While Scott Kirsner and my fellow Xconomist Tim Rowe both recently have commented on the benefits of mixing and mingling in Kendall Square, we have a more basic problem that won’t be solved by just rubbing shoulders. Chalk it up to Yankee stoicism; our long, dark winter; or our independent sectors of software, communications, medical devices, interactive media, financial services, health care, and finance. Whatever the cause, you probably haven’t heard of “Northern Hospitality” for a reason. Simply put, we just don’t talk with each other like people do in other parts of the country, and changing will help entrepreneurs.

Starting a new company is hard. We talk a lot about entrepreneurship and innovation in the technology community, but that’s not really the entrepreneur’s chief mission. Big companies innovate and create things. Mature small companies do, too. What makes entrepreneurs unique is coupling that with creating a new organization, which means creating something out of nothing.

To do that, they need to find those rare people who are willing to take the risk with them, and who share the dream and want to solve the same types of problems. These include co-founders, employees, lawyers, distributions partners, suppliers, and most importantly, customers.

Finding all those people takes time and energy. It can be hit or miss, and it’s mostly miss. Unfortunately for entrepreneurs, the biggest expense usually is time, which also is usually in fairly short supply. With a little effort from the rest of us, we can help entrepreneurs cut these costs dramatically and help build an even more vibrant technology community here in Boston.

Last year, Bill Warner (another Xconomist) and I collaborated with the Mass Technology Leadership Council to launch Innovation 2008, an “unConference.” Unlike traditional conferences with lots of speakers and little networking, this new model of conference is mostly structured networking that delivers content based on participants’ interests rather than a pre-planned rigid agenda. The attendees create the sessions themselves, allowing people with shared interests to find each other efficiently, and then they spend an hour at a time sharing their expertise, asking questions, discussing critical issues, and getting to know each other. It was a huge hit, particularly by breaking down traditional barriers between old and young, investors and entrepreneurs, and people in different sectors because everyone had something to offer.

This year, we are turning that event, which will be held on October 1, into the kick-off for a year-long platform. We will ask particular participants to become “connectors,” and for the next 12 months, they will try to be the quick “answer man/woman” who entrepreneurs can contact with the simple question: “Who do you think would be the right person to help me with __________?” Connectors either make an introduction and get out of the way, or refer the request to another connector who might have a better answer.

A select group of entrepreneurs from the unConference also will be invited to join a …Next Page »

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Two weeks ago, I was in Atlanta for the annual Angel Capital Association (ACA) conference and, this past week, here in Boston for the annual National Venture Capital Association conference. Depending on whom you asked at both conferences, it was the best of times or the worst of times, most likely depending on whether or not they had money to invest. In fact, NVCA conference chair, Kate Mitchell, even kicked off the event with that opening line from Dickens’ book.

That said, both events were generally positive-you’ve got to be an optimist to be involved in entrepreneurship-and both had a roll-up-your-sleeves, let’s-make-things better outlook. Overall, the mood and energy was somewhat more upbeat in Atlanta than in Boston, as characterized by ACA Chairman John Huston’s welcoming remark and call to action, “Thank you for supporting capitalism!” which drew a lot of applause. Perhaps it was because individual investors don’t feel obliged to go to conferences and the pessimists just stayed home. Maybe this part of the venture investing market is still so young that that there’s a lot to be learned and done.

The hot topics among angel groups were on fund formation, increasing deal flow, deal structuring, and how to syndicate deals—while top of mind with venture capitalists was how (or whether) to invest in the current climate. Kudos in particular to NVCA President Mark Heesen for making the trip down to the ACA annual meeting for the second year in a row to build bridges. He participated in an excellent, frank discussion about how venture firms and angel groups can collaborate better and more frequently. Attendance was about the same as 2008, with around 350 people present. Certainly, a lot of angels have had their portfolios hit hard by the recession and have cut back on investing, but at least this crowd was looking forward.

The NVCA meeting had nearly twice as many people, just over 650, but that was down by maybe half from last year when the conference was in Silicon Valley. To be fair, travel logistics from the West Coast to the East Coast for a mid-week conference may have also played a role, but the mood was still different.

NVCA does a vastly superior job to ACA when it comes to inspirational messages, but a lot of them provided a sober contrast between what venture capital has achieved in the past and what might no longer be possible in the future unless there is structural change in the market. Outgoing NVCA Chairman Dixon Doll’s opening comments included a call for action to the federal government: “Unless we are willing to pull out all the stops, we’re in danger of heading down a slippery slope.” He then proceeded to unveil NVCA’s “Four-Pillar Plan to Restore Liquidity,” which you can read by clicking here.

Both organizations had high concerns about liquidity and availability of capital. At ACA, a lot of the discussion revolved around state and federal tax credits to increase the availability of capital for individual investors. NVCA provided a lot more data and structure, as noted above in the call to action, showing that with liquidity down so much over the past 10 years, the cycling of capital already is decreasing and is at risk of slowing even more.

To me, perhaps the most important issue centers on the fact that these two meetings happened in two different cities. Overall, both organizations still have a lot to gain from each other. In addition to Mark Heesen coming to the ACA conference, about a half-dozen ACA members-including yours truly-also were present at the NVCA conference because we are members of both organizations. But there could be far more overlap and dialog as well. Roughly two-thirds of ACA-member angel groups co-invested with venture firms last year. We have a lot of the same goals and cooperate and collaborate far more than we compete. No matter if you think it’s the best of times, or the worst of times, ultimately, it’s the entrepreneurs who benefit by having the players in the capital markets work more efficiently and effectively together.

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Nobody likes to fail. No entrepreneur or venture capitalist thinks a particular venture is going to be the one to fail. As veteran venture capitalist Bob Crowley at the Massachusetts Technology Development Corporation says, “we’ve never made a bad investment; just investments that have gone bad.” If we as investors or entrepreneurs thought the odds were stacked against us at the outset, we wouldn’t pursue new ventures.

In reality, however, they are. And, rather than just accept that the risks are high and failure happens, there are many things we can do to better the odds of success.

1) Three ways to blow your precious venture capital round. Only about 1 in 100 companies that pursue venture capital money get it. Probably the worst thing you can do right after the financing is then to blow this precious resource. Yet, there is tremendous pressure to scale the company for a large market quickly. Here are the top three catastrophes I have seen first hand and heard from veteran venture capitalists time and time again over the years.

—Hiring the right CEO at the wrong time: Investors put money in the company to make money, and you do that by making a big company—fast. As soon as the round is closed, the new board of directors and the founders interview lots of candidates and hire someone who just amazes them with their vision and ability to grow a company quickly. That “professional” CEO starts hiring three to six VPs, they in turn hire three or four managers each; they then hire more staff. Headcount after a Series A grows two to five fold in a few months. That’s great if there is a rock solid foundation underneath the company, and it has equally strong ties to the market. It is a disaster otherwise, creating chaos, frustration, anger and tons of finger pointing. The new CEO takes a lot of the blame, but so should the founders and the investors. The CEO was probably the right person; the company should have spent three, six or more months refining the business model, sales process, marketing strategy, and product development process, as well as assimilating the people so they worked as a team, before hitting the gas.

—Scaling the sales force prematurely: This mistake is similar and often related to #1, but it’s enough of a stand-alone error that I put it in its own category. Venture investors look at initial sales traction and think the rest of the market buys the same way or has the same needs. It takes a lot of market research to make sure you are ready to scale. “How many times do I have to learn this lesson,” one general partner recently said to me.

—Building the product ad nauseum: If one is going for a big market, you don’t want to ship one that has bugs, right? That didn’t stop Microsoft—or many other successful software companies, for that matter. The trick is understanding what bugs will be tolerated by which portions of the market and limiting your sales to that segment until you’re ready for others. Lots of engineers absolutely hate that approach. With a lot of money in the bank, an engineering-heavy venture can be prone to come back to the board time and time again, saying, “we just need another quarter or two of development, then we will be ready for market.”

2) Three ways to blow your exit. After years of blood, sweat, and tears as well as much personal sacrifice, reward is in sight for your entrepreneurial venture. Large public companies not only want to partner and benefit from your work; they want to buy you! Suddenly, this lonely startup seems important, and pressure builds to make perhaps more of what you have than is possible. Here are three ways to grab defeat from the jaws of start-up victory.

—Get greedy: The forces of nature have formed a rare convergence around your company, and you think “well, if we’re this valuable now, we’ll be worth a LOT more in a year or two.” Lightning almost never strikes twice.

—Allow one party with a different agenda to control the deal: This mistake may have been made years earlier by bringing in an investor or strategic partner whose interests were not in alignment with the interests of others. Alternatively, one party’s interests might have changed because of some external factor. Head this off by having discussions with and among the investors about the pressures everyone is facing, as well as everyone’s goals and objectives.

—Try to save money by doing it yourself: A lot of entrepreneurs (and venture investors) bristle at paying an investment banker’s fee, citing other experiences where they or others felt they didn’t get any value. That’s a problem of hiring the wrong banker. Good ones earn every penny they make by creating an auction—or auction-like environment—that increases the value of the company substantially. It’s very hard for the CEO simultaneously to play good cop and bad cop with a potential acquirer—especially one they are likely to be an employee of in perhaps only a few days—or have a good feel for the rhythm of a deal because these are infrequent events for them.

3) Three ways to blow your company. There are better perspectives about company failure than I could provide, so here are links to three let-the-hair-down stories that tell it like it is.

—Roger Ehrenberg’s post-mortem about the demise of Monitor111. He lists more than seven major mistakes that killed the company, an information platform for institutional investors on Wall Street, and that are all too common. These include: lack of a single “buck-stops-here” leader, too much PR too early, and too much money.

—Chris Herot’s reflections on Convoq and Zing. Chris has some of the same points as Roger—particularly developing a product without enough customer input—but adds important points about the overall context and ecosystem around a company.

—Dan Weinreb’s analysis of Symbolics’ failure. Symbolics had great technology and a great team, but the complementary technologies changed. This is a great case study of the ensuing gyrations and apoplexy that many companies suffer in these situations.

If you have your own stories or know of similar posts, please feel free to comment and add them below.

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Over the past several years, and especially since this summer when CommonAngels (where I serve as managing director) became the first angel group to join the National Venture Capital Association (NVCA), I’ve frequently been asked in varying tones of voice from the curious to the cynical, “Is CommonAngels an angel group or a venture capital firm?” The definite answer is “yes,” which is less a statement about CommonAngels than it is about the substantial changes in the capital market affecting entrepreneurs.

Here’s some history and context. The Tech Bubble of 1999-2000 and subsequent Tech Wreck of 2001-2004 did a lot more than just flood the market with money and leave it dry. This boom-bust was part of a classic economic supply shock that has led to a restructuring of the capital for new ventures and changes in investment strategy that determine how that capital is deployed.

In a supply shock, the dynamic between price and availability of a good—in this case cash—changes significantly. Often, there follows a restructuring of the market as more efficient or more successful suppliers gain market share, buyers shift to more reliable or specialized suppliers, and both sides seek to alter their strategies to accommodate the changed market.

Economic treatises have been written on the general effects of supply shocks. But in the case of venture investing, what happened during the Tech Wreck was that asset allocations—meaning the amount of money available to both angel investors and venture capital firms—fell sharply, invariably in proportion to the loss in market cap of their portfolios. Whereas total commitments from limited partners surged during the Bubble to $83B in 2000, they fell during the Tech Wreck to just below $10B in 2003—and have only recently resumed their pre-Bubble levels of around $20B per year, according to figures from the NVCA/PwC/Venture Economics MoneyTree Report and Dow Jones’s VentureOne service. However, with the comeback, the distribution of those funds has changed—and so have the investment strategies.

Changes to Angel Investing
Perhaps the most visible part of this evolution has been the increasing pooling of capital and expertise by individuals into angel groups. Whether it’s because individual investors see safety in numbers, a stronger negotiating position for future rounds, better diligence through shared efforts, or just a more enjoyable process by working in teams, the basic principle is a classic division of labor. Rather than have each investor repeat the whole diligence and investment process each time, work can be divvied up to those with the most skill for a particular task—allowing a lead angel or manager to coordinate the process for both individual investors and the entrepreneur.

In 1998, there were roughly 20 formal angel groups nationwide. Six years later, 46 groups became charter members of the Angel Capital Association—a trade organization founded to support professional development among angel groups. Today, there are over 125 ACA member groups and almost as many unaffiliated angel groups.

Many of these groups also have hired staff and some have funds under management, much like a venture capital firm but with some structural differences I won’t go into here. CommonAngels itself is now a hybrid organization. We have 70 active angels who cut their own checks on individual deals, two full-time managing directors, and two co-investment funds. We’re members of the Angel Capital Association, the New England Venture Capital Association, and the NVCA. Our large network helps source deals, evaluate opportunities, and help companies; our pooled funds and professional management provide additional capital, complement our operational expertise, and provide consistency for entrepreneurs and co-investors.

Changes to Venture Capital
Venture Capital firms also have changed, but because those changes have mostly been internal to existing organizations, it has been a bit harder to notice. Each quarter, the MoneyTree figures grab headlines over the total dollars invested in startup companies and the number of deals done by venture capital firms, institutionalized angel groups, and various corporate investors. VentureOne adds to the debate by offering its (usually) slightly different figures based on a different methodology from those tracked by the other group. By either of these measures, investment levels have returned to “normal,” pre-Bubble levels. Inside those figures, however, the dynamics have changed significantly.

Since the Bubble, the average size of a venture capital fund has doubled, according to VentureOne, from roughly $100M during the Bubble years of 1999-2003 to an average $200M in both 2005 and 2006. A decade ago, the average venture fund was closer to $80 million. More importantly, however, last year saw the creation of the fewest number of funds under $100 million since VentureOne started keeping data in 1992.

Additionally, as Scott Kirsner recently noted in the Boston Globe, there are many challenges facing VCs raising new funds. As a result of the disruption in the market, the large institutions that invest in venture funds (institutional LPs) are increasingly pursuing “flight to quality” strategies—putting more money into the most successful funds, thereby increasing their strength and leadership position. Many of these large venture firms have now launched or are developing multiple financial products such as sector-specific funds, regional funds, or funds tied to particular stages of company development.

The average round size, meaning the amount invested at various stages of a company’s development—seed, Series A, Series B, and so forth—also continues to increase. But with that increase come further changes in strategy—most notably fewer seed stage deals. In 1995, according to MoneyTree, 17 percent of all venture capital dollars went to seed investing. By 2002, that figure hit a low point of 1 percent, and at the end of last year had only recovered to 4 percent. More telling, in 2006 there were only 326 “seed” deals done throughout the country, versus between 500 and 800 per year pre-Bubble.

The larger fund size has also had an effect. Even when investing small amounts of money in early-stage companies, venture firms are looking for an implicit or explicit commitment from entrepreneurs to build an enormous success (usually with an exit value of greater than $250M) in order to “move the needle” on the fund. This often means building a portfolio company to 20-50 employees much faster than in the past, creating an “instant company” effect that can actually increase risk if the firm is under prepared for that growth or if the market is not yet ready to support it.

Co-opetition between Venture Capital and Angel Investing
As both venture capitalists and angel investors evolve their practices, they increasingly need those with complementary resources to work with them. In fact, they both compete for deals and cooperate, sharing skills to evaluate and help young companies, creating what Prof. Barry Nalebuff at Yale University calls “co-opetition.” Most often, this correlates to size: large venture firms get deal flow from smaller ones; smaller venture firms from angel groups; and angel groups from individuals. Investing style also affects collaboration. The “instant company” investors tend to prefer working together, as do those who take a more conventional “organic” approach to growth by going with, not ahead, of markets. Finally, the personalities of both individual partners and investors, and the relationships and trust among them, also play big roles in how firms collaborate.

For example, at CommonAngels, our closest relationships are with the other angel groups and with venture firms that operate relatively small funds of between $50M and $300M and take more organic approach to portfolio company growth. These partners have provided $10 for every $1 that we have invested this year—a new record. We also refer opportunities to each other and seek advice. Occasionally, we compete against each other, but we tend to prefer to collaborate, for instance, by pooling our investments together to create a Series A investment of $2M-3M. Competition also comes from bootstrapping (meaning the entrepreneur funds himself or herself) or by entrepreneurs choosing strategies that require more capital than we ever could provide, leading them to work with a totally different set of players.

Looking Ahead
These changes are neither intrinsically positive or negative, they are just evolutionary changes that the industry has gone through—but it is important to know what they are and adapt to them. In the next five years, don’t be surprised to see more angel groups joining NVCA. Five years from now, perhaps as many as half the angel groups around the country will have managed funds, and at least a few will likely have funds of between $50M-100M. Similarly, larger venture firms will have more specialized product offerings, and many smaller ones will take “boutique” strategies of being best in class for a specific sector, style, or geography.

As the capital markets change, entrepreneurs should do diligence on investors before starting to look for money. Particularly if you are new to fund-raising, or have not done it in a while, you will likely find the market more segmented than in the past. Look for investors whose strategy, expectations, and personalities are more in line with your own and your company’s. This will likely leave you with a much shorter target list than in the past. But it should also be a much better one.

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…is coming soon.

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