Zelkova Ventures

This week I spent the day at one of our portfolio companies for a board meeting.  The format was a bit different than usual, in that prior to the meeting we invited the entire company to join the board for lunch and spend two hours discussing whatever came to mind, it was AWESOME!

The board and management started out by walking thru our vision for the future and discussing the past accomplishments and challenges, we kept the section short on purposes.  From there we turned it over team members to fire away questions, discuss thoughts, air concerns or anything else that came to mind.

As expected it was a bit awkward at first until someone broke the ice with the first question; but from there we were asked a range of questions from financing, staffing, sales, etc.   They weren’t softballs either and the board tried not to skirt around any questions.

From my perspective it was great to hear the questions that came in, brainstorm with the team on potential strategies and see the whites of the eyes of the feet on the ground! From the team’s perspective they were excited to get a chance to interact with the investors and understand what goes on behind the closed doors at these ‘exclusive’ board meetings!

A follow up from the meeting was to do the meeting in more regular intervals, which we will be doing.

To often board members and VC’s deal just with senior level management and don’t take the time to meet with all the team and understand their perspectives.  A few hours can really make a difference!

Online recruiting is broken…  we see opportunity to fix it! That’s why we are proud to announce — along with Polaris Ventures LererMedia Ventures, Jason Calacanis and Josh Kushner — our investment in JIBE (previously LocalBacon), led by Joe  Essenfeld and Peter Margulies. TechCrunch Coverage Here.

JIBE is a social recruiting platform for today’s world. More and more, we are hearing about people landing jobs from their activities on Facebook, Twitter and blogs. While this way of getting a job is growing in numbers, these job-seekers are still in the minority. For now.

We, and JIBE, feel social recruiting is the future, and  JIBE is launching a platform to help facilitate this type of recruiting via a “Employment Networking Platform.”

From a job seeker’s perspective, JIBE increases your chances of getting hired by getting you that warm introduction.  From a recruiter’s perspective, it provides more transparency in the candidate, helping in the interviewing and hiring process.

Another core philosophy of JIBE is fixing the two largest complaints of online recruiting:

1. Job seekers feel it’s one giant black hole to apply for a job online. You submit, wait & forget.
2. Recruiters are inundated with responses and can’t handle it all – help!

Look for great things to come from the team at JIBE!

You may have caught the news today that we invested in Plancast along side of SoftTech VC, TrueVentures, FoundersFund and a group of awesome angels.  We are very proud to be working with Mark, Jay and the rest of the team.

What got us going about Plancast is that it is filling a large gap in the near real time market.  There are services out there that tell allow you to tell whats on your mind now (Twitter) and there are services ou there that allow you to tell the would where you are, but few services out there provide the ability to tell the world and those you care about what are your intent and plans, this is Plancast!

Plancast is about sharing information around activities, events and intent that are happening in the future.  Currently Plancast (which has had some incredibly viral growth for a company of its age) is about sharing events/plans with the people you know and allowing them to add themselves “Count Me In”.  It has become the go to resource for me (and many others) in figuring out this whole SXSW stuff.

We look forward to excivting and innovating things coming from the team over at Plancast, Congrats to all involved!!!

You can follow Zelkova on Plancast  http://plancast.com/ZelkovaVC

This past Friday I had the pleasure of judging the Venture Capital Investment Competition (VCIC) at NYU Stern along with several other VC’s including, Bronson Lingamfelter from Rose Tech Ventures, Zach Schildhorn from Lux Capital, David Nevas from Edison Venture Fund, Justin Wohlstadter from Penny Black and angel Joe DeMartino.

Unlike most business plan competitions this one flips the model, the students act as VC’s and evaluate 3 real companies and determine which one to invest in.  As a judge you are not evaluating the companies, but evaluating the students abilities around diligence, term sheet development and negotiating a deal.

The three companies that volunteered to be poked and prodded by the students were MusicVilage, CalendarFly and Dr. Chrono.  The day started with 15-minute presentations by each company and was followed by a diligence session between the companies and each team.  From there the teams went off and developed term sheets for the company of their choice and than presented and negotiated them.

The six schools competing at the NYU event were Carnegie Melon, Columbia, Cornell, London Business School and Yale.

The fund profile the teams were given to invest from was an $80mm fund, that was 40% invested and invested in Seed / Series A Deals.  I believe this handicapped the teams as all three companies were seed stage companies that most of us agreed needed $500k – $1m to show some results.  Further there were some questions on whether the exits of the companies could move the dial for a fund of $80mm.   The fund size probably should have been around $30mm – $50mm, in which case any of these companies could produce appropriate returns for funds of those size.

A few themes out of the diligence sessions included:

• Focusing mainly on the business very little about the entrepreneurs
• No team gave the entrepreneurs the ability to ask them questions
• Few teams focused on product roadmap / development

A few themes that came out of the term sheet development and negotiations included:

• All teams over funded the companies significantly.
• Many of the term sheets used a complex traunching schedules.
• Valuations ranged significantly and were based on the science of financial models, which is very different than seed stage valuation determination
• Board sizing was interesting, most were 5 or more, and one team proposed a 4 person board

Congrats to all the teams that did a great job!  The top three teams were 1) Columbia 2) London Business School 3) Cornell.

I recently had an e-mail correspondence with a first-time entrepreneur about valuation. They requested pre-money of north of $100m, and I fell out of my seat. Luckily, our floors are carpeted, so it didn’t hurt much. But after many e-mails (note to self, I should have just picked up the phone) it became apparent that we weren’t on the same page, and the entrepreneur didn’t understand what I meant about valuation for investing purposes.

So what is valuation? It’s simply what a company is worth before and after financing.

Why is it important? Well, it impacts the cap table, which impacts what everyone involved owns, impacting how much one could potentially make one day, impacting one’s returns, impacting one’s motivation. I think you get the point – its impacts a heck of a lot.

So now to define some important terms and provide some color into the mechanics.

Pre-Money: This is the value of the company at the current moment, ahead of the close of a funding round.

The math formulas we were taught (i.e. the science) in school don’t work here, as generally there is no revenue or substantial assets to base them on. Using financial formulas would lead to a valuation of $0 or close to it, so that doesn’t work for anyone.

So if we cant determine a pre-money based on science, we need art. The bad news is that art is abstract, and in this case, a balancing act of the needs of the many parties involved. Here are some of them:

• Ensuring the founders / team have enough ownership now and in the future to be incentivized correctly; if not, the likelihood for success reduces dramatically.
• Ensuring the investors have the ownership level they need to properly generate the returns to support their investment thesis (there will be a future blog post on this).
• Setting it to the correct level, which will help facilitate a future financing round that doesn’t set the company up for a downround.
• What the ownership will look like for all parties after future rounds.

As a rule of thumb, you generally should expect to give up between 20% – 45% of the company in each round of early financing, regardless of the amount raised. Now, there are outliers to the rule (i.e. Twitter/Facebook/your company) but these are exceptions, not the norm. Further, there are always other terms (i.e. liquidation preference) that also have impacts on returns, ownership, etc.

Post-Money: This is the value of the company after the financing. This is equal to the pre-money valuation + total amount raised or the total number of shares in the company times the purchase price per share.

Dilution:

So why does this matter? Well, it determines how much everyone owns. To figure out dilution to the current owners (founders and any existing shareholders), divide the amount invested by the post money valuation and multiply by 100.

Example:
Amount Raising $2m
Pre-Money Valuation: $4m
Post-Money Valuation: $4m + $2m = $6m
Ownership to Investors: ($2m / $6m) * 100 = 33.3% (this is the dilution to current owners)
Ownership to Founders / Existing Owners: 100% – 33.3% = 66.6%

An Important Note about Convertible Debt

In a future post, I will explore more about convertible debt (both the pros and cons), but I wanted to quickly explain how it impacts the cap table. If you have convertible debt that is converting as part of this round, it needs to be included in the money raised and the post-money valuation, even though it’s not new money. Using the above example, lets say the company had $1m in convertible debt, here is what the thing looks like.

Amount Raising $2m
Convertible Debt $1m
Pre-Money Valuation: $4m
Post-Money Valuation: $4m + $3m = $7m
Ownership to Investors: ($3m / $7m) * 100 = 42.8% (this is also the dilution to existing owners
Ownership to Founders / Existing Owners: 100% – 42.8% = 57.2%

The important thing to look at here is where the breakout of the 42.8% goes. New money receives 28.5% of the company and convertible holders receive 14.3% of the company. (To make things easy, I have left out interest / discounts on convertible; though this only exacerbates the situation). Now, the new money $2m receives significantly less of the company due to the convertible debt (28.5% vs. 33.3%). The takeaway lesson here is to be careful about convertible debt and don’t take so much of it in that it impacts your ability to do a future round of financing. My rule of thumb is that existing convertible debt shouldn’t exceed 25% of the new money coming in so that it doesn’t have a huge impact on new money.

We’re looking forward to comments / questions / criticisms about this and all posts.