In early 2007 a new website was founded by someone only known as Ted. The website was simply called The Funded. Simply put, The Funded allows entrepreneurs to rate and review venture capital firms and angel investor groups. While the site, and its founder, has been highly criticized, The Funded took off. For the first time ever, entrepreneurs had a place to go and rate and review investors, and for those searching for potential financing, a place to read those ratings and reviews. The Funded has, in it’s own small way, leveled the playing field and has served the entrepreneurial and VC communities well. For the first time ever, VCs were publicly being held accountable. For example, see here for the most loved VCs of 2009. Some say it’s a one-sided forum, and many just don’t care. Most entrepreneurs agree though – The Funded is a good thing.

The whole idea of The Funded really intrigued me, and had something in common with this little side project of mine (The Founder’s Quandary). But I had no idea who was behind The Funded, so I had no idea who to contact about getting involved or at least offering a virtual high-five.

For it’s first six months it was unknown who “Ted” really was. That is, until Ted unveiled himself as Adeo Ressi, a well known, somewhat controversial, entrepreneur. In the past couple of years Adeo and I have exchanged a number of emails, mostly about how I might help The Funded and perhaps even help with something here in Boston. Well, the good news is that The Funded has announced Founder Institute, and it’s arrived in Boston!

The Funded Founder Institute, a four month program to help founders build the next generation of world-class technology companies, is launching a new semester in Boston from July, 2010, until October, 2010. The program is run by founders for founders, providing a structure for successful entrepreneurs to share their experiences and to provide guidance. Everyone that graduates from the program is invited to join a pool to share in the equity upside generated from the success of their peers. This adds a unique camaraderie to the program and creates a long-term peer support group with a vested interest in your success. If you have a new company or if you are thinking to start a company, take a moment and apply to the program. The program has an early acceptance deadline of May 23rd. Apply here.

If you’re an entrepreneur in Boston I hope you’ll take a look at this opportunity and get involved! I’m just thrilled to see this happen, and I’m eager to see Founder Institute nurture and provide fertile ground for entrepreneurs!

Related articles by Zemanta

• The Founder Institute Launches In Boston, Now Incubating Startups In 10 Cities (techcrunch.com)
• The Trouble With Venture, Through Adeo Ressi’s Eyes (blogs.wsj.com)
• The Founder Institute goes global (venturebeat.com)
• Born in Silicon Valley, Founder Institute Expands to Boston (xconomy.com)

Fred Wilson is one of the most visible and transparent VCs out there, and you might even say that he broke the mold on transparency in venture capital. He also happens to be a very sharp guy, who is not afraid to speak his mind. When Fred speaks I find myself nodding my head constantly, to the point where I get dizzy.

His latest blog entry is an appropriate subject for TFQ. I’ve quoted it below, but please head over to Fred’s blog and check out the comments and discussion yourself.

One of the more contentious things in the negotiation between an entrepreneur and a VC over a financing, particularly an early stage financing, is the inclusion of an option pool in the pre-money valuation. As my friend Mark Pincus likes to say, “it’s just another way to lower the price”.

I’ll accept that critique. And take it one step further. The option pool is absolutely a piece of the price negotiation. But it is a very important one as I’ll explain.

But first, let me lay out a few things for those who aren’t well versed in these matters. The pre-money valuation is the value of the company before the money comes in. Let’s say we call it $4mm. And let’s say the financing is $1mm. Then the post-money valuation is $5mm and the $1mm round is 20% dilutive ($1mm/$5mm).

But to the entrepreneur it might be a lot more dilutive due to the inclusion of the option pool in the pre-money valuation. Let’s say that the VC’s term sheet says that a 15% “fully diluted post money” option pool needs to be in the pre-money valuation. What that means is that the investor wants 15% of the company, after the financing is closed, to be in an option pool that has not been granted to anyone.

In the case of the $5mm post money valuation, that means there needs to be $750,000 worth of options in the pre-money valuation. If the pre-money valuation is $4mm, then that means the true pre-money valuation to the entreprenuer is $3.25mm. And therein lies Mark’s critique that the option pool is just another way to lower the price.

I am sure I lost a few of you on all of that math. If you want to drill down on it, please leave a comment and we’ll help you figure this out. It is very important you understand all of this if you are or want to be an entrepreneur who raises venture capital.

The bottom line is the deal I described leaves the entrepreneur and his/her shareholders with 65% of the company after the financing, the VC investor will own 20%, and there will be an option pool representing 15% of the company that has not been issued yet. The $1mm financing was not 20% dilutive, it was 35% dilutive.

So it is not surprising that entrepreneurs hate this provision and fight about it every time. And like most terms, VCs have been abusing it for years by asking for excessive option pools making the provision hated more than it needs to be.

The first point I’ll make is that VCs should be upfront about this provision and the fact that it is simply about price. In the example above, I’d be happy to pay $3.25mm pre-money with no option pool. Or I’ll pay $4mm pre-money with one. They are the same thing to me. What an entrepreneur needs to do is find out what the market price for their company is with and without an option pool in the number. Once they do that, the negotiation over this point is a lot less contentious.

The second point I’ll make is that the option pool request needs to be reasonable and based on some kind of budget. I generally ask the entrepreneur to put enough options into the “pre-money pool” to fund the hiring and retention needs of the company until the next financing. My thinking on this is that I don’t want to get diluted between financings. So I like to see a headcount based hiring plan with expected options against each hire combined with a retention plan for all current employees who will need additional option grants.

In most of the early stage financings I’ve done in the past few years this work on the option pool has shown a need for around 10% in unissued options. I’ve seen it as big as 15% but that is rare. I’ve also seen it as low as 5%, but that is even more rare. But the point is this; don’t guess or negotiate this number. Do the work, figure it out, and put it in the pre-money and then negotiate price.

I’ll wrap with a true story about this provision. When Mark and I were negotiating the first round of financing for Zynga, we got into a real tussle about this provision. He did not want an option pool in the pre-money valuation. I did. Once we agreed that it was just a fight about price, the conversation got easier. I got him to give me an estimate of the pool he would need. We added it to the valuation we had agreed to. He got an increase in price, I got an option pool. And I got one of the best investments I’ve ever made.

If you are an entrepreneur and don’t know about TheFunded, check it out. Get in there, look around, get involved, and subscribe to TheFunded’s newsletter. Here’s the latest from Adeo and TheFunded who was kind enough to let me post this up here on TFQ.

Unfortunately given that TheFunded is based on the west coast, most of their events on there as well. I’m on the east coast so I will not attending. But this is still worth the read and there’s some great results from a recent survey. Check it out below:

Hello,

The venture capital bubble has burst, and change is coming. Investments into venture funds are at a fifteen year low. There is increasing risk that innovative businesses will be unable to raise capital within 18 months, and TheFunded wants to do something about it. 82% of the Members are CEOs, and 75% are fundraising (see survey results below). The investors in venture funds, limited partners, are reading TheFunded weekly and reacting to the reviews. On February 18th, we are bringing together limited partners, venture capitalists, and entrepreneurs to discuss the Future of Funding. How do we want the future to look? Join us in the discussion.

– The Founding Member, http://www.thefunded.com

THEFUNDED EVENT CALENDAR
————————————————————
There are three events coming up: an exclusive “Future of Funding” conference, an improved “Showcase” event series for seed stage startups, and a launch of the Founder Institute in Seattle.

The Future of Funding: Feb 18, 2010, San Mateo, CA
– http://www.futureoffunding.com
– Members of TheFunded have 25 half price tickets to this intimate conference for top limited partners, leading venture capitalists, and entrepreneurs. Help shape the future of funding with the best minds in the industry.

Founder Showcase: Jan 14, 2010, Mountain View, CA
– http://foundershowcase.eventbrite.com
– Sign-up to pitch your company, meet your peers, talk to the media, andinteract with top-rated investors in this exciting Silicon Valley evening. Pitch tables are sold at cost, $350 each, and just a half dozen remain.

Seattle Founder Institute Informational Event: Nov 2, 2009 Seattle, WA
– http://institute-seattle.eventbrite.com
– Learn about the Founder Institute in this exciting evening at the University of Washington. There may even be a few special guests…

FOUNDER INSTITUTE APPLICATIONS DUE
————————————————————
If you know an entrepreneur that can benefit from experienced mentors helping their startup, then please invite them to apply to the Founder Institute. The San Diego, Washington DC, and Seattle semesters have applications due soon.

– San Diego Applications Due: Oct 27, 2009 (that’s now!)
– http://www.founderinstitute.com/apply/2

– Washington DC Applications Due: Nov 24, 2009
– http://www.founderinstitute.com/apply/4

– Seattle Applications Due: Nov 27, 2009
– http://www.founderinstitute.com/apply/5

SURVEY RESULTS
————————————————————
Over 300 Members filled out a recent survey. 81.7% are CEOs, just 29.1% are running their first startup, and 49.3% are on the West Coast of the US. Help TheFunded by filling out the nine question survey at http://bit.ly/1RpqX1. Survey results are below:

1. What is your role?
—————
81.7%  -  CEO
10.8%  -  CFO, CTO, COO
05.7%  -  Senior Executive
01.8%  -  Other

2. What best describes your experience with start-ups?
—————
29.1%  -  This is my first startup
23.7%  -  This is my second startup
23.0%  -  I have run multiple startups
12.2%  -  This is my first fundraising
11.9%  -  I have had multiple successes

3. What industry is your company in?
—————
16.9%  -  Software / B2B
14.7%  -  Internet / B2C
08.3%  -  BioTech / Health
07.9%  -  Social Networking / Community
07.9%  -  Other
07.6%  -  Digital Media / Content
06.8%  -  CleanTech / Energy
05.0%  -  Advertising
05.0%  -  Financial Services
05.0%  -  Games / Entertainment
04.0%  -  Mobile / Wireless
03.2%  -  Hardware / Electronics
02.9%  -  Communications / Networking
01.8%  -  Ecommerce / Retail
01.8%  -  Outsourcing / Services
01.1%  -  Security

4. What is the primary location of your company?
—————
49.3%  -  US West
25.2%  -  US East
12.2%  -  US Central
07.2%  -  Europe
03.2%  -  Asia / Pacific
01.8%  -  Canada
01.1%  -  Middle East / Africa
00.0%  -  South America

5. Are you currently fundraising or about to start fundraising within the next 3 months?
—————
25.4%  -  Not Fundraising
35.8%  -  Raising Angel
26.5%  -  Raising Series A
07.2%  -  Raising Series B
03.7%  -  Raising Series C or Later
01.4%  -  Raising Early-stage Debt

6. If you are fundraising, how much money are you looking to raise?
—————
01.4%  -   $10 MM US

7. How would you describe the profitability of your company?
—————
53.4%  -  Pre-revenue
13.4%  -  Unprofitable
15.9%  -  Almost Break Even
06.1%  -  Break Even
09.0%  -  Profitable
02.2%  -  Highly Profitable