Archive for July, 2008

VCs/Angels don’t do convertible debt

Wednesday, July 30th, 2008

Excellent articles on the topic:

Angels: Don’t Use Convertible Debt to Fund Startup Ventures

5 Reasons Convertible Debt Sucks

David Rose’s Angelsoft Blog lays out the reasons, along with some exceptions.

Here are some of the key points:

  • The primary reason, of course, is economic: the angel is investing at an earlier, riskier stage and therefore should expect a higher return than the VC, who is coming in when some of the risk has been removed, and after the entrepreneur has made the company more valuable using the angel’s money. For the angel to wait until the next round to value the company results in exactly the opposite: he or she takes the early stage risk and ends up with later stage valuation: a lose/lose proposition!
  • From the side of the entrepreneur, doing a convertible debt round correctly is complicated, creates a perverse incentive for the angel investor to work against the company, and ultimately doesn’t make a big difference for the entrepreneur.
  • Most of the time, the founder is in a much better situation to negotiate favorable (or reasonable) terms with friendly angel investors with professional VCs My recommendation is to use the opportunity to negotiate favorable terms with angel investors and these will likely become precedent for future rounds.
  • The biggest problem with convertible debt is that it aligns the interest of your angel investors with future VC investors and against you! Because the debt converts into equity at a price equal to or slightly discounted from what the VCs pay, the lower the price the more the angel investors will own. And often times, the angel investors will have the relationships and connections to VCs (and hence know them better than you do) so it is in your interest to get your angels on your side of the table.

    • One final comment against using convertible debt for angel rounds: Convertible debt creates misalignment between entrepreneurs and their angel bridge investors. Angels would prefer to see VCs invest at a lower valuation as the angels convert their bridge debt to equity (increasing the angels’ ownership fraction) while entrepreneurs seek VC investment at a higher valuation (maintaining more ownership for the entrepreneurs). Under these circumstances, angels may be less motivated to undertake activities that could increase valuation prior to the subsequent funding. Misalignment of entrepreneurs and investors is simply a bad practice.

Habit forming

Wednesday, July 30th, 2008

Article in NYtimes about Habit forming, which talks about using availability (with vividness) & representativeness bias (and mindless choosing!) to create habit formation to reduce the spread of diseases.

Warning: Habits May Be Good for You

Somewhat similar to my earlier post on “The Checklist”

Diseases and disorders caused by dirty hands — like diarrhea — kill a child somewhere in the world about every 15 seconds, and about half those deaths could be prevented with the regular use of soap, studies indicate.

But getting people into a soap habit, it turns out, is surprisingly hard.

“There are fundamental public health problems, like hand washing with soap, that remain killers only because we can’t figure out how to change people’s habits,” Dr. Curtis said. “We wanted to learn from private industry how to create new behaviors that happen automatically.”

If you look hard enough, you’ll find that many of the products we use every day — chewing gums, skin moisturizers, disinfecting wipes, air fresheners, water purifiers, health snacks, antiperspirants, colognes, teeth whiteners, fabric softeners, vitamins — are results of manufactured habits. A century ago, few people regularly brushed their teeth multiple times a day. Today, because of canny advertising and public health campaigns, many Americans habitually give their pearly whites a cavity-preventing scrub twice a day, often with Colgate, Crest or one of the other brands advertising that no morning is complete without a minty-fresh mouth.

At about the same time, the company’s staff psychologists were beginning to extend their understanding of how habits are formed.

“For most of our history, we’ve sold newer and better products for habits that already existed,” said Dr. Berning, the P.& G. psychologist. “But about a decade ago, we realized we needed to create new products. So we began thinking about how to create habits for products that had never existed before.”

Those and other studies revealed that as much as 45 percent of what we do every day is habitual — that is, performed almost without thinking in the same location or at the same time each day, usually because of subtle cues.

For example, the urge to check e-mail or to grab a cookie is likely a habit with a specific prompt. Researchers found that most cues fall into four broad categories: a specific location or time of day, a certain series of actions, particular moods, or the company of specific people. The e-mail urge, for instance, probably occurs after you’ve finished reading a document or completed a certain kind of task. The cookie grab probably occurs when you’re walking out of the cafeteria, or feeling sluggish or blue.

“Habits are formed when the memory associates specific actions with specific places or moods,” said Dr. Wood, a professor of psychology and neuroscience at Duke. “If you regularly eat chips while sitting on the couch, after a while, seeing the couch will automatically prompt you to reach for the Doritos. These associations are sometimes so strong that you have to replace the couch with a wooden chair for a diet to succeed.”

Dozens of other companies have also redesigned advertising campaigns around habitual cues. Beer commercials, once filled with busty women in ill-fitting tops, are now more likely to feature groups of buddies, because research shows that groups of friends are one of the strongest habit cues. Candy bar companies, through commercials, have tied their products to low-energy cues, transforming what was once a dessert into a pick-me-up for cubicle dwellers.

Almost half of its people were accustomed to washing their hands with water after using the restroom or before eating. And local markets were filled with cheap, colorful soap bars. But only about 4 percent of Ghanaians used soap as part of their post-restroom hand-washing regime, studies showed.

“We could talk about germs until we were blue in the face, and it didn’t change behaviors,” Dr. Curtis said. So she and her colleagues asked Unilever for advice in designing survey techniques that ultimately studied hundreds of mothers and their children.

They discovered that previous health campaigns had failed because mothers often didn’t see symptoms like diarrhea as abnormal, but instead viewed them as a normal aspect of childhood.

However, the studies also revealed an interesting paradox: Ghanaians used soap when they felt that their hands were dirty — after cooking with grease, for example, or after traveling into the city. This hand-washing habit, studies showed, was prompted by feelings of disgust. And surveys also showed that parents felt deep concerns about exposing their children to anything disgusting.

SO the trick, Dr. Curtis and her colleagues realized, was to create a habit wherein people felt a sense of disgust that was cued by the toilet. That queasiness, in turn, could become a cue for soap.

A sense of bathroom disgust may seem natural, but in many places toilets are a symbol of cleanliness because they replaced pit latrines. So Dr. Curtis’s group had to create commercials that taught viewers to feel a habitual sense of unseemliness surrounding toilet use.

Their solution was ads showing mothers and children walking out of bathrooms with a glowing purple pigment on their hands that contaminated everything they touched.

The commercials, which began running in 2003, didn’t really sell soap use. Rather, they sold disgust. Soap was almost an afterthought — in one 55-second television commercial, actual soapy hand washing was shown only for 4 seconds. But the message was clear: The toilet cues worries of contamination, and that disgust, in turn, cues soap.

Investing + Entertainment

Saturday, July 5th, 2008

This is just awesome

behavior-gap.jpg

As seen on nudges blog and indexed blog.