Go to War with the Army You Have

Stuart Ellman

Eric Wiesen

We recently had the opportunity to talk about the current funding environment with a bunch of smart people at a brown bag lunch hosted by our friends at Betaworks. A lot if important angles were discussed, including best practices for entrepreneurs, the mindset at different VC funds and tactical suggestions for getting a funding done in the current climate.

One point that’s worth stressing was raised by several people (including us): When you raise money, make sure you have investors who are prepared to continue to support you the next time around.

Backing up somewhat, let’s acknowledge that when times are good, fundraising usually follows a fairly standard pattern. An investor or group of investors funds a company at the Series A level for a given amount. When the company has reached sufficient proof points in the business and when new capital is needed, the company will raise an additional round of financing. A new investor usually leads this round, with participation (on a pro-rata basis) from the existing investors. The new investor is brought in for a number of reasons:

• This investor may be more oriented toward a later stage of the business and can add additional value;
• New investor may bring needed capital for future rounds of funding; but most importantly
• A new investor can set the price for the company. Prior investors may have conflicts relating to the prices of prior rounds.

When a new investor can’t be found, then the current investors face the choice of whether or not to do an “inside round”, meaning fund the company themselves. The point today is that many if not most follow-on financings are being done as inside rounds right now. The new investor who comes in and prices the company and puts in fresh capital is, in many instances, very hard to find. They are either trying to figure out how they are going to fund their own portfolio companies (and doing inside rounds for them) or they are struggling to raise their new fund and aren’t making investments in new companies.

All of this rolls up to the original point: when you build your syndicate for your Series A round, make sure you have a group of investors who will continue to support you when you need to raise more money. It’s fine to have an investor involved whose charter is solely to make Series A investments and then participate pro-rata down the road, but you should ALSO have an investor who is comfortable making Series B investments. Because as a lot of startups raising Series B and Series C rounds are learning, new investors are very hard to come by right now.

At RRE we are currently looking at funding two very promising early-stage deals. In both cases we could easily (given the amount of capital being raised) take the entire round ourselves, but we aren’t just thinking about today. Both of these companies are likely to raise more money later on, so in both cases we are bringing in partners who can both add value to the company, and who we believe will help us ensure that the company continues to be funded should the current climate last longer.

They say you go to war with the army you have, and the same is true for your venture syndicate. If at all possible, bring in investors you think can go the distance with you. It can make a big difference.

Setting the Record Straight

Stuart Ellman

I admit it. We at RRE Ventures are terrible at public relations. We tend to want our investments to speak for themselves. So, this is what I hear all of the time, “Yes, RRE… you guys do later stage enterprise and financial services deals, right?”

Wrong. Here is the real answer. The quote above was true in 1997. Not now. We have evolved, much like the rest of the venture industry. We have figured out what we do well, and where there is opportunity. Here is a snapshot of what RRE does in 2008:

Roughly half of our deals are in the New York Metro area. When we started RRE, this wasn’t true, but as NYC has grown as an ecosystem for technology startups, we have allocated an increasing amount of our time, energy and capital to companies here. We love doing NY deals for a bunch of reasons. The environment is getting better and better, we know the entrepreneurs, we get an early look at great companies, and awesome entrepreneurs are starting businesses here. The downturn on Wall Street will only bring more smart people to startups in NYC.

Roughly half of the deals in our latest fund are early stage investments. Why? Mostly because we can. We have a reputation with entrepreneurs for being good startup investors and a firm that’s genuinely interested in the type of company building early stage investments require.  Also, because there are only a handful of VC firms in NYC that will make early-stage investments, we get a look at the very good deals. We have incubated two companies per year in our downstairs conference room during each of the past few years. Sure, there will be higher failure rates with seed investments, but we are often backing CEOs that we have backed before, getting in at lower prices, and having a significant influence on how the companies are built.

Here are the industries that we focus on:
• Consumer and Digital Media
• Mobility
• Green Technology
• Software and Services
• Financial Technology
• Infrastructure

The proof is in the pudding. Here are the early stage and NY deals we have done in the past two years.
• Drop.io
• Storm Exchange
• RecycleBank
• GoMobo
• M-Via
• Peek
• Payfone
• Skygrid
• Stealth Company #1
• Stealth Company #2
• On-Deck Capital
• Betaworks
• Tendril
• Certeon

So yes, we agree that the venture market has gotten tough all of a sudden. But we are still doing deals. The bar is set very high and our valuation expectations have been lowered but we are closing two deals this week. And we like them a lot. And moving forward, we’ll continue to invest in the same mix of early and growth stage deals we’ve been doing for the past few years. We’ll spend a lot of time looking at deals here at home, but will continue to be active in Silicon Valley, Seattle, Boulder and other geographies as well.

In sum, sure – if you’ve got a great B2B company, we’d love to see it. But if you’ve got a great early-stage B2C or B2B2C company, we do those as well. A big reason why we started Five Years Too Late was to take the opportunity to let people know what we do here at RRE. We’re interested in a variety of sectors across a range of stages, and across the information technology spectrum. Late-stage enterprise and financial services deals have been very good to us, but there are a lot of opportunities in a lot of other areas today, and we’re looking at all of it.