Focus and Why Less is More
Besides questions about people, what’s often one of the most important execution questions for a startup?
What should we NOT do?
Focusing on one or just a few things is the proverbial strategy of “putting all your wood behind one arrow.” Yet it is amazing how much pressure there is to do more. Often investors will push to do more, you will feel competitive pressures to follow all the things your competitors do, and of course you have a long list of things that you’d like to do.
Yet the good thing is that focusing on doing one or a few things really well has proven time and time again to have amazing results. What if I told you that a product that weighs 137 grams or less than 30 quarters, could generate $10 Billion in revenue? in one quarter? That’s of course the iPhone. And what’s even more amazing, in the fourth quarter of 2010 Apple generated almost $27 Billion in revenue from products that can easily fit on a startup’s conference room table.
Now, it’s easy to look at one of the biggest blockbusters and successful companies and say everyone should do that. Yet when Steve Jobs returned to Apple, Apple’s annual revenues had been dramatically declining -- in 1995 $11 billion, in 1996 9 billion, 1997 7 billion -- and many had written the company off. It owes much of its turn around success to its effort to focus. (Disclosure: I worked at Apple from 1992-1996)
In a 1997 MacWorld speech, Steve Jobs outlined the key things on which the Company would focus:
- Board of Directors
- Focus on Relevance
- Invest in Core Assets
- Successful Partnerships
- New Product Paradigm
Fast forward to 9:10 of the video to see Steve talk about this.
Of course, with any good strategy, people should come first and the strategy should come second and thus Apple’s focus on the board and team. And yet points 2 and 3 are all about Focus. To enable its turn around Apple shored up its strengths and focused on creative professionals and education. It canceled lots of products to focus on few and made them great. It invested in re-building it’s brand. In general Apple focused on its core (no pun intended…) before it did anything new and only then did it have a chance to do new things and to eventually become the most valuable technology company today.
But of course, you’re probably thinking, ”Well that’s easy for Apple to do but we’re a startup. We have to go out and do lots of things to in order to become bigger and grow and become dominant!” Interestingly, if you look at almost any successful startup company, they got there by doing a few things, or even one thing, really well before moving on to do something new.
Facebook started out as a service just for Harvard, and then expanded to other Universities, before eventually opening up to everyone.
Google did great search.
Amazon sold books.
These were all unknown companies at some point.
Focusing on one or a small list of things that really matter and getting success there first is key in a startup because you have limited resources -- not enough people, not enough money, and definitely not enough time. You have to get success in one place before moving on to tackle the next set up of things. And there are lots of other examples from companies with which I have worked.
At Lookout (disclosure: I am an investor and Chairman of the Board), we developed mobile security software. We started with Blackberry, Windows Mobile, and Android. About a year ago, we shifted our focus from Blackberry and Windows and put most of our effort behind Android. And now we are the top mobile security app for Android, and one of the top ~25 applications for all of Android. It was a tough decision to shift our focus away from the other platforms, but we had a small team and decided to put all our proverbial wood behind one arrow. And it’s only now that we are talking about expanding internationally and looking at other platforms.
At ZangZing (disclosure: Co-founder), we’re building a new way for groups to share photos more simply and beautifully. We’re starting by focusing on the web and making sure that is awesome before moving into mobile apps. Some people say we should do it the other way around, but we think once you see what we’ve done on the web, you will understand why… And either way, we could have done web and mobile at the same time, but we have limited resources and decided to do one thing well first.
At Vontu (disclosure: Co-founder here too), we developed data loss prevention security software. We decided to focus initially on helping companies with lots of customer data such as credit card numbers, social security numbers and other personal information. And we focused on the US. And only on the Fortune 1000. And even within the Fortune 1000 only on a few key segments: financial services, retail, and insurance. And as we had success, we then expanded and eventually had customers all across the Fortune 1000 and outside the US. The revenue ramp was great -- half a million, 3 million, 13.5 million, almost $30 million, and on the path to $50 million when Symantec bought the company for $350 million.
In summary, in a startup, don’t give in to the temptation to do more because usually doing less results in more success, more quickly.
Anyway, i hoped you enjoyed the post. A few others you might like about planning and execution are Can you Count? and If you don’t know where you’re going, well, you’re lost.
And let me know what you think.
And thanks to Kevin for his awesome focus photo.
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ZangZing – Group Photo Sharing. Simply and Beautifully.
Hi Everyone!
We just rolled out the beta signup for a Group Photo Sharing company I co-founded at www.zangzing.com.
You can learn what we’re up to at our first blog post and thanks in advance for signing up for the beta at www.zangzing.com
Joseph
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Startup 132: Why an Exit Strategy is a bad idea
My apologies that it has been so long since I’ve written but I’ve been a little busy the past year and a half. I started a new company called ZangZing which is building a new service to help groups share photos. You can sign up for the beta here. I am also on the board of 3 other companies – Lookout, Smartling, and ccLoop – and an adviser to a fourth – MobileIron.
Exit Strategies
I have been meaning to write about the question of “Exit Strategies” for many months.
Not only has there been lots of press about exit strategies with Groupon turning down a multi-billion dollar offer from Google, but in about 1 out of every 2 recruiting interviews, I am asked the same basic question, “What’s the company’s exit strategy?”.
Let me get right to the point. If you work for a company or meet with a startup CEO that says they have an exit strategy, then you should find the nearest exit. Think of a company with an exit strategy as your floor lighting that will illuminate and guide you to the nearest exit – which may be behind you. (OK, after flying almost 1.5 million miles, airplane humor is too easy).
Now some of you might be asking, “But Joseph, you sold a couple of companies. Why and how can you credibly you say that?”
Well, it’s simple. I don’t believe there really is such a thing as an exit strategy. And I have never had one for any of my companies. An exit strategy implies very short term thinking about how Google, or Facebook or some other deep pocketed, cash rich company is going to come along and scoop the company up. And that type of thinking is simply a bad idea. Check out the definition of exit strategy from Wikipedia:
An exit strategy is a means of escaping one’s current situation, typically an unfavorable situation. An organization or individual without an exit strategy may be in a quagmire. At worst, an exit strategy will save face; at best, an exit strategy will peg a withdrawal to the achievement of an objective worth more than the cost of continued involvement.
When you think of a startup, it’s probably not a good idea if the team is thinking about escape or saving face or withdrawal.
Instead of thinking about the exit, startup teams (and potential employees) need to be laser focused on a success strategy. This means thinking (and asking) about the 3-5 most important things that will make the company successful, e.g. Who do we need to hire? What products do we need to build? How do we grow our user base? How do we make money and become profitable?
A success strategy is about building value. And when you are successful and build value, then you will have lots of options including continuing to grow the company, selling the company, taking a company public, merging with another company and more.
So stay focused on your company’s long term success and along the way you will have lots of hard choices about if and when to “exit”. In writing this, it seems so obvious, yet I am continually amazed that so many people think and ask about exit strategies. Hopefully no one will ask about exit strategies in any future interviews and if they do, then I know they are not good at doing their homework. 
Leave a comment and let me know what you think.
And here is another post about strategy planing that you might appreciate. If you don’t know where you’re going, well, you’re lost.
Lastly, you can also follow me on twitter or subscribe to email updates.
Exit sign courtesy of heathbrandon
Airplane exit sign courtesy of joeshlabotnik
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Riding in the fight against cancer
My apologies as I am updating my blog and it seems I somehow managed to send out an update on this post which I was trying to remove. I thought about sending out an apology email and then thought that “two spams don’t make a right.” I have since turned off auto email option and put the “safety” back on email notifications. Again, my sincerest apologies if you received an email message about this old post. Joseph
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It has been some time since I’ve posted. And this post is not about technology but about life.
Each year thousands and thousands of people are affected by cancer.
Some are survivors.
Some are caregivers.
And yet too many are lost.
The statistics are numbing.
But the names are not.
Grandpa
Angie
Bob
Aunt Rose
Bud
David’s Brother in Law
Mauricio’s Mom
Julie
Folia
And many many more.
Even in these tough times, we can not give up in the fight against cancer.
And so I am riding 100 miles to help raise awareness and to raise money. I am trying to raise $10,000. And I need your help.
Please give whatever you can. $1. $10. $100. $250. $1000. Whatever you can do, it will make a difference and inspire and empower people affected by cancer to face the challenges, head on, and hopefully live life on their own terms.
Please help and Donate at http://sanjose2010.livestrong.org/joseph
Thank you.
Joseph
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Startup 131: Term Sheet Dilution Calculator
Well, it’s been a little long since my last post and I apologize. Life sometimes has a way of getting busy but it’s been great. Anyway, given all the interest and posts about Startup Term sheets, I thought it would be useful to share a tool that Charlie Fortenbach, Vontu’s head of finance and operations extraordinaire, created for calculating dilution at various stages of investments.
It’s an excel spreadsheet and fairly straight forward. Please consider it a beta release and we would love feedback, comments, bug fixes, and suggestions for improvement. Also, if you make changes, it would be great if you can send them back to me and then we can incorporate them for everyone.
The model is pretty simple to use. For a series A, simply follow the five steps below.
- Enter the “Pre-money” valuation for the initial financing round (typically a seed round, or Series A venture round).
- Enter the investment amount for each Series A investor. The spreadsheet will handle up to a total of four distinct investors (Investor AAA, Investor BBB, etc.). The model makes no assumption regarding pre-emptive investor rights, such as “pro-rata shares”.
- Enter any issuance of Series A Preferred warrant shares. The issuance of warrants is typically associated with venture debt or convertible notes which is common in the early financing stages.
- For the initial financing round, enter the % of total fully diluted stock (post-money) that will initially be apportioned to the employee option pool
- Input the total “pre-money” stock fully diluted. Given the “Pre-money” valuation, this will set the Series A Preferred Price / sh. In the initial financing round the Preferred Price is generally driven to a round number, typically $1/sh. Certain adjusting splits may need to be applied to drive this price to $1/sh.
One piece of feedback we’ve already received is dealing with convertible notes and we’ll get to that eventually or if someone wants to update the sheet and send it back to me, that would be great.
Also, if you want to talk with Charlie, let me know and I can forward your info.
Enjoy. And if you like this, please share it with your friends using the add to any button below. And if you’d like an email or Twitter update on future posts, feel free to sign up for either.
Related Posts and References
- Startup 124: Term Sheet – Valuation and Dilution
- Startup 125: Term Sheet – Liquidation Preferences
- Startup 126: Term Sheet – Anti-Dilution
- Startup 127: Term Sheet – Voting Rights and Protective Provisions
- Startup 129: Term Sheet – Board of Directors
- Download sample Term Sheet from National Venture Capital Association
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Startup 130: 10 Questions for Ray Rothrock of Venrock
This post is an “email interview” I did with Ray Rothrock of Venrock. I sent Ray 10 questions on venture capital, what he looks for in his investments and the people he backs, as well as what are his favorite iPhone apps. Enjoy.
On Venture Capital
1. Venrock is celebrating it’s 40th anniversary this year. That’s a long time in the Venture Capital business and does not even include Laurance Rockefeller’s “venture” investments in the 1930s in Eastern Airlines and McDonnell Aircraft. How has the venture capital business changed since those early days and in what ways has it stayed the same?
Differences in the business are around the limited partners. These days the money comes from all sorts of institutions – foundations, endowments, retirement funds, etc. In older times, it was largely from wealthy families and individuals. As such, in the 90s the venture activity morphed into an asset class for these institutions as they diversified. The data for this asset class was based on a much smaller business, fewer venture capitalists, less money and still a fairly information inefficient world. That is all changed now. Today, success has a much higher bar because of information flow and ease of access of capital.
Similarities in the business are all about the entrepreneur. There are still people out there trying to invent things and change the world with their ideas. In short, entrepreneurs are still entrepreneuring. I think the personal drivers are also the same – it’s about changing things, not so much about wealth creation. Wealth often comes after success, not the other way around.
2. With so much money “chasing” both consumer and enterprise companies which can get real traction by leveraging services such as amazon’s ec2 and open source software, what are your thoughts about the suggestion that today’s venture model of large funds and big investments does not work?
Big outcomes are mostly driven by huge markets. If the market already exists, it is very hard to take share from incumbents. If the market does not exists, then you need some good luck for the market to happen. So, betting on the creation of huge markets and good luck is really hard to sell. I think a lot of folks have downsized because it is easier to develop numbers for the limited partners that will keep them investing, e.g. ROI. I think venture is about creating wealth – cash on cash. You cannot use ROI to buy a Christmas turkey. Make no mistake, small funds that have great results are wonderful things. If you have a big fund, then you are in a different returns regime.
3. What are Venrock’s top 3 investment areas going forward?
There is a huge trend of outsourcing everything and it is accelerating. Infrastructure that supports this is a huge trend – clouds, networks, SaaS, etc. Data control and management. As the world becomes more and more dependent on data, protecting that data is HUGE. Third, healthcare information. You can only manage what you measure. I think healthcare will see a revolution in measurement and systems associated with that.
4. In addition to a successful information technology practice, Venrock also has a very successful healthcare and medical investment team. How does the complete team work together and make investment decisions on things that are seemingly so unrelated?
Every deal is reviewed and approved by all partners. Technology is only part of the due diligence. Building a business – recruiting, selling, customers, all pertain to every business regardless of category. Since we focus on people, the CEO and team are crucial, even if I don’t understand a science or a market demand.
5. It seems most VCs keep a list of deals they “missed”. What’s your list?
We don’t keep one. We all have our story. Ours was Yahoo. Because of our early internet investing, we saw it very early when it was still at Stanford. We chose not to pursue. Ouch.
On Entrepreneurs and Startups
6. On the “quantitative” side of things, what are the most important things you want to learn about a company in a first meeting?
P&L and Balance sheet are really important. We do all sorts of “unit analysis” and compare margins, rev/empl, and things to determine if a plan is reasonable. One thing not to do, don’t show five year detailed projections unless you know every number. Someone will ask you about why the marketing budget, for example, change in 2013, and you better have a good answer.
7. On the “qualitative” side of things, what do you look for in a company and its founder/CEO? And what turns you off as well?
The CEO must be a leader and a good one. First impressions are crucial as well as impressions after the fourth meeting. I always ask myself if I would want to work for this kind of person. They of course must be knowledgable about all aspects of the business. They should not be flip in their remarks and answers. If they don’t know something – they should just say it and move on. The biggest turn off is, when asked a question it should be answered immediately. Don’t talk for 5 minutes and wander around. That tells me you don’t know the answer or afraid to state it or whatever. Answer, then elaborate, not the reverse.
8. What are the top 3 do’s and don’ts for an entrepreneur presenting at an all Venrock partners meeting.
Do – be mindful of the time and keep the presentation complete
Do – a demo if possible as this conveys best what it is you have
Do – know who are you are talking do. Do your homework.
Don’t – be too jocular or sarcastic or dismissive
Don’t – assume every one in the room has detailed science background to understand. If science is important explain it at a level all will get it
Don’t – don’t forget to tell us why we should invest, e.g. returns, outcomes, comps, etc.
9. What makes for a successful Board of Directors/Investor/Founder/CEO relationship?
Trust and openness. In meetings, keeping an agenda and sticking to it. Startups are complex and staying on point is important. Investor/directors need to be respectful of the preparation for a board meeting and do their homework, e.g. read the materials in advance.
Talk often. This eliminates things drifting too far before the group resyncs.
Bonus
10. What are your favorite 3 iPhone apps?
Music 2 by Simplify Media – access my home music server on my iPhone – I don’t have to carry my iTunes library with me. Shares with 30 people.
TripIt – trip itinerary automation.
AroundMe – access to local business and activities based on location.
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I hope you liked the post and feel free to leave a comment or question and I will relay to Ray.
Lastly, if you like this, please share it with friends using the buttons below. And, if you want an update for the next post, sign up below or follow me on twitter. Thanks.
More Links
- Startup 124: Term Sheet – Valuation and Dilution
- Startup 125: Term Sheet – Liquidation Preferences
- Startup 126: Term Sheet – Anti-Dilution
- Startup 127: Term Sheet – Voting Rights
- Startup 129: Term Sheet – Board of Directors
- Startup 128: An Interview with Bill Gurley of Benchmark
- Venrock – Full discloure. Venrock was an investor in Vontu.
- Follow Venrock on Twitter @venrock
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Startup 129: Term Sheet – Board of Directors
This post is a continuation of the series about venture capital term sheets. If you have not yet read the previous posts on Valuation and Dilution, Liquidation Preferences, Anti-Dilution, and Voting Rights and Protective Provisions, you might want to start with them. In particular, when thinking about the Board it’s important to understand investors Voting Rights and Protective Provisions, and the requirement of investors’ consent on certain decision. (The links are at the bottom of the post as well…)
There are lots of things to consider for a startup’s Board of Directors including its role, who should be on it, and how to best work with the board.
You’re Fired! (or Hired)
To start, a Board of Directors has one primary job, which is to hire and fire the CEO. Sounds a little like your worst Donald Trump nightmare, eh? What this truly means is that the Board is an oversight organization for all the company’s shareholders and an advisory group for the company’s management.
The Board ultimately holds the CEO and the executive team accountable for meeting agreed upon objectives, manages compensation for the top executives, and works with auditors to ensure appropriate accounting and business practices. This is their “ongoing” job. Additionally, over the life of the company, the Board will vote on key decisions such as raising more money or selling the company.
Term Sheet
Typically the language in a term sheet is very straightforward and will simply outline the number and names of people on the board. The Series A will set the basic blueprint including the representation of the common shareholders and founders. The following example language is from the NVCA’s sample term sheet:
“At the initial Closing, the Board shall consist of [______] members comprised of (i) [Name] as [the representative designated by [____], as the lead Investor, (ii) [Name] as the representative designated by the remaining Investors, (iii) [Name] as the representative designated by the Founders, (iv) the person then serving as the Chief Executive Officer of the Company, and (v) [___] person(s) who are not employed by the Company and who are mutually acceptable [to the Founders and Investors][to the other directors].”
Not only is this common language, but this also happens to be a very ideal structure with two investors, two common shareholders including the CEO and then an outside, non-employee and non-investor board member. It’s ideal because all shareholders are represented and if needed, the outside board member can serve a tie breaking function.
As you raise additional rounds of funding, almost every investor will want a seat on the board which can get quite unwieldy. I strongly encourage companies to have a small set of board members (ideally 5 but no more than 7) who appropriately represent the shareholders. Only if needed, offer to future investors “Board observation rights”. Observer rights allow an investor to sit in on a board meeting but they are not voting members of the Board.
The Board is Your Team
Choosing your board members is as important, if not even more important than the structure. Think about each board member as if you were hiring them to work for the company. Do they have certain technical competencies that make the company better? Ideally each board member brings experience with startup execution or understands the business and market or both.
It is also important that they have the right relational competencies to work well with you, the rest of the board and the entire company. A board of successful people does not necessarily mean a successful board. They have to work well together. (Read It’s the people, stupid part II for more on relational competenticies.)
Making the best of it
Now that you have the board set up, the question is how to best work with your board. Despite what many fear, the Board is not responsible nor does a good board want to run the day-to-day operations of a company. Does that mean that the Board will simply let you do what you want? Probably not but if your board wants to run the company then you have not put together the best Board or, and I hate to be blunt, it could be that you are not doing a good job.
The key to a successful board relationship is leadership. Being a good leader means you have followers. And the best way to have the board “follow” you is to set a plan, deliver on the results and keep in regular communications especially sharing bad news early. I have never heard of a successful company having a difficult board dynamic.
For more on this idea, I suggest you check out the posts If you don’t know where you’re going, well, you’re lost, and A few golden rules for a great Board relationship, and Control Freaks Are Us to learn more about how to ensure a successful board relationship.
Anyway, I hope this helps. Enjoy the other posts and please feel free to share your thoughts or questions. And to get notified about future posts, please to sign up for email updates or follow me on Twitter. Thanks, feel free to share the post with your friends, and go get started…
Related Posts and References
- Startup 124: Term Sheet – Valuation and Dilution
- Startup 125: Term Sheet – Liquidation Preferences
- Startup 126: Term Sheet – Anti-Dilution
- Startup 127: Term Sheet – Voting Rights and Protective Provisions
- Startup 131: Term Sheet – Dilution Calculator
- It’s the people, stupid part II
- If you don’t know where you’re going, well, you’re lost
- A few golden rules for a great Board relationship
- Control Freaks Are Us
- Download sample Term Sheet from National Venture Capital Association
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Startup 128: An Interview with Bill Gurley of Benchmark
This post is an email interview with Bill Gurley of Benchmark Capital. I sent Bill 10 questions on what he looks for in his investments, the people he backs, the state of the venture capital business and why Benchmark invested in Twitter. Enjoy.
On Venture Capital investing today
1. What are your top investment areas going forward?
We don’t really work that way. All I could tell you is what are the three most common investment themes looking back. We simply don’t sit around planning the future. We try to meet with as many great entrepreneurs as we can and then make a judgment on the quality of their vision versus the state of the market. Recent themes have been cloud computing, open source, user generated content (UGC) Internet plays.
2. What are the most important things you want to learn about a company in a first meeting?
• Quality of the idea – this is from both an economic standpoint and a defensibility standpoint.
• Quality of the founder – smart, motivated, goal oriented.
• Mode of operation – frugal vs. excessive.
3. It seems most VCs keep a list of deals they “missed”. What’s your list?
It’s long and painful.
I met with all of these companies at an early stage before they raised venture capital.
• Overture – Bill Gross was kind enough to show this to me
• Akamai – this was Mark Gorenberg’s deal at HummerWinblad, but I should have been supportive, and I missed it
• Skype
• Baidu
• And of course the big one: Google. I have profound admiration for John Doerr and Mike Moritz for knowing to step up here, especially at a high price. It was far from obvious.
I probably forgot 1 or 2, and I am confident there will be more.
On Entrepreneurs and Startup CEOs
4. On the “qualitative” side of things, what do you look for in a entrepreneur or startup CEO? and what turns you off as well?
On:
• Intellect
• Salesmanship without being overly promotional
• Pragmatism
• Resourcefulness
• Confidence
Off:
• Overly promotional
• Doesn’t listen
• Unwilling to focus
• Lack of appreciation for finance/economics.
5. What are the top 3 do’s and don’ts for an entrepreneur presenting at a Benchmark partners meeting.
I would suspect they are mostly the same (as question 4).
Here are a few tactical things for the partner meeting presentation
• Don’t bring people that don’t have a role in the meeting
• Always include at least one “financials” slide even if its more about costs than revenues — weird to have to ask, and even weirder to reply “we don’t have one with us”.
• Don’t use over 20 slides.
• Control the flow of the meeting.
On the Business of Venture Capital
6. Opentable (Nasdaq: OPEN) is one of the first “silicon valey” initial public offerings (IPO) since the economic downturn. Why do you think the company was able to get public and was received so well?
I actually believe that the buy-side has ample demand for IPOs. The key problem is a supply problem – most companies either don’t want to be public or aren’t willing to make the tough choices it takes to get public (healthy margins, sarbox implementation, etc).
Being public isn’t easy, and for the CEO and the CFO it’s downright brutal. I think that’s why the valley is obsessed with “alternative markets” these days. They want the benefit of liquidity without the headache of being public. I think they will be disappointed.
7. What do you think about the suggestion that today’s venture model of large funds and big investments does not work in a world where companies can get real traction both as a consumer company or a enterprise company by leveraging services such as amazon’s ec2 and all the available open source solutions?
I don’t think the data proves this theory out. With the exception of Salesforce.com and Siebel, I don’t know of any multi-billion dollar public companies that didn’t have venture capital. You might be able to build a feature for $1mm, but its much harder to build a company. All of the $B Internet companies have/had venture backing.
This doesn’t disqualify the accusation that some funds are too large. They are different issues.
8. Clearly, the startup world is much more “flat” with companies existing across borders and getting started around the world. What is your long-term view on Silicon Valley as the “epicenter” for venture capital in the next 10-20 years?
We are tremendously excited about the future of Silicon Valley — it is our unquestionable focus as a venture firm. We want to be the best firm in Silicon Valley.
That’s not a reflection on the opportunities elsewhere. I happen to be very bullish on China, Russia, and Brazil when it comes to venture opportunities. I just think those will be best served by local firms on the ground in those regions.
9. Benchmark has a unique structure in that all partners are equal – equal pay, equal carry, equal votes, etc. Why has that worked and why haven’t more firms adopted that model?
It works for 3 key reasons.
First, our partner’s don’t need to negotiate compensation every time they raise a new fund, so we are incented to all work together versus proving our worth to one another. My partners deliver value-add to the companies I work with all the time.
Second, it keeps a high bar on who comes in. There is no junior team at Benchmark.
Lastly, as an entrepreneur, you are always dealing with a General Partner that has a say in the firm — your deal won’t get trumped by the “Senior partner” back at the shop.
Others don’t adopt it for the same reason other partnerships in legal, investment banking, and real estate haven’t — it’s good to be king (from a financial standpoint).
On Twitter
10. Benchmark recently invested in Twitter at a pretty lofty valuation. What drove the investment and how are they going to make money other than the often-rumored acquisition?
See my answer to question #3 above.
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I hope you liked the post and feel free to leave a comment or question and I will relay to Bill.
Lastly, if you like this, please share it with friends using the buttons below. And, if you want an update for the next post, sign up below or follow me on twitter. Thanks.
More info
- Startup 124: Term Sheet – Valuation and Dilution
- Startup 125: Term Sheet – Liquidation Preferences
- Startup 126: Term Sheet – Anti-Dilution
- Startup 127: Term Sheet – Voting Rights
- Follow Bill on Twitter
- Bill Gurley’s Blog
- Benchmark Capital
- Full Disclosure – Benchmark invested in my last company, Vontu. I am also very proud that Bill recently rode up the mountain from which it’s named. Mont Ventoux. Here’s a shot of him on the summit.
- Home page photo of Bill from http://www.flickr.com/photos/briansolis/
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AT&T can run but can’t hide! Tethering hack and more on iphone v3 software…
Just uploaded iphone v3 to my 3g. Going to keep a running list of thoughts but here are some initial thoughts.
First, my AT&T rant. AT&T still, well, sucks. Almost every other carrier announces support for tethering, i.e. connect your phone to your computer to use as a wireless modem, except, well, AT&T. That’s the bad news. The good news, some smart guy figured out how to turn to make it work without jail breaking your phone! Download tethering here. About half way down the page, click on “Mobile Configs” and download section and then choose your country, (USA for all of us having to live with AT&T!) and then AT&T and it installs and requires a restart. Afterwards, on your iphone in the network settings you will see a tethering option using a cable or bluetooth! Now, allegedly AT&T is going to start charging for this in a month and rumors are that it won’t be cheap. Maybe an additional $55 which seem outrageous especailly in comparison to the rest of the world. Apple needs to support another US carrier to get some competition going… Also, there are instructions to turn on MMS for AT&T as well, but have not done that yet as not a big deal to me.
Anyway, now that I got the AT&T rant out. Here are some initial thoughts on what Apple as done on the software side.
Good Stuff
1. Speed – it’s faster. And the most important place its faster for me is with contacts. I have a couple of thousand contacts and it sometimes would take 10-20 seconds from when I would start typing a name before any would show up. now’s its a second or two. Also, other things generally seem snappier. Safari seems much faster too.
2. Search – having search everything is great. should have been in v1, but great its here. It’s a little strange how to get to universal search in that it is from your home screen and then you swipe to the left. a search button addition would have been a little more obvious.
3. Landscape mode for everything – pretty much works as you expect. GREAT for email. there are some kinks to work out as the super smooth scrolling from v2 has some bugs in landscape mode but they will figure that out.
4. Copy and paste – one word, finally. Ok, maybe a few more words. works pretty well. like the ability to extend the selection beyond what is initially highlighted. now if they would add some of the smarts from the mac for seeing a time and date in an email and offering to put it in the calendar, that would be great.
5. Calendar – can now synch with CalDAV to Google calendar and others as well as Microsoft ActiveSynch
6. MobileMe – after a year it seems to work well, which means that I update info on my desktop and it updates my phone and visa versa without having to think about it. There is still the occassional contacts disappearance but is always solved by creating a new contact and then all the old ones come back. That said, one cool feature that is new to mobileme is to be able to find my phone and also to wipe the data if I lost it. That’s a great feeling of security.
7. Upgrading – i have to say one of the things that is not often discussed is the fact that this is a phone and you can download all kinds of great new features. That’s actually pretty cool.
Not so good stuff
1. Buggy – there are definitely some small bugs. Scrolling issues, some screen update issues
2. Voice dialing requires new iphone 3gs hardware. Why? No idea. I will keep using Vlingo which works pretty well and does maps, searching, et al.
3. Maps – when using maps, it would be nice to have a button for current location when getting directions versus having to type “current…” and then choosing it from the top of the list. I do this all the time.
4. Camera – when taking pictures and you want to be included in the picture (not that I take lots of pictures of myself, but for example Alexandra and I together somewhere), it would be great if one of the buttons such as volume up or down would take the picture.
5. Did I mentioned how AT&T still sucks?
I have not tried the new phone itself, but would appreciate any thoughts on other good and bad on the phone. That said, I have to think that Apple is got something else up their sleeves as this phone design is basically two years old which is a long time for them not to innovate on some new hardware. Anway, leave a comment with your thoughts on the phone and software.
Lastly, if you like this, please share it with friends using the buttons below. And, if you want an update for the next post, sign up below or follow me on twitter. Thanks.
Update:
Techcrunch has done some reviews of the 3Gs hardware. Here are their thoughts on the video capabilities.
Startup 127: Term Sheet – Voting Rights and Protective Provisions
This is the latest in a continuing series of posts about venture capital term sheets. The first three dealt with term sheet issues around ownership, dilution and the impact of Valuation, Liquidation Preferences, and Anti-dilution. You might want to start with those three posts before diving into this latest which covers Voting Rights and Protective Provisions that venture capitalists require in their term sheets.
Voting Rights – What’s the Big Idea?
Voting Rights are pretty straightforward. The language you will find in a term sheet usually looks something like this:
The Series A Preferred Stock shall vote together with the Common Stock on an as-converted basis, and not as a separate class, except (i) the Series A Preferred as a class shall be entitled to elect [_______] members of the Board (the “Series A Directors”), and (ii) as required by law.
Voting on “an as-converted basis” means that in the case of any shareholder votes except for the Board Seats and assuming there have been no triggers for anti-dilution, the preferred shares convert on a 1:1 ratio and everyone votes based on their company ownership and the majority rules. But of course, it’s not as simple as that. And while Board seats are very important, before you think about how to structure a startup board, there is something even more important to understand which are called Protective Provisions.
Protective Provisions – What’s the big idea?
In general, the Board of Directors approves most strategic management decisions. And for most decisions requiring a shareholder vote, everyone votes based on the number of shares they own. However, there are certain things that investors get to decide (or at least must consent to) regardless of their ownership stake or make up of the Board of Directors. These include:
- Any sale or dissolution of the company
- Issuing new shares of stock
- Changes to the size of the Board of Directors
- Creating, owning or selling any subsidiary
- Any change to the certificate of incorporation or Bylaws.
- Changes to any rights of other shares which give the same or better rights as their preferred shares
- Purchases or any dividends on stock before the preferred shares
- Issuing any debt
In many ways, Protective Provisions are as important, if not more important, to understand as how to organize your Board of Directors (which will be the next post). Investors include them so that when the preferred share holders are a minority, they are protected against certain actions of the majority such as a the possibility that a majority of the shareholders being able to sell the company to a family member for $10 and as result, wiping out the investors. In general, they are reasonable protections when they serve as protections as opposed to control.
Protective Provisions – How do they work?
Protective Provisions are actually pretty straight-forward. There is the list of decisions to which the preferred shareholders have to agree or consent before the company can act. There is some negotiation for items such as taking on debt, as usually there is some threshold below which the company can take on debt without consent. Though most of the items are not very negotiable.
However, what is negotiable is how the Protective Provisions work when you raise multiple rounds of funding. They can either work in such a manner such that all the preferred shareholders vote together as a class regardless of when they invested or alternatively each series of preferred shares have the right to vote separately for each series on the protective provisions. As I will explain, having all the preferred shareholders vote as a class is in the company’s best interest.
Let’s take the example of a company that has raised one round of funding, called a Series A, in which the preferred shareholders own 30% of the company. In this case, the preferred shareholders have to vote on any of the itemized protective provisions and it’s simple.
Now what happens in the case that you raise two additional rounds of funding, a Series B and a Series C? Each time you raise a new round, it’s in the best interest of the company that the preferred shareholders vote all together and share the protective provisions otherwise you could have a small minority shareholder that has veto rights over what are big decisions. For example, let’s assume the Series B owns 15% and the Series C owns 5% of the company. If the Series C had their own protective provisions, then a 5% shareholder could veto a decision to sell the company even if 95% of the rest of the shareholders voted to sell the company. This is an example of how a protective provision can become a controlling provision.
Additionally, there is one other twist, which is the threshold for the voting in the protective provisions. In general, it is in the best interest to have a majority or close to a majority, such as 60% because again, this is supposed to be a protective provision and not a controlling provision.
In summary, while a company may think that the make up of the Board of Directors is the most important item, it turns out that the protective provisions give the preferred investors quite a bit of power over key decisions. Does this mean that the Board does not matter? Absolutely not, and that will be the topic of the next post.
I am also going to interview Bill Gurley of Benchmark Capital this week. Send me your questions for him via the Contact form.
Lastly, if you like this, please share it with friends using the buttons below. And, if you want an update for the next post, sign up below or follow me on twitter. Thanks.
More info and References
- Startup 124: Term Sheet – Valuation and Dilution
- Startup 125: Term Sheet – Liquidation Preferences
- Startup 126: Term Sheet – Anti-Dilution
- Download sample Term Sheet from National Venture Capital Association
- Ballot Box photo from http://www.flickr.com/photos/thomasroche/
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Term Sheet – Anti-Dilution
This is the third post in a series attempting to demystify term sheets. The first two posts are on Valuation and Liquidation Preferences and are a good place to start.
Delusional on Dilution
As mentioned in the previous posts, a term sheet is a non-binding letter of intent that outlines a potential investment in a startup. Much of what a term sheet covers is the value of the company and how much ownership the founders and other shareholders give up in order to get the investment. The amount of ownership a company gives up is called dilution. And between valuation discussions, liquidation preferences and especially with the math for anti-dilution, this whole process might start to make you a little delusional. But hang in there, as this is the last big term dealing with dilution.
Term Sheet Anti Dilution – What’s the Big Idea?
In addition to giving up a stake in the company, when you raise venture capital, in a term sheet investors typically get additional protection rights that, in certain cases, their ownership stake will not be diluted. This primarily deals with the case when a future investor gets a better price to invest in the company. The term is referred to, as you already guessed, Anti-dilution.
Anti-dilution is a price protection guarantee not unlike, for example, when a store like Best Buy guarantees it will make up the difference on the price you pay for a camera if you find it for a lower price later. In reality, you only have to worry about this term if you have a down round. A down round is when a follow on investment is made at a pre-money valuation that is lower than a previous round’s pre-money valuation. (Don’t know what pre-money means, then check out the post on Valuation.)
As a result, based on how well you execute you have lots of control to avoid having investors ever use this protection. (See previous post Control Freaks are Us). Plan, execute and deliver results and odds are that even in tough times your valuation will increase from each round. But let’s look at how this works in the case you do have a down round.
How it works
As mentioned earlier, Anti Dilution is basically price protection for the investors. Let’s go back to the example used in the previous two posts in which NewCo, Inc. sells shares in a Series A investment at a pre-money valuation of $6 million and raises $4 million of new money. If there were 6 million shares (4 million for the founders and employees plus 2 million for a 20% option pool), that would price the shares at $1 per share ($6 million/6 million shares). By raising $4 million, NewCo, Inc. issues 4 million new shares at $1 per share to the investors for a total of 10 million shares.
Following so far? I hope so because that’s the easy math!
Let’s say for some reason that disaster strikes and NewCo misses most of its goals, the economy goes into recession, and yet the company needs to raise more money. NewCo, Inc. gets an offer from a new investor to provide $1 million for a Series B at a $5 million pre money valuation. Since the post money of the Series A was $10 million and the pre-money of the Series B is $5 million, this is referred to as a down round. In this case, the Series A Anti-dilution protection would kick in.
There are two types of Anti-Dilution preferences – Weighted Average and Full Ratchet. Let’s start with the most common, which is a weighted average formula called “Broad based weighted average”. According to Wilson Sonsini, a leading Silicon Valley law firm, 92% of their term sheets in 2008 used Broad-based weighted average. And that’s good news, because it is the most favorable for the company other than not having any Anti Dilution which is probably not going to happen for most companies.
So what happens?
Basically, Anti-dilution lowers the price at which preferred shares convert to common stock. As mentioned in the previous post on Liquidation Preferences, in the case of a sale or an IPO that exceeds the minimum liquidation preferences, preferred shares convert into common stock. In the case of Anti-dilution, when the conversion happens, the preferred shares convert at lower price so that preferred shares receive extra shares of common stock as their price protection.
In the case of broad-based weighted average, the idea is to lower the original conversion price to a number somewhere between itself and the new price per share based on a weighted average of the shares issued in the down round and the number of shares that would have been offered if the round had been at the price of that investors round.
And now for the fun part – Algebra.
The formula to calculate the conversion rate is:
((Fully Diluted Shares pre-down round + Shares issuable if investment had been at higher round price) / (Fully Diluted Shares pre-down round + Actual shares issued in down round)) * Original Conversion Price
In our example of NewCo, Inc, the new conversion factor is calculated as follows:
(10,000,000 shares + 1,000,000 shares)/(10,000,000 shares + 2,000,000 shares) * $1 = $.92
- The 10,000,000 shares is Fully Diluted Shares following the Series A, all common shares help by founders and employees, all allocated in the option pool and all preferred shares help by investors.
- The 1,000,000 shares issuable is calculated based on if the investment had occurred at the Series A price by dividing the $1 million new investment by the Series A price per share which was $1.
- The Actual shares issued in the down round are calculated by determining the price per share ($5,000,000 pre-money valuation divided by 10,000,000 shares outstanding) of $.50 and then dividing the investment amount by the price per share ($1,000,000/$.50) which equals 2,000,000 shares issued in the down round.
- The $1 is the Series A price per share and conversion price.
As a result, the 4 million Series A preferred shares would eventually convert by dividing the total numbers of shares by the new conversion price.
4 million shares / .92 = 4,363,636 shares.
The 363,636 additional shares is the result of the Anti Dilution protection for the series A. In summary, the idea for a broad based weighted average anti-dilution is that investors get some protection based on the weighted average of all the shares in the company on a fully diluted basis. Of all the alternatives, this is the most reasonable and desirable for the company.
What are the Twists?
First, if there is more than one round of funding prior to a down round, then each round would go through a similar calculation. The difference being the “Shares issuable if investment had been at higher round price” uses the price for each round. This is not really a twist but causes further dilution as each round gets a new and lower conversion price.
Secondly, you will sometimes see something called “Narrow-based” weighted-average. These are far less typical and the difference is basically that it excludes unexercised options, warrants and the like. As a result, the new conversion rate is lower and more favorable to investors than broad-based weighted-average formulas.
Rachet and Clank
Lastly, there is the dreaded Full Ratchet. This is much simpler to explain yet thankfully in only about 5% of all term sheets though it was in 10% of 2008 down round term sheets (Again all data from Wilson Sonsini). How this works is that the lower price of the down round simply becomes the new conversion price. In our example, the Series A investors would convert at $.50 per share instead of $1. This means they would end up with 8 million versus the 4.3 million shares under the broad based weighted average. (4 million shares divided by .5) Clearly this is painful and it’s not that common because it dilutes the founders and employees to a point, that it’s not in their interest to stay for the long term as their stake is no longer meaningful.
Additionally, the earliest investors avoid using this because it may never benefit them and if the down round is higher than the Series A price, it may only cause dilution for themselves.
Summary
This has been a long post with lots of math so thanks for hanging in there. In summary, most every term sheet has Anti-dilution. If you can, focus on getting a broad based weighted average formula and then make sure you execute well so that this never comes into play.
UPDATE: Posted the next in the series Startup Term Sheet – Voting Rights and Protective Provisions
Please feel free to leave a comment or ask a question if something does not make sense.
And of course, if you like this, please share it with friends using the buttons below. Lastly, if you want an update for the next post, sign up below or follow me on twitter. Thanks.
More info and References
- Startup Term Sheet – Valuation and Dilution
- Startup Term Sheet – Liquidation Preferences
- Download sample Startup Term Sheet from National Venture Capital Association
- Wilson Sonsini Term Sheet Metrics
- Rachet and Clank picture copyright Sony Computer Entertainment
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Startup Term Sheet – Liquidation Preference
This is the second post in a series attempting to demystify startup term sheets. If you have not read the first post about Valuation, you can find it here.
Startup Term Sheet – Talking Stock
As mentioned in the previous post, a venture capital term sheet is a letter of intent that outlines a potential investment in a startup. The first and usually most debated item is the valuation as it has the largest effect on the dilution or amount of ownership you give up in order to receive funding. Once you agree on valuation (while keeping in mind the option pool twist), it’s important to understand what you have actually sold.
As in the public stock markets, you are basically selling shares of ownership. In the case of a traditional venture capital investment, each “round” or time you raise venture funding is typically referred to as a “series” and labeled alphabetically. A first round is typically referred to as a Series A, and subsequent rounds as B, C, D and so on.
Additionally, the shares sold to investors are “preferred stock” as compared to what is called “common stock”. Common stock is what founders and employees receive. Preferred stock is given to investors as a result of providing large sums of capital and they therefore receive various preferences over the common stock holders. These preferences include liquidation, dividends, unique voting rights, veto rights, and various other protections that will be discussed in future posts.
In exchange for the additional preferences, the price per share of preferred stock is typically greater than that of common stock. This lower price is why founders and employees can typically purchase shares in an early stage company for pennies per share. The price differential is changing somewhat with new accounting rules but more on that in a future post.
This post will review Liquidation Preferences, which are potentially the most dilutive preference to the common shareholders after the valuation and option pool size.
Liquidation Preferences – What’s the big idea?
Startup term sheet Liquidation Preferences sound like a preference for who has the right to drink from the water cooler first. And metaphorically, that is correct. Liquidation preferences provide that upon a sale of the company, the preferred shareholders are paid before the common shareholders are paid anything. In other words, they drink first from the proceeds from a sale of the company.
The simplest and most desirable liquidation preference for founders and startup CEOs is an amount equal to the amount invested, also know as a “1X Liquidation Preference”. This preference basically says that the investors get their money back before anyone else. That is of course assuming there are no creditors.
Let’s go back to the example from the first post on Valuation. In that example, Series A preferred shareholders paid $4 million to invest in the company. In the case of a 1X liquidation preference, the preferred shareholders would receive their $4 million before any of the common shareholders receive any payment for their ownership.
If for example, the company is sold for $5 million, the preferred shareholders would receive $4 million first and the remaining $1 million would be split across the common shareholders – even though the common shareholders may own a greater percentage of the company.
Let’s look at an example of what would happen if the same company is sold for $50 million. An additional right of preferred shareholders is that they can convert their stock to common stock at any time. In this example, it is more beneficial to convert their preferred shares to common. Instead of simply being paid back their $4 million, they would convert their shares to common stock and instead receive their 40% ownership portion of $50 million for a total of $20 million (assuming all the option pool shares have been issued).
What’s the twist?
This seems and is actually a pretty reasonable right. The investors put up the money, which was presumably used to pay out salaries to the team, and therefore the investors should at least get their money back first. And generally, a straight 1X Liquidation preference is what I advise founders or startup CEOs to accept.
However, there are two Liquidation Preference twists for which to watch. The first is a multiple greater than 1X and the second is called “participating preferred”.
First Twist
Sometimes investors will ask for a multiple greater than 1, for example a 3X Liquidation preference. In our example, this means, that investors would get $12 million of any company sale before any of the common shareholders. Therefore, this is dilutive to the common shareholders for any sale of the company for less than $30 million as that is when it is beneficial for the preferred shareholders to convert their stock to common and participate based on their ownership. The basic math being 40% of $30 million equaling $12 million, which is 3 times, the amount invested in the series A.
Often times this will be used in the case that investors want to ensure that the founders and startup CEOs are incented to focus on long term value creation versus “flipping the company” for a smaller amount earlier. It is also commonly used in later rounds of financing where the valuation has increased significantly and the investors in those rounds want to ensure some level of return.
In general, it is beneficial to have all the preferred shareholders use the same 1X liquidation preference especially since investors typically have preferred voting and veto rights for a potential company sale that will be discussed in a later post.
Second Twist
The second twist for liquidity preferences is called “participating preferred”. This right allows that investors not only get paid their liquidation preference multiple but then can also participate in the payout of what’s left as if they had converted to common stock. That’s right, they get their liquidation preference multiple such as a 1 or 2X liquidation preference and then also participate on an “as converted basis”.
This is referred to as double dipping since they participate as preferred shares and also as if they converted to common stock. This is very dilutive since it means that effectively the preferred investors get a share much greater than their actual ownership. If investors insist on this, it is common that there is a price for the sale of the company at which this right goes away, for example a sale of the company for $100 million or more. Yet I strongly encourage that participating preferred should be negotiated out and avoided whenever possible.
Keeping It Simple
One of the reasons many term sheets today are 1X liquidation preferences with no participating preferred is because investors in early rounds of funding, are often not the primary investors in future rounds. And as a result, if a Series A investor gets aggressive liquidation preferences, then future investors will ask for the same if not even more aggressive terms which may ultimately hurt the early stage investors in addition to the common shareholders.
Therefore it’s best to keep it simple and have all preferred shareholders with a 1X liquidation preference and to be treated equally regardless of when they invested. The concept that all preferred shareholders have the same right is a legal term referred to as pari passu. If you can negotiate a 1X Liquidation Preference, with NO participating preferred and treat every Series on a pari passu basis, you are getting very reasonable terms. And as mentioned in the last post, the way to ensure reasonable terms is to have multiple potential options for investment. The more bidders you have, the more clean your term sheet will be. Stay tuned for the next post on Anti Dilution Provisions and Dividends.
And please leave a comment or ask a question. And of course, if you like this, please share it with friends using the buttons below.
Lastly, if you want an update for the next post, sign up below or follow me on twitter. Thanks.
UPDATE: Continue reading the next post Startup 126 – Term Sheet Anti-Dilution
Other links and references
Startup 124: The Term Sheet – Valuation and Dilution
Download sample Term Sheet from National Venture Capital Association
Drop In Dime Photo by Chaval Brasil
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Term Sheet – Valuation and Dilution
Lots of folks have asked a very common question about startups: “What is a Term Sheet and what do all the terms mean?” In general, a term sheet is a non-binding letter of intent that outlines a potential investment in a startup. Since there are lots of terms as part of a term sheet, I will break the discussion of the terms into multiple posts to get the content out more quickly and in smaller digestible chunks.
Term Sheet – What’s the Big Idea?
Before jumping into post-money valuations, liquidity preferences and other legal mumbo jumbo, you must first decide whether you want to go down the path of taking venture capital.
The main reason to raise venture capital is because you need money to get your company off the ground or your growth is significantly constrained by not having more cash to invest. Put more simply, cash is the biggest inhibitor to your company growth.
It turns out that in some cases, you are better off growing your business organically especially in the current world of web and software as a service in which the needs for cash are dramatically lower than ever.
The Flip Side
Of course, just because you need money to grow, it does not mean that venture capitalists will want to invest in your company. Not only do you need to decide if you need funding but you should also do a gut check on if your company is right for the venture business.
At the end of the day, venture capitalists want to invest in great teams going after billion dollar markets through which they can return 5-10 times their investment. If you cannot convince a venture capitalist that your idea will achieve these results, then trying to raise venture capital is an exercise in futility.
Startup Term Sheet Basics
But let’s assume you are a good venture capital opportunity. To start, a startup term sheet is just that, a sheet of usually only a few pages with various legal terms that serve as an outline for an investment in your company. Other than the confidentiality of the term sheet itself, it is not a legally binding commitment to invest. It is basically a letter of intent. This point is very important to remember. Getting a term sheet does not guarantee your funding since it is not a legally binding obligation to invest, but it is usually a big milestone towards completing a round of fundraising.
Give to Get
To get venture funding, you have to “give to get”. And your “give” is some amount of ownership and control of the company. The question of how much ownership and control is the essence of the term sheet. This first post will deal with the question of valuation and ownership. I will get into the topics of control in future posts, but it is important to remember a term sheet is primarily about legal control versus actual control. (Read Control Freaks Are Us on how success is the best way to stay in control.)
Ownership and Valuation
While VCs use terms like pre-money, post-money, option pools, etc, the general idea for valuing and subsequently selling a portion of your company is quite simple yet with one important twist. A VC offers to buy a percentage of your company at a certain price and valuation. The price they pay is determined by first figuring out what is referred to as the “pre-money valuation”. On the simplest (though not completely accurate) level, this is how much the company is worth before the investment. This is best illustrated with an example.
Let’s say you are running NewCo, Inc. and want to raise $4 million. If a VC wants to invest $4 million, they may offer to value the company at $6 million. The $6 million is what is referred to as the pre-money valuation.
Post Money Valuation
The post-money valuation is, as you probably already guessed, the pre-money valuation plus the amount that gets invested. In this example, it is a pre-money valuation of $6 million plus the $4 million investment that results in a $10M post money valuation.
Pre-money valuation + Investment = Post Money Valuation
So What Did You Have To “Give To Get”?
The first thing you have to give is some amount of ownership in exchange for the investment. This is similar to an initial public offering in which a company issues new shares that are bought at a certain price. The amount of the company you give up is referred to as dilution. To figure out the dilution those with some good math skills probably divided the amount invested by the post money valuation and it would seem you gave up 40% of the company for $4 million dollars, right?
Amount Invested/Post Money Valuation = New Investor Ownership %
$4,000,000/$10,000,000 = 40%
The Twist
Well, there is one twist that complicates this. That twist is called the option pool. The option pool is a set of shares that will be issued in the future to new employees, board members, advisors and others. And the way traditional Silicon Valley style investing works, VCs require the option pool for these future grants to be part of the pre-money valuation.
As a result, by having more shares, which no one currently owns, included in the pre-money valuation total the VCs lower what is the true valuation of the company before the financing. You are probably thinking, “Wait, say that again? The pre-money valuaton is not really how much the company is worth?” Yes, that’s correct and let me explain in more detail continuing with the previous example.
In the case of NewCo, Inc, the investors offer to invest $4 million at a $6M pre-money valuaton. In addition, the investors require the very typical early stage company option pool equaling 20% of all the shares issued to founders, employees as well as to the investors following the financing also known as the fully diluted number of shares.
That means that instead of splitting the $6 million pre money valuation evenly across all the existing company share holders (founders and employees), it is split between all the existing shareholders such as the founders and employees as well as the shares in the option pool set up for future use.
Below is a table which compares what happens to ownership stakes both without and with an option pool.
Ownership Without an Option Pool Ownership With an Option Pool Existing Shareholders 60% 40% Option Pool 0% 20% Investors 40% 40% Post Money Total 100% 100%
As you can see, the True Valuation (this is my term and not a common term used by VCs) is actually $4M before any effect of the financing which equates in this example to 60% dilution when you count all the shares being issued for the option pool. In other words the calculation should be as follows:
True Valuation + Option Pool Valuation + New Money = Post Money Valuation
$4M + $2M + $4M = $10M
The term should actually be the “pre-money, post option pool valuation” but at least now you know what it really means. When evaluating an offer for investment, be sure to calculate the option pool to determine how much ownership you truly give up, which is the company’s dilution.
Now many of you are probably thinking, “Well, why don’t we include the option pool afterwards?” This is one of those things that simply put “just is”. It’s the way terms sheets work and you should not spend time trying to change this. The place to focus your negotiation should instead be on maximizing the pre-money valuation and managing the size of the option pool to accurately reflect the future needs to distribute shares.
The Art of the Deal
Some of you are probably thinking, “Great, so not only am I totally confused by all this math, but you have not helped me to figure out how to maximize the valuation of my company!” Unfortunately (or fortunately?), there is no magic formula. It is part science but also lots of art.
The science part is that most VCs look at what has been accomplished at the current stage of the company and have valuation ranges for each stage. The further along you are and the more traction you have, then the higher your valuation.
The art part is economic supply and demand driven negotiation which occurs between the startup and VCs. The greater the perceived demand to invest in what is a fixed supply of your company will increase the valuation.
Therefore, the key to maximizing your valuation is first to demonstrate why you have the best team to solve a problem and then to get as far along in terms of customer, product and market leadership. This will help to maximize the investment demand from a set of great investors. The more investors that are interested in what is a fixed supply of your company will result in a higher valuation. You should not go talk with every VC under the sun, but start with a focused set and work to get several of them to put forth term sheets.
Interestingly, getting a term sheet from one VC can often trigger more demand from others. A few years ago, a friend of mine made this cartoon that jokingly illustrates this point. Experience has shown that once you have multiple term sheets, you are in a much better position to maximize the pre-money valuation with the knowledge of what is the true money valuation of your company.
http://thevc.com/strips/strip08.html
The next set of posts will cover startup term sheet items regarding control such as liquidation preferences (UPDATE: The next post Startup Term Sheet – Liquidation Preferences is posted!), board of directors, and others. If you like this and want an update for future posts, feel free to sign up below for email updates or follow me on twitter. And of course, if you like this, please use the links below and share it with a friend.
Lastly, feel free to leave a question or comment if this does not make sense. Thanks for reading.
UPDATE: I’ve posted a valuation and dilution calculator that should help make this A LOT easier!
Reference Materials
- Startup Term Sheet – Liquidation Preferences
- Startup Term Sheet – Anti-Dilution
- Startup Term Sheet – Voting Rights and Protective Provisions
- Startup Term Sheet – Dilution Calculator
- Download sample Startup Term Sheet from National Venture Capital Association
Previous post Control Freaks Are Us on how success is they key to control
Check out thevc.com for more comic stip humor on raising money
Money picture by TracyO
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Startup 123: Another Reason Startups Kick Corporate Butt
As a previous post discussed, some of the reasons startups win are people, freedom and failure. In addition to these cultural differences, there are some inherent challenges for “entrenched” companies which startups often exploit to ensure their success. One of the challenges (among others…) is that entrenched companies have a set of assumptions that become out of date and incorrect. That often leads them to confuse the product they provide with the value customers perceive. And as a result, they become blinded by their existing business model success until it’s too late.
It’s 2am, do you know what business you are in?
What does it mean to confuse your product with customer value? Basically, companies assume the product or service they currently manufacture or provide is what customers want. However, customers don’t want products perse, they want a solution to a problem. And when a better solution in the form of a different product or service becomes available, and I am not talking about a slightly better solution, but an order of magnitude change in benefit of a new solution, they are often ignored or dismissed by the entrenched players because they assume their successful business will continue based on the product they currently offer. This idea of assumptions about a product and business is similar to many that Peter Drucker refers to as the theory of a business. (You can buy the HBR article The Theory of the Business
This is not a recent business phenomenon. In 1900, there were 7,500 companies in the US selling horse drawn carriages. Those companies sold 1,500,000 carriages for a total of $121 million in sales. Does not sound like much does it? Only .6% of US GDP. Miniscule. But what if I told you that in 2007 new car sales were in the range of 1-2% of GDP? Horse carriages were actually a pretty big business.
So why does this happen?
It’s simple – the horse drawn carriage companies assumed they were in the business of selling horse drawn carriages and probably even dismissed the idea of the automobile – until it was too late. In reality, they were in the transportation business and their assumptions of what that meant and what were their core competencies were no longer valid. It’s a common problem for any entrenched company.
Of the 7,500 carriage makers, there were only two that made the shift to providing cars – Studebaker, who was making six carriages a minute in 1880, and Flint Wagon Works, who bought a company called Buick – which was a failing startup at the time.
(As an aside, I learned that Studebaker’s first two years of production were actually electric cars and Buick is failing again - Interesting? Yes, but I digress and you can read more about my thoughts on the car companies here)
Transportation was already a big business but the assumptions around the technology available to solve the problem changed. This is a classic reason why entrenched companies fail and startups succeed.
This is the challenge we see today for the newspaper industry. They built their business around, well, newspapers – the printing and distribution of newspaper. Think about the slogan for the NY Times “All The News That’s Fit To Print.” Printing is in their company mission. It’s part of their DNA. Yet, the internet has changed all that. Their value is providing news. And in the case of newspapers, not only is the internet an order of magnitude better distribution model than printing (real time, no geographic limitations, etc.), but it also turns out to be an order of magnitude less expensive which which is another assumption that has radically changed their business and that of many others.
Companies need to know their true business and as changes occur, keep checking their assumptions on what they provide to solve a problem or even if the problem continues to exist. The value is not necessarily the product they sell as was the case for customers of horse drawn carriages or the way in which people consume news today.
Lesson for startups
If you are a startup and you can find a a solution which radically changes the economics (and assumptions!) around an existing problem, then you have a great chance of succeeding because it will take awhile for the entrenched players to realize their assumptions are no longer valid. Your biggest threat from the entrenched players will most likely be they acquire one of your competitors. It’s not likely that the entrenched player will act fast enough to compete directly with you. And that’s the bar to hold yourself to, radical change to the assumptions of a business, because the flip side to this is that if your new assumptions are only a little better, then you’re unlikely to succeed.
If you like this, please click on any of the links below and please share it with a friend. I appreciate the support. And of course, feel free to sign up for email updates of new posts or follow me on twitter. Thanks.
Related posts and references
- Previous posts – Why Startup Innovation Kicks Corporate Booty and What if GM was a Startup?
- The Carriage Trade By Thomas A. Kinney
- Various data sources: http://www.measuringworth.org/datasets/usgdp/result.php# http://www.bea.gov/index.htm BTW, my new car sales as a % of GDP estimate excludes trucks
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Startup 122: Speech – The Final Frontier
OK, I’ll admit it. I am psyched to see the new Star Trek Movie. Check out the new preview. This is clearly not your Father’s Star Trek…
But what does Star Trek have to do with startups? It turns out that Star Trek has successfully “predicted” quite a few modern day inventions. The most famous being the Communicator and the Cell Phone.
Yet even with all this forward looking Star Trek technology, what we never saw on The Enterprise are the crackberry, text messaging, facebook updating, tweetering, iphone addicts we’ve become. Look around and what do we do each day instead of talking?
Lots and lots of email. Text messaging. Maybe a few instant messages and skypes. Throw in a few facebook updates. And then of course some Tweets about, well, the most random of things.
While Twitter is certainly an interesting phenomenon, in many ways it is causing people to forget one of the most important ingredients for a successful startup (or any organization for that matter).
That ingredient is simply speaking to one another.
Yes, the final frontier is taking people back to the future of sitting down face to face, one on one, or as a team, or worst case using the phone to actually speak versus texting, emailing or twittering the days away.
Why is this important?
One of the best ways to have an engaged and productive team is for them to understand and be part of a team’s success. Engagement happens when you speak to the team, answer questions on why something is important versus other ideas, discuss what’s working and what’s not and what the team needs to do to succeed long term. Engagement does not happen with a quarterly email or 140 character update. Those are important elements of communications, but nothing can replace the importance of having an open forum and interactive discussion with your team about what are the team’s wildly important goals, its strategies for how to achieve them and discussion about how well the team is achieving against a set of measurable objectives. (See previous post on goal setting)
What to Share
In general, it’s important to share everything -- the good, the bad and the ugly (Ok, I promise last movie reference…). There are really only a few things I would never discuss openly with the team. They are things such as performance reviews, any health or other private matters, or compensation information. Additionally, there are certain things that are simply illegal to cover such as an acquisition by a public company or other financial information that could be used for insider trading. Other than those two big buckets, there are not many “off limit” topics.
As part of that, one of the things I encourage people to do is regularly share a startups financial results. It is incredibly empowering to a team to see the cash flow chart and the date it hits $0. While it may make the team nervous, maybe not knowing will make them even more nervous? And maybe knowing will actually have the team work either smarter or harder to change the trajectory? And if you also share the top line results, everyone gets engaged in the competitive thrill of making the company a success.
I am often surprised at how few leaders regularly share this information so please don’t be afraid to share more than less. The flipside is that if you don’t share, the team will likely assume things and they usually assume the worst.
Playing the drums
Larry, a great friend and incredibly talented business executive, always talks about setting a rhythm for the business. He taught me to set expectations and have a regular pattern in the company for things such as business reviews. I extended this idea to communications as well.
For Vontu, my rhythm for communications was each week started off with a team meeting of my direct reports during which we reviewed key updates starting with the team, and then sales, development, et al. This was a small meeting of ~10 people during which we could openly discuss the successes and more importantly the challenges we were facing in the business.
Also, each week I worked hard, especially as we got more and more busy, to have one on one meetings with each of the senior executives on the team. This is probably one of the most difficult things to maintain, as we were all busy and traveling hundreds of thousands of miles each year. If I could not meet in person due to travel, then this often times became a phone call.
Lastly, each week we had a one-hour all hands meeting for the entire company. People in the field would call in and everyone in the office would meet in a big conference room. This was an opportunity to introduce new people that joined the company, share any other people news, to review our wildly important goals such as sales, customer success and then often to discuss a special topic on an aspect of the business. The meetings were very interactive with lots of questions and discussions. Informally, I would also spend time each week simply walking the halls and talking with people.
The other big communications opportunities typically happened on a quarterly basis. Each quarter, we flew the whole company to San Francisco for training. As part of that we had everyone together for an all hands meeting in which I presented how well we had done in the quarter, what the top challenges for the company were, and tried to generally get the team engaged about our future. This ended up being a 2 hour session with lots of Q&A which often including the rest of the executive team. This was one of the best opportunities to make sure everyone knew what were the 3-5 wildly important goals and how well we were doing.
Like a great drummer which keeps the beat, a good leader keeps the rhythm of the company by setting a tempo of regular communications.
When in Doubt
Now, I am not suggesting all communications is about sitting in a room singing Kumbaya. As a matter of fact, one of the most important times for face to communications is in dealing with difficult situations and conflict. Let’s face it, it’s uncomfortable to tell someone you are frustrated, disappointed, unhappy, or even downright angry. And so today, it is amazing how often people revert to either doing nothing or sending the dreaded “flamagram”. It is much easier to tell someone bad news or deal with conflict over email because you don’t have to look them in the eye and deal with their reaction. Yet, as a leader, you should avoid this at all costs. And if you see others engaged in using email to deal with conflict that typically only causes more conflict, encourage people to move to a face to face communications.
What about the rest of my job?
Now if you add up all this time, communications takes up 25-40% of your work week. Does this seems like a lot? It is, but at the end of the day, if you are leading a team, your job is just that, to lead. And to lead you need followers. The best way to get followers? Tell them where you are going and ask them to join you in the journey. And remember to not just email, text, IM, or twitter your updates. Take the time talk.
And if you like this post, talk with your friends about it or tell them about it by twittering or using any other one of the links below. And feel free to leave a comment or two.
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Drummer photo by Bill Gracey
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Startup 121: Lessons for the Recession from Rice Krispies
The past few months have been, how shall I say, pretty crappy and have caused lots of cut backs for most startups (and companies of every size). Mostly, this has meant laying people off, cutting expenses, and generally “battening down the hatches to weather the storm”.
I randomly had several conversations with people on the topic of what a startup (or any organization) should do in times like these and some basic things came up each time:
- Measure to manage
- Mix it up
- Take calculated risks
Measure to Manage
Today, months into this recession, no one would argue that the economic outlook is negative. However, often times forecasting is challenging to say the least and usually only accurate in hindsight. I used to joke with our Board whenever I presented a financial plan that the only thing I could guarantee was that we would miss the numbers. That did not mean the results would be worse, but that I was positive we would not hit the plan to the penny. We would be roughly right, which in the words of Kenyes, is better than precisely wrong.
By Darren Hester
It turns that we were in good company as the record for long term forecasting of macro economic indicators by the “experts” is actually only roughly right in the near term and not so predictive in the long term. Just like a startup’s financial plan.
The Federal Reserve released a paper at the very beginning of the recession (coincidence? conspiracy? hmmm…), which analyzed historical accuracy of past economic forecasts such as the Gross Domestic Product (GDP see wikipedia).
OK, I admit, it’s little nerdy thinking that others would be interested in Average Root Mean Squared Forecast Errors but…
The report basically shows that most forecasts of growth are only good one or two quarters out, and beyond that, “…uncertainty about the economic outlook is considerable.” So if it’s hard to forecast a problem, what should a startup do?
In today’s world, measuring things is actually easier than it has ever been – Page views, Click Throughs, Conversion Rates, Leads, Registrations, Trials, you name it. Startups are actually pretty good at using data and all should have a set of good metrics to manage their business (See previous post If you don’t know where you are doing, well you’re lost).
In a startup this is usually easier than for big companies, but on a business by business basis, this should be possible even in the largest of companies but is something most don’t do well or at all. And it’s another reason why startups kick corporate booty. Let’s face it, startups are, well, smarter.
Now, all that being said, metrics need to be leading indicators for what will likely happen in the future as opposed to only lagging indicators. At Vontu, since we were doing enterprise sales (i.e. 9 months average time from a first prospect meeting to closing a 6 or 7 figure deal), even after having some of our best quarterly sales results, which is a lagging indicator, we were worried about the future because leading indicators, such as product evaluations (or as we called them, risk assessments), were not tracking to our historical averages. Team attrition is another example of a lagging indicator of a problem, that is to say if people are leaving, the problem already exists.
Now it sounds like I am talking out of both sides of mouth. And I am. Even though the Fed is not good with long term forecasting, having 6 months of visibility is still better than none. To know you have a problem (or an opportunity as the case may be), one can not focus enough on leading indicator metrics. And if you did not have the right metrics in place at the start of this recession, consider putting them in place now as you will also be a step ahead in predicting when to accelerate investment as things improve.
Mix It Up
Most startups (and large companies) made big people changes over the past 6-9 months typically in the form of cost cutting and layoffs and sometimes quite significant layoffs both in numbers and percentages. While layoffs are big changes affecting the lives of many people yet help in improving the health of the company for the short term, they are not about dramatic changes in leadership for the long term.
In my opinion, down turns are as good a time as any to make dramatic people decision that you have either been dreading or avoiding for whatever reason. First, there is already so much disruption that throwing some more into the mix won’t make much of a difference. Secondly, it is somewhat easier to hire great people given the macro-economic turmoil and increased unemployment. And lastly, everyone on the team already knows who is not performing. You as a manager and leader are usually the last to acknowledge the problem, yet the team expects you to make these tough calls.
Expectations for business results are low today so take the time to make the big people changes and if things get a little messy in the short term, but it’s all relative to the ongoing mess which already exists. And who knows, they may actually be better too.
Take Calculated Risk
My friend Phil forwarded me the New Yorker article “Hanging Tough” by James Surowiecki about what strategy some companies followed during the Great Depression. An example used two competitive cereal makers, Post and Kellog, and how chose very different market responses. Post did the standard cost cutting, yet Kellogg invested in advertising and new products and as a result, “Snap, Crackle, Pop!”, Kellogg became the dominant player it is today. For the same reasons it is a good time to start a company today (less competition, easier to hire, leverage the inevitable economic upswing), companies should be thinking about investments to be made today as the economy is at its lowest point.
In general, if one keeps an eye on the long term, one should always be making investments. Unfortunately, as the New Yorker article suggests, uncertainty overtakes risk taking. This short term uncertainty causes people to focus on what they can control, e.g. costs, as opposed to making smart investments for the future.
Yet history has shown that even during the Great Depression, companies that made good investments did well. Even the stock market came back more quickly than people remember.
At a recent presentation by Professor Jeremy Siegel from Wharton, he had a slide which stated, “On average, for the seven largest gaps [in performance relative to trends] over the past 145 years, the market has rallied 24% in the following year, 21.4% per year over the next 3 years, and 18.4% per year over the next five years.”
As suggested in the New Yorker, while most people are “battening down the hatches”, you might want to invest as the others might actually just might miss the boat.
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Econ 120: What Taxes and Splitting the Restaurant Bill Have in Common
Since it’s tax day and all, I figured why not post something that I am sure will spur lots of conversation (or maybe controversy?)
There are so many (mis?)perceptions on the tax system, I decided to get some facts about how it all works, or at least, to see what of the rhetoric is true. In particular, in most of the press and political speak out there, the common perception is:
- Tax cuts only benefit the “rich”
- The “rich” actually pay fewer taxes
Darren Hester
Now, without commenting on what the tax system should look like I figured it would be interesting to share a funny story to help explain why people perceive the first point and then share some data from the Congressional Budget Office on whether the the top income earners actually pay fewer taxes. (By the way, I am a first generation American and the son of Italian immigrants. My grandfather came through Ellis Island when he was 16. In other words, I come from very humble beginnings and I figure that might help in any emotional responses this post might trigger.)
Splitting the dinner tab
The following is a story about if we split the dinner tab like we split the tax burden and helps explain the misconception that tax cuts only benefit the wealthy. This parable has floated around the internet in various forms and no one is sure of its true origin though some trace it back to Don Dodson and a letter to the Chicago Tribune. Anyway, the story goes like this.
Suppose that every day ten men go to a restaurant for dinner. The bill for all ten comes to $100. If it was paid the way we pay our taxes (Editorial: this is not exactly how we pay taxes as you will see below, but its generally indicative of how it works), the first four men would pay nothing; the fifth would pay $1; the sixth would pay $3; the seventh $7; the eighth $12; the ninth $18. The tenth man (the richest) would pay $59. The ten men ate dinner in the restaurant every day and seemed quite happy with the arrangement until the owner threw them a curve.
0 + 0 + 0 + 0 + 1 + 3 + 7 + 12 + 18 + 59 = 100 cost of dinner
“Since you’re all such good customers, he said, I’m going to reduce the cost of your daily meal by $20.” Now dinner for the 10 only costs $80.
The first four are unaffected; they still eat for free. Can you figure out how to divvy up the $20 savings among the remaining six so that everyone gets his fair share? The men realize that $20 divided by 6 is $3.33, but if they subtract that from everybody’s share, then the fifth man and the sixth man would end up being paid to eat their meal.
The restaurant owner proceeded to work out the amounts each should pay under the same assumptions: Now the fifth man also paid nothing, the sixth pitched in $2, the seventh paid $5, the eighth paid $9, and the ninth paid $12 leaving the tenth man with a bill of $52 instead of $59. Outside the restaurant, the men began to compare their savings. “I only got a dollar out the $20,” complained the sixth man, pointing to the tenth, “and he got 7!”
0 + 0 + 0 + 0 + 0 + 2 + 5 + 9 + 12 + 52 = 80 reduced cost of dinner
“Yeah, that’s right,” exclaimed the fifth man. “I only saved a dollar, too. It’s unfair that he got seven times more than me!”
0 + 0 + 0 + 0 + (-1) + (-1) + (-2) + (-3) + (-6) + (-7)= (-20) savings on dinner
“That’s true,” shouted the seventh man. “Why should he get $7 back when I got only $2? The wealthy get all the breaks!”
“Wait a minute,” yelled the first four men in unison. “We didn’t get anything at all. The system exploits the poor.”
And that is why there is a perception that tax cuts benefit the highest income earners versus the lowest quintile. It’s because the percentages are already progressive, that is that the highest income earners pay a greater share of tax as well as a greater percentage of their income.
Just the facts
I am sure some of you are saying, “that’s not true” or quoting Warren Buffet who said something to the effect that his tax rate is lower than that of his secretary. Now I don’t know about Warren’s tax rates, but I figured a few charts would at least get the facts out there.
All the following data is from the Congressional Budget office using the latest tax year made available which is 2006. The data goes back to 1979 for folks that are interested. Links to everything are at the bottom of the post.
To start, I wondered what is the effective tax rate for various income levels. Do the rich pay a lower tax rate as Warren Buffet suggests?
The first chart is the Effective Tax Rate for all federal taxes paid (Income, Social Insurance (Social Security, Medicare, et al), Corporate Income Tax, and Excise Taxes. The second chart is just income taxes.
Effective Federal Tax Rates (2006). Source: Congressional Budget Office
Effective Federal Income Tax Rates. Source: Congressional Budget Office
I think the data shows pretty clearly, that contrary to common perception, the top income earners pay a greater percentage of their income. That is to say, the tax system is quite progressive both in total taxes and even more so with respect to income. Approximately, 40% of households pay no taxes on their income or actually receive additional money above their income.
The second question I wondered is on a dollar for dollar comparison, how do different income levels pay as a percentage of their total income. This graph is a comparison of total income earned compared to total taxes paid.
Share of Total Before Tax Income and Total Federal Tax Liabilities (2006). Source: Congressional Budget Office
This too shows how the highest quintile pay a higher share of the total tax liabilities in comparison to their income. Again, the system is progressive.
So what?
Of course the more interesting question for discussion is if this is the best and right way for taxes to work. Without tackling that question today, one other fact to share. Prior to the 16th Amendment being passed in 1916, it was unconstitutional to apportion direct taxes in any way other except equally based on the census. So is it right? Is it the best system? I will leave that for a future post but hopefully we can all start using the real facts versus common misconceptions.
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Source for chart data: Congressional Budget Office
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Startup 119: Why Startup Innovation Kicks Corporate Booty
I recently had coffee with David, a friend from college that was an advisor at Trio Development and an early employee at Connectify. As he now works in the incubation group of a large enterprise software company, he was lamenting about how hard it is for large corporations to innovate. That got me thinking about what it is about startups that leads them to “out-innovate” large corporations.
It ain’t about the technology
To start, I believe innovation is simply about creating significant new value though some combination of unique products, processes, and services. I do not think innovation is solely about creating new products or technology. That is simply invention.
While I am not an innovation scholar, my experiences suggest that innovation happens more easily inside of startup because they tend to have the right combination of:
- People
- Freedom
- Failure
It’s the people, stupid
Startups out innovate first and foremost because they build a complete team of dedicated individuals that eat, sleep and breathe the startups goals, which frequently include a goal to kick a large corporation’s you know what.
A complete team means “customer success oriented” engineers and product managers who spend lots of time working directly with customers; “take no prisoners” marketing people that are all about getting the startups message out and driving customer demand; “meat eating” sales people that make their quota solely on the success of the startups innovation; support and services people that are maniacally focused on making customers successful; human resources teams focused on hiring and engaging the best and brightest; and so on through the rest of the startup. It is also about a culture that is centered on the process of innovation as opposed to the vast majority of people in a corporation that are about the existing status quo.
Unfortunately, it seems that most large product and technology corporations think innovation is about having a team of engineers developing some new cool thing (again, that’s invention). And the thinking goes that once that new cool thing is developed then their hundreds or even thousands of sales people and vast marketing organizations will make it successful. The truth is that this rarely if ever leads to any new high growth businesses.
Corporate CTO’s organizations tend to be very disconnected from customers and only dabble in invention. Core product development teams are focused on improving or worse, fixing, their existing product. Corporate marketing teams love peanut butter too much. Yes, peanut butter. They take their marketing dollars and spread them thinly across lots of projects with little to no strategic thinking or accountability. And sales organizations rarely know how or are incented to sell anything but the company’s best selling products. The list of people challenges to innovation in a large corporation goes on and on. And when it comes to process, the place where lots of value can be created inside of large companies, the challenges are even more immense.
Startups are successful at innovation by first building a completely dedicated, funded and accountable team which takes something all the way from product or service creation through to selling and servicing the customer. And not only is that team focused but they have the freedom to execute in the best way possible to be successful.
Freedom
Teams need freedom to re-evaluate everything about a business from people, to process, to product and services. This freedom is often to do things that are radically different and often times competitive with the status quo of existing people, process, products and services with a corporation.
Salesforce.com is a great example for why giving a team freedom is unique in a startup and and hard to do inside a large company. Salesforce.com was started in 1999 at the height of the “dot com” bubble by a group of former Oracle executives who believed in a new way to deliver software applications. They were not trying to build some new product, but rather they thought that customer relationship management (CRM) software to manage sales process and customers was best provided not as a software application but as a service. (To learn more about software as a service, here’s some info at wikipedia.)
Their whole marketing campaign in the early years was “No Software”. They used that slogan everyone from their website, to advertising, to buttons they handed out at trade shows. And they were wildly successful because the time to value versus installing the market leader at the time, Siebel’s CRM software, was much greater for Salesforce.com.
It is unlikely they would have been successful with this innovation inside of a company like Siebel. Can you imagine one of the top software companies in the world giving a team the freedom to market a new way to deliver its services under the moniker “No Software” when the vast majority of the company’s revenue came from selling software?! No way. It turns out that Siebel did try software as service when they released a competitor sales.com though it ultimately failed and Siebel was eventually acquired by one of the largest software companies, Oracle. (Interestingly, Larry Ellison, Oracle’s CEO, has been an investor in some of the top SaaS companies which compete with Oracle including Salesforce.com and Netsuite)
The inability to give teams complete freedom is one of the reasons that innovation in a large corporation is hard. Once you are successful with an innovation, for example Siebel selling CRM software, it’s hard to put your own business at risk with new innovations such as Salesforce.com selling their solution as a service. Innovation can often not only threaten but require massive change to products, people, or processes.
Startups have the freedom to do things differently and that freedom often leads to innovation. While innovation can lead to massive value creation, more often than not, efforts to innovate actually fail. And failure is another reason why corporations do not innovate well.
Failure
We all know about the successful ones – the startups that go on to create new markets, big business and often times big companies. Some that come to mind are Google, Salesforce.com, VMWare, Amazon.com, and many more. However, the fact is that for every startup that goes on to create a new market, business or company, there were 10 or 20 times as many failed startups. And this failure is needed for innovation, yet it is not something corporations are set up to do. They are not likely to take hundreds of millions of dollars and have the majority of 50 some odd projects fail with the never-ending pressure of meeting the quarterly expectations of Wall Street.
The venture capital model basically is, for example, that out of a group of 50 investments over a 5-10 year period, there will be a few if not even just one big hit that provides for the vast majority of value creation. Think Google, eBay, Salesforce.com, etc. that end up with multi billion dollar market caps. Then there will be a few successful companies that are often acquired by larger corporations for several hundred million dollars. Think VMWave which was acquired by EMC before being spun out years later, Pure Digital, the makers of the Flip video camera acquired by Cisco and even Vontu by Symantec. Then there are basically the remaining 80+% that either simply fail or somehow return some small amount of the initial investment.
You need to invest money in lots of projects and only a few will succeed. Corporations cannot typically afford to do this. Which is why the most common route for successful innovation for large corporations is through acquisition of these companies. It is far less expensive and risky to acquire an ongoing business that has proven itself then to invest in the 50 different ideas to try and find one that works.
David and Goliath
While, there are lots of other needed ingredients for innovation to occur, having the right dedicated people with the freedom to try lots of things including the ability to fail, is a key foundation for startups – and something around which corporations are not organized. This foundation is one of the main reasons startups beat corporations in the innovation game and has been the case for decades. Until corporations figure out how to replicate this, my money is on startups to be the continued source of innovation for years to come.
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Some other interesting posts related to this topic:
It’s the people, stupid and It’s the people, stupid, part II. on the importance of people.
Following the puck can give you a black eye. on competing and innovation.
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Dear Mr. President, Two Wrongs Are Still Two Wrongs
Dear President Obama,
I can only imagine how busy you are these days, so let me be get to the point.
With all due respect, two wrongs will not make a right.
By responding to AIG’s bonus fiasco with exorbitant (extortionist?) tax rates on the bonuses of employees at banks with TARP money, a second wrong will most certainly only cause more harm to our very fragile financial system. In addition, it sets a precedent of using the tax system to punitively target minority groups of our country with excessive tax rates which is a very dangerous step for the government to take.
We all agree that the situation at AIG is a mess. Any company that needs a $170 billion government bailout is certainly a mess. And without knowing the facts, it is completely understandable why paying out bonuses of more than $165 million would ignite populist rage. (Whether any of those bonuses are deserved or needed is another question, but let’s put that aside for now).
However, the current taxation proposal is simply an emotional, populist driven reaction that will cause more problems than good. One of the lessons learned from the Great Depression is that populist driven, over-reactions such as the Smoot-Hawley act, which kicked off a global protectionist tariff war, severely worsened the length and depth of the economic meltdown.
The time is now to put aside emotion, ignore political polls, and to rise above party loyalties and partisan politics.
The time is now for you to Lead this Great Nation with integrity, respect and reason.
I strongly encourage you to immediately call for a stop to this legislative process for taxing certain employees of the banking industry and declare you will Veto the proposed legislation.
Yes, this “90% taxing of bonuses” might make some people feel better, but mob “justice” is never just and in this case it will only cause more harm and here are some of the reasons why:
1. AIG is the mess so deal with AIG.
AIG needs more oversight and governance. This administration should take some additional steps to put in place industry standard norms of governance for an investor with 80% ownership. These inlude:
- Appointing a set of board members, both industry executives and bureaucrats, to represent the taxpayers/shareholders interests as would any investor with 80% ownership in a company.
- Assigning at least one of the government appointed board members to the compensation committee.
- Setting requirements that certain expenses over a threshold (say the magical “$250,000″?) require board approval.
These are some basic rules of good corporate governance that even a start-up follows and I am more than happy to suggest additional ones if anyone is interested.
2. We need the best and brightest working hard to help drive growth in our economy.
We as a nation have prospered by unleashing the creative spirits of the best and brightest. And for that work, they should be paid a wage not set by the government but by the market itself. If we limit one’s ability to receive the value for their work because they are employed at US banks that have received TARP money, then it will lead to an exodus of the best and brightest from the places we need them most. We need them working day in and day out to help turn this economy around. And in the just announced Public-Private Investment Program to deal with the illiquid and “toxic” mortgage related assets, a key goal is to enlist the financial sector in helping to solve the problem.
3. It will lead to increased de-stabilization
Based on the resulting brain drain, banks will likely move aggressively to return all the TARP money they have received. While ultimately returning the money is what needs to happen, in some cases this will probably be done prematurely which will very likely lead to further de-stabilization. This will occur for two reasons. First, the banking system will simply be under capitalized. Secondly, those banks that return the TARP money will appear as better banks and could potentially lead to a run on the rest of the banks which do not return the TARP money. This will only serve to undo the improvements that are just now starting to take hold.
4. Lastly, this is simply an attack on the very foundation of our Great Nation.
One of our founding fathers, James Madison, is quoted as saying about taxation “…a national revenue must be obtained; but the system must be such a one, that, while it secures the object of revenue it shall not be oppressive to our constituents.”
The fact is that most of the employees at US Banks that have received TARP funding are good, hard working Americans that had nothing to do with the decisions at the banks that led to the issues we have today. It’s simply wrong to target all of them with exorbitant tax rates. It is wrong for a majority of any type – gender, race, creed, sexual orientation, or economic standing – to abuse the rule of law to oppress or limit the ability of a minority to achieve their full potential. It is a populist, anger driven attack on the basic foundation of our country’s principles of life, liberty, the sanctity of property and the pursuit of happiness.
As you stated in your inauguration speech:
We remain a young nation, but in the words of scripture, the time has come to set aside childish things. The time has come to reaffirm our enduring spirit; to choose our better history; to carry forward that precious gift, that noble idea, passed on from generation to generation: the God-given promise that all are equal, all are free, and all deserve a chance to pursue their full measure of happiness
The time is now for you to Lead. I truly do HOPE you are able to not only “proclaim”, as you did in your inauguration speech, but to bring about the CHANGE which results in “an end to the petty grievances and false promises, the recriminations and worn-out dogmas, that for far too long have strangled our politics.”
Sincerely,
Joseph Ansanelli
www.ansanelli.com
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Control Freaks Are Us
Let’s face it, startup entrepreneurs tend to be “control freaks”. I certainly have that tendency (Yes, that’s right, I admit I can be a control freak!).
The fact is that when you start something, sweating the details is important. By sweating the details, you establish a culture that important details matter and also that the highest quality of execution is expected. And sometimes, when the going gets tough, digging in is important to help ensure success. We all know this will drive the team quite crazy, and you have to know when to let go go, but that is the topic for a future post…
Control Freak Remote
Control Freaks vs Venture Freaks
Now, since most of us are all card carrying members of the Control Freaks Association (and the remaining folks don’t want to admit it) one of the biggest fears with losing control in a startup comes from raising money especially from venture capitalists (VCs).
So the question is once you raise money, can you be a control freak, or at least be in control of the company’s destiny? Or will the VCs take control and end up running the company?
Deliver
Well, the answer is quite simple. Deliver the results, and you are in control. That’s it. If you want to stay in control, give your investors a reasonable plan, and deliver the results. The very last thing a good venture capitalist (VC) wants to do is run a company.
Now you may be sitting here thinking about your last board meeting when the investors were adamant about telling you what to do. And yes, many VCs have their opinions, but at the end of the day, it’s your job to deliver the results. And how you deliver the results is ultimately up to you. And if you’re right and deliver, then, well, you are in control.
But if you’re wrong and don’t deliver results, then you should expect investors will get more involved and may ultimately fire you. And truth be told, if you don’t deliver, they should fire you. Just as you should fire anyone on the team that does not consistently deliver the expected results.
“You want to do what?!”
Let me give you an example of something that happened to me. There was a time in the early days of Vontu, when we had missed our first and second quarter sales results. And not a small miss, but a big miss. At this point we had raised $15 million from Benchmark, Venrock, and USVP. Needless to say the board meeting following the close of the second quarter was a little tense. And my proposal was that we needed to invest more money in sales and marketing as opposed to cutting expenses to manage our cash.
At first this proposal was received quite coldly – to put it mildly. The general mood from the investors was to conserve our cash. Yet, I believed that the right thing to do was invest. We were getting very real and very positive feedback from the market. We had concrete data on the number of product evaluations underway. And we believed that our issue was not having a high enough quantity of prospects in the pipeline given the long sales cycle in closing large enterprise deals.
While the investors were wary, they supported the decision (or maybe they simply relented?). I knew that if I was wrong, then I would be on a much shorter “leash”, and eventually possibly be fired.
Success breeds control
In this case, we over delivered on the next two quarters and caught up to the plan. And that was the first step in building trust. Over time the investors (and board) became even more trusting as we continued to deliver the results we promised. In other words, I was in control.
Not in a negative kind of way, but by delivering results, there was trust and respect. The board and investors gave advice and support, but ultimately we controlled our destiny on what and how we would run the company.
In summary, the first step for being in control once you raise money is to deliver the results. As a matter of fact, in almost any job you have, if you deliver, then you are in control. And the fact is that VCs would rather have you deliver the results than run the company. Same for a good manager. And of course, this makes all of us control freaks a lot happier too.
That being said, there is certainly the legal aspect of control in venture funded company from voting rights, to board representation, anti-dilution et al. And that will be the topic for a future post. And of course, as I’ve posted before, picking the right investors and board members is important too.
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Information on pictures used in this post:
(out of) control freak cartoon on main page
http://www.tomfishburne.com/tomfishburne/2008/04/out-of-control.html
Control Freak Remote
http://www.mcmorran.org/pages.php?page_id=317
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