USF Redefines Success In Angel Investing

I was privileged to attend a talk tonight at USF's School of Management campus in downtown San Francisco.  My own USF MBA has proven totally worthless but sometimes these talks are entertaining, and they always offer free food.  That's the only value I will ever obtain from my education.  I went to hear USF Prof. Vijay Mehrotra describe his "Confessions of Angel Investing."  He had five main lessons to share.  Here they are, verbatim.

1.  Invest in entrepreneurs who are sufficiently obsessed with their business success.
2.  Invest in those companies and founders who have a strong idea of who their customers are, and why they do (or do not) spend money.
3.  Invest in companies that have some kind of unfair advantage.
4.  Invest in and with people where your value to one another goes beyond money.
5.  Invest only with people who you deeply trust and share your values.

Those five lessons reflect a lot of the wisdom on display at countless tech conferences and VC panels I've attended since 2011.  I totally agree with Prof. Mehrotra that worthwhile startups should make the world a better place and that exceptional customer knowledge is tough to obtain.  His qualitative insights into the value of experience should include the one thing that I have come to understand as crucial for a successful startup.  That one thing is the presence of a serial entrepreneur on the team.

Serial entrepreneurs bring obsession as a habit because they've done it all before.  They have exceptional customer knowledge from launching and growing several startups in the same vertical.  The seasoned executive brings that "unfair advantage" of anticipating routine problems that rookie entrepreneurs don't see coming.  The remaining Big Data challenge is to somehow collate the quantitative results of serial entrepreneurs running startups.

Prof. Mehrotra shared some stories of acquaintances who succumbed to ethical lapses in their lines of work.  Even experienced angel investors can miss red flags in the character traits of founders.  I would add that due diligence requirements increase with the cash commitments startups need as they mature.  A few background checks on the founding team are cheap to perform.  Checking for fraud can save a lot of invested capital from entering the valley of death.

The good professor asked his audience to write down what "success" meant to each of us.  I did not have to think at all about what I needed to write, and I'll share it now.

SUCCESS
- Living with honor and integrity
- Having a small number of high-quality friends worthy of trust
- Achieving maximum possible self-actualization
- Sharing love and wisdom with others, especially the close circle of friends
- Having a clear understanding of one's place in the world

You may recognize some of these concepts from ancient Stoic philosophy.  Marcus Aurelius' Meditations helped me understand why these things are important.  Immanuel Kant's Categorical Imperative reminds me to always act in ways that support these beliefs.  Notice that I didn't mention money or worldly power in my success definition.  Those things should follow naturally once the above qualities are evident.

I left the lecture early due to a schedule conflict, so I missed the other experienced investor following Prof. Mehrotra.  I would like the angel investing community to take serial entrepreneurs and ethics more seriously.  Long years of varied experiences build the kind of intuition that serves executive judgment well.  Success should follow naturally.

The Haiku of Finance for 01/21/15

Self-proclaimed angel
No skill, knowledge, or background
Please get off the stage

The Wrong Ways to Fund a Dream

The perpetual merry-go-round of entrepreneurs and investors is full of wondrous sights.  I wade through the chaff so my readers don't waste their time.  I run down blind alleys far enough to know when to run back out.  I recently ran down one such alley with a group I used to think was reputable.  I shall correct that misjudgment right here in this article.

Raising capital requires hard thinking about proven methods.  Appeals to faith don't hold water.  It's not enough to tell people they've gotta believe in a capital raising system.  The system has to actually work.  If it is designed with a hidden agenda in mind, such as funneling deal flow to asset managers who do not have relevant expertise in helping startups, then the system does not deserve to be considered angel investing.

Introducing angel group team members begs questions about why they are on the team.  Are they experienced investors?  Are they entrepreneurs with successful exits?  If those don't apply, and they're just good technicians, then they are probably in over their heads as mentors to entrepreneurs.

People who want to inflate themselves will sometimes drop names of prominent people they've met casually, or who were early into deals when they themselves came in late.  That does not imply any formal business relationship between the big shot and the braggart.  I have been in the same room with tons of Silicon Valley's biggest names and none of them cared about me at all.  There is no way I can claim those billionaires as business partners.  Anyone can photograph a casual encounter with a business or political celebrity.  So-called investors who run their mouths about phantom partners should either publish proof of their claimed relationships or shut up.

I have never heard of waiting to the end of a receiving line to maximize face time with a VIP.  Think about it, people.  All VIPs are busy and waiting to be last in line risks missing them altogether when they have to pick up and leave for their next event.  Waiting around is never an effective tactic in my experience; being first in line for anything is much more likely to bring success.

In a similar vein, I have never heard of mapping out a wealthy prospect's personal network of gardeners and gold partners as a means of planting a venture pitch in their ear.  That is just plain ludicrous.  Every effective prospector knows the importance of getting past gatekeepers, not converting them into an unpaid sales force.

Angel investors are supposed to know certain things about technology startups.  They should know that a provisional patent offers some IP protection for a pre-revenue stage startup.  They should know that traction means sales, and nothing else.  They should know that metrics like CAC and LTV are ways to measure a marketing campaign.  They should not have to lean on an audience member to explain widely adopted concepts like the Lean Startup method.  They should know how funding rounds are linked to achieving operational milestones.  They should understand that VCs expectations are partly driven by a need to return capital to their investors, and that VC funds' stated lifetimes affect a startup's path to its exit event.  Finally, angel investors should know that an early expectation of an X-multiple ROI works backwards from the exit's terminal valuation, adjusted for dilution by terms offered to different investors.  I cannot take an "angel investor" seriously when they demonstrate obvious ignorance of these concepts.

Business fakers should be grateful that I am in solid control of my blood pressure.  Otherwise, I would be blowing up when I see self-described business leaders pull amateurish stunts.  I dislike watching an entrepreneur tell minions to adjust event admission prices at the door based on whether an attendee looks like they can afford to pay.  Doing that with real products or services leads to FTC complaints.  I also dislike watching a featured speaker adjust their presentation slides 20 minutes prior to showtime, wing it through the presentation, allow audience questions to go unanswered, and otherwise show a total disregard for people's time.  All of these things are very bad signs.  I run away from this behavior when I see it.

I cannot take seriously any claimed expert who engages in the bizarre tactics I described above.  Anyone who approaches early-stage venture investing in this manner will never figure out how to get their dream funded.

Startup Pitch Coaching Lessons Learned in September 2014

I had a fun day down in sunny Palo Alto today, coaching tech startups through their Cleantech Open pitches.  I learn as much from these sessions as the startups learn from me, if not more.  I am morally obliged to share my incredible genius with the masses.  This stuff is totally random and chaotic, just like running a startup.

The opening slide is the ideal time for the pitcher to state their name and title.  It's usually the founding CEO, and there needs to be a really good reason if it's someone else, like if the founding CEO is off pitching top-tier VCs at a major pitchfest and the COO has to give this other pitch to a second-tier angel club.  The intro of a long pitch is also a good time to reiterate the 30-second elevator pitch.  The elevator pitch ought to be on every employee's desk, repeated like a mantra whenever someone at the startup meets the general public.

Technical specs on competing products are less compelling than describing competing enterprises' market positions.  Knowing the big competitors' market size, solvency, and ability to defend their market positions shows a mature understanding of competitive reactions to a disruptive entrant.

Describing the team's composition is very important.  I am not swayed by headshots unless they depict really hot babes, with cleavage and pouty come-hither looks.  Okay, seriously, the team slide must describe what each team member brings to the game:  the scaling / serial entrepreneur, the scientific co-founder's patents, the super-salesperson who grew a product from zero revenue to eight figures or more annually.  Venture investors like visual stimulation and VCs in Silicon Valley are often focused on brand-name pedigrees.  VC partners with tech backgrounds have lots of Berkeley and Stanford degrees, and the ones with business domain experience have lots of Harvard and Wharton MBAs.  Logos for prominent schools and corporations are easy ways to make statements about the quality of the team's experience.

Never ignore Big Data as a cost center, revenue stream, and source of liability.  It's all the rage anyway and competently addressing its many facets shows maturity.  Big Data has storage costs in the cloud and they will grow with app downloads.  It can be a revenue source if its predictive analytics offer enterprise clients some ways to optimize whatever they do on their own.  The absence of privacy policies and other regulatory compliance standards opens the door to lawsuits.

Founders who are fully invested in their startups impress the heck out of sophisticated investors.  This is one bullet point that is best mentioned in passing while briefing the team slide.  It shows do-or-die commitment.  Some VC is eventually going to ask about it.

Look at my wonderful picture just above.  I drew this simple milestone slide as a sample of how startups can portray their growth expectations.  I believe it links projected revenue over time to product achievements and capital raising needs.  It also displays some kind of exit event.  Later investors want to know what the founders plan to do once the startup is successful.  The startup's strategies for finance, marketing, and capital raising are adjacent lanes on a highway, and the startup will change lanes at high speed.  Pushing back a milestone in one lane also pushes the others back the same distance.  Just link them all.  Each inflection point on the S-curve to adoption is theoretically driven by some success that justifies more capital.

I will never understand why some founders want their pitch decks to look like works of abstract art.  Diagrams showing lots of internal references between business units invite confusion.  Successful enterprises have an external orientation facing customers and results, not internal orientations facing their own processes.

The "secret sauce" of some magic technology means nothing if it does not generate a product with better / faster / cheaper characteristics.  Patents are nice but the consensus I've seen from VCs is that IP protection is worthless for a company that can't sell a viable product.  Stating price points and market positioning helps investors understand whether some startup can truly reach its target market.

The overused term "partnering" begs questions about what these partners bring to the table.  I want founders to tell me which of those corporate logos are in the supply chain because they're affordable, which are effective distribution channels, and which of the non-profits are helping ease the regulatory burden.  If they're just on the slide because someone in their purchasing department thought the startup had a neat idea, well, then they're not really a partner.

Everyone makes mistakes.  Founders should tell me how great they are at problem-solving and not belabor their mistakes.  My biggest mistake was attaining a degree from the University of Notre Dame that later proved worthless.  I recovered from that error by cutting off all contact with Notre Dame snobs who want me to fail.  Founders are free to describe how they triumphed over adversity, just like any good college football team that defeats the Fighting Irish.

Someone who is very proficient in the English language must proofread the pitch slides before the founding CEO makes them public.  This is more than just slapping in a Safe Harbor statement now that the JOBS Act puts pitches to non-accredited audiences (including those on crowdfunding portals) under SEC scrutiny.  Fix the typos and make the fonts readable.

Venture capitalists are renowned for their pattern recognition abilities.  They compare unknown enterprises to known business models.  Self-identifying as the "Uber of something" makes sense if they deploy a free app that programs an affordable service.  Self-identifying as the "eBay / PayPal of something" makes sense if they control an online marketplace that reduces several friction sources.  Cleantech startups have existing markets as reference points.  Renewable energy feed-in tariffs, solar  panel rebates, biofuel RINs, and carbon credits are all valid aids in pattern recognition.  Use them wisely if they resemble something brand new.

I told you this stuff is random.  Alfidi Capital is your source for truth.  Entrepreneurs are responsible for figuring out how to display their own genius in Guy Kawasaki's 10-20-30 structure or whatever format they must send to some pitchfest.  I'm outta here.  See you all tomorrow, or whenever.

Meditations on Early Investor Expectations for Startups

I moderated a recent Angel Launch panel at Founders Space where some early stage investors shared their expectations with attentive entrepreneurs.  This San Francisco event was very well-attended.  The investors' wisdom was a fresh reminder that I always have something to learn.  I'll share some of what they revealed below, commingled with my own thinking.

Startup founders need to implement good financial and legal controls at the very inception of their business.  Getting good advisers helps avoid common problems.  Setting up legal structures, bank accounts, and accounting software is the necessary first order of corporate housekeeping.  The founders must delineate their ownership stakes with term sheets that feed the initial cap tables.  I've blogged before about how attorneys sometimes deal with "phantom founders" in later stages whose rewards were not clear at the beginning.  

Experienced early-stage investors will set expectations for bottom-line results.  The team's goals for closing sales get a boost if they land a big-name customer.  Leveraging a corporate VC's brand name and ecosystem are important; some other gurus at one of the many conferences I've attended call this "hacking your pedigree."  Raising capital is not success, but too many startup CEOs think raising capital is their primary job.  Sales revenue from customers is real success, and CEOs need to think of revenue as a non-dilutive capital injection.  

I keep hearing about the importance of scaling from investors and entrepreneurs who succeeded.  Scaling matters only after a startup proves it has something customers want to buy.  Once the early adopters are in the pipeline, the total addressable market (TAM) they represent must be big enough to allow scaling.  Making the early customers happy is more important than worrying about scaling too early.  Startups can tweak their approaches to marketing channels later if they stay flexible.  Startups rarely fail for lack of scaling, because revenue from sales drives the enterprise's ability to scale.  I totally see how startups with unsound business models fail by scaling too early; they burn their capital on unneeded physical plant and IT infrastructure before they can pivot to a market segment that allows for revenue-based scaling.

Founders should expect decent terms from early investors but understand that investors must apply a high discount rate.  The founders who can protect their interests with liquidation preferences should expect investors to be just as sophisticated.  Founders should expect friend / family / fool (FFF) investors to subscribe to warrants, just like later investors.  

Serious investors must perform due diligence before committing to invest in a startup.  A small team of young people running a brand new company is the easiest to check.  They probably have very few legal or financial troubles that will pop up in a background search.  Top VC firms often hire private investigators to evaluate a startup team's background before committing millions of dollars in capital.  My own preference is to use the basic online search tools available to anyone, plus some pattern recognition techniques common in military intelligence training.  Running several Google searches on permutations of someone's name usually yields enough data points to vector their professional experience.  San Francisco Superior Court and other regional courts have case histories that anyone can look up free of charge.  

Every early investor has their own set of deal-breakers that will stop an investment decision.  The most important red flag for me is a lack of personal integrity.  I try to give people the benefit of the doubt at first contact.  Once I discover inconsistencies in the story someone gives me, they are gone from my professional life with no explanation necessary.  I tell people not to ever lie to me.  The people who don't listen don't deserve to have me around.  I can forgive an entrepreneur who has been through bankruptcy, especially if it resulted from a previous startup.  Entrepreneurs are expected to be fully committed to their dream and they do suffer financial penalties when dreams end in business failure.  I can understand a divorce settlement and child custody payments, because humans aren't perfect.  Sometimes people who possess bold, risk-seeking business personalities leave messy personal lives in their wakes.  The deal-breaker for me (besides lack of honesty) in personal affairs is a chain of unrelated bankruptcies, liens, divorces, and other financial train wrecks that recur for years.  A business person so immature and reckless needs to sort out their personality problems first before soliciting risk capital.  

Subsequent rounds of investment do change the relationship between founders and early investors.  The preferred order for expanding a capital structure is sales (first and foremost!), FFF, non-dilutive grants, crowdfunders, angels, and finally VCs.  The FFF and grant rounds are somewhat blended in a startup's chaotic early days.  Subsequent rounds are more complex and dilute early investors as the enterprise issues new shares.  Early investors are often pushed aside in those startups lucky enough to attract huge VC commitments, and they may even be forgotten after forced management changes.  The earliest backers need to store their original term sheets securely (yeah, no-brainer, but no one wants to be the FFF who lost their term sheet prior to a billion-dollar IPO).  The startup's attorneys are supposed to maintain the cap table proving early ownership but startups do change law firms sometimes.  The records transfer may not always be perfect.  Perhaps you can tell that I don't completely trust third parties to keep my best interests in mind.  

My regular readers know that I see the social / mobile / Big Data investing trend cooling off.  The smartphone market in developed countries is at or near its saturation point.  The next hot trends in wearables, IoT, and hardware are already visible but I believe early investors will be shell-shocked when they see the price tags for investment.  Hardware success stories need a lot more capital than software stories.  The elegant solution is early sales of simple beta products, but of course nothing is ever so simple.  I would like to see enterprise solutions address the performance gaps in supply chains.  Large VCs look down at such solutions because they don't scale to multiple billions of software sales, but I say they can provide startups with enough capital to help pioneer cheaper hardware as IT/OT integration takes off.  Startups aiming for base hits will take momentum from those seeking home runs in the next few years.  You heard it here first.  

Startups deserve to inhabit healthy ecosystems.  I blogged about The Rainforest:  The Secret to Building the Next Silicon Valley when I discussed my experience at this year's Cleantech Open National Academy.  Entrepreneurs operating a virtual enterprise in software can stay lean and code from anywhere.  They have fewer concerns than a hardware startup that must weigh physical distance to markets, length of supply chains, and sources for technology collaboration.  Colocation with a major research lab may matter in the early days.  Locating in a HUBZone may be relevant to startups targeting the government market or the supplier diversity programs of major government contractors.  Tax incentives matter once a startup has enough revenue to scale up its capacity; this may dictate a change in location.  San Francisco loves giving tax breaks to big tech companies that promise to bring in lots of new jobs.  Civic leaders who are serious about following suit in other towns need to follow the Rainforest blueprint.  The City By The Bay never gave me any tax breaks for creating my own job with Alfidi Capital, but I can't complain.

None of these meditations mean jack squat without action.  Entrepreneurs can will themselves to success if they move forward daily.  

Angel Launch Launches Startup Venture Summit

I was privileged to attend Angel Launch's inaugural Startup Venture Summit last week in Silicon Valley.  It was the perfect counterpoint in many ways to my Dreamforce 2013 experience.  The Salesforce honchos told their entire ecosystem which markets they wanted to penetrate and laid out the details of their platform updates.  Entrepreneurs at the Startup Venture Summit met investors and partners who could help them gain traction with a big ERP ecosystem.

That layout is typical of what you'll find at eBay's Town Hall venue.  I can be a very aggressive networker when I have a mind to do so but I now find that people at these events seek me out.  I'm sure my listing as moderator of two panels helped attract people, along with my pinch hitting moderation of a third panel at the last minute!

The first VC panel shared their perspectives on top trends.  Stars from Khosla Ventures, Draper Nexus, and Garage Technology Ventures were on hand to let us know that startups need to show investors their "map of the world" on how they will realize their vision.  Paradoxically, VCs are more comfortable funding a business that doesn't immediately need the money if said business spends more time chasing customers than investors.  They like product demos that are installed with customers.  I must agree, because there are way too many shelf-ready products launching at venues like DEMO that never make it anywhere but the showroom.  VCs like it when startups figure out the minimal amount of capital they need to solve their biggest risks.  I just did a Google search of "overfunded startup" to see the frustrations investors have when startups waste money just because they can.  We hear the term "traction" a lot at startup events but the VCs know the term is a proxy for sales and other metrics tracking external acceptance.

The next panel on attracting angels and family funds featured some investors I've known for a while, and a new media outlet named BayLive.  These guys have been around the block enough to know that pitching them something they don't care about is a waste of their time.  This was not the first time I'd heard the startup investing "T's" cited all in one place:  Team, Tech, Traction, Timing, and Total addressable market.  I don't think the set of T's is standardized because different gurus tend to reword them based on their investing preferences.  These guys were big on networking because strong networks share visibility and investor referrals.  Many investors prefer referrals from their networks of attorneys, bankers, and consultants over cold contact from unknowns.  One panelist modestly admonished startups to take money from well-known investors first if they have the luxury of choosing their investors.  I should add that name recognition isn't the only thing prominent venture investors bring to the table and that some third-generation investors just do it because it's the "family business."  I should also add that some banks go out of their way to offer startups a beginner's guide to the early venture ecosystem.  I'm thinking Umpqua Bank, New Resource Bank, and Silicon Valley Bank would be good places for startups to keep their cash if they can't afford a pedigreed introduction at Goldman Sachs.

The moderator for the panel on valuation, acquisition, and expansion strategies was a no-show so I jumped up to offer the conference organizer my services.  I was already there as moderator for two other panels so I might as well save the morning.  "Luck is what happens when preparation meets opportunity" was Seneca's ancient wisdom.  Well, I was prepared when this opportunity presented itself.  Salil Pradhan and Bill Reichert reprised their roles from the VC panel and got more specific on how startups prove their worth as they grow.  They commented that early stage valuations are too high right now, and I was tempted to refer to the infamous Bin 38 "Angel Gate" meeting from a few years back that tried to hold valuations down.  Ron Conway had the correct reaction to that ill-conceived plan.  Anyway, I asked our panelists what they thought of valuation models like the market comparable method.  They thought it was more useful in later stages as the exit event looms.  Early stage valuation is different because it accounts for how much money it will take to build the company, and entrepreneurs need reasonable data points to show early investors.  They also thought expansion strategies must be sales-driven, with a sales capability ready on day one to do CustDev.  The point is not to lead investors into discussing valuation, but to get investors to commit to a business model that can move up a sliding scale of growth.  Experienced VCs have seen that customer acquisition costs are unique to each company and are typically costly in early stages.  Startups that don't need money have the luxury of saying no to investors.  I suspect those startups are rare.  Rarer still are those that can negotiate from positions of strength at an exit.  Our panel felt that taking a decent exit early may be preferable to facing more VC-backed startups later.  I got two things out of my hasty entry into this panel.  First, the ABC of "always be closing" recalls Guy Kawasaki's lesson from "The Art of Rainmaking" that sales fixes everything.  Two, your network is your net worth, and the ecosystem of partners a startup creates looks even better when a potential acquirer wants to merge it with their own ecosystem.

I moderated my next panel on Big Data, analytics, and business intelligence.  Our topic had a huge scope but the collection of VCs from Fung Capital USA, North Hill Ventures, and Sierra Ventures had it under control.  I'm pretty sure the entrepreneurs in the audience benefited from hearing that product-market fit, tenacity, and fast-scaling sales were some of the things VCs want to see when evaluating early startups.  Stuff like proof of concept and financial due diligence come into play in later rounds.  These VC think ERP pain points exist in Salesforce's mobile integration and in customer in-store behavior prior to the point of sale.  Take note of that, entrepreneurs.  If you can meet those data needs and bridge the gaps between technology platforms, you've got an audience.  They also think that focusing on unit economics early on is a key to scaling up later.  Your high customer churn rates will look bad to VCs so get sticky customers whose lifetime value is clearly measurable.  I asked the panel if any non-transaction ERP functions like HR and supply chain management allow for disruption.  They said that supply chain forecasting is often guesswork and could benefit from data that saves margins.  They key is assessing whether an organization's IT mindset is amenable to changing other non-transaction modules.  The VCs had very diverse opinions on the types of KPIs enterprises should use for Big Data; they mentioned revenue per employee (FTE) should be at least $400K, and that the customer lifetime value must compare favorably to the customer acquisition cost.  Payback period matters too, because VCs can't wait forever before they see a return on their investment.

Some more experienced angels from SF Angel and World Capital Market were up next to present strategies for funding pitches.  My biggest takeaway was the importance of an attention-grabbing story, because investors will want to know what's in it for them.  A lot of the lessons from Guy Kawasaki's 10/20/30 rule carry over as long as entrepreneurs remember that execution matters more than the idea.  I liked that they understood how a founder should be ready to surrender the CEO role or a majority stake if that is what will help the company make it.  Their list of speakers to study for good habits includes Steve Blank and Alexander Osterwalder.  I've heard Steve Blank talk and that guy knows his stuff.

My moderator duties continued with a third panel on enterprise platforms, cloud services, and infrastructure. This was another huge topic for serious investors from RWI Ventures, Second Century Ventures, Opus Capital, Scale Venture Partners, and IPV Capital.  Once again, product-market fit emerged as a key early investment criterion but the size of a startup's opportunity and its whether its revenue growth is sustainable also mattered.  One VC surprised me by mentioning LinkedIn as a due diligence tool.  See folks, your network and professional history don't escape notice.  I personally like to use the name query functions on superior court websites to see if someone I meet has a history of bankruptcies or lawsuits.  I've avoided several potential business partners who had sub-par legal histories.  Anyway, my panelists thought universal connectivity has validated Big Data and users want it accessible 24/7 anywhere.  The roadblock to full implementation is that enterprises don't yet fully trust the public cloud for sensitive data and still use hybrids.  The type of customer an enterprise faces determines whether security trumps performance in the inevitable tradeoff.  Cloud solutions offer value to SMBs that have few tools but startups need to make adoption easy if they want to disrupt big models.  The switching costs and key features of the big providers' walled gardens inhibit customer switches, so the pain points would have to be pretty high to induce a switch.  I asked our resident chip expert whether Moore's law still holds; he thought it was still valid because quantum computing and MEMS can extend chip life.  Ecosystems matter because a startup has to participate in a community of contributors to open source hardware (Arduino) and software (Hadoop) to make them all happy.  Companies can add valuable customized layers on top of open source tech.  The investors like freemium product distribution as a good way to qualify leads, and app marketplaces are a good way to evaluate the size of a platform's ecosystems.  I'll close this one by listing these investors' favorite accelerators:  Y Combinator, InnoSpring, and NAR REach.  There you go, folks.  I know my recollections of these panels can be jumbled in a stream of consciousness style, but buried in all that knowledge are hints you can use to move your startup forward.

I had time to listen to one more panel on investment opportunities in Europe after I had completed all of my moderating duties (three panels!) for the day.  Europort is the EU's vehicle for trade promotion in Silicon Valley.  The Bay Area Council Economic Institute is becoming ubiquitous at these types of events by noting that foreign R&D facilities are growing in the Bay Area.  This panel's observation that virtual trade missions are economical for SMBs mirrored what I heard the US Commercial Service say at a trade promotion event several months ago.  The Euro-folks cut the audience a break by noting that an entertainment budget for a trade mission to Europe wasn't nearly as important as one for a similar mission to Asia.  I guess those old legends about drinking Asian business executives under the table in some Tokyo karaoke bar are true.  I had to do some of that during my years in South Korea in the late 1990s for different reasons.  Perhaps I should have done a lot more.

I was impressed with this AngelLaunch event.  It attracted the right experts and hit the right themes.  Entrepreneurs need to hear this stuff as much as possible in many venues.  The endless pitchfest circuit is always a gauntlet but the addition of crowdfunding kicks fundraising into overdrive.  Tech startups need a 24/7 presence on multiple fundraising portals that leverages the feedback they get at these summits.  I am totally looking forward to similar events from iHollywood Forum.  I'm ready for my close-up.  

Pay to Play, Or Smash and Grab

Venture investors and entrepreneurs can suffer for their innocence.  They can get taken for a ride in many ways.  One is "pay to play."  Another is "smash and grab."

A "pay to play" provision in an early investor's term sheet forces them to commit to investing more in future rounds or they get crammed down.  It can leave a bad taste in early investors' mouths because it implies future fundraising will not be advantageous.  The phrase has taken on another insidious meaning in the last couple of years thanks to questionable fundraising forums that charge startups to pitch.  Most reputable pitchfests in front of top-tier VCs or bona fide angel groups charge nothing.  Even pitchfests organized by groups like VC Task Force and various incubators charge only nominal amounts.  The free and cheap venues are worth my time.  A so-called venture investing forum that requires a startup to pay to play, specifically thousands of dollars up front, is not going to get any money from me.

The "smash and grab" is less well known.  It is an acquisition performed by institutional investors who seek to buy a startup as quickly as possible.  It sounds straightforward, but the acquirer may have performed just enough due diligence to realize the startup has something very valuable that they want to buy cheaply.  The strategic intent is to grab the startup's assets (possibly some unique IP) or just take the startup out of the market if it threatens the acquirer's business lines.  A naive startup founder can get taken by a major investor dangling a few hundred thousand dollars in the air for a quick buyout.  The early investors should intervene and help the company stay the course to a higher valuation.

I find both of these techniques distasteful.  They do not treat early-stage investors fairly.  The venture investing community can be prey for sharks sometimes.  On a related note, some folks operating in startups make themselves easy pickings out of ignorance or laziness.  I overheard one idiot at a recent conference make this comment:  "Hey, Facebook bought something like 200 companies this year.  That's like one every week, dude."  Yo, dude, please redo your math on that one.  If he's my competition, investing should be a walk in the park for me.  If he's running a startup, he won't get my money.  

Alfidi Capital Heard Roger Royse at Idea to IPO's Current State of Crowdfuning

I'm always checking out startup action in Silicon Valley.  The JOBS Act of 2012 was supposed to make that easier.  Performing due diligence online is one thing but actually closing an investment round is quite another.  The Idea to IPO Meetup group presented Roger Royse of Royse Law Firm last week down at Menlo College to give us all a rundown of the current state of crowdfunding.

The JOBS Act was intended to further democratize the venture investment playing field so that securities laws could catch up to technology.  Roger mentioned that the cost of fundraising has dropped in recent years and technology has expanded the types of offerings available.   He's published some good info on crowdfunding at his Royse University site.  The complications for startups raising money through crowdfunding portals can be tricky if those portals are open to any investors other than venture capital funds or angel groups.

The JOBS Act was supposed to make venture investing easier for individual investors but the SEC's rule changes so far are intended to apply to accredited investors.  Roger mentioned that Title III of the JOBS Act for retail investors does not yet have the force of law because the SEC has not yet finalized regulations.

Roger noted that venture capital firms have already begun stigmatizing crowdfunded companies as being otherwise unfundable.  Crowdfunded companies may find themselves in a "market for lemons" if they cannot obtain a subsequent funding round, forcing them to focus on an exit strategy.  I've heard VCs on public panels mention crowdfunding as marginally useful in extending the life of a startup that could fail prematurely, but that is probably a minority opinion.

Companies can advertise on crowdfunding portals for accredited investors now that the SEC has lifted the general solicitation prohibition.  The challenge for startups is that the SEC's rules are still in a state of flux and FINRA is still working on certifying crowdfunding portals that comply with the rules.  The SEC may be considering easing some investor verification requirements.  Roger thinks this environment is why startups need to get more conservative and refrain from discussing their financial status until the SEC finalizes more rules.  Pitchfests in front of investor panels may be considered a general solicitation.

I appreciated Roger's revelation that the SEC now considers a one-time placement fee for locating funding to be a transactional relationship requiring a registered broker.  I used to hear stories from old finance hands about how they earned finder's fees for connecting deal flow to investment banks on a freelance basis.  I had considered doing that myself for a while but I elected not to keep my securities licenses active once I launched into public commentary in 2008.  I was very aware (during my financial advisor days) of the SEC's guidance on public commentary for those who maintained securities licenses and fiduciary relationships.  Assuming a role as public commentator required me to surrender any and all means of maintaining fiduciary relationships or mediating transactions.  There are ways to navigate conflicts of interest but I'd prefer to avoid conflicts entirely.  I don't play games with my career or the law.  All I do now is speak my mind and invest my own money, any way I like.

Roger's talk was awesome and he covered way more legal ground than I can summarize here.  I spoke with him and some other entrepreneurs afterwards on the future usefulness of crowdfunding in such a complex regulatory environment.  I now believe the main advantages of crowdfunding for startups are the reduction of friction in closing deals and the compressed time windows for feedback.  Friction is lower on those portals that have broker/dealer affiliations, because accredited investors can theoretically complete a transaction online.  Feedback times are shorter because a startup can now appear in front of the entire early-stage investor universe simultaneously instead of spending months getting on the meeting calendars of angel groups up and down California.  The speed of feedback from investors, either positive or negative, will help startups pivot earlier if they combine it with feedback from their CustDev efforts.  BTW, I'm still convinced that those portals showing early success in generating deal flow will become acquisition targets for major brokerages.  They will be even more attractive if they add microfinance and P2P lending functions.

I'm already applying some of the insights Roger shared.  I've been attending pitchfest and business plan competitions for years.  I even pitched a tech startup idea myself as an undergrad at the University of Notre Dame in 1995.  I didn't state any disclaimers back then and neither have any of the entrepreneurs I've heard since then.  That is all going to have to change very quickly.  I attended a pitchfest in San Francisco last Friday and noticed that the startups in attendance need to get legal advice, get their paperwork in order with the SEC, and start using legal disclaimers that investors like me will respect.  They also need to be mindful of the FTC's privacy policy guidance if they handle customer data.  Failure to do so can subject them to severe regulatory sanctions.  I care as much about my own portfolio as entrepreneurs do about their startups, which is why early stage founders need to mitigate regulatory risk by keeping top advisers like Roger Royse in their hip pockets.

Full disclosure:  I have received no compensation from Roger Royse, his corporate entities, or the Idea to IPO Meetup organizers for this article.  This article, or anything else published under the auspices of Alfidi Capital, does not constitute legal or financial advice.  

Due Diligence on Small VCs and Angel Groups

The largest VC funds have the resources to perform legendary feats of due diligence on startups.  They can hire private investigators and run background checks to verify that entrepreneurs really are who they say they are.  Entrepreneurs have little comparable power to investigate investor groups unless they've had training as private investigators, law enforcement officers, bank examiners, forensic accountants, investigative journalists, or intelligence analysts.  This asymmetric relationship cries out for remedy.

The National Venture Capital Association and Western Association of Venture Capitalists have very well-defined criteria for membership.  Smaller VC funds and angel groups will fly under NVCA's radar and escape notice.  Checking out investors through the National Association of Seed and Venture Funds or National Association of Venture Forums would help if either of those organizations had a verifiable address, contact person, or website.  Those all seem to be dark at the time of this writing.  The Angel Capital Association and Small Business Investor Alliance are active with venture investors.  The National Business Incubation Association tracks the enabling ecosystem for entrepreneurs.  If I were a startup, I would inquire with those types of organizations to see if the VC/PE/angel investor promising to commit to me has a verifiable reputation.

Local chambers of commerce can be a source of background info on prominent venture investors if they're in traditional hotbeds of startup activity.  Read that as Silicon Valley, Silicon Alley, Boston/Cambridge, and North Carolina's Research Triangle.  Startups in other parts of the country used to have to wing it the old fashioned way by asking around local merchant groups about their prospective investor's reputation.  That is about to change in a big way.

The crowdfunding revolution will be a blessing and a curse for both investors and entrepreneurs.  Startups will face more reporting requirements but a cottage industry of advisers will spring up to help them.  Crowdfunding portals must verify the status of their accredited investors before they can commit money, so a portal's validation is a clear indicator to a startup that a prominent investor has some bona fides.  The non-accredited investors are a different story, so startups must accept the risk that those folks are just like their mom and dad putting in a few hundred bucks for gas money.  This revolution will not be televised - it will be webcast, with embedded data.

BTW, you won't find Alfidi Capital listed in any of those national VC/PE organizations at the present time.  I am what I say I am:  a non-accredited investor with lots of Web opinions.  I'm on several crowdfunding portals as a spectator rather than an investor, and whatever I do on those portals will be in accord with what the SEC allows someone of my status to do.  If my cash and sweat equity investments in a handful of startups pay off, my status will change overnight and I'll be driving a Ferrari to meet VCs instead of my old Ford Mustang.  Right now I use crowdfunding portals to educate myself on startups in my favorite sectors and watch angel groups I've never seen before.  They all have to disclose their status and I get to see some of their potential deal flow.  That's my asymmetric remedy.

Later Exits for Earlier Startup Investors

One truism in startup funding is that venture capitalists want to see a clean cap table before making a big investment.  Some VCs don't like an excess of FFF investors - friends, family, and fools - who may pester the big-shot VCs and their hand-picked board members with juvenile questions.  VCs sometimes ask founders to buy out their amateur partners so the cap table isn't so crowded.  The "how" of this buyout is open for debate.  I don't know if VCs expect the founders to commit whatever limited personal liquidity they have to a limited buyout, or if the VCs will allocate part of their own funding commitment for the FFF buyout.

I think VCs' cap table expectations are going to be increasingly frustrated as crowdfunding reaches its full potential.  Crowdfunded companies are eventually going to raise a lot of early stage money from plenty of people.  The FFF pool will grow exponentially and a lot of them won't be willing to sell until the startup reaches a mature exit.  Crowdfunding portals that operate secondary markets will see more early trading of these limited stakes and VCs will have to get used to using the price action as a factor in their valuations.

The good news for startups is that crowdfunding will keep many of them alive longer and help more of them reach success earlier.  The bad news for VCs is that they will have no choice but to tolerate more of those unwashed FFFs until the exit event.  Founders whose business plans anticipate raising significant VC money in later stages will have to think seriously about implementing shareholder buyback agreements and other founders' agreements early in their company's life.  VCs' attitudes toward some amateur investors didn't develop overnight and won't disappear until crowdfunding demonstrates its power to launch successful startups.

Report from Brown University's West Coast Accelerator 2013

I attended a terrific entrepreneurial event today down in Silicon Valley at the invitation of my entrepreneurial colleague Jonathan Speed.  He's the driving force behind the West Coast Accelerator of Brown University's Entreprenuership Program.  Brown University students get expert mentoring from technology executives and pitch their business plans to a panel of VCs.  The presenting teams deserve mentions here.

Consignd applies social media endorsements to e-commerce in consignment goods.  Boutique product designers have a difficult time with branding and distribution in e-commerce.  Consignd enables consolidated blogger endorsements of products offered for retail purchase.  I can see how this would appeal to people who buy stuff after following power users of Pinterest and other social media sites.  Popular bloggers could also use it to monetize their social media feeds by making product endorsements.  

Durgood is an online product recommendation site for buyers of durable goods.  Existing product review sites don't fully address non-obvious nuances like a home space's size constraints.  If you've ever bought a refrigerator or microwave without first measuring your kitchen door's swing radius, you'll understand how easily you can make a poorly sized purchase with many product reviews online.  Durgood users are presented with qualifying questions on their budget size, lifestyle, and home space to present them with workable product selections.  

Elevate is an umbrella brand for athletic apparel and equipment serving disabled athletes.  The current market for disabled athletes is fragmented with no clear pipeline for innovative products.  Elevate intends to license limited-run specialty equipment and donate a portion of its profit to disability awareness projects.  I noticed that this startup has a page on Start Garden, a funding project that selects portfolio candidates through crowdsourcing.  That's a unique twist on crowdfunding, and financier Rick DeVos is willing to see his VC fund's capital allocation decisions made by the public.  

Exersaur is designing an interactive watch that encourages children to exercise through social gaming.  I couldn't find a corporate website for Exersaur, but they do have a page at Brown's SII Hub.  The point of connecting the watch's animated character to an online community is to motivate children to track their fitness goals.  I've heard a lot about gamification at plenty of Silicon Valley technology conventions.  Pretty soon you'll be seeing game-like competitive metrics in your corporate performance evaluations, so getting your kids started early might help them win the corporate rat race as adults.

gSuccess is a mobile app developer for the standardized collegiate entrance exam market in China.  I couldn't find their official website, but descriptions of their concept are available at the MIT $100K Competition and the Dell Social Innovation Challenge.  Their concept is to incorporate study materials into apps that provide customized performance feedback and tips for improving test scores.  I'm curious about the price points of typical Chinese middle class mobile app users, and whether their rising per capita incomes will get them as addicted to downloads as Americans.  

LoveGov is a non-partisan political information platform that matches voters to causes they can support.  User-generated data from political preference questions and demographics will create a community of interest to political campaigns and public causes.  I think a whole host of user-driven sites with a narrow focus will spring up as Facebook exercises more control over the broad range of content now posted there by users.  Flagging controversial Facebook wall posts will eventually drive those users to niche services that welcome their preferences.

The folks running this incubation program are doing everything right.  The best practices of many leading academic incubators include matching business students with university scientists who want to commercialize technology developed locally.  I think university-run incubation programs can really benefit from connecting entrepreneurs with technologists at government labs.  I'm specifically thinking of DOE Innovation Hubs and wondering whether their scientists are in contact with sharp business students.  The Livermore lab community has been a prominent participant in a public-private partnership that commercializes energy technologies.  If I were a student today, I'd check out Technology Ventures Corporation for the latest government research that deserves to be made into a viable business.

Well done, Brown students.  Your concepts reminded me of a business plan competition I participated in as a senior at Notre Dame in 1995.  My idea for copyright protection marks in digitized intellectual property briefed well but didn't win the top prize because I didn't have the coding experience to make it viable.  I had a virus-based idea that would have been too much trouble to execute in the portable media market.  Leading book publishers and movie studios were just about to beat me to the punch anyway with their own watermarks, so I wouldn't have had a chance to license it out even if I had made a finished product.  Every viable business idea has a correct time to launch.

Full disclosure:  I have no financial positions in any of the startups mentioned, nor was I remunerated in any way for this article.  

First Ever San Francisco Veteran's Hackathon

The local tech community held a milestone event today.  TechCentralSF and Craig Newmark invited local military veterans to take part in the first ever San Francisco Startup Veteran's Weekend / Hackathon.  It's telling that TechCentralSF had to specify that this was intended for military veterans, because professional techies and entrepreneurs often refer to themselves as "startup veterans" with no reference to the original meaning of "veteran."

I absolutely had to take part in this event.  I even pitched an idea on the first day but I couldn't convince a critical mass of programmers to get excited about coding it.  I'm going to keep it close to the vest until I've refined it some more.  I did spend some time talking to other teams about their ideas.  The one team I really liked was launching The Peace Academy.  Their concept is to run an art auction both physically and online but enable it with a quantum tunneling processor that directly channels human consciousness.  This concept is pretty far out and it will take a while for most people to catch on.  Stay tuned for more details as I get a better understanding of how they plan to execute.

These kinds of events should be a regular part of the local tech scene.  Separating military veterans have plenty of skill but little opportunity to use it because of a wide gulf between the veterans community and the business community.  Veterans are easily trainable and work long hours with little regard for personal reward.  Those traits make them ideal employees for tech startups.  Word of veterans' abilities will soon spread with a few more hackathons.

I was slightly disappointed that Hermione Way did not appear as scheduled.  She is a babe and you can see for yourself by searching for her online.  I was hoping she would appear garbed in her famous microphone outfit (you'll see what I mean) but it was not meant to be.  Maybe she'll show up at the next veteran's hackathon.  That's reason enough for me to return.  

Impressions From VEDC Access To Capital Business Expo In SF

I can't resist free conferences on financial topics.  I saw an ad for the third annual Where's The Money? Access to Capital Business Expo in one of San Francisco's weekly magazines.  I signed up for a free pass out of curiosity, wondering what the Valley Economic Development Center from SoCal was doing holding an event so far up north on Nov. 19, 2011.  Don't they have enough SBA lenders in SoCal?  It was worth attending for the free lunch (thanks Chase Bank for sponsoring) and yours truly even learned a couple of new things. 

The winner for me was the panel discussion on "Sources of Unconventional Financing."  The stars of the show were Greg Salomon of Capital Partners, Dave Kocharhook from Riviera Finance, and Alan Tratner of Green2Gold and the California Coast Venture Forum.  Thanks to moderation from Antonio Pizano of Pacoima Development FCU, Dave and Greg were able to explain the nuances of asset-based finance (primarily factoring accounts receivable and merchant cash advances) and vendor finance (primarily purchase order financing).  Fully utilizing asset-based finance is a must for businesses moving physical goods.  Entrepreneurs need to check out ABF Journal for tips.  Retailers need to know that factoring breaks down into recourse and non-recourse factoring, where recourse factoring leaves the company liable for unpaid receivables.  I'm not a retailer, so I enjoyed hearing for the first time that a factoring transaction is priced according to sales volume, average invoice size, payment timing, and other elements. 

Alan wowed the crowd with awesome tips, as follows . . .
   - Forming a C-corp structure provides flexibility when you need to grant sweat equity to minority investors or get funding from VCs or angels.  VCs don't like to invest in LLCs or partnerships. 
   - The financial food chain for entrepreneurs includes both debt and equity funding.  It runs from the 3Fs (friends, family, fools) through crowd funding, VC/angel backing, and even licensing and co-ventures.  I had always considered licensing to be a form of revenue for a mature product rather than a financing option for something unproven, but some startups can apparently make a go of things by inventing stuff just to license out production.
   - The success rate for businesses that spring from a formal business incubator is 90%.  That got my attention.  You can find an incubator focused on your business's sector at the National Business Incubation Association. 
   - Doing a patent search before you file for a patent of your own will help determine whether you'll end up reinventing the wheel.

I did hear one other comment during the panel discussion that I had never heard before.  Alan said a business's brand identity counts as intellectual property.  This is a twist on the old definition of a brand as an intangible asset.  Apparently academic thinking on the subject of brand identity and ways to protect it has matured since I got my MBA nine years ago.  Copyrights, trademarks, and service marks can now constitute a brand portfolio.  How about that. 

I needed to talk to a few of the banks who staffed expo booths here because I'm wargaming whether I'll need a small loan to fund a business project I have in mind.  Please note that this project is super top secret and I will reveal it when the time is right.  Let's just say it's a practical application of the resilient community paradigm.  Anyway, Wells Fargo and TMC Financing were particularly informative.  Wells Fargo offers cash-secured commercial and consumer loans that are useful for equipment purchases, and TMC Financing offers SBA 504 loans for purchasing real estate.  I asked specifically if the SBA 504's requirement that a business facility be 51% occupied referred to the human proprietor's physical presence or merely the presence of continual business activity.  It appears that mere activity is sufficient; if correct, that will be key to execution of the 24/7 presence my remotely-monitored project will involve.  Hey reader, please don't take this as legal advice.  Check with your own banker and lawyer when you start investigating loan terms and requirements. 

I mentioned the free lunch already, but I will state for the record that the Hyatt Regency San Francisco prepares a decent chicken with risotto.  I went nuts for the cheese biscuits and I would have scored a second apple tart if some latecomer hadn't sat down at the last minute.  The keynote speaker, Dane Boryta of Bottle Cap restaurant, implored us to respect the cooking by cleaning our plates.  Entrepreneurs know good stuff when they see it.  VEDC needs to invite me to be a panelist next time so I can score some more free food. 

Nota bene:  None of the companies or institutions mentioned have given me any compensation or consideration for this blog post.  My recollection of this conference is provided as a public service. 

CVAC Systems: A Disruptive Health Care Technology

I'm always on the lookout for the next big thing, but the trouble with the San Francisco Bay Area is that everybody and his brother claims they can deliver it once you hand them a few million in startup cash. Startup investing is not for the faint of heart and requires thorough due diligence. I have only invested in one startup to date, but I believe I picked a huge winner.

In late 2006 I came across a remarkable startup: CVAC Systems of Temecula, California. The CVAC (pronounced "SEE-vack") acronym stands for Cyclic Variations in Altitude Conditioning. They have engineered a one-person pressure chamber that simulates a high-altitude physical training environment by exerting multiple pressure and temperature changes on the human body. The basic effect is to stimulate the body's production of red blood cells, producing the benefits of high-altitude physical training.

The basic description of this technology's potential effects piqued my curiosity, so I actually drove down to Temecula from SF in October 2006 to check it out for myself. CVAC's inventor, Carl Linton, put me through a 20-minute session in a prototype CVAC pod. Folks, all I can say is that after 20 minutes in that pod I felt like I could have run for ten miles.

I like several things about this company. The CVAC technology's potential applications in enhancing physical fitness and treating metabolic disorders (pending scientific confirmation) offers the possibility of multiple revenue sources once the devices are placed in rehab centers, clinics, fitness clubs, and anywhere else customers can access it.

The company recently released the results of a study by researchers at Stanford University that indicates the potential use of CVAC as a diabetes treatment. This ought to be jaw-dropping, given the size of the diabetes-afflicted population in the U.S.

I put some of my own money into this company in February 2007 because I was convinced that this company's technology will be as disruptive to the health care industry as the Palm Pilot (PALM) was to mobile communication devices. I have complete confidence in the ability of CEO Allen Ruszkowski and his team's entrepreneurial vigor.

In a side note, Johnson & Johnson's (JNJ) latest quarterly earnings held up very well. Why mention this here? Medical device companies are considered defensive plays in recessions, so device makers may perform well even if the U.S. economy continues to stall in the near future. This is a potential feather in CVAC's cap if they go IPO between now and 2011 or so, because reliable share price performance from comparable peers in their sector will make it easier to price their own shares.

I remain convinced that CVAC is a winner. If anybody else can show me a startup with similar potential for multiple revenue streams and monopolistic pricing power, I'm all ears.

Nota bene: Anthony J. Alfidi holds a small private stake in CVAC Systems Inc. This company is privately held and represents a high-risk opportunity typically limited to institutional investors and accredited investors as defined by the SEC.