VCs on Series A Valuation

I had the pleasure of attending a daylong symposium at Dartmouth College last week, Dartmouth Ventures. One of the panels featured these prominent VCs speaking about “Financing 102- After a Seed Round.”

Ned Hill, Managing Director- Mercury Fund

Steve Bloch, General Partner- Canaan Partners

Liam Donohue, General Partner- .406 Ventures

 

This was a fairly cut and dried panel except a few things stuck out:

On the subject of how to find the right valuation, I was expecting to hear “the market sets the price” and “we look at similar transactions” and the other basic VC valuation tools. However, what I heard was a discussion about “What’s fair?” “How much money the company needs” and “backing into the right ownership.”

Of course, the right ownership is up for debate and the subject of much friction between investors and entrepreneurs. The implied definition of “right” in this case was high enough to provide meaningful incentive for the entrepreneur but also low enough to provide a large stake and significant returns for the venture fund.

The other really interesting part during the discussion of valuation and the preferences that investors get through their Preferred Stock. One VC talked about the idea that “management has an implicit preference” relative to the investors and other stockholders. This refers to the “Liquidation Preference” that virtually all VCs insist on- namely, that they get their money back out before the common shareholders.

The concept of an “implicit preference” (and this is somewhat advanced for 1^st time entrepreneurs) is that in a liquidation or exit scenario, the management team needs to be taken care of. So as much as the VCs rights allow them to get their money first, potentially taking all of the exit price, this doesn’t really happen in practice. The buyer will take care of management, often making them whole, since management is needed to run the company and extract the value for the acquirer. This “implicit preference” of management could trump the actual legal preference that the VC gets through Preferred Stock.

The implication from the VC panel was seemed to be that founders don’t have nearly as much downside as it would seem on paper. And that the VCs felt justified in asking for somewhat lower valuations, and higher ownership positions, as a result.

What do you think?

Financial Plans for early stage investors

This is a follow up to my prior post ‘Do you need a Financial Plan to Raise Seed Capital?’

I had a number of entrepreneurs ask me what I meant when I described investors wanting to see that the entrepreneur understands the levers of their business. Specifically, people have asked about the “levers” of your business. Simply put, the “levers” are the critical factors that make your business run.

In an Internet media or SaaS company, they might be:

• Arrivals (consumers or B2B prospects who land on your web site)

• Conversions (number of people who sign up for your site)

• MAU, DAU (Monthly active users, Daily active users)

• Monetization- How do you (plan to) make money from your users? advertising (CPM, sponsorship), premium subscriptions (% who subscribe, price point). What are the assumptions here? Are they reasonable given other similar businesses?

• Churn- how many users leave the service

• Marketing Costs- how do you get users to know about you? Paid advertising? SEO? Social media? Costs of development? Costs of advertising?

• Sales expense- If you’re a SaaS business, do you plan to use sales people or are you freemium? If you use sales people, what will you pay them? How long will they take to ramp up? What quota will they carry? Will you upsell these customers? David Skok of Matrix Partners has written some great, in-depth blog posts about SaaS scaling here.

There can be a ton of complexity if you allow it. To reiterate a point from the prior post, the point is NOT that you have a complex 5 year financial model. It will certainly be wrong, and investors know this. The point is that you have a handle on the KEY metrics that will allow your business to grow rapidly.

Are alliances part of growth hacking?

Most people familiar with early stage companies understand the concept of “growth hacking.” If you’re not, you can see one definition here but basically it refers to creative uses of product design and data to enable users to discover, use, and share new web sites, SaaS applications, or mobile apps.

So perhaps is a purist sense of definitions, alliances and partnerships are not part of growth hacking since they don’t tend to involve product modifications (other than into the partner’s site/product) or viral hooks.  Most of the best examples of growth hacks, like the example with Twitter onboarding where Twitter discovered that users were more likely to tweet and return if they followed five people, are product centric. BTW,  Twitter started making suggestions of who new users should follow.

But really, growth hacking is about getting new users with little to no marketing. So yes of course, alliances and business development is part of that, because alliances are about distribution. It’s a rather fine line between partnering with a company for distribution, and engineering it (like AirBnB did to enable its users to crosspost to Craigslist).

I think Brian Balfour captured a number of interesting examples of alliance hacks (like Match.com and Kayak) here:

http://brianbalfour.com/post/60293339476/complete-guide-growing-consumer-startup-partnerships

These examples are good ones, one generation removed from Monster partnering with AOL and MSN to power those companies’ Jobs portals.

In my view, startups absolutely should look at alliances to supplement their own organic growth tactics. But because of startups size and limited resources, they need to be even more thoughtful, strategic, and aggressive. I have a longer post on early stage Business Development, but here are a few tips:

• You need to articulate why you matter to the big company. What’s in it for them?
• You need to wait for the right time. Big companies don’t often create prove demand, they fulfill it. In other words, you need product market fit first before you go seeking partners.
• You need to hold your partner’s hand. They are offering you access to their users. You need to be willing to do (almost) everything else. I agree with Balfour that you need an implementation team. For your partner, this is a product launch and you should treat it that way.
• You should measure and modify your tactics quickly. Big companies lose interest if things aren’t working. They don’t have the same iterative approach that you will, and they don’t tend to tolerate “failure” as well.

There is also the important issue of who should take on alliances activity. Personally, I think it should either be the CEO or a dedicated business development person, preferably one who has been through a few battles and seen deals work and go south. I don’t think you want to risk your company’s reputation because your alliances person is learning on the job. Or worse, if you need to unwind the partnership, you don’t want to find out that your green biz dev person didn’t really understand the contract.

Lastly, if one or two alliances are moving the needle, I think it’s important to understand why. Do a periodic review, prioritize your efforts for current partners, and also for your future partnering activities.

Do you need a financial plan to raise seed capital?

In addition to working in growth companies, I also mentor a number of entrepreneurs. One question I am asked often is “Do I need a detailed financial plan to raise seed capital?”

It’s an interesting question and one I will answer, but it’s actually not the right question. The right question is “Do I need to understand the financial levers in my business, and my current planned business model (or a few variants) when I talk to investors?”

The answer to that question is unequivocally “yes.” Investors, even seed investors who are investing in you and your crazy idea, want to know how you are thinking about turning your idea into a business. 

So to answer the first question, the answer is no you don’t need one. It’s probably a waste of time to have a complex financial model by month with multiple tabs. (I had a detailed model, but that’s because I’m an analytical person and I wanted to be sure I knew how we might be successful.)

Many entrepreneurs I speak with don’t have a detailed five year projection. They do, however, have a good sense of where the seed money is going to go (something almost every investor wants to know).

I think most early-stage investors know that projections are BS. But they do want to see:

-how you think about the business

-if you understand various levers for generating revenue, AND eventually generating profit

-your level of financial acumen

So you probably can skip the 5 year projection, but don’t skip the spreadsheet altogether. It’s the thinking behind the model that may help convince your prospective investors.

Learning from the Fire Hose

I am a first time founder & CEO, but I am not new to the world of tech companies. However, even with my…ahem…decades of experience, I am amazed at the volume of learning I am managing on a weekly basis. Being a startup founder is for you if you love to learn, perhaps more than you can handle.

When I first got into venture capital, I often heard young VCs and the Kauffman Fellows Program staff refer to the program as “drinking from the fire hose.” I think there were elements of truth to that with regard to the VC world, but I think it pales in comparison to the volume that comes with being a first time founder and CEO.

I read somewhere that in a startup, the term “CEO” actually stands for Chief Everything Officer. It is true that you wear so many hats in the course of a day, week or month. You are working on product, marketing, finance, hiring, board management, team management, legal, vendor management–all of it.

But man, what learning. In each of these areas, you may bring some skills, perhaps even advanced skills. But even if you do, your skills are in a different context, under different time pressures, with (generally) more help. For me, I am learning hands-on specifics about PPC, email marketing, A/B testing, project management, site design, and so much more.

Beyond the business and skill learning, I am also learning a ton about myself. About better personal time management discipline, about needing to continually keep my motivation high, about powering through moments of procrastination, about brutal focus. I often ask, “What is the single most important thing to do to advance the business?” But then, how do I allocate time for networking, which I know I need for perspective, emotional support, and to broaden my view, but which may not qualify to advance the business today?

I struggle with enjoying the journey, and not just the destination. I need to keep reminding myself how much I am learning.

Crowdfunding- Everything is New, Everything is the Same

The combination of the JOBS act (open solicitation and communication of fundraising by startups) and crowdfunding sites promises to shake up the way that seed-stage financing gets done.  Crowdfunding sites, like AngelList, have offered open, public disclosure of startups and their financing activities. Now, with the addition of open syndicates, the combination could prove to be powerful.

In only a few days, syndicates of angels have emerged that have the power to seed companies entirely, with $500K to a few million, in a matter of hours. Already, we have seen formal and ad hoc syndicates form from Foundry Group (FG Angels), Jason Calcanis, Tim Ferris, LaunchAngels, and plenty of others.

Will this fundamentally change seed stage VC or angel rounds? Does this matter more for markets outside of Silicon Valley? Perhaps.

In effect, AngelList has enabled the rise of the ad hoc VC firm- these groups are taking carried interest on the syndicates they lead/create. Since many are well known, the angels are using their Internet notoriety to offer “regular” angel investors the chance to invest alongside them.

But… One of the hardest parts of raising early stage money is in finding a lead

Even if it’s a “party round,” someone still has to throw the party, buy the beer and the chips, find the location, and clean up after. As Chris Dixon points out here, financings tend to be oversubscribed or undersubscribed.

Traditional angel groups are tough to pitch, can move slowly, and the real challenge for the entrepreneur is in finding a lead, because most investors want to follow. One of the most frequently asked question in angel AND VC rounds: “Who else is investing?”

So while AngelList syndicates offer the chance to change the game for entrepreneurs by significantly altering the speed of the raise, it seems to me that the entrepreneur still needs to find that lead, push the rock up the hill. Once that happens, then the power of openness, networks, and speed can take over.

Finding the RIGHT investors

I recently went through a low point, a crisis of confidence in our startup’s plan, the team, and myself.

Anyone who has been through startups knows that this happens in the seed phase, often multiple times. (As an aside, I am amazed at how few people admit it.  Everyone else seems to be “crushing it.”)

After multiple phone conversations, I had a Board sit-down meeting where I led the board through a number of alternatives. Our seed stage VC was such a voice of calm reason, helping to guide the conversation and helping me to see the big picture.

It struck home with me how lucky I am to have this VC investor and mentor.

While I know he has a duty to look out for his investment, I never felt that he was doing so during this conversation or the follow ups. What I felt was his concern, guidance, and empathy.

So entrepreneurs, do heed the guidance of those who tell you to do your due diligence on your investors- check with other management teams how your investors have acted when things are not going well. It will give you a sense of what support you are likely to get when you go through it.

Is Microsoft Giving Up?

Yesterday brought news that Microsoft is raising its dividend by over 20% and allocating $40B of its cash horde to buy back its own stock.

Rational stock market investors and business school graduates will probably applaud the move. Generally speaking, it is better for a company to give money back to shareholders through dividends or buybacks rather than spending it on uncertain initiatives with unknown paybacks. That is true in many industries and I’m sure we’ll see Microsoft stock move up as a result.

However, Microsoft isn’t in most industries, it’s a technology company. Technology companies are supposed to make bets on uncertain initiatives in the hope of producing exceptional returns. In consumer and enterprise software, consumer entertainment technology, Internet media and search, and consumer and enterprise communication (and mobile phones and software), the world is changing rapidly. Competition is coming, and coming hard. And many of Microsoft’s emerging businesses, like Skype, Bing, Windows Mobile and Xbox are not dominant and could use additional investment or influx of talent from acquisitions.

By moving forward with the buyback, Microsoft seems to be signaling that it does not intend to invest further in these businesses, nor does it want to acquire large technology companies to pursue new talent, new technologies, or new ideas in order to stake a leadership position in an emerging area. (To be fair, Microsoft will still have billions available for acquisitions of smaller innovators). The company has been playing catch up in mobile, in search, in SaaS, and in consumer platforms like tablets.

The combined buyback/dividend raise seems to me like a very strong signal that they won’t invest internally NOR will they invest externally. While the PC isn’t going completely away, and Windows and Office will continue to generate substantial cash flow, it seems quite clear that Microsoft isn’t sure how to pursue dominance in any of these emerging areas. While they did just spend $7B to get Nokia’s mobile business, I’m not sure exactly what they got for it.

Feeling Blessed

I did not wake up today remembering that it was 9/11.

Instead, I woke thinking about my blessings: my family, my health, my supportive wife, my entrepreneurial journey (which I try to remember is a blessing despite the wild ups and down of the business and my psyche). I am so incredibly grateful for these blessings and so many more. I am trying to use gratitude as a way of channeling my energy, anxiety, and ADD tendencies. I think it’s working.

But realizing that is it 9/11 prompted all kinds of other feelings and memories:

Twelve years ago today, I was attending a board meeting as a VC.  Another board member was attending the meeting by phone and alerted us that a plane had flown into the World Trade Center. We all thought it was a small craft and kept going with the meeting. When he informed us that another plane had hit the Center, we adjourned the meeting. I spent the afternoon and evening watching the news with my wife, feeling numb and helpless.

-Realizing how thankful I am that I am in good health. I am rather lucky that my genetics enable me to keep my weight stable despite not working out anywhere near enough and with high levels of stress. I really need to change my workout pattern, for stress and sleep benefits. Today I re-committed to that.

-I am trying to enjoy the journey, the learning, the personal growth, especially that which comes from being an entrepreneur.  As a goal driven person, it has been quite a challenge for me to embrace the uncertainty, the downs (that of course go with the ups), and the feeling that, some days, I don’t know what I’m doing. This has arguably been one of the toughest things I have ever done. Through another blog, I came upon these beautiful words from Antonio Machado- “Traveler, there is no path. The path is made by walking.”

-Thankfully, 9/11 didn’t impact me directly too much. But thinking further about my blessings has heightened my understanding of how precious my relationships are with family and friends. I have not done a particularly good job in including the friend part of my life with business and family. It’s tough to do, but I am increasingly realizing that it is something I need. As driven as I am, and as much as I attach self-worth to my work, it is family and friends that really give life meaning. I don’t have enough friend connectedness right now. That needs to change.

Is it a new era or noblesse oblige?

In the last week, we have seen 2 major newspaper companies, The Boston Globe and The Washington Post, acquired by wealthy business people.  John Henry in the case of the Boston Globe and Jeff Bezos with The Washington Post.

The revenue declines, struggles to retain readers, and high cost structure of the print newspaper business have been well documented and I won’t go into them here. But in trying to turn around these businesses, there are not obvious examples to follow, so it’s a bit of a Brave New World.

Can these owners make money in the news business (I won’t call them “newspapers” anymore) with original news content, through a digital-only or “digital primary” business model? What areas of news or content will they try to dominate? How important is the brand? The Post has an incredible brand in politics, The Boston Globe does in local sports and local news, but there are so many more competing options for Globe readers these days.

Where will the revenue come from? Not from classifieds, not anymore, not even online. What Monster and Autotrader did to newspaper print classifieds, Indeed and Craigslist did to Monster and the online classified business. That toothpaste is out of the tube…

It would seem as though there should be revenue available through local search and buying intent, helping local small businesses reach large swaths of local consumers. News companies still have large groups of local consumers reaching their online properties, but they monetize this audience through banner advertising that is not targeted and has very low CPM.

One thing Bezos knows is personalization, and that is good for news companies because they do such a poor job of it today. As a fairly regular Boston.com reader, I get lots of banners and they are pretty generic. I almost never notice or click them.

Bezos is an amazing innovator. But how much of that can he push as an owner rather then CEO?

News organizations should be able to make this equation work- Local business relationships + local info + deep personalization = local commerce That business model agenda would help The Post, but not Amazon, since it competes with local merchants. So we’ll see how Bezos’ manages this conflict, or even if he views it as one.

With John Henry, he has proven to wring extra revenue out of the RedSox so we can expect he’ll try to do the same with the Globe. But owning the team, a cable channel and the major news company is a conflict in it’s own right. Maybe the play is with advertisers, to give them multiple channels. It will be interesting to see how the Globe and the Red Sox co-exist and also how NESN factors in.

Of course, all of this could simply be a case of noblesse oblige regarding  these news institutions.