company some time to present their technology. I noted to this person that it may be a "lost cause".

By "lost cause" I don't mean that Yahoo! and Google are lost causes as businesses. What I meant was that it may be a lost cause for the entrepreneur in trying to get air time with the Yahoos and Googles of the world.

What could cause it to be "lost cause"?

I find that there are two reasons for the "lost cause" label. The first being organizational defects, and the second being the people themselves.

Organizational defects:

Basically, too much work and unaligned goals. Sometimes an org places so much work on an individual where he just can't think clearly about anything else but what he has to get done now. So all future, innovative stuff goes down in the dumper. He can barely get the stuff he has now done, let alone freeing up brain space to process new stuff.

As for unaligned goals, here is an example. At a major internet company, the goals of a general manager of a business unit were very numbers driven. I make my numbers, I get a raise. I don't, no raise. Anything that clearly helps me make my numbers gets first priority. Anything else that is unclear in driving towards me making my numbers (hence my goals) is shoved down the priority chain. So you show up with your nice tool, but there are about hundred other things that this GM knows could make his numbers faster in the short term and decides he doesn't have time to talk to you.

People defects:

Some people just can't grasp the big picture. They can't see broadly where things could fit in. They may be smart, and great operations folks and get lots of things done, but sometimes can't figure out how to integrate a new thing. This relates to multi-tasking ability, ability to handle information overload, general creativity, and physical/mental/emotional energy. When you're in a place like a Yahoo! or a Google, you're running at 1000 MPH. You get the physical/mental/emotional energy sucked out of you, and you can't multi-task or handle all this information and you are back to just doing what is placed on your desk at that time.

Again, new, innovative stuff just falls off the plate.

The entrepreneur suffers because he could be selling his technology to a prominent company; the company suffers because they may be missing something they should be integrating.

How do we, as a society of businesses, do better?

How funny was the site Fucked Company back in the day.

But now it seems very quiet on the personal attacks and sensational content front. It is filled with rumors, but it seems so dry. I find that Valleywag is much better at the fun, outrageous stuff you want to know about each internet company. Think gossip magazine for Web 2.0.

But I did find something useful. I dug up my copy of F'd Companies by Philip Kaplan who is the founder of the fuckedcompany.com site.

I love his brash and cutting style on writing about these dot-com boom era companies. Companies that had such ridiculous, or no business models and were getting unbelievable funding. As I thumb through its pages, I reminisce about those days where us naive Internet pioneers thought that anything should be tried, and who knew what would work and what would not. And all these money people tried to jump on the bandwagon, fund any company whatsoever, and try to take the most ridiculous companies IPO in an attempt to score big.

But now, I find I am drawn back to some of the businesses in that book. In today's Web, things are different. Now some of these businesses that failed could realistically be tried again. In fact, I just read an article about some venture fund guys who were precisely "mining" old Industry Standard and Wired magazines just for that reason. Sometimes a tweak is all it takes.

I am hoping to find some ideas in F'd Companies and see if they work today. But I also think that some of the ideas were truly F'd and should never again see the light of day!

These last two days have been incredibly busy. We've driven all over the Bay area now, meeting up with people we've been introduced to.

Some items of note:

1. Gotta have a great personal brand. Otherwise, why would someone introduce you to one of their buddies in the VC world?

2. Try to find the good people. So many VCs are into the money and that's where the term "sharks" comes from, and they always want something. We've been really fortunate to have been introduced to many who have offered their help to a bunch of amateurs like us.

3. Making the connections is crucial. Who knows when you'll need some other people to go into a deal with? Or, they can help you with deal flow they see by referring deals to you that are more appropriate for your model versus theirs, and likewise.

4. More and more entrepreneurs are popping up. It's nice to see this happening with previous associates. Many are starting up things and now looking for funding. As soon as they hear what we have to offer, they really like what we bring - experience, connections, help.

If only now we had the money....Onwards to fund raising. Our paperwork is almost done!

An interesting comment from one tech venture firm. They actually liked the fact that we didn't have business cards. The reason they gave was that it showed that we were focusing on the work and that we weren't about the "flash".

I guess that meant that if we had shown up in suits, flipped out some bad-ass designed business cards, showed some swank term sheets and/or presentations, that would have presented a different view of us. Instead of being heads down and about the work, people could have interpreted that kind of presentation as being all fluff and no substance.

In the previous Internet boom years, I suppose many people showed up with fancy powerpoints, documents, and cool business cards. I would think that many people couldn't live up to the fluff, despite how much money they had put into it. These showmen lost a lot of money for investors and now people are wary of the "flash".

We were lucky that we showed up the way we did. Being Mr. Designer guy, it doesn't take much work to whip up some decent looking business cards. It was only pure chance that I got hung up trying to buy a good piece of stock photography for the card's imagery and never made it to a printer to get some made.

But now we've had another valuable lesson in the current venture environment, and that's to not be that showy, but to focus the attention on ourselves and what we bring, rather than hiding it behind a showy presentation.

I am now working on the website and some business cards. I think showing up with nothing can't be good in all cases. I think something simpler but professional looking should be good for us, and definitely something that does not remind people of the "all-flash" designs of 1999...

These last few weeks have been filled with meetings. At each one, we describe what we're trying to do and we've been getting almost unanimous consent that what we're doing is great and that we have something really interesting going on. They tell us that we're on the right track and tell us they want to put some cash into our fund.

When we come out of those meetings, we're on a high. Getting positive validation about what we're trying to accomplish makes us feel incredibly good about what we're doing, and when we survive grillings on our plans by seasoned professionals in this area, we gotta feel good about that!

It's like going to a therapist. You have a problem; you're depressed; you feel like the world is down on you and you can't make things right. You hate yourself and it seems like everyone else thinks you're worthless too. Then you see a therapist. They boost you; they tell you you're not a loser. You can get better and they'll show you how. They change your outlook on life and you start feeling really good about yourself again as a result.

These meetings are like therapy. We go in wondering if we'll leave mildly bruised from the expert pounding. Instead, we defend our plans and assumptions and the biggest validation anyone can give us is for them to commit their own funds to us, which shows their trust in our model and in ourselves. So instead of leaving feeling like we suck, we leave instead feeling like we're doing great and other people think so too.

But at this stage, it's all therapy to me. The next stage is about commitment.

People say they will invest in us, but who knows if they really will. Money changes people, as I said in a previous post. Saying something is not the same as doing. Until we see the money actually come in (or in this case, commitment by signing the subscription agreement), it's just all therapy. Nice therapy for sure, but our goal isn't to prop up our self-esteem; our goal is to build our fund and implement our plan to prove it works.

I have already met people who have changed when it came to money. I have already met people who could not commit their own cash no matter what. I am sure I will meet more, and even some who will invest money and then change later. Does money bring out our true natures? In the uncomfortable world of cash, I almost think I don't want to find out some things about people, especially those close to me.

Yes it is an interesting thing, to peer into peoples' inner feelings. But as I said before, it's about the commitment and not therapy and truly, it is a "put up or shut up" world we've leaped into...

Corollary 1: Saying you'll do something and actually doing it are two very different things.

Corollary 2: Don't start work until you see the cash in the bank account.

A repeating notion we've found while raising money, as a budding new venture fund and as a bunch of guys with no track record, is that we want to appear as ordinary as possible.

By ordinary, I mean that we don't want to do anything that is not traditional to the world of venture funds. In doing so, we concentrate the discussion on ourselves and our value, versus why a bunch of inexperienced amateurs want to try something different and potentially introduce more perceived risk.

Some of the things we have encountered that we wanted to do, but are very wary of, or status-ing down, or not doing at all anymore are:

1. We are going to have larger than normal fees. Normal fees in venture funds are about 2% of the fund annually. We need more fees because we think we can do more with less cash, which also means we need more staff to hire and help us manage our investments.

2. We were going to start an incubator but are not going to do this or even use the word 'incubator'. We have found that a huge amount of the investor community have suffered greatly with the spectacular flameouts of virtually every incubator through the Internet bust years. To suggest that we, a bunch of newbies, could do it better would probably not be believed. The funny thing is that incubators actually do exist in different forms within some venture funds now. Many use the term 'Entrepreneur in Residence' to describe people who sit with venture firms, dream up new ideas, and try to create businesses out of them. The second funny thing is that even though we were thinking of doing an incubator in the beginning, we still want to do an internal think tank. But now we'll have to shove that into our list of projects, not draw attention to it, and face investor approval to begin it.

3. We intend to deploy cash as soon as we get it. There are already several entrepreneurs who want to work with us but need cash right now. Traditionally, the fund raises money first and then begins to deploy cash. We, however, want to invest as soon as possible. This method brings more risk to early investors as their full investment could be deployed to early investments while traditionally the risk would be spread out to other participating investors. However, we do want to diversify as soon as possible to minimize risk to these early investors.

Everything else is pretty much in line with what experienced investors would see with any other venture fund's term sheet. So hopefully the above three points won't cause too much consternation, confusion, or make them wary of us as we ask for their money.

Doing this without a track record doesn't give us much leverage in being creative in setting up our fund, but on the other hand, we don't need to be too creative at this point either. And especially if it is a detriment to us raising money, we won't do it.

Today my partner and I went to visit some Masters in the art of venture funding, if such a thing could be labelled.

These guys have been doing this for about 25 years. That's a pretty long time.

One thing they said that struck a chord with me was:

If there was a way for an entrepreneur to fuck up, we've seen it.

In that one statement, it dawned on me that I was talking to true Masters. Their decades of experience in entrepreneurship give them an incredible leg up on how to create sustainable, growing businesses. To discount their advice would be foolhardy and ridiculous.

Their other piece of advice was our desire to form an internal innovation lab where we could build stuff from our own ideas and launch them. Due to the spectacular failures of almost all of the incubators through the Internet years, there is a incredibly bad taste in investors' mouths about incubators since none of them delivered to the potential they said they could.

In the interest of not generating negative opinions about us by doing something different than the norm, we've decided to tone down the labs and put it as a future thought for a project that will be approved by the investors. We won't be setting this up at the outset, which could sour investors' opinions of us due to their past experiences with previous incubators.

I am fortunate to have met these individuals and look forward to working with them, and learning from them. I kind of feel like Caine in "Kung Fu"....before he could snatch the pebble....

Today, we officially kicked off our venture fund formation with our law firm. How exciting!

We're still weeks away from getting the paperwork done, but we'll do it right.

Right now, we have a bunch of entrepreneurs on deck and we need to select the method of collecting money now while investing it while it comes in. It is a slightly different way of operating than other funds, which seek to raise money first and then go out and look for investment opportunities.

It's an interesting way to work.

The pros are:

1. We deploy money as soon as possible.

2. We collect management fees sooner.

The cons are:

1. Early investors carry more risk, as the fund is not diversified yet.

2. More paperwork for us, and thus more time and money spent on that.

3. Management fees come in, but we won't get enough to support ourselves. Full budget is achieved when we raise the entire amount.

I think the most important part is that we get our entrepreneurs off and running. They need cash now and we shouldn't hold them up....

So important in the venture world...

We had a meeting with some prominent folks today and presented our current line of thinking on our fund and how we want to operate.

At the end, the advice given to us was to start small and build up a reputation first, before attempting to tackle bigger projects.

This reputation would hopefully embody positive working relationships and performance. A big return at exit would have a hugely positive effect on our reputation, and our abilities as entrepreneurs and to generate great businesses and positive return for our investors.

In the venture world, my guess is that there are too many charlatans out there, those who are out to get your money and then can't execute. Or, it ends up that it sucks to work with these guys, even though they seemed sweet in the beginning.

So at least I have a positive beginning with my work history. It has carried me this far and now I have to bring that to the startup/entrepreneurship world.

I can only hope I can deliver....

What kind of investors are venture capitalists?
Venture capitalists are professional investors who specialize in funding and building young, innovative enterprises. Venture capitalists are long-term investors who take a hands-on approach with all of their investments and actively work with entrepreneurial management teams in order to build great companies.

Where do venture capitalists get their money?
Most venture capital firms raise their "funds' from institutional investors, such as pension funds, insurance companies, endowments, foundations and high net worth individuals. The investors who invest in venture capital funds are referred to as "limited partners." Venture capitalists, who manage the fund, are referred to as "general partners." The general partners have a fiduciary responsibility to their limited partners.

What makes a good venture capitalist?
Management backgrounds and networks in specific industries, financial skills, "people skills", negotiating skills, statesmanship, and boundless energy are some of the prerequisites of a good venture capitalist. But all that's not enough, because at its core, venture capital is truly an apprenticeship business. It takes years of mentoring to learn how to assess investment opportunities, set pricing and strategy, build and motivate management teams, deal with inevitable and unpredictable threats to the businesses, source additional capital and strategic partners, and, finally, divest (for better or worse) these illiquid investments. The good ones view it as a calling, not a career.

How are venture funds structured?
Venture Funds are usually organized as limited partnerships where the investors are limited partners, and the managers are the general partners. The majority of funds range in size from $5 Million to $100 Million, and have between 2 and 5 GP's. These partnerships generally have a five to ten year life, which allows sufficient time for the managers to make investments, assist in their maturation process over several years, and then arrange appropriate sales of the partnership's interests.

How do I invest in a venture fund?
Venture fund general partners accept "qualified" limited partners, who commit in writing to invest specific sums in their fund. Limited partners become parties to the Partnership Agreement, which spells out the terms of the fund, and must be prepared to invest their commitments when called upon by the GPs. Capital calls are made in some funds over the first years of the partnership's life, on fairly short notice.

How is my investment repaid?
When a company in the fund's portfolio is sold or taken public, the partnership receives compensation in the form of stock or cash. The general partner typically distributes any cash proceeds to the limited partners immediately and will distribute securities when they are free of most trading restrictions and have reached a reasonable and stable valuation in the general partner's opinion.

What are the income tax considerations of investing in a venture fund?
Venture capital investments usually span several years and do not generate ordinary income. Realized gains on the sale of these investments typically qualify for long term capital gains treatment. In fact, in cases where the LPs receive stock distributions, taxable gains are deferred until the stock is sold by the LP. Most taxable investors find the characteristics of venture capital investing to be particularly advantageous, as investments normally compound in value over several years free of income recognition until sale.

Excerpted from National Venture Capital Association and B4ventures.

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.

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 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.

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...

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.

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....

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

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....

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.