Portland Startup Tax – Bad Investor Behavior

I want to wrap up the discussion about the Portland “startup tax” with a focus on Portland investors. My last post outlined mistakes Portland entrepreneurs often make. Now I want to focus on bad investor behavior.

Most investors I’ve met in Portland have a horror story about getting stuck in a company that ends up going nowhere. Or, being in a growing company but getting washed out on a later round.  This has lead to a number of investor behaviors that often prevent good companies from getting access to growth capital.

Early stage Silicon Valley investors have developed entrepreneurial friendly investing behaviors that coupled with lean startup methodologies have proved extremely successful. Many of Portland’s bad investment habits hobble Portland entrepreneurs and add to the Portland startup tax. Here are a few practices Portland investors need to adopt to lower the tax.

Quick Diligence

Too many Portland investors see virtue in time consuming comprehensive diligence. Traditional business diligence looses its relevance with nimble, agile and lean early stage startups. Scouring existing financials and forecasts has limited relevance in a lean startup that depends on speed and agility. Plus the distraction to the founding team is costly.

Investors should invest in areas in which they have knowledge and are comfortable. It’s most productive to limit early diligence to the market space and the team. Most oving quickly and helping founders focus on the business.

Fund Fast

Many Portland investors are drawn to contingent funding. Forcing entrepreneurs to find additional funds is too often viewed as a test that lowers risk. I’ve seen several instances when entrepreneurs tie themselves up for months trying to find additional investment dollars so they can take down contingent investments. Rather than test, this can kill a company by exhausting entrepreneurs and delaying execution. If a company needs more money that an investor can supply than the investors should do their share to syndicate the deal.

Set Reasonable Valuations and Caps

Portland investors often force low valuations because they can. But, this can be counter-productive. Too much early low valuation money crowds a cap table scaring off later stage capital. Later rounds that leave the founders with too little ownership increase the execution risk (by demotivating and distracting the founders), limiting the upside for everyone. In Portland, this often drives early sales of companies even when they have tremendous growth potential.

Forcing low caps on notes is the same as setting too low a valuation. The idea of a note is to avoid pricing a round before there’s enough business to value. Investors should either use a note as intended – a quick lightweight way to bridge a company forward (with discounts and interest as the incentive). Or, they should price a Series Seed round. The cap should merely protect an investor from not appropriately participating in extraordinary appreciation. A note with a low cap can either telegraph a low valuation for a subsequent round or scare off investors with a inappropriate differential in share price.

Keep Terms Simple

Funding terms only get worse in subsequent rounds. Early multiples of participation, ratchets, anti-dilution ratchets and other onerous terms rarely ever go away. And although they may seem to favor investors, they can encumber companies and compromise the ability to raise needed capital and restrict strategic options. Early investors are most successful when they align their interests with the entrepreneur’s.

Portland’s seed and angel investors need to better partner with entrepreneurs. Putting a company in a position to find the best future investors optimizes returns for everyone. All behavior that slows a company, or attempts to protect the early investor from the entrepreneur essentially increases the Portland startup tax and limits everyone’s upside.

The Portland Startup Tax – Lack of Local Capital

Last week I presented at Immix Law Group’s PowerUp Event on fund raising. It gave me the opportunity to discuss the Portland “startup tax” that local entrepreneurs pay when raising capital.

It’s no secret that raising capital in Portland is harder than in the Silicon Valley or even in Seattle. Portland has so little native investment capital. Check any credible source, like the NVCA Year Book, and you’ll see that Oregon has double digit millions under professional management. These numbers barely register on the same graph as Washington, which has single digit billions. You can’t even get Portland’s amounts to show up on a graph when compared to California’s nearly triple digit billions, even with a log scale; California has over 4 orders of magnitude more capital under management relative to Oregon.

This means Portland entrepreneurs have to raise money from elsewhere and pay a tax in the form of: time, valuation, and lower levels of support. Fund raising outside the area takes more effort than fund raising down the street. And because it’s harder to get investor attention, fewer investors result in lower valuations. This means Portland companies give away more company for less money.

Plus once they get VC money, Portland entrepreneurs receive less benefit than companies local to a venture group’s networks and support. CEOs outside Silicon Valley constantly bitch about VCs only investing in companies in easy driving distance. But this is a real practical consideration. Not only does it require less partner time, but support in the form of mentoring, introductions, and educational sessions are higher return with tight nit groups of local companies. Portland entrepreneurs get fewer opportunities for help at a higher cost than their Silicon Valley based sister companies in the same VC portfolios.

This part of the startup tax will never entirely go away. But it will get better as Portland’s many successes attract more capital at a lower cost, and Portland companies represent a higher density in VC portfolios.

I think the more interesting contributor to the startup tax is our own bad behavior. In my next blog posts I’ll discuss how we need to get out of our own way. Our own bad behavior, by both Portland entrepreneurs and investors, contribute significantly to the tax we pay.