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Pennsylvania Fearmongers Attack Crowdfunding.

Hopping Mad as Commissioners Go Over the Line.

This is a re-post by David Drake of LDJ Capital & The Soho Loft.

A shocking press release hit the net last week, purportedly from the Pennsylvania Securities Commission. The link to the “advisory” goes to http://www.psc.state.pa.us, but that site doesn’t seem to host a copy. Even so, if the press release is accurate, it amounts to an unfair characterization of the JOBS Act and new Crowdfunding regulations.

Crowdfunding under the Act is portrayed as creating a Wild West style free-for-all that will attract fraud and con artists of all stripes. They cite the current lack of hard and fast rules to govern the sector and then assume no rules will be in place before next year’s launch. That’s nuts.

Here’s a typical quote:

Commissioner Steven Irwin summarized, “The way the new law was written, it’s pretty much ‘Buyer beware.'” He added, “It’s not that we don’t need new incentives to attract more investments in startup companies. It’s just that the lax oversight implicit in the new law is likely to attract people trying to game the system and scam people out of their hard-earned money.”

Excuse me?  RocketHub has had zero fraud incidents since launch in 2009. 

The plain fact is that we do need a new structure to help start-ups. Crowdfunding and micro-financing is an ideal way for new investors to participate and energize our sluggish economy. Small entrepreneurs find themselves shut out of the game. A game that already has its critics.

Take a look at the analysis of VC opportunities as they exist now – you have the WSJ exposing a scheme where GP’s rake in the major profits while late-comers to an investment bear the burden of more risk and lower rewards.

A history of overblowing risks!

It seems the PASC takes their watchdog role very seriously. They did a similar warning back in 2010, only then it was another piece of federal legislation: PA Regulators Warn: Investor Scams, Like Flu Virus, Will Mutate to Adapt to New Federal Financial Reform Bill. Here are some of the entries on their top ten list of investment traps then: ETFs, forex, gold and precious metals, “green” investments, and oil and gas.

It seems their motto is, “panic first.” And that may be their charge. After all, as a state run commission, they should have one eye on regulations and another looking out for scofflaws. But this latest hit piece goes too far.

Of course there needs to be rule-making to regulate the Crowdfunding market. Everyone agrees on that.

Of course disclosure and investor protections have to be front and center.

And read what Pennsylvania Securities Commission Chairman Robert Lam had to say in their Spring Bulletin: “The Internet is a powerhouse, and maybe – just maybe – Crowdfunding will be a good thing once it matures and we have some ground rules in place.” Somehow Mr. Lam moved from cautious optimism to fear monger – while the rules are still being written at the SEC. At the risk of being repetitive – That’s nuts.

Our real concern isn’t about one small department in one state. Our concern is that this mischaracterization of Crowdfunding will catch on without those in authority positions doing their homework. Crowdfunding is worthwhile and it offers something no other framework can – access to funding for those too small to interest VC players.

Good ideas and good companies deserve a chance to present their case to the public, and the public deserves a chance to reap the rewards.

A turf war between federal and state regulators shouldn’t have the ability to libel an entire market. Should it?

One editorial comment: The very essence of crowdfunding, aka the crowd, is the built-in protector acting on behalf of all the investors, aka the crowd. The crowd will quickly, in fact virtually instantly, call out the fraudsters and the system gamers before any crowdfunded offering gets off the ground. Um, that is the whole idea behind crowds.

So, my question is, would you rather place your $100 in the hands of a Wall Street banker to invest in, I dunno, Proctor and Gamble? Or, would you rather place it in the hands of the next Facebook, with the support of 1,999 others (aka a crowd)?


10 Tips For Entrepreneurs.

Major magazines and bloggers are always interviewing successful startup CEOs about how they did it, and what advice they have to offer young entrepreneurs who are just starting out.

Just starting out to do what, I wonder. If they are just starting out to build a company from scratch, the successful startup CEO is usually full of tales about following your dream, doing what you love, 80 hour work weeks, living on pizza and diet coke, constantly begging for money, going without salary for months, squeezing friends for sweat equity participation and trying and failing a hundred times to get his vision off the launch pad.

Sounds like so much fun that I am amazed that not everyone in Grad school is licking their chops for an opportunity to do it as well. Though, given the economy and the rapid development and adoption of social network technologies, there are more and more students and young professionals taking the startup leap every day. Deal flow in Silicon Valley has not been bigger since the early days of the dotcom bubble in the late 1990’s and 2000.

So, for the hordes who are taking that leap, what are the best tips that will guide them and be useful to their experience in trying to bring a new company to life? I am asked this question a lot. Having started several companies and taken 3 of them to successful exits, while the 4th is still a work in progress, I think I have learned some pretty simple rules for launching a startup, and particularly in today’s funding reality. These 10 tips are not the usual business-school guidance, but rather the pure, unvarnished reality of what you need to do and be, in order to launch and fund a successful startup:

1) Fierce determination and the ability to see the truth is GOLD. Good entrepreneurs never, ever give up, and they always, always adapt their plan to what works, while rapidly abandoning what doesn’t work, no matter how much of their ego is invested in the outcome. Think Bill Gates. And, nothing ever goes according to plan. Self-delusion is very bad in startups, and it will cause you to squander precious capital chasing great technology for which there is no market. Or, big markets for which you have no useful solution.

2) If you have a vision for something that hasn’t been done yet, stick with it. People don’t know what they don’t know and they don’t want what they haven’t seen. Facebook? Really? Pinterist? iPADs? Instagram? Really?

3) Know who you are. And who you are not. Don’t try to understand how the berries actually grow in Legal, Finance and Compliance. Think Mark Zuckerberg. Hire good lawyers and accountants when you can afford them. Look in the mirror. That’s who you are. Be that.

4) Become a great story-teller. Learn how to tell your story to investors in 15 minutes or less. Unfortunately, you must use PowerPoint. Never read from the slides. Pictures are worth thousands of words. Think about what you’re doing as if you were showing a trailer to a film and you want the audience to come see it. Think about all the trailers you’ve seen and make your pitch as compelling as the best of the best. Top Gun would be a good place to start. If this is your trailer, is your audience going to be interested in watching the film or not? Think Steve Jobs. If you can’t tell a convincing story, you’re done. You don’t get the second date. It’s like speed dating, and you want to get to the real date. That’s what pitching to investors is about today.

5) What is your story about? People (and VCs are actually people) love and, more importantly, remember stories. Make it your story. Personalize it. Make your product or service come from your own experience. Why you needed to bring this to market and why it will change the world. It also needs to solve a really big problem, and one that VCs can relate to even if it doesn’t affect them personally. Your challenge is to bring your story down or up to their level of understanding, empathy and sensitivity. Create the “Ah-Hah” moment for them, so your story sticks in their minds. There is a ton of deal flow, and your story needs to rise above all those other business pans. The great news is that if you can do this well, you will find very few competitors. It is also what will set you apart as a leader.

6) Have a really great team. Not for the VCs, though they always fund the people over the plan, but have a great team for you. Your idea is not the company. Your team is the company. You are not the smartest guy in the room, and you can’t do this without them. You may have the vision or the technology or the marketing savvy to create huge markets, but without all of the other moving parts, you will not bring anything to market. If you are in love with your team, your investors will get it and if you aren’t, they will get that too.

7) Get the money. Many entrepreneurs get fixated on the size of the raise or worse yet, the valuation. You may believe that your amazing play is worth millions pre-money, but the fastest way to kill a deal is to come in with a term sheet that’s says you know nothing about how to valuate a startup. No one else does either by the way, but the key is reasonableness (just like in life) and VCs want to see a reasonable leader put forth a number that makes sense. If your revenue projection is conservative and it says you will be at $5M in 3 years and it will take $2M to get there, a fair pre-money valuation is probably $5M, which means you are willing to give up 40% of your company to get the money to start your dream toward reality. That doesn’t mean you should start at $5M, but it also doesn’t mean you should start at $12M. If you have pitched your deal 40 times and you find one VC willing to invest $1M, modify your plan so that you can make that $1M work.

8) Keep your powder dry. Just because you raised that $2M, doesn’t mean you have to spend it. Be really frugal. Pretend it’s your own money. Constantly ask yourself whether you would spend your own money doing whatever. Enlist other people in your dream. Now that you are a great story-teller, that should be easy. Get them to work for a lot less than they think they can or should. If they won’t, they don’t belong on your team. This is a startup. It isn’t GE.

9) You will make bad decisions. It’s OK. Recognize them when they happen and correct them really fast. Acknowledge your screw-ups to your team. Explain what happened and why you will never do that again. You will all learn.

10) Enjoy every minute of it. Work 80 hour weeks. Live on Pizza and coke. Push yourself beyond your wildest imagination. Lead. This will never happen again. Not this.

Best of luck. You will need all of it you can get.


The Disruption of Venture Capital.

“…most often the very skills that propel an organization to succeed in sustaining circumstances systematically bungle the best ideas for disruptive growth. An organization’s capabilities become its disabilities when disruption is afoot.” – Clayton ChristensenThe Innovator’s Solution

In November 2005, Paul Graham wrote an essay titled “The Venture Capital Squeeze.” It had been over five years since the Nasdaq peaked in March 2000, and it was becoming apparent that VC firms were having trouble deploying the tens of billions of dollars they raised during the boom years. Graham argued that the proliferation of money combined with the decreasing costs to start a business were making the VC job more difficult, prophesying significant changes for the industry. He was right.

Over the years, venture capitalists have been some of the most ardent students of disruptive innovation. Large pools of capital have been funding risky ventures since antiquity (for example, when the wealthy Marcus Crassus backed an upstart Roman general named Julius Caesar). The industry was born in its current form, however, when the first venture capital firms were founded in the middle of the twentieth century. In a relatively short time, venture-backed companies have grown to account for over 20% of US GDP today. The best VCs have successfully identified major industry disruptions before they occur. Nevertheless, recent attention garnered by start-up accelerators, micro-VCs, and angel investors has led to a new debate: is there a wave of disruption in venture investing itself?

A key constraining resource in traditional venture is a VC investor’s time. This means that a performance metric every investor must consider is time spent / capital invested. Hedge fund investors who deploy capital in large and liquid markets can scale their time well. Bill Ackman‘s hedge fund Pershing Square, for example, has $9 billion in assets under management and fewer than ten investment professionals. VCs, on the other hand, are finding it increasingly harder to scale because the declining cost to start a business means that VCs must invest in more companies just to deploy the same amount of capital. In response, they can choose to participate in more deals or bigger deals. Often, the latter wins because most VCs will spend a substantial amount of time evaluating a deal, regardless of deal size. Money scales, time spent on analysis does not.

The business model innovation of accelerators is that they have a systematized selection process that is akin to the application process for college. Because of the limited investment that accelerators offer companies (usually less than $40,000), they can evaluate business plans and founding teams more quickly than traditional venture investors with arguably less risk. Accelerators with a handful of full-time employees and no limited partners will accept dozens of companies each year. Where accelerators fall short is in leading investment rounds deep into the company’s lifecycle, the purview of traditional venture funds. However, accelerators are capitalizing on thedecreasing costs of starting a business, new thinking on how to run startups, and the increasing importance of mentorship to take companies further down the path towards success — even with smaller check sizes. Organizations such as Y Combinator and TechStars have become magnets for some of the most talented US entrepreneurs by providing expert guidance with limited funds. Additionally, being anointed by a top accelerator is a mark of achievement, similar to attending a top university, that propels the credibility of the founders.

Ultimately, industry disruption will be measured by the ability of accelerators to capture an increasing proportion of industry returns. This entails accelerators moving upmarket. Y Combinator and TechStars have demonstrated that systematized programs are highly effective for startingcompanies, but it is unclear whether they will ever be effective for growing companies. By nature, accelerators will be able to place more bets than traditional venture firms, but accelerators cannot yet place the big bets that generate the lion’s share of industry returns.

Companies that successfully graduate from an accelerator program still need significant amounts of additional capital to grow. Though a VC might invest in hundreds of companies, most returns come from finding and growing a handful of startups, such as Facebook, Groupon, Zynga, and LinkedIn. There are parallels with the music, publishing, and movie industries where returns are still largelydriven by blockbusters rather than the long tail. Firms with the appetite to maintain their ownership stake through follow-on investments will capture significantly higher aggregate returns (though lowerinternal rates of return) on the blockbusters, even if they enter in later, higher valuation rounds.

To disrupt the larger ecosystem, accelerators will need to evolve their models to push companies through later stages of the business lifecycle. Accelerators might be able to accomplish this task by raising internal funds (which can be tricky) or establishing non-traditional funding partnerships. On the latter, we will be carefully observing how developments such as Yuri Milner’s Digital Sky Technologies — and, more broadly, the entrance of hedge funds and large institutional investors — will affect the landscape of startup financing.

In classic cases of industry disruption, such as in steel or airlines, incumbent firms have tens of thousands of employees. But VC firms are small places, and even the largest ones only have a few dozen investment professionals. They are acutely attuned to disruptive innovation, and their size makes them nimble. Still, being astute and agile does not guarantee immunity to disruption. Darwin puts it best: “It is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change.”


Dow Jones Said VCs Had a “Lackluster” 2011, Recession Still in Effect.

Don’t let the good times roll just yet, Silicon Valley:  Analysts at Dow Jones are saying the effects of the 2008 economic crash still haven’t worn off for venture capitalists. This is actually a good thing for the industry as weaker performing VCs fail to raise new funds and are squeezed out in the process.
While U.S. VC funds finished the year with a strong fourth quarter of fundraising, funds raised by VCs during 2011 came in at barely more than half of the 2008 total.
“The industry has not yet bounced back from the recession,” said a Dow Jones spokesperson in an email.
The numbers for 2011 were slightly higher than those from 2010 (by 5 percent, to be exact), though that was largely driven by activity in early-stage funds. All told, 135 U.S. venture capital funds raised $16.2 billion, representing a 12 percent decline in the number of funds raised this past year.  Fundraising for the fourth quarter alone came to $5.2 billion — that’s more than the total funds raised during the second and third quarters put together.
While the state of VC fundraising in the U.S. could best be described as “meh,” the story in Europe was even less positive.
European VCs, said Dow Jones, hit a record low in 2011, when 41 funds raised just $3 billion in 2011.  This represents a year-over-year deep decline — a 20 percent drop in the number of funds raising cash and an 11 percent drop in the total amount raised.
We asked Dow Jones for some historical context — just how much have funds dipped and surged since the 2008 crash? “You’ll see that investment in early-stage and multi-stage funds dropped significantly between 2008 and 2011,” said a company representative, who kindly provided us with data for the graphs we’ve created below. “Later-stage funds, however, are faring better in terms of capital collected having raised $4.7 billion in 2011 versus $3.9 billion in 2008,” the rep concluded. “The drop in the number of funds collecting capital is also notable and shows consolidation in the industry.
In 2008, 205 funds won commitments from Limited Partnerships. In 2011, 135 funds won commitments.”


“While brand-name firms are able to raise funds, most firms face significant challenges in fund-raising,” said VentureWire editor Zoran Basich in a statement.

“Limited partners remain wary of the industry after a decade in which returns have not matched expectations. Unless that changes, limited partners are likely to stick with what they view as the tried-and-true fund managers.”


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