5 ms·

I really really dislike when VCs make a pro-investor claim and try to hide it in founder-friendly terms. Priced rounds are great for VCs because they remove al

by pbiggar 10y ago

I really really dislike when VCs make a pro-investor claim and try to hide it in founder-friendly terms. Priced rounds are great for VCs because they remove all their risk. But they don't remove any founder risk. Do a down-round after a priced round and you'll wish you were just taking more dilution from a SAFE. > "1. They defer the issue of dilution until a later date". When the company is doing well, notes allow founders get less dilution, sometimes way less. This is great for founders, and is just about the only time in the whole startup thing where things go better than expected for founders. If the company is doing badly, I'll take a lower conversion rate over having to raise a down-round any day. > "2. They obfuscate the amount of dilution the founder(s) is taking. I think many investors actually like this" He sets up a moral imperative: you're an irresponsible founder if you don't know what dilution you're taking. But I know what dilution I'm taking: it's X _or less_!! (Again, in a down-round I'm fucked either way, so the downside of notes doesn't matter) > "3. I cannot tell you how many angry pissed off angel investors [..] they own a LOT less than they thought they did." And here we get to the crux of the issue, investors own less. If investors own less, who owns more? Founders do. > "4. Most importantly, we cannot and should not continue to allow founders to issue notes to investors and not understand how much dilution they are taking on each time they do it. This is WRONG." "Silly inexperienced founders accidentally give investors a bad deal. This is morally WRONG". Needless to say, I'm unsympathetic to this view. Look I understand why VCs don't like notes. But to pretend that this is a founder-friendly thing is beyond irritating (note: he's far from the only VC to do this!). And this is one of the reasons I trust YC far more than any other investors - they're in it to help people make startups and they argue for founder-friendly terms. (PS there is a real issue in that inexperienced founders might raise too much thinking its free money, and then they get a lower cap than expected. But my only bad experience with raising with notes is that VCs treat it as a lower implied valuation when raising the next round.)

platosrepublic 10y ago
Exactly. Pissing off an angel investor because some equity goes to the founder instead of the angel is bad for a VC, because that VC needs that angel to help funnel them deals in the future. But it's good for the founder, because the founder keeps more equity. This is a very disingenuous argument by Fred Wilson, which is a shame because his analysis is usually so intelligent. But when it comes to convincing founders to give VCs more equity, he's driven by his own incentives just like any VC.
sandGorgon 10y ago
Also the biggest issue - it defers the question of valuation. That is a huge thing in pre-product/pre-traction stages when valuation is what you believe in. 99% of first time entrepreneurs have a simple question - "how do you value an idea, an early stage startup": It completely eliminates this question.
- graycat 10y ago
  There should be better ways to know how to "value an idea.". I believe that there are better ways, that the VC-startup world does poorly there with biggie costs on the both sides of the table, that there are some good examples of the ways, and that, really, we are awash in both how to do this and examples. First, we start with evaluating ideas. Gee, guys, the research community does that many times daily. A researcher who pursues dumb ideas in a few years is known as a poor researcher. So, good researchers know how to evaluate ideas. The researcher's superiors, the proposal reviewers, and the funding agencies also all know how to evaluate ideas and where here the ideas are just research directions with the ideas not really formed yet. Moreover, for publication in peer reviewed journals of original research, the standard criteria for evaluating the ideas in a paper are "new, correct, and significant", and these criteria get applied with good accuracy. Moreover, for a Ph.D., one way to evaluate the work is "an original contribution to knowledge worth of publication." And, before a Ph.D. student starts their research, they and usually also their faculty advisers have to evaluate the research direction, even before a solid idea. The US NSF, NIH, DARPA, ONR, etc. are also quite good at evaluating research directions well before a finished idea. Of course we can evaluate ideas, especially ideas already polished and ready for publication and also finished, polished ideas already implemented in solid, running code. Then, sure, that evaluation does not necessarily lead to business success, that is, traction, revenue, earnings, money in the bank, an a good ROI and exit for investors. Right. But, wait, there's more! Second, here's a severe way to evaluate such a polished idea ready or nearly so to go for first traction: Or, with the running software, can see that it works. Now the severe question is, "Is that software a must have solution with enough users/customers and revenue per each to make the big bucks or is that software just a nice to have and/or for just a niche?" And we will want to know about barriers to entry, scalability, etc. Doing well on these criteria should be darned good signs. Apparently instead the VC community wants to judge based almost entirely on traction and rate of growth in traction. Yes, that's hard headed; it's also dumb headed, ignoring important information. Some businesses do quite well with new ideas: Xerox did well with the research direction of electro-static photocopying -- from just the research direction through creating a major company. At each smaller step in line width, Intel does well. Who would have believed 1 billion transistors on a postage stamp with line width 14 nm? The pharmaceutical companies that do original research make their money on picking good research directions and then doing good research. And may I have the envelope, please [drum roll]! The all-time, unchallenged, unique world-class, grand champion of going from mere research directions to world changing results is the US DoD. Second and third places are occupied by the NSF and NIH. Intel, some of the pharmaceutical companies, and more are also on the award stage. VCs need to start learning up from those examples. The VC approach would have been, "You build and test the first one, and we will chip in for the gasoline for the Enola Gay." Instead, IIRC from books of Richard Rhodes, the Manhattan Project cost ballpark $3 billion in 1940's dollars. Okay, big, expensive waste just from war time, right? Maybe not: Let's divide $3 billion by one million -- right, even without a super-computer, that's $1000. And the relevance? The estimates were that a US invasion of the home islands of Japan would cost the US 1 million casualties. Given the experience at Okinawa, Iwo Jima, etc., the 1 million was believable. So, the Manhattan Project saved expected 1 million casualties at, right, from the arithmetic, $3000 per casualty. Grand bargain just from the money alone! If your father, son, brother, uncle, etc. were one of those casualties, then you would have regarded the $3000 as a grand bargain. And the Manhattan project spent money like it was worthless -- cost no object or concern. Good ideas are like that.
hkmurakami 10y ago
>> "3. I cannot tell you how many angry pissed off angel investors [..] they own a LOT less than they thought they did." >And here we get to the crux of the issue, investors own less. If investors own less, who owns more? Founders do. I think in this case there are just "more investors than the earlier investors expected to exist". In any case, if there's a subsequent convertible round after the round you were in, of course there will be more dilution for the angel! And honestly if the subsequent noted were raised at higher caps comparable priced rounds, then the dilution to the earlier angels should be less anyways. This just sounds like optimistic angels not understanding the equations they are a part of. Frankly said angry Angel should recognize that any subsequent round dilutes them and the founders in similar fashion, and any instrument that is "founder friendly" is existing investor friendly as well by definition.
- pbiggar 10y ago
  > This just sounds like optimistic angels not understanding the equations they are a part of. I agree. I edited out of my rant the fact that investors are supposed to be sophisticated. Everyone knows what they're getting into here. Angels are typically way more sophisticated than startups (if you've done 1 deal that's usually 1 deal more than a founder has). If you can't do the math on this you shouldn't be investing in startups.
fredwilson 10y ago
I wrote this from the heart. You can ascribe whatever agenda you want to believe. But I wrote this for founders and it is based on thirty plus years of working with founders. I don't want to see them get screwed and notes screw them over a lot
- throwaway23422 10y ago
  Could you poke holes in his/her arguments? Or perhaps cite examples? The counterpoints seem convincing but, hey, I might be totally missing something. For context, I'm a long-time fan of your writings and REALLY appreciate how much you've given to the community (with the only VC blog worth reading IMO). Just want to fully understand the issue at hand here.
- pbiggar 10y ago
  Thanks for saying that! I don't have any agenda or ascribe any to you. All I think is that to the untrained eye, this post comes across as founder-unfriendly.
- brudgers 10y ago
  I believe that. Yet, I think founders getting screwed over is largely orthogonal to the type of instrument used to fund companies in the early round. The scruples and sophistication of the parties involved play will tend to play a bigger role. Among the asserted merits of SAFE's when the came into the YC ecosystem was that it removed some of the distraction that trying not to get screwed over created for founders at 'demo day' or earlier stage companies. At the time, an investor's willingness to use a SAFE might have had an inverse correlation to their willingness to take undue advantage of unsophisticated founders.
- deleted 10y ago
  [deleted]
svskeptic 10y ago
The VCs keep pushing the 'stage ask' further upstream every year. So, what used to be considered good for A round traction/revenue/MAU is now considered Seed and so on up. They'll only want to invest when 'I know this is the winner in this category', but I'll call it Series A and Series A has always been done at valuation $x. FU! You won't fund a deal till it's profitable and all the risk is taken off. But, I need to get money from somewhere! So, I'll get it from small angels and individuals. And since I have to collect it 25-50K at a time, I can't do a priced round. You set this board up, now don't complain that you have to deal with the mess. [Edit] And if you'll only be dealing with a startup once it has gotten some level of success, you have no option but to deal with the mess, if you want the deal.

by pbiggar 10y ago

platosrepublic 10y ago

Exactly. Pissing off an angel investor because some equity goes to the founder instead of the angel is bad for a VC, because that VC needs that angel to help funnel them deals in the future. But it's good for the founder, because the founder keeps more equity. This is a very disingenuous argument by Fred Wilson, which is a shame because his analysis is usually so intelligent. But when it comes to convincing founders to give VCs more equity, he's driven by his own incentives just like any VC.

sandGorgon 10y ago

Also the biggest issue - it defers the question of valuation. That is a huge thing in pre-product/pre-traction stages when valuation is what you believe in. 99% of first time entrepreneurs have a simple question - "how do you value an idea, an early stage startup": It completely eliminates this question.

graycat 10y ago
There should be better ways to know how to "value an idea.". I believe that there are better ways, that the VC-startup world does poorly there with biggie costs on the both sides of the table, that there are some good examples of the ways, and that, really, we are awash in both how to do this and examples. First, we start with evaluating ideas. Gee, guys, the research community does that many times daily. A researcher who pursues dumb ideas in a few years is known as a poor researcher. So, good researchers know how to evaluate ideas. The researcher's superiors, the proposal reviewers, and the funding agencies also all know how to evaluate ideas and where here the ideas are just research directions with the ideas not really formed yet. Moreover, for publication in peer reviewed journals of original research, the standard criteria for evaluating the ideas in a paper are "new, correct, and significant", and these criteria get applied with good accuracy. Moreover, for a Ph.D., one way to evaluate the work is "an original contribution to knowledge worth of publication." And, before a Ph.D. student starts their research, they and usually also their faculty advisers have to evaluate the research direction, even before a solid idea. The US NSF, NIH, DARPA, ONR, etc. are also quite good at evaluating research directions well before a finished idea. Of course we can evaluate ideas, especially ideas already polished and ready for publication and also finished, polished ideas already implemented in solid, running code. Then, sure, that evaluation does not necessarily lead to business success, that is, traction, revenue, earnings, money in the bank, an a good ROI and exit for investors. Right. But, wait, there's more! Second, here's a severe way to evaluate such a polished idea ready or nearly so to go for first traction: Or, with the running software, can see that it works. Now the severe question is, "Is that software a must have solution with enough users/customers and revenue per each to make the big bucks or is that software just a nice to have and/or for just a niche?" And we will want to know about barriers to entry, scalability, etc. Doing well on these criteria should be darned good signs. Apparently instead the VC community wants to judge based almost entirely on traction and rate of growth in traction. Yes, that's hard headed; it's also dumb headed, ignoring important information. Some businesses do quite well with new ideas: Xerox did well with the research direction of electro-static photocopying -- from just the research direction through creating a major company. At each smaller step in line width, Intel does well. Who would have believed 1 billion transistors on a postage stamp with line width 14 nm? The pharmaceutical companies that do original research make their money on picking good research directions and then doing good research. And may I have the envelope, please [drum roll]! The all-time, unchallenged, unique world-class, grand champion of going from mere research directions to world changing results is the US DoD. Second and third places are occupied by the NSF and NIH. Intel, some of the pharmaceutical companies, and more are also on the award stage. VCs need to start learning up from those examples. The VC approach would have been, "You build and test the first one, and we will chip in for the gasoline for the Enola Gay." Instead, IIRC from books of Richard Rhodes, the Manhattan Project cost ballpark $3 billion in 1940's dollars. Okay, big, expensive waste just from war time, right? Maybe not: Let's divide $3 billion by one million -- right, even without a super-computer, that's $1000. And the relevance? The estimates were that a US invasion of the home islands of Japan would cost the US 1 million casualties. Given the experience at Okinawa, Iwo Jima, etc., the 1 million was believable. So, the Manhattan Project saved expected 1 million casualties at, right, from the arithmetic, $3000 per casualty. Grand bargain just from the money alone! If your father, son, brother, uncle, etc. were one of those casualties, then you would have regarded the $3000 as a grand bargain. And the Manhattan project spent money like it was worthless -- cost no object or concern. Good ideas are like that.

hkmurakami 10y ago

>> "3. I cannot tell you how many angry pissed off angel investors [..] they own a LOT less than they thought they did." >And here we get to the crux of the issue, investors own less. If investors own less, who owns more? Founders do. I think in this case there are just "more investors than the earlier investors expected to exist". In any case, if there's a subsequent convertible round after the round you were in, of course there will be more dilution for the angel! And honestly if the subsequent noted were raised at higher caps comparable priced rounds, then the dilution to the earlier angels should be less anyways. This just sounds like optimistic angels not understanding the equations they are a part of. Frankly said angry Angel should recognize that any subsequent round dilutes them and the founders in similar fashion, and any instrument that is "founder friendly" is existing investor friendly as well by definition.

pbiggar 10y ago
> This just sounds like optimistic angels not understanding the equations they are a part of. I agree. I edited out of my rant the fact that investors are supposed to be sophisticated. Everyone knows what they're getting into here. Angels are typically way more sophisticated than startups (if you've done 1 deal that's usually 1 deal more than a founder has). If you can't do the math on this you shouldn't be investing in startups.

fredwilson 10y ago

I wrote this from the heart. You can ascribe whatever agenda you want to believe. But I wrote this for founders and it is based on thirty plus years of working with founders. I don't want to see them get screwed and notes screw them over a lot

throwaway23422 10y ago
Could you poke holes in his/her arguments? Or perhaps cite examples? The counterpoints seem convincing but, hey, I might be totally missing something. For context, I'm a long-time fan of your writings and REALLY appreciate how much you've given to the community (with the only VC blog worth reading IMO). Just want to fully understand the issue at hand here.
pbiggar 10y ago
Thanks for saying that! I don't have any agenda or ascribe any to you. All I think is that to the untrained eye, this post comes across as founder-unfriendly.
brudgers 10y ago
I believe that. Yet, I think founders getting screwed over is largely orthogonal to the type of instrument used to fund companies in the early round. The scruples and sophistication of the parties involved play will tend to play a bigger role. Among the asserted merits of SAFE's when the came into the YC ecosystem was that it removed some of the distraction that trying not to get screwed over created for founders at 'demo day' or earlier stage companies. At the time, an investor's willingness to use a SAFE might have had an inverse correlation to their willingness to take undue advantage of unsophisticated founders.
deleted 10y ago
[deleted]

svskeptic 10y ago

The VCs keep pushing the 'stage ask' further upstream every year. So, what used to be considered good for A round traction/revenue/MAU is now considered Seed and so on up. They'll only want to invest when 'I know this is the winner in this category', but I'll call it Series A and Series A has always been done at valuation $x. FU! You won't fund a deal till it's profitable and all the risk is taken off. But, I need to get money from somewhere! So, I'll get it from small angels and individuals. And since I have to collect it 25-50K at a time, I can't do a priced round. You set this board up, now don't complain that you have to deal with the mess. [Edit] And if you'll only be dealing with a startup once it has gotten some level of success, you have no option but to deal with the mess, if you want the deal.