Article 1: Common Ground December 3, 2009Posted by Lawrence Lenihan in Uncategorized.
Fortunately, there is a way for both sides to protect their rights. In fact it is very simple and straightforward. For the entrepreneur, get as far as you can without raising capital and then, when you do, raise as little as you can. The early capital is the most expensive, so treat it as such. Raise what you need to get to a value-creating milestone, execute well, and demand that this “expensive” money that you take contributes to your success. What’s a value-creating milestone? Proven technology in the form of a working product, demonstrated market by paying customers, good management shown by growing revenue/profits, etc. Each one of these milestones increases the value of the business and decreases the risk of the VC enabling us to pay a higher price.
For VC’s, we have to realize that the days of the $10MM early stage Series A round are forever gone. At least they should be. Of course there will be $10MM Series A rounds for companies that are later in their development, but my point is that too much money, too early is bad for everyone. The entrepreneur, of course, gets wildly diluted and/or the chance of the VC to hit his return hurdles are very low (a violation of both sides of Article 1!).
Also, it is simply not fair for a VC to say “we need to put $X dollars to work in each investment”. That is our problem, not the entrepreneur’s. Remember, I stated that a company needs only 1/10 to 1/100 of the capital it did years ago. That means that VC funds need to be smaller to accommodate the obvious consequence of this trend.
By the way, the worst part of raising too much capital is that it often creates bad companies. Companies that raise too much money are often internally- rather than customer-focused. What often happens is that these companies build a product that they think the customer wants rather than one the customer really needs and will purchase. If you need to sell something to feed your family, you’ll sell it. If you can think about it and plan on it and have offsite meetings on it for months or years, you won’t! Think of two kids on Christmas morning. One gets Madden 2010, a PS3 and a 52” flatscreen TV for his bedroom and the other kid gets a football and a backyard. Both kids will learn the rules of football, but you’re going to end up with two very different kids….