I am going to serve on a panel and answer some questions. I thought I might post them here and let you respond and see what you think. The questions are in italics. My answers are in type.
What is your perspective on the current state of the VC market, deal flow, etc? How are things looking in the Midwest in particular? How do you see the volatility in the public equity market affecting venture investing? How is the LP/fundraising atmosphere for early stage investing, i.e., are institutional and similar investors bullish on this asset class or migrating to safer havens?
I see the VC’s as becoming more active. However, only a few of them are reaching down to the angel level. Sandbox, Apex, and New World. We are seeing more super angels, Lightbank in particular. JB Pritzker also is a super angel. Increasingly, the private deal flow networks that existed are turning to angel networks. There are some active angel networks in the midwest.
What are the current trends you are seeing in VC/Angel investments? Smaller deals vs. larger deals, down/up rounds, early/later stage rounds, different terms or financing structures, etc..
Trends, no one likes a down round. I see entrepreneurs coming in with higher expected valuations, but we aren’t paying them. The deal size is about the same, but I see more syndication. Groups are more willing to work with each other. I also see angels completing more earlier rounds, and then VC’s taking over later rounds once valuations get over 7-8m. If you want angel financing, be prepared to rigorously defend yourself if you want more than 2M pre-money.
What types of exit strategies are available to consider and how important are they to a venture capitalist? How important is it for the founders to map out their exit in marketing materials?
You should have a potential exit in mind when you pitch your business. Angels need to know how they can at least expect to get out. This gives them a basis to value your company on exit-at least they can look at similar multiples. But, I wouldn’t be married to the exit. Businesses change, and plans change. Markets change. It is only a guideline. Also, the world cannot be bought by Google, so have a real exit strategy.
When VCs value a company, what techniques do they use? How important are projections, and what level of backup/validation do you expect to see (e.g., should companies be seeking third party valuation?)
Angels will use different techniques than VC’s. 99% of our companies don’t have cash flow. So it’s all about feel. We use a target. More than 2 million in valuation, you ought to have some real customers and cash flow. Most angel funded companies will be under 2 million. We look at comparables where they are relevant. But, a lot of comparables don't make sense. If we can't come to some general agreement on valuation early, we won't invest.
What really stands out in offering books/PPMs - anything critical (testimonials, customer reviews, etc.)? E.g., I often see companies focus on how unique/revolutionary their product is, but not enough focus on their competition. Competition can be a positive thing and can validate the market. Thoughts?
What stands out to me is data. If you say you have proof of concept, show it. For example, in a consumer product I don’t want to hear about if you sold it into stores or not. I want to know about inventory turns in that store. There are few consumer products that are revolutionary-most are variations on things that are already tried or out there. Why are you different than the competition, and why are you going to win? A lot of consumer products will get picked up by Whole Foods. That's nice, but how did they do? Did customers repeat buy? Did Whole Foods expand distribution?
I also want to know what happens to your cost structure when you scale. If your product is a smashing success, what happens to working capital? What's it take to get to scale? What happens?
How important are advisors who help companies raise capital, and for companies that are using advisors, how should they maximize value from that relationship?
Advisors to the company only matter if they have significant domain expertise, and are willing to leverage their networks to help the company. It also helps if they write a check and have skin in the game.
What should the early stage company expect in the due diligence process? How can they best prepare in advance?
What should you expect? Background checks, reference checks. We might even want to speak with someone that had an adverse relationship with you. We want to know about your successes,and your failures to see if you learned anything. It's frustrating, be patient. We are assuming a long term risk.
How important is it for the founders to contribute their own capital to the venture?
I won’t invest in a company unless the founders are committing some capital. Even if they don’t have money, they need to show that they have skin in the game other than their time.
For consumer products businesses, royalty-based financing (e.g., percentage of revenues up to a fixed multiple) can be an alternative to straight equity? Is this something you see catching on in the investor community, and should early stage companies be looking harder at this model? Where does it make sense (or not)?
We don’t like royalites. We are not in the business of financing a lifestyle business. We want debt or equity and want to sell the business at a greater value than where we invested.
Governor Quinn recently signed new legislation which increases the treasury allocation to venture/technology investments? How has this program been perceived in the investor community? Is this for real or for show in your view?
Gov Quinn’s legislation is perceived differently by different people. For myself, I think it’s window dressing. The tax and regulatory environment has a lot more to do with start ups than Illinois treasury allocation to venture investments. It would be smarter for him to offer permanent tax relief to corporations and individuals that have a lot of expertise to do these investments rather than the government which doesn’t know much about anything.
Many of you may have heard about the federal tax stimulus that creates a potential capital gains exclusion on exit for certain qualified small business investments? The program expires in December 31 of this year. Is this something that is (or is likely) to motivate investors? Given all of the hoops/hurdles for qualifying, are investors viewing this as a long shot? Or should all early stage companies convert to a C Corp structure to take advantage of this potential tax benefit?
It’s not a good business strategy to tailor your business to a federal statute or tax program. One stroke of the pen can wipe away your business. Structure your business to take advantage of the market. If being a C corp is more advantageous for you, then be a C corp. Most VC’s will only invest in C corps or will require a conversion once they make an investment. LLC’s also have advantages and weaknesses. Structure your business to derive the greatest all in benefit from the market: this takes into account who your potential investors are and your core go to market strategy.