“Smart money” the key to take start-up to round 2

Published in UT San Diego, August 5, 2013

Crossing the chasm, a phrase made famous by Geoffrey Moore, relates to the problem early-stage companies face as they try to take their product past the “early adopter” to the mainstream customer.

Today, there is a new chasm — and one that is equally wide. The new chasm is the one between the initial $500,000-$600,000 angel round and the infamous Series A round of $4 million to $6 million. And it is that Series A round that is scarce and expensive. There are a multitude of reasons for that, but this column is not about venture capitalists. This one is about the entrepreneur.

In Wired.com, Ryan Tate wrote a column in which he cautions that Silicon Valley “startups fattened by plum valuations and hefty bankrolls in their infancy are finding nowhere to turn when the money runs out.”

The movie “The Fly” said it best. “Be afraid, be very afraid.”

Ben Horowitz, managing partner at a very famous, powerful and rich venture firm, Andressen Horowitz, blogging on the Fortune magazine website, compared startup founders to the captain of the Titanic, warning them that the funding environment could change “radically” and advising those burning through cash to “swallow your pride, face reality and raise money even if it hurts.” And of course that means at a lower valuation than you convinced the original angels to invest at — in other words, the dreaded “down round.”

The financing environment for startups has changed, says Horowitz. Valuations are down in part because there are a plethora of early-stage companies all standing at the door begging for the reduced amount of food from the reduced number of venture firms. Welcome to Econ 101 — the concept of supply and demand.

And frankly, in my humble opinion, the entrepreneurs have only themselves to blame. To quote that great thinker, Pogo, “We have met the enemy and it is us.”

To some extent this phenomenon is a function of the massive increase in “incubators” like Y Combinator, Tech Stars, Tech Coast Angels, EvoNexus, StartUp Leadership, and Founders Network. The world is awash in organizations anxious to give advice to the aspiring entrepreneur, as well as on occasion to write checks. And so the entrepreneur has begun to see himself as a rock-star persona and so demands a higher valuation as well as only blue M&Ms in his dressing room.

“You saw where seed rounds would have valuations of $10 million or more — for really raw startups,” said Josh Stein of Draper Fisher Jurvetson. And that is not sustainable when the next round of capital is going to come from the “professional” investor.

Barbara and I have often ranted about “smart money” and the imperative that the startup entrepreneur vigorously looks for it. It is always expensive but you get what you pay for. It comes with a network and a Rolodex and the scars from previous companies, some successes, some failures. You can’t buy that at the five and dime.

Lastly, a short comment on the D-word — dilution. Ignore it. It means nothing. It’s better to have 0.00465 percent of Google or Facebook than 74 percent of Manny’s Deli. Never bet against the macro. Play for the grand slam, the big inning. You can hit singles when you get old and need a walker to get to first base.

Rule No. 265

“If you can keep your head when all about you are losing theirs” either you don’t understand the situation or you are very smart.

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