Inspiring both controversy and the imagination, like many innovation before them, drones were built first by the military, for the military. Interestingly, the technology that enables drones, and drives their proliferation, also comes from the military. The internet and social media have pushed drones into the mainstream consumer’s life, with vast numbers of people being reached by drone-driven content daily. Additionally, the Internet of Things has helped further the applications that make drones so useful today.
Where else do we see drones? Farmers, as it turns out, are pretty good customers of drones. From crop surveillance to precision agriculture, drones, like other autonomous vehicles, have revolutionized various processes for farmers.
More you ask? Well there are professional drone races with racers pocketing a cool 6 figures for their efforts. They deliver packages, although your pizza is probably going to take a while before it learns how to fly.
Learn more in Ethan Harden’s Drone Industry Outlook here.

According to the U.N. and the World Bank, the world population is set to reach just shy of 10 billion people by 2050. While a lot of focus has been put on the urban housing crunch that will create, as well as questions about employment in the face of growing populations and the rise of smart machines, a larger question looms: how do we feed that many people? With 795 million people reportedly not getting enough food in the world already, how do we feed 40% more people? And how do we do this while meeting our environmental goals?

A number of startups are sowing those seeds of innovation and disruption already. Aquapod is taking fish farms to a new level: they put fish farms in the ocean. Tortuga is building smarter farms for a hungrier future. Biopac’r builds machines that break down grass and all the chemicals sprayed on it, creating safe feed sources. Companies like the Rocky Mountain Micro Ranch are innovating the western diet with microlivestock: edible insects that use less land and less feed per pound than our meatier sources.

Now, the savvy investor has a unique opportunity to get ahead of the harvest, producing opportunities to reap what’s being sown. Seed companies need seed rounds, too, leading to the coming RVC AgTech Investing event.  Our keynote speaker, Paul Hoff, is the COO of Agribotix, a company enabling a technique known as precision agriculture through the use of drones. Join us for an early evening (snacks and drinks included), learning more about what opportunities exist to harvest the rewards of feeding the future. If you need more information, you can read RVC’s Ethan Harden’s industry outlook on AgTech to better understand the bunches and bushels of opportunities out in the world.

What does sequencing the wheat genome have in common with corn that makes its own nitrogengeodesic spheres for fish, and figuring out just what in meat makes meat taste meaty? They’re all agricultural and food technologies, or AgTech, the wave of innovative concepts with the goal of feeding the world for the years to come. From precision agriculture and crop engineering to tiny robots that pick strawberries, AgTech solutions bridge the gap between the rapidly expanding tech sector and the hard earned knowledge of generations of farmers. You’ll hear the scientists behind parts of this movement say things that may sound extremely strange, such as calling cows “obsolete food technology“, while others are breeding so called “supercows” and investing in the future of cowtech. To be frank, it’s about time, considering that the major breakthroughs in ‘modern’ farm science, up until about 10 years ago, have been Round Up, artificial fertilizers, and autonomous tractors. So what’s, quite literally, in store for the future? Will our produce be grown above our supermarkets and be picked by robots as we make selections on tablets? Perhaps scientists will learn how to grow bread in a petri dish, although petri dishes are more likely to make animals obsolete before wheat. From software to vehicles to the future of seeds, read the outlook here for more info.

Last weekend to register!!

RVC’s Summer Pitchfest

Tuesday Aug. 14th | 5-8:00 PM | Denver SBDC 1445 Market St. Denver, CO 80202

Meet the companies!

Available Via Livestream

Ascent360 provides cloud-based software that enables highly targeted, multi-channel communications direct to prospects and customers. Our secure, scalable software aggregates all inbound data including promotional, transactional (PoS/eCommerce), product registration, etc. via a web-service feed. ascent360.com

Cherryvale Farms is a fast-growing natural foods brand with thirteen products across three product lines: baking mixes, microwave mug cake mixes and whole grain snack bars. Proudly plant-based, Cherryvale Farms products are free from animal ingredients, boast clean nutrition labels and feature family-friendly flavors. Stocked in nearly 4,000 stores nationwide, the brand sees strong YoY, same-store sales in top retailers like Whole Foods, Sprouts and divisions of Kroger, while continuing to innovate with delicious, novel plant-based foods. cherryvalefarms.com

FitBot- Personal training is moving online and trainers are struggling to take advantage of this massive emerging opportunity. The percentage of trainers offering remote training services has grown from 10% to 33% in the past 7 years. Fitbot has already helped thousands of trainers save time and make more money through remote training, and with 300,000 trainers in the US and 1 million globally, we’re just getting started. thefitbot.com

iEldra has developed a Smart Activity Monitoring (SAM) platform uses non-invasive sensors to track a person’s Activities of Daily Living (ADLs). These sensors provide input to our proprietary SAM software to establish individualized, typical levels of daily activity. We call this a “routine” for each person being monitored in their individual home. This “routine” becomes the benchmark for establishing when the person may need assistance from family, friends or caregivers who may receive the alerts. iEldra.com

Tersa Inc. was born out of a hatred for traditional laundry methods like ironing, machine washing and dry cleaning. We saw the need for a supplement so that we could spend less time washing, and more time living. We create high end garment steamers designed for affluent professionals and marketed to their favorite hotel destinations. We offer the first automated garment steamer as well as traditional hand held models to fit into any room. tersasteam.com

Upsuite is an online B2B marketplace that makes it easy for corporate teams to find the best coworking spaces. Unlike other alternatives, Upsuite provides complete verified inventory in local markets so that teams can find, compare, share, and tour spaces. Our vision is to empower teams to do their best work together. upsuite.com

Zay Products- It’s no wonder why 130 million downhill skiers around the world look forward to taking their boots off at days end. Ski boot companies have failed to address key fundamental elements of their design and produce a cold, stiff and un-comfortable ski boot. Zay has a patented solution that will change the way skiers, from recreational to elite, think about their boots. Join the revolution as it spreads from the US to Europe and on to the explosive Chinese market. zayproducts.com

REGISTER NOW

Available Via Livestream

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We all know a handful of busts in the venture capital world. Whether the lesson to be learned is for the entrepreneur or the investor, every failure is a learning opportunity. Bigfoot wrote an article in May about some of these lessons.

Closing a venture round is the dream, right? As Founders, it’s how we know we’ve arrived, primed for our Techcrunch cover.

This transforming event is why we pull our aspirational all-nighters, scour CrunchBase for the latest capital raise news, and espouse mighty, world-altering visions.

After all, with that first, third, or fifth round of venture funding, we’re well on our way to the Unicorn Club!

Let’s start with remembering what a unicorn is: a privately held startup valued at over $1 billion.

So, how does one get into the club? Well, it’s generally based on the amount of venture capital you’ve raised.

A billion dollar private market valuation shakes out from the private market investors that need to justify a valuation in order to make their investment.

Unicorns are a rarity in statistics and reality.

Unicorns are a rarity in statistics and reality.

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The venture capital game is binary and with this amount of VC behind you, the path is to either get huge or die trying.

Unicorns die when they have to move beyond raising money and actually build a sustainable business.

Framed this way, our obsession takes on an unhealthy connotation.

Turns out, no amount of capital solves fundamental flaws in a business that, when unresolved, drive it to the graveyard.

Let’s look at two cautionary tales of one-time high fliers that recently flamed out and see what lessons we, as Founders, investors, or employees can learn from their falls from grace.

Theranos

theranos

Image source: bodetree.com

Let’s start off with a bang. There may be no better recent cautionary tale than Theranos, a one-time DECACORN. That’s right, this company (or shadow of a company) reached a peak valuation of TEN BILLION DOLLARS. Now, the company and its CEO and President have been charged with massive fraud by the SEC.

The Facts

Capital Profile

  • $1.4B in funding from over 10 rounds
  • Two private equity rounds totaling $547B, a secondary market sale of $582B
  • Investor Lemming Effect, based on a hope, a prayer, and a promise of revolutionary technology that was never developed and deployed

Shut Down Date: Potentially within next 2 months if cannot get lifeline capital

Time to Shut Down: 4.5 years post first private equity fundraise, 14 years post-founding

Lessons to Learn

  • Complexity kills

For years, Theranos promised revolutionary technology that would simplify and speed up the blood testing process. It’s admirable to tackle a big, hairy problem, but it turns out that radically improving chemistry is really challenging and takes forever. Remember this as you: 1) consider problems you want to tackle and 2) consider adding complexity (more people, more process, more product features, more capital) to your business.

  • Be suspicious of vague communications

Specifics and details matter, especially when dealing with a highly-specific problem set, such as blood testing. We’re not talking about provisioning servers and pushing CRM code to a repo here. Stakeholders must hold those in executive positions responsible to implement and act under a framework of governance and fiduciary responsibility. Eschewing this responsibility is a major red flag.

  • Set realistic expectations

It feels like Elizabeth Holmes and Theranos set themselves up for failure. Why couldn’t they have come out of the gates setting reasonable expectations around their technology and build up to being the massive market disruptor they and their investors envisioned themselves becoming? Maybe they did and just failed in executing, or maybe they promised the moon, took a lot of money from other people and delivered nothing. Let’s remember to underpromise and overdeliver.

Juicero

Juicero

A WiFi-connected juicing system

The people need JUICE! The people must not have to clean on their cleanse! Who are these people and how did they ever justify a peak valuation exceeding a quarter of a billion dollars?

Juicero made it almost five years, taking about three and a half of those to get their product to market. Ultimately, they ended up in the venture capital graveyard.

The Facts

Capital Profile

  • $119M in funding from 16 institutional investors, Series C
  • $70M Series B (3/31/2016) and $28M Series C (4/1/2016)
  • All capital raised before the product went to market

Shut Down Date: 9/1/2017

Time to Shut Down: 17 months after Series C

Lessons to Learn

  • Don’t be a solution in search of a problem

Part of Juicero’s product appeal was it’s single serving juice packets that made juicing simple and required no clean up. Sure, cleaning juicers sucks. But, is it really a top of mind problem for a significant portion of the population? To generate an equivalent amount of revenue to the capital it raised, Juicero needed to sell ~72,000 juicers to people who were going to consume 3 $8 juice packs/week for a year. Turns out, that market’s likely not out there.

  • You must match price to perceived value

Juicero’s pricing scheme required an upfront $400 a juicer (reduced from the launch price of $700) and ongoing spend of $8 per juice pack. That’s a significant capital investment into juicing, which feels possible for the 1%. When people discovered they could extract the juice from the pack without the machine, the company’s days were numbered. Good news for Soylent I suppose!

  • True differentiation and improvement are necessary to disrupt

Stripped of its sleek design and wifi compatibility, at its core, Juicero was a cold press juicer (excuse me: a “cold-pressed juicing system”) just like any other. In reality, it was a status symbol, a talking point. It was a Concorde in a market that didn’t really need it. Thus, it was not a sustainable business.

  • Hubris is blinding

Please read “A Note from Juicero’s New CEO” four months pre-shutdown. I understand that many of us Americans have a problem with our relationship with food often going for convenience, pleasure, and price to quench our hunger pangs. Now, I have no clue how to solve this. But my first and best thought would likely not be a $400 juicer.

Imzy

Imzy

The “kinder, gentler community platform

Ok, Imzy was nowhere close to a unicorn, but, hey, they’re an early-stage venture-backed company whose shut down we decided to analyze. Imzy made it about a year and a half, making it to a beta launch. Ultimately, they ended up in the venture capital graveyard.

The Facts

Capital Profile

Shut Down Date: 6/23/2017

Time to Shut Down: 8 months after Series A

Lessons to Learn

  • Markets don’t form around ideals

Imzy was unable to find its footing in the online community space. The Founders came out of Reddit and idealized a nicer Internet. To their credit, they realized somewhat quickly that their desire to provide a troll-free utopia for the sharing of ideas and passions was just not something a massive amount of people were going to flock to.

  • Imzy was a vitamin. Strive not to be one too

Yes, this is cliche, but it’s true. The Founders had an idea for an itch they wanted to scratch. The CEO was an entrepreneur who sold his previous company to Reddit. So, chances are, he dreamed up a problem while at Reddit and just couldn’t bear not willing it into existence. That’s admirable, but also dangerous. Turns out people will put up with some stuff they don’t like (i.e., trolls and profanity) if the core experience is satisfying their need.

  • B2C communities are incredibly hard businesses to build

This is not a surprising shut down. Scaling an online community from scratch is no joke, just ask the Founders and investors behind App.netOrkutSecretSo.cl and what was that other one? Oh yeah, MySpace.

Conclusions

This was not meant to be a slam piece. There’s no shortage of those already out there.

These companies are in the spotlight, with bright lights shining on their flaws, unfortunately for them. Fortunately for us, that scrutiny gives us the opportunity to gain new levels of understanding of both how incredibly hard it is to build a market-changing business and what it takes to keep your startup surviving and thriving.

You need to be more than just passionate, smart, and idealistic.

You need more substance than loads of capital supporting your effort.

Then, you need to build a product that a market truly understands, needs, and values above and beyond the competitive set.

You need to price and package that product appropriately, making it the obvious choice for customers

 

 


This article was originally published by our friends over at Bigfoot Capital on their blogBigfoot Capital provides growth capital for SaaS businesses that have achieved initial revenue scale ($30K-$150K MRR) by selling to SMBs. Our ongoing capital investments range from $150k-$750k to support efficient growth and help Founders retain the lion’s share of their equity and upside. Beyond capital, we have built relationships with specialized services firms across sales and marketing, product development, and operations to help you scale beyond your current human resources. Want to learn more? Visit www.bigfootcap.com or schedule a time to chat.

The holodecks of the Star Trek universe once captivated millions of people’s imaginations. For the unfamiliar, holodecks were rooms that became any setting you wanted, from a dojo to a sprawling valley in Austria. While today’s reality bending technologies don’t quite reach the same level on integration, advances in the industry are shaking things up. Google’s Tilt Brush turns your room into a personal graffiti studio while esi-group is building a tool for industrial product pitches. The virtualization of fabricated reality with digital tools isn’t anything new. Nissan’s Gran Turismo Academy trains pro gamers to be pro drivers using the realistic racing game Gran Turismo. This year, the advantages of virtual reality training has landed the programs alumni a ban from Britain’s premier racing tournament. NASA started using early virtual reality with flight simulators in 1959. The turning point bringing this technology to the masses has been the analogous VR/AR headwear.

The initial push into consumers lives were Google Glass and the Occulus Rift headset, but the move has slowed down since the HTC Vive. Everyone from Samsung to Dell has some version of the VR headset. As the race for smaller and smaller transistors heats up, we’re likely to see the landscape change. Google Glass was premature to market, lacked positive consumer sentiment and because of ithat ultimately failed as a flagship of the augmented reality sector. However as our smartphones become more powerful and various wireless technologies come into greater maturity, we are likely to see new attempts at the eye wear of the future.

As with last month’s outlook on nanotechnologies and advanced materials, which have some heavy implications for the VR/AR industry, VCA team member Ethan Harden has prepared an outlook on the future of augmented and virtual reality. His report goes in depth about the future of these technologies, their mediums, and the mix of revenue streams projected to grow in this industry. You can download the outlook here.


Ethan is a Sr. Financial Analyst at Stantec, a Top 10 design firm awarded by Engineering News Record. He works as a financial consultant primarily serving water and wastewater municipalities across the country. His focus is to provide value to his clients through technical financial planning, cost-of-service, plant-investment fee and affordability financial modeling.

Ethan’s enthusiasm to work in a fast-paced, volatile and varying environment has led him to venture capital to employ the full business acumen he has developed. He is looking to immerse himself in venture capital to gain the knowledge and understanding of the fundraising process in order to be prepared for his next opportunity.

He holds a degree in Finance, Marketing and a Masters in Business Administration from the Daniels College of Business at the University of Denver.

Hello RVC members, my name is Justin and I am a summer intern for RVC. One of our primary objectives for this summer is to provide an update on RVC portfolio companies for members. This week, I’m bringing you an update on Silvernest. Finding a roommate is important, but it is never an easy task, even for open-minded college students with low standards.  As a typical cash-strapped CU Boulder student, I can rant about how expensive rent is and how difficult it is to find a good roommate all day long. The roommate situation and process are more challenging for the community age 50 or above. As people get older, they seek out supplemental income and companionship, and the housing situation for empty-nesters and baby boomers is currently a national concern. Nearly half of adults in U.S age 65 and older live in poverty and cannot afford to live in the nursing home. Public housing is not a viable solution either, as the average wait time exceeds a year. For example, the average wait time is more than four years for public housing in New York. Wendi Burkhardt understood that this is a critical issue that the government won’t be able to solve, which inspired her to co-found Silvernest to tackle this problem. Before starting Silvernest, Wendi held multiple executive positions in the tech industry and has years of experience in marketing and sales. Silvernest is the only roommate matching and home-sharing service designed specifically for the community over 50. It is a brilliant service to lighten the financial burden and to find trustworthy companions for the aging community. For a small fee, homeowners have access to 60 days of unlimited communication, matching and background screening for their potential roommate.

 

Silvernest hasn’t always sailed on smooth waters. Wendi and her team have faced numerous challenges and hurdles since the formation of the company. According to Wendi, it is very difficult to be a female founder in the startup world, since it is tough to raise capital as a female founder in a industry that is primarily dominated by men. This is a truth we see resoundingly supported by data, with female founders receiving just 2% of venture  dollars in in 2017. Wendi was able to secure funding through grit, perseverance, and tenacity, along with the help of her wonderful team. Another challenging process for Silvernest was building partnerships with non-profit organizations (NPO). Silvernest currently partners with multiple organization including Village to Village Network, an NGO that helps communities establish and manage their own aging in place initiatives called Villages. This is a great achievement for Silvernest, given that most NPOs tend to be  hesitant to partner with for-profit organizations status.

 

Silvernest received national recognition after their RVC Angel round in 2017. It now operates in all 50 states but markets actively in Colorado and California. Silvernest has been expanding rapidly and successfully raised more funding after the RVC angel round. It raised $1.3M back in 2017 and is currently close to finalizing an additional round of funding. Despite recent success, Wendi was very humble throughout the interview. She stated that the primary objective remains helping the boomer generation and that Silvernest will not deviate from its mission. Although Silvernest became very popular in the general roommate matching market, 90% of Silvernest’s subscribers are over the age of 50 with the average age of the renter being 40. Wendi also mentioned to me that the proudest moment for her was when Silvernest was one of 46 companies selected out of 1,000 by 500 Startups.

 

Silvernest is an amazing company with enormous potential. It is certainly a great way to find affordable housing and has an enormous social impact. Some of the houses listed on there make my Boulder apartment looks like a flaming trash heap, and yet they are in a similar price range. I am already better situated than most other Boulder students, as I am not paying $800 to live in a closet without AC along with five other roommates, and maybe three raccoons. However, we should never let good get in the way of being great, and based on what I saw at Silvernest, we can all live a great life. That is all for today, have an amazing day and enjoy the air conditioning in this hot weather! Most Boulder kids don’t have AC at their home, including myself, so crank up the AC for me!

If you ask an engineer what stands between them and their dream, they’ll probably make a joke about debt. If you throw a pile of cash at an engineer and ask them again, the problem may be solved, or they may tell you, “It’s just not possible yet”. New materials have been at the forefront of every technological or industrial revolution in history. We title eras of history by the materials that defined them, from bronze to steel, leading up to today’s so called ‘Silicon Age’. Electricity and fertilizers shaped the 20th century’s population boom, and progressively lighter, stronger steel gave it further form. As we begin to outstrip the capabilities of the materials that made our achievements possible in the past, materials engineers are rapidly pursuing new, novel materials to drive our advancing needs. Case in point, 2017 was the year of graphene with its promise to reshape how we do everything from computing to water filtration. 2018 is shaping up to be a year of silicon, lithium, and cobalt as we sprint towards newer, better batteries; bioconcretes are looking to be the future of roads and construction. Questions then arise. What technologies will drive the next wave of growth? What are engineers building now that will shape our next major wave of new inventions? What will those markets look like in 5 years? Ethan Harden, an analyst on the VCA team at RVC, has created an Industry Outlook about nanotechnologies and the advanced materials they’re driving. You can read it here.

Convertible debt is commonly used in seed stage transactions, and for anything but friends and family, or a true 90 day or less bridge, I cannot understand why anyone would use these to fund a company, regardless of whether you’re an investor or founder – it’s equally bad for both.

Fallacies about convertible debt - peter adams

There are a lot of otherwise smart people out there who continue to support fallacies about the

 benefits of convertible notes.  I’ll walk you through the claims and show you how they are not only wrong, but are the exact opposite of many people’s beliefs.

 

Fallacy #1:  Convertible Notes are Cheaper than Preferred Equity Deals.

This belief comes from a shallow idea of the cost of a note.  While it’s true that the legal costs for doing a note are $2500-$5000 in many markets and the cost for doing a preferred equity round can be as much as $10,000 to $20,000, there are other costs to consider.

If the note is for two years, for $1 million at 8% interest, then the entrepreneur is going to have to pay $166,400 in interest.  Some will argue that this is rarely paid in cash, but it is still a huge amount of dilution for the company and represents a real cost to them.  So, when does it make sense to “save” $15,000 when it costs $166,400 to do so?

The other part of the fallacy of this thinking is that the note cost is the only legal cost.  In fact, the entire premise of the note is that it will convert into equity when the company has a priced round, usually of $1 million or more.  At that time, the company will still have to pay the $10,000-$20,000 PLUS the original $2500-$5000 that they paid for the note originally, That’s right – the founder is really going to have to pay for both, resulting in 25% HIGHER legal costs than just doing an equity round in the first place.

 

Fallacy #2: Convertible Notes are Easier than Preferred Equity

It’s true that a note is only a few pages and very few terms to negotiate and Preferred Equity requires changes to multiple documents; the term sheet, subscription agreement, changes to the articles of incorporation, etc., but in the long run, convertible notes can end up being much more complicated and require a lot of legal time to figure out the ambiguous outcomes.

 

Let me start by saying that “simple” does not mean “best”.  Leaving major terms and issues undecided and unaddressed helps neither the founder nor the investor.  I recently had a portfolio company that almost went out of business for no other reason than that they had used convertible notes injudiciously and they found themselves in default on multiple notes simultaneously.

 

Let’s just consider a simple case of convertible debt vs. preferred equity in two rounds.  Let’s ask ourselves, how many shares does each round of investors get and how many does the founder get?  (Note that this conversation doesn’t occur until conversion, so many founders, attorneys and investors don’t think about these until it’s too late.)

How Many Shares do the founders have after these three rounds?

How many shares do Round 1 investors have?

How many shares do Round 2 Investors have?

How many shares do Round 3 Investors have?

 

Convertible Note

10 million shares authorized and 1 million shares issued to founders at start.

Preferred Equity

10 million shares authorized and 1 million shares issued to founders at start.

Round 1:  $1 million convertible note, 8% interest, 20% discount, $4 million valuation cap.

Round 2: $2 million convertible note, 8% interest, 20% discount, $6 million valuation cap.

Series A Conversion with Priced Round: $5 million Preferred Equity with $10 million pre-money valuation

Round 1: $1 million preferred equity with $4 million pre-money valuation.

Round 2: $2 million preferred equity with $6 million pre-money valuation

Round 3: $5 million Preferred Equity with $10 million pre-money valuation

Round 1: Founders 1 million/ Investors 0

Round 2: Founders 1 million/ Round 1 Investors 0, Round 2 Investors 0

Round 3:  Founders 1 million shares

Round 1 Note holders convert at the better of 20% discount from the priced round or the valuation cap.  Since 20% discount from $10 million would be $8 million, they will take the valuation cap at $4 million.

But wait – we have to calculate Round 2 simultaneously.  They would also take the valuation cap at $6 million, since that’s less than the 20% discount at $8 million.

Now, the Series A investors get 33% for their $5 million on $15 million post-money, right?

Or, since the first two notes are now converting, this round is actually $1 million from Round 1 plus $2 million from Round 2 plus $5 million from Round 3, so the total is $8 million on $10 million pre-money.

So, how many shares do each of the investors get?

Round 1 is $1 million on $4 million cap, so they get 20%

Round 2 is $2 million on $6 million cap, so they get 25%

Round 3 is $5 million on $18 million post-money, so they get 27.8% of the company.

The Founders get what’s left – 27.2% (1-.333-.25-.2)

That works out great, unless the Series A investor has negotiated $5 million on $10 million pre-money for 33.3% of the company.  That’s not technically how it should work since the post-money valuation is $18 million, not $15 million. The Series A investor might want to come in as if the first two rounds were equity and theirs would be the only new money coming in.  This is called “The Golden Rule” – he who has the gold makes the rules. In that case, what does Round 1 get? They should still get their 20% since that’s what they negotiated, and Round 2 should get their 25%. So, here’s how the percentages should work out in this scenario:

Founders 21.7% (1-.3333-.25-.20)

Round 1 20%

Round 2 25%

Series A 33.33%

Alternatively, the Series A investor might require that the investors in the first two convertible notes take the dilution hit instead of the founders.  Or they may figure out a way to share the dilution between early investors and founders. In these scenarios, the people who took the greatest amount of risk can be unfairly treated by later round investors who come in after the deal has been de-risked.

Believe it or not, there are still other ways that this scenario can be calculated and it gets even trickier if there is a carve-out for an employee option pool.   But the point is that there is a lot of ambiguity and this can result in higher legal costs and difficult negotiation after the fact.

Ok, so now we have to turn these percentages into shares.  For the first scenario, the only party to the transaction that we know how many shares they have is the founders at 1 million.  We know that they will own 27.2% of the company, so we need to find the number that 1 million is 27.2% of which will be the total number of issued shares after Series A.  Then we can just apply the percentages to see how many shares each party gets.

So, 1,000,000 divided by .272 gives us a total of 3,676,471 and the shares would be distributed as follows:

Founders = 1,000,000

Round 1 = 735,294

Round 2 = 919,118

Series A = 1,022,059

Round 1: Founders 1 million, Investors 250,000 (Note – investors own 20%, having invested $1 million with $4 million pre-money/$5 million post-money.

Round 2: Founders 1 million, Round 1 Investors 250,000, Round 2 investors 416,667 (Note – Round 2 investors own 25% having invested $2 million with $8 million post-money and 416,667 equals 25% of the total shares outstanding)

Round 3: Founders 1 million, Round 1 investors still have 250,000, Round 2 Investors have 416,667 and Round 3 Investors get 835,836 (again, 835,836  is 33% of the company since Round 3 Investors put in $5 million with $15 million post-money, so the calculation is easy)

 

So, between figuring out the math and negotiating all the ambiguities between the parties, doing the conversion on a convertible note is much more complex and challenging than just going through a vanilla Series Seed term sheet for Preferred Equity.  Anyone can read Venture Deals to learn about the terms and then work with their attorney to come up with a reasonably negotiated term sheet. That’s a lot easier than going through all the headache and ambiguity of converting complex convertible notes.

 

* BlockChain ICO Note:  one more complexity that is becoming more common is that companies are choosing to do an Initial Coin Offering (ICO) rather than going to Series A.  This can mean that the note never converts because there is no priced round to drive the conversion. Again – the complexity is much greater on convertible notes!

 

Fallacy #3 You can Avoid Valuation by Using Convertible Debt

 

Many people falsely believe that they can “kick the can down the road” on valuation by using convertible debt and then letting the Series A investors set the price and terms.  While this may make sense when friends and family are investing, angel investors who are investing for profit rather than family or friendship are going to need to have a valuation cap if they use a convertible note.  You may recall that in the examples above, the cap was always lower than the discount, so if investors had used an “uncapped note” without a valuation cap, they would have overpaid for their investment by millions of dollars!  For that reason, virtually none of the notes done today are done without a valuation cap, so there is still valuation work to be done to calculate what the cap should be.

 

While many recognize the need for a valuation cap on the note, many people do not understand how to calculate the valuation cap.  The formula for calculating the cap is easy:

Valuation Cap = Equity Valuation

 

That is to say, the valuation cap is calculated in exactly the same way that we calculate the equity valuation for a company when we do a preferred equity round.  

 

Venture backed companies grow as much as 2X in value every year – it would be injudicious for anyone to put their capital at risk to invest in a convertible note with a return of only 20%.  At that rate, the angel investing community would pack up their bags and go home when calculating the cumulative losses in their portfolios and lack of tax benefits.

 

I have heard no argument for why the valuation cap should be anything more than what the valuation would have been if it were an equity round.  If anything, it should be lower because of the lack of tax advantages for gains or losses to investors which can cost 20% difference in terms of after tax cash in the bank because of penalties for using convertible notes vs. equity.  (See Section 1202, Section 1244 and Section 1042 of the IRS code to understand the benefits to investors investing in preferred equity deals that are not available to convertible note investors.)

 

Valuation is a function of risk.  It makes sense that the value an investor pays should be tied to the risk AT THE TIME OF INVESTMENT.  Some get confused by thinking that the value should be set at the time of conversion, once the investor’s capital has been put at extreme risk in order to reduce risk for future investors and to increase value for the founders.  There is simply no rationale that says that value should be set at a future date when risk is lower and even less rationale to argue that a 20% discount off the de-risked value would be appropriate.

 

Conclusions

While I’ll grant that there are a few narrow uses for convertible debt today, the widespread use of them in the startup and seed stage investing community is dangerous and unjustified for both founders and early stage investors.  Attorneys should understand these fallacies and lead their clients to preferred equity deals that will better serve the needs of startup founders and investors.

 

Denver, CO – Rockies Venture Club (RVC), one of the largest and most experienced Angel investing organizations in the country, led and closed 15 funding rounds over the past year. RVC has created a community of accredited investors who are passionate about helping early stage companies raise the capital that they need to grow.

This trend of early-stage investing in Colorado is encouraging considering the fact that there has been a downward trend in early-stage activity worldwide. A November 2017 report by TechCrunch shows that despite record levels of Venture Capital being raised, the number of funding rounds has been cut in half since 2014. This indicates that capital is being concentrated into larger, later-stage companies. With this being the trend, it would seem that Rockies Venture Club and more largely Colorado as a whole is providing its companies the capital they need to grow.

According to RVC Executive Director, Peter Adams, “One of RVC’s leading principles is to be as diversified as possible when investing in companies. We believe that investing in a variety of sectors allows our Angel investors to diversify their personal portfolios while having fun learning about industries they don’t have past experience in.” This is something that the Angel group truly puts into practice if their 2017 portfolio is any indication. Among the 15 new companies that RVC backed in 2017, there was industry representation within CyberSecurity, AgTech, FinTech, Medical Devices, and Consumer Products; just to name a few.

In addition to engaging local capital through its network of over 200 active Angel investors, Rockies Venture Club also syndicates many of these deals with other Angel groups from across the U.S. Dave Harris, RVC’s Director of Operations, states, “RVC has been working to develop strong partnerships with other Angel groups for several years now. This allows companies to more quickly and easily close their funding rounds, bring deal flow to other areas of the country, and ultimately results in a greater amount of capital being invested directly in Colorado companies.”

Among the 15 deals, RVC led the seed-round in the female founded, Fort Collins company, The Food Corridor (TFC). TFC is the first online marketplace for food businesses to connect with available commercial food assets. Food businesses can find and book commercial kitchens, equipment, commissaries, processors, co-packers, and food storage spaces. CEO Ashley Colpaart put together a $550k round through Rockies Venture Club, Rockies Venture Fund, and other Northern Colorado Investors. Peter Adams stated, “I believe that RVC investors were especially interested in this deal due to Ashley’s deep industry knowledge and the promising early traction they have gained with food entrepreneurs and commercial kitchen spaces.”

RVC Angels also invested in CirrusMD’s $7 Million Series A Round. CirrusMD is a company that gives patients immediate access to providers via secure chat so healthcare organizations can excel in a value-based care environment. This was the third round that RVC has participated in, having first invested in the company in 2014. Since then CirrusMD has expanded access to care to over a million of patients and formed strong partnerships with some of the largest health systems across the country.

Beyond closing the 15 deals, in 2017 Rockies Venture Club created the Women’s Investor Network(WIN), an initiative created to address the lack of diversity in Colorado’s investor community, launched the Rockies Venture Fund, an early-stage VC fund that invests alongside RVC’s Angel investors, and collaborate with the Colorado OEDIT to create the OEDIT HyperAccelerator, program that helps Advanced Industry grant recipients raise the necessary matching funds.

Looking forward to 2018, the club will be hosting the 11th annual Angel Capital Summit (ACS) in March. The Angel Capital Summit is the largest Angel investing event in Colorado, bringing together over 300 investors, entrepreneurs, and community members together under one roof. This year the conference will focus around current, past, and future waves of innovation that have had or will have lasting impacts on the venture capital industry. RVC is excited to announce that there will be two keynote speakers at ACS this year: Divya Narendra, and Colorado’s own Andre Durand. Dyvia is the Founder and CEO of SumZero, and co-founded ConnectU, the inspiration behind Facebook. Andre is the Founder and CEO of Ping Identity who lead the company through a $600M+ acquisition by Vista  Equity Partners in 2016.