Chris Dixon

Good post, Chris. This is indeed an issue that entrepreneurs need to be careful about. One way to mitigate the risk is to only take seed money if there are clear, agreed-to milestones that would trigger the (often pre-negotiated) Series A. That’s how we try to set up our seeds at Flybridge to try to avoid the very issue you’re raising.

Another mitigating point would be – don’t take seed money from one VC. Insist on taking two. We recently came into the Series A on a deal that was seeded by two VC firms and one dropped out. We did our diligence, disagreed with the firm’s conclusions, and jumped into their shoes alongside the first VC. By having two VCs split, say, $500k and setting up milestones that would trigger a pre-negotiated Series A, you can possibly get the best of both worlds – VC-quality help with angel-level dilution and initial post-money bar.

Chris, great thoughts.

If you haven’t already, take a peek at:
http://venturehacks.com/articles/options-open

Good analysis.

But to be able to make a decision like this founders must ensure that they are in a very strong position and can afford to make choices – when it comes to taking money.

My rule of thumb is that once you start, don’t spend any time raising money, spend the first 12-18 months building value – product, traction, beta customers, feedback, more customers, monetization and take your venture cash-flow positive.

If you can walk into a VC and say we can continue to grow even without, but with your money we can scale it faster and bigger. You sure can make the choice of whom to take the money from. If not then chances are you may not a lot of choice when it comes to money.

The whole VC concept and practice is debatable. I’ve personally seen three different businesses run into the ground and destroyed as a direct result of VC domination of the companies. As a result, I’m extremely nervous about borrowing *any* money for *any* business ideas at all; it’s a risky proposition. It’s refreshing to read Chris’ thoughts and insights.

Chris, there is a great comment thread happening on a TechStars’ forum re: your post. Unfortunately, it is not publicly available. Thus I have posted a slightly modified version of my original comment below:

I participated in TechStars in 2007. The first question afterward from nearly every investor was: “is Brad investing?” (Brad Feld is a VC and co-founder of TechStars) However, I also believe that this “negative signal” (or “Brad effect”) created by VCs’ involvement in seed stage mentor-driven investment programs (such as TechStars) is only half of the story.

Basil Peters, a member of the Bellingham Angel Group, wrote a great book titled Early Exits, Exit Strategies for Entrepreneurs & Angel Investors (But Maybe Not Venture Capitalists). I highly recommend that every startup founder READ THIS BOOK BEFORE TAKING A CENT OF FINANCING. Basil puts forth that the current VC model is broken. He cites shorter innovation cycles & the fact that tech startups do not require the intense amount of capital that they once did as two reasons that the old system is breaking down. Furthermore, Basil identifies an inherit conflict of interest between VCs and startup founders; stating that VCs have a tendency to block exits that would be completely acceptable to the founders & angel investors in the hopes of “hitting it out of the park”. Unfortunately, although this strategy works out in the end for the VC, several viable business are effectively bled to death in the process.

To a certain extent, it could be postulated that mentor-driven seed stage investment programs are the VC model’s adapted response to shorter innovation cycles & the requirement for less cash. Again, as a strategy, this makes very good business sense. However, there is perhaps an even more disingenuous conflict of interest that occurs within the adapted model when such a business is outwardly constructed as a mentorship. I say this, because the second you label it as such, it inherently possesses a grossly different mandate, which IMHO can’t socially afford the traditionally accepted “trail of blood”. In other words the culture needs to evolve with the model.

Having stated this, I would like to also say that my experience participating in TechStars was overwhelmingly positive.

Chris – I agree that it is important to understand what you are signing up for first. I think that this was the biggest mistake for me during TechStars. In 2007 I came into the program viewing it primarily as a mentorship and educational opportunity. However, I emerged realizing that in certain respects it was a relatively cut-throat traditional business environment (which offered its own educational value). For example, we had individual “mentors” who would just as soon hire our team apart for their own VC backed projects as actually mentor our business.

Please Note: I would still recommend that anyone given the opportunity to participate in TechStars seriously consider doing so — just know what you are getting into.

Furthermore, as an entrepreneur, I think it is important to realize that there are several different investment strategies, which you can choose to align yourself with. For instance, the strategy that Basil discusses in his book is not about “swinging for the fences” so much as winning the game by consistently hitting singles and doubles. It all depends on your goal as an entrepreneur.

Also, I ultimately agree that VCs are generally a good thing for entrepreneurs and society at large. But again, culture needs (and will) evolve with the model — especially as business continues to become more transparent via social media.

Last but not least, I was mistaken, the TechStars forum is publicly viewable, you just have to be a member to post: http://startup.techstars.org/discussion/14/The-Problem-With-Taking-Seed-Money-From-Big-VCs

Chris,
Great post and truly admire your foundercollective.com, it was long-overdue. Some quick questions:

a) does a dedicated seed-fund charge management fees to its investors? if not, how does the fund cover opex? For example, in the VC model, GPS charge management fees to LPs and get paid carried interest;
b) How and when would “seed-lps” get paid?
c) What kind of support can you offer entrepreneurs, beyond coaching/advising/contacts?
d) What would the typical ownership stake be for a seed investor (I know that y-combinator takes a very small stake for a very^5 small investment); and
e) how many companies you need to invest in to start generating portfolio effects?

Would love to get your take on these, if you have time of course.

Thanks!
Enrique
617-780-5465

sorry, we will answer all the emails in time. just really behind right now.

“I sometimes compete with big VCs…” You should.