September 30, 2005

How to select your co-founders

Allen Morgan of Mayfield, has some great suggestions on how entrepreneurs should go about creating their start-up team - especially selecting co-founders.

He points out how VCs most often pass on interesting ideas because they don't like some of the co-founders.

..for a VC firm that is comfortable with early stage startups, an incomplete startup team is preferable to a team with the wrong team members.

First, VC’s pride themselves (some are even good at it) on being good at helping their companies recruit. If a startup has an attractive couple of founders and a terrific business idea, a VC can imagine how additional, world-class team members could be recruited to fill out the team.

...Second,.. it’s always hard to transition the “wrong” co-founder out of the Company – it’s also economically unattractive to the remaining co-founders.

Org-charts

We’ve all seen a “standard” organization chart. It has (1) the CEO at the top, (2) Four to eight Vice-presidents below, each in charge of a business function and reporting to the CEO, (3) Directors in the reporting chain below the Vice-presidents, and (4) a variety of folks with different (and non-standard) titles in the reporting chain below the Directors.

I would claim that this “standard” org chart is actually a good template to follow in organizing a startup through, say, the first 40 people. ..there is an interestingly strong correlation between (1) startups with org charts that were “contorted” in some way (compared to the “standard” one) and (2) startups that ended up with some kind of founder trouble. Thus, if there are “odd” lines of reporting, or if there are “odd” titles that don’t fit in a standard org chart, it usually raises a red flag. If you’re having trouble fitting one of your co-founders into a standard org chart, you should think about whether he’s the right person (or, at least, in the right role).

...Another thing founders often fail to realize: not every member of the founding team has to be a Vice-president (or higher). It’s OK to have “TBD” in a number of the Vice-president “boxes” in the org chart of a startup (and elsewhere). For example, don’t worry if you have a great Director of Engineering but no Vice-president of Engineering in your startup. Any Director worth his salt should be able to manage a startup engineering team through 6-8 people, particularly if the CEO has technical experience. In this situation, the VC’s question will be: will the combination of the CEO, the Director of Engineering and the company idea be attractive to a great Vice-president of Engineering when hiring one becomes appropriate.

..Almost guaranteed, any startup that has both a CEO and a President/COO has the wrong person in one or the other (or both) of those roles. This sort of title inflation and proliferation is almost always – like most other “contortions” of the standard org chart – a red flag to VC’s. Can easily be taken to indicate that some of the co-founders are more worried about titles (and ego’s) than success.

.. My advice, however, is to not be afraid of putting “Interim” in front of anyone’s title when it’s reasonable to assume that an early task of the startup is to recruit someone else to that role. This is particularly, but not exclusively, true of the CEO role. VC’s love entrepreneurs with the self-confidence and guts to start a company, as well as the wisdom to realize that they’ll need help.


UPDATE: Allen has followed-up with a very useful suggestions on how to avoid the problem of the "forgotten founder"

UPDATE 2: Jeff Cornwall provides the Why, What, How and Who of selecting your co-founder

Why:
My last set of start-up ventures worked well because my partners and I balanced each other's personalities. One of us was the aggressor; one was the worrier; one was the analyst. We always kept each other in check. This helped us to generally be fairly prudent in our decision making. Also work habits, personal goals and so forth are all important factors to consider.

What?
During the pre-venture stage of your business, one of the first challenges is to assess the specific needs of your new venture. Is there specific business expertise that you need in your particular start-up? If you will need access to a significant amount of capital, that is millions of dollars, then you will want to have someone on your team who has experience in securing such funding. I often see entrepreneurs suffer from either over kill in hiring or from under estimating the skill set needed on the team. If the venture is only going to need limited funding, say $200,000, it would be over kill to bring in a business person whose experience is in moving venture through multiple rounds of venture capital financing. On the other hand if you do need multiple rounds of VC money it is best to have that skill set somewhere in your team. Before you start adding people to your start-up, have a clear enough vision for the business to begin to know what you really need in terms of help.

How?
Just because you need help on your team does not mean the person needs to be a partner. You can often hire high level talent and offer them a limited equity stake in the deal that does not make them your equal in the venture.

Who

Here are some issues you need to explore before "tying the knot":
- Do your share the same vision for the business?
- Do you share the same aspirations for the business? Does one want to build an empire while the other create a simple lifestyle kind of business?
- What are your work habits and work ethic? Are they compatible enough to keep the partnership feeling fair to all the partners?
- How much time off to you plan to take each day, each week, each year?
- How much money will you put into the business?
- How much do you expect to get out of it?
- Who will be the President of the company? What roles will the other friends play?
- How will decisions be made?
- What is everyone's credit rating? Can all help to guarantee a loan, if necessary?
- What if one of you gets married and the new spouse gets a job offer in another city? Would you move away?
- What are your core values and how do you want to see them play out day-to-day in the business?
- How will employees, customers, suppliers, etc. all be treated?
- What will you consider to be real success in this business?

Arun Natarajan is the Founder of Venture Intelligence India, which tracks venture capital activity in India and Indian-founded companies worldwide. View sample issues of Venture Intelligence India newsletters and reports.

Managing the board

Allen Morgan, quoting his friend John Kernan, has tips on conducting board meetings:
1. NEVER have the board meetng "at" the board meeting. ALWAYS call every director a few days before the meeting and run every important issue by them to get their input, Also update them on company performance, especially the bad news, and let them "beat you up" privately. That way, the meeting can focus in a constructive fashion on problem-solving and building the Company for the future.

2. Maximum Powerpoint show is four slides from any presenter, especially yourself. This should be the limit of director interest in detail.

..4. Have your key team members do almost all the presentations. It gives them exposure and allows you to make sage comments along with the rest of the board. A perfect board meeting is when 10% of the talking is done by the CEO, 60% by the team, and 30% by the directors.

..8. For VC directors, try to picture how they are describing your Company to their partners, and what questions their partners are asking. Your job is to make each director a hero to their partners (or corporate boss).

If you work hard, always act in good faith and in the best interest of the Company -- and if you follow these 10 rules -- most VC's will still be interested in financing your next deal, even if the Company tanks.

Arun Natarajan is the Founder of Venture Intelligence India, which tracks venture capital activity in India and Indian-founded companies worldwide. View sample issues of Venture Intelligence India newsletters and reports.

September 27, 2005

"Why risk a start-up when MNCs pay such high salaries?"

Rajesh Jain's has posted on a topic that I have heard several times from other entrepreneurs and VCs.
(I had a discussion) with a US-based venture capitalist of Indian origin who had an interesting take on the problems with entrepreneurship in India. He made four points.

First, salaries in India will rise faster than cost of living which would make it unattractive for employees working with the international majors to quit and create or join a start-up. Second, even the ones who are venturing out seem to be more focused on services than products. Third, the few in the products area seem content OEMing their creation to the market leaders rather than taking them on with full stacks. Finally, Indian companies lack vision to think big and global. I agreed with him on all four counts and added one of my own. It is well nigh impossible to do a tech, product-oriented start-up because angel and early-stage funding is simply not there.

The post also features interesting comments from other entrepreneurs and wannbee entrepreneurs.

Arun Natarajan is the Founder of Venture Intelligence India, which tracks venture capital activity in India and Indian-founded companies worldwide. View sample issues of TSJ Media's Venture Intelligence India newsletters and reports.

September 25, 2005

"The Top Ten Reasons Companies That Should Make It ... Don't."

Jeff Cornwall quotes bankruptcy lawyer Bobby Guy:

10. Over-expansion. The need to get there first or to demonstrate revenue growth to anxious investors leads businesses to grow too fast.

9. Poor Capital Structure. Companies take on too much debt....Enough said!

8. Failure to Control the Controllable Costs. Businesses spend down the initial cash before it is flowing in at a positive rate.

7. Failure to Prepare for Volatility of Uncontrollable Costs. For example, energy, materials, labor, or insurance.

6. Add New Products or Divisions that Drag Down the Profitable Ones

5. Poor Internal Controls and Execution -- customer service, accounting controls, theft, fraud

4. Poorly Designed Business Model

3. Reliance on Critical Financing that Dries Up

2. Failure to Adapt to a Changing Market

AND THE #1 REASON? Management in Complete Denial......

Arun Natarajan is the Founder of Venture Intelligence India, which tracks venture capital activity in India and Indian-founded companies worldwide. View sample issues of Venture Intelligence India newsletters and reports.

September 19, 2005

"Time is the entrepreneur's enemy, but the VC’s friend"

Jeff Bussgang on what’s an entrepreneur to do in the context of a fundraising process when time is their enemy, but the VC’s friend?

One piece of advice is to simply recognize this difference in this attitude towards time and try not to fight against it.  One wizened general partner at a top firm once remarked to me about a particular deal:  “They told me I had to make a decision in the next few days, so I told them I’d save them a few days and simply pass.  It’s VC 101 – anytime an entrepreneur puts a gun to my head, I pass.  There’s always another deal.”  

If you can create a sense of urgency in the fundraising process, you’re running an unusually charmed process.  More typically, you can expect to run a fundraising process where you simply have to give VCs the time they need to “soak in” the deal, live with it for a few months and then, at the right moment, try to call their interest to question.  Rushing the process only gets the VC alarm bells ringing.  For the entrepreneur, this start-up is their life’s work and on their mind every moment of every day.  For the VC, there’s always another deal.

Arun Natarajan is the Founder of Venture Intelligence India, which tracks venture capital activity in India and Indian-founded companies worldwide. View sample issues of Venture Intelligence India newsletters and reports.

September 17, 2005

"Why most start-ups should avoid VC funding"

Extracts from a great post in SiliconValleyWatcher.com by Greg Gianforte, CEO of RightNow Technologies:
-If you start by selling your concept to potential prospects (rather than stock to VCs), you will either end up with initial customers or a conviction that your idea won't work. Why raise money and then find out which one it will be?

-Raising money takes time away from understanding your market and potential customers. Often more time than it would take to just go sell something to a customer. Let your customers fund your business through product orders.

-Adding VCs to the mix early gives you an additional set of masters you must serve in addition to your customers. It is always hard to serve two masters, especially in a startup.

-With no money you can't make a fatal mistake. This is a blessing. Without VC money, you are forced to figure out how to extract funds from your customers for value you deliver. Ultimately that is the only thing that really matters.

-Raising VC money determines your exit strategy. You will either sell the business or take it public. What if you end up with a very profitable, modest sized business that you want to just run? That is no longer an option once you raise VC money.

Arun Natarajan is the Editor of Venture Intelligence India, which tracks venture capital activity in India and Indian-founded companies worldwide. View sample issues of Venture Intelligence India newsletters and reports.

September 15, 2005

Negotiating your earn out deal

Today, a lot of start-up acquisitions come with a “earn-out” provision for the founders – i.e., a part of the payment that is linked to their sticking around and meeting some performance targets. A Business Week article advises entrepreneurs on how to deal with the earn out agreement.

The key to a successful earnout lies in negotiating smart, achievable targets, making sure they're spelled out clearly in your contract, and keeping some power over decisions that directly affect them. You'll also want to nail down your own position in the new company -- and your eventual exit from it.

...Many experts recommend using revenue targets instead (of profits). "It's harder for buyers to do things that will depress sales than to depress income," says Mihanovic.

...No matter which type of target you use, fight for sliding-scale rather than all-or-nothing payments. That ensures that "if you're within 80% of the threshold, you'll get 80% of the payout," says Dexter. Ask also that disagreements over how costs are determined be submitted to binding arbitration.

...Then there's the unenviable task of trying to guess the future. What if the acquiring company gets sold? Or goes public? What if your division gets transferred overseas?

...The last task is getting your own employment contract. Without one, "They can pull the rug out from underneath you," says Phil Thompson, a partner with Thompson Associates, a law firm in Richmond Hill in Ontario, Canada.


Arun Natarajan is the Founder of Venture Intelligence India, which tracks venture capital activity in India and Indian-founded companies worldwide. View sample issues of Venture Intelligence India newsletters and reports.

September 11, 2005

Make “no shop” and other clauses in the VC deal mutual

From Tom Evslin:

My advice to entrepreneurs on this clause is to say politely and firmly “what is sauce for the goose is sauce for the gander.” The no shop should prohibit the VC from entering into financing discussions with competitors broadly defined of the company during the exact same period when the company can’t talk to other investors. If your VC won’t agree to this, don’t hesitate to ask what discussions they are engaged in

In general it is good negotiating advice to make sure that every clause which can be mutual is mutual. Often this technique helps in reaching agreement. For example, with a truly mutual no shop neither party will want it to be very long and both have a strong incentive to complete negotiation quickly.

Assembling a startup team that sticks

BernardMoon of GoingOn Networks, Inc. has some good advice in this AlwaysOn post:

The bottom line is that no matter how good your team appears to investors, what really counts is how your team works together in the trenches. Poor team dynamics and failed chemistry can sink even the most promising companies—a fact many founders and investors discover too late.

...Partner with people you trust. My first piece of advice for any budding entrepreneur, and one I always overstate is, "Trust is essential." If you have any doubts about a potential partner, clear the air or steer clear completely. As John Doerr of Kleiner Perkins Caufield & Byers puts it, "You must ask, 'Are these the people I want to be in trouble with for the next 5, 10, 15 years of my life?' Because as you build a new business, one thing's for sure: You will get into trouble."

...Keep the communications channels open. Don't horde information. In today's fast-paced technology world, it's important that all members of your company have access to the best and latest information. Establish a culture in which there are no information gatekeepers. When one person controls the flow of information, a fiefdom usually emerges in which that individual plays one side against another to increase his or her own perceived value. This creates conflict and inefficiencies—neither of which startups can afford.

...If your network doesn't present a capable candidate whom you know well, take a test-drive, if the situation allows it.

September 06, 2005

Be careful with your angel round valuation

Make sure your angel round doesn’t make you walk off a pier, advises this post on the IBD BlogAngels tend to have higher valuations than venture firms. The angel investment instrument is often a bridge loan to the close of the Series A round. The problem with high valuations is they may stop the VC from investing. Angels must feel comfortable that a Series A will close. Otherwise, a bridge that doesn't get finished is called a pier, and you don't want to walk off of a pier.

Is your company VC fundable?

We primarily fund early-stage companies looking for 1st round funding, which is typically $3-5 million. I want to see the potential of a $100 million revenue per year company. It’s interesting to me when I see company projections and forecasts based on compound interest. I don’t think about compound interest. I can do Excel, too. I invest in companies to get 2-3 times the multiple of revenue (implying at least a $200M exit valuation). And sure, VCs have bigger appetites these days to build smaller, more targeted companies, in less time. And yes, M&A is the more likely exit. That’s the trend. I look for deals that will get 10x the return, and I don’t really care if that takes 3 years, 5 years, or 8 years.

-- George Zachary, Partner of Charles River Ventures in IBD Network

September 02, 2005

And MBA or a PSD?

"I would say that I'm an Ace Greenberg P.S.D. Ace has a saying: 'I won't hold an M.B.A. against you; but I prefer Poor, Smart, and a Desire to be rich.'"

-- Bear Stearns vice-chairman Fares Noujaim in New York Magazine.