Tag

private equity

Leadership

Are your investors double dipping in your startup?

I’ve been working with a number of small companies this year. I’m on a mission to help CEOs, especially women, figure out how to grow their businesses, manage their investors and boards and to create a level playing field for themselves.

But as I have spoken to some of these CEOs I’ve seen several data points which are very worrying, and which I hope don’t make a line! These data points are investors putting money in to companies, and then taking the money back out for services – so effectively reducing the cost of their investment. Double dipping.

For example…. The professional service provider:

This is the case for a small software company, lets call them W. W has developed a software technology to improve building management, and so reduce insurance costs. It wasn’t an easy company to raise money for and in the end the CEO raised from angels, one of whom invested $480k. Nice.

But he then turned around and sold W the development service to create the product from the technology for $490k. He didn’t require it, but it was “expected”. Assume a typical margin of 50% then the service cost for the angel to deliver is $245k and he has a profit of $245k. So he got $480k worth of equity in W for $235k. And to make matters worse, when the product delivery was not to the satisfaction of the CEO she found it very difficult to push back on him in the way she would have been able to push back on an independent contractor. It’s awkward to say the least, but I think it’s what in a public company would be called a related transaction – it is simply not independent and so has the potential for conflict of interest.

The investors with a side business:

Another small app company, raised money from an angel group. The angel group has a strategy of creating an ecosystem from their companies, and providing services to them to drive the market adoption. But, unlike the old school VCs like Mayfield and KP, or even the new large scale guys like Andreessen Horowitz, this group turned around and charged the company (which had only raised $1.5M) $11k/month for marketing. That’s $132k per year – which could have been spent on another engineer or a lot more marketing consulting from an independent.

The board member who wants a salary:

This time a technology company in the security space. Killer technology, but a turnaround from a prior (not-well-run) incarnation so raising money was hard. In the end money came in from a PE firm. But after the close the PE firm put in an executive chair to “help” and insisted he be paid $180k a year for a few days a week. Now I am supportive of a board deciding a CEO needs some help and adding in an exec chair if the CEO agrees (or even if she doesn’t if it’s really needed) but to pull a salary out of a company that is not profitable is very tough on the company. And in the end it’s not in the best interest of the investors; it doesn’t make sense.

I wonder if I have seen a few outliers and this is not the new normal, or if this is a new trend? Is it a result of the number of angel groups out there who are not professional investors (and so to give them the benefit of the doubt we could assume they don’t realize the impact of what they are doing), is it a result of the tightening of investment (and so they can get away with it) or it is a result of the simply huge number of startups and first time CEOs who can be taken advantage of? If you have an example in¬† your own company inmail me on LinkedIn.

Equality

Living the Social Network: a Silicon Valley cliche

The Rosewood Hotel sits in the perfect location. At the intersection of 280 and Sand Hill Road with beautiful views of the Portola Valley hills it’s surrounded by sleek offices dedicated to making money. The who’s who of venture capital, private equity, and now even tech centered hedge funds for the guys who want to be where the real action is (and that’s not New York if you are a geek investor).

On any given evening the people watching in the Rosewood bar is better than any movie. Take an evening a week or so ago. To my right a group of Justin Timberlake knock offs – all white young men, 30-ish, dark shirts, dark pants and one even had on a fedora (I thought he was trying a little too hard). These are probably associates from a local private equity or venture capital firm – MBAs from the best schools apprenticing at the feet of the masters. Looks, brains and confidence – making money but less knowledge than they think.

After a while two women approach them, very tight white jeans, high heels, the requisite small slice of midriff showing below deep cleavage. Long hair and on the prowl for customers. A toss of the hair subtitle “have you noticed me yet”; a well practiced eye lock and knowing smile subtitle “I find you attractive and am available”; and next thing you know they are sitting snugly on a small sofa with money.

To my left a man walks by to greet the waitress with a knowing hug and a pat on the butt. Dark tan, shirt unbuttoned showing chest hair and a gold medallion. Thinks he’s a player but I doubt he is – he’s prowling.

In contrast standing in front of me are very young interns. 20-ish, skinny boys and girls, in cheap, ill fitting suits (short skirts on all the girls) clustered together drinking expensive drinks they can’t really afford. But no worries, there is usually a partner or two in the mix hosting them. They are earnest, ambitious and often an easy mark. The friend I was with is a wealthy partner in a prestigious firm and he sized them up with a practiced eye – giving me a hilarious commentary at the same time.

It’s not all about sex and entertainment. There are the two serious VCs sitting at a cocktail table outside under a heat lamp. They’re older – in their late 40s – and oblivious to everyone around them as they hammer through how to get a stumbling deal funded. If you listen carefully you hear talk of pre-money valuation, revenue run rate and dilution. Many a deal gets done on a hand shake in places like this.

I bump into a friend who is a partner at a household name law firm – although the lawyers are usually pale and tired – they don’t get out much when the Valley is as hot as it is right now.

The place is packed and the air is on fire – talking, flirting, drinking (vastly over-priced drinks), deal-making — many are there to experience Silicon Valley, to find the next big thing and ride the wave. The movie captured it well, and made it a cliche. It was like this in 99, again in 07 and now again in 2011. Wild, geeky and the real money is being made by the facilitators – the investors, lawyers, bars and entertainers all preying on the brains who hope to come up with the next big idea.

And me? The Rosewood bar is on my way home from the office, has terrific olives, and is a convenient place to meet my Palo Alto friends. I don’t go for the buzz and the people-watching, do I?