Along with Avalon Ventures, my firm Nueva Ventures provided the first capital to Cloudkick in August 2009 that enabled them to kickstart their idea into a business. I heard their pitch at the Under the Radar Cloud Computing Conference (my wife Charlene Li actually moderated their panel) and foretelling of things to come, CloudKick won best of show. 

 The founders had only recently graduated from college, were amazingly efficient and insightful at product development, and determined to succeed. I was a believer in them from the get go and got busy introducing them to other funds to co-invest with us. Along the way, they got what seemed to be the usual dose of Sand Hill Road treatment, but persisted to pull together the seed round with us and Avalon Ventures, including adding Avalon’s Rich Levandov to the Board, an experienced entrepreneur with deep computer industry experience (Rich was the inventor of Phoenix Bios).

We invested in Cloudkick out of a pilot fund my partner Neil Weintraut and I raised in 2008. Neil and I launched our fund with three beliefs: Entrepreneurs, Cloud Computing, and Super-Angel capitalization. Namely, that you back entrepreneurs, the future is (and greatest opportunities are in) ventures that take advantage of Cloud Computing, and the capitalization model, speed, and mindset that has come to be known by the term “Super-Angel”, is best for success, the entrepreneurs, and yes, investors.

Alex, Dan, and Logan, thanks. This is only the beginning for you and your accomplishments! It has been a real pleasure to work with you and we wish you well in your new home as you build out Rackspace in the Bay Area.

Pharmacy TV was one of Nueva Ventures’ first investments in 2005 and in that time much has changed in the digital media space. The Pharmacy remains one of the most attractive locations for place based media in the largest advertising vertical – health and wellness. The service is a win for multiple parties: Pharmacy and grocery chains improve customer experience by proving useful content in the pharmacy prescription waiting area. Advertisers can reach a relevant target market right at the point of purchase. Consumers get to watch useful content and relevant advertising while waiting for prescriptions.

Success in this relatively new model is all about creating efficiency through scale, measurement of reach and ROI performance in store for advertisers, and development of a standard media buying platform. I believe the next 3-5 years will see the full potential of this model realized as Pharmacy TV partners now with a larger, more broadly diversfied player in RMG committed to excellence in content and placement of its screens across complementary locations where messages can be reinforced. RMG’s team, salesforce, technology platform and investors are unparalleled in the industry. We’ll inevitably see more consolidation to build scale and efficiency. Like the Internet, we’re seeing a shift in advertising from traditional broadcast to this sector with serious $ now being spent on digital in-store media as the ROI is measurable and compelling.

My heartfelt congratulations to the team at Pharmacy TV, of which I count myself part of having filled in for the better part of 3 years as its CFO, the team at RMG including CEO Garry McGuire whose relentless support saw this through to completion, and the investors who got us here thus far.

What is an SBA Loan? It’s a loan provided by a major bank to grow your business which is quaranteed by the US Government under the Small Business Administration lending program.  Here is a good link describing it:

http://usgovinfo.about.com/od/smallbusiness/a/sbaloans.htm

It is a loan that you, as the entrepreneur/founder, have to personally guarantee with your personal assets. That could be equity in your house, savings or other personal assets. If the venture fails, you are on the hook to pay it back, so only do this if your financial situation permits and you understand the risks.

The nice thing about this sort of financing is that it is non-dilutive, no equity is given in return. However, like all capital raising, it involves a lot of paperwork, perhaps even more so as a government program.

Although we had no idea what the process entailed, we suspected it was rather involved and thought seriously about why we’d put ourselves through the ringer doing all the paperwork when at the end of the day we’d be personally guaranteeing the loan anyway. Why not instead just draw upon a home equity line of credit?

Well, this is a cleaner way to do it – it’s a loan to the company and the interest is tax deductible while the HELOC’s interest is only deductible at the personal level up to $100K of principal. It also forces some discipline in financial planning, reporting and cleaning up elements of the company that you may not have tackled so far and would usually come up when raising your first institutional funding round.

Here is what we went through:

April:

- Contacted 3 local banks (Bridge Bank, Wells Fargo and First Republic) to inquire about their SBA programs. Only Wells Fargo could do this program and it turns out they are the largest in Silicon Valley doing it. Bridge Bank considered doing an accounts receivable (AR) factoring line, but this was quite limited given the early life of the company and First Republic considered a much smaller line of credit, also due to the early stage of the company.

- The ideal structure would have been a line of credit (draw as needed / pay interest only when needed). Wells Fargo could only do a term loan with a short draw period. Not ideal but something we could live with. So we went ahead with them.

May:

- Filled out the SBA loan application form, gathered supporting documentation. This took about a week to do.

- Submitted 3 years personal tax returns including all K1s. Also: retirement savings balances, checking/savings account balances, home equity line, mortgage and home value information.

- Submitted historical actual and detailed financial projections for the company’s revenue, operating costs, hiring plans, cash, AR etc. This detailed model took about another week to pull together but was a useful exercise.

- Wells Fargo provided critical review of financial projections and suggested some items that were missing or may have been optimistic. This was actually quite helpful.

June:

- Back and forth on financial projections and size of loan. $100K seemed all they could do based on the assets of the business, it’s 1 year operating history (even with strong cash flow) and a 3 months maximum drawdown period. It was quite disappointing to arrive at this after two months of working it.

- 6% interest rate, not bad but certainly not as good as our HELOC which is running around 4%.

July:

- Resubmitted financial statements for June including accounts receivable.

- It turned out that the business had a surge in revenue in June/July and a corresponding larger accounts receivable, which ended up being a key factor in getting approval for a larger $250K loan versus a $100K. Our Wells Fargo rep also succeeded in getting the underwriter to approve a 6 month draw period, much better. They came through nicely here!

- Paid $2,200 fee deposit, which goes about half to Wells Fargo and half to the Government. In the end, the fee ended up being less at about $1600 and we got a refund. The Obama administration is waiving most of the usual $4,000 SBA fee, so this is a decent incentive.

- Submitted fully executed Operating Agreement, filed Articles of Organization, sorted through a 1″ thick stack of SBA forms – #159, 1624, 4, 413 and 912.

August:

- In preparation for adding people, the startup secured new office space and signed a lease. That triggered another round of paperwork – submit the new lease, get the landlord to sign a Landlord Waiver Form and add lender as an Assignee on the lease. Also, we needed to put in place a business hazard insurance policy with Wells Fargo as a loss payee. Fortunately this could be done quickly with a local agent at State Farm, Manny Casillas, who our realtor, Samia Morgan, recommended. Samia was awesome at helping get the office, touring some 30+ properties! Manny was also terrific.

- There were complications/delays, related to things like business registrations, leases, ownership structure, and flood plain insurance (don’t ask). You have to have all of your ducks lined up in a row, and it’s hard to do this while actually running and growing your company, as things change almost daily.

So 5 months from start to end, longer than the time it would typically take for a VC or angel investor to do diligence.

It’s a risky way to bootstrap your business and certainly not as ideal as a revolving line of credit, but as a new startup it may be the only source of debt financing out there. While the amount of the loan is limited by what appears to be the amount of AR or equipment assets, it can provide a useful way to finance a few months of growth until enough time goes by that AR based lending can kick in at larger amounts or it would make more sense to raise a venture capital or angel round.

If you would like more information from our Wells Fargo contact, get in touch with Rick Shade or Chad Barbieri, I’d highly recommend them - Rick.Shade at wellsfargo dot com or Chad.Barbieri at wellsfargo dot com

1) Tim Draper’s Rose Colored Glasses. Tim thinks “the next eight to ten years are going to be the greatest venture capital years in the history of the world”.

He has an interesting perspective on international investing. Having done startups in places like Africa, I also think there are incredible opportunities outside of Silicon Valley but as an investor you need the local firm infrastructure to be able to identify and work with the best. My hats off to Tim who has built a great firm that has reached out to the far corners of the globe using a model of a network local funds.

Incidentally, Tim agreed to seed the first startup I did with Monique Maddy providing wireless telecommunications services in Africa, which sold in 2007 for $160M to Zain Telecom. This was back in 1994 and Tim truly was a visionary. Although we wanted Tim as an investor, we could not agree to giving up 20% of the company for $50K!

2) Venture Capital Elders Say Think Small: Alan Patricoff left the large VC firm he co-founded, Apax, in 2004 to start Greycroft, a $75M fund doing investments <$3M.

He says:

“I personally believe and I think the evidence proves that the venture industry has gotten too big, the funds have gotten too big,” he said. In order to invest their enormous amounts of capital, venture capitalists end up choosing companies that are not sufficiently disciplined or capital-efficient, he said. And because firms have invested so much money, they depend on taking their portfolio companies public to get great enough returns, at a time when I.P.O.s are few and far between.”

Couldn’t agree more, although Alan is now raising Greycroft II which is rumored to be $125-150M in size. Perhaps a bit of a departure from the model he so dearly likes to speak about?

Although this pre-dated the conference, here is another article on Patricof’s model. Particularly relevant:

“The paradigm has changed for the venture business. We can no longer realistically expect the same kinds of absolute returns that were achieved in the past through a quick turnaround from start-up to liquidity through an I.P.O. Rather, I believe that most of the companies that venture capitalists are funding today will find an exit through merger or acquisition. And if we expect to achieve a return in a reasonable time frame of three to five years, we are probably looking at a sale price of $20 million to $100 million. This is the valuation range where most young companies are being acquired.”

Exit flexibility is one of the most important elements of your capital strategy and why we advocate so strongly that less is better. The less you can take, the more of the company you as an entrepreneur retain and the more attractive it is to exit for you. Similarly, your investors also benefit from a lower capitalized valuation and will be more inclined to want to exit with you as that will result in a good return.

3) With Industry in Doldrums, LPs and GPs Locked in Uneasy Alliance: This post sums up some of the problems plaguing the VC industry, in case you are wondering what is happening in our world. Back to Alan’s views, which we share, that smaller is better and has the potential to generate better returns in today’s exit market.

A few of my own observations:

Fundings are happening for first rounds. The saavy investors who have capital know this is a great time to invest – teams are able to do more with less, valuations are reasonable, talent is plentiful and there have never been such a great set of tools at your disposal to launch and build efficiently – from offshore talent networks, open source, APIs, cloud computing, Google keywords and viral social marketing.

1) It’s all about traction and showing that you can get things done.

I really like the UserVoice story. Have a look at:

http://blog.uservoice.com/2009/04/17/the-year-of-the-scrappy-start-up/

After hitting a wall fundraising last fall, the team basically went into extreme “Ramen” bootstrap mode. They all shacked up together and moved to Santa Cruz to keep costs down, did some consulting on the side and raised a little friends and family money to pay the bills, focused on finishing and launching their product, and started to get customers to download and pay for the product. By the time they returned to the fundraising circuit in Feb/March, they had over 10K customers. Suddenly they were showing serious traction and had an over 3x oversubscribed round. They made it happen.

2) Investors are taking longer to make decisions because they have the luxury of seeing more opportunities and less capital chasing them. If it feels like herding cats, maybe consider this case:

We invested in Grouply back in January. In December, I had a conversation with the CEO that he thought he had enough interest around the table but there were still many investors ”kicking the tires”. My advice was that if he was comfortable enough he’d get to a close, to set a date and get on with drafting the documents. It’s always a risk to do so but it tends to drive things to close – if there is momentum, no one wants to miss the boat on a good investment opportunity. Sure enough, he set the date a month later and ended up closing in an oversubscribed round. He was smart to take more capital and extend runway rather than be too concerned about the dilution that had.

3) If your capital needs are below what a VC would look for, explore alternatives:

I just met with another seasoned entrepreneur yesterday, starting a SaaS business to automate tracking of finished goods through supplier networks to end customers and returns. He’s chosen to bootstrap the business by targeting a couple of major accounts where he has gotten their attention with the possibility of substantial cost savings and through a consulting engagement to do an audit of their logistics. He will implement the new product there as part of the consulting gig (free add on) and get them using it. If it sticks, he’ll start charging soon after as they upgrade in scope.

Yet another option to explore: an SBA backed loan. Wells Fargo is a leading lender in this program which can provide up to $250K in funding. You have to personally guarantee the loan, which may not be the right fit for everyone, but if your venture is showing signs of cash flow and you need a little growth capital, this could be the right fit for you.

Grants: although I have not had much experience here, I am hearing stories of others having good success in getting government program grants. Basically this is no strings attached money that is non-dilutive. It may take some time to secure it but could well be worth it.

http://www.nytimes.com/2009/05/14/business/smallbusiness/14hunt.html?_r=1&em 

“Researchers found that venture capitalists, who screen hundreds or thousands of solicitations each year, pay little or no heed to the content of business plans. Instead, the study said, because they make decisions “under conditions of high uncertainty,” venture capitalists rely on instinct and their expertise in ferreting out information by other means to evaluate the prospects of a business. That means, the study said, that they pay little attention to the documentation from entrepreneurs about their academic credentials, work or start-up experience, previous success in raising equity capital, ability to form a top-notch management team or even how much money they want.”

I agree with this. Insofar as materials go, I advise entrepreneurs to put together a single page executive summary that covers the vision, team, business model, go to market strategy, differentiation and competition, funding sought and summary of financial projections. Next, a concise 8-10 page powerpoint designed for a 20 minute pitch followed by a detailed (although not excessive) financial model. But really that’s just the start.

Somehow you need to find a way to connect with the VC through a referral. Somone who is referred in will be more likely to get attention because that is already one sign of validation that you are part of a trusted network.

I also agree with Jeff Fagnan’s view that it’s all about validation but also about traction. I’m often asked what it means to show “traction”. Obviously it’s different in every start-up’s case.

Today I was meeting with an entrepreneur with deep industry expertise who had done a successful (IPO) startup in the mobile space targeted at large enterprises. He was now starting a new company in the same space but targeted at SMB and utilizing a more open source/SaaS approach. Great team, solid idea, already had a product up and running on <$150K of friends and family money. Already there are signs of traction – building on experience, keeping a low burn and doing a lot with very little, releasing a product, starting to get customer feedback.

We explored what the next phase to de-risk in the venture would be and demonstrate “traction” and in his case it was all about which verticals would be the first adopters, how to reach them, what the sales cycle looked like and whether they would pay what he thought he would charge. if we could see some early signs of validation here, that would greatly reduce the risks. Being able to show these metrics and the start of proving a hypothesis, in a meaningful and tangible way, is what showing traction is all about.

Utimately the VC is betting on your ability to make the vision happen. There is nothing more validating than showing and doing it. I also encourage you to keep showing updates. Even if a VC says “no” (and many won’t give you that direct an answer unfortunately) for now, you can show traction by continuing to keep them up to date on key things you accomplish.

As a former entrepreneur (I guess I still consider myself one having started Nueva Ventures to take on some of the structural problems with the VC industry) I’ve had to raise capital for extreme startups and often in challenging times.

My first venture at Adesemi Communications was to launch wireless telecom ventures in Africa, “the last frontier”, requiring large amounts of capital to buy equipment and get these networks going. We started this back in 1993, when the whole idea of investing in emerging markets was not even on most VCs radars and it was a stretch to even get an east coast VC to invest in the west coast, let alone Europe or Africa!

My co-founder, Monique Maddy, started out by bootstrapping it with corporate money – Motorola, Sprint, Hughes and a few others provided consulting money just to scope out the market to see if there might be opportunities for them to deploy equipment and services in certain markets in Africa. With that first $100K or so of essentially no strings attached capital, we were able to make progress in lining up operating partners and securing licenses.

Next we found a couple of key angel investors who understood emerging markets, the telecom sector and had invested before in very early ventures. I often use the advice “rifle target your angels”. It can be a real stretch to convince someone to invest at the earliest stage where you might have just an idea and some smart people chasing it, let alone the complexities of the technology, sales cycle and in our case country specific risks like riots, coups, out of control inflation and the likes. If they get your space, at least they can get comfortable with a big part of the risk equation. We were able to raise $250K from a couple of such angels, which made a huge difference in our advancing the plan.

The angel round was certainly not enough to draw a significant paycheck and I had to adjust my lifestyle to cope – cutting way back on expenses and living out of a suitcase for over a year given the demands of travel to our target markets. Since I just came out of business school, I was not used to much of an income anyway. Stretching my student loans was a challenge (!) but I had an understanding lender (my folks). I also found it necessary to make the occasional payroll with my credit cards, something I doubt I’d do again (and certainly not without my spouse knowing all the details) but at the time seemed like the only way. I got very good at moving balances around to take advantage of zero interest financing offers.

As we progressed, we went through another angel round but this time with seasoned VCs from the space (again who “got” our space) who invested personally after they were unable to get all the partners of their firm on the same page. We also leaned on our equipment suppliers to extend us credit and leases. We were opening up new markets for them and spun a good story that, although not without much selling effort, got us some very attractive terms.

The institutional venture rounds that followed were the result of an intense global search for capital, much of it not exactly the traditional VC path – one large fund of funds private equity investor with a side venture fund for direct investments (the founders had traveled extensively to Africa and believed in the opportunities), two European project financiers who were used to doing project finance in Africa, and a strategic partner, a carrier in the cellular space. We eventually found our investors but it wasn’t without a wide search, everything from traveling to Korea and meeting with KT for funding, meeting venture capital firms in South Africa who ended up being gun shy about doing anything outside of their backyard, and a long list of US VCs who invested in telecom but could not get comfortable with the emerging market risk.

This was a venture that required a long term investing horizon and therefore investors that needed to be aligned with that expectation. Case in point, our largest operation, Westel Ghana, which we started in 1996, was sold in 2007 in a transaction valuing the business at $175M to CelTel/Zain. A total of around $25M had been invested in it.

On to a different case study, my last startup, CDR, which did VoIP telecom to markets in Africa, was a completely bootstrapped venture. We started this in 2000 right after the dot-com bubble had burst, probably one of the worst times to start an Internet and Telecom company all in one! We decided right from the start that we’d structure it in such a way as to avoid having to raise much capital. We started the business up with one international route to Africa which needed a single Cisco AS5300 switch, which we bought on eBay for half price. I made a few brief phone calls to friends and family, asking for just $10-20K each and a quick decision – telling them in no uncertain terms that this was highly risky and they should only put in what they could afford to lose entirely. It was heartening to them that I was putting in some of my own money. Our $50K of initial fundraising was over in a half hour.

Most importantly, we structured a key revenue sharing deal with a traffic wholesaler to source and terminate traffic for us while they provided us with all the equipment and technical support we needed to expand. This meant that we no longer needed to build a big operation, could focus on our core skills -structuring carrier deals in Africa – and keep our burn way down. My CTO partner built our network management system himself from open source software, all for under $5K. We each had a monitoring server in a closet at home. It paid off handsomly as the venture became cash flow positive within a couple of months of turning on the route and grew to over $10M/year in revenues in its second year. With a tax efficient LLC structure, we provided a great return to our investors.

So what are the lessons here?

1) Think of your business structure – are there different ways to run the business that would enable you to need less capital than you think, or are you simply going to have to raise a large venture round because of the nature of your business model? In the case of CDR, structuring the revenue share deal with a key corporate partner was what made it possible to keep capital needs way down. While we had thought it would need far more equipment to build a robust, redundant and reliable network, getting up and running on just one switch got us up quickly and to cash flow and the service, while more prone to interruptions, was still far more reliable than anything else currently running in the market. We followed the mantra I often preach- release early and release often. Get something out there and going, get market feedback and adjust quickly to improve it.

2) What is the appropriate type of financing you need for the stage you are at:

- Bootstrap: The bootstrap scenario is where you have to make serious tradeoffs between using your savings and what resources you can harness at low cost. Be prepared for economic hardship and maybe load up on credit cards or a HELOC. You might think of supplementing your income by doing some non-core activities like consulting in the mean time to keep some income going.

- Friends and Family: They know and trust you so will probably be willing to write a relatively modest check to keep you going pursuing your dream. It won’t matter to them that you have no revenues or product yet, just that they are encouraging you and you will put your heart into it. Treat them generously and fairly in the terms you give (e.g., give them the equivalent of founders stock rather than a convertible note, but watch there are no weird terms that would scare away a VC later…see an earlier post I did on structuring terms). Be sure that you and they won’t feel bad if you lose their money and they understand the risks from the get go. I would say the upside here is that it feels really great to deliver a nice return to your friends and family and you can directly see the impact if things work out. I’ve seen F&F rounds of $50K-$500K.

- Angels: Rifle targeting…means finding individual investors who get your space and can add value. While some organized angel groups can be worth the effort (and I do think it is a lot of effort, be prepared) in raising some larger round sizes, I believe that finding investors in your space who bring relevant expertise and contacts to be the most valuable. I call them “power angels”. They usually make faster decisions. You might add one or two to your Board or at least make them formal advisors with some stock incentive to keep them engaged. I rarely added an advisor who did not invest his or her own capital. I’ve seen angels personally do anywhere from $10k-$1M, with typical investment sizes of $50-100k.

- Micro-cap VC: usually target round sizes of $1M as the first “institutional” capital in, done as a Series A or Series Seed round. We look for entrepreneurs who want to prove out the business model with less capital before raising larger venture capital to ramp. The advantage is less dilution at what would otherwise be a highly dilutive phase, exit flexibility – being able to sell the company if an attractive offer comes in that would not otherwise move the needle on a large VC fund, and enhancing your chances of success by maintaining a low burn while iterating the business model until the right approach is found. We often co-invest with others like us and the community is fairly small that we know most of them. A microcap venture firm should always be reserving capital for follow on needs, be sure to ask about that.

- Standard VC: plenty of talk but usually won’t be interested unless you need >$5M, have launched the product, significant ramping revenues, well rounded team and sales cycle all figured out. It’s not to say that no VCs are out there that would do a <$5M round and bend on these issues, but their incentives are tied more to capital deployment. If you are going after standard VCs, try to do some homework on the kinds of sectors they focus on and understand if they have recently raised a fund. If they raised a fund more recently than 1-2 years, it’s likely they still have plenty of dry powder to invest in new ventures versus allocating capital to existing portfolio. Traditionally the path was Angels to Standard VC, but now Micro-cap exists between them.

- Strategic Partners: I’ve had good success with securing capital from companies that are natural customers and could be acquirers. There is always a tradeoff in disclosing your state and possibly losing a key customer because they don’t think you are capitalized well enough, or even worse having your IP stolen. You have to make the call about whether there is a risk versus the possibility of funding. In cases where I did structure strategic finance, we did equipment loans on very attractive terms and in one case structured a large direct investment into a convertible note. In the latter case, we opted for a note because the company wanted to figure out if they really wanted to buy our company, yet we wanted the flexibility to pay them off if a competitor wanted us instead. That structure turned out to be very effective when the competitor bought our company. Other forms of strategic investment are NRE (non recurring engineering – a flat out payment for development work) or consulting as we did when starting Adesemi. NRE is good because it allows you to show progress in securing a paying customer.

3) What are the milestones you are going to have to meet to get past each step of the way. In the case of Adesemi, we knew that we’d have to stay in bootstrap mode until we were able to secure our first license. After that we were able to get angel funding and then progressed up the chain with our first revenues starting. Keep in mind that fundraising is time consuming – taking 2-4 months typically, perhaps longer in this environment – so you have to add time beyond when you will achieve your milestone to ensure sufficient time to raise the next round. I always like to see at least a year of funding between rounds, ideally 18 months.

4) I can’t stress enough the importance of networking in fundraising. At all steps of the way, getting referred in, ideally through more than one path, is the way to rise up above the noise and get attention. Your referral will also be able to check on status and get feedback if, as is often the case, you just don’t get a straight answer about interest or not. Find a way to get to the person you need to reach and get them to say something good about you to open the door.

5) Traction & momentum: Also at every step of the way, it’s about traction – charts showing adoption, customer testimonials, pipelines, usage metrics – what gets investors excited is knowing that something is taking off and if they don’t move on it, they will be left out. The more you can convey this excitement and progress, the better. It’s also about periodic updates…if you are targeting to raise funding from a VC later on but are not quite there yet, find a way to send a periodic update to the partner, or have an informal lunch/coffee to get their reaction on where you are at. When getting ready to close a round, it’s often a forcing function to set a date and get the documents going.

And I do believe a lot of it is luck…my best wishes as you embark on the journey. Be sure to pause once in a while and enjoy it.

It was on the topic of becoming an entrepreneur and the things you should consider in the process of making that decision. It made me think about a lot of the issues I went through as I did my several startups and having most recently started my own venture capital firm after seeing a clear lack of innovation in the space.

But more importantly, it created a framework for doing so and I find myself meeting with more and more people in Silicon Valley that are hatching great new ideas and getting ready to take the plunge to start their own business. Let me give you my two cents on the various questions the article poses:

1) Are you willing and able to bear great financial risk?

You should be prepared to go without pay or way below what you are used to making for quite a long time. My first startup in Africa doing wireless telecom, I went without a paycheck for nearly two years. It was tough, especially with all the debt I racked up in business school, and I had to make radical changes to the way I lived (basically packing up life into a suitcase) but I still fondly recall that venture as being one of the most challenging business I ever started. I would advise being sure you have savings for at least 6 months without income or have a very supportive spouse who can carry you through it. I recently heard Peter Thiel of Paypal on a panel talking about how he believed there was a positive correlation between how low a CEO/founder’s pay was and the success of the venture – low pay sets a threshold for capping other employees’ compensation which in turn keeps burn low and increases chances of success – a mantra we at Nueva Ventures strongly believe in. My second startup relied on just $80K of angel capital and in the first year we took almost no pay. Within 18 months we had ramped to $10M in sales and delivered a fantastic return for our investors.

Also be thinking of ways to drastically cut back on your personal cost structure. The more flexibility you have, the longer you can keep a buffer. When your resources are exhausted, before starting to finance the business on credit card debt, be sure you see #3 below! I racked up some serious credit card debt financing a few payrolls, something I don’t think I’d be comfortable ever doing again given more wisdom, or at least limiting it to what I could afford to lose. It was a serious issue with my wife too!

2) Are you willing to sacrifice your lifestyle for potentially many years?

Relates closely to #1 for costs but keep in mind starting a new business is going to put you on the path of some really hard work. As a small business owner, the buck stops with you and you are going to be thinking about all aspects of your business 24 hours a day 7 days a week. It’s going to be a real challenge to maintain a personal/work life balance. And just when you think things are going great, some random thing can happen throwing all into disarray. Be prepared for huge highs and lows.

3) Is your significant other on board?

Absolutely a must and probably one of the MOST important things you need to do. It’s extremely lonely being a founder and there are few people you can turn to when things are really rough. Your spouse needs to understand the risks and rewards and be part of your decision making process because this decision is going to impact the whole family – economically and emotionally.

4) Do you like all aspects of running a business?

When you start a company, whether it is venture funded or angel funded, you have to wear many hats, but most importantly you are chief salesperson. You will be selling to customers, to convince people to sign up to your vision and join you, suppliers and landlord to believe in you and extend you credit etc. Ultimately you have to get things done and use your resourcefulness and creativity to their greatest abilities. A lot of it can be unpleasant work – dealing with accounting, angry customers or suppliers, inconvenient travel etc. A lot of it can be great – closing your financing, launching your product, experiencing customers buying it and delivering returns that can change lives!

5) Are you comfortable making decisions on the fly with no playbook?

You will find yourself making decisions constantly with very little guidance. Surround yourself with the best people that you can, be generous on incentives to motivate them to join you and take risk, confide in your advisors and investors, try to join a mentor group like YPO or find others who have started businesses, even outside of your space as they can still have very relevant advice and experience you can benefit from.

6) What’s your track record of executing your ideas?

Given the vast number of decisions you will be making, you have to be comfortable managing and executing across multiple dimensions, keeping track of all that you have to do, being organized and disciplined. How well did your lemonade stand do as a kid?

7) How persuasive and well-spoken are you?

Howard Stevenson my professor of entrepreneurship at HBS defined entrepreneurship as “the pursuit of opportunity beyond the resources that you currently control”. That has stuck with me all these years since I graduated. When all you have is a vision and your talents, you have to convince investors to believe in your vision, people to join you, customers to buy your product…and when things are tough, possibly laying people off and keeping morale up for the remaining team, or getting your suppliers or debtors to cut you slack while you restructure. Given the times we’ve been through the last few months, I’ve found myself helping my portfolio CEOs do a whole lot of the latter, quite unpleasant but necessary and requiring the same skills.

8) Do you have a concept you are passionate about?

If not, don’t bother…it’s so much work that you have to be fired up about your idea as does your spouse and a host of others. I would invest significant time to get feedback on your idea before taking the plunge – talk to some potential customers, check whether someone else has tried this before, get some insight into what the key drivers of success are going to be. My entrepreneurial field study at business school was about starting a new business in the computer space. I spent a whole lot of time talking to potential customers, culminating in finding a person who had previously tried what I was going to do and failed miserably – resulting in my shooting it before investing years getting it off the ground. Time is really all you have – are you going to devote the next 5-10 years on this idea or are you better off doing something else. How will you feel if at the end of 10 years your venture fails?

9) Are you a self-starter?

In the face of discouragement, you have to find inspiration and energy to keep going. I’m convinced it’s a key factor – you have to able to react constantly and decisively to correct course.

10) Do you have a business partner?

Maybe not necessary at the beginning but it sure helps to weather the ups and downs to have someone else as closely involved and experiencing all you are going through to relate. The next closest thing is your spouse or perhaps an experienced friend you might convince to invest in you and be your mentor.

I have to say what keeps me going is having often tasted failure and learned from it, I’ve also tasted success and know just how great that feels. I love being able to be in control of my own destiny, feeling challenged like nothing else – whether things are going well or not – and inventing something new that customers appreciate and buy. And of course there can be the financial rewards and good feelings knowing you are creating jobs in this bleak economy!

I personally use LinkedIn a lot for networking and opening doors. I think you get out of it what you put in – make the effort to do a detailed profile so people can search and find you, keep it up to date and link up with others. I find myself using Linked-in a lot more than Facebook for my professional work. When I finally made the commitment to really use it a year or so ago , I used the LinkedIn tools to upload my contact database and scan my e-mails for contacts which provided the fastest way to get going and link with others.

http://blog.guykawasaki.com/2009/02/10-ways-to-use.html

Another good resource to use is the quarterly publication of venture funded companies put out by VentureOne and the San Jose Mercury News. This one lists all the startups in the Bay Area that got funding in Q4, how much, what sector they are in and which VCs did the round. These startups secured funding so are likely hiring but may not be listing job openings so you might use Linked-in to connect with a VC that funded them or an executive in the company in your area of expertise.

http://www.mercurynews.com/vcsurvey

The Q4 fundings are here:

http://www.bayareanewsgroup.com/multimedia/mn/biz/specialreport/vcchart_q42008.htm

It was quite fascinating to me to hear Spencer talk of the history and strategies followed some 50 years ago. How the industry was formed on investing tiny amounts of capital, intensely nurturing those startups and bringing the right mix of talent in to scale the business up, and the returns brought about by investing early at low valuations and high corresponding multiples at exit.

One of the questions asked of Spencer was how the General would see today’s VC industry as compared to that of when he started. He commented that there has not been much innovation in venture capital in the past two decades. Many in the industry have enjoyed “sitting on their laurels” while returns to LPs have declined. The sheer size funds have grown to and number of firms seems too large to be able to deploy all their capital across the best startups. With the exit markets the way they are, too many billion dollar sized exits are needed to make these funds return capital. That’s not going to happen anytime soon.

At the end, he expressed that if he were going into VC today, he would be aiming to raise a micro-cap venture fund, investing $500K sized amounts at the earliest stage, injecting the right mix of DNA to help it be successful and being flexible in today’s exit market- exactly what my vision was for Nueva Ventures when I started it 5 years ago.

As a serial entrepreneur, I experienced firsthand in raising capital the large disconnect between the amount of capital standard VC wants to invest and what is really needed to prove out certain business models while maintaining flexibility in today’s exit market. I felt the VC industry had not scaled well and a new model – or perhaps more of a return to the way the industry started out – was necessary to overcome the challenges of today’s market conditions.

So what is a micro-cap fund and how are we different?

I’d say there are a few things that destinctly characterize a micro-cap fund and why as an entrepreneur you’d want to consider taking money from one versus standard VC:

1) A micro-cap fund makes $250k-$1M sized investments in a startup. They offer a far more efficient fundraising path than pooling angel capital and they are usually managed by full time partners whose job it is to work with their entrepreneurs much as General Doriot did in mentoring his companies. Standard VC has effectively abandoned this sized investing because the economics of their fund sizes and demands on time are such that it cannot work for them.

As an entrepreneur, I would say your job is to eliminate risk as efficiently as possible. If you eliminate risk with less capital, you can conserve more upside. Today’s cost of technology, outsourcing options and distribution channels offer a more efficient path to prove out a business model before ramping it. Why not take the least amount necessary, albeit maintaining a prudent amount of runway, to prove out the business and then be in a great position to raise larger ramp capital at a better valuation once that milestone is achieved? Such a path also preserves your exit options. If you take $10M from a standard VC, it might be hard to convince them later to sell the business for $50M (making them say a 2x return on investment) while you may really think that is the right strategic move to make at the time. A micro-cap fund could make a 10x return on such an exit and would be more inclined to seriously consider it.

Furthermore, taking more capital than you need can actually decrease your chances of success. It encourages hiring more people and building large overhead, raising your burn to such a level that makes it hard to rapidly change course if things are not working as planned (and they won’t!). It can make you over develop your product and lengthen time to launch iterations since you feel obliged to get it all right before launch, avoiding getting critical market feedback early and often.

2) Micro-cap funds can make smaller sized investments because of the way they are structured. They typically have $10-25M of capital under management per partner, compared with $50M for standard VC. While the focus in both cases is on homerun potential startups, the micro-cap fund gets in earlier and has higher return multiple potential. The ones who make the most money are usually the first ones in – e.g., Andy Bechtolsheim’s legendary $100K seed funding in Google worth $1B at exit. The exit economics and lower fund sizes are such that doing smaller investments earlier can move the needle on a micro-cap fund’s overall return.

Now come the economics of the fund: why would a fund manager choose to manage $50M versus $10-20M? It comes down to fees – it is more lucrative to be guaranteed to earn a 2.5% management fee on $50M than on $10M, especially if you are not delivering ROI and earning a carried interest which kicks in only after returning all of the original capital of the fund! It’s also a lot nicer to have a fancy pants office with an army of administrative and analyst support staff, and the perks – attending fancy conferences, travel, etc.

Making a small fund work means deliberate and frugal choices about how to run the fund – just like the entrepreneurs we back. I don’t have an administrative assistant and book meetings myself (I find this more efficient actually), I use a lot of low cost technology to support a highly streamlined operation, I do the accounting myself as a former CFO and I do the detailed diligence myself while once in a while consulting with experts in my network who are happy to help out for free. I really don’t need much of an office because most of my time is spent up and down the valley meeting with entrepreneurs and our portfolio companies at their offices – I get to see firsthand how they operate and if they are up to bootstrapping. I know that I have a greater part of my compensation directly tied to delivering return to my investors, totally aligned with their incentives, and can live with that and look forward to a decent carried interest return eventually if I do my job well and luck is also on my side.

Many VCs forget that ROI for a venture fund results when there is a large numerator and as small a denominator as possible. That means getting into a startup very early on in its formative stage at a low valuation, backing entrepreneurs who can prove out the business model with less capital and being able to make returns on what may amount to lower exit values than has been traditionally the case. An entrepreneur should not be bragging about how much venture capital they raised. It just makes it that much harder to generate ROI.

3) Most micro-cap funds practice the same sort of “hands on” value add as a standard VC. While there are many best of class angels who do the same, often it’s hard to get that same professional attention and help as you go through the trials and tribulations of starting and managing a new business. In our case, we want to be part of your Board, we’re dedicated to being there when times are tough and choices unclear, we help you find talent and resources.

The one key difference is that an early stage investor, closer to seed financing, is going to face a higher rate of failure. We take that into account in terms of how we can allocate our time efficiently across a portfolio and the expected rate of attrition freeing up time. A micro-cap fund has to do more investments, we think 2x as many as a standard VC, because of expected attrition. This has to be carefully managed such that at the end of the day we follow industry norms about how many companies we can be involved with. Standard industry rule of thumb is no more than 8 board seats per manager. Sometimes I feel that even 8 may be too many given the intensity of involvement at the early stage of the start-up’s life. Working back from that number, translating it into how many investments each manager can therefore make and how much capital that means is needed is the way we calibrate our fund size.

This gets us to a key issue – why the VC industry has not scaled well. I believe that the fee driven approach to raising ever larger funds has moved most if not all standard VC up to doing later stage investing or to encouraging putting far too much capital in at the early stage, a “capital deployment strategy” per say rather than a prudence strategy of de-risking a business. This has created the gap that exists today in raising capital between $500K – $2M. Too big for most angels and too small for standard VC.

I’ve been in the entrepreneur shoes and I’ve been tempted quite a few times and have taken the larger capital offered by the “capital deployment strategy” – the rationale being if I’m going to be diluted only a little more, why not take the larger capital amount. My experience has been that taking that larger amount resulted in ramping our burn, making us far less able to iterate and change our strategy and product quickly, and put us on a path to having to exit at a huge number. My most successful startups (both from experience as an entrepreneur and investor) have been those that took the least amount of capital and focused on proving out the business model first.