Image source: Flickr/money in jar
I walk into the Cambridge office of General Catalyst, located in a 4th floor office building adjacent to the Charles hotel. The space is warm and well-lit, with modern furnishings and polished hardwood floors. Chatter floats from nearby conference rooms as smartly-dressed partners wander in and out of the lobby. It’s business as usual on Monday afternoons: founders to meet, deals to source, due diligence to be done.
Peter Boyce II ‘13 soon greets me with a charismatic smile. An investor at General Catalyst and former resident of Mather House, Peter is instantly recognizable by his black-rimmed glasses, signature mane of dreadlocks, and easy-going persona. A natural conversationalist, he possesses a champagne-like buoyancy that instantly puts one at ease. He apologizes for getting pulled into a partner meeting earlier: “Mondays are the busiest days for VC firms,” he explains, “but I’m usually pretty good about making time for people.”
Peter is an optimist. As he talks about the new wave of millennial needs and the role that software might play in those experiences, he weaves together a picture of what the future might look like a decade down the line. “The gap between finding an opportunity to create something, and being able to do that, is just collapsing,” he explains. “I think that this is going to dramatically change the opportunities, especially for folks in universities.”
A Billion Dollar Check by Any Other Name
We live in a world of billion-dollar valuations. The most valuable private startups in the world—known as “unicorns” in tech parlance—include household names like Spotify, Dropbox, Pinterest, Uber, and Airbnb. In 2014, a 23-year-old Stanford dropout and CEO of a popular photo messaging app turned down Facebook’s $3 billion offer to buy his startup. Today, SnapChat is valued at $16 billion—higher than the GDP of Iceland.
Stories like these are so remarkable that they sound like fairy tales. Once-mythical companies now surround us on all sides, their college-age founders ascending to fame and fortune on the backs of unicorns. Using the spell of technology, they’ve allowed us to accomplish anything we want with the touch of a button. In order to scale the magic, however, they need support from the modern-day Wizards of Oz: the venture capitalists.
Venture capitalists are professional investors who understand the intricacies of financing and building startups. In exchange for assuming the high risk that comes with investing in startups, they receive a significant share of equity and a stake in the future direction of the company. Because VCs expect a high return on their investment, they will often work with the company for five to 10 years before any money is repaid. At the end of the investment, they hope to sell their shares of the company for at least 10 times more than they initially invested.
But all that glitters is not gold. While venture financing can present an alluring option for founders, “Money is the wrong motivation for doing a startup,” explains entrepreneur, social investor and Cabot House Co-Master Stephanie Khurana. Khurana maintains that the real value of a startup lies not in the investment itself, but in the vision behind it, a sentiment shared by venture capitalist Michael Skok. “Great entrepreneurs are not thinking about funding; they’re thinking about creating value,” Skok notes to the HPR. “They don’t get themselves confused with the car and the fuel that makes it run.”
The typical seed round of venture funding ranges between a few hundred thousand dollars to a few million. Because of the substantial numbers involved and expectations of exponential growth, funding is only appropriate for innovative startups with demonstrated traction that have exhausted all other available resources. Within the Harvard startup ecosystem, there are many options for bootstrapping and funding less substantial capital needs, including business competitions with prize money and “pre-seed” rounds hovering around $20,000.
After all, VC money comes with strings, and sometimes the smartest approach to funding is the most thoughtful one.
Minimally Viable Product
In today’s day and age, two friends studying computer science could conceivably incorporate a software company in their dorm room with minimal overhead cost. Thanks to advances in technology and the widespread availability of online resources, companies are becoming easier and less expensive to found. A quick Google search will lead you to website templates, online platforms to find designers and developers, invoice generators, free legal documents, website analytics, email management software, and courses and e-books to teach you how to do it all.
Moreover, there are a multitude of free resources available within the Harvard community to help student entrepreneurs. These include co-working spaces such as the Harvard Innovation Lab, competitions such as the President’s Challenge and the Harvard College Innovation Challenge (which offer prizes that range from $1,000 to $70,000), classes in entrepreneurship and computer science, access to a network of Harvard alumni working in technology, and a lenient “time off” policy in case students want to temporarily drop out of school to work on a project.
Yet in spite of this lowered barrier of entry for entrepreneurship, a basic level of funding is often necessary for students to keep working on an idea over the summer. “If you have the opportunity to intern at Facebook, [and you] tell your parents that you’re not going to do that because you want to work on an idea—chances are, they’re probably going to want you to live in an apartment over the summer, to have food to eat,” explains Boyce. “That’s the role of capital today. It’s being able to live while you’re building an idea.”
A need arose for “pre-seed funding,” in cases in which founders needed a few thousand dollars to pay for capital expenses that were too large to pay out of pocket, but too small to necessitate a formal seed round. As a student at Harvard, Boyce founded Rough Draft Ventures—a student-led venture branch of General Catalyst—to address this need. A similar student-led venture firm known as Dorm Room Fund was created and backed by First Round Capital.
While there are minor differences between Rough Draft Ventures and Dorm Room Fund, the two funds are very similar in nature. Both are comprised of student partners who source deals from talented entrepreneurs on campus. They do this by screening applications for funding, inviting the best student teams to pitch their ideas in person, then voting on which startups to fund. Both are financed by their parent firms: General Catalyst and First Round Capital, respectively. And both offer around $20,000 in pre-seed funding to startups in the form of uncapped convertible notes, which translate into equity during a future financing round.
“We have the friendliest term sheet an entrepreneur is going to get,” explains Lisa Wang ’16, a student partner at Rough Draft. “I think giving students a little bit of money to get off the ground makes a big difference.” Karine Hsu ’16 of Dorm Room Fund adds that the biggest advantage is that the student partners of these firms are typically younger, more accessible and easier to approach in person than venture capitalists, whose schedules are often packed. “It’s cool because we’re all students at the end of the day,” says Hsu. “We’re all here to learn together, and we can have a conversation over dinner.”
Ultimately, pre-seed investments are a win-win on both sides. Whether or not the student portfolio companies succeed or fail, the investments are significant enough to encourage their peers to continue with entrepreneurship, yet small enough to minimize risk to the firm. Moreover, venture capital firms want to establish relationships with talented young founders from Harvard who become career entrepreneurs later in life. What better way to find the next Mark Zuckerberg than by hiring students—who are intimately familiar with the who’s who on their campuses—to serve as talent scouts?
Gaining Traction
Because the majority of early-stage ideas don’t gain enough traction to necessitate a formal round of funding, college is more often a valuable learning experience for future founders than a launching pad for the next Facebook. Exceptional student startups are rare by definition—they require hard work and incredible diligence to sustain, and they need a compelling and timely reason to motivate investors and consumers around their product.
They do, however, exist.
Scott Xiao ’19 and Alexander Wendland ‘19 are the co-founders of Luminopia, a mobile application that combines hardware and virtual reality to treat lazy eye in children. Although lazy eye affects more than 5% of the population, the patch is the only effective treatment that currently exists. “We saw that there was a lot of pretty solid research showing that virtual reality could treat lazy eye, but there was no one bringing it to market,” explains Xiao. He and Wendland had met during Visitas, along with a third co-founder, Dean Travers ’19, who is currently taking a semester off to work on Luminopia.
Unlike software startups, biotechnology startups are heavily capital intensive. To test out their idea, Luminopia needed to run a clinical trial, which costs “between $150,000—$250,000,” according to Xiao, who adds that they were fortunate enough to raise enough seed money from family and friends. Wendland says that they are hesitant to raise capital at the early stages because “prior to a clinical trial, it would have required too much equity,” but eventually they may need to raise a round of VC funding to cover 3-4 more clinical trials before market expansion.
Entrepreneurial blood runs in the family. Scott’s older sister Grace Xiao ‘17 was named a 2016 Thiel fellow for creating Kynplex, an online life sciences platform that allows scientists to find and connect with scientific companies, labs, and investors. Kynplex co-founder Raul Jordan ’17 explains that he and Grace were initially looking for labs to work at, and discovered in the process that “scientific information is scattered and virtually nonexistent on the Internet.” Having collectively raised $25,000 from Rough Draft Ventures and $100,000 from the Thiel fellowship, Jordan plans to take time off in fall 2016 to join Grace, who has already left school to build out their startup. According to Jordan, “We realized that this is our creation, this is what we love, and we’re not going to give this up that easily.”
High Risk, High Return
There are benefits to raising venture funding that extend beyond just taking a check. According to Ben Pleat ’17, Vice President of Harvard Ventures, VC firms “give you the name, they give you the money, but they also give you the network, feedback, and their portfolio of other companies that they work with…it’s a very strategic thing because it puts you in a network of a company that wants you to succeed, go public, cash out.”
These benefits come at a cost. A significant portion of equity is exchanged for funding, especially at the early stages of a startup. Founders start with 100 percent ownership, which is typically diluted by 10-50 percent through each round of investment. Wendland notes, “as soon as you get funding, you’ve giving up control.” According to Khurana, entrepreneurs need to be thoughtful about the kind of business they’re building, honest about whether VC money is truly necessary, and skilled at holding their own in negotiations. “Chances are, if it’s only a good idea, you’re not going to keep a lot of equity,” she says.
Money also changes the nature of the work. Once you raise funding for your startup, the stakes are higher, the pressures are intensified, and your investors are expecting a 10x return. “Before funding, you’re a team of three undergraduates working on a cool project,” says Pleat. “After funding, you’re a team of three undergraduates playing with other people’s money.” Khurana advises entrepreneurs to take the process at their own pace—to build a quality business on their own timeframe. “[VC’s] are going to want to see a rocket ship. When you take that money, they’re going to want to see the rocket ship fly.”
According to Skok, the biggest risk of entrepreneurship is not monetary in nature. Because entrepreneurs are inherently risk-takers with their life, they’re making the most valuable investment of all—their time—and the VC is essentially investing behind that. “I can’t get my time back, but I can get my money back. Good entrepreneurs understand that very well, and they’re very thoughtful about how they spend their time.”