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The Entrepreneurial Bible to Venture Capital is packed with invaluable advice about how to raise angel and venture capital funding, how to build value in a startup, and how to exit a company with maximum value for both founders and investors. It guides entrepreneurs through every step in an entrepreneurial venture from the legalities of raising initial capital to knowing when to change tactics.
Andrew Romans is the co-founder and general partner of Rubicon Venture Capital, a venture capital fund that invests in privately held technology companies and enables its investors to co-invest along side the fund on a deal-by-deal basis via innovative sidecar funds right up to IPO or M&A exit.
Start Me Up!
Starting a new company that requires capital to get going is a bold and risky move. I have pulled together stories and advice from key members of the ecosystem in an effort to derisk this endeavor and make everyone more successful. Many of the tactics and tales are timeless, but the appetite for investing in startups oscillates between fear and greed correlating with economic cycles. Tim Draper, the only third-generation VC I know, does a great job of setting the stage with his description of the "Draper Wave."
Why Now Is a Great Time to Start a Company, Be a Venture Capitalist, Be an Angel Investor, or Invest in a VC Fund
In an interview with Tim Draper, founder and managing director of Draper Fisher Jurvetson (DFJ), I asked him to explain his "Draper Wave" that shows historical trends in a cycle between venture capital and private equity (PE). Tim responded:
After the bubble burst in 2000, we had 10 flat years in venture capital. Then in 2008 the world came to an end and I thought: Oh my gosh! We're gonna be hit again! Gradually I realized that just can't be! It can't be right, because eventually these things do come back. I started to analyze history, trying to put this all into perspective, going back to 1957 when my grandfather started venture capital on the West Coast. I created something I call "The Draper Wave" (see Figure 1.1). Venture capital is not a classical sine wave cyclical business, but it is indeed cyclical. It follows waves opposite to those of the private equity business. While venture capital goes up like a shark's tooth (nothing ironic there), then comes down and sort of flattens out, the PE business is simultaneously coming down and then going up like a shark's tooth, flattening while venture capital is revving up again.
There's nothing scientific here, but the data and the emotional strength of the venture business does follow this pattern. I don't really know what happened when my grandfather was in the business from 1957 to 1965, but let's assume he was trying to solve a big problem during a recession when people are out of work and looking for something to do. They might say, well, you know my boss wasn't that good at what he did. I can do better. Or there's an opportunity here that the company I worked for didn't really take advantage of. So entrepreneurial ideas start happening, and then venture capitalists come in, enabling those entrepreneurs to start employing people. Jobs start to pick up, pick up, pick up, attracting more and more venture capital. Investors begin to see that these are great companies and they pour it on, rising to a crescendo and (often) crashing down. From 1965 to 1974 the big companies became conglomerates, buying other companies, slashing employees. That's how they grew. They'd acquire and fire, acquire and fire, and they made everything much more efficient. That was the roaring sixties that continued from 1965 to 1973.
At that point I think things probably got too frothy and came crashing down, causing the 1973–'74 recession. People were looking for things to do, the computer industry started, and other interesting things happened. Between 1974 and 1983 venture capital boomed again, creating major employment. This peaked in 1983 with Arthur Rock and Steve Jobs (for the first time) on the cover of Time magazine, soon before things crashed.
I joined the venture business in 1985 when the headliners were the LBO [leveraged buyout] folks. This was a new form of leverage that improved the efficiency of the system much like the conglomerates had before. They leveraged up, up, up until 1991 when the RJR Nabisco deal brought the house down. The banks decided not to lend anymore; they had lent too easily and too crazily. Of course that led to the 1991 recession.
From 1991 people began starting new companies again, creating the almost decade-long Internet boom; but eventually came the end-of-cycle 2000 crash.
The PE business was really just the LBO business between 2000 and 2008. PE-LBO made the inefficient companies created during 1991 to 2000 more efficient. But once again, in August 2007 the credit crunch brought the cycle crashing down. The venture capital crash followed, and in September 2008 another recession arrived.
We are now about five years into what I see as a nine-year cycle. People are beginning to create new companies, start employing people, and attract venture capital. More and more venture capital is coming out from hiding. I therefore conclude that today is actually an amazing time to start a business and an amazing time to be a venture capitalist. The angels have it right. They were funding these smaller businesses at just the right times. It's all going to pay off very well for them. I don't think we're going to have another bubble until say 2017 or so. This means that we have plenty of time.
I noted to Draper that right now there is more angel investing activity in the Silicon Valley and globally than ever before in history. Accelerators are sprouting up everywhere spawning new ventures, so the sheer number of companies being started and funded right now is higher than ever before in history. At the same time, the dollar amount of money going into first round series A venture capital financings is contracting. I asked, "How do you believe these companies will finance their businesses when the balance has shifted so much?" Draper responded:
What I was saying with the long history is that when there's a need, the investors fill in. Once they start making money in an area, then they pile on, the frenzy begins, followed by the crash. In our present case, the angels were very necessary between 2008 and 2011. The fact that there are more angels than ever before is in general because the venture capital business is growing globally. You are going to have a lot more angels. You're going to have a lot more entrepreneurial successes. You're going to have a lot more businesses that take off because of venture capital. There will be more competitors worldwide, and so the competition will be fiercer. But the markets are also bigger. And so I think everyone will benefit from more venture capital and more entrepreneurship. You will see each of these 18-year generations is going to be bigger than the last until it hits a steady state, which I think will be many generations out.
There are a lot of places in the world that don't really have a lot of venture capital and entrepreneurship, and so there's still opportunity for growth there, East Africa for example. By nature you will see a lot more angels now. I think you are asking where these new accelerator and angel-backed companies will get their financing after three years when their angel funding has run out and they are looking for where their next round will come from. The next round will come from either angels that invest at later stages, venture capitalists, or private equity or hedge fund guys that say—hey, I have to get into this because there's an opportunity. I think where there are good companies there will always be funders behind them. Good companies are only limited by people's imagination.
Imagination is everything. It is the preview of life's coming attractions.
Branchout: The Textbook Case Study for Superb Angel Advisory Round and VC Funding
BranchOut is worth examining for a number of reasons. Rick Marini is a very dynamic CEO, the angel group backing the company is unusually powerful, and the value prop is simple and clear: enable Facebook users to connect to existing contacts relevant to their business. BranchOut is basically LinkedIn on top of Facebook.
For a company that has only been in existence for a short time, BranchOut boasts a remarkable constellation of investors, as well as Rick's own choice of VCs. Rick Marini put in the effort and care to recruit over 20 advisors and angels into his deal before going to VCs, creating huge momentum for his company and the VC fund-raise. BranchOut is a masterfully architected super-high-growth enterprise.
Here is Rick's story in his own words.
Every company needs a solid foundation: a great idea, a world-class team, and the capital to fund growth. BranchOut was rare because our foundation was formed very quickly.
In June 2010, I was working with a small team of engineers and a designer who had been with me for years. We founded Tickle.com in 1999 and built it into one of the first social networks. Tickle was the largest personality testing site on the Internet, with 200 million registered users. In 2002, Tickle won a Webby for being the fastest-growing website. In 2004 we sold Tickle.com to Monster Worldwide for over $100 million. Our next company was called SuperFan. We built social games and Facebook apps for entertainment companies, like MTV, CBS, Sony, Warner Music, and Universal. So when the idea for BranchOut came, we already had the foundation of a team with experience in viral growth, Facebook apps, and online recruiting. It was the perfect storm.
One day a friend reached out to me to see if I knew someone at a specific company. He wanted an introduction to a sales lead. Having nearly 2,000 friends on Facebook, I searched to see whom I knew at the company in question. Facebook didn't make it easy to find people based on where they work. So I turned to Nate Smith, our director of engineering, asking him to build a widget that identified friends and friends-of-friends by company. Nate's widget worked perfectly, so we immediately decided to pivot the entire company and build BranchOut, the largest professional network on Facebook. On BranchOut people can create professional profiles, search for jobs, and find helpful connections for business opportunities. The opportunity was obvious since Facebook was rapidly becoming the biggest and most visited site online.
One night, very late, I got a call from Michael Arrington, then editor of TechCrunch. Mike had heard about what we were up to and wanted to break the story. The next morning BranchOut was on the TechCrunch home page and the VCs started calling. We had the big idea and perfect team on day one. Now we just needed the cash.
I had raised $9 million with my Tickle.com cofounder, James Currier, so the process was familiar. The difference this time was that we had so many investment offers so quickly. For example, I went to one of my friends, a prominent super angel, asking for feedback on my pitch before meeting with Sand Hill Road. After seeing the first two slides he stopped me and said, "I don't need to hear any more. I get it. I'm in for a million." I wasn't even pitching him! Clearly this was a big idea and my challenge would be to limit who could participate in the round to those investors who brought the right connections, strategic advice, and vision to build BranchOut into a billion-dollar company.
All of the investors I met with were great, top-tier VCs whom I respect tremendously. Knowing that the lead investor would be on our board and we'd be working as partners, I wanted someone who was the perfect fit. Kevin Efrusy at Accel Partners stood out as just that person. He was the one with the foresight to see that Facebook was the next big thing when no one else saw it. He was tenacious in convincing Mark Zuckerberg and Sean Parker that Accel was the best investor to grow the company. He also invested in Groupon, where he's a board member. I met with Kevin, as well as a number of other VCs, each time checking in on Foursquare so they all saw the number of VCs interested in funding BranchOut.
One day, after an afternoon of back-to-back meetings in Palo Alto, I was driving back to San Francisco when Tim Chang, then partner at Norwest Venture Partners, called and said, "We need to have dinner tonight." He could tell things were heating up and wanted to lead the round. A few minutes after scheduling dinner with Tim, Kevin called and said, "We need to have dinner tonight." I laughed and explained that I was meeting with Tim. Kevin persisted and countered with "Fine, let's have drinks. You name the time and place. I'll drive up from the Valley." So I told him where to meet me and drove to the restaurant to meet Tim.
Tim and I are good friends. We had a great dinner, during which he did something I appreciated and will never forget. He explained, "As a VC I want to lead the round, but as your friend, I can admit that Kevin is also a great fit. If you let him lead, I'll understand. But I want in either way." We wrapped up dinner and I met Kevin at Gordon Biersch, a brewery near my apartment. It was clear he wanted to lead the round. When we got to negotiating the valuation for BranchOut, we literally did it on a napkin. He wrote a number on the napkin and slid it across the table. I crossed it out and wrote a bigger number. He didn't accept, so I proposed a valuation that I knew was fair for both of us. We shook hands, and that was that.
Accel Partners led a $6 million round with Norwest Venture Partners and Floodgate Fund participating. I carved out room for a dozen super angels to also invest, including Shawn Fanning from Napster, Michael Birch from Bebo, Naval Ravikant from Angel List, Dave Morin from Path, Matt Mullenweg from WordPress, Chris Michel from Military.com, Tickle cofounder James Currier, and others. Most of these were friends. I wanted them involved, both for their strategic advice and the potential for them to benefit if BranchOut had a big exit.
Those were the early days of BranchOut. We had the idea, team, and venture funding early on. A few months later we had millions of users, a total of $49 million in venture capital and a product people loved.
Add Angel Dignitaries to Your Series a VC Round
At The Founders Club, when we get a VC to commit to the series A financing for example $5 million, just at the last minute I have my CEO say to the VC, "Wait, I don't want the check for $5 million. Make that $4.5 million, and here's a list of 20 people that will invest $25,000 each after the $4.5 million has been wired. The names on that list are all CEOs and cofounders of major league companies scattered across the United States, Europe, and Israel. Then when we announce the series A financing with your big-name VC fund we disclose that these 20 people also participated." The names on that list are a real Who's Who. VIP entrepreneurs and other people will wonder how a company located in Stockholm, for example, managed to get those people from the Valley and all over the world to invest in that round. This gives you a BranchOut rocket launch. It may be counterintuitive to add angels after the VCs, but it's a brilliant move. And those angels are lucky to get in. At $25,000 being a small amount for them, they don't care if they lose it. If you want to be one of the 20 people on that list, get in touch. We just did one of these this week in San Francisco for a company from Stockholm.
Why Entrepreneurship Is Becoming Increasingly Important and Why Angel Investing and Venture Capital Are Here to Stay
The opening of free markets combined with evolved telecommunications, broadband, and the instant spread of ideas is resulting in major shifts in economies. Traditional industries like manufacturing have shifted in large part from the United States and Europe to developing economies with lower total costs of production and new hungry markets to serve. Countries around the world from Chile to China are not passively watching the Silicon Valley. They want Silicon Valleys in their countries too.
The pace of innovation will only increase, and the cost of creating startups continues to fall. A company can launch today with $500,000 in funding compared to needing $5 million to achieve the same results just 10 years ago. In the 1990s when I had a venture-backed startup, I remember paying $50,000 per Sun server and way too much for Oracle software licenses. Now we have Amazon and cloud computing. You pay as you scale. You pay for what you eat as your revenues grow. Marketing is now built into the product. Many startups are just designers and engineers without a sales force but with a savvy marketeer. Companies promote their products and even their funding rounds on social networks and funding websites laid over an abundance of angel investors everywhere. This is all combining to increase the volume and quality of tech startups everywhere. The cost of starting a mobile app and a website is around $5,000. Compare that to spending two years of your life in an MBA program and paying $3,000 monthly for student loans for 10 years after you graduate. I agree with Tim Draper: now is a great time to start a company, a great time to make angel investments into tech startups, and a great time to be a venture capitalist or invest in a venture capital fund. Not everyone needs to move to the Silicon Valley. Technology corridors are flourishing in many places. There are plenty of dead zones, but particularly in the various hot spots, they are highly networked together and are changing the world repeatedly at an increasingly rapid pace.
Excerpted from THE ENTREPRENEURIAL BIBLE TO VENTURE CAPITAL by ANDREW ROMANS. Copyright © 2013 McGraw-Hill Education. Excerpted by permission of McGraw-Hill Education.
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List of Contributors and Interviewees
Foreword by André Jaeggi
1 Start Me Up!
2 Angels, Mortals, and Super Angels
3 How Venture Capital Works
4 What to Bring to the Dog and Pony Show!
5 Practical Ideas and Advice on Raising VC Funding
6 Corporate Governance: Who's The Boss?
7 Company Building and Growing Value
8 Which Way to the Exit?
9 Do We Need All These Lawyers?
10 Ladder to Liquidity: The Secondary Market