Crowdfunding and the Bad Dancer

Dance contests usually follow a predictable pattern. Bad dancers are eliminated early in the competition. Good dancers progress through the rounds. Eventually one of the best pairs wins.

But something funny on the way to the forum happens when the crowd vote is counted. Bad but popular dancers can reach the finals at the expense of much better dancers who, but for the crowd, would have progressed.


Crowd funding websites are the modern day equivalent of this new breed of reality TV shows. Very often the business that gets funded is not the best business, but merely the most popular business.


This, is where the parellel ends, however. The success of the bad but popular dancer is certainly not someting fans of good dancing approve of, but at the end of the day TV is entertainment. Realty TV is in some ways more of an illusion than a reality anyhow. Who wins and who loses really isn't so important.


For the past several weeks Czech TV audiences have been wintessing a battle between style and substance.  At the moment, style seems to be winning, much to the dismay of purist dance fans.
The unfolding drama can be seen on Saturday nights when Czech TV airs the popular series "StarDance."

For those of you who may be unfamiliar with this show, StarDance is based on a British TV series called Dancing with the Stars.   The show pairs a number of well known celebrities with professional ballroom dancers. Each week the dancers compete by performing one or more choreographed routines that follow the prearranged theme for that particular week. The dancers are then scored by a panel of judges.


Audience participation plays a pivotal role. Viewers are given a certain amount of time to place votes for their favourite dancers, either by telephone or (in some countries) online. The show format is highly popular and has been licensed to over 42 territories over the last ten years.

 The protaganist in this drama is a comedian named Lukas Pavlasek.  He is perhaps best known for his appearances in a series of commericals promoting cellular communications provider T-Mobile.  In addition to his regular appearances as a stand-up comedian he's had numerous film and stage credits and he is a prolific writer and song lyricist.















By almost any measurable standard Pavlasek is a poor dancer.  My colleague Jitka Rombova calls him the "anti-talent."  He's not graceful by any stretch of the imagination and he's often out of rythm.  Out of a possible score of 40 points he consistently gets below 20.

Yet what Pavlasek lacks in substance, he makes up for with unbridled character, enthusiasm for dance and his comedic wit.  For this reason up to now he has defied conventional contest logic.  On the strength of his scores he would have been gone several episodes ago.  But week after week he's received enough votes from the crowd to progress to the next round. He's now among the final 4 contestants.

Catering to the popular will of the crowd is profitable.  TV advertising revenues are driven in large part by the number of people watching.  Viewers like Pavlasek, so they vote for him and many viewers look forward to his upcoming performance the following week.  He's what we in the investment world call a "disruptive business model" - one that challenges the status quo and changes the way manner shape and form that products and services are delivered.

The duel between style and substance certainly makes for an interesting program.  All in all, everyone wins.  TV producers get advertising revenues and viewers get an engaging entertainment experience.

But when it comes to investing popular will of the crowd the dynamic of mutual success between supplier and customer breaks down. Crowdfunding websites dangle in front of investors the prospect of investment rewards and the satisfaction that comes from helping an entrpreneur get started.  The companies raising money couple that appeal with presentations that are long on style and often short on substance.

Dancing is a transparent business.  You see the presentation and you can instantly tell if the product or service is good or bad.  Predicting who will win the contest usually isn't so hard, particularly as the field narrows.  Pavlasek is surely the exception rather than the rule.

This is not true with startup and early stage companies.  Presentation is the surfacce.  It is at best only the cover on the book.  You can only judge the real quality by drilling down into the detail.  What drives the success of a crowdfuning campaign is often not the detail of the company, but the packaging and the presentation, combined with the fact that people are naturally more willing to risk a small sum of money for the sport of it than to drill down into the detail and risk a larger sum of money.

The successful crowd funding campaign ends with money in the company's treasury and profits for the website provider.  I've yet to see hard evidence that investors benefit, however. In the investment business when form takes a back seat to substance investors usually wind up losing their money.

The math I see is that at least half of startup and early stage companies fail within five years. An investor who gets an average return of 25% annum will see $100 turn into $244 in five years.  If, however, half the companies fail the other half of the companies much produce each a return of 4X in order for investors to clear the 25% hurdle.

My advice is as follows: Investors should approach crowd funded investments with a healthy dose of scepticism.  Ask questions - lots of them!  Be selective. Select only the companies who you believe really can succeed AND provide the possibility for an exit within five years.

As for our friend Mr. Pavlasek.  I actually think he is improving from week to week, I enjoy his performance and I think the judges have been perhaps a bit too harsh on him in recent weeks.
But my view is that substance and form will win over style.  He'll be well remembered as the guy who almost won StarDance.

My rationale is perhaps naive. The way I figure, the majority of the TV viewers want to see the quality dancer win.  Each week there are fewer good dancers to choose from, so the majority that want to see the good dancer win will finally be able to cheer for the substance and form it desires.

After all, dancing is certainly not the same as crowdfunding.  Is it?

Seeding with Convertible Notes - Watch for Thorns!

I've seen many startup and early stage companies present their idea and ask for funding in the form of convertible notes. This is a particularly common tactic in the US that has not quite found its way to Europe.

Far be it from me to say the emperor has no clothes, but.....guess what! The emperor looks likes scantily clad.

Mind you, that's not to say all convertible notes are bad.  They are not all bad.  All I'm saying here is that I have many more questions than answers.  Call me a frightened old toddy if you like.  But I have several concerns and that's among the reasons why to date Symfonie Angel Ventures has never bought a convertible note.

What's a Convertible Note ?

Those of you who are familiar with the structure can skip this part.  Those you who would like a bit of a primer - read on!

The convertible note is a way of the investor and the entrpreneur saying - "Valuing a startup or an early stage company is a thankless, almost irrelevant task. Rather than haggle over valuation and ownership stake, we'll agree to put that discussion on hold until there is a real business to talk about, which will be when we do a big financing called an A-Round."

So instead of selling equity the company issues a convertible bond.  The terms of the bond are something like the following:  

The bondholder gets a coupon of (for example), 8%.  Maybe this is paid in cash annually, maybe not. Maybe the interest will be paid in cash when the A-Round happens or when the note matures.  Maybe the interest will be paid in the form of shares down the road.  Every convertible note is different, no two are the same and the first question the noteholder should ask is - "when am I supposed to get my interest and how will it be paid."

The convertible note is a bond, so it has a stated maturity - say five years.  By then in theory the A-Round should have happened, supposedly, so its convenient to just assume maturity is not particularly relevant but just some notional fiction to be dealt with down the road.

So the second question the noteholder should ask is - how will this be repaid when maturity comes along?  Am I supposed to assume the business can re-finance the note?  Am I supposed to take it as a given there will be an A-Round and I will never see maturity?  What if the A-Round never happens at all?  What if the company can't repay?  What then?  Are we supposed to have a valuation discussion or am I supposed to assume the business will have failed?

Third element for the convertible note is the definition of an A-Round and what the note converts into.  Well, tough, to say!  Each note is a different animal, each has its own bells and whistles.  Typical I have seen is - "An A-Round is defined as being capital raising of at least $2,000,000.  When that happens the convertible note is converted into shares of the company at the same valuation as the the capital raising.  So for example, $2,000,000 is raised and the company sells shares with a valuation of $10,000,000.   The convertible note is $500,000 so therefore $500,000 converts essentially into a 5% ownership stake.

Often there is a bell on the convertible note called a "Cap."  The "Cap" is designed to ensure the convertible noteholder gets the benefit of the A-Round in the form of a reduced share price - say, for example 50% of the shareprice that is in A-Round.  So when the $10,000,000 valuation  A-Round comes along the convertible noteholder gets shares equivalent to a $5,000,00 valuation, so actually winds up with effectively a 10% stake, using the numbers above.  The bell is supposed to make the investor whistle away with the headline that there is a 50% discount to the A-Round.

The Devil is in the Details

For those of you who read the primer, you can see that I am just beginning to peel the onion on this topic.  For those of you who skipped the primer the bottom line is - this is a terribly thorny garden of roses so before you even consider walking in you'd best think not twice, but five times!

I went to business school at the University of Rochester.  I'm proud of that so I say that as often as I can.  To this day I marvel at the fact that the William E. Simon Graduate Schoold of Business accepted my application and moreover, that eventually, they gave me a merit scholarship. Priscilla Gumina was the admissions officer at the time.  She stayed there for many years after I left, so apparently my admission was not a disaster for Priscilla and certainly not for me!  Thanks again, Priscilla!

I had a professor at the Simone School by the name of Ron Schmidt.  This is where I get to pay tribute to him, which pleases me greatly.  He was undoubtedly among the best professors I had during my graduate and undergraduate training.

Professor Schmidt gave really hard exams!  They required essays for answers.  But in some ways they were easy.  You see, you got 50% credit if you just started your answer by saying "It depends."  The other 50% of the the credit you got by presenting a concise, well thought out answer that explained what it depends on and what the range of outcomes could be.

So - here's the question:  An entrpreneur wants to fund a startup.  An investor wants to invest in a startup. Is a convertible note a good choice for the investment structure?  

The answer is, of course, "It depends."  Now - onto the meat and potatoes.  There are at least five things every entrepreneur and every investor should think about before walking into this supposed garden of eden.  Here they are:

1. The interest rate - is that paid in cash or in kind.  If paid in cash when is it paid?  Annualy?  Monthly?  Quarterly?  At maturity?  Upon conversion into equity?   A cash coupon is nice!  If the company is successful finding other investors or the company starts generating some revenues, or if the company manages to hang around long enough - say really five years, at 8% I stand to get back 40% of my initial capital.  Forgetting the time value of money, there's something to be said about getting back some capital that was placed at serious risk. 

2. The maturity - What happens if the A-Round never happens?  Or what happens if the A-Round happens but not at a threshold valuation to trigger a conversion?  How will the company repay?  Will the company be able to refinance itself?  Or will the company be bankrupt?  What are the noteholder's rights as a creditor?  Is there any security at all is just a lottery ticket?

3. The business prospects - What has to happen for the company to have an A-Round?  What are the milestones and thresholds that need to occur?  What should the company look like in terms of revenue and profits?  Will the company still be loss making when the A-Round comes?  Will the A-Round be one on a long series of capital raisings needed to keep a company afloat while it looks to build moment and traction?  Some companies lose thousands, millions, even hundreds of millions and stay in business a long time and have multibillion dollar IPOS and make fortunes for the early investors.  That's the exception rather than the rule.

Startup City is littered with a pile of companies that received lots of investment only to go down in a ball of flames when there was no more capital to be found or the next great widget came along.

4. The Convertible Valuation - is it reasonable?  Can it be somehow economically and quantitatively justified?  Does the discount to valuation and the time until A-Round comes compensate for the risk?  Does an A-Round represent a real exit opportunity or is just another step to the exit?  When will the exit finally come and what can the return on exit potentially be?

5. Investor Rights - Does the investor owning the convertible have any rights in corporate governance?  What reports will the investor receive?  What say does the investor have in major corporate decisions?  How much more debt can the company take on?  What are the anti-dilution provisions?  Is the company obliged to set aside cash from capital raising, revenues or profits to repay the convertible? Can the entrprener and equity holders get dividends, bonuses and other cash out before repaying the convertible?

The Bottom Line According to Mike

Here's another tribute to Professor Schmidt.  Once he was lecturing about corporate structure and corporatae taxation.  To this day I remember him pounding his fist in the air and stressing the economic reality. I will paraprhase here, the quote might not be exact.

"You don't tax corporations, you tax people.  Someone owns the economic rights in a corporation.  Some derives economic benefits from the corporation.  When you tax the corporation you are taxing people!   Corporate taxation is one of the five greatest idiocies of the twentieth century."

I never asked Professor Schmidt what are the other four idiocies.  Suffice to say, that in my very humble opinion, Convertible Notes for Startups are a good candidate for one of the other four idiocies.  Hopefully they will not come to the shores of Europe anytime soon.  

Stay Tuned!!!

I laid out a fistful of problems.  I have a good friend and colleague named John Vax.   I had the pleasure of working with him for many years and he used to tell me that when he ran the Capital Markets desk at Commerzbank in Prague his staff would come and tell him about problems.  His reply was often (and again, I paraphrase):

"I know there are problems.  That's why I hired you.  I need the solutions, so tell me how you think we should solve the problems."

Having presented the problems with convertibles, the next blog I write will offer solutions.  Real, practical, honest to goodness solutions I will bring!  How's that for service?

Until then - remember - investing money is easy.  Investing takes no talent, takes no guts.  Investing successfully - well, that's a completely different story.

Want more information about my Angel Fund?  Click here!

10 ReasonsWhy We Invested in Venzeo

I often write about criteria angel investors should consider when making an investment.  Recently the Symfonie Angel Fund invested in one of the few companies that fit our criteria - Venzeo.  Time will tell if we were right or wrong with Venzeo and there is much hard work ahead in order for us to make this investment succeed.  I hope my post is helpful to all the other angel investors out there who are considering their next investment. 

1. The product fills a market need.  Any business that uses photos for documentation or evidence can save time and money by using Venzeo.

2. Similar businesses are successful in other markets.  Look at the US.  Fotoin (www.fotoin.com) and pdvconnect.com have emerged and are growing rapidly.

3. It's not all plug 'n play. Venzeo's service is easy to use.  The application downloads easily into many mobile phones.  But once business start to use the service and they realize the benefits, they come back to Venzeo, ask for more devices and ask for customisation to their specific systems and procedures. Customers that integrate a solution into their business are customers that are in for the long haul.

4. Wayra - Venzeo received an investment early on from Wayra, the tech incubator affiliated with Telefonica. Venzeo and Telefonice both come out ahead.  Venzeo developed a relationship with local units of Telefonica to distribute Venzeo service to Telefonica customers.  This partnership has already begun winning customers.

5. Proven demand - Vezneo is winning customers.  The typical customer starts with trial use period.  Once they start to use the service and realise the benefits, they quickly add users to the installation base.  Today's small subscriber becomes tomorrow's key customer.

6. Scaleable  - Adding more users means adding more servers, not building factories or leasing more real estate.  Sales can be outsourced and franchised to re-sellers who are already close to the end customer. When local subidiaries of large international companies share best practices with each other, Venzeo wins additional business.

7. Hard to displace once embedded -  Venzeo's service is not particularly expensive.  Once a customer starts using the service and likes the service, there's no great incentive to switch to another supplier.  If anything, changing suppliers can be painful.  This is why first movers like Dropbox, Facebook and LinkedIn are so successful. Customers like to stay with something that works.

8. Highly fragmented industry - There are only a handful of companies like Venzeo operating and there are hundreds of thousands of companies that can become customers of firms such as Venzeo. Fragmented industries mean there is ample opportunity for new firms like Venzeo to compete and succeed.

9. Not easy to replicate - Developing the application takes  time money and effort.  Venzeo had a small, but dedicated, team of developers working full time for more than a year before it could launch a version of its service.  By learning from customers Venzeo develops value added solutions that enhance it's marketability.

10. The modest investment we make can have a large positive impact on the company.  Venzeo's core solution is developed, tested, proven and operations.   What's needed now is build out of sales and marketing, coupled with value added improvements. The marginal dollar invested today goes quickly to the bottom line, so the company is well positioned to become self sustaining.

Find out more about Venzeo at www.symvest.com/prereg/venzeo. Feel free to contact me directly at  msonenshine@symfoniecapital.com if you have questions or comments.