Chris Dixon

It seems like every successful entrepreneur I know at one point or another kicks around the idea of creating an incubator. The appeal is the idea that you can do not just one startup but many, and just focus on the “fun stuff” in each one (idea generation, product features, strategy, etc).

History has shown that incubators are really hard to pull off. In fact, the results from incubators in the 90s were apparently bad enough that the word itself carries a bad connotation in VC/startup circles.

Here’s why incubators are so hard to make work. Every successful startup requires a great entrepreneur focused solely on that company’s success. You can’t just take a great idea and have a great entrepreneur work on it for a while and then pass it off to a mediocre entrepreneur. It just won’t work. Maybe you can do that after the product is launched and gaining traction. But this is hardly an incubator. It’s more just like an early-stage entrepreneur transitioning to an advisory role – a pretty common practice a few years into a venture.

And maybe you can find exclusively great entrepreneurs to take over the companies, but then what you are doing is much more like active advising/investing, or “hatching” companies, as some VC’s now call it, presumably to avoid the dreaded I-word.

At first it seemed like Silicon Alley Insider would be this, but they seem to have moved away from covering NYC startups.

The New York Times covers national tech, as does the WSJ. The majority of their tech articles are about CA companies.

I think for the NYC tech startup ecosystem to really become as vibrant as CA’s, we need a TechCrunch equivalent. I hope someone starts one.

There are all sorts of protocols in the VC world. Most of them make sense upon further examination, but if you’re a first time entrepreneur, they aren’t obvious, and it’s very easy to mess them up. Here’s one of them.

From VC’s perspective, one of the most annoying things an entrepreneur can do is “shop” a term sheet.  That means after they’ve offered you a term sheet in writing you take it to other investors to try to get a better deal. Most VCs I know won’t even send anything in writing until you have verbally agreed on all essential terms precisely to avoid this possibility.

Why are investors so sensitive to this?  First of all, no investor wants to think they are “just money” – the idea that you want to get an explicit auction going suggests that.

More importantly, what often happens is that once a VC has offered you a term sheet – especially if that VC is well respected – other VCs suddenly become interested.  It is pretty much guaranteed that if Sequoia offered you $4M pre, there are many other investors who, simply because of Sequoia’s offer, would offer you a higher price.  So if Sequoia allowed their term sheets to be shopped they’d never get deals done.

Some entrepreneurs think they are being savvy by shopping a term sheet but I would strongly caution against it.  The VC/startup community is extremely small and this will usually come back to bite you.

Note that I am not saying an entrepreneur shouldn’t get a competitive process going and try to get the best deal with the highest quality investors.  You just need to do it in the right way.  Discuss things verbally and only accept a term sheet when you have agreed on all significant terms.  At that point, assuming the term sheet agrees with what you said, you should sign it and return it within a day or two.  (Don’t say you need to wait for you lawyer to review it – if you want to be an startup CEO you need to learn how to review and evaluate term sheets.  Have your lawyer teach you about term sheets before you receive them.).

Also, don’t shop a verbal offer.  You can’t go to, say, Greylock and tell them Accel offered you 4 pre.  First of all they might collude.  Secondly it’s very likely to get back to Accel (they all know each other) and you might lose both deals.  What you can say is “I’m planning to wrap things up by X day and I have a lot of interest” and see what Greylock does.

I’ve gotten some emails recently from readers of this blog with questions about early stage startups.  I’m sorry if I haven’t responded to all of them yet.  I’m happy to try to answer questions but would generally prefer to do them on the blog so they can be shared/discussed.

Here’s one I got recently:

So you’re joining a startup as one of the first, or the first, non-founding members.  At the moment, the company generates little or even no revenue, but they do have a working first version of their product and a few early users.  To this point the company has been surviving on a modest amount of “friends and family” capital, which has largely been used to support the founders as they built the company and their product.  The founders, however, are convinced that a significant investment is imminent and you will be receiving a reasonable salary in short order.  They are equally certain that their product and their plan is ready to take off.

Determining a fair equity grant at this time is tricky enough; there seem to be far fewer established norms and guidelines for determining compensation in a pre-investment startup than there are following such a milestone.  To further complicate this situation, fast forward 6, 9, even 12 months into the future.  That “imminent” investment has not yet materialized and you have yet to receive any salary (though perhaps the founders have continued to subsidize themselves from the earlier friends and family investment).  The original product has been slow to build traction.  The product has undergone significant upgrades, and one or more new products have been developed, all with your input and assistance.

At this time, both sides decide to sit down and more formally address the issue of your equity grant, but by now the boundaries of your role have become even more blurred than when you first joined the startup.  To be sure, you are not one of the founders, but it seems the founders were not as far along as they believed when they brought you in.  Of course both sides are still likely to overvalue their contributions, so what guidelines and norms can you and the founders possibly look to in order to reach a fair and reasonable agreement on your equity grant?

Honestly, I’m not sure my top worry would be my equity grant at this point.  If I understand correctly, you’ve been working for a year with no written equity grant, no salary, for a company that has gotten little traction, and for founders who were way overly optimistic about their chances of raising money…? (perhaps even misleadingly so?)  I guess if you really love the vision or have no other options then you stay, but otherwise I’d recommend looking for a new job.  At an absolute minimum you should be given an option grant in writing ASAP, and I think that given your sacrifice and the uncertainty of raising any money beyond friends and family that grant should be significant.  If your skills are as important to the company’s as the founders, I’d say it should be at or around founder level.

I worked for a startup once where my equity grant wasn’t in writing.  Needless to say, when the company was sold, I got nothing.  Always, always get your equity grant in writing. Quality entrepreneurs will simply give you your grant in writing without you even needing to ask.

Many seasoned entrepreneurs have had the following experience.  A VC eagerly wants to meet with you.  You have what seems like a very good meeting, and yet the VC’s excitement level drops noticeably in follow up conversations. Then he says “No” in VC language.  What just happened?

The answer is that besides cold hard cash the other currency in venture capital is information.  A VC will meet with pretty much anyone they deem “serious” in order to gather more information, which they can then use to discover interesting investments, do better diligence on potential investments, impress entrepreneurs and other VCs with their knowledge, gossip with other VCs about recent deals and trends, and give seemingly informed advice to their portfolio companies.

I’m not saying VCs are trying to take your trade secrets and give them to competitors.  The vast majority of VCs would never do this.  Instead, they are after much more general, innocuous information, like the rough valuations of recent financings, what companies and markets are “hot,” what products are getting popular, what marketing tactics are proving successful, and so on.

Imagine you were a professional sports bettor but none of the existing information sources – Internet, TV, etc – existed.   The only way you could get information was by talking to people who actually saw the sporting events live. This is kind of what it’s like to work in venture and why VCs are so desperate for information.  There is very little publicly written about what’s really going behind this scenes. Occasionally juicy tidbits will come out on blogs like TechCrunch, and some moderately useful stuff appears daily in peHUB and other VC newswires – but crucially missing are the valuations, cap tables, competitive offers, companies’ performance, and pretty much everything else people really want to know.

In the way they cross-polinate information, VCs play a role with startups similar to what consulting firms like McKinsey play in the Fortune 1000 world.  They spread best practices around from one firm to another, in the end, on average, making everyone more efficient and informed, while also reducing informational advantages

My advice to entrepreneurs is not to run and hide.  Instead, you need to learn to play the game.  Meet with as many VCs as you can.  They are great sources of high level information.  Such and such assets are cheap right now.   Startups are having success with a such and such marketing channel.  A certain venture firm is eager to deals in your space.  Staying in the information flow is one of the main reasons many serial entrepreneurs angel invest on the side.

Just go to these meetings with the proper expectations – the VC’s eagerness probably has more to do with gathering information than investing in your company.