Matt McCall and I had a conversation a few days back about Dan Primack’s post on new VC models (I wrote about Dan’s piece a little over a week ago for those that missed it). I focused on the fact that too much money has been pushed into venture capital during both my conversation with Matt and in my blog post and I do believe that it is a main issue.  However, it appears that the increasing amount of money going into VC funds has a couple of underlying causes (if not more).

1. LPs are trying to push more money into venture capital funds to get lower their unfunded obligations.
2. Venture capitalists are only too happy to take the extra cash to bump up their management fees (since exits and carried interest are hard to come by these days).

Unfortunately point number two is causing a big issue.

VCs nowadays, at least the ones who have raised successive ~$500mm – $800mm funds (i.e. large funds) every couple of years, are in a position where management fees are so high that they can potentially lead to salaries to the main partners in the $6mm – $8mm range (give or take).

This fact, combined with the fact that the IPO market is essentially closed (meaning it is harder to generate exits and, subsequently, carried interest), means that VCs are content raising a lot of cash and deploying it fast so they can cash in on their management fees.  Any good investments that create some carried interest are simply a bonus.

For venture capital to work, carried interest, the amount the partners take of successful deals, needs to be the main driver.  Once management fees get too high they can become a primary driver and, as mentioned above, this scenario becomes even more pronounced when the IPO market is lacking and exits are harder to come by.

Matt just wrote about a post about his thoughts on the VC compensation issue, which, given his many years of experience, has a lot more meat to it than this post.  It is a must read post so please check it out when you have a chance. (Matt also talks about the structure of Warren Buffett’s first fund, which is interesting to note especially in the context of VC compensation.)

Dan Primack of PE Hub passes along an idea on how to revolutionize venture capital in his latest post. The idea, given to him from an unnamed Boston based VC, centers around the partner as the core of the VC fund.  Partners have always been the core of a VC fund, right?  Right.  However, in this new model Primack suggests there aren’t really any partners to speak of.  Each “partner” would work on his or her own with his or her own pool of money provided by one (or perhaps more) LPs.

The analogy Primack uses to explain this new idea is that of a professional athlete.  VCs have been compared to professional athletes for a long time due to a number of similarities with both professions. In this case the similarity we’ll focus on is that VCs, like professional athletes, usually work in teams but are judged on their individual numbers.

The issue with teams both in sports and in the VC world is that the stars can get pulled down by poor team members.  So, the thought is, why can’t a star VC just go “one-on-one” and raise an evergreen fund  from one LP (or perhaps more) that only he or she will manage.  These star VCs can then sign contracts with their LPs  (3 – 5 years to start was what was suggested), take a salary of $1mm per year, get 15% of any carry and hire an assistant and an associate.

It is suggested that this new venture capital model would provide better returns for LPs if the star VCs remained stars and, even if those VCs dropped off, the LPs would lose less then they would have if they picked a losing fund with multiple team members.

Primack, of course, realizes there are some issues with this idea and lists them in his post.  Two of them caught my eye:

1. What about the fact that the partnership model encourages working together to figure out if the deals a firm is looking at are really the best deals? Partners, in theory, should be helpful in that they may have different points of view about a deal that the deal-leading partner didn’t think of, etc., etc.

Primack refutes this by saying that most modern partnerships operate within a quid pro quo of silence. i.e. Don’t knock my deal and I won’t knock yours.  I haven’t been involved in any funds other than DFJ Portage and we operate in a very collegial way and speak our minds freely. That said, I actually haven’t seen Primack’s argument in reality although I could see his argument being the case at larger funds.

2. Would LPs be able to pick the right individual VCs?

That’s a big question but if an LP is on top of the goings on of their VC funds they probably already know who the superstars in their funds are.

I think the bigger question really is: Would the superstars consistently perform?

I don’t have the data on this but I know my friends at Cambridge Associates do so perhaps they can carry out this proposed study for me (hint, hint).

My idea for a study is to look at data from as far back as one can until the present day and then use the data to figure out if superstars are consistent over a long period of time or if the superstars during one 5 – 10 period are the dogs of the next. My guess: they aren’t consistent over long periods of time.

I fixate on this particular issue for one main reason and that is the fact that even the biggest of the big name VC funds – the blue chips as it were – are inconsistent in their returns.  Some of a given firms’ funds are top quartile and others are bottom quartile and some are in between.

A number of the big guys have fund returns that look like a roller coaster and it makes me think that the superstars would not fare much better.

Another point along the same line of thinking is that the superstar VC may actually be a superstar due to his or her team.  This point is also highly correlated to the entrepreneurs VCs back in that the team (the entrepreneurs plus the folks they hire) is everything.  Entrepreneurs have to be great leaders but they also need to hire great teams around them if they intend on bringing their companies to the highest level. Venture capitalists may also need their teams to help the VCs perform at the highest level possible.

With all that said it seems to me that trying to move the industry as a whole to the individual model or the partnership model doesn’t make much sense.  What works will differ based on the individual.  Some folks work well alone, some with a team, and so on and so forth.  What we, as an industry, probably need to address is the following:

Too much money has been flowing into VC for a while now.

Because of this fact funds are too big to do what VC is supposed to do.  $100mm or less (maybe a little more in some cases) is probably a good size fund for true seed and early stage investing.  Venture capital just doesn’t scale well and perhaps we need to accept this as an industry.  This is an important point and one that still needs to be addressed.

I am continually thinking about how to improve venture capital because I think venture capital is vital to the creation of great companies and life improving technologies. It has become fashionable to argue otherwise and I am actually happy about that.  I relish the posts about the death of venture capital.  Why? Well, because I try to look at those posts as a challenge for us, the VCs, to do better.  We can always do better.

Perhaps this superstar VC idea isn’t the way to improve venture capital (although some folks could try the model as it may work for some) but I am sure that through all of the discourse we will have as an industry in the coming years we’ll figure out of a few things that will make venture capital better at doing what it is supposed to do: find and fund bright entrepreneurs and then help them to create the next generation of new technology companies that will move the human race forward (while also generating a great return for our LPs of course).

I have to admit that Umair Haque’s recent two part series of posts on venture capital really made me want to start writing on this blog again.  His posts, entitled “Asleep at the Wheel of Creative Destruction” and “Five Problems Venture Capitalists Should Have Solved (But Didn’t)” really got me thinking.  In the words of my friend and partner in TECH cocktail crime, Frank Gruber, Haque got me “fired up!”

At a high level Haque is calling for VCs to step up their game and push innovation forward rather than sitting back, like some have been, and making a lot of “me too” investments that, even if they play out, don’t really move the needle much for the world in terms of meaningful change, job creation, etc. Here, here! I am with him 100% on changing the world for the better.  That’s why a lot of us got into VC and entrepreneurship in the first place.

I agree with Haque on a number of the points in the “Asleep at the Wheel” piece.  It certainly seems that the VC industry is flooded with too much capital looking for homes that don’t exist (however, some places, the Midwest for example, don’t have nearly enough capital to fund the great entrepreneurs, ideas and technologies they have) and that, as Haque puts it, a culture of imitation, rather than innovation, has started to permeate venture capital.  I also agree that “transparency, disclosure and discussion” can help venture capital by allowing it to become more participative and open.

Haque closes “Asleep at the Wheel” with this statement:

Unfortunately, today’s venture investors are about as interested in reform as yesterday’s bankers were. So it just might take a venture crash – just like Wall St’s financial crash – to wake up the guys and gals asleep at the wheel of creative destruction.

Ouch!  He may be right about some folks but, as long time readers know, I have been a big fan of innovation in the VC business for some time now (and have written about some innovative ideas in detail) and there are many other forward thinking VCs that are interested in improving their business too.

That said, we need to figure out a way to innovate that can also provide great returns for our investors.  One of the main issues is that we hold illiquid investments for a relatively long period of time before we can either sell them or, hold on to your hats people, IPO them (haven’t seen one of those in a while).  Once we put money into a company the clock starts ticking and, when the investment is finally exited, that clock allows VCs and their investors to calculate the efficiency or quality of an investment, which comes in the form of an IRR or Internal Rate of Return.

The IRR allows different investments to be compared to each other directly to help asses if the VC investment was a good one as compraed to, say, putting money in an S&P 500 index fund (i.e. just because you received 5x your money, for example, doesn’t mean the investment was the best one you could have made – the time your money was locked up in that investment needs to factor in).  Here is an example:

Say you invest $1,000,000 in a startup right now and you get $10,000,000 back at some point.  Either way you look at it you got 10 times your money back.  A huge home run right?  Not necessarily.  Let’s take a look at your IRRs at different periods of elapsed time:

$10,000,000 returned at 5 years: IRR = 58%

$10,000,000 returned at 10 years: IRR = 26%

$10,000,000 returned at 15 years: IRR = 17%

$10,000,000 returned at 20 years: IRR = 12%

Interesting isn’t it.  You wouldn’t have done much better than the long term market return if you couldn’t exit your deal before 20 years of hold time.  That means, at 20 years, you and your investors didn’t get a great return especially considering that, generally, the startup you invested in was inherently more risky than the overall market and, therefore, should have had a far better return than the market to account for the excess risk you took (more risk needs to equal more return to make things work – see alpha).

This is why VCs have specific hold time targets (usually about 5 -7 years and sometimes less) and limit their funds’ life to 10 years (if you have to hold investments longer than that the IRRs, even at 10x your money, start to degrade and the folks investing in your VC fund become unhappy).

The folks that invest in venture capital funds (i.e. the big institutions) want returns that make it worth the risk they took and those returns are affected by investment hold time.  Some of the things that Haque suggests VCs should have fixed or innovated on and the markets we should have created don’t appear to have the profiles that would make for good investment where good equals what LPs want in terms of IRRs.  Therefore, even if VCs did dive into this harder-to-solve stuff they may have done a lot of good but the returns may not have been there and, thus, these VCs would not be able to raise a new fund and continue to innovate since their investors would have been unhappy.

Bottom line: if the VC business wants to start moving in the direction of some of the issues Haque puts forth and suggests VCs should have solved than VCs need to figure out how to get the returns their investors demand while pushing forward on harder to solve problems.

At the end of the day venture capital still needs to be sustainable and that means driving good returns to LPs. Good returns enable VCs to continue to raise new money to invest in innovate young companies and to perpetuate the innovation the cycle.  Returns are our constraint as VCs and we need to find creative ways to work within that constraint while still taking on the big risks that help to create new industries and completely revitalize old industries.

This is the challenge and it is a big one but one that will be exciting to work on.

At the end of Haque’s “Five Problems Post” he suggests that if VCs can’t solve problems like:

• Reinventing communications
• Reconceiving capital markets
• Business models for public goods
• Business models for radical responsibility
• Discovering new sources of advantage

than VCs are obsolete.  In fact, he says VCs are obsolete as of right now since we didn’t solve those issues.  I am not sure that he correct when he says that and I do think he trivializes the issues the VC business faces by ignoring the fact that VCs do need to provide returns that make sense to their investors.

However, I tend to look at Haque’s two recent posts as inspiration.  He’s right.  VCs can do better and VCs need to continue to strive to do better and to foster meaningful innovation.

I am not sure what the answers are in terms of working to reshape the VC business into one that address what Haque suggests VCs should be addressing. That said, I am willing to investigate the issues and to try to find some solutions that can get venture capital to the next level and I am sure many others are as well.  I am really glad that Haque and others continue to challenge the VC business.  It is too easy to become complacent and posts like Haque’s can really kick people into gear.

If a number of people heed Haque’s call some really exciting new ideas, businesses and industries will no doubt emerge and we (VCs and entrepreneurs) will continue to be able to combat the world’s largest, and most nagging, issues.

I read an interesting post by my friend Ed Kohler of Technology Evangelist today (you may remember all of the video he and his team shot for TECH cocktail 2 – thanks again guys!). Ed wonders whether a lot of budding entrepreneurs never get to carry out their business dreams because they need to pay off educational debt.

The story that Ed thinks may be the case all to often is as follows: Student has a great idea but has to put it off in order to take a “safe” job that allows him/her to whittle down their debt. While he/she works this safe job they may meet someone, get married, have kids, take out a mortgage, etc. which forces him/her to further put off their idea since they now have dependents and a mortgage and maybe even have some debt from school left. The dream is crushed and the world is left with one less exciting idea.

Ed sees this as an opportunity for VCs to innovate. He suggests VCs find exceptional students with good ideas coming out of school and offer to:

1. Pay off their debt
2. Pay them a salary – maybe $30,000/year
3. Cover their housing

The VC would get equity in the new venture as usual and would shell out $100,000 per student on average according to Ed which, if even a few of the companies made it would be a good deal for the VCs.

I think Ed’s idea is a great one and very innovative. I have no doubt that a lot of ideas go to waste each day due to college debt and this would help to alleviate that problem. The ideas that are saved could also end up as huge wins for the VCs that came with low investment cost. Everyone wins. However, there are a couple issues to consider.

1. VC Fund Sizes
2. Inexperienced Entrepreneurs

VCs have differing fund sizes and numbers of partners so not all VCs will be able to put small amounts like we’re talking about to work. Perhaps angel networks and angels in general are in a better position to take this innovation and run with it. They can generally put smaller amounts of money to work and don’t have other constraints that come with a VC fund.

Since the entrepreneurs will be very inexperienced good advice will be very useful. Investors that try this innovative approach will need to be able to advise and mentor the entrepreneurs they pluck out of their cap and gowns. The better the investor can mentor and provide connections to the entrepreneur the higher likelihood the venture will succeed.

All in all I think finding students just out of school and taking care of their debt in exchange for equity in their company is a great idea. It allows good students to become entrepreneurs. Investors will see more deal flow. More interesting ideas will come to light and benefit the world.

As always, I would love to get a discussion going on this topic. The more we can talk through new ideas and refine them the better.

Photo Credit: KrassyCanDoIt on flickr

My friend Noam Wasserman (check out his blog for more great founder research) sent me a note last night with a link to a piece about a new class of stock called FF stock that the guys at the Founder’s Fund have started to work into their term sheets. Noam sent the article my way because we have talked a lot about the idea of partial founder buyouts as a way to better align the interests of VCs and entrepreneurs and FF class stock is an attempt at making partial founder buyout a reality.

Soon after I saw Noam’s note I caught my friend Fraser Kelton’s piece on FF stock and knew I had to put some of my own thoughts together so here we go!

First off, it is great to see innovation in early stage investing starting to become more commonplace. It is no surprise to me that the Founders Fund is leading the charge on this. The Founders Fund, for those who don’t know, is a VC fund in which all the investment professionals were entrepreneurs and in some cases still are. The Founders Fund team is responsible for founding companies like LinkedIn, Facebook and Paypal.

The latest innovation the Founders Fund has implemented is the idea of FF class stock. The basic idea is this: FF stock is convertible to any future class of stock during a new issuance of stock. Let’s say there is a new issuance of stock in a company due to a funding round. At that point the founders can convert their FF stock, if they choose, and sell it to investors. I am sure there is more legalese involved (a lot more no doubt) but that’s the basic idea (check out VentureBeat for more).

FF stock allows entrepreneurs to partially cash out early on to make their lives a little more comfortable. I would argue that partial liquidity early on affords entrepreneurs the ability to focus more on the company and go for the big win which is exactly what VCs want to do. Interests are aligned. Case closed, right?

Well, as I have talked about in the past there are some investors who don’t like the idea of partial founder buyout/FF class stock. Their main argument, from what I have seen, is that entrepreneurs will be less hungry if they are able to partially cash out early. That may be true for some but I think most entrepreneurs are in the game to see their baby succeed and are able to keep their eye on the prize regardless of what else is going on.

What other issues could investors have? It seems that investors may not like that fact that entrepreneurs would be able to cash out before them. It also looks like investors don’t see upside for themselves in the PFB equation. These thoughts were expressed in comment on this post. The comment, shown below in full, was written by an angel investor.

The reasons why founders are jazzed about FF class stock are obvious, but so are the reasons why investors are opposed to them. As an angel investor, I think it is ridiculous to allow even a small liquidity event for founders before investors with cash in the deal receive anything.

Founders, by the way, take salaries and benefits along the way. If investors have to wait on an exit for some “comfort”, why should founders or management be relieved early? Ah…yes, greed.

I do think that there are clear benefits to investors especially in the new age of web start-ups where companies don’t need a lot, or any, outside capital to get things moving. The example I go to time and time again is Flickr.

VCs were looking to put money to work in Flickr previous to the Yahoo! acquisition and we all know that some money was left on the table by the founders. Can you blame them though? These were their options (simplified of course):

1. Let a VC or VCs take a bunch of the company away from us, sit on our board and decide where our baby should go and, since they’ll push us to a huge exit, we may possibly never make it and walk away with $0 (while the VC still has a number of portfolio companies and is diversified).
2. We can pocket $20+ million and get nice jobs at Yahoo! as well.

However, if a fund came in and allowed them to have some of their stock set aside and available to convert in a later round/issuance of stock for a small amount of liquidity they may have went for the big win and taken the VC money. In that case the founders would have probably made more and the VCs would have had a winning investment.

With more companies able to start up with no outside investment VCs will need to start innovating and providing incentives to entrepreneurs to get the best deals. However, entrepreneurs should be careful as there are implications for them as well.

Fraser points out the million-dollar-Saturn incident and I’ll quote the VentureBeat anecdote as Fraser did to illustrate the point.

The founder of Viaweb, a Paul Graham company, cashed out in order to buy his wife a Saturn car. It became known later as the “million-dollar-Saturn,” because of the worth that stock would have been had he kept it.

There are always pros and cons to any innovation and they come from both sides of the fence but, all in all, I love to see innovation happening in early stage investing. I can’t wait to see how FF stock plays out over time and whether or not it finds its’ way into more term sheets.

The subject of whether or not the VC model is broken has come up again so I thought I would weigh in. This time the New York Times started the discussion with an article discussing Sevin Rosen’s decision to abort the process of raising their 10th fund. The reason for the cancellation of Sevin’s 10th fund is summed up in a quote from General Partner Steve Dow:

“The traditional venture model seems to us to be broken…”

This is very interesting and intriguing for a couple of reasons.

1. Sevin Rosen is a very respected firm that has been around for a long time (25 years or so) so hearing them say that the VC is broken means a lot more to people than Fraser and I talking about it.
2. The firm had already taken somewhere between $250mm and $300mm in commitments for their fund meaning they had a lot of management fees coming to them.

Of course there are a lot of VCs who don’t think the model is broken. One of the first VCs to respond was Fred Wilson. Fred’s conclusion was that the VC model is not broken but just a model that needs to be tweaked. His suggested tweaks, which he says a lot of VCs, including himself, are already employing are as follows:

• Raise smaller funds.
• Do less “hard tech” and more “soft tech”
• Figure out how to make great returns on $100mm to $250mm exits
• Limit our IPOs to our very best companies

I totally agree with Fred on those points. In fact, I have talked about the benefit of smaller funds before (check out my post on <$100mm funds for more). However, I think that the New York Times article is referring to the “traditional VC model” which is… well, I don’t really know. My guess is that most people would disagree on what the traditional model actually is.

I think that the traditional model the New York Times was referring to is large funds looking to put a lot of money to work into companies that will generate high 9 to 10 figure returns through IPOs. This is exactly the opposite of what Fred calls for which leads me to this statement:

Perhaps Fred doesn’t think the VC model is broken because he is, in fact, one of the “new school” innovative VCs.

I happen to believe Fred is very innovative and what seems so natural to him doesn’t come natural to others.

VC funds themselves are not the only piece of early stage investing that is going through some changes. There are also other innovative trends happening now that are changing the game. One of those trends comes in the form of “advisory capitalists” or ACs. ACs put time to work instead of (or along with in some cases) money for a share of the company. They are basically a hybrid between a VC and a consultant.

There are some problems with ACs though like the fact that they probably won’t be able to put up money when the company needs it leaving the ACs piece of the pie vulnerable to serious dilution. However, the idea is interesting and new and that’s a good thing (check out my previous article on ACs). If you would like to read more about the innovative things that are happening in early stage investing please see Fraser Kelton’s post from earlier in the week that includes a nice summary of the new ideas including ACs.

In the end of the day there is definitely one thing that everyone can agree on though: It is a very exciting time for early stage investing. I, for one, am excited to continue watching the progression while hopefully contributing to it as well.

Update: It seems as if the reason Sevin Rosen gave for halting their latest fund (VC model is broken, etc.) has come into question.  VentureBeat is reporting that Sevin Rosen may have orchestrated a snow job on the New York Times and that the real reason for the halting of fund X was due to internal personnel issues.  Either way – discussing the venture model and how it may be tweaked to perform better is still important.

The latest podcast in Pascal Levensohn’s VC-IO entrepreneur series came out today and the subject matter was CEO compensation and the founder discount. Compensation in start-ups is something I am very interested in and, as long time readers know, I have talked about ways compensation could be structured differently to better align entrepreneurs with VCs (the previous link is to the first in a string of “fixing the VC model” posts). Little did I know that there was a man by the name of Noam Wasserman, Harvard Business School professor and blogger (I am now subscribed to his feed), who has done a lot of research in this area.

The fifteen minute discussion that ensues between Noam and Pascal on the podcast covers a lot of material so I will highlight some key points here although I suggest listening to the whole thing if you can.

• Difference in (cash) comp between founders and non-founder averages $30k per year in the non-founders favor
• This gap persists in booms and busts
• There are some voluntary (take a pay cut to keep the burn rate down) and some non-voluntary (board won’t give founder CEOs a raise since they know the founder doesn’t have any ground to stand on because the business is their “baby’) reasons for this gap
• As the company grows the gap starts to disappear
• About 50% of CEOs in the study make the same or less than one of their subordinates and almost all of the 50% are founder CEOs
• Non-founder CEOs are less aligned with investor interests
• Equity is an important thing to consider but these findings take equity into account

As Pascal asks in the podcast – Why should we care about this? Isn’t this what being an entrepreneur is about? Taking pay cuts to work on your “baby” and to gain on the upside of your equity stake? At first blush caring about this may seem silly but when you look deeper you can see that there are significant issues brought on by compensation.

Founders will eventually be faced with hiring non-founders that get paid more than they do at which point they will begin to wonder why they are worried about saving that extra $30k for the company. The founders can also become distracted by their lack of pay and begin to lose focus on the business. In these cases, if the founders were just paid adequately they would be able to focus more on the business and less on how they are going to pay their bills and whether or not they may ever see any upside on their equity stake (this could be another case for partial founder buyout although PFB has its’ drawbacks as well).

Founder compensation definitely plays a role in how a company will move forward and I know I will continue reading Noam’s blog for the latest in compensation and other studies on how non-founders and founders differ.

Noam’s latest paper on founder/CEO compensation can be found in the October 2006 issue of the Academy of Management Journal and is one of a series of papers dealing with the differences between founders and non-founders.

It occurred to me while writing the piece below on the current state of the IPO market that VCs could differentiate themselves by putting in more of their own money into their funds than the traditional 1%. This would lessen the desire to place money into investments solely to gain more management fees (it should be pointed out that most VCs strike it rich from making good investments and not on management fees). It would also align firms more closely with the entrepreneurs they work with. Some VC firms, like MK Capital, are already doing this (MK is the largest investor in their own fund) and it seems to be working great for them. Love to hear your thoughts on this.

I read a great post today by Matt McCall of Portage Ventures. The post was titled “The Angelitis Blues” and focused on how seed round deal structures can really affect future professional VC funding rounds. Apparently this is becoming a bigger issue in the new “low cost” start-up market. Matt mentions that he and his partners at Portage had to walk away from three deals recently because of the deal pricing discrepancy issue. Essentially what had happened was the entrepreneurs had priced their previous angel rounds too high and did not want to go through a down round.

This is something that I had not thought of when going through my previous “Fixing the VC Model” posts. I had focused a lot on how cheap it was to build companies, the disconnect between the mega VC funds and entrepreneurs needs and how more angel funded companies could be a good thing for entrepreneurs. In reading Matt’s post the hole in my thoughts (one of them at least) was brought to light. I had failed to discuss how angel funded rounds, if not structured properly, could potentially impede a company’s ability to raise money from a professional VC.

I will quote Matt’s example so you can get an idea of the problem:

The company raises the first $500k at a $5M post-$. They grow and need more capital to ramp sales/marketing, so they raise the next $500k at a $10-15M post-$. At this point, the company is probably doing $1-3M in annual sales and growing linearly. The entrepreneur decides it is time to raise a venture round now, and goes to market with a $5M raise at $20M pre-$ valuation ($25M post-$). This is where the disconnect hits.

A company that is growing linearly (say $1-2m going to $3-5m this/next year in revenue) is going to be valued at a $3-7m pre-$ valuation. (I will write about different pricing approaches coming up.) The revenue often does not ramp as quickly as the entrepreneur expects (plans from two years ago had probably shown revenue of $10M vs. the actual $2M). Angels, being less price sensitive, had been willing to invest at the higher valuations. However, when the company needs more capital to scale (and is tired of living off of $500k rounds), it is forced to go to the professional venture community.

Matt provides one possible answer to this dilemma saying that entrepreneurs should use a convertible debt structure for their angel rounds. This will allow the money to convert to the professional VC round when it is raised. The angels may push back on this for various reasons but if they go for it it will ensure the entrepreneur is not stuck in the future. Entrepreneurs should heed this advice and really think past the dollars when considering their initial funding rounds (and all financings for that matter). Thanks for bringing this up Matt. I look forward to some more posts on Angelitis soon!

Stowe Boyd brought up an interesting notion of Advisory Capitalists (or ACs) last week and it had created a lot of stir with people on both sides of the coin chiming in to flush the idea out. One of the more interesting chime-ins was Fraser Kelton’s. Fraser brings up the idea that VCs could add advisory services to their offering as a happy medium to either VCs or ACs. I liked this idea enough to comment on Frraser’s piece. Here are my comments:

There are a lot of great hands on investors out there that are, in a sense, adding a lot of advising time in with their cash investment. I believe that most of the better VCs are doing this and it is why they are in the positions that they are. Entrepreneurs are getting smarter about capital all the time. They know that they need not only the cash but a partner that will stick with them for the long haul through the good times and the bad. As more and more entrepreneurs figure out that VC isn’t all about the money, more VCs with advisory capacity will appear but the guys that have been doing it all along will still have a good stronghold.

On a side note: It was mentioned that ACs alone would not have the capital to put up once an entrepreneur needed it. This is probably the case (depending on the AC of course) considering that they are only individuals while VCs have a lot of money raised from their Limited Partners to put to work. It was also noted that ACs may not want to part with their vaulable advice for such a small portion of the company. This is especially important considering that ACs would not have the cash to continually participate in subsequent funding rounds leaving their positions to get diluted even further.

Let’s also remember that the VCs are not bad guys. A lot of them are great guys who really want to help companies out. Yes, they are worried about losing investments but it should be noted that a lot of times they are managing money for foundations, non-profits, pension funds and college endowments so the more money they can make the more these institutions will be able to help people (and, of course, the more money they make for themselves as well).