Archive: funding

There’s something rotten in the Kingdom of Venture Capital

It’s generally a bad idea to generalize….(pun intended).


And criticizing VCs when you are in the process of fund raising is probably a bad idea and puts whatever you say at risk of being perceived as whining.


But having raised an excellent early stage round from some of the best Angel Investors and Entrepreneurs that I know, I cannot help but reflect on the contrast between the approach of the Angel Investors we have on board compared to the process and decision making that we – and others – experience with insitutional VCs.


The cliché of Venture Capital investments is that Angel Investors invest on a hunch, whereas insitutional VCs follow a more rational, risk-balanced and professional process.


Our experience has been that the really good, tough questions have been asked in detail by our Angels – to skim just the top of these questions:

- explain your metrics?

- what is the margin of error of your financial model?

- how do expect to scale?

- how much do you get out of a dollar spent?

- how big is your adressable market?

- what is your competitive moat (Buffet terminology)

- what are the strengths of your team, what do you need movong forward?


Too often, these were not the questions asked by VCs. It may be that in today’s market, they simply don’t have the time to parse their deal flow in depth and instead rely on market consensus that this or that startup is “hot”. This leads to herd investing, and that may explain the disappointment of portfolios largely kept alive by follow-on rounds and convenient “exits” to friend VCs portfolio companies. It even makes sense, in a way, by “pooling resources” – if, that is, the VC initially triggering the herd did actually ask and answer the hard questions.


What it does not do is create an environment for the type of long shot value creation that Silicon Valley excels at. Ueber, AirBnB, Twitter, Quora would not have stood a chance with how many European VCs – obviously not all – approach their deal flow.


Add to that the rituals of pitching, event networking, and buzzword-slinging that are endemic, and it makes you wonder whether these VCs really are following the right path to identify truly ambitious startups correctly. Today’s hot startup often gets caught up tomorrow in business model issues that were recognizable from the outset. I sometime miss an analytical response and understanding of the market, at least from VCs that do not have an industry focus.


It’s hard to picture a barefoot Steve Jobs convincing any of today’s European VCs to invest in Apple.



the Hamlet VC

Rezession die beste Zeit für Social Media? [German]

Peter Turi hat ein Video – Interview geposted, dass er mit mir auf dem DLD 09 geführt haben. Darin stellt er solche spannenden Fragen wie:

1) Ist Rezession eine schlechte Zeit für Startups?

2) Wird sich bei den Startups die Spreu vom Weizen trennen?

3) Wird YouTube sevenload verdrängen?

4) Was ist das “nächste große Ding?”

Hier sind meine Antworten:

Interview Turi2 (2009): Interview with Axel Schmiegelow about his entrepreneurship (German) from curtis newton gmbh on Vimeo.

Reps and Warranties in Venture Capital Deals

This weekend a friend of mine called me up, as he was completing – as a leading seed investor – the first round (series A) of a company that I have a minority stake in. He told me that the round being negotiated was just short of Signing, as all main deal elements had been agreed with the investor (a large and well-known VC Fund), but there was one last point of contention left, and – big surprise! – that was Reps and Warranties.

That made me think once again about the peculiar habit of venture capitalists to turn Reps and Warranties almost as much a difficult topic as in M&A. If you think about the term “Venture Capital”, the whole concept is that you venture into something and there is no precisely NO guarantee of success.

Of course it makes full sense to commit founders to proper representation of the state the company is in and to also make them liable for the so-called Title Guarantees, in effect making sure that the shares being transferred to the investor are free of third party rights, are indeed constituted legally and are not subject to any limitations. However, I do not understand why these Reps and Warranties so often go to the core of the risks of the business model, thereby in effect giving the venture capital investment more the character of debt financing, disguised in the Reps and Warranties clause.

Why do I say this?

Because if a founder signs up for – say – a 3 Mil. Euro investment and the company fails due to an event that is at the core of the typical risk of the business model, this may create a warranty case that in the worst of all contract agreements may include full damage to be paid by the founder. This then means that the investor may get up to the total sum of that investment in damages from the founder because of an event that constituted the essence of the typical venture risk.

So put very bluntly, by enforcing Reps & Warranties covering business risks, the investor covered his venture risk by making the founder liable for failure of exactly that risk.

We all know that founders who may be otherwise admirable do not like to focus on legal details and may have bad luck in a choice of their attorneys.

That can be a deadly mistake.

When founders find themselves in such a contract situation, it is not just a reflection of poor negotiation skills on the side of the founders, who – one might argue a bit unfairly – therefore would not deserve anything better.

Such contract clauses are also always a case of misguided priorities on the side of the investor.

While as an investor I have full sympathy for contractual rules that prevent an irresponsible founder from walking away, as in the old adage “with my time and your money to waste, we have nothing to lose”.

However, it is equally unfair to put the investor of a venture in a position where his investment becomes more a case of debt with higher returns and higher default risk than of real venture investment. Moreover, discussions and probable litigation about business risk damage retribution by the founder can divert vital energy from surviving the damaging event, since both the founder and the investor will bes spending considerable time hedging their risks or enforcing their rights. THat can ultimately be much more damaging than the damaging event itself.

Here is my advice to founders in any negotiation about Reps and Warranties:

1) Before negotiation of deal terms, identify the natural risk of your business model

2) Prepare to describe and argue to the investor what the typical risk of the venture is and make it clear from the outset that that risk cannot will not be carried by the founder(s).

3) Make the investor acknowledge these risks early in the process of negotiating the terms

4) At term sheet level make sure that the basic principles guiding an equal distribution of reps and warranties rights between founder and investor include the following

a. Liability of founders is limited to willful behavior and gross negligence

b. There must be a cap of a certain percentage of the investment, in my opinion not more than 50% of the investment sum.

c. For all cases of non-willfull behavior the warranty term should be at most 12 months

d. Each founder is only liable for the fraction of the cap that corresponds to his fraction of shares in the entire company, so a co-founder who has 20 % of shares in a company shall only be liable up to 20% of the cap.

e. All shareholder managers with shares smaller than 7% should be exempt from any liability unless there is a specific reason for that.

f. Damages should be paid only to the extent that the Founder / Manager liable had best knowledge of the Warranty issue.

g. Retribution of damage should be limited to the damage that is incurred directly by the damaging event, confirmed by court ruling and could be reasonably expected. There should be no damage retribution for a loss of valuation of the company, which should be explicitly excluded. Valuation loss is usually covered by downround protection clauses.

h. Retribution of damage should be limited to such damages as cannot be corrected or “repaired”.

i. No damage retribution should be given for damages that are incurred due to lack of cooperation on side of the investor. This could include anything ranging from late payment of investment funds, lack of cooperation in litigation cases, failure of the board members dispatched by the investor to agree in litigating to avoid the damage, and so forth.

k. The most important advice that can be given to any founder signing Reps and Warranties is to put a large amount of energy into the due diligence and disclosure process and the documentation of that due diligence and disclosure process. THis is where attention to detail is a very necessary evil. The contract must include a clause that no events or fact about the company that were or could reasonable have been expected to be known to the investor at the time of the investment can lead to a claim of the investor against the founder. Thus claims are excluded if the the facts that led to the damage were known to the investor.

l. Negotiate all these points, then focus on disclosing well all risks that are part of the business model or lie within the company.

Often investors will present the founders with tough Reps and Warranties basically to incentivize them to puta significant amount of energy in thinking through the risks of the company and the development stage the company is at.

However, founders should rate their investors on the basis on their willingness to accept clauses that correspond with or at least resemble what I advise.

Good Luck!

Musings on how to do the VC Round

I promised to blog my reflections on the 18-hour stint – well, here goes:

1) Provided you can choose from equal VC quality, choose a VC with an Office in your country -

2) or calculate three extra weeks on legal hassle because they just won’t understand your legal system (unless, of course, you share legal systems)

3) Be ready to bypass the lawyer of your VC at any moment (incl. @ 03h00 AM – myke sure you have a contact who will comply) – remember there may be a Principal-Agent-Problem between Vc and his Lawyer – the VC wants the deal @ good terms and low cost, but he wants the deal. A Bad Lawyer often raises his profile by being excruciating and blaming a bummed deal on you.

4) Align your Business Angels, if you have any, into your interest. If need be, point out that you can always gang up with the VC. But it is best if you don’t have to go there – that depends on the mentality of your BAs. I’ve seen both.

5) Don’t succomb to the enticements of the new. The nice great VCs who now are a tremendous success may just be your worst nightmare two years down the road, so remember to balance control power in your company. In the best of all worlds, as an entrepreneur, you get to pick who you work with on which issue because you gang up with the Business Angels if the VCs get unreasonable and you gang up with the VCs if the BAs get unprofessional or greedy. Make it clear that, while alle share the risk, you are the entrepreneur who is going to make it happen – or not.

6) Don’t overestimate yourself and consider – in your inner fort – the scenario if the company outgrows you or you get boreed. Few Entrepreneurs are as good in the 0 – 100 employees periods as the are in the 100 – 1000 or beyond periods. That was not an issue in my recent experience, but it is always worth remembering.

7) Don’t bind yourself to milestones. Business Plans are a process, not a bible. Focus on the metrics and never tie your investment capital to that. There is only one 100% sure fact about your business plan: it is not going to happen. The story will always be different, for better or for worse. So while building the structure of the company for the VC phase, make sure you have a tight-knit communication, frequent consultation infrastructure (Board) – share decision responsability. Stop selling your venture the minute the money is in the bank and all covenants are through (that’s why milestones are unwise for a VC too, because then reporting focuses on showing how milestones are met, not on the actual problems and necessary adjustments of and to the business model). Make sure you have VCs you are comfortable sharing your worse problems with.

In this sense, there is no real “stupid money” – you should always keep that communication line open so noone will feel thumped and try to get back at you (of that, the stupidest money sources are always capable). And sometimes even the worst moron will see something that you, in the Hamster wheel, won’t.

That’s a first – discussions welcome.

The Crazy VC Days are back!!!

I Just emerged (at 04h00 in the morning) from an 18 – hour (!!!!) – bit of negotiation with two international VCs in one of the startups dw capital is invested in. We had the full program:

- the Lawyer pissing contest (pardon my french)
- the last-minute deal restructuring
- the last-minute battle over terms
- the nerve game on who gets to leave the table first (well not quite, but we did have a little theatre play)
- we used three rooms and a hallway to do all telcoing back to the principals

But now come the differences:

- a savvy founder who kept his nerve and outplayed the lawyers well (it always helps to just call the principal of the VC)
- and a really easy-going notary, funny on top of it

So it all ended

a) succesfully
b) even on friendly terms
c) and with two bottles of champagne….

I’ll get back to the audience on my findings out of the process. Still a lot to be learned, or remembered again at the very least.


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