I recently got a small dividend check from a venture-funded startup.

This was unusual:  why is a startup giving out precious cash to stockholders?  It seems counter-intuitive;  the company should be (re) investing any cash into growth.

But in some cases, this move can address a real problem.  I’ve written before about the risk problems when you pair entrepreneurs (e.g. all eggs in one basket) with VCs (e.g. a whole portfolio of eggs).  For entrepreneurs with no previous exit, a startup with real traction creates a wealth concentration problem.  With 95% of her net worth tied up in the startup, the entrepreneur starts to get conservative (as she should).

This scenario is certainly a good problem to have, but is far from hypothetical:  there’s a recent unnamed but well-known startup exit, where the widely-held view is that the CEO pushed to sell out too early.  A major factor (insiders say), is the 8-figure personal outcome for the CEO — he didn’t want to risk losing that.

Unfortunately, many investors let emotions dominate, and won’t let anyone make money before they do.  A rational investor will understand founder wealth concentration.  If the company is doing well, is solidly capitalized and is cash-flow positive, it’s a reasonable idea to give entrepreneurs some diversification and re-align interests for a “go long” play.

If you want to know more about profitable selling in business read Sellers Playbook.

I just finished up stock paperwork for a new venture-funded startup. Each time I do this, I’m shocked by the complexity in stock terms. I’ve written before about the general problem of venture capital overhead, but there’s a slightly different issue here.

I think the core problem is a kind of “feature creep”. Preferred stock terms are designed to protect investors in downside scenarios. Everything some new bad thing happens, the lawyers come up with a new term that protects investors the next time around. Examples:

• Had a company go on forever (e.g. not go public, not shut down — no closure)? Let’s put in redemption rights.
• Had a co-investor bail in a later round? Let’s put in pay-to-play so they get spanked (converted to common) for not participating.
• Had an entrepreneur buried in preference resisted an exit where the commons make nothing? Let’s put in drag-along rights.
• … etc …

Stuff gets added, but never taken out. Trying to get rid of it gets responses like, “we always do things this way”.

Unfortunately, I think, entrepreneurs have to get educated, get good representation, and live with it. Two excellent resources: Brad Feld’s series on term-sheet terms, and the National Venture Capital Association’s model financing documents.

One of the problems in venture capital today is a fundamental impedance mismatch: fund sizes remain large, while capital requirements for many Internet/software deals are shrinking.

You don’t need much money anymore for many software ideas: the software stack is free, servers can be rented for $50-$100/month, and there’s cheap labor offshore. There are a lot of ideas that can be vetted for $100k to $1m.

At the same time, venture funds have grown and stayed big, driven in part by VC compensation. As I wrote in an earlier post: venture isn’t generating great returns these days, pushing VCs to make their money on fees. The larger the fund, the larger the fees.

The mismatch happens when you do the math: for a $200m fund with 4 partners, each partner needs to invest $50m. If each partner does 1-2 new deals/year, and the fund is committed over 3 years, then each investment has to be a $8-$16m commitment. (That doesn’t mean that Series A needs to be $8m, but it means that the total invested is in that range).

You can see where it is hard for many firms to do $1m investments — it’s just too small. And some of the most interesting stuff is happening “down there”!