VentureBlog

Announcing August VII

I am extremely excited to announce that my partners at August Capital and I have raised a new fund. This fund is the seventh in August Capital’s twenty year history. And while the venture capital industry has seen a fair amount of change over the last twenty years, our approach to the venture business has remained quite consistent. We believe that the venture capital business is, by its nature, a boutique business. And we believe that venture capitalists are in the business of helping to make entrepreneurs successful, and not vice versa. August VII will follow in that tradition. We look forward to supporting amazing entrepreneurs building game changing businesses.

The raising of August VII also marks my 15th year in the venture business. I have seen stunning ups and downs in the economy over the last fifteen years. And I have seen stunning ups and downs in the venture capital industry. The VC business was left for dead in the early 2000’s. In fact, the first decade of the 21st century was marked by net negative returns across the vast majority of the venture industry. Yet venture capital came roaring back with the economy.

The first half of this decade has been marked by ever bigger financings and ever bigger venture capital firms. Yet, as we approached the raising of August VII, we sat down as a partnership and asked ourselves what we wanted our new fund to look like. Did we want to raise a billion dollar fund and jump on the “ever bigger” band wagon? Or did we want to stick to our knitting and focus on what we do best — supporting a manageable number of great entrepreneurs as they navigate the challenges of building game changing businesses? The answer to us was clear.

In December we approached our existing investors with a blue print for August VII. Rather than raise two separate funds, as we had done before (an early stage fund and a special opportunities fund), we decided to raise a single fund that would focus on spectacular entrepreneurs independent of stage. We also decided that we would raise a cozy $400 million dollars, which would give each of our 5 General Partners about $80 million dollars to invest over the coming years. August’s seven funds have ebbed and flowed over the years, but have always been about $80 to $100 million per investing partner. It may not be everyone’s sweet spot, but it certainly is ours. And it has been a winning formula that has delivered meaningful returns to our investors over our lifetime.

Despite the fact that we started the fundraising process right before the holidays, we were thrilled to see that our Limited Partners shared our philosophy about the venture business. We had some fantastic conversations with our investors in December and January. They remain as bullish about the tech economy as are we. And in just under two months, we were able to close our seventh fund. Our biggest challenge was figuring out how to squeeze hundreds of millions of dollars of interest into a $400 million fund. In the end, we had to expand the fund a little bit, so as not to disappoint our long-time supporters — we closed a $450 million fund the last day of January.

As excited as we are about closing our new fund so that we can get back to supporting great entrepreneurs, we are particularly thrilled to do so along side our new partner Tripp Jones. Tripp joined us a few short years ago and in that time has proven to be a thoughtful investor and steadfast supporter of the entrepreneurs he backs. Tripp has invested in such great companies as Paperless Post, WattPad and Adara, and will no doubt find world class entrepreneurs and breakthrough companies in which to invest in August VII. I join Tripp, along with Vivek Mehra, Howard Hartenbaum and Eric Carlborg as General Partners in our new fund. Our partners Dave Marquardt and John Johnston will continue to play the role of Founding Partners and support our existing portfolio. August Capital would not be what it is today without the incredible stewardship of John and Dave, and we are grateful to have their ongoing participation and support.

I am repeatedly surprised that it is news in the tech world when a venture capital firm has raised a new fund. After all, venture funds are merely a means to an end. As VCs, our job is to find spectacular entrepreneurs and help make them successful. Of course, first and foremost, we help entrepreneurs by giving them the capital they need to build big businesses. So we are thrilled to have raised August VII and look forward to working with more amazing people solving valuable problems. My partners and I consider it a great privilege to work with entrepreneurs day in and day out, and we are excited to continue that tradition with August VII.

Pick Your Angel Investors Wisely

A great deal has been written about angel investing in recent years. Angel investing has become the sport of choice for many successful entrepreneurs in Silicon Valley (e.g., Dave Morin, Chris Michel, Ariel Poler, etc.). What's more, it has spawned a whole new class of venture funds -- once called Super Angels, now called Micro VCs (e.g., First Round Capital, True Ventures, SoftTech VC, etc.). And now traditional venture investors (e.g., Greylock Capital, Andreessen Horowitz, CRV, etc.) have created programs to invest small amounts of money in large numbers of startups. Unfortunately, as seed investing moves from a boutique practice to more mass market, its value is diminished dramatically.

As a general matter, I think that more seed funding is a great thing. It is certainly beneficial -- often times essential -- for small companies to raise a little bit of money to help validate an idea or market. But historically one of the most valuable things about angel investment was that it was accompanied by an angel. That angel wouldn't just invest in the company, he or she would serve as an indispensable advisor to the company as well. Not only did you get money to propel your business forward, you also got the help of someone who had run the startup gauntlet before you.

Regrettably, what once was a boutique business has in many instances become mass market. While there are some angels and Micro VCs can provide meaningful time and attention to their entrepreneurs, there are a number of folks out there who think that angel investing is a volume business. Needless to say, as the number of companies financed by any given investor grows, the amount of help that investor can give to each company diminishes proportionally. These investments become more about the placing of bets than they do about helping entrepreneurs succeed.

Sure, some of these stock pickers will make some good bets and even make some money. But it won't be any thanks to them. As a general matter, early stage entrepreneurs don't just need money, they need help and advice. And if help is no longer part of what you get from your seed investors, I believe the likely success of those investments will diminish.

Worse yet, taking seed investment from traditional venture investors can be counter-productive. It is impossible to imagine how a VC firm that is investing in dozens of early stage startups can find the time to be helpful while also working with their more traditional portfolio. You may get a little of their money and a little of their reputation, but you will get it at the expense of any real help in building your business.

So why have VC funds started investing in seed rounds? They do it because they think it gives them an option on future financings. By putting a little bit of money into a company's seed round, they get a seat at the table. And from that seat, in theory, they can keep track of how well it is going and preemptively finance the "best" companies that they've seed funded. The only problem with the theory is that these traditional VCs don't have the time or capacity to actually keep track of all the companies they've seed funded. So they aren't capable of being pre-emptive. Instead, they expect an early look at any Series A financing, despite the fact that they haven't earned the right by actually being helpful to the companies they have seeded.

More importantly, traditional VCs are incapable of providing one of the most important and valuable angel services -- introductions to future investors. As is becoming increasingly clear, investment is the life blood of the startup world. The problem that companies seed funded by traditional VCs have is that there is a natural assumption that any company that does not receive follow-on funding from its earlier VC investor is fundamentally broken. There is virtually nothing that a VC can say in his or her introduction to other investors that won't raise eyebrows. So taking angel money from a traditional venture investor is a bet on that firm funding your Series A. Unfortunately, if that doesn't work out, you're back is up against the wall. [1]

It is true that money is fungible. But investors are not. The choices you make when raising seed capital can have a meaningful impact on the long-term success of your startup. So find investors who will bring you value beyond the dollars in your bank account. Find investors with the time and inclination to help you. Find investors who will increase your chances of raising additional capital, not diminish those chances. Great angel investors are invaluable. So pick your partners well.

 

[1] On the rare occasion that my partners and I seed fund a startup, we work hard to alleviate the concerns I've described above. We only invest in a very small number of seed stage opportunities and we commit meaningful time and attention to those businesses, often going on the board (for example, I was the earliest investor in the likes of WePay and Splunk). Moreover, we take a substantial lead role in the seed financing, so there is no negative presumption when we introduce the company to our VC friends for the next round of financing. We will invest along side the new VC, but have no need to lead the Series A ourselves. Needless to say, this approach won't scale to dozens of startups. But it will increase the likelihood that those business we seed fund are successful.

Great Lawyers Are Worth More Than $5,000

If you want people to leave lots of comments agreeing with you, write a blog post saying that something is too expensive. And if you read the comments to Fred Wilson's latest post -- "A Challenge to Startup Lawyers" -- you'll see a whole lot of agreement. Fred argues that it should cost less than $5,000 in legal fees to close a straight forward seed transaction and asks, "[w]hat do we need to do to get there?"

Ordinarily I wouldn't jump into the fray here. What's the upside in defending attorneys? Everyone thinks that lawyers are a "transaction cost" and an impediment to getting real business done. Everyone thinks that they're getting overcharged for their legal bills. Everyone loves hating attorneys. That is, everyone but me.

So why jump in here? Because I think Fred's challenge misses the point. These "simple transactions" are the very foundation on which the companies in which we invest are built. They may involve uncontroversial terms (although, I don't think that is really true either -- look at Fred's own comment in which he objects to Ted Wang's "standard" financing docs as "missing a few things"), but they are not trivial by any means.

The contents of a company's Delaware charter will control the long-term governance of that company (and should it really be a Delaware company? a New York company? a California company? a Nevada company?). The terms of a company's "standard" stock option plan will have a huge impact upon how those shares are treated and traded (anyone who's watching what is happening with Facebook stock on the "private" secondary market today knows that something has to be done to fix these broken plans). The protection of intellectual property from day one is critical for a startup. And the failure to understand and comply with mundane tax laws can cost founders and companies millions down the road. These aren't exciting topics and they won't make a startup successful, but they are critical to the long term success of a company.

I am sure that the mere process of closing a seed financing could be achieved for less than $5,000. Fred's post essentially describes a situation in which the lawyers are merely the scribes of a pre-determined, uncontroversial and standard financing deal. In that case, the lawyers are really acting as overpaid secretarial staff -- do a search and replace for company name and send the docs off to Delaware. There's little question that a lawyer can get that done for five thousand bucks.

But even if such a simplified financing actually existed, the lawyers wouldn't be done. No two companies are alike. The founders all come from different places (did they start the company while working at another company? did they start the company at school? did they start the company alone or with a pair of megalomaniacal twins? etc.). They are all attacking different markets with different competitive landscapes and different competitors. They all rely upon marketing, business development and relationships differently. And they all have different histories (has the company been around for a day or a year or a decade?).

All of these things have a big impact upon not only how you set up your company but how much work it takes to get the company in shape. I have certainly seen some daunting legal bills when I first put money into a company, but in those cases it was not driven by wasteful attorneys, it was driven by real messes that needed to be cleaned up. If your assumption is that you are investing in a company for the long haul and are hoping to build a big and valuable business, every penny spent getting your house in order before moving forward is money well spent.

Sure, you could close an angel round for $5,000. But it would be penny wise and pound foolish. Establishing the foundation for a great company matters more than a few thousand dollars. Anyone who's worked with outstanding attorneys knows that they are more than overpaid scribes -- they are invaluable business partners. Maybe its just the former lawyer in me speaking, but I think a better challenge than getting your financing done for $5,000, would be to get your financing done right.

Deal or No Deal Podcast

In my last VentureCast, I started out by claiming that I was going to talk about two things: conferences and my Deal or No Deal blog post on VentureBlog. Well, it turned out that I rambled on for over a half hour talking about conferences, so I decided that my discussion of Deal or No Deal could wait. But that long wait has ended. In this episode of VentureCast, I go into a bit more detail on how I think about acquisition offers and startups in the context of what has become an acquisition economy (by virtue of the very limited number of IPOs that have been launched in the last handful of years). If you're interested in hearing more about Deal or No Deal, this VentureCast is for you!

Google/Yahoo: Deal or No Deal

There continues to be a lot of discussion in venture capital and entrepreneurial circles alike about the onslaught of early acquisitions being made by the folks at Yahoo, Google, InterActiveCorp and increasingly Fox Interactive Media. The question I am often asked goes something like, "isn't this really bad news for venture capital?" After all, if all the "good companies" are bought up before they have the chance to raise venture money, how will we VCs make any money?

Early acquisitions are nothing new. While it feels like they are occurring at perhaps a faster pace for the time being, it has always been the case that the "good companies" attract lots of attention quickly and end up with early acquisition offers. Sometimes entrepreneurs accept those early buyout offers. And sometimes they don't. But when the do it is by no means an indictment of the venture capital industry. It is simply a decision made by an entrepreneur at that particular point in time that the risks associated with continuing to build enterprise value in the future are outweighed by the certainty of a particular price paid today. To my mind, these acquisition offers are just like the new TV game show Deal or No Deal.

For those of you who haven't seen Deal or No Deal, it is one of the more brain dead game shows created. At the beginning of the game, a contestant stands in front of 26 models holding briefcases in their hands. Each briefcase contains a particular dollar amount, ranging from one cent to one million dollars. The contestant picks a briefcase but does not get to look at the dollar value in that case. She then proceeds to pick a half dozen briefcases, the dollar values of which are revealed. As each case is picked, its dollar value is removed from the board of potential winnings. Once the first six cases have been chosen, a fictitious "Banker" is asked what price he will pay in exchange for the case held by the contestant (this is perhaps the most glamourous job ever held by a statistician -- for insight into the Banker's psyche, you can visit his ridiculous Bankers Blog). In theory, the Banker knows no more about the contents of the contestant's briefcase than does the contestant herself. If the six cases eliminated were all low numbers, the Banker will offer a number in the tens of thousands of dollars. If the cases revealed high numbers, however, thus indicating a higher likelihood that the contestant holds a low dollar value in her chosen briefcase, the Banker will offer a buyout of mere thousands. The contestant then has to choose to take the offer based upon the information available or risk potential losses while turning over some more cards. The case picking and Banker offers continues until the contestant either takes an offer from the Banker or has chosen all of the cases and gets to reveal what is in the briefcase she originally picked.

Entrepreneurs who receive acquisition offers early in the lifetime of their companies are essentially faced with the same conundrum as that posed in Deal or No Deal. Relatively little information has been revealed about the long term value of the company, yet the entrepreneur must decide whether or not to take the offer and, in essence, stop playing the game. As can be seen from the game show itself, in many instances taking the deal early on is a good idea because as each new briefcase is opened, the perceived value of the case being held by the contestant goes down, as do the buyout offers from the Banker. However, in many other instances, as time goes on and risk is removed (all the low numbered briefcases are picked), the buyout offers from the Banker increase to substantial dollar values.

Some recent acquisitions and acquisition offers reveal the parallels to Deal or No Deal. Companies like Flickr, Delicious, Bloglines, Writely, etc. had early success and were offered solid amounts of money to sell very early on. Little had been revealed about their long term value but the early indications were excellent (the first briefcases picked were low numbers) and therefore Yahoo/IAC/Google were willing to pay millions of dollars to buy them early. On the flip side, Friendster had similar early indications of high long term value and accordingly Google made an offer to buy the company based upon those early indications. In that instance, however, the company decided to open a few more briefcases, and, unfortunately, each new briefcase revealed negative news about the long term value of the business (in other words, the briefcases all held high numbers). As a result, the offers from Bankers to buy the Friendster business have fallen precipitously. Another twist on the same theme is the Facebook story. Early indications on the Facebook were excellent and the management decided to pass on the first set of acquisition offers. Yet, as the Facebook continues to open briefcases, they keep finding nothing but good news. Thus, if the rumors are true, with each additional piece of good news, the Bankers have offered larger and larger numbers to buy out the company. The folks at the Facebook, however, continue to refuse buyout offers and play on. With any luck, their value will continue to go up until such time as they choose to sell or take the company all the way (I suppose, to kill an already wounded analogy, sticking with the original briefcase you chose and discovering it holds a million dollars is the equivalent of a startup going public).

I don't for a second want to suggest that the long term success of companies is purely a question of chance. Nor do I want to suggest that the key to financial success in a startup is only about selling at the right time. Unlike the contestants on Deal or No Deal, entrepreneurs have a lot of influence over what dollar values are revealed in the cases they choose to open. Successful entrepreneurs systematically eliminate risk while building increased value in their companies. While some factors are outside an entrepreneurs control (e.g. market adoption), many of the risks are influenced by the smart choices made by entrepreneurs along the way.

Ultimately there will come a point in time when each entrepreneur will have to ask him or herself, "deal or no deal?" That some entrepreneurs will choose "deal" early in their company's life cycle is not an indictment of the venture capital industry, it is merely an indication that the Yahoo and Google Bankers are making offers some entrepreneurs cannot refuse. That's good news for entrepreuners. And as companies mature and additional briefcases are opened, in many instances the Bankers' offers continue to grow. And that will prove to be good news for VCs as well. I just pray that Toby Coppel isn't replaced by Howie Mandel any time soon.

On Board With Six Apart

Until today it has been my practice to avoid directly discussing the companies in which I have invested. That is not because I have nothing to say about them. I could write a whole other blog about them. Nor is it because I am not enthusiastic about the businesses they're in. I am wildly enthusiastic about all of the businesses in which I have invested -- that's why I invested in them. But it has never struck me as that relevant or interesting to the VentureBlog readers. But for every well-reasoned rule there is an equally well-reasoned exception. Thus, please forgive me for heralding my latest investment on VentureBlog. It almost seems inappropriate not to blog about this one.

It is with great pleasure that I write about having invested in Six Apart. As many of you know, Six Apart is the maker of Movable Type and TypePad. Since its inception, VentureBlog has been powered by Movable Type. It is a wonderfully powerful piece of software that embodies the simplicity we have all come to expect from blogging software with the incredible flexibility and extensibility of the finest modern application software. I am also a big fan of TypePad, which powers my personal blog, SaysMe! TypePad is the yin to Movable Type's yang -- it embodies the flexibility we have all come to expect from application software with the incredible simplicity and reliability of a rock solid hosted service. As I've said before, "I think that blogging software is revolutionizing the way people communicate--whether to share pictures with family members or distribute a product spec to an engineering team" and Six Apart is at the forefront of that revolution.

Of course, there's more to Six Apart than powerful software. As elegant as I think both Movable Type and TypePad are, to quote myself again, "it's the people, stupid!" The Six Apart team is phenomenal and getting better every week. I don't invest in products or ideas or business models. I invest in entrepreneurs. And Ben and Mena and Barak and Andrew and Loic and Michael . . . and the list goes on . . . are some of the most dedicated, smart, creative, persistent, honest entrepreneurs I've had the good fortune to spend time with. It is my great pleasure to join the Six Apart Board and help build what I believe will be a hugely successful and influential company in the months and years to come.

What's Left To Say About Participating Preferred Stock?

Man has Venture Blogging come a long way since we started VentureBlog a year and a half ago. At that time, the only way that there would be robust discussion and debate about venture capital related topics in the blogsphere would be if Andrew and I took different sides of an issue and duked it out on VentureBlog. Now folks like Brad Feld from Mobius Venture Capital and Fred Wilson from Flatiron Partners are discussing and debating VC issues of real interest and import. While Venture Capital still remains quite individualistic and, at times, enigmatic, VC bloggers have gone a long way to help demystify what has for years been a bit of a black art.

It struck me just how much information was being shared these days as I read a set of posts about Participating Preferred Stock by Brad and Fred. While there are real world implications to decisions made by VC's and entrepreneurs about Participating Preferred Stock, this is still a pretty esoteric topic. As recently as a year ago, the posts about venture financings were pretty rudimentary (here's what Joi was talking about, and here was my effort to just put the terms in context). Brad and Kevin Laws (at VentureBlog) upped the anti with deeper analysis of Preferred Stock. And now there is a debate raging online about the use and appropriateness of Participation in Preferred Stock. The real debate, mind you, is in the comments of Brad's and Kevin's pieces (we VC's are far too gentle on one another but entrepreneurs are more than willing to call BS when they see it).

Quantitative Evidence Of An Upswing

I am often asked if things are feeling better in Silicon Valley. Are things looking up? My answer is essentially "yes." Things do feel better. Serial entrepreneurs who sat out the early 2000's are getting back into the game. Deal flow has picked up across the board. The public market for technology stocks is opening up . . . a bit. Later stage venture investors are more enthusiastically looking for opportunities to put money to work. The environment really is feeling better. But as much as it's feeling better, it has just been that, a feeling. Until now.

I've written about Fenwick and West's survey of venture financings before. Fenwick has been tracking venture financing terms since the second quarter of 2002. In this quarter's survey (First Quarter 2004) Fenwick is reporting a noticeable and uniform upturn in venture financings. For the first time since 2002, the number of up rounds (51%) exceeded flat (19%) and down rounds (30%) combined. In fact, the percentage of down rounds decreased in every series, most notably in Series E and higher. Terms generally followed price as well, with less punitive liquidation preference and anti-dilution being the norm. Given all that, I would say that we have our first quantitative piece of evidence that the venture financing environment is on the upswing. That's good news. I hope that the trend continues.

Ok, that said, despite the apparent evidence of an upswing, lawyers can never leave well enough alone, can they. The Fenwick survey points out, "it is important to bear in mind that most of the companies that raised funding this past quarter last raised funds 12-24 months ago, when valuations were depressed." Sure, that's true, but the environment still feels better to me. So we'll have to wait and see if the trend continues.

Steve Case Makes A Career Of Vacationing

What do you do with your time when you're a retired Internet mogul? Some would say the thing to do is go on vacation. Instead, Steve Case has decided to buy vacation. As is announced tomorrow morning in the Wall Street Journal, Steve Case has recently purchased a 50% interest in a elite vacation club called Exclusive Resorts. Exclusive Resorts is in essence a high end timesharing company -- but unlike the 1 bedroom condo in Tanglewood my family enjoyed a week each summer when I was growing up, Exclusive Resorts has over 30 multi-million dollar homes (in places like Wailea, Los Cabos, Telluride and Whistler) that club members can use at any time (at least so long as someone else hasn't reserved the house). Exclusive Resorts was started by Brad Handler, Ebay's first attorney and another Internet Retiree. Handler started Exclusive Resorts after he found a lack of great vacation experiences available for his family, including his two small children. Like Case, Handler determined that there was no better way to enjoy retirement than to make a new career of vacationing.

What strikes me as significant about Steve Case's investment in Exclusive Resorts is that he is not only investing his money but also a significant amount of his time. Case has gone on the Exclusive Resorts board but, more significantly, he is scouting properties, soliciting board members and advisors, recruiting executives and generally lending his good name and power of persuasion to the enterprise. There is no question that Exclusive Resorts will get great value out of Case's involvement. It is precisely the sort of value that entrepreneurs should look for from their investors, be they angels or Venture Capitalists alike.

Public Markets Drive Private Investment

I'm asked pretty frequently these days about the impact of the rising market on the venture business. People want to know if VCs are putting more money to work now that the market has stabilized a bit and it looks like there may be an IPO market some day soon. It's a perfectly reasonable question and the short answer is "yes." But the full answer is much more involved.