Angel Investment Journal - Angel Investing and Entrepreneur Blog

Paul Graham has a great piece called The Hacker’s Guide to Investors. He makes a lot of great points, but a very interesting point is this:

“A high valuation can be a bad thing. If you take funding at a premoney valuation of $10 million, you won’t be selling the company for 20. You’ll have to sell for over 50 for the VCs to get even a 5x return, which is low to them. More likely they’ll want you to hold out for 100. But needing to get a high price decreases the chance of getting bought at all; many companies can buy you for $10 million, but only a handful for 100. And since a startup is like a pass/fail course for the founders, what you want to optimize is your chance of a good outcome, not the percentage of the company you keep.“

In addition, a valuation that may be too high may make it difficult if you need additional funding. Mainly because the initial investors want to see that their investment has increased, so they will expect the next round to be higher. However, if you increase the valuation too much, it makes the investment less attractive to the potential investors in the next round.

Congress is discussing passing legislation that would give tax breaks for angel investments. Tax breaks are given to corporations for a variety of things and they get tax breaks for moving (or keeping) a factory in a certain city, state or even the country. But how much does keeping factory jobs in the US actually help the economy? Companies that are pursuing new ideas and innovation are things that have grown this country (and others) and encouraging that type of activity is a fantastic way to continue economic development.

Seth talks about how finding your niche is much better than attacking an entire market.

Related to this, a lot of entrepreneurs try to present to investors and say “We only need 1% of the market”. Guy says this is pretty ridiculous. First, why would anyone want to get a 1% market share? Second, how do you know 1% will be the magic number? How do you know it won’t be .1% or 5%? Entrepreneurs should do a bottom’s up forecast. Define the niche in the market you are going to target and make a forecast based upon this. Don’t say you need to capture 1% of the worldwide hat industry. Instead, say you want to capture 20% of the Church Hat market (that was a quick plug for Evetta).

Side note, isn’t it cool to be known just by your first name (like Seth and Guy).

Entrepreneurs looking to get funding for their start-up company often value their company much differently than investors. Entrepreneurs use the concept for the business (the product or service) as the driving factor behind the valuation they seek and feel they deserve. In fact, they usually think the idea is so brilliant, that they attempt to keep it top-secret and prefer not to disclose many ideas. They even like to require that investors sign an NDA (see my previous post related to investors and NDA’s).

Unlike Entrepreneurs, investors tend to place much more value on the management team. Bill Payne’s book, The Definitive Guide to Raising Money from Angels, shows the general breakdown for what he considers when valuing a start-up:

Management Team - 30%
Size of Opportunity - 25%
Product or Service - 10%
Sales Channel - 10%
Stage of Business - 10%
Other Factors - 15%

Even though this breakdown makes the percent of the valuation attributed to the product or service appear to be very minimal (10%), Bill mentions that there are other factors that are directly attributed to the product or service, such as size of the opportunity. But it is obvious that the management team of the start-up is very important. Some of the most successful companies are not a result of the initial product idea. For example, you probably know that Flickr started as an online multiplayer game. The team behind the company adapted and made it into something huge.
So just because a company has a brilliant idea or a fantastic technology, it does not support a huge valuation.

By the way, if you have not checked out Bill’s book, I would highly recommend investing the money to purchase it.

A team that is attempting to compete for the Lunar Lander X-Prize is trying to raise money by auctioning a piece of the action. The auction on eBay says that you can bid on the chance to not only sponsor the lander which they build, but you get to keep one of two crafts which will be used in the contest. In addition, you get 50% of the prize money, meaning you could win up to $675k. Via Engadget.

This is a creative and potentially successful way to help raise money for their venture. Not only does it help raise funds, but the method of raising the money can generate great publicity.

Business 2.0 has a brief write-up about how some VC firms are doing seed stage funding and, in turn, investing smaller amounts of money compared to their usual investments of millions of dollars.

The article is not entirely accurate in that many VC firms do early stage investments. It is correct in that they generally stay away from the seed stage since so little money is required. According to the VC’s, it is not usually worth their time to invest in companies that are not looking to raise at least a million dollars or more (and most like to stay above the $3 million range). They have so much money to invest, it is not worth the time to do due diligence and the other work required to make an investment or else thye would never be able to invest their entire portfolio.

The article mentions how Y Incubator is investing amounts of $15,000-$20,000 and is focused on software companies. In exchange, they expect anywhere from 2-6% of your company, so don’t expect to get funding from them if you value your company at a million or more. Thsi is true seed stage funding.

First Round Capital is also mentioned even though they are not focused exclusively on seed stage investments. They invest in all types of early-stage funding and are interested in investing $100,000 and more.

Finally, Charles River Ventures is mentioned since they provide companies with a debt option, meaning the company does not give up equity. They offer a loan between $100,000 and $500,000. For this, the debt will be converted into equity at the first round of funding. But the equity options means you do not need to negotiate valuation at this point. This is a fairly interesting strategy since a lot of VC’s have to compete to get in on the first round of some very promising companies. Michael Arrington talked about Charles River Ventures back in November and expanded on what they do. He explains that the debt is converted into equity at a discount to what the first round of investors are paying.