The idea that angel investing typically declines in a recession is not new. The logic behind this is pretty basic – when the market crashes angels feel less wealthy and generally deploy less capital as a result.

When the market tanked last fall – the concern about the angel market (very reasonably) was one of the first to be raised by our industry pundits. For about ten weeks – this was the de facto conversation at venture events. The sky was falling and angel investing was expected to follow suit. Here’s what is interesting.

The New Hampshire Center for Venture Research recently reported that number of angel deals done in 2008 was down 2.9% in 2008.

To make sense of this number, we need to look at the run-rate of angel investments as that’s what is indicative about 2009. To this point, the run-rate for angel investments coming out of 2008 is probably a good bit lower than 3% down from 2007 given that the ‘wealth effect’ felt by investors was probably most prevalent in the last quarter of the year. To make a simplified adjustment, if you assume the entire decline in investing occurred in the fourth quarter, the implied run-rate would be 88% of the number of investments in 2007. In other words, the number of deals done by angel could be down by as much as 12%.

Looking at the big picture: The economy is in the midst of the worst financial crisis since the Great Depression, unemployment is sky rocketing, governments are pouring trillions of dollars into stimulus packages and angel investing is only down about 10%. That’s it? What happened to the belief that market for seed stage capital was going to completely dry up, leaving a wasteland of pre-revenue entrepreneurs to re-define the meaning of bootstrapping? It didn’t appear to happen – thank the big man.

The story, however, isn’t entirely rosy unfortunately. The pundits and the venture socialites were not wrong – the amount of angel capital deployed did declined by about 25%, meaning that entrepreneurs raised significantly smaller angel rounds.

If I had to choose, however, between fewer entrepreneurs getting fully funded or a lot of entrepreneurs raising less, I would vote for the latter. While fewer capitalized entrepreneurs nearly ensures that there will be fewer great new companies emerging, less capital per startup does not. While it will be more difficult for entrepreneurs to succeed with less capital, the best founders seem to have a knack for stretching a dollar as far as it needs to go. Furthermore in some instances under-capitalizing a startup can increase its chances, as limited resources can force entrepreneurs to operate more efficiently and position them to be more responsive to changes in their markets.

Startups are the fresh blood in our economic system. From a macro-perspective new companies drive growth, create jobs and increase the overall standard of living. They are always the team to be rooting for. As a result, the fact that angels are helping to keep the pipeline of new companies full is important news – news that beats expectations.

It is often said that the best entrepreneurs evolve, meaning that they successfully redefine their business models to match their changing understanding of their opportunities. For many, this means focusing on a new customer base, leveraging a new channel, repositioning a brand, restructuring pricing or making changes to the team.

The bigger plan, however, is sometimes destined not to succeed regardless of how much tweaking the entrepreneur does. Fundamental flaws in a business model can loom out of sight, only to be unearthed when a company first tests the waters by making its service available to customers. For example, in some cases, it might turn out that customers value something very different than what a company is offering. The entrepreneur’s intuition may have been off. Even worse, this situation can arise after an entrepreneur does the proper diligence. While an entrepreneur may have conducted surveys that demonstrated resounding customer interest in his service, customers may still not be motivated enough to act when it comes time to sign-up or pay. Yes, customers often can’t predict their own behavior.

Regardless of why an entrepreneur hits a dead-end, it is important for him to take a step back and look at the bigger picture. Doing so is a much more difficult proposition that one might expect, as the conventional wisdom told to entrepreneurs is that they must be perpetual contrarians; they must champion their ideas even when everyone around them, fellow entrepreneurs, investors, friends and even family, says that they’re crazy.

Well, the conventional wisdom isn’t that practical. Entrepreneurs do need to assume that most people won’t “get it”. Some, not all, of the other folks with relevant domain knowledge, however, should see the vision. If every knowledgeable colleague they know says that it’s a terrible idea, it probably is.

Another indicator of a fundamental business flaw comes in the form of an issue that the entrepreneur already knows about but has elected to ignore. It’s the question they admit to always getting stuck on, but have still somehow decided won’t hamper their progress. “Yeah that is a problem, but we’ll just work through that.” If you find yourself unable to answer a key question about your business it may be your Achilles Heel. It’s an optimist’s natural tendency to ignore underlying issues. If you find yourself unable to answer a key question, it’s time to take a step back and re-evaluate. Clear your head and reassess the practicality of your venture.

While other people’s opinions can be a helpful leading indicator, at the end of the day an entrepreneur needs to be the one to decide that his business plan is flawed. If the plan is in fact flawed, the sooner that he figures that out, the better.

When acquirers and the shareholders of a company come to an impasse on valuation based upon assumptions about future performance, the pricing gap is sometimes bridged through an earn-out. In an earn-out, the buyer agrees to pay the current shareholders additional compensation as pre-determined future operating metrics are achieved.

For example, if shareholders expect sales to increase next year and the acquirer doesn’t, the acquirer might agree to pay more for the company in the future if sales do in fact increase. Doing so enables the acquirer to protect itself from paying too much for the target in the event that sales don’t increase – the seller takes on the performance risk.

While structures vary greatly, in the plain vanilla version the target is purchased for a base price with the possibility of an additional earn-out. Earn-outs need to be well defined to ensure that both parties know when the payouts are triggered.

While in theory earn-outs are quite simple, these structures can make it difficult for unprepared entrepreneurs to get their fair payouts. One of my mentors, Jed Katz, has lots of his experience as both an operator and investor. During his time as an entrepreneur, he learned a few tactics that can help entrepreneurs increase their chances of maximizing their payouts. Here they are – the top four ways to avoid being burned by an earn-out:

#1 Base The Earn-Out On Simple Metrics

Earn-outs are most effective when the size of the payout is determined based upon one or two simple variables.

For example, higher revenue might lead to a higher payout to the shareholders of the acquired company.

In contrast, imagine an earn-out based upon price changes, customer acquisition cost and customer retention. To complicate matters, these variables might be woven together in an arbitrary equation that provides each metric with a weighting. In pursuit of maximizing the payout, management might focus on trying to optimize too many variables in the business, potentially resulting both in management not focusing on what matters most to the buyer and making it difficult for management to maximize their payouts.

Simplicity provides incentive alignment, clear objectives and less room for argument when it comes time to sign the check.

#2 Base The Earn-Out On Metrics You Can Control

The metric used to determine the size of the earn-out can vary – it’s negotiable. It could be a financial metrics (e.g., revenue, gross profit, EBITDA, etc.) or an operating metric (e.g., page-views, customers, etc.).

Entrepreneurs need to be sure that the selected metric is one that they can directly influence after the acquisition. For companies that are acquired for their cash flows (probably EBIT in this case) it’s important to base the size of the earn-out on a top line metric, such as revenue. There is good reason for this – the expenses allocated to the target might be very different once the target is integrated into the acquirer. Transfer pricing, overhead expense allocation and new accounting methodologies may drastically alter bottom line figures. As a division of the acquirer, the company’s EBITDA margin might be half of what it was before the acquisition – making it difficult for a management team to meet EBITDA growth targets.

This same logic applies to companies that are acquired before they are generating revenue. If a company is acquired because it generates lots of page-views, but no revenue, management should be wary to base an earn-out on revenue. If these entrepreneurs find themselves stuck using a poor monetization solution (that is mandated by the buyer), the revenue targets may not be in their control. In a case like this, management might only be in direct control over the number of page-views and therefore that’s the target metric that payouts should be based upon.

#3 Ensure Access To Sufficient Resources

Imagine it’s the day after you inked the sale of your company. Much of your pay-out is based upon meeting revenue targets in the coming quarters, but you’re confident that you’ll meet the revenue targets – managing this business is as easy as turning a crank at this point. You’re on cloud nine. That is, until you check your voicemail.

The second message is from the CEO of the buying company, your new boss. He notifies you that your marketing budget has just been cut in half as part of a cost cutting exercise. You know that it is now impossible to meet the revenue growth targets outlined in the earn-out – you’re not going to be able to maximize your pay-out. You just sold your company at a discount.

Scary scenario? You bet. Here’s another.

You are two months into the agreed upon one year employment at the buyer’s company. You have been instrumental in ensuring that your company, now a division of the mother-ship, is hitting its numbers. With close monitoring, you’re confident you’ll get the rest of your payout.

After getting settled into your office for the day you head over to the CEO’s surprise strategy meeting, where he introduces a new product line that he feels you would be perfect to run (since you’re the only person in the company that has built anything in that sector). Aware of your commitment to your division he asks you to split your time – allocating 50% of your attention to the new product line. You leave the meeting trying to find a way to reposition yourself, as you’re worried that your division won’t perform enough to meet the earn-out benchmarks without your full attention.

While it’s impossible to layout all of the details around the resources (staff, capital and your own time) you’ll need when you enter into an earn-out, you should try to obtain agreement from the buyer about your resource availability and you should have your lawyers bake in some language that can protect you.

You should also try to create a formal mechanism for increasing your resources as needed. If market dynamics change, market rates for key resources change or unique opportunities present themselves, you need to be able to take advantage of those changes. Incentives should be aligned; it’s bad for everyone if the company stifles your business’ growth just to minimize your earn-out. Having a pre-defined process for making these adjustments can help along the way. One approach is to have a formal quarterly review of your resource allocation that includes all of the appropriate people.

#4 Keep The Earn-Out Period Short

It’s important for entrepreneurs to negotiate hard to limit the length of time under which the earn-out metrics are evaluated. There are two key reasons for this: external and internal changes.

First, exogenous factors can limit an entrepreneur’s ability to maximize their payout. If the economy falls into a recession during the earn-out, revenue targets might not be as viable. The longer the earn-out period, the more risk the entrepreneur is taking.

Second, as more time passes the odds of the buyer’s strategy changing increase. While leveraging your company may have been a strategic imperative when it was acquired, market dynamics may dictate a different strategy post-acquisition. Or, perhaps, a new management team was brought into run your acquirer. Either of these factors (and many others) could lead to a change in priorities which could leave your business last in line to receive capital, support or other mission-critical resources.

In sum, it is advantageous for entrepreneurs to minimize the length of the earn-out (so long as they have sufficient time to meet their earn-out benchmarks).

The average company exiting through a public offering is more mature than a company that exits through an acquisition, at least since 2000.

There is good reason for this extra maturation. Public investors are often seeking to buy shares in companies that will continue to operate independently long into the future. In contrast, corporate acquirers may buy companies when they are very young before the company has demonstrated its ability to sustain itself. There are a variety of reasons why a company might be bought without demonstrating financial sustainability; a fledgling company might be acquired for its assets (technology, customer, contracts or management) or it may be acquired as a defensive maneuver – to eliminate the opportunity for the company to become a long-term threat.

It could also be argued that Sarbanes-Oxley legislation, which requires additional internal process documentation and oversight by public companies traded on U.S. exchanges, has delayed public offerings. Companies must ensure they will be compliant with Sarbanes-Oxley regulations, and that they can afford to pay the associated costs, before they can issue public stock for the first time.

From the period of 1996 to 2008, the average company that IPO’d was 8 months older than the average company to be acquired. It’s worth noting that this pattern didn’t hold true during the Internet boom. In the period of 1996 to 1999, the average software company making its initial public offering was five months younger than the average company being acquired (according to Dow Jones Venture One data).

The general trend of IPOs taking longer to realize than acquisition also puts pressure on investors to push for larger exit values. VCs are judged by their investors based upon a number of metrics, one of which is call the Internal Rate of Return (IRR). An IRR is an accurate way of measuring the average annual rate of return on invested capital adjusted for the timing of cash flows. A simple relationship that comes from this math is the fact that longer times to exit reduce the effective annual return. Returning 200% of invested dollars in 1 year implies a higher average annual increase in value than returning 200% of invested dollars in 10 years. As a result, the delay in exit time drives VCs to require higher exit values to adjust for the delay. While in theory the increase in value can be justified by the company’s ability to expand its operations and increase revenues over that period, every exit is ultimately a negotiation and this delay drives VCs to target higher exit values.

I recently attended a networking event with Jeff Stewart, one of the founders of both Mimeo and Monitor110 (two of our DFJ Gotham portfolio companies). Over the course of the event, I heard Jeff offer some advice to a group of younger entrepreneurs. I found one of his points to be very compelling and thought I would share it here.

Jeff argued that trying to raise money from venture capitalists early in the life of the company is a great idea. While he thought securing capital was important, however, the money wasn’t the reason he encouraged the young entrepreneurs to engage in the VC fundraising process. The benefits he cited were as follows:

• Enhance the plan: By pitching to VCs and getting feedback, an entrepreneur receives valuable feedback that helps him refine his business model, marketing strategy and other aspects of his plan.
• Make connections: While VCs don’t make introductions for every entrepreneur that they meet, Jeff argued that the entrepreneurs would likely be connected to important customers, partners and future members of their teams through the investment community.
• Learn how to pitch the company: By pitching early in the life of the company and pitching often, entrepreneurs learn how to sell their companies. From his perspective, selling in this way is not only important in fundraising, but is also critical for making key hires, securing partnerships and literally selling the company when the right buyer comes knocking.

Here are five ways to make the fundraising process more useful to your operation:

1. Create projections in a manner that makes them easy to use for future planning and budgeting,
2. Design your uses of capital raised analysis to play into your short term budgets by making it sufficiently detailed,
3. Leverage the addressable market analysis to identify the most attractive target customer segments,
4. Revisit your competitive landscape when preparing investor materials to look for best practices and opportunities to enhance your model, and
5. Generate a sales pipelines document that can be leveraged by your sales department going forward (you’ll probably need an operational version of this document to share with your board in the future).

Fundraising can be a tedious process – try to get as much operational value out of it as possible.

This column was provided by Mark Davis. Mark is the author of Get Venture, a column designed to help entrepreneurs raise venture capital. In addition to his column, Mark is active in the venture community as an entrepreneur, advisor and venture capitalist. He currently works at DFJ Gotham Ventures, a leading early-stage IT venture capital fund based in NYC.

I have tried to identify venture capital best practices. There is more to the business than picking winners; the nuances of interacting with and supporting entrepreneurs are potentially more important. While I have found that there are dozens of small processes that are exemplary, the principles that make a VC effective and poised for long-term success can be boiled down to a top ten list. Although exceptions always exist, these ten guidelines appear to be the guiding light for how the best VCs interact with entrepreneurs. I believe that these rules are worthwhile for entrepreneurs to be aware of, as it is my hope that they will set the bar for their expectations.

Top Ten Ways In Which The Best VCs Interact With Entrepreneurs

1. Be respectful of entrepreneurs and their efforts – remember that they are changing the world.
2. Handle sensitive information carefully.
3. Be forthcoming if you are evaluating competitive opportunities.
4. Be honest about your intentions.
5. Respond as promptly as possible.
6. Help entrepreneurs when possible regardless of whether or not you intend to invest.
7. Ensure that entrepreneurs share in the upside.
8. Be an active board member.
9. Pursue the exits that are best for everyone around the table.
10. Support the entrepreneurial community.

More broadly, these guidelines address three potential VC short-comings that are commonly cited by entrepreneurs: arrogance, inconsiderate behavior and selfishness. The best VCs avoid these behaviors like the plague, and they do it for good reason; in the long run, it makes them more successful.

The all-stars of VC understand that the entrepreneurs are the stars of the startup show. This perspective keeps actions that could be perceived as arrogant in check. With this mindset, these VCs know that egos are unjustified and, very often, destructive. Simply being respectful can make life for entrepreneurs easier and can enable a type of board room collaboration that yields the most productive outcome.

As I mention in my post, The Venture Police: Reputation, VCs needs to be considerate in order to develop the kind of reputation that attracts the best entrepreneurs. Being considerate means a few things. First, it means stating intentions up front. For example, VCs who are looking at multiple opportunities in an industry need to inform entrepreneurs of that fact. Second, responding to entrepreneur emails in a timely fashion is also important. Responsiveness is part of being a team player – fundraising is a stressful process that does not need to be complicated for no reason. Furthermore, responding to emails is the same courtesy afforded to nearly everyone in business – entrepreneurs deserve the same respect. I have found that a quick “no” is always appreciated – like everybody else, entrepreneurs want to know where they stand. While promptly responding isn’t always easy for VCs when their email inboxes are being bombarded, efforts to be responsive appear to be appreciated.

Lastly, even when VCs don’t plan to invest, trying to selflessly help entrepreneurs is a noble pursuit – this goodwill gesture not only helps a VC’s reputation, it is the right thing to do. Helping an entrepreneur can increase the odds that a new service makes it to market, that new jobs are created and one person gets a little bit closer to realizing a dream.

The best VCs appear to understand that being perceived as arrogant, inconsiderate and selfish can damage their reputation and future deal flow. As a result, they go to great lengths to avoid these perceptions. Ultimately this unique alignment is one of my favorite aspects of the VC role – it’s in a VC’s best interest to be a good guy.

This column was provided by Mark Davis. Mark is the author of Get Venture, a column designed to help entrepreneurs raise venture capital. In addition to his column, Mark is active in the venture community as an entrepreneur, advisor and venture capitalist. He currently works at DFJ Gotham Ventures, a leading early-stage IT venture capital fund based in NYC.

Methodology

The AEA Cybercities report provides a great deal of data about the high-tech sectors in the top 60 US cities. However, the city view doesn’t accurately capture the regional tech communities – these ecosystems often span more than one city. As a result we rolled up the territories defined in the report into regions that parallel the actual technical communities. While the AEA has Silicon Valley as an isolated territory, we integrated San Francisco, Oakland, Menlo Park, etc. into what we called the Silicon Valley Region – a more realistic view of where Sand Hill VCs actually invest and where entrepreneurs out there consider their stomping grounds. Similarly, the SoCal Region includes San Diego, LA and a few other independently listed geographies. The NY Region includes East PA, East NJ, West CT, Westchester, etc.

Findings

Here’s the scoop. Based on the AEA data, of the major regions the NY Region is:

• 1^st in total high tech jobs
• 1^st in the number of new high tech jobs annually
• 4^th in high tech salaries, behind both Boston and Silicon Valley

Making Sense of This Information

Given the sheer number of people in the densely populated NY region, it’s not surprising that there are a lot of high tech workers. However, the fact that there are more techies here than anywhere else in the US might surprise some. My gut tells me that this viewpoint may be a result of the reality that the NY tech scene is sometimes overshadowed by the other prominent industries in the region (finance, advertising, pharma). However, living in a land of giants doesn’t make you small.

It’s worth noting that based on this the implied percentage of the technical talent in the NY Region is currently working in startups in smaller than that of the Valley, leaving a deep bench of talent to join companies or start the next big thing.  We’re poised to continue to grow.

On another note, it’s common to hear those who don’t know NYC well state that it’s an expensive place to be a startup. I often hear the local entrepreneurs argue otherwise. The data point about NY tech talent being less expensive than it is in Boston or out West supports the argument that NY is an affordable place to start a company, at least with respect to the biggest cost for most start-ups: people.

It’s nice to see some data that supports what all of us on the ground here already knew: New York is hot.

This column was provided by Mark Davis. Mark is the author of Get Venture, a column designed to help entrepreneurs raise venture capital. In addition to his column, Mark is active in the venture community as an entrepreneur, advisor and venture capitalist. He currently works at DFJ Gotham Ventures, a leading early-stage IT venture capital fund based in NYC.

Editor’s note: After you read Mark’s guide below, check out all of our LinkedIn coverage and join our LinkedIn networking group.

Why you should use LinkedIn:

1. The service allows you to see who your contacts know – something that is virtually impossible to do sufficiently through normal social interactions.  LinkedIn takes the coincidence out of networking.
2. It enables you to passively keep up to date contact information for all of your contacts.
3. It facilitates introductions through your broader network.
4. It enables people to find you based upon your background and who you know.
5. It is a professional network that excludes unnecessary personal information.

Why You Should Expand Your LinkedIn Network

I find that a lot of people define ‘using’ LinkedIn as having a profile, but not a lot of connections. As a result, I think it’s worth pointing out that the more you expand your network the more valuable the service will be for you.

As you add more contacts:

1. You will have a larger database of people to search through when you are looking for a contact.  When you search for a person or a background you can only see contacts in your three degrees or contacts – more contacts means more people in your searchable pool.
2. More people will be able to find you when they search for someone with your background.

LinkedIn Best Practices

Here’s my short list of LinkedIn best practices (and how you do them):

1. Customize your LinkedIn profile page URL name.  Go to ‘edit my profile’ in your LinkedIn account and click on ‘edit’ next to ‘Public Profile’ a little way down the page.
2. Add your LinkedIn profile page to your email signature.  For gmail click on ’settings’ in the upper right hand corner and in the text box half way down the page labeled ’signature’ enter a custom signature including your new Public Profile URL.
3. Connect with your existing contacts.  Click on ‘add connections’ on the left side of the screen and follow the process of letting LinkedIn scan your gmail, outlook or other contact lists.  By doing so you will be able to invite your contacts to connect using the very easy process provided on the site.  Note that you will not automatically invite everyone in your gmail or outlook contact list.
4. Use the Browser Toolbar.  The most important feature of the browser toolbar is that it adds a LinkedIn icon next to email addresses in your gmail.  This icon enables you to see a LinkedIn summary (job title, position in your network, number of contacts, etc) of any person who emails you.  It also enables you to invite people to LinkedIn from your gmail account – making it easier to connect with people.
5. Use the Outlook Toolbar.  This application integrates into your outlook as is useful in a few ways.  First, it adds a LinkedIn icon that is similar to the one described in the browser toolbar.  Second, it enables you to update your outlook contacts based upon changes that people make to their LinkedIn profiles – keeping your contacts up to date.
6. Add a picture.  It’s always helpful for other people to be able to associate your face with your background, making it easier for people to introduce themselves at social events.

LinkedIn Etiquette

Standard for connecting.  When I first started using LinkedIn I viewed a connection as an endorsement.  I no longer see it that way, because I realized that my connections do not have direct access to each other – I have to approve introductions.  At this point, I am willing to connect with anyone with which I would normally exchange contact information (e.g., a business card).

Appropriate use of the name field.  Some folks insert additional information into the name field on their profile.  The most often additions are a title or an email address.  I understand that they do this because in some forms of search on the site the name field is the only thing that shows up.  However, I don’t like it.  Not only does it seem aggressive in general, but also it screws up their contact information for everyone that uses the outlook toolbar. 

It’s OK not to forward an intro:  People can request that you introduce them to someone else in your network.  While it’s a bit awkward to say ‘no’, I think that it’s appropriate to do so if it makes you uncomfortable.

This column was provided by Mark Davis, the author of Get Venture, a column designed to help entrepreneurs raise venture capital. In addition to his column, Mark is active in the venture community as an entrepreneur, advisor and venture capitalist. He currently works at DFJ Gotham Ventures, a leading early-stage IT venture capital fund based in NYC. Mark has also setup a variety of regional venture communities on LinkedIn.

In my post, How A VC Is Funded, I listed four ways that VCs obtain capital to invest in startups. Each of these four sources of capital has slightly different implications for entrepreneurs. In this post, I will discuss the implications of a public funded VC.

Capital Constraints
Similar to family office funded VCs public funded VCs raised a relatively fixed pool of capital from the public markets, which they continue to recycle from exits to new investments. Entrepreneurs should be sure to ask any fund that relies on recycled capital for future investments about their reserves to ensure that capital will be available in the future. While in theory the fund can always tap the public markets, that may not be the reality.

The Public Eye
Public companies have to make public disclosures. As a result, more about your company and its operations may be easily accessible to third-parties if you have a public investor. If your company requires substantial privacy because your strategy relies on being the first mover or otherwise then you should ask these VCs about the disclosures that they will make.

Bureaucracy
Too many entrepreneurs bureaucracy is the anti-Christ. If this is the case beware of the additional administrative burdens that might be required if you accept money from a public fund.

These funds are regulated by the SEC and have substantial reporting requirements. Be prepared to answer questions and provide lots of data as necessary.

This column was provided by Mark Davis, the author of Get Venture, a column designed to help entrepreneurs raise venture capital. In addition to his column, Mark is active in the venture community as an entrepreneur, advisor and venture capitalist. He currently works at DFJ Gotham Ventures, a leading early-stage IT venture capital fund based in NYC. Mark is pursuing his MBA at Columbia Business School.

In my post, How A VC Is Funded, I listed four way in which VCs obtain capital to invest in startups. Each of these four sources of capital has slightly different implications for entrepreneurs. In this post, I will discuss the implications of a government funded VC.

Both the federal and local governments have created venture funds that seek to harness the free markets to achieve a social objective. The federal government has one fund that seeks to identify and incorporate new technologies into the military. Many state and city governments use these entities to stimulate local economies.

Capital Constraints
Similar to both the family office and public funded funds these funds recycle capital from one investment to the next. As a result, capital constraints can be an issue if they don’t have robust capital reserves are timely exits from other portfolio companies.

Furthermore, these funds are subject to the whims of legislators. It’s possible that your capital reserves could be re-appropriated to another state agency with a change of administration or policy.

Double Bottom Line
As aforementioned, these funds typically invest both to increase the size of their capital pool and achieve a social objective (e.g., supporting new technologies, creating tax revenue or decreasing unemployment). As a result, you should be thoughtful about the motivations of these VCs. A pre-requisite for their investment may require moving the company to a new location or taking the time to license the product to the government.

This column was provided by Mark Davis, the author of Get Venture, a column designed to help entrepreneurs raise venture capital. In addition to his column, Mark is active in the venture community as an entrepreneur, advisor and venture capitalist. He currently works at DFJ Gotham Ventures, a leading early-stage IT venture capital fund based in NYC. Mark is pursuing his MBA at Columbia Business School.

In my post, How A VC Is Funded, I listed four way in which VCs obtain capital to invest in startups. Each of these four sources of capital has slightly different implications for entrepreneurs. In this post, I will discuss the implications of a family office funded VC.

By family office I am referring to one family’s private capital. In this scenario the VC firm is essentially working for a very wealthy family to enhance the family’s personal endowment.

Capital Constraints
Some of these VC funds can have a relatively limited amount of capital under management. Since they typically don’t raise capital from third parties, they can only invest what the family allocated to them. Furthermore, once that’s invested they have to wait for a company to be sold in order to have access to more capital.

One risk in this situation is that if the fund has invested a large proportion of their assets under management they may not have the resources to continue to support your company in future rounds. The takeaway is that you should take a look at their balance sheets before accepting an investment.

At The Mercy Of The Family
There is some risk that families may be able to pull their capital out of the fund if they have a sudden need for liquidity. The impact of this would again be an inability of the fund to support you in future rounds.

This is a question worth asking the VCs – they may or may not have protective provisions in their contract with the family that prevent sudden withdrawals.

Even-Keeled Investing Strategy
The psychology and objectives of a VC at a fund with fragmented LPs typically changes through the stages of their investment cycle; they are willing to take more risks at different points in the fund. While this is may be a pro and a con for the entrepreneur, it differs from the styles of family office VCs.

Family office VCs with pools of capital that far exceed their investment capacity are more likely to have a consistent risk tolerance, making for more predictable investment decision making. However, funds with more limited AUM may become more risk adverse as capital pools continue to become increasingly constrained.

Board Accessibility
VCs that have a fragmented LP base become very busy every 3 to 5 years as they go out to raise capital from their LPs. This can make them less accessible to their portfolio companies. However, the best ones make sure that they are still available.

Family office VCs don’t have to spend lots of time raising money, meaning that should be slightly more consistently available to their entrepreneurs.

This column was provided by Mark Davis, the author of Get Venture, a column designed to help entrepreneurs raise venture capital. In addition to his column, Mark is active in the venture community as an entrepreneur, advisor and venture capitalist. He currently works at DFJ Gotham Ventures, a leading early-stage IT venture capital fund based in NYC. Mark is pursuing his MBA at Columbia Business School.

In my post, How A VC Is Funded, I listed four way in which VCs obtain capital to invest in startups. Each of these four sources of capital has slightly different implications for entrepreneurs.

Fundraising Cycles

Investments made in a VC fund by a diverse group of limited partners are integrated in closed end funds. As a result, VCs who raise money from a diverse group of LPs have to go and raise capital from limited partners every 3-5 years. Money is raised, the fund is closed, the capital is invested and then another fund is raised.

As a result, entrepreneurs can be affected by where the current fund is in its lifecycle. If you receive an investment from a VC when they are raising another fund, the VC will likely be slightly busier than they would otherwise be. Fundraising is a very time consuming process for VCs, making them very busy. This doesn’t mean that they won’t have time for you, it just means that their schedules will be more complex and they will be slightly harder to reach.

However, this does not mean that they will not be able to make follow-on investments in your company. Good VCs keep capital reserves to support their portfolio companies even after they raise their next fund. Be sure to ask them about their reserve policy to ensure that they will be able to continue to support you.

Limited Partner Network

Another consideration created by this funding structure is that these VCs often have a deeper network of people vested in your company’s success. High net worth individuals who invested in the fund will care about the success of your company. If a VC has an investor (limited partner) that could help your company they will typically contact them.

Risk Of Exiting The Business

If you raise money for a poorly performing VC fund, it is possible that they may not be able to raise a subsequent fund. As a result, in extreme circumstances they may be forced to find new jobs before you have sold your company.

This column was provided by Mark Davis, the author of Get Venture, a column designed to help entrepreneurs raise venture capital. In addition to his column, Mark is active in the venture community as an entrepreneur, advisor and venture capitalist. He currently works at DFJ Gotham Ventures, a leading early-stage IT venture capital fund based in NYC. Mark is pursuing his MBA at Columbia Business School.

The risk categories essentially can be categorized according to the investment criteria that VCs consider. While there are many risks associated with any investment, I have included a short list of risks that typically distinguish one VC investor from another.

• Management Risk: While few VCs will state that they are willing to gamble on a bad management team, some VCs place more importance on the strength of the management team than others. Some believe that an average team can make money with a good idea, others don’t.
• Product Risk: Commonly referred to as ‘technology risk’ in the IT sector, product risk refers to the chance that the product will not be successfully developed. If your product is a highly complex piece of software that has not yet been developed, you are asking a VC to gamble on your team’s ability to get the coding done with a given set of resources. Some VCs will take that risk and others won’t.
• Revenue Model Risk: Revenue risk refers to the potential that your company may not have a model for generating revenue. Not every business plan includes a revenue model and some that do don’t have very good ones. Some VCs are comfortable backing the YouTubes of the world – ideas that will attract lots of users – with the belief that the entrepreneur will figure out how to monetize the service later. Others want to see a plan for generating revenue up front.
• Market Risk: Market risk refers to the risk that the addressable market may not exist. Truly disruptive technologies rely on an assumption of adoption which may not materialize. Furthermore, markets may dissolve if the landscape undergoes unforeseen change. Some VCs require that the market be validated through customer adoption; others don’t.
• Competitive Risk: Competitive risk refers to the potential for a venture to be beaten to market, outperformed or substituted. Competitive risk varies by the competitive landscape, barriers to entry, threat of new entrants and so on. VCs’ aversion to this risk varies.
• Partnership Risk: Partnership risk refers to the risk that key partnership may not be obtained. This significance of this risk is driven by the importance of the partnership to the success of the business, the number of potential partners and the difficulty of obtaining partnerships. As with the other risks, VC tolerance for this varies greatly.

You should honestly evaluate each category of your business when selecting VCs to target. Your time will be better spent if you only pursue VC funds that can accept the risks associated with your business.

Unfortunately, most VCs do not articulate their risk profiles are their websites. As a result, the best way to learn about a VC’s appetite for specific risks before using a favor to get introduced is to both look at their portfolio and ask around.

This column was provided by Mark Davis. Mark is the author of Get Venture, a column designed to help entrepreneurs raise venture capital. In addition to his column, Mark is active in the venture community as an entrepreneur, advisor and venture capitalist. He currently works at DFJ Gotham Ventures, a leading early-stage IT venture capital fund based in NYC. Mark earned his B.A. in Economics with a minor in History at Duke University and is pursuing his MBA at Columbia Business School, where he is the Early Stage President of the Private Equity and Venture Capital Club and the Founder of the Columbia Venture Community .