Brad Feld on How to Be Smarter Than Your Lawyer and Venture Capitalist


Brad Feld has a lot of good advice. He's made a living in innovation for more than twenty years, helming various startups and venture capital firms. His current firm, Foundry Group, boasts a portfolio comprised of names like Cheezburger Network, StockTwits, and Zynga.
Luke and I had a chance to get some of Brad's insight recently on a number of topics, including financial literacy, questions of funding rounds, and how to get started as an entrepreneur. We also talked about his thoughts on social media company valuations and Google+. See below for the full transcript.

Benzinga Radio: Brad, thanks for coming on the program.
Brad Feld: My pleasure.
Let's talk about the new book you just put out. It's called Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist. What does an entrepreneur need to do to be smarter than his or her lawyer and venture capitalist?
Brad Feld: Well, hopefully read the book! My partner (Jason Mendelson) and I have been doing venture deals for over 15 years and we've done hundreds and hundreds of different investments. About five years ago we were motivated to write a blog series I put up on my blog at Feld.com, which decomposed a typical series A term sheet for a venture capital deal.
The motivation for it was that something like it really didn't exist and so the only people that really understood how venture capital deals worked were the VCs, lawyers, and entrepreneurs who had done it multiple times. A first-time entrepreneur often knew very little about how the deal actually worked.
Interestingly, many experienced entrepreneurs knew relatively little about how the deal actually worked because they had either deferred plenty of it to their lawyers or didn't really focus that much on it during the time that they did their deal. That term sheet series, which was about 30 posts, was very popular, has been used both by many numerous entrepreneurs, but also by many schools, both business schools, law schools, etc.
And then subsequently, many of the new accelerator programs which I co-founded (one called TechStars), where first-time entrepreneurs are using it to help understand what their deals look like. Jason and I had been talking for a while about actually writing a book that not [only] built on the term sheet series and sort of cleaned it up, but also talked about deal making, talked about how the venture capitalist business worked, talked about some basic negotiating strategy, and also all the different players involved, and that's what we took on with this book.
It's great that you are putting this information in the hands of entrepreneurs who are not necessarily as well versed in this as a venture capitalist or a lawyer would be. What was the impetus for that, aside from the fact that they just simply didn't have that information? What was the need, in your mind, for them to have that information and be on the same level as a venture capitalist or a lawyer in those types of discussions, at least in certain areas?
Brad Feld: I started my adult life as an entrepreneur and now as a venture capitalist. The information asymmetry between entrepreneurs and venture capitalists in the context of deal negotiations has always bothered me. We try to keep our deals very straightforward and we try to be very sort of straight up the middle in terms of negotiation with the entrepreneur, but the fact that entrepreneurs didn't really have the same information as VCs put them at a disadvantage.
I think that was the original motivation; it was just like…I should say it's not that hard but it's complicated. It takes understanding, and as an investor who came from the world of being an entrepreneur, creating great companies is extremely hard and frankly the entrepreneur should have the same level of information and understanding when they are negotiating their deals for investments in their companies as investors have.
I also feel really strongly that it is the entrepreneur's responsibility to negotiate the deals, not their lawyers. I think their lawyers can guide them and help them, but I've seen way too many times where entrepreneurs defer to their lawyers and their lawyers are either not that sophisticated with these types of investments or they're too busy and they're not paying attention or they don't really understand the nuances that the entrepreneur really cares about and sort of makes generic tradeoffs.
Fundamentally, if the entrepreneur wants to be the one that is driving the negotiation, then being armed with more information is better for them and we viewed that as a good thing for the universe.
And certainly there are situations or scenarios where the interests of the venture capitalists and the interests of the entrepreneur might become slightly misaligned.
Brad Feld: I don't think slightly is appropriate. I think there are lots of cases where they are misaligned. I mean, if you go through the book we break down the notion of a venture deal and a typical term sheet into three categories: economics, control, and everything else.
Economics tend to be complicated and there are lots of different ways in the term sheet and in the deal that a VC can get differential economics, especially in a downside case if the entrepreneur doesn't quite realize what is going on. In the control scenario, VCs tend to be very obsessed with control, especially around their investment and in many cases around the company and I would say there are many situations in which the entrepreneurs that I've interacted with both pre- and post-deal that don't really understand the nuances of the control dynamic.
If everything is going great and it's a win and everybody is happy, oftentimes nothing comes into play. But if things go sideways or if there are bumps in the road or even downwards case scenarios, many of these terms can have real impact on who owns what part of the company and what the economics are.
Along those lines, we noticed on your blog at feld.com that you've been lamenting the lack of financial literacy in the entrepreneurial community. What are you trying to do with the new Finance Fridays series?
Brad Feld: I'm trying to get two things. One is to help entrepreneurs understand some basic accounting without making it boring and tedious. One of the challenges of a book like Venture Deals or Finance Fridays, Fred Wilson has a great series of posts on his blog at avc.com called MBA Mondays which Finance Fridays hopefully will be a nice book end to…this stuff can be incredibly dull and entrepreneurs don't have time for dull, they don't have the patience for it, they have way to many things going on and frankly the information doesn't have to be dull, it can be presented in a way that is accessible, fun, clever, and highly relevant.
We tried hard in Venture Deals to write a book that was easy to consume. It's the second book I've written; the first book I wrote was a book with David Cohen, the CEO of TechStars, called Do More Faster. It's hard to write a book; it's very different than the short form of blog posts a long form of a book. With Finance Fridays, our goal is to, you know, write 20 or 30 posts similar to what I did when I wrote the original term sheet series with Jason that helped with the basic entrepreneurial accounting so that entrepreneurs can understand balance sheet, income statement, cash flow statement and how all the pieces run through it.
Again, I run into so many situations where the entrepreneurs don't really understand the economics of their business and more distressingly sometimes their investors and VCs and board members don't really understand it and sometimes it's because they don't understand basic accounting and sometimes its because of the complexity of how cap accounting actually works so hopefully we will help demystify that some.
Your portfolio is very much focused on Internet and social media investments. Certainly, the funding process can be daunting for a first-time entrepreneur. What advice would you give to an aspiring entrepreneur who might have a great idea for a business in that space but is unsure about how to get started?
Brad Feld: Well, two things. One is if you're passionate about the area that you're working on, just get started. There is no magic to it. But if you're not passionate about it, don't do it. I think that there are a lot of people, especially as entrepreneurship becomes a thing that everybody is talking about again, you know we go through cycles and we are in a cycle where entrepreneurship is very front and center. I think that it's really, really important that the type of product and the business you're going after as an entrepreneur is one that you are incredibly passionate about because it is going to be unbelievably difficult to create something successful.
The second strong piece of advice I would give you is to surround yourself with experienced people. I call them mentors. Find mentors that have been through things that you're going to go through that are interested in helping. Some of them will help because they are just giving back; others will help because they view it as interesting to them to help with first-time entrepreneurs.
Some of them will help because there is something very specific about you or your business that captivates them, but look for people who recognize that they benefited from being successful entrepreneurs along the way they probably had their own mentors and people who invested in them. I certainly did. As a result, take advantage of their interest and their willingness and their desire to help a first-time entrepreneur.
That's great advice. What are your thoughts on the funding process? When should an entrepreneur be looking at raising funding and going through various types of funding?
Brad Feld: Yeah. My general feeling is that an entrepreneur should at the very early stages try to make as much progress as possible with the least amount of funding. I have a way of describing it, which is, define an amount of funding which gets you to what you think is the next level of your business and that's the amount of money which you should raise.
The problem is that there is a lot of uncertainty, they're right you can't define any of that stuff precisely – the next level or the amount you need to get to the next level or how long it will take but if you take the approach of minimize the amount of capital you need to raise early on, spend that money efficiently, prove value, and make real progress with your business at the point at which your making progress it becomes very easy to raise capital.
The challenging points in time to raise capital are sort of in that middle zone where you've raised a bunch of money and haven't made a bunch of progress but need to raise more money to continue going, generic advice is to keep your burn rate low, raise relatively little money on the front end, make progress and then start to accelerate as you feel like your hitting a seam.
When you look at your portfolio, what are some of the recurring themes or qualities that you see in companies that you invest in that make them attractive or exciting?
Brad Feld: For us at Foundry Group, we invest in a series of themes that we define at http://www.foundrygroup.com/wp/themes/. As a result, we have a very tightly defined set of areas that we invest in. Because of that, we don't really have to spend a lot of time understanding the markets because the themes that we invest in, we know those markets really well.
What we end up looking for are entrepreneurs who are incredibly obsessed about the product or service they are creating, who love the markets that they are building product in, who have expansive visions about what they want to create, and are able to both go deep technically as well as broadly in terms of the market and customer dynamics.
Most of our focus once we identify something that is within one of these themes that we are interested in on the entrepreneur and the characteristics of the entrepreneur involved and the product. We are real product nerds and we love to play around with products, both hardware and software and whenever we see something we are really trying to understand if it's a product that we want to invest in long term as well as people.
Would you give more weight to one or the other?
Brad Feld: No, and we don't really have a quantitative approach to our decision-making process. I would say it's very qualitative again because we know the markets really well. All four of us work on the same stuff and so qualitatively as we are evaluating a company and getting to know the people and understanding the products, if one of the four of us loses interest or is less excited or has diminishing excitement about what is going on, we tend to pass at that point rather than get in a situation where we are trying to convince each other that this is something we should do and part of that is because it's a relatively small fund, we can make about 10 new investments a year and we see hundreds of things we could probably invest in, so we can set our filter very, very high.
You are also co-founder of TechStars, which is the seed fund for new startups that provides financial backing and mentorship for entrepreneurs. What are some of the exciting companies or trends that you see coming through there lately?
Brad Feld: TechStars has now expanded [to] four programs. One in Boulder, one in New York, one in Boston, and one in Seattle. We had a hypothesis that there would be some regional differences based on the mentor communities as well as the entrepreneurs present in those different geographies, and it turns out that that's true. The New York program had a handful of really interesting media-oriented companies in addition to some consumer and business Internet-related companies.
The Boulder program tends to have a pretty good mix of that. The Seattle program has a couple of game-oriented companies; there is a very big game presence in the Pacific Northwest, as well as consumer business Internet. The common theme across all the programs is that we are seeing a very, very high-quality of technical entrepreneur and product entrepreneur teaming up with first-time business entrepreneurs, but in a way where there is a lot of trust and guidance that happens from the mentors.
Some of the companies coming out of the program, especially ones that have deep consumer roots or sort of soft infrastructure roots, companies like SendGrid, which is a Boulder company from last year that we invested in. There is another one called Orbotix, which is another one from Boulder.
Growing at an incredible pace is another New York company that is doing extremely well – OnSwipe. And so you are seeing these companies that in one or two years get to a place where you know when I was an entrepreneur you might dream about getting to in five or more years.
Now, of course, we have to ask about Zynga. They are part of the Foundry Group portfolio. Zynga recently filed their S-1 in order to go public and we know that they are in a quiet period right now. A lot of critics these days are saying that social media companies are coming to market at excessive valuations. What are your thoughts?
Brad Feld: Well, I can't talk about anything with regard to Zynga specifically. I would say that generally speaking, there is an enormous amount of chatter around the valuations of all the companies who have recently gone public or are looking to go public and my point of view is very simple as an investor, which is that the goal of the company should be to build something that is very valuable and sustains value and the IPO is just another path along that process. I have no idea what the performance of these companies [will be] two or three or four years down the road, and that will determine if the prices today are appropriate or not.
At Zynga, I assume that you see the passion that we discussed earlier and also the technical ability?
Brad Feld: Absolutely. We were the first round investors at Zynga with Union Square Venture and at the CEO Mark Pincus, who is the primary founder, and somebody who Fred Wilson and I have known for a number of years. If you know Mark, you know that he is an awesomely passionate person who is focused and obsessed with whatever he is doing.
What are your thoughts on Google+?
Brad Feld: I have been using it intermittently since it came out. I think that it is extremely well done. I think it is very clear that Google has put an enormous amount of energy into the product vision. I think that it is different than Facebook and it is different than Twitter and one of the things that I find most compelling about it is that it uses the follow model that Twitter has but you have pretty fine grain controls about who you broadcast your data to which I've always had an incredibly difficult time dealing with on Facebook and so it does address certain things in Facebook in a very different way.
It will be interesting to see a year from now how people allocate their attention, when you're allocating your attention primarily between Facebook and Twitter, especially with the fact that they can connect together, you get a certain type of behavior. Now that you've got significant social networks, obviously these three as well as some others that people are paying attention to like Foursquare, there is a finite amount of attention that anyone individual can spend on these things so it will be interesting to see how it shake out.
It's a zero sum game when it comes to users, right?
Brad Feld: Maybe, maybe not. I mean, I think that there is a scenario where people will use multiple tools for different things. I think that the social networks aspiration is to be the primary tool that people use. I think that Twitter is somewhat different categorically in terms of the way that it is used in the infrastructure and I think that gives it a very durable long term advantage as something that people will use alongside of other tools.
I, for one, hope that Twitter does not lose its simplicity in that regard because I think that's part of the genius of it. When you look at Google+, you look at LinkedIn LNKD, you look at Facebook, you start to think how you might break down the uses of those in different categories and you get one lens.
The other thing is, as a Google Apps user, I find the integration, one Google+ is fully integrated within Google Apps, there is so many powerful things you can do across other sorts of messaging whether its video or chat and I think that creates a lot of potential disruption for Skype and whatever Microsoft's MSFT long-term strategy is.
The neat thing about all of this from a user perspective is that the pressure on these companies to innovate is higher than it has ever been, especially when you toss mobile and tablets into the mix and I think that is what's going to make better products for everyone long term which is a good sign.
find us on Twitter @matthewboesler, @lukelavanway, @BenzingaRadio, @Benzinga
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