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February 20, 2008

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Elliott Dahan

Why The Charles River QuickStart Program Can’t Work (speaking of VCs trying to get into the Seed Funding Game)


The first question to ask – why would an old line / big time VC firm want to get involved in the Seed Market ?

1) The Need Is There (this is not altruism –this is recognition that there are good deals available )

Funding dollars for Seed and Early Stage companies declined 30 percent in Q1 (2007) to $1.1 billion in 259 companies, a 26 percent decline in deals. Average post-money valuations of Early Stage companies were $11.13 million for the 12 months ending Q4 2006. National Venture Capital Association April 24, 2007

“While angels continue to represent the largest source of seed and start-up capital, market conditions and the capital gap in the post seed investing stage are requiring angels to engage in more later-stage investments. New, first sequence, investments represent 63 percent of 2006 angel activity, indicating that some of this post seed investing is in new deals. This restructuring of the angel market has in turn resulted in fewer dollars available for seed investments, thus exacerbating the capital gap for seed and start-up capital in the United States,” Sohl said.

Jeffrey Sohl, Center For Venture Research March 19, 2007

2) Get More Bang For Your Buck

Funding a Candidate to Viability is getting less expensive – open source software, cheaper hardware, ASP-based services to handle back office processes, Web 2.0 buzz – “I came to the conclusion that $500,000 is the new $5 million” – Mike Maples Jr.

3) Competitive Advantage / Vertical Integration and Generally Getting in on the Ground Floor in a Very Crowded Market

Since 1986, 32 firms have accounted for 10% of the venture capital raised but produced 56% of the total returns, said Diana Frazier, a managing director of fund-of-funds manager FLAG Capital Management LLC. She said her calculations, based on confidential data collected by FLAG, understate the discrepancy because they exclude Greylock Partners, Sigma Partners and Sutter Hill Ventures. Mr. Doppstadt said 10 of the some 165 funds that Ford has invested in since 1970 produced about 45% of its returns.
MATT RICHTEL New York Times 5/11/2007

No need to go on and on and on here – it makes a helluva lot of sense to address the Seed Market.

The second question to ask is – Charles River & other VCs – why will they fail in their Seed Program efforts ?

1) Financial Metrics Don’t Work

Seed Level Funding is not economical in terms of ROI, Time and Personnel Costs for Traditional VC Firms. Rather than creating a string of contingent hypotheses about this amount per investment and this amount equity conversion and this amount of companies invested in and this amount of exit value per company and . . . .let’s look at the common sense side of the financial equation.

How much is Associate’s time worth ? How much is Administrative time worth ? How much is Partners time worth ? What is the allocation of fixed overhead costs ? And on and on. Doesn’t make sense.

Now, if the VC firm is amortizing some of the cost of the Seed Program as a Development expense (think about major league baseball helping to fund minor league teams), then one could make an argument that the financial negatives of establishing a Seed Fund within a VC fund may be rationalized.

But, I just don’t know.

2) Organizationally

This is a very important negative for the VC firm. VC firms are overwhelmingly passive in sourcing investments. They usually wait for folks to come to them. Or, they spend time within a small group of folks who know folks who know folks. At the Seed level, they wait for the mail to be thrown over the transom or for the email to arrive addressed to the wrong person.

VCs usually invest after a company has created a level of buzz or visibility. Organizationally, VCs follow. They do not lead. That is a plain and simple definition of what they do and who they are.

And, equally – or even more – important than the sourcing problem is the after investment oversight problem. Assume that CRV dedicates $12million to the QuickStart program. Assume that an average QuickStart investment is $100K. That translates into 120 investments.

Even if you could find 120 worthy investments in a reasonable geographic distance from a CRV office, how can CRV possibly provide guidance, business development contacts, advice to 120 portfolio companies ? And, remember that these 120 companies are Seed companies – there are usually no other Board members except for company people, friends, family and maybe the company lawyer (who gets both his hourly fee and stock options up front).

(this after investment oversight comment also relates to not fitting into the Financial Metrics comments above.)

I can see the VCs saying, “well, 120 companies . . . maybe 40 actual get off the ground by themselves and attract a real Series A . . .and of those 40 survivors, maybe 5-8 actually exit and . . . .

And maybe entrepreneurs will soon figure out that they are considered right on a level with raw meat. Between being considered Raw Meant and a natural distrust, you get comments such as this one from one entrepreneur member of The Funded:

Quickstart; renamed Quicksand

Fund: Charles River Ventures

Posted by blk911 on Sun May 06 22:54:18 EDT 2007

Public: The details of the program seem to be fairly straight forward: fund at the seed level, get a ConvDebt w/pref in exchange for shot at series “A”. [sic] We’ll fund some projects early, not expend a ton of overhead scrutinzing the incubation and launch then get more heavily involved at the first ‘open’ round. I made an inquiry on a Friday night at 9pCST, rec’d a reply in 40min. “Nice…but they didn’t address my concern” which was that I wanted to have a phone conversation prior to sending in my Exec Summary. 4 days later the reply came “We can’t do that…”. So I sent a link which gave some public details and ask for a phone convo. “Sorry”. Seemed like it was not too much to ask, since our business is in the mobile space and todate, a completely unique concept there (hence a bit concerned about a blind mail-in). 2 emails more and we concluded that I would contact them post-launch. As described above, I wonder if they are for real or fishing for ideas or getting educated on what folks are doing in what spaces. We have an experienced team, seasoned vets in mgmt, code done, beta launched…and won’t even do a phone call? Odd.

3) Attitude

Great segue from the last comment above into Attitude.

Entrepreneurs Genuflect and VCs Pontificate. Think about it.

Who is doing who a favor here ?

Read TheFunded.

There is a solution to creating an effective Seed Funding Program, but it does not sit within the offices of the VC.

Unless you Live in the World of the Entrepreneur you really don’t understand the Attitude Problem most VCs have.

Elliott Dahan

Why The Charles River QuickStart Program Can’t Work (speaking of VCs trying to get into the Seed Funding Game)


The first question to ask – why would an old line / big time VC firm want to get involved in the Seed Market ?

1) The Need Is There (this is not altruism –this is recognition that there are good deals available )

Funding dollars for Seed and Early Stage companies declined 30 percent in Q1 (2007) to $1.1 billion in 259 companies, a 26 percent decline in deals. Average post-money valuations of Early Stage companies were $11.13 million for the 12 months ending Q4 2006. National Venture Capital Association April 24, 2007

“While angels continue to represent the largest source of seed and start-up capital, market conditions and the capital gap in the post seed investing stage are requiring angels to engage in more later-stage investments. New, first sequence, investments represent 63 percent of 2006 angel activity, indicating that some of this post seed investing is in new deals. This restructuring of the angel market has in turn resulted in fewer dollars available for seed investments, thus exacerbating the capital gap for seed and start-up capital in the United States,” Sohl said.

Jeffrey Sohl, Center For Venture Research March 19, 2007

2) Get More Bang For Your Buck

Funding a Candidate to Viability is getting less expensive – open source software, cheaper hardware, ASP-based services to handle back office processes, Web 2.0 buzz – “I came to the conclusion that $500,000 is the new $5 million” – Mike Maples Jr.

3) Competitive Advantage / Vertical Integration and Generally Getting in on the Ground Floor in a Very Crowded Market

Since 1986, 32 firms have accounted for 10% of the venture capital raised but produced 56% of the total returns, said Diana Frazier, a managing director of fund-of-funds manager FLAG Capital Management LLC. She said her calculations, based on confidential data collected by FLAG, understate the discrepancy because they exclude Greylock Partners, Sigma Partners and Sutter Hill Ventures. Mr. Doppstadt said 10 of the some 165 funds that Ford has invested in since 1970 produced about 45% of its returns.
MATT RICHTEL New York Times 5/11/2007

No need to go on and on and on here – it makes a helluva lot of sense to address the Seed Market.

The second question to ask is – Charles River & other VCs – why will they fail in their Seed Program efforts ?

1) Financial Metrics Don’t Work

Seed Level Funding is not economical in terms of ROI, Time and Personnel Costs for Traditional VC Firms. Rather than creating a string of contingent hypotheses about this amount per investment and this amount equity conversion and this amount of companies invested in and this amount of exit value per company and . . . .let’s look at the common sense side of the financial equation.

How much is Associate’s time worth ? How much is Administrative time worth ? How much is Partners time worth ? What is the allocation of fixed overhead costs ? And on and on. Doesn’t make sense.

Now, if the VC firm is amortizing some of the cost of the Seed Program as a Development expense (think about major league baseball helping to fund minor league teams), then one could make an argument that the financial negatives of establishing a Seed Fund within a VC fund may be rationalized.

But, I just don’t know.

2) Organizationally

This is a very important negative for the VC firm. VC firms are overwhelmingly passive in sourcing investments. They usually wait for folks to come to them. Or, they spend time within a small group of folks who know folks who know folks. At the Seed level, they wait for the mail to be thrown over the transom or for the email to arrive addressed to the wrong person.

VCs usually invest after a company has created a level of buzz or visibility. Organizationally, VCs follow. They do not lead. That is a plain and simple definition of what they do and who they are.

And, equally – or even more – important than the sourcing problem is the after investment oversight problem. Assume that CRV dedicates $12million to the QuickStart program. Assume that an average QuickStart investment is $100K. That translates into 120 investments.

Even if you could find 120 worthy investments in a reasonable geographic distance from a CRV office, how can CRV possibly provide guidance, business development contacts, advice to 120 portfolio companies ? And, remember that these 120 companies are Seed companies – there are usually no other Board members except for company people, friends, family and maybe the company lawyer (who gets both his hourly fee and stock options up front).

(this after investment oversight comment also relates to not fitting into the Financial Metrics comments above.)

I can see the VCs saying, “well, 120 companies . . . maybe 40 actual get off the ground by themselves and attract a real Series A . . .and of those 40 survivors, maybe 5-8 actually exit and . . . .

And maybe entrepreneurs will soon figure out that they are considered right on a level with raw meat. Between being considered Raw Meant and a natural distrust, you get comments such as this one from one entrepreneur member of The Funded:

Quickstart; renamed Quicksand

Fund: Charles River Ventures

Posted by blk911 on Sun May 06 22:54:18 EDT 2007

Public: The details of the program seem to be fairly straight forward: fund at the seed level, get a ConvDebt w/pref in exchange for shot at series “A”. [sic] We’ll fund some projects early, not expend a ton of overhead scrutinzing the incubation and launch then get more heavily involved at the first ‘open’ round. I made an inquiry on a Friday night at 9pCST, rec’d a reply in 40min. “Nice…but they didn’t address my concern” which was that I wanted to have a phone conversation prior to sending in my Exec Summary. 4 days later the reply came “We can’t do that…”. So I sent a link which gave some public details and ask for a phone convo. “Sorry”. Seemed like it was not too much to ask, since our business is in the mobile space and todate, a completely unique concept there (hence a bit concerned about a blind mail-in). 2 emails more and we concluded that I would contact them post-launch. As described above, I wonder if they are for real or fishing for ideas or getting educated on what folks are doing in what spaces. We have an experienced team, seasoned vets in mgmt, code done, beta launched…and won’t even do a phone call? Odd.

3) Attitude

Great segue from the last comment above into Attitude.

Entrepreneurs Genuflect and VCs Pontificate. Think about it.

Who is doing who a favor here ?

Read TheFunded.

There is a solution to creating an effective Seed Funding Program, but it does not sit within the offices of the VC.

Unless you Live in the World of the Entrepreneur you really don’t understand the Attitude Problem most VCs have.

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