AgileVC - Lee Hower

It's no secret, we VC's are programmed to think in Powerpoint (or Keynote if you're an Apple person).  We almost always ask entrepreneurs to show us a slide deck either before, during, or as a follow-up to a first meeting.  

There's lots of resources out there with suggestions on how best to construct a VC fundraising deck.  VentureHacks has some good stuff on the topic and some simple searches on Google, Slideshare, or elsewhere will turn up plenty of other ideas.  

But I'm not aware of many discussions of why investors usually like to see slide decks.  I thought I'd try to outline some of these reasons, both good and bad:

1) Structured Conversation - I'm happy to have unstructured, informal meetings with entrepreneurs especially if they're not in formal fundraising mode.  But even if a discussion diverges away from the slides, having a deck as a guidepost for a conversation about a particular startup can be useful.  It keeps both entrepreneur and investor on point and can ensure both parties cover all the areas they hope to in an initial meeting.

2) We VCs are Time Constrained / Lazy - Your average VC sees hundreds of investment opportunities each year.  Unfortunately there simply isn't enough time in the day to spend an hour or two with each and every company to hear their story.  So a slide deck is often a useful tool which enables us to learn about far more companies than we otherwise would if we had to rely on meetings or phone calls alone.  

Some entrepreneurs prefer to try to get a meeting rather than sharing a deck, in the belief that telling the story that way will allow more nuances to come through.  I can appreciate this sentiment and given the choice between the two I think a meeting is better.  But particularly for investment opportunities that don't come thru a personal relationship with an investor or a trusted referral, the choice may be sending a deck or a potential investor never seeing the company.  

3) Decks are Shareable - When I say shareable, I mean within a partnership not externally.  I've never sent a deck outside my partnership without an entrepreneur's explicit approval.  But a slide deck is a useful, asynchronous tool for the other members of a VC partnership to get familiar with a potential investment early in the process.

4) Example of Structured Thinking -  Albert Einstein famously said "If you can't explain it simply, you don't understand it well enough."  Yes, I know... ironic for a theoretical physicist.  But having been through the process of raising money for a startup from VCs myself, I can tell you his point is absolutely true.  As an investor it's very helpful to see how entrepreneurs crystallize their product, market opportunity, and potential revenue model in a succinct presentation.  If a startup concept can only be explained through a 1hr in-person meeting, for me it raises questions how clear and focused the vision is in the entrepreneurs' own mind.

Few people (myself included) love the intellectual constraints inherent in a slide deck.  And I think it's dangerous for potential investors to become overly reliant on decks and think only in powerpoint, without digging in through personal interactions with the team, product demos, and other aspects of evaluating an early stage startup.  But I think it's useful for entrepreneurs to have some perspective on why most investors always ask for presentation decks.

Much virtual ink has been spilled on the pros and cons of taking seed stage investment from larger VC funds.  Chris Dixon and Fred Wilson have their viewpoints, more recently Mark Suster and Brad Feld added their perspectives and helpfully laid out their firms' specific approach to seed investing in a clear and public manner.  Fred Destin also had a good post which categorized various type of seed investor, and also highlighted the fact that at the end of the day alignment, mutual respect, and cultural fit are most critical regardless of what type of seed investor you're talking about.  And Chris Douvos, an investor in both traditional and micro VC funds, weighed in with some LP perspective [NB - PEHub paywalls after 7 days].

The changing startup landscape, at least for internet / software enabled companies, has forced nearly all large VCs to evaluate their approach to seed investing whether they've been active in the seed space historically or not.  The general pros and cons of large VCs as seed investors have been thoroughly discussed.  

But given the continuing evolution of many VC's philosophy towards seed investments, I thought it would be helpful to lay out the different approaches I've seen large VCs take towards seed investments.

1) Seed Investment No Different - These firms will make investments at a seed stage, but treat them no differently than any other early-stage investment (e.g. Ser A or B).  A GP that wants to pursue a seed investment has to allocate one of their deal "slots" to it, must convince the full partnership of the merits, and the firm treats it like every other portfolio company.  These firms typically do a relatively small number of seed deals per year, most often with repeat entrepreneurs with whom they have a relationship.

ENTREPRENEUR PROS - If these firms invest you typically get full firm buy-in and help, have much higher confidence VC firm will follow-on. 

ENTREPRENEUR CONS - Process often takes a long time, must convince firm that concept has a high probability of being "venture" scale and team is capable of executing at that scale, optionality for funding and exit post seed round may be constrained.

2) Seed Program as a Basket of Options - These firms have a specific program for seed investments, which will often entail a process and investment team staffing that's different from "full-scale" investments.  Whether expressed publicly or not, the firm's expectation is that only a small number of seed investments will ultimately be suitable for full-scale investments.  But the option value to the VC firm of the few that do outweighs the capital expenditure in the ones that don't.  These firms often do a very large number of seed investments per year.

ENTREPRENEUR PROS - Often easier to obtain seed investment from these groups, may have standardized process and terms.  

ENTREPRENEUR CONS - Negative signaling issue is incredibly acute given firm's low follow-on rate.  Only the chosen few companies that graduate to full-scale investments receive the firm's full backing, both in financial and human capital.

3) Seed Program as a Mini-Fund - These groups specifically carve out a portion of the large fund, but manage it to a very different set of expectations than the large fund (e.g. deliver good seed returns on this "separate" pool of capital).  Staffing and investment process may be different or at least a subset of the entire firm.  Theoretically this "fund within a fund" is benchmarked essentially on it's own, by the agreement of both the GPs and LPs.

ENTREPRENEUR PROS - Done right it has the potential of the best of both worlds, in having the perceived support of a large VC fund but with the expectations and support of a dedicated seed fund.  May be easier to get seed investment from these groups than VC firms practicing model #1.

ENTREPRENEUR CONS - Could be a wolf in sheep's clothing, either in reality or by perception.  If other investors believe the "mini-fund" VC is in fact taking approach #2 this could create many issues.  There are also very few precedents for this approach and internal support within large VC firms for this type of program may change over time.

4) GP Angel Investments as Seed Program - A number of partners at large VC firms invest as angels at a seed stage.  Typically, though not always, these firms do little or no seed stage investing from their funds.  A very small number of groups have "formalized" the angel investing efforts of their GPs for the benefit of their funds.    

ENTREPRENEUR PROS - May provide opportunity to work with helpful investors earlier than they typically invest.  

ENTREPRENEUR CONS - May still have perceived signaling issues regarding follow-on.  Potential conflicts of interest may arise, between the individual GP who invests and his or her partners and between the GPs and the fund LPs.  This potential conflict is why Brad Feld stopped making angel investments when Foundry was formed, and an example of this issue came to light a few years back with angel investment by some partners at Insight Ventures in Photobucket.

5) VC Fund as Investor in Seed Investment Programs - Some large VC funds have invested capital in various seed investment programs (incubators, accelerators, seed funds, etc).  They do so generally to gain privileged access, whether explicit or implicit, to promising startups that they can invest in beyond the seed stage.  Some publicly announced examples include investment in Betaworks by RRE Ventures and others or Sequoia's investment in Y-Combinator, but there are plenty of other examples that are kept quiet.  

ENTREPRENEUR PROS - If you take investment from one of these seed programs, you may get better access to the large VCs who invested.

ENTREPRENEUR CONS - These relationships may not be transparent when you speak with these seed programs.  

As many of you know I'm a seed-stage focused investor thru NextView.  For the record, we've co-invested with all types of seed investors from angels to micro VCs / seed funds to large traditional VCs.  At the end of the day, entrepreneurs seeking capital have the primary goal of getting their vision funded which I can certainly empathize with.  But I tend to be uncomfortable with any situation where a VC views a seed investment as an option. 

In truth though, there is no "right" type of seed investor for every situation... what's far more important is for entrepreneurs to have a frank conversation with whoever they take seed investment from to understand the investor's objectives, approach, and values.  Index Ventures, which has a long history of seed investment, talks about a strong preference to invest at the seed stage with like-minded "fellow travelers" regardless of what type of investor they might be.  This means investors that truly understand the risk profile of a very early stage startup, are willing & able to roll-up their sleeves and constructively help, and is seeking success on that seed investment rather than some hypothetical future investment round.  This is a sentiment I tend to share.

The social games market has exploded onto the startup scene in the last three years.  We all know about the remarkable growth of companies in this space, yet we tend to forget that Zynga was founded in July 2007.

But the social games business has clearly entered a new phase of institutionalization. I don't mean just consolidation via EA acquisition of Playfish, Disney acquisition of Playdom, huge strategic investments from Google & SOFTBANK in Zynga, and plus countless smaller consolidations.  I mean there are secular shifts going on in the industry which mean the land grab of the recent past is beginning to wane, and the near future of social games may start to mirror other gaming waves (PC, console, handheld, etc). 

1) Production Values Going Up – Every social game developer I speak to agrees that production values are increasing.  Consumers should benefit from richer, more engaging games but obviously development costs are going up as game companies large and small engage in an “arms race” with their competitors. This may also have the potential to shift gamer attention from other platforms or other forms of entertainment.

2) Low/No Cost Customer Acquisition Is Largely Gone – This has been true for some time (6-12mo), as social networks like Facebook changed the way in-game activity could be published to status feeds.  These changes dramatically impacted zero-cost viral growth, but even paid acquisition through FB ads has transitioned from what was once a very cheap arbitrage to materially higher CPAs.  It’s still possible to attract hundreds of thousands of players relatively inexpensively, which can produce an attractive small scale revenue stream (low 7-figure annualized) for games that monetize reasonably well.  But to create a breakout hit w/ 1M+ DAUs now requires a real marketing budget.

3) IP Starts to Matter – Disney didn’t buy Playdom for a huge user base or massive current revenue stream.  Playdom had essentially built up a holding company of several social game studios, both through organic growth and acquisition.  Disney bought the second largest social games labor force in the US, through which they will pump their massive portfolio of IP (Mickey, Buzz Lightyear, and the rest) to create branded games.  EA is doing the same with their licenses from sports leagues, Playdom had perviously lined up a deal with World Series of Poker (http://blog.games.com/2010/07/28/playdoms-poker-palace-gets-world-series-of-poker-branding/), and the trend will continue.  There’s still lots of opportunity for “original” games not developed on existing movies, sports stars, and books and plenty of developers will continue to clone each others’ games in popular genres.  But just like PC, console, and other game platforms, web & mobile social games will transition from being largely original to greater use of existing IP.

4) Zynga is Still Huge - Followers of the social games space know that Zynga has repeatedly broken records for the rapid growth of games like Farmville and others.  But the most staggering stat is that measured by daily active users (DAUs), the #1 social game company (Zynga) is larger than the #2-#30 companies combined.  That's Google-like market share dominance.  Marc Pincus and the rest of the Zynga team clearly know how to run a studio that can continue to crank out hits.  They have the human and financial capital to deal with trends #1-3 above, but the nature of the competition is clearly different now and the company is working very hard to diversify it's dependency on Facebook.

5) "Hardcore" Social Games Emerge - Most prior waves of the video game business have been driven initially by "hardcore" players rather than a "casual" mass market.  Casual is best thought of both as a demographic and a gameplaying context... but the browser-based social games world has been flipped, whereby "casual" led the evolution.  I think you'll start to see more web and mobile social games which are targeted to "hardcore" players albeit often still in a "casual" gameplay setting.  But the latter will start to blur, with more social games targeted towards gamers who currently spend far more time on other platforms.

6) Picks & Shovels Businesses - The online offer companies (Offerpal, TrialPay, et al) pivoted neatly to serve the social games space, but I predict we'll see more picks and shovels type businesses emerging in this sector (either within bigger companies or startups).  Cross-promotion platforms, payment systems, maybe even game engines specifically designed for the social games business will come down the pike.

The gold rush isn’t over, and there’s still huge opportunities for lots of new social game franchises to be built by both small and big developers.  But we’re pretty clearly moving into the middle innings here and everybody in the social games ecosystem is furiously trying to adapt.

I recently gave a brief talk at Boston Angel Boot Camp regarding valuation and this blog post is adapted from those comments.

It's sort of heretical for a VC investor to suggest that valuation doesn't matter.  So let me be perfectly clear... I certainly believe valuation matters to some extent in all circumstances and to a great extent in certain circumstances.  And I work diligently to try to negotiate an attractive, reasonable valuation to maximize the potential return on all deals whether I'm investing my own capital or other people's money.  But the world of early stage venture investing is clearly not one of perfect market efficiency as others have pointed out.

Let me get my caveats out of the way first: 

• Valuation matters a lot in mid-late stage VC investing, where the difference between a 2x return and a 3x return is significant

• Wanton indiscipline about valuation is bad for any investor, regardless of stage

• Early stage companies that raise capital at very high valuations run the risk of creating an "overhang" which makes future fundraising difficult (if your Series A is at $40M pre, it makes raising a Series B vastly harder than if your A was $10M pre).  Reid Hoffman makes this point in this video (about midway thru), in terms of planning for capital raises over the life of a company not just maximizing valuation of the first round.

But overall valuation matters substantially less than one might initially think, at least for early-stage investors.  There are three underlying dynamics at work:

1) Startup investment outcomes, at the earliest stage (i.e. seed or Series A), do not map to a normal distribution.  A lot go to zero.  Some result in small returns which for this purpose I'll define as >1x - 5x.  A handful are 10x outcomes and a tiny fraction are monster 30-100x+ returns.

2) The market for early-stage VC investments is intensely competitive, but one that is inherently inefficient.  Any mutual fund or hedge fund investing in public markets can freely trade in the equity and debt securities of every public company in the world.  Every VC sees different startup investment opportunities, and even the largest and most well known firms don't see 100% of the most promising early-stage startups.  Later-stage VC and growth equity investments are arguably somewhat more efficient markets, since the companies are larger and typically more broadly known.  Also intermediaries like investment bankers and brokers play a greater role in this end of the market.

3) Similarly, early-stage investing is one of imperfect information.  Imperfect in that different potential investors may have more or less information about an opportunity, perhaps due to a prior relationship with the entrepreneurs or differential knowledge of a market's prospects based on sector focus.  And certainly imperfect in that all early-stage startups have a limited body of historical performance on virtually every dimension (financial, product, etc) which an investor can assess.

Combine all three factors and you end up in an environment where early-stage valuations matter comparatively little.  Instead an investor's ability to source, select, and win investments which ultimately have good outcomes matters immensely.  Let me highlight a hypothetical example with numbers to illustrate.

Scenario:  A seed stage investor is considering investing $1M in a very raw startup, but one being built by an exciting team in an interesting market.  The "bid" on pre-money valuation is $2M, the "ask" is $3M.  The ask is obviously 50% higher, which is a heck of a lot.  Compare this to a hedge fund evaluating an investment in Google... the difference between buying at $475/share and $715/share will probably make a huge difference on ultimate return.

This seed stage company goes on to get acquired for $50M without taking additional capital.  If the seed investor paid $2M pre they'd make over 16x on their investment.  If they paid $3M pre they'd make over 12x their investment.  Heck, even if they paid $4M pre they'd still have a 10x return.  

A $50M exit may not be meaningful for a large VC but it can be a great outcome for the founders or seed investors.  But you can play out this exact same scenario for a "venture scale" company, with larger investment over multiple rounds and exit amounts in the 9 and 10 figure range.  The result for the earliest investors remains basically the same.

In other words, even if the seed investors paid 50-100% higher valuation then they initially contemplated they'd still have a great investment outcome.  What matters isn't the exact valuation... but rather the fact that they invested in that company and other successful ones like it.  Getting rock bottom valuations in a portfolio of mediocre startups tends to produce a bad fund level outcome for a VC.  As a former colleague used to say, there is no subprime strategy for venture capital.

We obviously can't invest with the benefit of hindsight.  But if valuation matters far less in early-stage investing, how can VC's build competitive advantage to ensure they're investing in the startups that ultimately become the most successful?  I have specific thoughts about this which I'll save for a follow-up post.

I attended the inaugural Open Angel Forum event in Boston last Friday night with a handful of other angel and seed stage investors.  There were six companies that presented at the event, some of which I'd previously met with but several were new to me.

I take my hat off to Jason Calacanis and his OAF collaborators for launching the program in 8 cities thus far less than a year after inception.  Some things I particularly liked about their approach:

• Cultivated Dealflow - OAF famously doesn't charge entrepreneurs to pitch, and in fact they started at least in part in reaction to some "pay to play" angel/seed forums.  But there's a handful of interesting, quality startups presenting that have been evaluated by a team of entrepreneurs and investors.
• Short Pitch - Startups have a 5 min pitch/demo and 5 min Q&A, and the OAF team makes them stick to it.  It's ample time to quickly learn what a company is up to and whether you're interested in hearing more in a follow-up meeting or not.
• Valuation Expectations - Companies have to state how much capital their raising and provide some expectations around valuation.  Many other pitch sessions like Y-Combinator and TechStars do the former, but few do the latter.  Of course angel participants are asked to keep this info confidential and all things in life are negotiable.  But it gives potential angel investors some sense of the investment opportunity itself again so they can independently decide which ones they might pursue.

I know OAF has been successful with these forums in Silicon Valley, New York, and elsewhere.  I'm pleased to see them active in Boston and look forward to future events.