Chris Dixon

I’ve seen a number of situations recently where entrepreneurs decided to shut their startups down while they still had cash in the bank. (Contrary to popular mythology, I’ve never seen a case where investors forced an early-stage startup to shut down before they ran out of cash — it has always been voluntary).  Shutting down is an incredibly hard thing to do.  It takes great maturity and intellectual honesty to realize things aren’t going the way you hoped and that it might be better to just close shop and do something else.

How entrepreneurs handle shutting down is very important.  First, try to return as much capital to your investors as you can (after paying off employees and other important debts – but don’t waste money on an expensive legal process). Second, if you’ve developed IP, spend a few months trying to sell it to recover as much capital as you can (often investors will offer a “carve out” to incentivize entrepreneurs since the likely return to investors will be under total number of preferences).  Don’t go off starting a new venture before you’ve properly closed down your current one (I’ve seen this twice recently – very bad form).  Finally, for your own learning as well as your reputation, write a detailed post-mortem about what went right and wrong and send it to your investors, and then try to follow up with in-person discussions.

Here’s the good news.  One of the great things about angel and venture investors is that failure is accepted, as long as you do it in the right way. Venture investors will often fund entrepreneurs who’ve lost their money in the past. They understand that if you build an interesting product and, say, market forces turn dramatically against you, that’s a risk they took — and the type of risk they will take a again. Also, entrepreneurs tend to be judged by their wins (max() function), not their average.  You’d be surprised how many entrepreneurs have failures in their past that no one remembers once they have some success.

Short answer:  enough to get your startup to an accretive milestone plus some fudge factor.

“Accretive milestone” is a fancy way of saying getting your company to a point at which you can raise money at a higher valuation.  As a rule of thumb, I would say a successful Series A is one where good VCs invest at a pre-money that is at least twice the post-money of the seed round.  So if for your seed round you raised $1M at $2M pre ($3M post-money valuation), for the Series A you should be shooting for a minimum of $6M pre (but hopefully you’ll get significantly higher).

The worst thing a seed-stage company can do is raise too little money and only reach part way to a milestone. Pitching new investors in that case is very hard; often the only way keep the company alive is to get the existing investors to reinvest at the last round valuation (“reopen the last round”). The second worst thing you can do is raise too much money in the seed round (most likely because big funds pressure you to do so), hence taking too much dilution too soon.

How do you determine what an accretive milestone is? The answer is partly determined by market conditions and partly by the nature of your startup. Knowing market conditions means knowing which VCs are currently aggressively investing, at what valuations, in what sectors, and how various milestones are being perceived.  This is where having active and connected advisors and seed investors can be extremely helpful.

Aside from market conditions, you should try to answer the question: what is the biggest risk your startup is facing in the upcoming year and how can you eliminate that risk?  You should come up with your own answer but you should also talk to lots of smart people to get their take (yet another reason not to keep your idea secret).

For consumer internet companies, eliminating the biggest risk almost always means getting “traction” – user growth, engagement, etc. Traction is also what you want if you are targeting SMBs (small/medium businesses). For online advertising companies you probably want revenues. If you are selling to enterprises you probably want to have a handful of credible beta customers.

The biggest mistake founders make is thinking that building a product by itself will be perceived as an accretive milestone. Building a product is only accretive in cases where there is significant technical risk – e.g. you are building a new search engine or semiconductor.

Now to the “fudge factor.”  Basically what I’d recommend here depends on what milestones you are going for and how experienced you are at developing and executing operating plans. If you are going for marketing traction, that almost always takes (a lot) longer than people expect.  You should think about a fudge factor of 50% (increasing the round size by 50%).  You should also have alternative operating plans where you can “cut the burn” to get more calendar time on your existing raise (“extend the runway”). If you are just going for product milestones and are super experienced at building products you might try a lower fudge factor.

The most perverse thing that I see is big VC funds pushing companies to raise far more money than they need to (even at higher valuations), simply so they can “put more money to work“. This is one of many reasons why angels or pure seed funds are preferable seed round investors (bias alert:  I am one of them!).

Suppose you are in the enviable position of choosing between offers from multiple VC firms.  How much should you weigh the brand of the VCs when making your decision?  I think the answer is:  a little, but a lot less than most people assume.

First, let me say the quality of the individual partner making the offer matters a lot.  However, in my experience, there is a only rough correlation between a VC’s brand and the quality of the individual partners there.  There are toxic partners at brand name firms, and great partners at lesser known firms.

There are only two situations I can think of where the firm’s brand really matters.   First, if you manage to raise money from a particular set of the top 5 or so firms, you are almost guaranteed to be able to raise money later at a higher valuation from other firms. In fact, there are VC firms whose explicit business model is simply to follow those top firms.

The other way a VC firm’s brand can help is by giving you credibility when recruiting employees.  This matters especially if you are a first-time entrepreneur whose company is at an early stage.  It matters a lot less if you’re a proven entrepreneur or your company already has traction.

In my opinion that’s about it in terms of the importance of the VC’s brand.  Too many entrepreneurs get seduced into thinking they’ve accomplished something significant by raising money from a name brand VC.  Also, remember that if you are raising a seed round, the better the firm is, the worse it can actually be for you if that firm decides not to participate in follow on rounds.

I’ve been trying to set up a “Popular Posts” widget on the sidebar of this blog but somehow repeatedly failed.  So instead I’ll just post them here:

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There is a widespread myth that the most important part of building a great company is coming up with a great idea.  This myth is reflected in popular movies and books: someone invents the Post-it note or cocktail umbrellas and becomes an overnight millionaire.  It is also perpetuated by experienced business people who, for the most part, don’t believe it. Venture capitalists often talk about “the best way to pitch your idea” and “honing your elevator pitch.”  Most business schools have business plan contests which are essentially beauty pageants for startup ideas.  All of this reinforces the myth that the idea is primary.

The reality is ideas don’t matter that much.  First of all, in almost all startups, the idea changes – often dramatically – over time. Secondly, ideas are relatively abundant. For every decent idea there are very likely other people who’ve also thought of it, and, surprisingly often, are also actively pitching investors. At an early stage, ideas matter less for their own sake and more insofar as they reflect the creativity and thoughtfulness of the team.

What you should really be focused on when pitching your early stage startup is pitching yourself and your team.  When you do this, remember that a startup is primarily about building something.  Hence the most important aspect of your backgrounds is not the names of the schools you attended or companies you worked at – it’s what you’ve built.  This could mean coding a video game, creating a non-profit organization, designing a website, writing a book, bootstrapping a company – whatever.  The story you should tell is the story of someone who has been building stuff her whole life and now just needs some capital to take it to the next level.

Of course a great way to show you can build stuff is to build a prototype of the product you are raising money for.  This is why so many VCs tell entrepreneurs to “come back when you have a demo.”  They aren’t wondering whether your product can be built – they are wondering whether you can build it.

As readers of this blog know, I’m a huge fan of the startup and venture capital world but also a sometimes critic of how the venture capital industry works. For a long time I’ve wanted to do more than talk about this and actually start a new kind of venture firm, designed the right way from the ground up.

Last year two friends of mine who are both very successful, serial entrepreneurs — Eric Paley and Dave Frankel — were brainstorming ideas for what to do next when the thought occurred: why not make their next startup a new kind of venture firm, the kind we had wished existed back when we started our first companies?

So this is what we, along with a bunch of other serial entrepreneurs, decided to do. We call our new firm Founder Collective. Joining us are Mark Gerson (founder of Gerson Lehrman Group), Zach Klein (co-founder of Vimeo/Connected Ventures), Bill Trenchard (co-founder of LiveOps), and Micah Rosenbloom (co-founder of Brontes). We expect to add more founders over time.

We think of ourselves as part of a new wave venture firms led by Y Combinator, First Round, Maples, Ron Conway/Baseline, and Betaworks, among others, that have adapted to a world where venture capital is abundant but authentic seed capital and, more importantly, mentorship from experienced entrepreneurs, is scarce. We have many similarities to these firms and also some differences:

1) We have a small fund – approximately $40M – and intend to keep it that way. This means seed investments are our entire business — they are not options on future financings. Hence our interests and the founders’ interests are aligned. This also means we are happy with smaller exits if that’s what the entrepreneur wants to do.

2) Each person involved in Founder Collective is an entrepreneur, most of them currently running startups full time (my full-time job is CEO/co-founder of Hunch).

3) We believe the best people to predict the future — and create it — are fellow entrepreneurs, not former bankers drawing graphs and developing abstract theses.

4) We try to be respectful. We’ve all sat in countless meetings where VCs show up late, email while you are presenting, and generally act arrogant and dismissive. We try really hard not to be like that.

5) We’ll make investments anywhere in the world but tend to favor our home turf – New York City and Cambridge, MA. New York is a hotbed for online media and advertising startups. In Cambridge, there is a constant flow of ideas coming out of places like MIT that just need a little capital and guidance.

We realize the word “Collective” sounds a bit radical, even socialist. This is deliberate. While we have an actual fund — we are not just a group of angel investors — we also have a unique structure where active entrepreneurs lead investments, work hard to help their investments succeed, and share in the profits when they do.

Think of it as peer-to-peer venture capital.

I’ve seen a number of situations recently that are something like the following.  A VC firm signs a term sheet with an early stage company. Let’s say it’s a $2M round.  The VC and entrepreneurs decide to set aside $500K for small investors (individual investors or micro-VCs). Because it’s a “hot” deal, there is way more small investor interest than there is capacity (the round is “oversubscribed”), and the entrepreneur needs to decide which investors are in and which are out.

The most common mistake entrepreneurs make is to base their choice solely on the investors’ “celebrity” value (by “celebrity” I generally mean in the TechCrunch sense, not the People magazine sense).  Picking celebrity angels might help you get a little more buzz when you announce the financing and a few SUL tweets, but that’s about it.  A startup is a long trip — what you should care about is whether, through the ups and downs and after the buzz dies down, the investors will actually roll up their sleeves and help you.

That isn’t to say that being a celebrity and being helpful are mutually exclusive.  Ron Conway is a celebrity (in the startup world) and is one of the hardest working investors I know. But there are other celebrity investors who I’m a co-investor with in a few companies who literally don’t respond to the founder’s emails.  And these are successful companies where the founder sends them only occasional emails about really important issues.

The second biggest mistake is picking angels that benefit the lead VC.  A lot of times when VCs guide entrepreneurs to certain investors what they are really doing is “horse trading” – they want you to let in so and so, because so and so got them into another deal, or will help them get into future deals.

It’s also smart to pick a varied group of people.  If you want a few celebrities to create some buzz, fine.  You should also pick some people who are connectors – who can introduce you to key people when you need it (varying connectors by geography and industry can also be helpful).  Also very important are active entrepreneurs who can (and will) give you practical advice about hiring, product development, financing etc.

Finally, don’t spend too much time agonizing over this.  One particularly silly situation I was involved with was where the CTO had invited me to invest but then the CEO decided he wanted to put me through multiple interviews before he’d let me in.  He probably spent a day of his time deciding whether to give me some tiny fraction of the round. Eventually he dinged me because I wasn’t famous, but at that point I was frankly kind of relieved since the CEO seemed to have such a bad sense of how to prioritize his time.

Disclosure: This post is entirely self serving, as I consider myself a non-celebrity but hard working small investor.

There is a certain well respected venture capital firm (VC) that has a program for fledgling entrepreneurs.   The teams that are selected get a desk, a small stipend, and advice for a few months from experienced VCs.  I could imagine back when I was starting my first company thinking this was a great opportunity – especially the advice part.

Here’s the problem.  A few years into the program, approximately 25 teams have gone through it.  The sponsoring VC funded one team and passed on the other 24.  None of those other 24 have gotten financing from anyone else.  Why?  Because once you go through the program and don’t get funded by the sponsoring VC, you are perceived by the rest of the investor community as damaged goods.

Most early stage investors are bombarded with new deals.  There is no way they could meet with all of them, or even spend time seriously reading their investor materials.  In order to filter through it all, they rely heavily on signals.  The person referring you to them is a very big signal.  Your team’s bios is a very big signal. And if you were in the seed program of a VC who has a multi-hundred million dollar fund and who decided to pass, that is a huge signal.

Meanwhile, the unsuspecting entrepreneurs think: “I was at a prestigious VC this summer – this will look great on our bios and company deck.”  The truth is exactly the opposite:  the better the VC, the stronger the negative signal when they pass.

Thus, the most important question to ask before taking seed money is: How many companies that the sponsor passed on went on to raise money from other sources?

The best programs don’t have sponsors who are even capable of further funding the company.  Y Combinator simply doesn’t do follow ons, so there is no way they can positively or negatively signal by their follow on actions. (Although now that they have taken money from Sequoia people are worried that Sequoia passing could be seen as a negative signal.  I just invested in a Y Combinator company and was reassured to see Sequoia co-investing).  Other seed programs lie somewhere in between — they aren’t officially run by big VCs but they do have big VCs associated with them so there is some signaling effect.   (I would call this the “hidden sponsor” problem.  I didn’t realize the extent of it until I got emails responding to my earlier seed program posts from entrepreneurs who had been burned by it).

The most dangerous programs are the ones run by large VCs.  I would love for someone to prove me wrong, but from my (admittedly anecdotal) knowledge, no companies that have been in large VC seed programs where the VC then stopped supporting the company went on to raise more money from other sources.

As has been widely noted, startups – especially internet-related ones – require far less capital today than they did a decade ago.  The VC industry has responded by keeping their funds huge but trying to get options on startups via seed programs.  Ultimately the VC industry will be forced to adapt by shrinking their funds, so they can invest in seed deals with the intention of actually making money on those investments, instead of just looking for options on companies in which they can invest “real money.”  In the meantime, however, a lot of young entrepreneurs are getting an unpleasant introduction to the rough-and-tumble world of venture capital.

Disclosure:  I am biased because as an early stage investor I sometimes compete with these programs.

Andy Weissman’s blog has the tagline “Maximizing the serendipity around you.”  It’s a good philosophy.  I think one of the simplest ways to do this is to ask people lots of questions when you meet them.  I’m surprised how often people fail to do this.  Besides being good manners, it’s also an efficient way to learn about the world and sometimes make important discoveries and connections.

About 6 years ago, when I was working at Bessemer as junior investor, I was at a dinner with a group of friends and acquaintances.  The guy sitting next to me was a business school student who spent most of the dinner talking about how he was trying to get a job in venture capital.  He never bothered to ask me what I did for a living and I never mentioned it.

Now, I wasn’t a particularly important venture capitalist, but getting a job in the industry is all about meeting as many people who work in it as you can.  The fact that he happened to be sitting next to one was potentially serendipitous – had he only bothered to ask questions.

There has been a lot of talk the past few days about Twitter raising $100M at a $1B valuation.  To understand what is going on from the investor side, you need to know about David Swensen, the man who (inadvertently) destroyed venture capital.

Mr. Swensen manages Yale University’s endowment and is the inventor of the so-called “Yale Model.”  Basically this is a model for people who manage the largest pools of capital in the world – universities, pension funds, wealthy family funds, etc.  The major idea behind the Yale Model is to put significant portions of one’s fund into “alternative asset classes” like venture capital.   Yale had phenomenal returns for many years (until this year, which was a disaster) and thus was copied by fund managers around the world.  This created demand to invest hundreds of billions of dollars into VC funds.  This in turn radically increased competition amongst VCs, thereby driving down their returns (public pension funds like California’s release the returns of their VC investments and they aren’t pretty).

What this means is that there are lots of VCs out there with huge funds and very little chance of getting “carry” (performance fees), since most will have negative returns (and they know it).  So instead they are collecting management fees (typically, 2% of the fund for 10 years, so 20% of the total fund).  They need to justify collecting these fees, which is why if you hang out with VCs you’ll often hear them talk about needing to “put more money to work.”  I would bet that the new investors were the ones arguing for Twitter to raise more and more money, even if it meant a higher valuation.  I’ve seen it happen many times.