How the interests of VC's and entrepreneurs become misaligned under the VC-Preferred model

The ideal startup investment structure aligns the interests of the VC perfectly with those of the entrepreneur. Unfortunately, this is not the case with the VC-Preferred model. This section describes a disparity in motivations and tolerance to risk and goes on to explore how the control in the hands of the VC can be detrimental to entrepreneur, the Company and its common shareholders.

VC's are from Venus, Entrepreneurs are from Mars--Differing motivations & tolerance for risk
The profiles of entrepreneurs and VC’s share similarities in that, contrary to some public opinion, both groups are averse to risk and take whatever steps they can to minimize their exposure to risk. However, the two groups take a very different approach to dealing with risk, and one group has the tolerance to bear significantly more risk than the other.

With ten year term funds, VC’s often invest as lead investors in a portfolio of around 10 companies, follower-investors in a further 20 companies and charge management fees, usually in the range of 2% of the funds under management. So, a $1bn fund will pay the VC firm, usually consisting of a handful of partners, $20m/year in management fees. With this virtually guaranteed flow of cash covering their salaries and costs for ten years, VC’s are somewhat buffered from the risks inherent in the portfolio, or any individual startup.

Portfolio theory[1] is based on the old adage “don’t put all your eggs in one basket”. The expected return of the portfolio is the probability-weighted average of all the possible returns after considering the risks. So, the portfolio return is the sum of all investment returns, but the portfolio risk is not the sum of all investment risks. The risks associated with any single company investment can be almost eliminated with more than 30 diversified investments in the portfolio. With a portfolios of investments, the VC’s also reduce the unsystematic risk (risk associated with one specific Company) to a minimum. Through syndication (discussed later), each investment is shared among several VC’s and the risk is further diffused. Following portfolio theory, the VC’s can bear the risk associated with one portfolio company in the knowledge that the other companies in the pool provide a hedge.

Under the VC-Preferred model, the startup entrepreneur on the other hand almost always has all his/her eggs in one basket and it completely exposed to the risk of failure of the one startup. Prior to raising VC funding, the entrepreneurs usually raise money to finance the seed stage of the Company through personal debt—often through refinancing their homes or borrowing on credit cards. So, the entrepreneur has a great deal to lose if the Company fails—his/her home (provided as collateral for seed funding), salary and benefits, shareholding in the Company and, as we will see later, the patents, ideas and inventions he/she created through the Company end up belonging to the VC.

With a startup failure rate of more than 90%[2], the question arises as to what would motivate a rational entrepreneur to bear this risk. Why would a rational person risk so much when the chance of success was less than one in ten? For several years, there seemed to be an unresolved dichotomy. Researchers were baffled to find that entrepreneurs do not have a higher tolerance, or appetite, for risk than non-entrepreneurs. They appear to be aware of the risks but take them all the same.

Research now seems to have finally resolved the dichotomy and provides a telling insight into the motivation of the entrepreneur. The recent study and paper[3] by Anne Marie Knott and Brian Wu was designed to address a long-standing puzzle regarding entrepreneurs. Why do entrepreneurs undertake ventures with substantially greater risk, while most psychological studies show they have no better tolerance for that risk? "Everyone assumes that entrepreneurs are these cliff-jumpers—able to take a leap of faith and confront unknowns that would deter the rest of us from even trying," said Knott. "In fact, it is more likely that they are skilled hang-gliders, with confidence that they can tackle any conditions." The findings of the study indicate that entrepreneurs are prepared to take these extraordinary risks because they have unusual confidence in their own abilities to succeed. With this belief in themselves, entrepreneurs realize there’s less than a one in ten chance of success but they take the risk in the confidence that they personally have what it takes to beat the odds. Entrepreneurs believe they can personally drive their Company to become the one in ten that achieves success.

Looking at the risk profiles and motivations of the VC’s and the entrepreneurs they fund may be vitally important in understanding the dynamics and the VC-entrepreneur tensions in these companies. The startup entrepreneurs have all their eggs in the one basket, they are highly exposed to failure in the one startup, they are risk averse but confident in their abilities to beat the odds and make the Company succeed. With portfolios of investments, VC’s have eggs in several baskets and the risk of failure in any one startup is offset, or hedged, by the risk of success in the others. By investing in a range of different business sectors and business models, the unsystematic risk is almost entirely eliminated. In the unlikely scenario that all the portfolio were to perform poorly or fail, the VC’s can always fall back on the management fees that usually account for several million dollars each year.

One of the most significant points made by this paper is that VC’s are much more likely to take risks with a startup than the founding entrepreneurs. Although highly exposed, the entrepreneurs take the risks because they are confident in their own abilities to beat the odds. However when VC’s invest in the Company, the entrepreneur loses control and finds himself backing the VC. As the risk tolerance of the VC is much higher than the entrepreneur, this leaves the entrepreneur in a precarious position. As we will see later, the VC’s focus on ‘home run’ successes and the rejection of ‘single’ smaller exits may be a reason for the excessive rates of failure in technology startups.

Effects of the VC-Preferred model
We now move on to explore how the VC-Preferred model, when combined with their differing motivations and risk profiles, can lead to a misalignment of interests and tensions between the VC and the entrepreneur.

The unusual VC-Preferred corporate governance structure
The VC-Preferred model has the effect of placing high levels of power and control into the hands of the VC. In their paper “The Vulnerability of Common Shareholders in VC-Backed Firms (Ganor, 2005)”[4], Jesse Fried and Mira Ganor describe the venture capitalists’ use of preferred stock and control rights as “..a highly unusual and perhaps unique corporate governance structure: one in which preferred shareholders, not common shareholders, control the board and the corporation”. The paper goes on to argue that the “structure leaves common shareholders vulnerable to opportunistic behavior by preferred-holding VC’s especially under current corporate law doctrines”.

The model is unusual in that VC’s not only take control of the startup companies in which they invest, they get to act as owners, creditors, managers at the same time and through liquidity preference, they get to stand in line ahead of the founders and common stockholders when the Company is sold.

Agency
Corporate governance is established through a chain of agency. The shareholders appoint the board of directors as their agent to direct the activities and operations of the Company. The board of directors then appoints the officers as agents to run the day-to-day operations. The officers then appoint managers and the agency chain continues down the organization chart.

Papers on the corporate governance structures of venture backed startups have often focused on agency-related issues. Under tradition corporate law, the outside investors relinquish control of their assets (investment funds) to managers (agents). Reporting from the management to the shareholders forms an agency cost and shareholders struggle with control issues when they disagree with decisions of management. However, under the VC-Preferred structure, the outside investors have almost full control of the Company and agency issues are somewhat unusual. Where the VC is actively involved in the Company, management is essentially performed by outsiders—VC partner who has less than 5% of his/her time to spend with the Company.

The agency problem as applied to VC backed startups is, at the very least, unusual. The VC Preferred model raises some serious questions regarding agency:

• As we have established, in the VC Preferred Model, the board of directors is controlled by the VC partner. In this position, the question arises as to whether the VC partner is acting as an agent to the shareholders of the Company, as he/she is duty bound to do by law, or whether he/she is acting as an agent for the VC?
• Another question arising from this arrangement is whether the primary link in the agency chain exists at all. It can be argued that there is no agency relationship from the VC to the board of directors as the VC is running the board and Company directly, not delegating its duties to another party.
• As the CEO and officers of the Company are selected, and appointed by the VC, and they wish to be repeat players in the VC-Preferred marketplace, are they acting as agents for the Company or the VC itself?
• One final question is who is acting as an agent and fiduciary for the founders and other common stockholders?

The concept of agency becomes somewhat distorted in the VC-Preferred model where a high degree of power rests in the hands of the VC partner.

Asymmetry of information
Traditional corporate theory is based on the assumption that management has inside information that is not freely available in the marketplace and this puts management at an advantage over shareholders. In the VC-backed startup, there is an asymmetry of information—the employees and management within the Company are communicating with customers and the market and gather ‘inside information’ that is highly useful. However, the insiders in this model, have to defer to the outside VC’s to make strategic decisions. The outsiders hold the power to make decisions, and the insiders do not.

Commercialization strategies and choice of exits
The VC-Preferred model can restrict the choice of exits open to startup companies. Where many founders would be prepared to hit a ‘single’ and pocket a few million dollars from their startup ventures, the VC-Preferred model is built upon the huge returns of one or more ‘home run’ successes from the portfolio. The veto rights discussed above, together with board control, allow VC’s to decide the type of exit for the Company. There is a tension and misalignment of interests in choice of exits that is at the heart of this paper.

Before investigating further the tensions between founders and VC, it is important to understand some of the challenges and steps in the startup process. Technologies developed by startup entrepreneurs can be commercialized through a variety of routes. The route that is taken usually determines the exit that is achieved.

The home run
The conventional route is to form a startup corporation, complete the contractual transfers of title so the Company owns the intellectual property, then develop the technology into one or more products, build routes to market involving sales, marketing and distribution channels, and reach profitability by selling the product through these channels. Building out the sales and marketing channels can be very expensive and take several years. To finance these costs, the Company raises private funds under Regulation D exemptions from VC investors, usually in several rounds of preferred stock. The Company then becomes publicly held by selling shares to the public in an IPO (initial public offering). At this point, the preferred stock is converted to common and the preferred rights of the VC investors are lost. After a lock up period of 6 or 12 months, the VC’s and other common stockholders are able to sell their shares to the public through the capital markets.

The value of the Company will usually increase from something in the region of $10m for the first round of VC funding to several hundred million (or even several billion) dollars following the IPO. So, the VC investors achieve a return on investment that is often higher than 10X through this process. This is the home run success that drives the VC business and provides the profits to finance the portfolio strategy that the VC’s adopt.

The ‘asset sale’ single
This IPO-driven home run success is achieved by a small fraction of startups. According to Fenwick & West Publications, there were approximately 8 M&A transactions for venture backed companies in the U.S. for every IPO in 2006 (335:56)[5]. For every startup that reaches IPO, many more are acquired en-route by larger corporations that are looking to grow through consolidation and sourcing of new products, new technologies and new revenue streams. Considering that these large, established corporations have often spent decades building sales, marketing and distribution channels and have efficient, global routes to market, they are often on the lookout for new products that they can sell through these channels—an acquisition of startups is an appealing growth strategy.

These corporations have sales and marketing channels in place already, so what they are acquiring from the startup is essentially a set of assets. The primary reason for acquiring the Company is to win the exclusive right to market the product and its supporting technology. The target startups’ cash flows are often insubstantial and insignificant from the perspective of the acquirer, so this is essentially an asset sale[6] transaction.

The most significant challenge of technology commercialization is not creating a new product but building effective channels to market. Many startups succeed in creating new products but fail to establish profitable and efficient routes to market. Recruiting and training a sales team is expensive. Establishing distribution channels can take many years, especially on a global scale. Startup entrepreneurs find that the channel is the most significant challenge they face in bringing their technologies to market.

From an economic perspective, it makes little sense to incur the cost of building new routes to market for each new technology or startup invention. Applying this model to Hollywood and the entertainment industry would mean building a movie studio for every new movie. Producing a movie and bringing it to market by building a whole studio with its own sales staff, international distribution arrangements would take many years, cost huge sums of money and would result in the vast majority of movies failing to reach the market. The established Hollywood studios have spent decades establishing their routes to market and the economically efficient route to commercialize a new movie is to deliver it through the existing channels by establishing licensing or other arrangements with the large studios. A new movie studio like Dreamworks doesn’t appear very often, and the studio is certainly a home run for the investors but the studio leverages its established routes to market to provide channels for ‘single’ movie hits with movie successes that are profitable for the studio and the entrepreneurs behind them. The vast majority of new ideas and creations coming out of Hollywood are commercialized as singles (new movies) and it is economically inefficient to attempt to commercialize them as home runs (new studios).

Commercializing a new technology can be even more expensive than producing a new movie. For successful commercialization, many new technologies and inventions require channels to market that take hundreds of millions of dollars and decades to establish. For example, new semiconductor technology cannot be commercialized by a startup company unless it can gain access to the manufacturing capabilities and channels that have been developed by established players like Intel and Fujitsu. The cost of establishing a semiconductor manufacturing plant, in China, is around $300m. Startups in the pharmaceutical sector also realize that the only way they can realistically reach a global market is to sell their inventions, in an asset sale, to large pharma companies such as Merck and GlaxoSmithkline. Startup companies that are able to develop products and technologies without asking for VC funding are often willing to sell their technologies to large corporations under terms that would not be attractive to VC’s.

Some acquisition transactions, such as the Google acquisition of YouTube, can be viewed as ‘home run’ successes for the VC’s that backed them. However, the typical asset sale looks more like a ‘single’ in the baseball world. Virtually every product in the Cisco line up was acquired through an asset sale[7]. The Cisco acquisition of Protego Networks is a good example.

Case Study—Protego Networks
Imin Lee left Cisco in 2002 to form a new company she named Protego Networks. She raised around $2m from angel investors and built a compelling new product that was ideally suited to Cisco’s customers. Protego Networks was acquired by Cisco in 2004 for $65m in cash. Cisco now has a new product line from Protego that has produced excellent results when sold through the Cisco channel and Imin Lee is back at Cisco as an employee. The angel investors received a profitable return on their investment and this is a good example of an invention reaching the market, with the founding entrepreneurs and investors making a profit along the way.

Interestingly, there were no VC investors in Protego, and as this paper shows, and Imin Lee admits, VC’s would have been unlikely to have accepted the offer from Cisco. Instead of taking the Cisco offer, several VC’s proposed investing $10m+ into Protego in a series A preferred round of funding. Portfolio theory and the VC-Preferred model force VC’s to seek a return of at least 10X, so the VC would have required at least $100m for its shares in an acquisition from Cisco or anyone else. VC investors would have rejected a $65m acquisition offer and would have taken the risk to push the Company toward IPO where much higher returns may be achieved. If VC’s had invested in Protego, the price for Cisco to acquire the Company would have increased from $65m to at least $500m[8].

So, following the VC home run strategy, the acquisition offer from Cisco would have been declined by Protego and the two companies would be left to compete with each other in this sector. Cisco’s strength is its brand and global distribution channels, but Protego has the product and technology available today. As the rejection of the acquisition offer would mean Protego and Cisco competing head-to-head, the question is whether Protego could build sales and marketing channels independently that could compete with Cisco and whether Cisco could build its own products and technologies that could compete with Protego. The chance of Cisco successfully building its own product line and pushing Protego out of business is something that Imin Lee as the entrepreneur was not prepared to accept. The risk of losing a market battle against a large global competitor like Cisco is something that a VC can accept—as any losses incurred from Protego being forced to shut down would likely be recovered by a home run hit from one of the other companies in its investment portfolio.

The $65m offer would be classified as a single rather than a home run but was clearly highly appealing to Imin Lee. If Protego had taken preferred stock funding from a VC, the focus on a home run success may well have led to Cisco launching its own competing product line and using its market muscle to force Protego out of business. Fortunately, Imin Lee had the authority to accept the offer from Cisco, the Protego product line now forms a profitable source of revenue for Cisco, the customers have new products available, and the angel investors in Protego have made a handsome profit.

The exit tension between founders and VC investors
Although an asset sale exit may be appealing to the founding entrepreneur, it may not be acceptable to the VC’s. An entrepreneur, like Imin Lee at Protego Networks, offered $65m for a startup company will likely accept, especially if he/she receives a good proportion of those proceeds. However, VC’s operating under the prevailing portfolio model will be forced to reject such an offer and drive the Company toward IPO or cash flow sale. For a VC, one successful exit has to finance nine or more failures, so the proceeds of that one exit have to be much higher than the founding entrepreneur would settle for. By rejecting an asset sale offer, ploughing more funding into the Company and driving the business toward a potentially more profitable exit, the VC’s are significantly increasing the risk of failure.

If the founding entrepreneur wishes to accept the asset sale offer, but the VC’s wish to reject it, we need to look at the corporate governance structure of the Company to determine which decision is made. Under the VC-Preferred model, through the veto rights written into the terms of the preferred stock agreements, the VC has the right to veto a sale of the Company. Essentially, the founding entrepreneur’s vote is overruled by that of the VC.

So, the ‘single’ asset sale exit route, although it may be the most economically efficient, and highly appealing to the common stockholders such as the founders and employees, is blocked by the VC investors through the control rights written into the preferred stock agreements.

Exit timing
As discussed earlier, VC funds usually have a term of 10 years. The timing of where the VC fund lies in relation to the portfolio companies can be an extremely important factor in the decisions made by the VC with respect to selling the portfolio companies. A fund that is close to the end of the term is looking to liquidate the portfolio investments. A fund that is in the first phase of its fund is looking to grow its portfolio. This can affect how decisions are made by the VC partner regarding the exit strategies of the portfolio companies they control. For example, if the VC takes on a new startup in year 8 of its 10 year term, it is likely that the VC will drive toward selling the Company very quickly. This may not be in the best interests of the Company—especially if it is in an early stage of growth.

Another issue arises with VC’s in the first phase of development. During the first few years in the 10-year life of the fund, the VC’s want to impress their limited partner investors with the strong portfolios they have assembled and they look for ‘home run’ candidates that will allow them to raise more funds from these investors in future funds. Startup entrepreneurs complain that VC’s in this position often refuse to allow portfolio companies to be sold at less than ‘home run’ returns. After they have developed their products, many startups find that they are unable to build the sales channels and routes to market necessary to reach customers in the volumes they need. An asset sale ‘single’ is the clear exit for these companies as large corporations with the sales and marketing channels in place already are looking to acquire new products that they can push through their channels and develop into new revenue streams. A startup in such a position often faces two alternative routes—an asset sale now or a shutdown in two years when the funding runs out. The logical choice for the entrepreneur is to select asset sale. However, if the VC is in the early stage of its funding cycle, it may be reluctant to accept an asset sale single, as this would need to be reported to its limited partner investors that they led to have ‘home run’ expectations. Disclosing portfolio failures does not reflect well on the VC. So, the VC in this situation may decide it is in the VC’s interests to continue to operate the Company for two more years, running the risk of shutdown, rather than accept an asset sale exit today that would need to be disclosed to its limited partners.

So, the current corporate governance structure puts the timing of exits in the hands of the VC and considerations other than the best interest of the common stockholders affect how exit decisions are made. Exit timing is often motivated by the VC to maximize value to the venture fund rather than maximize value to the entrepreneurs and stockholders in the portfolio companies.

Management
The appointment of new CEO and management following the first round of VC funding can have a detrimental effect on the Company. The founder often has the most passion, drive and the most in-depth understanding of the business and is the best person to run the Company. A founder is commonly perceived as the heart and soul of the Company and his/her removal from the CEO position can be damaging to the shareholders, employees, customers and whole community of interests.

A decade-long study of Silicon Valley (California) technology startups finds that companies were three times more likely to fail if at some point they altered the founder’s blueprint for employee relations than if they maintained their original employee model[9]. Steve Jobs was replaced at Apple by John Sculley, a professional manager from PepsiCo. Meanwhile, Bill Gates and Larry Ellison managed to stay in executive positions at Microsoft and Oracle. VC’s involved in the John Sculley appointment process admitted that replacing Jobs was a mistake[10]. Apple lost a significant lead in the industry and the Company’s value, higher than Microsoft during Job’s tenure as CEO, dropped to a fraction of that of Microsoft or Oracle after the professional management was installed by the VC-led board of directors.

Entrepreneurs often complain that managers appointed by VC’s have a tendency to spend cash more readily than the founders. This is not always frowned on by the controlling VC as this can lead to the VC’s investing more funds, taking a larger percentage holding of the Company, and more dilution for the common stockholders.

The VC-Preferred model can lead to less-effective management being appointed to run the Company.

VC-encouraged spending
As discussed earlier, increases in the size of VC funds is leading to an increase in the size of each venture investment. VC’s with larger funds are under pressure to invest more money into each Company in the portfolio—the VC’s are not geared up to make large numbers of small investments and favor small numbers of large investments. Some large VC’s, such as New Enterprise Associates (NEA), are reluctant to consider investment opportunities less than $10m—and look to invest more than $15m in each Company in the portfolio[11].

Each investment by the VC increases the VC’s percentage control over the startup, and decreases that of the founder/entrepreneur. A high-spending startup provides the VC with a good opportunity to accumulate a large shareholding position, focus on fewer larger investments, and through liquidity preferences, a higher share of the proceeds when the Company is sold.

So, it is in the interests of the VC for the Company to increase spending. As the veto rights are only available to the VC, the entrepreneur is in no position to veto the Company raising new rounds of funding or prevent the VC taking an ever increasing percentage of the total ownership. Ever larger investments provide investors with larger stakes and entrepreneurs with fewer rights.

Lack of alternative funding sources
There are over 3,600[12] VC firms worldwide, so it would be reasonable to expect competition among firms to attract entrepreneurs and alternative corporate governance structures. There are some minor differences in how these firms operate, however almost all VC’s operating today have adopted the VC-Preferred structure. The structure has been adopted in China, UK, and other parts of the world where the VC community is growing. The demand for funding from entrepreneurs so outweighs the supply of funding from VC’s that the suppliers of capital have not entered into market competition to make their offerings more palatable to entrepreneurs seeking capital.

As it is common practice for the VC community to syndicate deals, each one is encouraged to standardize on the VC-Preferred model of corporate governance. Syndication requires standardization. A VC that adopted an investment and corporate governance structure that was different would find its syndication options severely limited. The rules of membership of the investment syndicate govern how each of the VC’s structure their investments.

Before the dot com crash in 2002, angel investors became active backers of technology startups and provided several billion dollars per year to new ventures. However, after the crash, the angel funding for new companies dried up significantly[13]. Other investment options such as real estate became more appealing, but many angel investors were dismayed at the way their investments were diluted and their rights were lost when VC’s used contractual terms like the one below to condition their investments on having the rights to restructure and alter the relationships with the angel investors[14].

Existing preferred stock
The terms set forth below for the Series [_] Stock are subject to a review of the rights, preferences and restrictions for the existing Preferred Stock. Any changes necessary to conform the existing Preferred Stock to this term sheet will be made at the Closing.

In recent years, angel investment in technology startups has bounced back[15]. However, angel investment now operates in a very similar way to VC funding. The Band of Angels[16], and Garage.com[17] are examples of high profile angel groups that were setup to provide early state seed funding but have developed into VC funds. These angel funds now too follow the VC-Preferred model. Even with angel investment available, the terms are similar to those offered by VC’s and the options open to founding entrepreneurs are limited.

Shopping for the best deal among the VC community is also usually restricted. The no-shop provision of the VC term sheet discussed above prevents entrepreneurs from shopping for alternative investors after the term sheet is signed.

When raising several million dollars, the options open to entrepreneurs are limited. An entrepreneur that refused to accept the terms of the VC-Preferred model would find fundraising very difficult.

Lack of incentives for the employees and other common stockholders
The superior position of preferred stock over common stock can lead to a lack of morale and lack of incentive for employees, management and other holders of common stock. With control in the hands of the VC, liquidity preferences blocking the common stockholders from sharing in the proceeds of a sale of the Company, there may be little in the way of incentives for employees and those charged with driving the Company toward success.

The asset sale (single) exit becomes unappealing to the common shareholders after funds have been raised through the VC-Preferred model as these individuals realize that they have to stand in line behind the VC and preferred shareholders when it comes to sharing the proceeds of the sale of the Company. When management and the employees realize they will receive nothing from a ‘single’ asset sale, this can damage morale if a ‘home run’ is not clearly in sight. There is little financial incentive for management to drive the Company toward an exit.

The avoidance of venture funding
Entrepreneurs are increasingly being advised to avoid VC funding[18][19][20]. This means that they either abandon their startup ideas or they bootstrap—attempt to develop the business slowly through self-financing or moonlighting to support the startup phase of the business. This is a clear example of how the corporate governance practices of VC’s can be accused of stifling innovation and preventing new technologies from reaching the market. Inventions and innovations that are valuable to society may be suppressed because the entrepreneurs that understand the VC-Preferred model calculate that it doesn’t make sense for them to pursue funding under the VC-Preferred model.

[1] Modern portfolio theory (MPT) proposes how rational investors will use diversification to optimize their portfolios, and how a risky asset should be priced. The basic concepts of the theory are Markowitz diversification, the efficient frontier, capital asset pricing model, the alpha and beta coefficients, the Capital Market Line and the Securities Market Line. MPT models an asset's return as a random variable, and models a portfolio as a weighted combination of assets; the return of a portfolio is thus the weighted combination of the assets' returns. Moreover, a portfolio's return is a random variable, and consequently has an expected value and a variance. Risk, in this model, is the standard deviation of the portfolio's return.
[2] Discussed in another blog.
[3] Entrepreneurial Risk and Market Entry. Best Doctoral Paper award from the Small Business Administration by Brian Wu, The Wharton School, University of Pennsylvania and Anne Marie Knott, Robert H. Smith School of Business, University of Maryland.
[4] Fried, Jesse M. and Ganor, Mira, "Agency Costs of VC Control in Startups" (August 15, 2005). UC Berkeley Public Law Research Paper No. 784610.
[5] Source: Current Venture Financing Environment, 4Q 2006 Bay Area Venture Capital Terms Survey. Fenwick & West Publications. http://www.fenwick.com/publications/
[6] Use of the term ‘asset sale’ throughout this paper does not refer to the structure of the M&A transaction but the fact that the acquirer’s motivation for buying the startup is to acquire its intellectual property and other product and expertise related assets.
[7] “For more than 20 years, it has successfully used acquisitions, both large and small, to enter new markets and round out its product portfolios. With more than 100 purchases under its belt, the Company shows no signs of slowing down as it prepares to take its biggest leap yet into the consumer electronics and home entertainment markets”. http://news.com.com/Ciscos+acquisition+guru+speaks+out/2008-1041_3-6042499.html.
[8] Based on the VC taking a 20% stake for $10m investment, and requiring a 10x return from its stake.
[9] “Organizational Identities and the Hazard of Change,” Michael T. Hannan, James N. Baron, Greta Hsu, and Özgecan Koçak, Industrial and Corporate Change, October 2006.
“Organizational Blueprints for Success in High-Tech Start-Ups: Lessons from the Stanford Project on Emerging Companies,” James N. Baron and Michael T. Hannan, California Management Review, 2002.
“Employing Identities in Organizational Ecology,” James N. Baron, Industrial and Corporate Change, 2004.
After tracking the success of more than 150 start-up firms founded since 1994, Stanford Graduate School of Business Professor Michael Hannan and collaborators found that not only did altering the system for managing employees hamper success, but also such firms had long-term stock valuations that were nearly six times lower. His study, coauthored with former GSB professor James Baron and Greta Hsu and Özgecan Koçak, both graduates of the School’s doctoral program, is the culminating piece of research to spring from the Stanford Project on Emerging Companies (SPEC).
[10] Paul Dali, Venture Investor with Dali Hook & Partners and former Apple Computer executive. Interview recorded at Santa Clara University, 2005.
[11] Stewart Alsop, Partner NEA. 2005.
[12] VCPro Database. www.vcprodatabase.com.
[13] The funding from angels dropped to less than $1m per year according to Ann Winblad, Hummer Winblad Venture Partners.
[14] "During VC negotiations, angels are often worried about being diluted out, especially if they are unable to participate in subsequent funding rounds... the VC will radically rework the valuation, diluting the angel’s share." Angels Dance With VCs in the Pale Moon Light. M.R. Olson. The Angel Journal. Friday, 27 October 2006.
[15] According to the 2006 Angel Market Analysis, the Center for Venture Research at the University of New Hampshire “The angel investor market has shown signs of steady growth in 2006, with total investments of $25.6 billion, an increase of 10.8% over 2005, according to the Center for Venture Research at the University of New Hampshire. A total of 51,000 entrepreneurial ventures received angel funding in 2006, a 3.0% increase from 2005. The number of active investors in 2005 was 234,000 individuals. The sharp increase in total investment dollars was matched by a more modest increase in total deals, resulting in an increase in the average deal size of 7.5%, compared to 2005”.
[16] The Band of Angels Venture Fund, L.P. is a $50M venture fund comprised exclusively of institutional partners including three corporations, two university endowments, and a large pension fund. The fund is directed by Ian Sobieski and coinvests in deals that are subscribed by members of the Band of Angels. Initial investment sizes are typically $300,000 with total commitments for successful companies reaching $2.5M. Generally, either a member of the Band of Angels or one of the Fund's partners will take a board seat as part of an investment.
[17] Garage Technology Ventures describes itself as a seed-stage and early-stage venture capital fund.
[18] Most startups should avoid venture funding, not pursue it. Tom Foremski. Silicon Valley Watcher. http://www.siliconvalleywatcher.com/mt/archives/2005/07/thoughtleaders_2.php.

[19] Venture Capitalist and Venture Beat contributor Charles Moldow, offered some conflicting advice to entrepreneurs seeking capital, warning against venture funding in certain situations. Using the analogy “not many mice ever grow up to be antelopes,” Moldow infers that while every small company wants to be a big company, not every idea is venture worthy. A large investment for a company with miniscule pre-funding valuation is nonsensical, decreasing financial return for both entrepreneurs and venture capitalists. Stay Private and Avoid Venture Capital. By Andy Angelos, American Venture Network Regional Editor. January 23, 2007. http://www.americanventuremagazine.com/blogs/Stay_Private_and_Avoid_Venture_Capital/650
[20] Greg Gianforte has a soon-to-be-published book called: "Bootstrapping Your Business: Start and Grow a Successful Company With Almost No Money." says "Raising venture capital for early stage start-ups seems to be the prevailing path for most entrepreneurs; however, most would-be founders should reconsider".