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CRV QuickStart
The venture capital industry is evolving, trying new things to adapt to changing realities in the enviroment. That's a good thing and further proof that the venture business is not broken, but in fact changing.
The latest move comes from Charles River Ventures, one of the older firms in the business, who are announcing a new program called CRV Quickstart to provide loans (no warrants, no equity) of up to $250,000 to entrepreneurs with interesting ideas. Miguel Helft (fourth link to him in the past 30 days, I hope this one doesn't end up dead because of Times Select) has the story on the New York TImes website.
I agree with Ron Conway who told Miguel:
“I think the earlier the V.C.’s get into the food chain, the better.”
We are reacting to this new environment too at Union Square Ventures as I explained in my recent post on the Union Square Ventures weblog on Deal Size.
I have posted a bit about Paul Graham's Ycombinator in the past. The Quickstart program reminds me a bit of what Paul is doing and one of Paul's investments, Reddit, which was just sold to Conde Nast, was featured in Miguel's story today.
You may ask, why don't you guys do this? Well for one, we are not staffed at the moment to respond to the deluge of opportunities that Charles River Ventures is likely to get from this initiative. We are already looking at so many opportunities and we have a fund that is designed to do four to five new deals per year.
And second, we really want to engage with each and every investment we make. I read comments all the time on my blog and elsewhere that suggest that the new environment rewards firms that can make a much larger number of investments because web services are capital efficient and you can do more with less. Well that may be true, but we have been rewarded the most over the years when we engage deeply with a company and we are not going to lessen the engagement simply to get more names in the portfolio without thinking long and hard about the tradeoffs.
Finally there is David Sze's comment:
But David Sze, a partner at Greylock Partners, which has led small investments in promising Internet start-ups like Digg, said the program could force entrepreneurs to commit to a particular venture firm before they are ready to do so.
“I’m not sure whether there will be an advantage to an entrepreneur,” he said.
David is referring to this feature of the CRV Quickstart program:
Charles River would then have a right to be part of the company’s first real round of venture financing, where it would invest beside others.
I went to the CRV Quickstart page to learn more about this feature since it's really the key to the whole program for Charles River. Here are the details:
It is our intention to convert our debt into equity if and when your company closes its Series A round. If the company successfully raises its Series A, in exchange for sharing the risk with the entrepreneur, CRV receives a discount on the conversion price when the loan is rolled into the Series A. The discount will be a maximum of 25% (determined ratably at five percent per month, depending on how long it takes to create a Series A financing, up to the maximum).
A simple example: if CRV loans your company $100,000 with a six percent interest rate, and six months later the company closed a Series A round, at that point the loan balance (with interest) would convert at a 25% discount (value = loan dollar amount plus interest / .75) into $137,333.33 worth of Series A stock. Given that seed funding amounts are typically very small compared to the amounts one might expect to raise in a Series A round, as the example illustrates, the aggregate discount amount, in this case $37K, is a tiny fraction of what is likely to be a multimillion dollar Series A financing.
In addition, CRV would like the opportunity to support the Series A financing and thus retains an option to contribute up to 50 percent of your Series A funding. For example, if you raise a $3M Series A round, we can contribute up to $1.5M of the round.
I think that's a very fair deal. The loan is structured very similarly to what some angels are doing these days (loans that convert at a discount). And then Charles River gets to take up to half of the round on the same terms as the other new investor.
There is a lot to like about this deal. I hope Charles River shows us the best deals that come out of this program!
Comments (12) | Posted November 1, 2006 in Venture Capital and Technology
Comments
The cheese has moved, it's clear, but it seems you're reluctant to take the next step. I understand you're booked with four or five deals a year with all the due diligence and support involved. At the same time, if you don't adjust, you risk being left behind. Right now you -need- to have a high success rate because you bear almost all of the costs. What are ways you could change that mix, to support more deals but with less actual cost?
Here's an idea: What if you hire some sharp MBA just out from college (to keep it cheap), and make him or her responsible for culling deals based on the following offer: up to $200,000 in a co-signed loan that would make the entrepreneur(s) personally liable for, say, 70% of the amount. The rest of the deal follows the CRV Quickstart parameters. The costs in terms of risk of potential default rates could be small enough that it could support a lower percentage of successful deals.
Posted by: Hem and Haw | Nov 1, 2006 10:09:27 AM
Interesting indeed. I think the gesture is noble and will probably help many young entrepreneurs... but those getting the loans would probably get VC money anyway.
I think this might be an actual disservice to entrepreneurs because it gives the VC an option but not an obligation to invest. That's not really fair.
In fact, if VCs now want to become lenders then for the love of all things holy the VC landscape is more troubled - and scared - that I thought.
For more:
http://www.watchmojo.com/web/blog/?p=667
Posted by: ashkan karbasfrooshan | Nov 1, 2006 10:25:20 AM
Why such a big deal about this Fred? In my experience this has been a common approach by many for years.
I even advised on one such deal done by Nokia's innovent fund about 3 years ago. They put up 200k in a convertible preferred, validate the technology through the company, and usually pass the deal on to series A with participation preferences and so on.
The real question is exactly what CRV intends to attach to the note - Patents, IP rights etc.
And as for noble? well i'll bet that CRV is not doing this for kicks and giggles. To me this is CRVs way of applying market coverage to an emerging trend of software companies that require far less in terms of capital than their predecessors of 5 10 years ago.
Further validation of your fund size fred?
Posted by: mark slater | Nov 1, 2006 12:17:20 PM
What I see as the real benefit is that the lender, CVR in this case, is viewing the loan as a step to an A-round. This is very different than trying to raise $100K-250K (plenty these days to get a V 1.0 web site up) from friends & family (many of whom don't really understand what they are investing in) or angels, many of whom these days act more like VC's in the way they evaluate deals. The folks looking at these opportunities @ CRV will view them through a VC lens which says "if this company hits its milestones based on this loan, is it something we would like to invest in as a fund?".
Fred, you do bring up a great point about the deluge of applications this is going to create. I think for this to be a really great experience for the startup & entrepreneurs - it should be wicked fast......... 30 days or less from application to commitment. Thumbs up or down - no list of thing to go off and do....
I really like this idea and hope it stimulates some more early-stage activity here in Boston.
Posted by: Myron Kassaraba | Nov 1, 2006 1:14:39 PM
Mathematically to make this thing really work they need to close deals on a colossal scale way beyond anything they may have experienced making traditional VC scale investments. There's a lot of hit and miss involved at the earliest stages of a Startup.
What we're talking about is akin to record labels giving out record deals based on a song idea with no lyrics or sheet music and no demo. As I said in a comment on the Redeye VC site:
“VCs…should probably create wholly-owned seed stage VC subsidiaries or partner with small VCs, angels, incubators, and 'internet labs' to build a portfolio of early stage investments with the idea of evaluating open betas then making commitments to play prominent roles in standard-sized Series A investments within one year…”
With this strategy they could achieve the deal volume that enables them to come close to traditional VC fund returns, while spreading much of the administrative costs and other risks associated with early stage investing. Startups that have traction can then move on to a sure bet Series A, while seedlings still in need of nurturing or strategic redirection may be allowed to bootstrap in incubation mode until they scale into a Series A round.
Moreover, they’re selling the idea of active engagement. At the seed stage of a typical web 2.0 company there isn’t really that much of a company to actually engage with. The current crop of startups comprise of small groups of founders with wet ink on the incorporation documents, a couple servers, ramen noodles, and plenty of code.
Posted by: Gerald Joseph | Nov 1, 2006 1:22:45 PM
Not sure why this is news now -- CRV has been offering this type financing since at least 2001.
Posted by: steve | Nov 1, 2006 8:40:26 PM
Fred,
Thanks for the recognition. Now to clear up some confusion and some FUD:
1) Do we attach any rights to the seed loan to the company?
Only one: we ask to have the option to invest EQUALLY with other new investors in the Series A. On our site (www.crv.com) we mention having the right to participate in 50% of the Series A. We said this to make the announcement simple. If the entrepreneur wants more than 2 firms involved, we are happy to split the round proportionately.
There are no IP rights, patents, other attachments, at all.
2)What freedoms does the entrepreneur have to raise equity? We are letting the entrepreneur control the size and timing and valuation of the Series A round. They are 100% totally free to talk to whatever investors they want for that Series A round. They can do it themselves. They can ask us for introductions.
3) Why a seed loan? Well, frankly, because entrepreneurs were asking us for it. If the entrepreneur wants it to be seed equity versus a seed loan, we are happy to do that too.
4) Will CRV allow others (individuals and/or firms) to work with them in the seed round? YES. We are happy to do that!
4) Is this really new? No, as a structure it is not. As a formal program for a venture firm, it absolutely is.
By and large, we have received overwhelming positive feedback from the community. The only negative bit we received was from literally two angel investors that didn't like the disruption of their seed equity model that our seed loan model has created. We aren't doing this to purposefully disturb our investor brethren.
We are doing this to meet the market and what it wants.
In closing, thanks for the recognition Fred. And to answer your question, we would love to work with you on these seed opportunities. And will gladly share with you.
Thanks,
George Zachary
Charles River Ventures
www.crv.com
senseandcents.blogspot.com
Posted by: George Zachary | Nov 2, 2006 2:23:51 AM
I'm an entrepreneur singing hoseannas about the idea - even though we probably will go straight institutional.
Until yesterday, my early-stage options were:
1) continue funding from home equity, pushing my wife to the looney hatch
2) borrow unsecured from the government, in a cumbersome process
3) take an investment from VCs, in a dilutive amount either well above our needs or an attention-wasting amount well below theirs
4) sell angels on an esoteric b2b product that only appeals to institutional money
Better tools and access to great employees across the world have made founding a business ridiculously cheap. Even by the standards of 5 years ago.
This idea seems like a terrific adaption to the new venture ecology. If you view this growing food source (the set of companies that can get valuable for little money) as mastodons, it's possible we will all be hunted out of existence before the series A.
$250K is enough to flesh out many great companies before the series A. I think the 50% shared investment will go much more often to tier I VCs and deal flow for investors that don't adapt will dry up.
Primarily, I'm just thrilled as an entrepreneur.
Posted by: Michael Schoeffler | Nov 2, 2006 7:15:45 AM
The opportunity for innovation in early-stage investing is apparent and it's great to see the experimenting going on in the space. Investors and entrepreneurs will be better off for it in the long-run.
I think your strategy of focusing on deep engagement with a limited number of investments will yield the best returns for both the fund and the entrepreneurs. Now the question is, can you scale that strategy up? Or, maybe more importantly, would you want to scale that up?
Posted by: Fraser | Nov 2, 2006 11:09:53 AM
Putting more capital in entrepreneurs hands early in the process is rarely a bad thing and for companies that CRV ultimately chooses to go forward with this is a terrific way to get jump started. In effect, CRV is buying an option to become a lead or co-lead investor in more companies than they may otherwise have the chance to see through this program. However, not every firm who receives a loan will get funded by CRV.
Explaining to the investment community why CRV is passing on the A round when they have a legal right to participate may create a very difficult trap for the entrepreneur. Despite what might be legitimate reasons to pass, most outside investors would wonder why a "current" investor would choose not to go forward. In the venture space, the seller always knows more than the buyer. A no-confidence vote from CRV could be devastating to the future fundability of the business. Will VC's want the deals CRV passes on?
Posted by: Todd Klein | Nov 2, 2006 12:44:38 PM
Fred,
As always, you highlight great events from both the perspective of both the venture firm and the entrepreneur. However, the CRV hype is far from game changing.
Forgive my cynicism, but as a former entreprenuer, private equity L.P. and current equity analyst, this "new venture model" is a) not revolutionary, and b) not "new." CRV has merely decided to enter the realm of angel investing -- a big deal, but only insofar as saying "we really want to be early stage."
There is a reason venture firms love seeing deal flow from angels like Ron Conway, but don't want to BE Ron Conway. As Geoff Yang told my firm in the 1990s, "we don't think angel investing exhibits the appropriate risk-return characteristics" (more of a paraphrase than a quote). CRV will get some branding out of this, but isn't the magic of deal sourcing not the net, but the filter? I would be shocked if these investments returned appropriate early stage venture-like returns.
From the entrepreneur's perspective, this deal structure is at least more intelligent than most angel rounds that have inflated valuations, egregious anti-dilution terms, among other problems. As long as angel investors and entrepreneurs take a similar deal structure, CRV adds nothing to the mix. CRV will not be a funder of last resort -- in other words, entrepreneurs that choose CRV will have other options.
By the way, my former firm (one of the largest LPs in the world) thought very well of CRV, in spite of the fact that we were not investors in their funds. I applaud CRV for moving earlier stage -- but, that is a fund I would probably turn down.
Posted by: Rick Summer | Nov 2, 2006 2:58:18 PM
Money from the wrong place, at the wrong time, can have a bad effect. I admire CRV for trying to create a formal program to address an issue -- but I'm not sure it's good for entrepreneurs.
Taking money from someone as tried and true as CRV is going to mean that day one you're a) optioning out of a competitive A round situation, b) skipping the ability to experiment because you are immediately adding a layer of reporting.
more:
http://nabeel.typepad.com/brinking/2006/11/vcs_look_to_com.html
Posted by: Nabeel Hyatt | Nov 7, 2006 9:43:05 AM
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