Should Startups Move?

TechCrunch has an interview posted today focusing on whether startups should move locations (presumably to the Bay Area, but perhaps Boston or New York) to be closer to venture capital investors. The answer (in the interview at least) is no.

I often get this question from founders and entrepreneurs in the Atlanta area and my answer is generally no, as well. Although there is a well documented capital shortage here in Atlanta, that is mitigated by (1) the region's surplus of skilled technologists (esp. Georgia Tech grads), (2) the limited number of competitors for such capital and (3) the easy access through Hartsfield-Jackson to venture capital centers nationwide. It is just a day flight, even from San Francisco.

Admittedly, some entrepreneurs have chosen the path of relocation for various reasons. But many more have built strong businesses here in the Southeast.

Volatility's Impact on the Venture and Angel Markets

This has been a tough week for the markets. with the DJIA down more than 10% from a month ago, and gyrating by 200 to 400 points a day.  I've read multiple comments on the impact of the pullback and increased volatility on private markets and the consensus seems to be that there is none-- it is not clear whether venture investors will pull back, keep investing or run for the hills.  A few thoughts that might impact the decision follow:

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2011 to be Breakout Year for Venture Capital

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By John Hurley, Senior Executive, DLA Venture Pipeline. John Hurley has advised hundreds of emerging growth technology companies on various aspects of their business plans, including management and recruiting issues, market development, strategic partnerships and financing strategies. He has helped more than 50 firms raise capital through DLA Piper's collective global network of angel, venture, institutional and strategic investors.

If the first quarter of 2011 is any indication of things to come, the Venture Capital market in 2011 may have a breakout year.  In Atlanta, for example, Venturesource reported 17 transactions for a total of $187M in venture financing in Q1 2011 vs. 11 transactions for $66M in Q1 2010. The success in ‘Q1 can be attributed to three key factors:  (1) an improving Venture Capital exit market; (2) a strong Venture Capital fundraising; and (3) an increasing size of Venture Capital investments. 

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Term Sheet Tips: Effective Valuation and Warrant Coverage

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Early stage entrepreneurs often get caught up in negotiating valuation while failing to consider the impact of other critical terms of a financing transaction.  There is a great post on Venturehacks about the impact of an oversized option pool on a Company's effective valuation (i.e., the valuation that would put the founders in the same position as without such deal term).

Warrant CoverageThe same analysis can be applied to warrant coverage.   See our previous post "What is a warrant?" for background.

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Startup and Venture Impact on the Atlanta Commercial Real Estate (CRE) Market

Below is a guest post from Brett Kingman, Assistant Vice President with Colliers International. 

As Ross Moore, Colliers International's Chief Economist, reports in his article "Venture Capital Slowly Trending Up:..", venture capital investment is slowly trending up and creating new demand for commercial space.  However, most of the activity is happening in....you guessed it, Silicon Valley.  Silicon Valley companies have received 42.4% of the new venture capital invested thus far in 2011, out-pacing their 33.7% long-term average.  While the Southeast, and more specifically, Atlanta, is currently underperforming against their long-term average, large funds are being raised by the likes of Noro-Moseley, TTV Capital, Fulcrum Ventures, and others.  With these new funds and Atlanta's contingency of FinTech, Internet Security, and Healthcare IT companies, we expect venture capital investments in Atlanta to increase within the next 12 - 24 months.  As these early-stage companies receive capital, the technology industry will continue to lead the way in the commercial real estate recovery by backfilling a good portion of the currently vacant space.

Measuring VC Excellence

An interesting post on TechCrunch today (here) describes a new method of ranking VC firms -- by network connections, meaning the extent of the fund's co-investment.  I'm not sure (despite the cited research) that this is a particularly useful approach, given the myriad factors that contribute to syndication (including fund size and preferred investment size and round, which would strike me as not necessarily correlated with performance), but it is an interesting list which includes the following funds:

  1. Andreessen Horowitz
  2. Sequoia Capital
  3. Accel
  4. Benchmark Capital
  5. Union Square Ventures
  6. General Catalyst Partners
  7. NEA
  8. Kleiner Perkins
  9. Khosla Ventures
  10. Greylock

Sequoia, General Catalyst, NEA and Kleiner have all invested in Atlanta companies.

Has the VC cycle shortened?

My partner Jeff Leavitt presented on the state of the VC market at Atlanta Venture Form on Wednesday.  His presentation is below:

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Jeff posits that there is a specific venture capital cycle, where the market moves from free-fall, to bottoming out, to "firming," to acceleration.  He theorizes that great companies are often established during the "firming" stage, including Microsoft, Apple, Amgen and Facebook.  Of course, denoting the stages of the cycle is most easily done in hindsight.  In his presentation, Jeff suggested that -- although virtually everyone had thought that Q3 2010 was the transition from bottoming out to firming, we may have already passed through the firming stages and are headed straight to acceleration.

There are many other great insights in the presentation, but the possibility of a shortened VC cycle (and an earlier-than-expected bust) is perhaps the most intresting, especially given all of the discussion on blogs and elsewhere regarding an impending social media bubble.

 

Convertible Notes as a Seed Financing Strategy

We often counsel clients at the seed stage to explore the convertible note structure, where the company issues $X of notes, at a mid-level interest rate (usually 8-10%).  The notes typically mature in 12-18 months, and automatically convert into shares issued in a preferred financing before the maturity date, at a discount (typically 15% or 20%). 

What are the advantages of the convertible note structure?

- It delays valuation -- the company trades the discount on the Series A for the ability to hit additional valuation-adding milestones between the closing of the notes and the initial closing of the Series A.

- It is typically faster than an equity round, with fewer documents (often just a loan agreement and notes).

- Especially on the East Coast, where accruing dividends are common, the interest rate mirrors the preferred dividend and is not an additional cost of capital.

- Its cheaper -- a convertible note round without too many bells and whistles can usually be lawyered for between $5k and $10K, whereas even the simplest "form" Series A costs more, as Fred Wilson has pointed out.

- Investors often like it because they have more security in the notes (especially if they are secured notes) than they would in holding equity.

The downside?  A company's bridge can turn into a pier-- if the notes never convert into equity because a preferred round is never completed, the noteholders have an enormous amount of power to foreclose (if the notes are secured), to cramdown the common holders and/or to push the company into bankrutpcy.  Alternatively, if an equity round takes too long to materialize (or the milestones are not hit), the new investor is likely to treat the notes as coming in on a pre-money basis, making the discount that much more painful.