Seed Capital From Angel Investors: Brian Garrett, Co-Founder And Managing Director, Crosscut Ventures (Part 10)

By guest authors Irina Patterson and Candice Arnold

Irina: What is your preferred type of investment?

Brian: It’s preferred shares in a traditional equity financing. If we do a note, it’s usually a convertible piece of debt with a cap. Going back to that original comment, we don’t like our money being used to drive the value of the business up and then let it get converted at whatever price the new investors come in at; that’s not the proper sort of reward for the risk we took alongside that entrepreneur.

So, most of our deals are preferred equity financing, and you can now get those done for $25,000 or $35,000. In certain circumstances, we’ve done convertible [note] done that’s capped so we know that the price with which our money will get converted won’t be any higher than x.

Irina: Have you had any exits yet?

Brian: No. In fund one, it’s been only two years. Most of those companies need some more maturity. My partner and I have been investing for 10 years. We have multiple exits from our past investments in our days at Palomar and before that, so we have a long track record of investing and returning capital.

This first fund for Crosscut was raised in one of the worst times, August 2008. We closed on the capital, we got to work and we’ve been putting together this portfolio.

A lot of the companies are making great progress. Several are in conversations about acquisition, but nothing has been realized yet. It would be incredible for any of these companies to have hit a maturity level that drove these acquisitions at levels that we’d be excited about.

Irina: In your personal past, what’s been your biggest investment success?

Brian: I was involved in a company called DATAllegro that sold to Microsoft for a very large figure. I was involved in the investment for Lombardi Software that sold to IBM. My partner Rick was an investor in MicroMuse and several other pre-bubble companies that exited for very nice multiples. So, we’ve invested probably $130 million together, and we’ve generated returns far above that over the past 10 years.

Irina: What do you think is the most important thing that entrepreneurs could do to improve their chances of success?

Brian: I’d say, in this current environment, to increase your chances of success raising capital, it’s do more with less. It’s get as far as you can on your own dime, on friends and family money, and so on, before you go out and raise outside capital. That will lead to better valuations for you, fewer dilutions for you.

I would also argue that not every company needs to, nor should want to, raise venture financing. It is not a cheap form of capital. There are plenty of businesses out there where you can bootstrap it on credit cards and some friends and family money and get to critical mass with profits and growth.

Not every business needs significant capital to hit milestones and be successful. So, think about that long and hard before you try to raise the capital. If you do, I think your chances of success increase by having hit some really meaningful milestones on your own dime.

After they’ve raised the capital, then that’s a much tougher question in terms of how to increase their chances of success.

That’s unique to every business opportunity, every market segment, and so on. It’s tough out there. There’s a lot of competition. I think the beauty of what’s happened to the venture capital industry in the past four years with the shrinking of it is that there’ll be fewer venture-backed companies in any given segment, less over funding of a given idea; therefore, the best entrepreneurs with the best ideas will rise to the top and will create great successes.

Irina: That’s excellent advice coming from a venture capitalist that venture funding is not absolutely necessary. I like that.

Brian: Sure. I’m not trying to talk people out of it, but I do acknowledge that there have been many, many great successes that didn’t have venture capital financing behind them.

At the end of the day, we are salesmen for money, but I think being candid with an entrepreneur about our perspective on their opportunity, our interest, our needs as investors [is important]. They need to understand everything. Once you get into a deal with an entrepreneur, a lot of these deals last longer than marriages.

This segment is part 10 in the series : Seed Capital From Angel Investors: Brian Garrett, Co-Founder And Managing Director, Crosscut Ventures
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