Other People’s Money

"There’s only one thing I love more than money. You know what that is? OTHER PEOPLE’S MONEY.
"
— Danny Devito in Other People’s Money

I haven’t posted in a while as work has been absolutely chaotic as the pre-Thanksgiving rush has begun. Start-ups, acquirers, partners are all pushing to close transactions before our business begins to wind down in the Thanksgiving to New Years period. I am up in Wisconsin with my son who is getting one last golf tournament of the year in. The aptly named “Intimidator” tournament has a steamy 40 degree wind chill, 17 mph winds and light rain. I elected not to walk the course with the other parents in his group for some reason. So, I can catch up on some posts here…

A friend of mine sent me a question I thought warranted a post. He was wondering how VC’s viewed a) founders investing their own capital in the early rounds and b) founders raising money to pay themselves normal salaries. Pre-bubble, VC’s preferred to see the founders have a significant portion of their net worth tied up in the deal. This aligned interests and kept the entrepreneur focused. Nothing like a mortgage to encourage strong commitment to a deal.

However, as top deals became more competitive and successful entrepreneurs built up sizable nest eggs, entrepreneurs began to push back on the notion and embraced the OPM (other people’s money) philosophy. They were committing time and giving up opportunity cost to pursue the venture. What more could a VC demand?

Most VC’s, while preferring to see financial skin in the game, are focused more on the quality of the team, the market and the deal terms. Additionally, true entrepreneurs are driven by a core desire to make a difference (and notch a win) so monetary sticks add only incremental leverage (though more so in downside scenarios).

Most entrepreneurs will take the middle ground. They will choose to bootstrap the business through proof of concept (site launch, etc) and then push for funding. Often they will self-fund or use angels so as to increase valuation when the larger capital comes in.

On the salary front, VC’s are not fans of entrepreneurs who raise capital and then turn around and give themselves $200,000 salaries. Knowledgeable entrepreneurs also usually don’t do this since this is expensive, dilutive capital they have raised. They are taking significant dilution in order to gain incremental salary. If the deal is successful, every early dollar will turn into $15-25 worth of foregone equity at the exit…ouch! So, it is a bit of an IQ test from the VC’s perspective. Generally, the entrepreneur passes and takes a $60-100,000 salary early on and moves this up once the company is more mature.

Some entrepreneurs are forced to take in larger salaries to pay the bills at home. This is not a great situation from which to start a business. I counsel friends thinking of starting a company to make certain they have (preferably) cash equal to two years worth of personal expenses saved up. This way, they can focus on the business and not on the wolves at the door.

Today, VC’s aren’t as focused as in the past on how much cash the entrepreneur has sunk into the business. We would still view it as a strong positive, but the realities of the market have pushed this term down the list. However, I would highly recommend that they start with a nest egg, bootstrap their business and use new capital predominantly for infrastructure and new hires.