Real Options: VC Style
90% of the MBA’s will tell you that if there is one thing that we all learned at school is that “options have values” and that more volatile/riskier the outcome, the higher the value of said options ... transposing that to the venture world, the option to own ~15% of a ultra risky startup must have lots and lots of value ...
Charles River Ventures announced its QuickStart Seed Funding program yesterday (or is it the day before?) which institutionalize an open secret weapon of savy entrepneurs - the convertible debt.
A simple example: if CRV loans your company $100,000 with a six percent interest rate, and six months later the company closed a Series A round, at that point the loan balance (with interest) would convert at a 25% discount (value = loan dollar amount plus interest / .75) into $137,333.33 worth of Series A stock. Given that seed funding amounts are typically very small compared to the amounts one might expect to raise in a Series A round, as the example illustrates, the aggregate discount amount, in this case $37K, is a tiny fraction of what is likely to be a multimillion dollar Series A financing.
To be academically correct, CRV is not just getting an option ... they are getting 1) an option to invest 2) coupons(interest) 3) small amount of equity ... but the option is what they really want ...
Tom Evslin is right that this is a great deal ... If you are single and under 30, I say jump on this right now ... especially because there is no personal liability... if these guys were some 2nd rate vc firm I would have concerns about getting engaged at the birth (best analogy I can think of), but CRV is pretty reputable and I’ve heard nothing but good stuff about them ... (no they are not Jessica Alba but at the very least the hottest girl in your dorm).
Taking a step back though, I would make sure entrepreneurs understand what they are getting into with or without the quick start program.
1. 250,000K will NOT pay enough salary and company expenses for the two founders (or more employees). It takes atleast a household income of $150K to live comfortably in the valley . .. be ready to tough it out with or without the 250K
2. Career wise, make sure you are ready to take this step. At this point, you are risking more than the VC’s. They have $250,00 at risk. You have a career at risk ... millions of dollar of future earnings ... the love and faith in your “idea” is so much more important now than ever. This 250K should not drive your decision to start the company. If you are going to start the company even if dont get Quick Start investment, go for it. If you are NOT going to start the company without the 250K, dont do it even if you do get it from CRV...
3. Lets say CRV puts away $10M for the program (reasonable) . .. at $250K a pop... the program will have a portfolio of 40 companies ... again ... serious asymmetry in committment & resources. No way CRV has enough people to invest their time in the entire portfolio (Fred Wilson alluded to this point) The model built into the program (not explicitly stated) is that if your company is a dog shortly after funding, dont expect CRV to lend a big hand. See it as money and thats it ... CRV can only afford to invest time in the superstars in the portfolio
In the end, for a fund of their size, this is a no brainer for them - the downside is limited, say if the entire program tanks, $10M is a bad series B investment in ONE company . For entrepreneurs, as always - nothing has really changed . . there is comparatively more to lose (and to be more lots more to gain as well) ...