Investing In Venture, A Bit Like Buying A Great Bottle Of Wine

I have seen a lot of articles published recently on the rise of “enterprise” investing in venture.  It’s supposedly back en-vogue!  Social media is dead and enterprise and data are where all the investors are going.  Personally, I think this is ridiculous.  It points to what is exactly wrong with the common media coverage of the venture capital market.  What is the next trend?  Where is the money going?  What exits did best in 2012?  These are questions that don’t really have a lot of relevance to most investors. They are simply ways to quantify what is largely unquantifiable.  Sure, firms have returns, but these are established in 5-10 year increments, not 1-year increments.  A firm might have had a few exits this year and then none next year.  Measurement comes at the end of a fund life.  I know that’s hard for most investors to grasp, but this asset class is not like a hedge fund or for that matter, not much like Private Equity either.  Investing in venture is a bit like buying a great bottle of wine. You can pick the producer, region, even vintage, but when you open it can determine what the experience will be.  Funds invest for 2-4 years and then harvest for the next 5-7. A fund is typically 10 years for a reason; it can take this long to create the complete picture. Just like a good Bordeaux!

For large established firms, venture is and always will be a trend-following business; some are leaders, some are followers.  Some even try to influence trends with their investment philosophy, making bets across a sector to create markets.  They can afford to do so.  They have to put all that money somewhere! On the other hand, smaller, more regional or industry focused firms like Cava are very specific in what and where we invest.  Our approach has been very simple and aligned from day one; focus on pioneering businesses that have demonstrated some quantifiable customer success in the marketing solutions and software industry, and then be very active and help them grow, any way we can.  Simple as that.  We believe that the world of marketing is under assault and the companies that are leading the way will dominate the new norm when it settles. Our focus on Enterprise is not because it is trendy or more profitable or has a better chance for success.  It is simply because that is what we know best as operators and where we can help a company succeed. So instead of asking what the trend is or which firm ranked first in 2012 exits, ask the principals what they believe in, how they will accomplish it and where they are best poised for success.  Not so different than a company in that sense.  Bet on the team, their process and how they execute.

Ask the VC: When To Jump From Angel to VC

The next question in our series of posts from my Startup America Q&A might just be the best question of the bunch.  “How do you know when it’s time to jump from seeking a large angel round to asking for venture capital?”

Wow, the magic question.  Though I’m not sure I have the magic answer.  This is one that founders have been wrestling with for decades.  What makes this more complex is the ever-changing options for financing that are available today that weren’t 5, 10 or 20 years ago.

Let’s go back and look at the ecosystem in the past. VC was really a club industry.  Funds were smaller, there were a lot fewer firms and the path to raising capital was pretty clear; self finance, get some angels, friends and family money, and then, when applicable, go right to venture.  The angel capital community was small and well known, and the small number of VCs made the process relatively black or white.  What changed?  The Internet bubble of the 90’s.

All of a sudden, there was a proliferation of angels, newly minted dot.com millionaires who could and did have an active financing strategy.  This created a wave of investment capital into companies. VC’s raised ever-larger sums of capital for their funds and corporate VC came back.  Still the process was clear, angels first, then VCs after proof of concept.  This lasted until the bubble burst.  Many of the VCs that were created then are now either not around or have raised substantially smaller funds.

Fast forward to today, we have angel, angel networks, crowdfunding, institutional seed funding, venture of all stripes, growth capital, strategic corporate capital, hedge funds, family offices doing direct deals, and hybrid funds like Cava doing special purpose funding on a deal by deal basis.  The point is there are plenty of choices and the lines between with whom and when you fund is blurred.

So the simple answer is, there is no answer.  The right question is “who are the right investors for my company?”  This is usually a combination of personality, industry, value add, luck and timing. But we could talk about that in a whole other post.

In case you missed the first three posts from Ask the VC:

Accelerators – Not All Are Created Equal

Top Three Slides In Your Pitch Deck

Price Caps and LLC vs. C Corp.

Ask the VC: Question 3 on Price Caps and LLC vs. C Corp.

Continuing our “Ask the VC – Startup America” series after a bit of a blog hiatus (we have closed 3 deals in the last 3 months), this was a popular question that I still hear a lot:

“As a very young startup, with a validated concept and freshly built app, will raising from angels on convertible debt with a price cap hurt me?  Also, does it matter if we are an LLC or a C Corp?”

For the first question, the answer is no.  Raising an early convertible debt round will typically not hurt you in future fund raising endeavors.  This is a commonly used structure that many entrepreneurs use in the early stages.  The reasons are twofold; first it allows you and the investors to not have to set a valuation on the business at this stage when many of the early questions on customers/users, etc. are not answered.  Second, it is simple and cost effective to do and can measurably decrease the time needed to get a financing done.

On the valuation point, a convertible debt round can be beneficial for the founders and other employees in terms of potential early dilution.  If at the first equity round your valuation is higher than it would have been prior to the convert, then most times you will be a net winner.  With this being said, the angels also benefit by typically getting a discount on their conversion to the first equity round, effectively giving them a risk premium for financing at the early stage.  Because it’s pretty straightforward and usually pretty clean, it’s an easy structure to get done, doesn’t involve much legal advice (forms are readily available online) and is commonly used.

Now what about a Cap?  Caps (dollar amount thresholds that are used for the price conversion) are meant to protect everyone in case the valuation gets pricey at the first equity raise.  It also provides protection in the case the opposite comes true and the company can be financed, but only at an extremely unattractive valuation; instruments can be used to protect the founders equity from being over-diluted.  For those who take the early risk, they are betting that they will end up with a fair equity share when there is a conversion.  If the valuation gets really high, let’s say $50M-100M like we’ve seen recently with some Social Media companies, then the early angels may end up with a very small percentage of the equity, even with their discount – not very attractive considering they took all the risk.  Therefore, caps can be used to protect the investor downside on the ownership.  Keep in mind this can complicate the next round of financing, but can usually be worked through.

As far as an LLC vs. a C Corp, most equity financing done by VCs are into C Corps.  This doesn’t mean we won’t invest in an LLC (we just actually completed 2), but eventually those companies will need to be converted prior to an exit.  Seek legal advice here as there is a potential tax consequence associated with these structures you should be aware of.

In case you missed the first two posts from Ask the VC:

Accelerators – Not All Are Created Equal

Top Three Slides In Your Pitch Deck

Top Three Slides In Your Pitch Deck

Continuing our series of entrepreneur driven questions from my “Ask the VC” session with Startup America Partnership, I thought this question was very appropriate, as I have heard it multiple times over the past few weeks.

Question:  “What is the single most important item in the Pitch Deck that VC’s pay attention to?”

As an early growth round investor, we might have a slightly different answer than Seed or Angel teams.  Instead of a single important item, I tend to focus on 3 slides.

First, what is the problem that you are trying to solve?  How big is it (addressable, not total size of market) and frankly, does anyone care?  To further clarify, are you trying to invent a problem for your solution or is it built from a real need from which you have unique experience.  You would be amazed how many great ideas we see that have no apparent problem attached to them.  Demand is driven from a need.  Supply driven solutions can be huge (almost all consumer driven internet applications), but there is also a high failure rate.

Second, where are you in your journey?  Do you have real traction, whether that is revenue, or customer acquisition in some other form (users, partners, etc.)  Again, ideas are great but meaningful measureable proof of traction is a must for us and many other institutional investors.

Lastly – the team.  Who are you?  Why are you uniquely qualified to be the source of inspiration, knowledge, talent acquisition and leadership in the industry?   Why is your team the best for convincing prospective clients and investors to support your execution capabilities?

Certainly not an exhaustive list, but definitely three things I want to leave with in every meeting.  Other things obviously include the product strategy, financial plan, use of funds, measurement objectives, marketing and support plan and others.   But if you don’t have these three slides tightly communicated in your deck – the rest may never see the light of day.

Accelerators – Not All Are Created Equal

A few weeks ago, the terrific folks at  Startup America Partnership asked me to host an hour web conference called “Ask the VC”.  I had a great time answering questions on a wide variety of topics related to entrepreneurship, the current funding environment and how we look at companies during various stages of growth.  As I was speaking, I kept thinking that many of these questions would make great blog topics.  So, here is the first of, I hope, a string of topics driven by the entrepreneurs themselves.  However, if you read nothing else in this post, please join the Startup America program;  it costs you nothing and provides so much!

Question:  “Accelerators are very popular right now.  Admittedly, not all are created equal.  On average, is an investment from them at $20k, in exchange for 5-10% of the company, actually a good deal?  It seems like a low valuation opportunity for the investors, not the entrepreneurs”

This question is very relevant right now given the explosion in accelerators, incubators, and programs designed to foster innovation.  The simple answer is yes, they are worth it if you are able to get in a program that can accelerate your path to success.  Most of the programs are staffed by great entrepreneurs themselves, have venture and angel investors working with them directly, and provide access to tools, people, technology, space, services or a myriad of other things that can be extremely helpful at the earliest stages.

If I am correct, Techstars claims that the success rate for their graduates in securing funding is in the 70%+ range.  By any measure this is truly amazing and worth 5-10% alone.  With that said, if your company is more mature and has some existing traction, you need to think long and hard about the dilutive effect that the implied valuation might have (although many of these programs only take common stock, warrants or in some cases, a convertible note with some discount).

My advice is think about the types of groups that you are applying to, what they can bring to the table and whether your chance of success can be dramatically accelerated by the program.  If the answer is yes, take the deal.

Venture Capital Vs. Private Equity, Setting It Straight

It has been fascinating to watch the 2012 Presidential campaign kick into high gear. I liken it to rubbernecking on the highway. While I am not making a political statement on this blog post, I think we need to have a discussion on the differences between Private Equity and Venture Capital, considering the frenzy around Mitt Romney and Bain Capital. It’s amazing to me how a lack of fundamental understanding of this concept has permeated its way into the campaign. I know I shouldn’t be surprised when the media doesn’t do basic research or homework to truly understand an issue. However, I am more agitated with the candidates themselves who regularly use phrases like vulture capital to describe Bain Capital and their strategy. This is not only completely incorrect, but misleading and hurtful to a company, person and industry that has done some truly great things. Let’s be clear, there is a major difference.

Venture Capital describes a class of investment that focuses on smaller, earlier stage companies. Our investment is virtually always for equity only and is never leveraged. We initially take Minority ownership positions to make sure the early team is properly motivated to build a high growth company and share in the financial success. We are backing entrepreneurs, their ideas and their ability to scale the business. Think of it in terms of rocket fuel. Many crash and burn, but the successful ones can be spectacular. The risk is higher, but offset by potential return. In the process, these investments can create many jobs, as early growth stage companies typically need to scale rapidly.

Private Equity is an asset class that Venture is technically part of, but is usually meant to describe the investment strategy. Private equity firms are typically acquiring majority or controlling positions in larger, more established companies. The larger deals use leverage to complete the transaction as many of these can be in the hundreds of millions or even billions of dollars. The firms then help to manage the newly acquired asset, often replacing top management, selling or divesting of underperforming assets and acquiring other strategic companies to build a more efficient and profitable entity. The goal is to then sell the company at a premium. When it is successful, the emerging company will be more successful, can provide a great opportunity for job growth and build shareholder wealth.

Both investment strategies are appropriate for certain investors and both can offer tremendous value and return as well as create jobs for the future.

Good investing.  Comments always welcome.

Getting Connecticut Back to Work, Part II

In Part I of my blog post “Getting Connecticut Back To Work”, I recommend increasing access to venture capital and angel financing as a way to support CT’s growth and job creation in the tech space.

Another strategy to encourage state growth is to stimulate and develop new funds or entities and other sources of capital financing.

One option is to cultivate the number of private and public sources of capital, in addition to the work done by Connecticut Innovations (CI).  CEOs of major Connecticut companies could be encouraged to allocate funds, either directly by such companies or by their pension funds, to one or more new Connecticut venture funds.  This can be coupled with tax incentives or credits, not unlike the existing Insurance Tax Credit program.  An important part of the message is that all stakeholders in Connecticut must work to reinvigorate the state’s economy, thereby enhancing the overall entrepreneurial environment.  Connecticut businesses, be they multinational or local, should support this effort.  In addition, it is time to start encouraging the pension funds to think CT first. While these funds have private equity allocations and even some later stage venture, a very small amount is actually in CT based early stage venture; the point at which many growth businesses are being created.  The growth of venture and other sources of capital will compliment the efforts of CI directly.

Another option is to create a state SBA program similar in scope to the federal level program with matching funds for state allocated investments. Matching at 1:1 or 2:1 is acceptable. The federal program has been successful in the past and has created several new firms in the process. At Cava, we are on the ground, finding great companies and working with their management teams to execute their vision. A state program could be very effective in drawing funds to the area, enticing more companies to build their futures here with the increased access to capital.

Getting Connecticut Back To Work

As a Connecticut business owner and resident, I have a vested interest in the success of my home state. It is regretful that CT has had such a poor record in job creation over the last 20 years. In fact, the state ranks dead last in net job growth over that period.

As a venture capitalist in the area, we have been focusing the majority of our time on opportunities coming from NYC, where the innovation and investment pace have been meteoric. However, we have made it a goal of the organization to support CT’s growth initiatives as best we can.  Cava has decided to headquarter in Norwalk, CT with an office in NYC as well.

Cava has two investments already in Connecticut: etouches; the leading provider of event planning software to organizations worldwide and Zadspace; an innovative advertising technology solution for ecommerce providers. Both are located right in the heart of Fairfield County, which has long been home to many marketing services and direct marketing organizations. Zadspace was originally located in Los Angeles. We decided to relocate the company to CT in order to take advantage of the talent and client base located here.

I am committed to help spur CT job growth and prosperity while still remaining true to Cava’s discipline and approach. On that note, I have decided to do a series of posts recommending how we might all work together to foster a community of high quality opportunities, while reversing the trend of poor job creation in the state.

Recommendation # 1:

Increase access to Venture Capital and Angel Financing

Venture capital financing is the “lifeblood” of emerging growth companies. As part of my dedication to CT, I have been working with several other investors and entrepreneurs on a task force for Economic Development in Connecticut, specifically focusing on the Emerging Companies Sector.  In particular, I am a huge believer in starting at the ground floor; building an early stage angel and venture culture. This has been done very successfully in NYC where they have created a friendly environment to spur angels to invest. Some ideas include refining the state angel tax credit system and starting a fund-matching program for early stage VC. This will help get much needed capital into the hands of early entrepreneurs who are very nimble at this stage. We can attract entrepreneurs to relocate to CT or we can keep the incredible talent and resources we have coming out of our fine institutions right here in our state.

Such early stage angel and venture financing is key to building a critical mass of tech companies in Connecticut. If we look around the area, NYC has built an impressive and vibrant community of venture investors, angel and seed investors, entrepreneurs and growth capital. Companies are flocking to New York to start and operate their technology businesses. In fact, New York has shown an incredible burst of innovation, specifically in the Media sector. According to the latest venture data last quarter, NY ranked #2 behind Silicon Valley in dollars invested. We have seen virtually every major VC firm in CA and Boston open offices in NY to take advantage of the deal flow and opportunity. In fact, NYC is now considered the East Coast capital in VC. This took roughly 10 years.

I am committed to making 2012 the year that poor job creation in Connecticut is replaced with exciting and innovative growth.

Subscribe to my blog for Recommendation #2:  Stimulate and Develop Other Sources of Capital Financing

The Tweeners Have This VC’s Attention

What is the inevitable outcome from the amazing amount of seed capital that has been deployed to hundreds if not thousands of companies over the past few years?

• Dead soldiers? Well yes, that happens all the time.

• Amazing companies ready to soar to the next level, seeking large amounts of capital to continue their growth at sky-high valuations? Of course, welcome to the boom and bust nature of venture capital.

Somewhere between the two you’ll find the companies I’m talking about; those which have exhibited really compelling early progress, but not quite enough to naturally fall into the hype category, giving them freedom to raise whatever they want at whatever valuation someone is willing to pay.

I’ve named this middle bunch “Tweeners”, somewhat akin to that uncomfortable zone kids go through right before blossoming into full-blown teenagers with all the potential in world ahead of them.  It’s not too difficult to find them if you look hard enough, but don’t confuse them with the “Weaners” – those that can wean you of your money faster than you thought imaginable! If you can find and engage these Tweener companies, it can be an amazing journey.  This is classic value investing, VC style.

It goes something like this.  In walks a really compelling company which is on the right track:

• Value proposition is right.
• The business solves a really well defined problem and early beta customers rave about the usefulness of its product or service.
• Technology is working great and looks great (UI). They might be in version 1.0, but their roadmap is well defined.
• The team looks solid, albeit a bit thin, as they have been  bootstrapping on some early angel or seed capital that helped define and build the technology.
• The balance sheet looks solid as the team has been judicious about their cash flow and budgets.
• The business model needs some definition as they are  juggling 2 or 3 revenue sources (Licensing, Subscriptions, Advertising) and determining which has the most promise (in consumer, it might be less about revenue and more on customer adoption).

And then the hammer –  “We need to raise $5 million.”  Sound familiar?

This used to be the place for institutional entry points, the classic series A.  However, that has now been shifted to the institutional seed and angel rounds. But it doesn’t solve the problem. For the most part, these companies shouldn’t be raising $5 million.  It would be nice, of course, but if they could raise the $5 million, money would have come to them before they even hit the road. What they really need is another $1-2 million to further refine the model, grow the team, demonstrate revenue / traction and focus, focus, focus.

This is the hardest thing for most new entrepreneurs to figure out. Thriving on chaos is fun but can also be very counter-productive. For everyone’s best interest, the CEO needs to set 3-5 measureable goals, metrics, and core focus points that the entire organization can achieve on the appropriate raise of capital.  Such as:

• physical customer count growth
• site traffic
• revenue
• average sale growth
• product features and performance
• partnerships
• new hires
• customer support

These should be very well defined and an integral part of the road show’s pitch. Put them out front, “We intend to use the money in the following ways and ACHIEVE these 4 things. This is how you measure your investment in us as a team and me as a leader.”  This method is bankable and it is smart. It shows maturity and leadership. It gets everyone on the same page.

What does that mean for your valuation? As I have always said, don’t get so fixated on valuation at this stage. This is the time for building a great company, team, investor group and a compelling story for continued success. Focus on the size of the pie, not the slice.  If you do what you say you will do, the next round will take care of itself at a very compelling valuation for everyone involved. It’s in everyone’s best interest to make this happen.

We are seeing a number of Tweener companies right now and frankly, I am enjoying every minute of it. They feature inspired young entrepreneurs with big visions and grand plans. I am passionate everyday about helping them build something great.  Now let’s grow some companies!

Response is great for LOCAL RESPONSE

Cava is pleased to announce our latest investment in Local Response, the leading check-in based ad network.

The amount of press received on this deal is impressive.  Click here to see coverage from The Wall Street Journal, Business Insider, Ad Age and more.

Our intense focus on solutions that provide marketers new and integrated ways to reach consumers drove the thesis for the investment decision. Local Response is led by a industry leading and very talented team and has developed a solution that is resonating nicely with leading marketers and brands across the US with average CTR of campaigns ~40%. Clients include  Coca-Cola, Microsoft, Verizon, General Motors, Aveda, Walgreens and MacDonald’s.

The total investment of $5 Million dollars was led by Cava Capital with Vodafone, Advancit, Progress and existing investors all participating. Funds will be used to scale the sales team, ship an enterprise version of the product and augment distribution channels.

We look forward to supporting the team and the success of the company. GO Nihal, Kathy and the LR Team!!