This is the excerpt from The Smart VC starring Andy Rachleff, a general partner at Benchmark Capital. Needless to say his understanding of what entrepreneurs are facing is very good.

Q. What are your suggestions for the entrepreneur suffering from the old "chicken or the egg" dilemma? Should he attempt to raise seed or first-round financing first to attract key people, or should he attract key people to obtain funding?
A. We're looking for visionaries, not operating execs, at our stage [which is primarily first-round investments]. Too often, entrepreneurs recruit people to fill out the team to try to make a better impression for fund-raising, but then they alter their course to one where the people they recruited aren't relevant. That's one of the key areas of focus of our entrepreneur-in-residence program. We tend to seed and incubate an individual rather than teams of people. That way the individual can spend all of his time aiming the rifle, figuring out exactly what he's going to pursue. Once we lock into what he's going to pursue, then we can go hire the appropriate people. But hiring people and then trying to get financing can be fraught with risk, because if you then ask those people to leave the team, it can lead to some really difficult interpersonal issues. What happens if the person who is no longer relevant played a key role in convincing the visionary to pursue the vision?

PROUD AS A PEACOCK

Q. It sounds like this is a common mistake. It's almost like the entrepreneur is trying to be a peacock showing all of its feathers.
A. It's a common problem. They want to appear to have critical mass. But we don't care. At least for Benchmark, we don't care. What we do care about is that there is an entrepreneur with vision. We revere that individual.

Q. What advice would you give a recent MBA graduate who has had startup ambitions for the past eight years? Should he continue to work for a PC company to gain marketing/product launch experience, or should he join a startup in a marketing capacity to hone his skills for his future self-startup ambitions?
A. Nothing attracts a venture capitalist like success. So the single most frequent piece of advice that I give people is to become successful, because you get more credit than you deserve for working for a successful company and less credit than you deserve for working for an unsuccessful company. So if you ultimately want to work for a successful startup, you want to get a little success aura around yourself. Keep in mind that the people who make the most money in startups -- by a wide margin -- are the first ten employees and the executives. So ask yourself, "How am I going to get myself into a position to be one of the first ten employees or one of the executives?"

Q. So, it doesn't matter whether you're at a large company or a startup?
A. No. The issue is, Did they come out of success? Think about it. Would you think someone was attractive if they stuck around a sinking ship? No, you'd think they didn't have options.
 

ANGELS WITH DIRTY FACES

Q. What critical advice would you give to young companies generating significant interest among organized Silicon Valley angel investor groups?
What should the startup team absolutely avoid doing in these early rounds if it still wants to be attractive to a mainline firm like Benchmark?
A. If you are pursuing a big idea, don't bother with angels. It's a waste of time. [Appearing soon in The Smart VC: an angel investor. -Ed.] As good as angels might be, they're doing it as a hobby, not a profession. If you're going after a big idea, and Internet time is critical, you should have professional venture capital. If you must have angel money, price it as debt with warrants. In other words, don't price the angel round. Take the money as a bridge that can be converted into preferred A stock at the same price as the venture capitalists', and then give the angel 50 percent warrant coverage as a sweetener for taking on the added risk.

Q. Why is this so important to the entrepreneur?
A. Because if you price the round, then the angel expects to get a significant markup on it, and you end up pricing yourself at a level that we don't want to invest in. This takes away the sting but still rewards the angel for taking on more risk by getting in earlier. An angel is more likely to pay a higher price than we will. So they get in and pay a $6 million valuation, then the company raises $2 million, so it's $8 million post money. In the next round, they may want to do it at $20 million pre [money], but typically they don't make a lot of progress on that angel money, so for a company at that stage of development, we might be willing to pay $6 [million] or $8 [million] pre. But the angel is arguing, "We deserve a return on our money." This way, we can invest at $8 [million], and the angel investor invests at $8 [million] with the right to buy 50 percent as much stock as they already have at the same price in the future. Unlike other venture firms, we prefer not to have angel firms in before us. If we do, we'd rather have it in this structure. I'm on the board of Cacheflow (Nasdaq: CFLO), and that's what they did. [Cacheflow went public with a bang on November 19, putting it in sixth place in the Redherring.com IPO Hall of Fame.]
 

Source: By Lawrence Aragon, Editor, Redherring.com, December 04, 1999