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February 21, 2005

Venture Capital – An Entrepreneur’s View

For those of us who start a new company rather than look for a new job, it’s important to understand venture capital and venture capitalists.  One of the best ways to understand the mind of a good venture capitalists (there are, of course, good VCs and bad VCs) is to read Fred Wilson’s blog (avc.blogs.com).   Fred gives the VC view in an ongoing blogosphere debate but he scrupulously points to opposing views.  His latest post specifically on this is Fixing Venture Capital and has a worthwhile comment thread below it.

Over the next two days I’ll blog the nine ten lessons I learned about dealing with VCs.

Lesson #1: there are times when raising venture capital is a bad idea.

One question under debate is:  “is venture capital a good or bad thing?”.  This is a pretty silly question since the answer depends purely on the circumstance.  If you don’t need capital, then raising it through a VC or in any other way is a bad idea.  You sell (“give away” from an entrepreneur’s point of view)  part of your company when you raise venture capital.  You cede a significant amount of control over the future of the company, particularly over future financing.  Most of us entrepreneurs are control freaks – that’s why we start companies in the first place – so losing some autonomy is no little thing.  One of the best things a VC ever did for me was show me that the company I was running at the time didn’t need any capital.  It was his way of showing me to the door, but he was right and raising venture capital at that time would have been a mistake.  A good VC will tell you if you don’t need funding.

Lesson # 2: there are times when it makes sense to raise venture capital.

But there are times when venture funding from a “good” VC or VCs is absolutely the right thing for a company.  ITXC, the Internet telephony wholesale carrier that my wife Mary and I started, was venture funded and benefited greatly from both the funding and the association with the VCs, one of whom was Fred Wilson. 

We were in a business that runs on capital: even a “virtual phone network” requires equipment to operate.  The business allowed us to leverage the intellectual property we developed for making acceptable-quality voice calls on the untamed Internet (this was 1997) but developing and deploying  technology as well as signing up initial customers is a capital-intensive activity.  In a network business, you will always lose money until you get to a critical mass of customers (a consequence of Metcalfe’s law is that small networks are economically inefficient) so again there was a need for capital to get to critical mass.

We were initially too small to go public or to borrow big, even in the halcyon days of the late 90s.  We had stretched our own out-of-pocket financing and vendor financing as far as we could.  We were too big for angel financing.  So venture funding made sense.

Lesson #3:  raise your venture funding as late as possible.

It certainly helped that, for the only time in my long career, there was more money around than ideas. Mary did a great job of PR when we launched the company and I had some notoriety from AT&T WorldNet and Microsoft so people knew we existed.  VCs were calling us!

We held them off for a while (in normal times you won’t have this problem unless you are a serial startup success).  We told them, truthfully, that we didn’t have a business plan ready.  We also had enough money initially so we felt it was better for us to prove some of our business plan before negotiating for a VC round of funding.  We closed our first venture capital round after going live with our first customers.  We got a better deal – kept more of the company – because some of the risk had already taken, some of the concepts had already been proved, some customers were already paying real money.

Our deal came close to collapsing when AT&T pulled out as a venture source at the extreme last minute but survived, I think, because the business was so far along.

Lesson #4: pick your VCs well.

We also used the time our initial capital bought us to talk to lots of VCs.  It turned out that West Coast VCs including some of the great ones didn’t really understand or like service businesses.  We wrote software but we sold wholesale phone calls.  In the end our major VCs were Chase frontended by Flatiron Partners (that’s where Fred Wilson was then and where I met him) and Spectrum Equity from Boston.  Flatiron was a quickly emerging major firm in Silicon Alley in New York with a good understanding of Internet businesses and Spectrum was well-versed and well-invested in existing communication businesses.  We also had investment in this round and our next one from Intel Ventures, the Israeli firm Pitango, and VocalTec, the firm that practically invented Internet telephony and which supplied us with much of our equipment.

VocalTec’s Chairman and CEO Elon Ganor  had encouraged me to start ITXC and helped think the business through because he reasoned – correctly – that successful VoIP companies were necessary for the success of a VoIP equipment supplier like VocalTec.  For this same reason, VocalTec provided both angel and venture round funding.

Your VCs will monitor what you do with your money closely.  Some of them will end up on your board.  Fred Wilson, Elon Ganor, and Bill Collatos from Spectrum joined CFO Ed Jordan and me on our board.  If they had not understood related businesses well and not been willing to learn with us as a new industry emerged, it would have been impossible to run the company.  Sure, there were times when I wished that just Mary and I and the increasingly good executive team we were putting together could debate every question; in fact there were times that I would just as soon have made very decision myself without debating with anyone. 

But companies can’t really grow well that way.  My board was sometimes in the way; much more often it was helpful.  I know many other companies where a mismatch between the capabilities of the VCs and of the executive team have led to paralysis.  Incompetent VCs, of course, are a disaster.  A good VC, like a good startup CEO, must be able to learn and adapt!  Sure, you all agreed on a business plan before they gave you the money and you ceded absolute control over your company.  And, just as surely, at least half the assumptions that business plan was based on will turn out to be wrong as well as many of its conclusions.  If your VCs won’t let you – won’t help you – adapt, you’re toast.

Fred stayed on as a director when we went public.  In a recent post he said he is not willing to serve as a director of a public company anymore – largely because of class action lawsuits.  We are not going to get the kind of corporate governance we need if people like Fred are disincented from being public directors but that’s another topic for another post.

The remaining six lessons are in the next post.

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» Venture Capital - An Entrepreneur's View from robhyndman.com
Tom Evslin has a great post, the first in a series, on lessons he's learned about dealing with VC's. [Read More]

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但是如果按照那种方式,公司不会非常好的发展。我的董事会有时候会阻碍我的发展,不过更多时候它是有帮助的。我知道其他公司里,由于VC和执行团队之间的磨合有问题导致公司的瘫痪。无能的VC是个灾难。而一个好的VC,就像一个好的创业 CEO一样,愿意不断学习和适应!当然,在他们给你钱之前你同意了他们的商业模式,而你失去了对于公司的绝对控制权。至少一般建立在主观意愿上的假设是错误的,很多结论也是如此。如果你的VC不让你,或者是不帮助你适应环境,你应该庆祝。... [Read More]


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