The other two thirds of the time, I spend more time with the entrepreneur to understand the business as best I can and as quickly as possible. After 35+ angel investments, I should be able to determine the value of a startup quickly, yet, it doesn’t actually seem to be getting any easier. Or, at least, I’m not getting any better at it. Of course, the amount of time I spend coming up to speed with the team depends on my interest and varies quite a lot. In the end, the vast majority of people I talk with ultimately get a “no.” That’s just how the numbers work out. I can’t invest in everything.

In almost all cases – there are those who take a “no” like I said their mother is ugly and are complete assholes about the situation – I do my best to be supportive and helpful in my rejection, explain why I’m not interested and almost always try to connect the entrepreneur up with someone who might be better equipped to help or might be interested in investing. But, it’s still a rejection and it’s tough to take. It’s in how the entrepreneur handles this situation, that I learn more about them than during any of my previous discussions.

Once in a great while, someone will hang up on me or clumsily end a face-to-face meeting with some poor excuse. More likely and if email has been the primary form of communication, I might never get a response to my “no,” which is also a non-response to my offer to hook the person up with another potential advisor or investors. Sometimes, the entrepreneur digs in his or her heals and pushes even harder, thinking that they can force me into changing my mind. Often, pleading, in various forms, takes place.

I’m here to tell you folks, this is all bad. If you’re an entrepreneur (or any one doing business), you should treat each relationship you establish as a long-term, important one. You just never know when you’re going to need it. Sometimes you need it and you don’t even know it – like when another investor calls for an opinion or a reference. I don’t hold a grudge, but I’m not shy about sharing my thoughts about things, especially with people I have an established relationship with (there’s some recursion here, I think).

I’m making it sound like very few handle the situation well. Many actual do handle themselves wisely and professionally.  What do I mean by this?

• They politely ask “why?” to fully understand my decision without trying to convince me otherwise
• They thank me for the time I invested and for my consideration of the team and idea
• They usually ask if I mind if they can engage me for advice or guidance in the future or if they can send updates on what is going on with their new baby.

Yes, for the most part, it’s political and maybe even pandering. It’s also smart. Some people handle it so well, I question my decision not to get involved. Handling it well gives me the impression that the entrepreneur might have the right stuff to be a great CEO. I’ll take that over a great idea any day (although both is nice, obviously). Even if I don’t get involved, that’s what I’m going to tell others when asked.

I’m not trying to be the Emily Post of startup venture engagements here. But handling this basic stuff right can get you very far. There will be MANY more “no’s” in your future. They are always harder to handle than “yes’s.” If you can handle them well, you’ll demonstrate what you can do when things are not so good. A much more important skill than what to do when things are going well. And that’ll get around.

I get why certain investors want this term in there – if a co-investor is not going to continue to invest in the company in subsequent rounds, why should they retain the rights and privileges of a holder of preferred stock? The same rights and privileges that investors investing their pro rata portion.

I understand the logic, but as an angel investor, I find little to like about the provision in virtually any form. If I, as an investor, supported the company early on and took on all the risks involved with an early investment, why should I ever lose the rights that came along with assuming that risk? That was the exchange at the time – money for some ownership and rights associated with the form of ownership. In my opinion, no future acts (legal, up-and-up ones, that is) should cause the retraction of rights I already have (superseding those rights is topic for another day).

When I invest in a company, I always reserve some money for the next round. Since I generally invest in startups, I consider what a reasonable jump up in the A round valuation might be and hold enough in reserve to maintain my pro rata share in the company through that round. If the A round is a large – dollar-wise – or there are rounds beyond the A round that I haven’t reserved for, I can easily find myself in the position of not having the funds needed to maintain my share. A pay-to-play provision, in these cases, would cause a draconian (yeah, I’m biased) removal of the rights I had already paid for through investment and risk. It just doesn’t make any sense.

I could whine or cry and say that such terms are unreasonable or unfair, but that would be stupid. In the end, I can only do one thing when I run across a pay-to-play provision in  a term sheet, treat it as a big negative in my investment decision. I strictly stay away from deals that go as far as converting the preferred shares of those who don’t invest their pro rata percentage in future rounds to common. I treat as a negative, but don’t always walk away from deals with such provisions that are less onerous. Like I said, I understand why big, later stage investors want this term in the agreement. From my point of view, though, it punishes those who took the biggest risk when the company needed it most.

I’ve seen this before (although less frequently over time) and it boggles my mind. Yeah, if you have a boatload of little investments the cap table can be a bit complicated, but that’s just math. Generally speaking, smaller investors don’t have any strong voting rights, board seats or other forms of control so punting on them doesn’t improve the speed or operations of the company. It’s treating form well ahead of function.

So why explicitly exclude or inhibit any investor small or large from investing in your next round? Are you afraid that you might scare off a large, future investor who doesn’t want smaller investors involved financially? Think about it. Are there rational people who would take this position? If so, are these people you want to deal with? To me, the fact that existing investors want to invest more money to retain their ownership is a hugely positive signal indicating that the people who know a lot about the company have faith in its progress and opportunities for success. As an entrepreneur, don’t you want to encourage such behavior?

By not explicitly giving investors pro rata rights (keep in mind that this provision simply grants the investor the right, it’s not a requirement – I’ll write a post on “Pay-to-Play” term sheet weirdness soon), you not only create a problem in subsequent rounds of funding, but you also create a problem now, in the current round. If, as a potential investor, I fear that I may not be able to prevent my dilution in future rounds, how anxious a I going to be to get involved. I’m not. Thus, my exit from the deal this week.

As my long-time friend and corporate general counsel, Peter Johnson, always says, “it’s, at worst, giving them the sleeves of your vest.” “Them,” in this case, being the investors you want to have involved in the company now and, hopefully, in the future.

BTW, there are loads of resources on the web discussing term sheets from many points of view. I highly recommend you take a look at Brad Feld’s and Jason Mendelson’s term sheet series as a starting point.

This is even a bigger problem for startups than it is for established companies. In startups, ideas tend to be in more flux than in mature companies because of the limited time and resources startups have to completely understand the customer. While older companies aren’t immune to these challenges, they are generally not subject to the same limitations.

So, how does any organization hire the right people? Well, starting with a great team helps, of course, but understanding what’s important in expanding it is crucial. Here are a few things to ask yourself when trying to identify the next person you’ll add to your team.

• Is there a cultural fit? Far more important than having the knowledge required for the job is whether the candidate will fit in with the rest of the team and, in fact be a driver and communicator of the culture you want in you company.
• Is the candidate a risk taker? He/she should be. Why would you want someone who is going to move slowly and cautiously in your organization. The best people are aggressive in their actions and play offense all the time.
• Does the prospective employee fear change? Hope not. In fact, the candidate should love change and even seek it out. Many people are afraid of change and even fight it in passive ways, slowing the organization down. If you want a hard-driving, fast-moving organization, you need people who love to drive and be involved in change.
• Can the candidate work as part of a team? Not only are great people more effective as individuals, but when put together as part of a team, they can virtually make miracles happen.
• Does he/she have the skills you’re hiring for? Duh. You’re probably hiring because you’re either stretched too thin or you need new skills in the organization. It’s good to thoroughly check if the candidate actually has these.

This is far from a complete list. There are going to be criteria specific to your organization and core to your success that you’ll add to it. The key point here is that hiring the right people is as important as it gets when it comes to running a company or managing any group of people. It’s the team you have that will make the difference in the end and having the best team possible should never be sacrificed.

Using these, you’ll ultimately have the data you need to plug into a spreadsheet and generate a cash flow estimate – one used for planning AND tracking cash flow – based on the high-level needs of the company and with an eye to future investment rounds.

My thoughts here hold true whether you’re pricing your round or, for the most part, if you’re doing a convertible note. I should also state that this post looks at the question primarily from the entrepreneur’s point of view, although is certainly aligned with the thinking of investors as well. As always, your mileage may vary. This is my opinion and it’s worth exactly what you’re paying to read it . . .

• Take enough money to securely get you to a step up in valuation. I’m not talking about some marginal increase, but a real increase in valuation – double, triple or maybe even more. What creates that? Usually the achievement of some significant milestone. It’s great if that’s revenue or profit, but a large number of active users or even a major product release are good milestones to increase the perceived value of your company. It depends on what you’re doing. A web service is going to have different metrics than an enterprise software company which will have different  metrics from a hardware company, for example.
• Take enough money to move quickly, but assume that you will not move as fast as you think you can. Don’t starve the company. Make sure you take enough money so that when you look back over any preceding month of operation you don’t say, “I could have done so much more with $X more.” Additionally, take into account that things will not always go as well as you’d like and, while you’re moving fast, you need to leave some space for stumbling on your way. Map it out as you see it, then add a dash of conservatism.
• Take enough money to hire the key team members you need – that’s where your leverage is. Never, ever rob yourself of great human resources. Success begins and ends with the level of people you add to the team.
• Valuation is less important than you think it is. Yeah, this is a hard one to buy into. If your valuation sucks, make sure you’re following the previous guidelines, swallow hard and take the same amount – the amount you actually need. If you are truly uncomfortable with how much of the company you’re trading for cash, go out and look for an investor who will give you a better valuation – but don’t try to do your startup on the skinny, it’s already going to be hard enough to succeed. Keep in mind that your odds of succeeding are not highly correlated with the amount of stock you retain.
• Leave yourself some runway to close the next round. Many young companies forget this when planning for the uses and needs for cash. It’s unlikely that you’ll have someone at your door ready to write a check the day you run out of money. You wouldn’t want to hand over such leverage to someone anyway. Make sure you have enough money to fund you through the time and effort to get the next round closed – at least 90 days. 120 to be safe.

No, it’s not a science. In the end, the most important part is to get the money you need and to get moving. Time is your biggest competition and it works tirelessly 24/7 to kick your ass. Try not to get caught in abstract notions about valuation. Do a sensitivity analysis, it’s likely to be less important than you subjectively think it is. That’s not to say it’s unimportant, but you should think about what the valuation being offered really means in terms of what you take away from the company given various scenarios. Ask yourself what it is you want to achieve, personally. If the valuation doesn’t seem right after that, move on and find someone else to invest. Otherwise, take the money you need and start executing. And don’t forget the spreadsheet. It really is a good tool.

I invest because I have a blast doing it. It’s about 75% of the fun of running the company yourself with only 5% of the stress. I get to meet smart, energetic people with great visions and boundless energy. It keeps my head in the game, and when I can add value (in addition to money) to help a startup weave it’s way through product, market and management mine fields, I avoid feeling like the least productive member of society for yet one more day.

The difference between a second tier investor like me and the first tier guys (other than brains and talent), is that the first tier investors actually work at finding investments. I’m, dangerously (see below), more passive about it, reacting to the investment opportunities that come to me. I get to see my fair share of of potential deals, but by selecting from a smaller set I not only miss loads of opportunities, but my comparative perspective is likely skewed – the best companies I see may be among the worst potential investments out there.

Fortunately, I’ve been moderately successful with this type of investing. A little over one third of my investments have provided reasonable returns over time with a few big successes doing most of the financial heaving lifting for my “fund.” While my 300 foot yacht with accessory submarine and helicopter remains on the wish list for affordability reasons, I haven’t had much trouble putting food on the table.

While I don’t have any absolutes when it comes to investing, I do have some guidelines that I loosely attempt to adhere to, at least when they’re convenient. Some of them are general and are similar to those used by many angel investors. Others are more personal and, for one reason or another, I’ve picked up over time as a result of my investment experiences.

The general guidelines:

• “Drill more holes” – I once heard the CEO of Shell Oil speaking with analysts at a conference. When asked how Shell was going to diversify in the coming year, the CEO responded with the statement, “we’re going to drill more holes.” Investing in many companies is the only way to balance the risks of markets, teams and competition. Maintain a relatively large portfolio.
• Invest in stuff you understand – bright shining objects attract attention (“we have the basis for a cure for cancer”), but the more you know, the less shiny things often look. If you can’t judge the team, market and product relatively thoroughly, it’s probably not a wise investment.
• Keep some powder dry for subsequent rounds – while the best return in a successful investment comes from investing earlier, holding some cash back to see how the company does and to play alongside any institutional money that comes into the company mitigates some risk and ensures you’re playing on the same terms as the rest of the investors.
• Everything looks good during the honeymoon – don’t make assumptions that problems you see will go away or that things, in general will get magically better. They won’t. While making an investment, you’re probably seeing the company in its best light. Things will likely get worse before they get better.

My Personal Guidelines:

• I don’t like convertible debt – the investor takes on an inordinate amount of risk with a convertible note which he/she is generally not compensated for. Think about a note holder who waits 18 months before a conversion is triggered with an equity investment at a higher valuation. For a small percentage (8-10%), the “investor” takes all the risk in funding the company without participating in most of the potential uptick in valuation. Some strange debt instruments are being created now to fill this and other holes, but for all their complexity, the company should just do a seed round.
• Team over idea – Ideas are cool, but quality teams are cooler. A great team can make a mediocre idea soar or morph the idea into a better one over time. Often, mediocre teams struggle to create success even starting with a great idea. I have to believe that the team can knock the ball out of the park. Only then do I consider the idea itself. As a corollary to this, I need to trust the CEO. Surprisingly, I find this to be a real issue from time to time.
• There has to be a grownup involved – for all the energy, drive, brains and talent in most startups, there’s often a dearth of wisdom. Someone needs to be involved to provide it and be a sounding board for the startup team. This person or these people, should be on the company’s Board of Directors (check out Every Company Needs a Board of Directors – Startups Too). They can come from inside or outside of the investor group (inside preferable). If I’m the best qualified person for the job, I’ll step up. Usually, though, it’s someone else involved.
• I hate leading a round – someone has to be in charge of representing the investors in the seed round. Negotiating the fine points of the deal, working with lawyers, getting everything signed, communicating every step of the way, etc. I hate doing it, but once in a while, I draw the short straw. I like investing along side seed or angel funds as a result. They’re pros and do it all the time. It’s not even heavy lifting for them. Most importantly, they’ll do all the herding of the investment cats required. It’s often a real pain in the ass.
• You can’t and don’t even want to try to tie up every loose end – as much as you’d like everything in the investment to be taken care of, completely thought out and totally bulletproof, it ain’t gonna happen. Stuff is going to change along the way anyway.  The investor and founding team need to feel like they will make adjustments together as warranted.
• Friend’s before business – this is a personal rule of mine that have broken more than once. Fortunately, it’s never backfired on me. I take both my friendships and my involvement with companies seriously. As such, the potential for conflict is high if I mix them – things never go the way you plan. There are always going to be situations in which the investor needs to support either the company or the management team. Can you support the company over your friend? Your friend over the company? Why even put yourself in that position?

This is hardly a definitive list of any kind, of course, but hopefully it’s a starting point for anyone wanting to get involved in angel investing and for anyone looking for an angel investment. Keep in mind that none of these guidelines have anything to do with the actually business criteria used in selecting an investment. I’ll leave that for another post.

To me, the most important of these is that board members, unlike informal outside advisors, have a fiduciary responsibility to the company and, therefore, offer advice that is often better thought out and more responsible. After all, it’s their job. Additionally, because there is greater long term continuity with board members than other advisors, the input received from directors tends to be more specific, context sensitive and applicable to the company’s long term strategy. Finally, a board tuned in to what the company is doing and how it is doing it can provide dynamic guidance, including a kick in the ass now and then, that advisors without an ongoing, interactive relationship with the company are unable to deliver.

To some new company founders, these advantages may seem to be a bit abstract. In fact, lately, I’ve seen some resistance to the concept of establishing a board of directors entirely. From what I observe, this seems to be primarily driven by three factors:

• Fear that creating a formal board will somehow turn control of their baby to their new “boss”
• Reluctance to “spend” the equity necessary to recruit and retain quality board members
• Belief that they already have advisors who deliver all the guidance they need

Yes, there have been cases where boards have fired CEOs or somehow otherwise wrested control of the company from its leader or founder. I’ve certainly never seen this type of thing from non-investor board members and even with board members who are investors, it’s incredibly rare and definitely a last resort type of move. Virtually no one outside wants your job.  If they did, they’d just go start another company or take their money to another playground.

Yes, you will have to compensate outside, non-investor, board members.  Don’t be cheap. The compensation will be with equity, likely a single percentage point or lower and vesting over four years.  What you will get in return will likely help you immeasurably. It may not be the sole difference between long-term success and short term failure (it might), but the advice you get will at the very least make your life easier and substantially increase your odds for success.

Finally, and I sorta hit on this earlier, having many advisors and mentors is terrific.  You shouldn’t have fewer of these when you establish a board – they are always valuable.  They do not, however, take the place of a dedicated group of individuals who have committed their efforts and wisdom to the success of the fledgling enterprise.  Outside advisors will never have the volume of background data that your directors have to analyze situations nor will they feel the responsibility to do the right thing. Directors are tied to the company’s success and failure. Advisors and mentors are not. There’s a huge difference in responsibility and, ultimately, quality of action.

So there you have it. Do you still have a reasonable excuse for why you shouldn’t establish a board? If so, I’d like to hear it.  “It’s hard,” by the way, doesn’t count. You’re an entrepreneur, just work harder and smarter to get it done.

You’ve probably read dozens of books that have discussed the importance and value of planning and how time spent in architecting a system is a drop in the bucket compared to the time it saves on the back end.  I neither have the skills nor the eloquence to drive that point home any better.  What I’d like to do, though, is to present a high-level view of how you might think about the architecture of your product so that it provides a framework for you to make rapid changes to the application and makes it easy for others (partners, customers, etc.) to extend the product in ways you may not have considered.

There is nothing revolutionary here.  Let’s just call it a reminder that you will end up rewriting your application or, at least, its framework, in the future if you don’t adopt something like this early on.  You may not see it yet, but like I’ve already said, that rewrite is going to be very expensive and painful and will ultimately cost you customers, competitive advantage and money.

The idea here is that there are are two programming interfaces.  One separating you’re application from your core libraries or base layer of functions and another separating your application, as well as the lower-level programming interface from the outside world.  The lower level, base programming interface, allows you to build an application virtually independent of the core functionality of the end product.  Architected this way, you can build and test the application and the base code separately and make incremental changes to each part far easier.  In fact, one can be changed without affecting the other as long as the base programming interface remains the same (it needs to be well thought out to start with, of course).

The higher-level programming interface gives you the power to add functionality to your product quickly, using the code in the base programming interface as well as code in the application layer.  Using the application programming interface, you can prototype new functions rapidly and get quick fixes for bugs to users faster.  Perhaps even more importantly, it enables easy access to most of the guts of your system to partners and customers so that they can extend it as they see fit.  This access can be provided without having to publish hooks to the internals of your core system and exposing a boatload of potential problems that foreign calls to those components can create.  If you’d like, though, you can also expose some of that base functionality to the high-level API as is shown in the “optional” architecture slice in the image above.

Simple, yes.  It requires more work up front – both in planning and in coding – but with such an architecture, you’ll be able to roll out new functionality quickly and to fix mistakes as fast as you find them (well, almost).  Ultimately, you’ll get the functionality your customers want into their hands faster than if you hadn’t adopted such a system.  You’ll also be able to continue to roll out enhanced and improved functionality without getting bogged down with thinking about an architecture rewrite or with a huge backlog of nasty bug fixes.

The anxiety about getting your product to market will lead you to think that hacking together a system and refining it later is the way to go.  Virtually always, this is a mistake.  Speed is of the essence, but only the speed which you can deliver sustainable, quality product that continuously stays ahead of the competition.  Look before you leap, it’ll make life so much easier.

So, with all these qualities, it shocks me how often entrepreneurs choose a mentor because they’re the loudest guy in the room.  You know that person, the one who likes to talk incessantly about all of his or her accomplishments and is quick to give advice on any and all subjects.  The person who speaks before listening and has never had any failures.  Yeah, that guy.  Somehow, in the sponge-like desire that good entrepreneurs have to vacuum up every morsel of knowledge, they often attach themselves to the first person who sounds like they know anything.  Unfortunately, that’s usually the one who brags the loudest.

So, here’s a simple three-step plan on how to avoid adopting Mr./Ms. Know-it-all as your savior:

• First, recognize that you’re your only savior, everyone else is there merely to supply data, offer up some wisdom and, maybe, hold your hand.
• Second, put yourself in a situation where you can get access to many mentors.  You can do a load of legwork or sign up for a program like TechStars where mentorship (and a boat load of mentors to choose from) is the core of the program.
• Finally, ask questions.  Don’t grill a potential mentor, after all, you’re looking for free help.  Instead, have a conversation and learn about what the person has actually done – how they’ve succeeded and how they’ve failed.  Make sure they have real accomplishments and real failures (you learn more from failures than successes) and can communicate what they learned in a way that works for you.  If hubris is what you hear, try somewhere else.

I’m no psychiatrist, but the loud braggart in the room is probably making up for something else (get your mind out of the gutter, I was referring to some business deficiency) or has had too much to drink.  Either way, they do you no good.  Be selective, find an adviser with both good advice based on things they’ve actually done plus the ability to communicate they way that works best for you.  You’ll be much happier and likely, more successful yourself.

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Sure, when things are going well and life is good, almost any organizational structure will be somewhat effective.  It’s when the road gets bumpy, which it inevitably does, that the wheels of the multi-headed vehicle come off.  Decision-making is tough when things are tight and as much as you would like to believe that two or more people can reasonably make an informed final decision, a hundred thousand years of human nature stands against you.  This is why, by the way, when you’re out looking for VC funding, investors will simply laugh you out of the room when you say that the partners are co-CEOs.

Just because one person should be chosen as the final arbiter of decisions doesn’t mean that the entire founding team doesn’t remain active in strategy, tactics and corporate philosophy, it simply means that a single person is responsible for ending the conversation and making the decision on which path to take.  There is also no reason for differences in compensation or company ownership, if that’s what you’d like (although I’ve met VCs that get heartburn when this happens).  In the end, it’s simply about a single person being in charge; a go-to person (as viewed from inside the company and outside of it).  In all other ways, the founding team can remain equal.

Far be it from me to plug my own blog posts, but I wrote about this a couple of years ago and I urge you to read about it before throwing yourself into the abyss.

Hope it helps.