george tziralis log

The most analytical yet lean 101 text on venture capital investing I was lucky to discover so far is the exceptional MSc Thesis of Shikhir Singh at Cass Business School back in 2005, entitled as “Structuring Venture Capital Deals”.

Firstly, I’d like to highly recommend it to all of you who would like to have a good understanding on the subject, potentially targeting a VC investment in the foreseeable future, rather than just having a casual interest by scanning the twittersphere. You may read the full thesis or download its pdf via scribd at the end of this post.

And, remembering back in the engineering school, most students were avert to anything with the cost/profit/economy keywords attached, even if the math were much more easier than literally everything else they have ever tried. You’d better not replicate such an approach here, geeks can and should know the VC stuff, and it is to our very benefit to know the basics.

Moreover, I’d like to stress out some critical points and differences to the local greek legal framework that have turned out to be serious difficulties in setting up the Openfund (a more official post will follow-up, outlining the solutions we were finally able to iron out).

Terminology

To start with, let me first attempt to briefly summarize the most common VC terms, as shaped out by Singh. You may also use the list below as a quick reference.

Liquidation event: An exit event for the VC (sale, merger, closing or IPO). Serves as VC’s target.
Pre-money: The value of the company prior to receiving the outside (VC) financing.
Post-money: Equal to Pre-money plus external funding received.
Option pool: Unallocated stock options, created prior to an investment for new hires so as not to require further dilution
Share Price = Premoney / (Shares Outstanding + Option Pool)

Grounds for the Term Sheet

The need for a term sheet is justified by potential conflicts of interest, Singh comes to summarize perfectly:

‘

The goals of an entrepreneur of a company which is seeking funding are to:

1. Create a successful company
2. Get the funding necessary to create a successful company
3. Maintain maximum value and control of the company
4. Share the risks with the investors
5. Obtain the expertise and contacts that help the growth of the company
6. Obtain a reward for creating a successful company

‘

The goals of a VC which is seeking to provide funding are to:

1. Maximize return to justify the risks and effort in funding company
2. Ensure that the company makes best use of the capital provided
3. Ensure the ability to invest in later financing rounds if it so chooses
4. Ensure the ability to liquidate their assets to match their funding cycle
5. Develop a reputation that attracts other venture opportunities

‘

Conflicts of interest arise due to differing objectives between VCs and entrepreneurs on:

1. Split of the financial return of the company
2. Liquidation of the company
3. Control of the company

After all, it is clear that an investment negotiation is essentially a power struggle, with the VC attempting to minimize risk and maximize returns, while the entrepreneur tries to share risk and receive the investment. The provisions to be described hereafter come to address the conflicts of interest, within the investment term sheet.

Liquidation & financial split provisions

The following are the most common deal terms designed to address the conflicts that may arise regarding the liquidation and financial split of the enterprise.

Redemption Provision: Penalty clauses required by VCs to speed up a liquidation event. May include paying back initial investment or multiple of it, paying unpaid dividends, appointing committee to look for exit opportunities, or providing more board seats or other special rights to the VCs.

Redeemable Preferred Stock: Special class of stock securing priority to any cash available from a liquidation event. In case of an exit, VCs owning preferred stock get first their share -their initial investment or a multiple of it- and the common stockholders follow to divide up what is left. Preferred stock holders’ upside potential is limited in this case.

Redeemable Preferred & Common Stocks: A combination of the above, which enables the VC to get first rights to any cash available, thus making money from both the initial investment multiple and the common stock.

Convertible Preference Shares: Such shares can be converted to common stock at a predefined conversion price, at various points during the life of the company (for example, when new stock is issued or at any exit). Investors use the right to convert if the pre-specified conversion price is lower than common stock’s liquidation share price.

Participating Convertible Preference Shares: Participating convertible preference shares carry the right that in case of any liquidation event other than an IPO, the VC will get face value plus get free shares as though the VC had the convertibility option. In the case of an IPO, the VC has just the liquidation preference or the convertibility option.

Multiple Rounds Standards: When multiple rounds of financing occur, it is typical for each new investor to ask for liquidation preference over the previous investors.

Anti-Dilution Provisions: Anti dilution provision in VC contracts refers to securing that the value of a VC’s investment in a company will not be decreased in a case of a “down-round” (and it does not refer to keeping the percentage of shares steady, as anti-dilution is generally perceived). In such a case, anti-dilution clauses result in the investors getting additional shares for free, providing full or partial counterbalance to their decreased investment’s value. The right to anti-dilution clauses only applies to investors holding convertible preference shares and participating convertible preference shares. The most common anti-dilution provisions include full ratchet and weighted average provision, Singh also provides a more illustrative example.

Full Ratchet: With a full ratchet, enough new shares are issued for the investor holding the anti-dilution right, so that his investment value remains intact.

Weighted average provision: This provision stands between the full ratchet and no anti-dilution. It’s formula re-prices an earlier round by issuing enough additional shares to that round to bring its investment’s value down to the (weighted) average price of both the new and the previous round.

Pay to Play Provision: In one of the few provisions that benefits the entrepreneur over the VC, pay to play clauses require that VCs participate proportionally in future rounds or they will lose some or all of their privileges (anti-dilution rights, liquidation preferences, voting rights, preferred stock or a combination of the above).

Control provisions

Common provisions to address the struggle for control within the enterprise include the following:

Board Members: The board of directors is set up to protect the interests of the corporation and the equity holders. It also monitors the progress of the management team. The number of board seats a VC gains after an investment is a point of negotiation, while in new investments the board is typically expanded. The VCs can also ask for their board members to be granted special rights.

Milestone Provision: The VC usually gives or takes something if specific milestones are met or not. Milestones may include developing a prototype, getting a large customer, sales or profit targets, among others.

Class Veto Rights: VCs almost always require some veto rights, disproportionate to their shares. These may include “mergers and acquisitions, restructuring, issuing of new shares, changes to the company charter, amendments which will alter the rights of preference shares which the VC owns, annual business plans, profit distribution and employee stock options, borrowing more than a certain amount, buying assets more than a certain amount, sale of major assets, and sale of copyrights, trademarks, or intellectual property”.

Dividend Provision: VCs can request a dividend provision where the company has to pay the VCs annual dividends. The dividends can be either cumulative or non-cumulative. Usually, the value to the dividends is predetermined.

Fees: The most usual kind of fees include deal fees, annual management fees, legal fees and due diligence fees.

Lockup Provision: The time window after an IPO during which VCs and founders cannot sell their stocks, typically negotiated with the Investment Banks to ensure the owners will remain in place.

Founder Shares Vesting: This provision requires the founders to give their shares to the company, and the company will return them back over a period of time (to ensure that the founders won’t leave the company after VCs’ investment).

Drag Along Provisions: Drag along provisions give the majority of the shareholders in a particular class the right to sell the company and force the rest of the investors to sell under the same conditions offered to them. They are designed to inhibit a situation where a minority of shareholders holds a company hostage by refusing to sell.

Tag Along Provisions: This -rarely negotiable- provision ensures that if the entrepreneur gets someone to buy his shares, all the shareholders holding those rights can sell their shares to the same shareholder under the same conditions offered to the entrepreneur in proportion to their holdings.

Afterthoughts

I do believe that the above provide you with a broader view on the subject. Singh moves on to provide some quick stats on the frequency of those terms; these are not harsh VCs reprisals, but the most common or default options a VC has available, in order to secure the most basic forms of your commitment, in return of his money. And money -next to time- is the strongest expression of commitment; you have to be reasonable to ask for them, either we speak about $1 or €1M.

So, VC funding has nothing to do with donations, or gifts, if you used to think of it like that you’d better reconsider. What’s more, valuations are rather just the tip of the iceberg, you’d better ask for the full term sheet and think hard about the total value you’re carrying forward, before you speak your mind.

Finally, to put the above into the Openfund context (and I’d be really happy if you could prove me wrong), let me mention first that the only class of stock available under greek law is common stock (update: It seems that there is a kind of “preferred stock” for greek SAs, with some rather limited and predefined rights -yet I’m missing a link in english. Still, this is not the case for limited companies). I really don’t know if this occurred out of a political axiom or anything else, but I do need to mention that it invalidates most of the financial provisions deployed above. Moreover, the notion of the Board of Directors is not valid in greek limited companies (Ltd), there are just shareholders and “administrators”. There is of course another class of companies, “Anonymous companies” or “Societe Anonyme, SA”, prescribing the existence of a Board, but a minimum capital of €60k is needed for their incorporation.

If this sounds like a pretty unsolvable problem of the “good luck with this” category, you’re not that far away. But, I’m happy to report you that we have reached an elegant solution; which is of course the subject of another post…

Understanding Venture Capital Term Sheets

Comments

Now that other projects are unfolding it may also be a nice opportunity to re-examine what’s the status of previous ventures.

And by that I mean websource.it, a simple website that allows you to compare the number of Google results for up to five searches simultaneously. It’s a simple way to basically compare spelling of phrases or alternatively determine which of terms is most ‘popular’. As simple as the concept is, so is the business model: just display Google ads that are relevant to the terms searched for.

We started all that less than a year back and managed to achieve quite a few of what we thought back then were milestones for such a project. However, getting written up in a few popular blogs of the field and generating some buzz isn’t that important as we found out. And in that websource.it was an important learning experience for us. Your service has to be both useful and stay pretty constantly in the news in order to spread and gain critical mass.

It also demonstrated brilliantly even (or perhaps because of) its primitiveness that ads can only take you so far in terms of revenue.

We also had a few positived surprises though. We didn’t expect the service to be a hit by editors, translators and proofreaders - in their case where Google-comparing alternatives is a quick way to avoid checking the dictionary, websource.it makes good sense.

We also didn’t expect websource.it to be a hit in China and Brazil - but it was. Poor English skills, a desire to look in the developed world, who knows what the reason is - these two countries registered many hits. And also the Czech Republic - we still haven’t figured that out…

But with all its failures and successes we must admit that the project has become stale. And it really is time to take it to the next level - or to abandon it alltogether. Instead of abandoning it entirely, we thought we could do something more creative with it. So here’s the offer.

We are willing to pay 50% of the revenue for the next 3 months to anyone who is willing to take on the business development aspect of the project. The person we choose will be responsible for detailing a business plan (no need to actually write it, just formulate it), promote the service, handle marketing and SEO services, manage the community, use social and new media and generally be creative about expanding it. And at the end of the 3-month period we discuss the collaboration anew.

That’s it really. There is no restriction as to who can apply. Wherever you are in the world and whatever your background, if you’re willing to put in the hours, you’re eligible. All we ask of you is a short (one page) description of what you plan to do - and a short CV (a LinkedIn url will do). We will choose the most impressive and creative entry. You may send it here, or just put the text in the comments below, and this is it!

Cross-posted by the websource.it blog.

Comments

It clearly took a lot of time, effort and reengineering (and I need to especially thank my friends and partners Dimitris and George for contributing the biggest part of it), but today I was happy enough to publish the document that brought us a really long way in setting up the Openfund.
To further support the term “open”, you’ll find there extensive details on the processes and structures created, next to our vision and market opportunity we target at (still, we kept some ROI details for the eyes of our investors alone). And, while the document’s extent will almost prevent anyone but those really interested from reading it, I do believe it stands as an unbiased indicator of our truly commitment and I would appreciate your comments and constructive criticism if you belong in the latter category.
Enough said, you may now just toggle to full screen or download the document to dive into all the details.

Comments

I’m providing here the slides of the presentation I gave a few hours ago at Open Coffee Athens XXIII, introducing the Open Fund.

Comments

Tumblr is uber-sexy and it had served me pretty well so far. But my homepage was way more than obsolete, and I am getting used to the capacity and flexibility of the WordPress platform (administering 4 WP blogs, if I remember well). Add these to the greek easter “holidays”, and what you have is a brand new personal homepage and blog.

I’m using a slight modification of the enormous theme by -my favorite- upstart blogger, and I came up with a more-than-minimal theme, for which I’d like to hear your comments and further ideas (update: As of July 20, I’ve changed it to the WP Typo theme, I just love it’s typography). It is still a work under progress though; I haven’t yet managed to import the old disqus comments in each post (nevertheless I need to thank the disqus team for the excellent personal support), the content in the various pages is not completed, categories and other goodies are missing etc. But I think that the switch was more than needed and I feel pretty happy about it - and, who knows, I may blog more often now :)

PS: On a side note, I’m spending the following week in the Valley, speaking in an event on greek entrepreneurship at Stanford, so if you happen to be there and want to meetup, let me know.

Comments

As you grow up, work deteriorates in mails & meetings.
This older tweet of mine tends to be an accurate description of my daily schedule lately…

Comments

Every new day brings a new opportunity and today I had the fortune to enjoy a unique experience; the one of receiving a cease and desist letter. The email regarded the “use of XXX company’s logo and trade name in my websites http://datamine.it & http://gtziralis.com/post/59121553/introducing-datamine-it” and I cannot put it better than pasting some (slightly modified to avoid mentioning the sender, if that is possible after all) excerpts from the letter itself.

As it is already known to your goodselves (comment: I appreciate that, nice template by the way!), our clients have already registered the logo and trade name “DATAMINE” in the Greek Ministry of Commerce under the Number XXX since XXX (pursuant to the decision XXX of the Trade Mark Committee).

According to the said decision XXX has the right to use the above mentioned logo in order to distinct specific products and services, such as, information technology services, data warehousing, gathering and process analysis, IT infrastructure architecture and systems integration, reporting, predictive modelling, software engineering, statistical science, data-mining and many others.

Given that XXX is the sole beneficiary of the Logo “DATAMINE” and since your behavior to act in the Greek Market under the same Trade Mark by sending business offers to our clients deceiving them on your identity, constitutes an illegitimate and unconventional act, and in order to avoid any legal proceedings against you and your company, we hereby, without prejudice,

CALL UPON YOU (caps are not mine)

to immediately cease, discontinue and interrupt the use of the Trade Mark and Logo “DATAMINE” upon receipt of the present notice of demand. Otherwise we are left with no alternative but to proceed, without further notice, with any and all steps available to seek security/satisfaction in case you have not taken the proper action.

Ok, let me now shed some light and put things in context. When we came up with the idea of getting together and turn our humble expertise into a start-up (the story is in the link above, put the blame on me!), we didn’t even think of the term “data mining” as a trademark or anything like that (you know, we are scientists and engineers above everything else and we lack knowledge of legalities or pathological imagination, poor us).

So, we started looking for a catchy domain name to better describe our offering, which is, well, data mining (check wikipedia for more on this popular research area, plus there exist today only 14.3 million relevant results in the web, according to google). We came up with the phrase “data mine it” and the italian domain “datamine.it”, utilizing a “domain hack” just like myriads of other web services like del.icio.us, blo.gs, grou.ps etc. ad infinitum do.

And we launched the website about three months ago, targeting the international market and waiting for our services to mature before we get incorporated or quit our day jobs (neither of which is a fact yet). To give you a better idea of the way we look at things and “competition” (with the conventional use of it), we also organized an open event entitled “data mining in business”, sending an invite to company XXX to be our proud guest speaker.

We actually didn’t receive a reply, or I think -to my great surprise- we just did, asking us to comply with some requirements I personally find nonsense, to say the least. And it is not that big of an effort to satisfy these requirements; to be honest it’s a matter of minutes and a few euros to find a better domain and change our logo, plus we haven’t build such a fantastic brand awareness yet and a simple redirect will do the job for us.

However, before moving on, I need some clear answers in the following questions and I would be glad if you could elaborate.

• Firstly, is it possible for a firm to trademark the name of a research field or a popular tool (like data mining or statistics or … email)? In this context, if company X registers the trademark “statistics” or “email”, then nobody is able to provide email services, or relevant services to email, or utilize anyhow the term “email”, is that correct?
• Second, if a company owns the “trademark” of “datamine” (or anything else in that matter) in Greece, or Delaware or Papua New Guinea, then every other company willing to pitch a customer in that location, having a name or offering somehow related to this trademark (like datamine.co.uk, datamine.com etc) should ask for the local company’s permission first?
• Finally, if “datamine” is registered as a trademark, then is this trademark also valid in every other derivative of it (just like the full “datamine.it” we are using religiously) or every component of the word (in our case “data” and “mine”)? In that case for example, should every company ask for British Airways’ permission to include the syllable “ba” (as of ba.com) in its brand?

Generic nonsense or our innocence, I would be happy if the above proved to be just a poor joke. In case that it’s not, while I undertake full responsibility of everything wrong (?) happened, I dare to say that our team is more determined and passionate than ever to turn threats into opportunities and a bad (?) start into a great asset, good karma included.

You get to know the results.

Comments

A paper I co-authored is finally published (in early view, .pdf) in the journal of Managerial and Decision Economics. Along with Konstantinos Kirytopoulos, Athanassios Rentizelas and my professor Ilias Tatsiopoulos, we proposed an holistic approach to investment assessment, a process of value that may be highlighted under the current economic situation.

To make a long story short, the typical approach to investment assessment includes the following steps, as these are described in the figure.

However, one may argue that the process remains fundamentally suboptimal, with the discrete nature of its steps serving as one of its most important flaws (given that the optimization of each step does not necessarily result into the optimization of the process as a whole). We tried to address this concern by introducing an integrated holistic approach, as in the figure that follows.

The input variables to the selected criterion’s function (typically Net Present Value) is broken into two categories, the ones directly defined by the investor being the first (like investment’s height or operational specifications), and those that cannot be modified  being the second (interest rates etc).

The approach suggests initially assigning to the latter ones their most probable values, so as to be able to optimize (using genetic algorithms, because of the tough nature of the problem) the values of investor defined variables, then moving on to an extended risk analysis by Monte Carlo simulation to accurately (probabilistically that is) compute the implied risk of the investment. We also introduced NPV Expected Shortfall and NPV Risk Preference Index, providing a customizable metric of high informational value picturing the whole probability density function, next to demonstrating the whole process by an extended case study regarding the comparison of two renewable investment scenarios.

As a closing note, I should mention that, to me, the concept of studying the problem at hand by separating its variables to the ones you can influence and the ones you cannot, while then attempting to optimize the first set and track the total risk of the second, remains an approach of great practical -if not philosophical- value, next to its academic one. And I do hope that is of interest to you, too.

Comments

The last day of the year is a good chance to review what you did and what you didn’t, helping you shape out tangible plans for the year to come. I’ll try to do so in the lines to follow, based on the sparse 35 posts I happened to post in this blog during 2008.

So, what did I do?

• finally launched -together with Efthimios- AskMarkets and AskMarkets Services, but we’re clearly in the very beginning
• had a very poor year academic-wise, with a few minor research contributions (some others are to come up soon though), while focusing mainly on my PhD
• watched Open Coffee Greece and the local start-up community bloom, with 21+ events (including one with TechCrunch), 87+ speeches (among them Jason Calacanis) and hundreds of participants, I was happy enough to get to know tons of people, too
• teached A Course by Blog on data mining, next to a couple of lectures on prediction markets (all of them in greek, apologies), then set up DataMine.it MineKnowledge as a start-up with my fellow students
• launched with Efthimios and Dimitris a little web service which got some serious coverage, WebSource.it that is
• set up the promising HowSocial.ru with a fantastic team within a weekend
• turned almost into a ‘parsley’ by gaining (or not) some media attention (ok, I’m joking, but to me media coverage is far from an achievement)

So, I can roughly describe 2008 as ‘a year of launches’. And that makes the target for 2009 clear. Turn launches into successes, premises into actions, potential into results. PhD included.

PS: Can’t wait, will be fun!

Comments

About a month ago, I receive an email from Business Week, stating that I was one of the about 40 nominees for the Europe’s Best Young Entrepreneur 2008 contest. That was a really pleasant surprise, asking me to reply with more information on my business, next to confirming that I am 29 years old or younger, I am the founder or manager of my company, my company has been in business for five years or less and it is a viable, revenue-producing entity, not just a business plan.

I finally wasn’t happy enough to be included among the final entrants, and to my disappointment there is only one entrant from Southern Europe, but I think my reply mail is of an almost autobiographical value you may find of interest (event it is kind of outdated one month afterwards), so I’m attaching it hereby:

Comments