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Hi, I’m Brad Feld, a managing director at the Foundry Group who lives in Boulder, Colorado. I invest in software and Internet companies around the US, run marathons and read a lot.

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You Don’t Mean Average, You Mean Median

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Every quarter, without fail, a bunch of articles appear talking about the venture capital industries investment pace as a result of the PWC MoneyTree report.  I used to get calls from all of the Denver / Boulder area reporters about my thoughts on these – that eventually stopped when I started responding “who gives a fuck?”

A few days ago I got a note from Steve Murchie about his new blog titled Angels and Pinheads.  I’m glad Steve is blogging about this as he’s got plenty of experience and thoughts around the dynamics of angel investors – some that I agree with and some that I don’t.  Regardless, my view is that there more there is out there, the better, as long as people engage in the conversation.

In his post Mind the Gap he made an assertion that “the VC industry has effectively stopped investing in seed stage ($500K and less) and startup-stage ($2M and less) opportunities.”  As a VC who makes lots of investments between $250k and $2M, and who has plenty of good friends who happen to be VCs that also make investments in this range (such as Union Square Ventures, First Round Capital, True Ventures, SoftTech VC, FB Founders, Alsop Louis, O’Reilly Alpha Tech, and Highway 12), I thought Steve’s assertion was wrong and I told him so in the comments.  He countered with the PWC Moneytree data on Q3 VC investments.

Stage Total $M % of Total # Deals Avg / Deal $M
Later Stage 1611 33.49 168 9.6
Expansion 1610 33.48 185 8.7
Early Stage 1081 22.49 198 5.5
Startup/Seed 507 10.54 86 5.9

Steve’s response to the Startup/Seed “Average Deal Size” was “WTF??!”  While that is the correct reaction, his conclusion (that VCs aren’t investing between $250k and $2M) is incorrect for two simple reasons: (1) the data is the PWC MoneyTree Report is incorrect and incomplete and (2) the interesting number to look at, assuming the data is correct, is the Median, not the Average.  If you wonder why, Wikipedia’s explanation is pretty good: “The median can be used as a measure of location when a distribution is skewed, when end values are not known, or when one requires reduced importance to be attached to outliers, e.g. because they may be measurement errors.”

Let’s look at the underlying data in Silicon Valley (that results in the above table) to understand this better.  Going to the PWC Moneytree Startup/Seed investments in Silicon Valley for Q309, you get the following:

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The first six “startup/seed” investments each raised $10M or more.  Now, I’ll accept that these might be classified as “startup rounds” (e.g. the first round of investment) but no rational person would categories these as seed investments.  But, for purposes of this example, let’s keep them in the mix.  The average is $6.4M and the median is $5.0M.  Now, let’s toss out only the ones $10M or great since these clearly aren’t “seed” investments.  Our average is now $3.4M and the median is now $2.0M.

I’m still feeling generous (e.g. I’ll waive reason #1 – that the data is incorrect / incomplete – for the time being).  Let’s look at the PWC Moneytree Startup/Seed investments in New England  for Q309.

image

The average is $8.4M and the median is $5M.  Now, toss out everything above $10M.  The average is now $3.9M and the median is $4M.

But it gets better.  Let’s take all of the PCW Moneytree Startup/Seed Investments in the US for Q309.  There are 86 of them and as we know from the first table the average is $5.9M.  But the median is $4M.  Now, toss out the ones above $10M.  The average is now $4M and the median is now $3M.  This exercise – again – assuming the data is correct – shows the difference between average and median, as well as how much the numbers are skewed upward by “startup/seed” investments $10m or more.

I’m not going to try very hard to show that that the data is incorrect, but I’ll give you two examples.  The first is FourSquare, a well known seed investment led by Union Square Ventures and O’Reilly AlphaTech.  It was a $1.35M financing, has three employees, and occurred in 9/09.  This is about as close to the definition of a seed investment as you can get.  Yet, PWC Classifies it as Early Stage (plus they got the investment amount wrong as they list it as $1.15M.)  For reference, Dow Jones VentureSource classifies this as a seed investment and gets the amount right.

Let’s do another one.  This time look at what PWC MoneyTree has on First Round Capital

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compared to what Crunchbase has on First Round Capital for Q309.

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The differences that I think are incorrect on PWC’s part are that (1) GumGum is missing, (2) CoTweet is classified as Early Stage instead of Seed, (3) BigDeal is missing, (4) DNAnexus is missing (although it looks like it might have happened in Q2 even though it was widely reported in August), (5) Continuity Engine is classified as Early Stage instead of Seed, (6) ClickEquations is missing, (7) Sofa Labs shows up twice, and (8) Sofa Labs is classified as Early Stage instead of Seed.  Now Crunchbase is missing Project Fair Bid (even though they reported on it) so they aren’t perfect, but at the minimum the misclassification between Seed and Early Stage is dramatic.  Just for grins I looked these up in Dow Jones VentureSource and their data is closer to CrunchBase’s (especially the Round Type), but there are still differences.

Ever since I started investing in 1994 I’ve heard people spouting VC investment statistics to justify different viewpoints.  I’ve always felt this was a “garbage in / garbage out” phenomenon.  While there are some academics that do rigorous work around this (and understand the difference in importance between averages, medians, and er – statistically significant results), they are few and far between.  And – most of the data people actually use and discuss is stuff like the PWC Moneytree Report.

I keep fantasizing that this madness will stop, but I doubt it will.  In the mean time, I think I’ll go for an average run at a median pace.

The Downsides of Large Syndicates

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There were some great comments on my post from Sunday titled Being Syndication AgnosticOne of them was from Kevin Vogelsang – he asked the following question:

What are the downsides to syndicating a round of financing for the entrepreneur/startup (assuming the relationship with all investors is a good fit of course)? By syndicating a deal, the entrepreneur gains access to a larger network. This seems to be a big positive. However, there must be downsides (less attention, more interest groups, etc.) Love to hear more on the topic.

While there are plenty of downsides, I’m going to take on five common ones in this post. 

Too Many VC’s on the Board: Most VC’s want a board seat when they invest in a company. At the early stages this is usually manageable (although not necessarily desirable).  However, once a company has raised several rounds of financing and built increasingly large syndicates, this can quickly get out of control.  The largest board of a VC backed company I’ve ever been on was 11 (8 VCs, CEO, founder, one outside director).  It was a completely ineffective board.  Now, the board size problems can be dealt with by a strong CEO and a strong lead investor who will help the CEO organize the board in a manageable way, but it has to be done proactively.

Too Many People in the Room: This is a corollary to “too many VCs on the board.”  If the VC doesn’t get a board seat, they’ll want an observer seat.  In addition, most later stage VCs or strategic investors want observer seats.  Suddenly even though you’ve managed the size of the board effectively, there are a bunch of people in the room.  I’ve been in board meetings with over 20 people in them (I don’t know the exact max, but I’m going to guess it’s around 25 since eventually you run out of chairs.)  Not surprisingly, these tend to be weak or inefficient board meetings with separate “executive committee meetings” where the real board meeting happens, and then another three hour song and dance for the benefit of the 15 other people.

Both of these are a natural result of most investors in private companies wanting to have a seat at the table.  While a reasonable expectation, it’s important for the CEO and founders to set an appropriate tone and expectations with their investors early on so that there’s actually an effective board, investor, and company dynamic as the syndicate gets large.

Misalignment of Interests: With each round of investment and each new investor comes new expectations.  As the syndicate size grows, the chance of interests between parties getting out of alignment increases.  This is especially true when each round has different dynamics beyond price (such different preference structures, protective provisions, voting thresholds by class of stock, and various participation caps.)  When everything is going well this isn’t an issue, but the minute the business goes sideways (or worse) strange things start to happen.  As the situation degenerate, the knives (or flamethrowers) come out.  I’ve been involved in situations that resulted in the destruction of companies that deserved to live another day because the investors around the table (which included me) couldn’t get their collective shit together.

Decision Vacuum: This is a corollary to “misalignment of interests.”  It’s similar to when I lived in a fraternity at MIT and a dozen of us would stand in the hallway trying to figure out where to go out to eat.  This drill could go on for a while, especially if we had a keg of beer (or, er, something else) nearby.  Eventually someone stepped into the decision vacuum and said “I’m going to Mandarin – come with me if you want” (well – that was what I usually said – others had different choices).  Whenever you’ve got at least four VCs sitting around a table, you run the risk of a decision vacuum forming (queue snarky jokes here).  If you are a CEO of a company and you see a decision vacuum developing, grab a bunch of matter and get in the middle of it.

Lame Duck Syndrome: There has been plenty of personnel changes in the “VC business” in the past five years, including plenty of firms that are winding down, have shrunk in size (and let partners go), and have disbanded.  However, they are still investors in your company and some of them still sit on your board.  In some cases they are just hanging around to “protect their investment” although they have no ability or interest in putting additional capital into your company.  Now – some folks in this position are incredibly helpful, but many don’t do much more than show up.  And – the more of them like this around the table, the less fun it can be.

Now, there are plenty of other downsides as well as plenty of advantages of large syndicates.  If you’ve got additional ideas, or stories to share (especially horrifying ones showing the downside), comment away even if you change the names to protect the not so innocent.

Being Syndication Agnostic

Comments (34)

Bijan Sabet started it with a great post titled We Gotta Do A Deal Together and Fred Wilson followed with an equally great post titled Trading Deals, A Lost Art?  I’m going to try to add to the mix with this post by describing our strategy at Foundry Group around syndication and explain a little of where it came from.  Please read both Bijan’s and Fred’s posts as it’ll provide a lot of context for this one.

At Foundry Group, we describe ourselves as syndication agnostic.  Specifically – we are delighted to work with a syndicate of other investors and we are equally delighted to invest by ourselves.  Another way to say this is that we are indifferent as to whether or not we have co-investors in a company with us at any stage of the investment cycle.  I realize this isn’t the classical definition of agnostic but I think it’s an appropriate use of the adjective form. 

Here’s what this means in practice.   In an early stage investment we decide whether or not we want to invest and then leave it up to the entrepreneurs if they want to add anyone to the syndicate.  If so, and they are someone we like working with or would like to try working with for the first time, we encourage it.  If the entrepreneurs just want to get going with us, that’s fine also.

Now, assume there is no syndicate for the seed or Series A financing (e.g. it’s just us).  Well in advance of when the company needs to raise the next round we’ll decide whether or not we’ll make another investment.  If we are supportive, we are direct with the company, figure out a price we are willing to do it at (we are willing to invest by ourselves at a higher price if we believe the progress of the company merits it), and give the company the choice of having us invest in another round by ourselves or add another investor to the mix.  Again, it’s up to the entrepreneur, but we signal our intent clearly and early, are willing to put a term sheet down, and lead the financing with or without a new investor.

Two things make this strategy work for us.  We only invest in software and Internet companies.  We have a deeply held belief that we can figure out “if things are working” by the time $10m is invested in a company.  As a result, we are willing to invest up to $10m on our own to play out the early to medium stages of a company.  By the $10m point we have to make a theoretically harder decision, although ironically it’s usually a pretty easy one.  The company is either unambiguously on a success path, at which point adding additional investors to the syndicate is easy (since it’s a highly desirable later stage investment) or it’s a tough situation that’s not working out.  Occasionally it’s in the middle (e.g. unclear and ambiguous), but not very often.

Some recent examples help illustrate this:

Next Big Sound: We led the seed round and co-invested with Alsop Louie (Stewart Alsop) and SoftTechVC (Jeff Clavier) – two VCs that we love to work with.  We could have easily invested by ourselves, and Next Big Sound had a long list of VCs that wanted to invest (more than 5, less than 10).  The founders chose the syndicate.

StockTwits: The seed round was led by True Ventures.  We decided proactively that we wanted to invest in StockTwits as part of a new theme we are developing and approached Howard Lindzon (the founder/CEO).  He was in the midst of closing a follow-on with True.  We have enormous respect for True but hadn’t done a direct investment with them (I’ve personally invested in several companies with them) so were extremely interested in doing something together.  They reciprocated and we put together a bigger financing than planned (although still a relatively modest amount as Howard isn’t interested in raising a lot of capital) that allowed everyone to be happy with their stake in the company.

Cloud Engines: Cloud Engines had raised some angel money (from well respected angels) prior to our investment.  We did the first round by ourselves and recently did a second round by ourselves.  We did this quickly because we were thrilled with their progress and this allowed the company to ramp up production to meet demand.  We left the financing open for a strategic co-investor although we are perfectly happy to take the remaining piece for ourselves.

The common two themes from this for us is: (a) we only co-invest with people we like, trust, and respect and that like, trust, and respect us and (b) we view it as our responsibility to make a decision about whether or not we want to invest independent of any other investors (VC or angels) at the table.

For completeness, we love investing with Union Square Ventures (we are co-investors in Zynga) and Spark (we are co-investors in AdMeld) and we hope to make additional investments with both of them in 2010. 

Ultimately the syndicate is the entrepreneurs’ choice.  And our goal is to make the discussion simpler, cleaner, and crisper, so the entrepreneurs aren’t having to guess, or jump through bizarre hoops, or play a difficult VC-centric game as they finance their company.

Maniacal Crazy People

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Three of my VC friends (Santo Politi, Mark Suster, and Kate Mitchell) were on Fox Business’ Capitalist Ad”Ventures” series.  The underlying theme of this segment was the characteristics of entrepreneur that VCs look for.

Fox doesn’t seem to have embeds, so you’ll have to use this URL to watch “The Future of Venture Capitalism”.

While Santo, Mark, and Kate weren’t the maniacal crazy people (although I’m sure some will argue that), they were clear about the ones they are looking for.  Nice job gang!

It’s Not My Company

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VCs say a lot of stupid things.  I’m guilty of it plenty and whenever someone calls me on it I try to acknowledge and change.  One that I try really hard not to do is say “my company” when referring to companies I’ve invested in – I think it’s one of the most annoying things a VC can say.

I was talking to a VC the other day about a few companies he had invested in.  By the third time he referred to one of the companies as “my company” (as in “My company is working on X”, “My company would like to talk to Company Z about thing Y”) I felt myself starting to react.  I didn’t really have a relationship with this VC, but I knew that he had never run a company (investment banking post college, MBA, then VC). I realized I wanted to stop him at some point and say “dude – it’s not your company – you are merely an 18% shareholder in the business.”  I bit my tongue and had the conversation, but I’ve been thinking about this in the back of my mind ever since.

One of the great lines from TechStars is “It’s your company.”  That’s the way David Cohen and I remind the TechStars’ founders that ultimately all the decisions are theirs – the mentors (and us) are providing data, feedback, thoughts, and insight – but not telling them what to do.  Sure – a lot of our (and the mentors) language is directive (e.g. I just sent an email to a TechStars CEO that said “you should do thing W right now”) but ultimately the decision as to what to do is the CEO’s.

While I’ve got plenty of rights as an investor, I’m very aware that I’m “an investor.” If you are a CEO or an entrepreneur, I can’t imagine anything more annoying than hearing one of your investors refer to the business as “his company.”  Now, if the investor owns more than 50% of the company, I guess this is a legitimate legal perspective, but it’s still an incredibly demotivating position to take.

So – to all my friends out there in VC-land – let’s try to change the language.  Some of the VCs I respect the most – like Fred Wilson – diligently refer to investments they make as “portfolio companies” (as in “our portfolio company X").  I often refer to them as “our investment” or “our portfolio company”.  Regardless of the approach you take, think about the language you use, especially the impact on the people who are working their asses off every day to make “their company” successful.

Sorry if this feels pedantic to you.  It’s now out of my head and on this blog so I can move on.  As someone I love likes to say “my work here is done.”

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