Friday, July 19, 2013

Enabling Early Startup Investors' Skin In The Game While Saving Money

Last night's TiE Silicon Valley event on sources of funding for startups yielded a treasure trove of wisdom on exhausting every avenue available before seeking VC money.  I'll plug their affiliated Startup Leadership Program because the program alumni who presented at TiE impressed me.  If the startup bug has bitten you, get your fill of accelerators and conferences at F6S.

The founder of Micello regaled us with stories from the trenches about how he raised money for his startup without significantly diluting equity.  I was amazed to learn that major prospective customers are willing to subsidize up to 50% of their estimate of a tech startup's product development costs if the beta version is something they really want to use.  Putting IP in escrow is no worry as long as you execute and crowdfunding is an excellent way to discover demand.  Early stage startups can skimp on non-core functions by getting free or cheap services, bartering for services, getting loaner hardware from excited business development reps at big partners, holding meetings at free WiFi hot spots, and volunteering at events just to get access to big shots.  These are all IMHO examples of effective Toilet Paper Entrepreneur tactics for success.

I noticed that serendipity played a major role in the lives of many of the entrepreneurs at TiE who have shared their stories.  Getting outside your comfort zone increases the numbers of people you meet who may help you with free services or product development subsidies.  Attending conferences and winning startup contests is integral to amassing a "collection of small wins" that will keep a startup team motivated through the ups and downs of its early years.

The best lessons were about parceling out equity in exchange for services.  The Micello co-founders had to buy their way in if they wanted significant equity; other employees and advisors who aren't being paid in cash would be smart to have options agreements that grant them more equity later as they keep performing their roles.  I did not know that some law firms will accept a deferred payment for their services in lieu of equity, so long as the startup successfully raises capital later.

Convertible notes are useful in Silicon Valley.  Micello granted a convertible note to an early partner that funded their product development.  Convertible notes can be "fixed discount" or "capped convertible."  The very first angel investment I made in 2007 was under the terms of a convertible note called a bridge loan.  It granted me shares upon the company's completion of a subsequent fundraising round and had a warrant attached that allowed additional shares to accrue.  I've read a few VC blogs on the subject and capped notes seem be falling out of favor because they offer little flexibility in subsequent fundraising rounds.  Convertible notes increasingly come with liquidation preferences nowadays so earlier investors have some options in later rounds.  Speaking of options, sweat-equity contributors need to know how their equity options accrue and entrepreneurs need to know how their attorney accounts for their vesting schedules in the cap table.

I have much more appreciation for the nuances of early stage investing after reading up on the controversies around some ways to structure convertible notes.  I'm not the kind of investor who holds entrepreneurs over a barrel and I won't structure my own investment in a way that hurts a company's future growth.