Last week, a group of successful entrepreneurs launched Capital Factory here in Austin. It's a program that is similar to Y Combinator (out of Silicon Valley) and TechStars (in Boulder - where I went to college).
Programs like these are great deals for young web entrepreneurs. Oddly, I hear the following complaint most often from these same young entrepreneurs:
"They want 5% of my company for $20,000. That's a valuation of $400,000 and I think that's a lousy deal. Angels are giving money out at $2-3 million pre-money."
The thinking behind this objection is all wrong. Yes, that 5% does imply a value of $400,000. But lets look at what makes up that value: an idea and the willingness of a few smart people to follow up on it. No traction required. No customers, no revenue, no actual proof of anything. Those $3M angel deals are very different animals - they have money, products, and often customers.
As one of my colleagues put it, it's $400,000 more than you had yesterday.
Second - the money that Capital Factory invests is not really an investment. At least, that's not how you should think about it. It's a vote of confidence. It's a signal to other investors that you and Capital Factory are serious. It's a test. What can you do with $20,000 of someone else's money? Can you create tangible value when given the chance? It's a way to convince your family that you're not off on some wild goose chase.
You are not trading 5% of your company for $20,000. Any motivated group of young entrepreneurs can come up with $20,000 very easily without giving up any equity.
No, you are giving up 5% of your company to engage a group of people who have an interest in your success and who have the ability to impact your chances for success. That's worth a lot more than $20,000. Not only to your current venture, but to your future endeavors. This is the stuff that makes ventures work. It's not about the money - it's about the people.
So why offer the money at all? When it comes down to it, the money is just a tangible symbol of seriousness - a way to communicate a sense of urgency and a glue to keep all the parties interested and involved.
So if you think you have what it takes to make a company from nothing, come to Austin - and let Capital Factory help.
5 comments:
I enjoyed reading your post about Capital Factory. I was thinking about finding an investor for my educational tutoring company to help me purchase high-tech video streaming to be added to my site until I found that all I needed was video conferencing and web conferencing from http://www.24conference.com to interact with my students. Capital Factory may be worthwhile for entrepreneurs. I think I may still check it out.
Thanks for your post Damon! While the $20,000 catches everyone's attention, it is truly the least valuable part of what entrepreneurs will get from Capital Factory.
More important than the cash is the insights and relationships of the 20 mentors. We will help these companies to focus on the right things, hone their pitch, identify their first customers, and raise the next round of funding.
Going into the program your valuation may technically be $400,000, but I can guarantee you that coming out of the program 10 weeks later it will be much higher.
I have been somewhat following Capitol Factory and I think it's great to have a group like this in Austin. I am a trying to get a startup off the ground from College Station, and it's wonderful to know there is a group close to home in Austin (instead of having to relocate all the way to ycombinator or techstars).
They will be presenting at BarCampAustin this Saturday (Feb 28, 2009) (http://barcamp.org/StartupCampAustin), I hope to meet up with them, hopefully if you are around Austin, this would be an excellent opportunity to meet with them as well.
"The thinking behind this objection is all wrong. Yes, that 5% does imply a value of $400,000."
No, it does not. Read the fine print at these incubators. They want a 5-10x return. So a 6-5% stake in your company actually values it at 2 million at the low end. The liquidation preferences are 2 million. This is the main reason people are rejected. The angles don't believe the product has the potential to have that sort of return.
Will, the valuation I'm talking about is at the time of financing, not at some future exit.
And I believe that if you look at Y Combinator's legal documents, you will find a very reasonable 1X liquidation preference. Capital Factory, last I heard, will be taking common stock. TechStars claims to require no special terms, which I would interpret as common or perhaps a 1X preference. You are simply mistaken about the $2M liquidation preference, which would be beyond obscene (100X!) for a $20,000 investment.
The point here is that the value contributed by these incubators is far greater than the value of the cash they invest. So getting wrapped around a $400k valuation is to miss the big picture.
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