We’ve all heard about the “Half-Bill” financing rounds that have taken over the tech news wires lately. Just last week it was Ning taking in $60 at $500 pre. Before that it was Slide at $500 with $50 invested. Rumored Rockyou at $400. Glam with $85 on a $500.. And the motherlode, the Facebook quadtrillion dollar round with gazillian ruppees invested.

So whats the common theme in all the financings? A) An investment bank was involved and B) The entrepreneurs are all smiling very widely in the pictures I saw.

If this was 2000, they would have been scared shitless worrying about their participating preferred and liquidation preferences. But instead, these guys are building new houses at pebble beach and buying Euro denominated bonds instead.

So what happened? Well, a lot . . . maybe most, of these guys (and gals) cashed out. The investment banks were able to convince the so called”dumb” money (industry term, not mine. . . remember Bowman Capital?) hedge and crossover fund investors to fork over cash to the entrepreneurs for their founders stock instead of newly issued preferred sotck in the company. This means a portion of the money that was raised didn’t go into the company’s bank account but went into buying a Ferrari instead.

Just 3 years ago, it was completely unfathomable to the VC’s that anyone would allow entrepreneurs to have an “exit” before they do . . . “what happened to aligning interest,” they used to cry. Not anymore. The tide has changed. For the better or worse I don’t know; but certainly great for entrepreneurs who deserves more than what we got in the dot-com era.

Of course, all of this is done on the down low . . . without journalists asking too much questions. How would the employees feel if they found out? What would this say about the company’s prospects when the inside-insiders cash out? . . . just smile and say no comment is what I would suggest . . . or simply say “Its good to be the entrepreneur”

Great story on the founding (and funding) of Ooma. The truth is that every startup has their version of this story . . . love gain, lost, and sometime returned. The startup life is never simple . . . reading between the lines of this story you can gather the disappointment, betrayal, even now-faded anger for everyone involved. Sometimes its easy to jump to conclusion on who’s right and who’s wrong . . . but unless you’ve ever tried to start a company youself, you’ll never understand that there is no sides, no morality, no truths . . .

The herculean act of starting company is a miracle in of itself; enjoy it, revel in the experience, appreciate the people that once (and maybe still) believed in the impossibility with you. And finally learn to let “it” go . . . all the drama, conflicts, and rumors.

Thats the best advice I wished I had received almost 10 years ago. . .

Being too good looking means that no one will take you seriously plus everyone will only either want to be your friend or sleep with you. . . life will be so hard cause some regular looking people that you might like will automatically not approach you cause you are too hot . . . . So goes Jeremy Liew’s argument against entrepreneurs raising cash at too high of an valuation

Jeremy spent yesterday trying to convince the world of “Asymmetric risk and the dangers of too high a valuation”. I have to take a step back to say that Jeremy has one of the most practical and useful blogs out there for entrepreneurs, but this time I would have to disagree.

On the other hand, if she raises at a valuation that is too high, she runs the risk of a future “down round“, or even worse, being unable to raise more money at all. Valuation is always based on some combination of past performance and future potential. When valuations creep up and are based more on future potential than past performance, more pressure is put on the company to hit its potential and justify its valuation. If things don’t go to plan, when the company next needs to raise money it may not be able to justify its past valuation at all.

There is such a things as too much of a good thing. Raising too much money means that entrepreneurs might have a huge liquidation preference to deal with and the investors will have an incentive to push the entrepreneur towards taking bigger and bigger risks in order to justify the return on the huge investment. This, however, has nothing to do with “too high of a valuation.”

Down rounds happen when the companies’ current value (when the entrepreneur is looking for financing) is lower than the last time he/she raised money. Usually this happens for a few reasons

1) multiples compression of the entire industry - such as a NASDAQ crash
2) business prospects turned south for the company (revenue flat or even worse, decreases)
3) Series R+1 investor values the company at a valuation lower than Series R investor (a rare idocyncratic issue thats not really systematic)

Jeremy is talking about (3) but the solution for entrepreneurs caught in this situation is NOT to seek a lower valuation to protect one self but actually raise more money with the higher valuation.

The solution in this case, where the entrepreneur raised $1.5m at a $30m valuation, the entrepreneur should have raised around $10M instead. Thus he/she would have enough cash to run and grow the business for a while (atleast 18-24 month) to hit the next milestone (adoption, new features, revenue etc) so that the company can “catch up” and pass the original $30M valuation (or post money $40M) which is admitedly a little high for the stage. Granted, sources that can put together that amount will most likely be VC’s who would not have put the valuation at $30M so the valuation will naturally compress a little bit but atleast not because the entrepreneur decides to throw money away.

Maybe the better advice (which Jeremy might actually mean to say) is that entrepreneurs should not jump at an investor simply because of superior valuation, there are other financial terms within the investment that might be equally or more important (liquidation preference for one, implied exit multiple for another).

My general theory on raising captial goes something like this. . .

1) go for highest valuation
2) but dont be afraid of dilution, raise a much as you can
3) keep liquidation preference at no more than 1.5x - reduce round size if you have to to get this number down
4) make sure you are raising enough money to hit the next financialy projectable milestone in your projections + 6 month

if you do all 4, the final result would be that dilution would naturally be reasonable while maximizing the success rate of the company (ie there is already so much operating risk, you want to take the financial risks to zero as much as possible as long as your founders equity is protected). Also there are other sneaky terms you have to be careful about but thats outside the scope of this post

Its amazing the stuff you can find online if you just look around. Last week I was (for whatever reason) on the Khosla Ventures website and reading David Widen’s profile. One of the links I discovered on the page is a presentation regarding a market entry strategy framework called “Rifle”

The framework is somewhat similar to something I’ve seen from Bain but simpler in its data resource requirements. The framework answer the question of which segment within a market to enter, what accounts to target, and HOW to win those targeted account. It works in the following steps

1) Find the right segment within a market via a combination of easy of entry attributes (competition, product, channel, etc) and market size

2) Rank companies within attractive segments via the another set of attributes which predicts likelihood to win a deal and deal size

3) Understand each target companies ecosystem of partners and leverage existing products and existing assets

As interesting as these slides are, they lack a lot of detail on the latter part of the framework (#2, #3) . . . it looks like some slides were taken out OR supplementary material (spreadsheet? presentation notes?) missing. Would have been really helpful to a lot of entrepreneurs if these details were available somewhere.

Anyways, the website is somewhat half done (I think) so I hope David put up a more complete version soon . . . if you are going to share your secret sauce, might as well do it all the way instead of being a tease

I have a huge suspicion through out the years that VC’s tends to invest in entrepreneurs with big personalities. Those that can withstand the glare of partner meetings and talk non-stop on the phone for hours with a VC they barely know.

Buried in a great profile of Michael Moritz by The Guardian is this priceless paragraph.

Backing start-ups is high risk and Sequoia has had its failures, the most famous being Webvan, which hoped to create a business offering delivery services to retailers, and eToys, the internet toy retailer; both collapsed. While Moritz blames the demise of the former on trying to expand too quickly, he puts other mistakes down to backing the wrong entrepreneur: executives with guns in their drawers, drug habits or a tendency to try to mow down co-founders in their car.

WOW . . . I actually only know one or two person in my whole life that I would consider capable of such a behavior. To have that many (atleast 3?) in the portfolio must mean that his selection criteria might bias his group toward that kinda of behavior.

In many cases, people with big personalities can become somewhat bi-polar. They angry easily and obsess endlessly. They are often emotionally unstable, and filled with self doubt. On the other side of the coin, their tirelessness and paranoia is perfect for the improbable world of startups.

I guess in the end, if you are looking for homeruns, you go with a home run hitter who hits 50 HR a year but has a .230 batting average than go with a 5′ 7″ shortstop who slap singles all day. The strike outs on a slider in the dirt are built into the business model . . .

Graham R. Joyce over at Pragmatic Marketing (a product mangement consultancy) shot over to me a link to their latest e-book The Secrets of Market-Driven Leaders a few weeks back. Didn’t have a chance to look at it until this weekend (sorry Graham!). Take a quick scan, it has some funny anectdotes as well important lessons for product managers.

Here is the main nugget of the pdf (if you are too lazy to read).

I rarely embed pictures into my posts eventhough I should (more readers). . .but usually I’m too lazy and posting is an impulsive activity I do randomly throughout the day. But this time, I thought it was important enough to get into my flickr account and make sure this graph is in the post.

Now, ofcourse its important to be at the upper right hand side, but even more important is to realize that the green arrow ALSO represent a time axis for a startup. IE. . . startups are often first founded on (1) a technical idea or breakthrough. The MBA then comes on the team and helps put together a business plan by (2) analysis of competitors and how to position in the market in respond to those pressues.

Now here is the hard part . . . once a company is launched (already hard enough to get to the second step) , a sucessful company will move toward either of the 3 quandrants left. Most start ups, if they are lucky enough, become sales or customer driven. Being customer/sales driven (ie focusing on your CURRENT/EXISTING/ALMOST customers) is not a bad thing to do. I can only wish more companies are like that.

But, sometime in the near future for a startup to scale (or another word, to cross the chasm) it needs to focus on solving the need of its entire target market. The sales and customer driven quandrants offer Calypso-like bounties but entraps the startup in a state where it is narrowly focused on a niche and thus caught in a detour from its true mission.

Perhaps a little counter intuitive, the startup needs to be a little more selfish & strategic in its priorities. It needs to understand that Market Driven vs. Customer/Sales Driven is the difference between $50M and $500 in revenue. Of course, its hard to do, thats why most startups fail and even less become an industry changing company.

Back in the good old dot-com days, companies runtinely uses its balance sheet (more specifically its ability to raise money and put it in the balance sheet) as an competitive advantage to acquire companies that has either better traction or revenue but not the access to cash. This strategy is often used by buyout shops to roll up companies without the sophistication to know how much they are worth or the ability to put together a business plan and financial model to pitch to PE shops. As much as we would like to believe capitalism is without friction, the VC or buyout circle is small and requires specific language, behavior, and access.

A classic example of “tail wagging the dog”, by virtue of raising a ton of cashing, the cash rich venture has essentially “sucked up” all the cash that VCs are willing to dump into a space. Even if a competitor comes along and achieve better traction, VCs are loath to invest because of the cash hoard that the original company has amassed. (its like competing against MSFT vaporware in the early nineties)

Well today, Obopay acquired BillMonk. A cool little app that seemed to have gathered a small but loyal group of users. Not to take anything away from obopay, (its succesfull in its own right), this is a case book study on “throwing your weight around” to gain (additional?) traction.

Ran across a timely academic research on the first internet boom/bust - aka the “dot com” era. Goldfarb, Kirsch, and Miller has published a huge amount of material on the era. Furthermore, they are widely considered the leading business historian on the time between 1998-2004 (really between Netscape IPO and the rise of web 2.0). In fact, they are major contributors and curators to the Business Plan Archive. The 50 page report is titled Was There Too Little Entry During the Dot Com Era?.

Seems like deja vu lately with a very public discourse on the simultaneous rise of web 2.0. bubble and bust (so which is it?) between Arrington and Fred Wilson. With commentary from NYT and Zoli.

Perhaps its because the paper is 50 pages of equations, regression, and bayesian analysis; no one picked up on its publication. But I do find that it provides a eye openning analysis of the era and how we have learned (perhaps not individually but as an institution) and applied it to web 2.0.

Before I jump in, I’ll have to say that I’m biased. I had a Flatiron partner as my board member during the dot-com era. And I myself was roasted by the Fucked Company mob (sometime deservingly but other times not). I dont feel so bad now, as the Pud’s company, Adbrite, is now run by a CEO who was also tarred and feather by Pud’s creation I believe studying failure is important, but even more importantly, it needs to be constructive (like Goldfarb, Kirsch, and Miller). The Techcrunch Deadpool serves an important purpose but it has the potential to degenerate into useless personal attacks and rumor mongering. Either way, Arrington is like a hedge fund manager, he likes volatility and profits from it . . . the Deadpool is his hedge or even an instrument to profit from the web 2.0 cycle. (dont get me wrong, there is nothing wrong with it, I would be doing the same if I’m a jounalist . . . no he is not a blogger, not anymore)

The paper tries to prove a few points

1. “Get Big Fast” was the predominate strategy for venture startups and it created a cascading effect commonly called house of cards or greater fools theory in which assumptions build on top of other assumptions driving irrational behavior.

2. Ironically, the GBF strategy created a huge concentration of investments in a few large companies - belief that first mover + funding amount is a barrier to entry which prevented more startup in any space from getting funded or even started.

3. As a result, eventhough the AMOUNT of venture investment might have been irrational, the number of startups was actually lower than ideal.

A few surprising numbers crunched by Goldfarb, etal support this

Exit rates of dot com firms are comparable with or perhaps lower than exit rates of entrants in other industries in their formative years. Five year survival rates of Dot Com firms approach 50%.

Survival is unrelated to the receipt or the amount of private equity financing. VC-
financed and other privately financed firms were neither more nor less likely to survive. There is no evidence that return on private equity investment was positive or that, conditional on survival, internet traffic ratings was higher for private equity-backed firms.

In more detail,

Annual exit rates for autos during 19001909 averaged 15%, 21% during the 19101911 shakeout and 18% during the period from 19101919. The annual exit rate from the tire industry during 19051920 averaged 10%; it was 30% during the shakeout in 1921 and 19% during the period from 19221931. The exit rate from the television (production) industry was 15% during the period 19501952. Finally, the exit rate from the penicillin industry was 5.6% during the period 19431954 and 6.1% during the period 19551978. These numbers suggest that the exit rate for Dot Com rms is in line with other emerging industries.

In sum, the survival analysis shows that in our data private equity investment is not related to firm survival and this result is robust across many specications. Moreover, we also found unremarkable IRR and no relationship between web traffic rankings and the receipt of VC funding. We interpret these results as consistent with the hypothesis that pursuing a GBF strategy was, on average, a poor strategy for most internet businesses during the late 1990s.

Well, you know where I’m going with this . . . we are smarter than we thought! Look at the current web 2.0 modus operandi . . .

- small investment is not neccesarily bad (as large funding round does not equate success)
- VCs are not the pre-dominant source of equity capital
- GBF is not the preferred strategy
- double or triple the # of competitors in any space compared to dot-com
- re-cycling or old 1.0 ideas (cause ideas failed for reasons other than the concept itself)

In short, failures are the REQUIRED by product of needed experimentation to exploit an opportunity as big and important as the Internet. Bubble or not, deadpool or not - the opportunity justifies irrationality as the rational thing to do.

To be clear, we do not posit that there was insucient investment in internet ventures. Rather in the absence of a belief cascade, more entrants might have received smaller amounts of funding. To envision how these events might have unfolded, consider the case of Webvan, a $1 billion internet grocery venture that entered many major cities in 1999. Webvan turned out to be a spectacular failure. Absent beliefs about the necessity of GBF, we might have observed many smaller-scale startups all experimenting with different models perhaps in different cities delivering grocery products to the consumer. Instead, we observed a single very large bet on one particular delivery model. In general, mistaken belief in GBF concentrated too many resources in too few ventures. In this sense, we argue, there was too little entry.

Randy Komisar of KP said this at a Venture Beat Interview

I’m personally not doing much in Web 2.0 at the moment. I’m looking for more fundamental innovations. I’m less interested in the content and media fallout. There are no strong barriers to entry in Web 2.0. If by Web 2.0, you mean companies that build an audience to be monetized by Google, I am not actively pursuing them; though I should never say never.

I’m not sure how long YouTube would have remained an independent business had they not been bought by Google. Google has an efficient search engine to monetize large audiences. If you’re creating Web 2.0 products and media, its tough to build anything of sufficient scale to remain independent — you are more likely to end up being a feature on Google, Microsoft or Yahoo…

I couldnt agree more . . . and you can gleam lots into what type of internet companies KP wants to invest in

1. Companies that does not rely on search engines for more then 20% of its traffic in the long run. Otherwise you are just asking google to come and eat away at your margins through adword (notice I mean organic and paid traffic). . . (translation, B2C e-commerce is a tough place to play unless you have the secret sauce)

2. Companies that does not rely on an “ad network” (read adsense) to monetize its traffic (even if its completely type-in, self generated). This could mean that the company can achieve enough scale to build its own ad network or ad sales force. BUT more likely it means the company has figured out a way to make money outside of begging user to click on ads.

In short, stay away from Google, beat it where it aint (and there are many places it aint). Ofcourse, I’m not sure staying away from the INTERNET completely is a good idea

hat tips to VC Ratings

As many people already know, one of the original bloggers in the tech blogosphere (no its not Arrington of Techcrunch . . . earlier by 2 years atleast ) Jeff Nolan has left SAP Ventures and joined Teqlo as the CEO. Jeff’s latest post is about honing the “positioning” statement for VC’s. The comment section is really interesting with everyone constructively helping to improve the statement.

Truth be told, it was quite ironic to see Jeff having to struggle through this having been on the other side for quite a while as a VC . . . ( one of my VC’s in fact) . . . This is a very hard task especially for Teqlo because they are not an application company, but a enabling infratructure with a end user utility (wow, a hybrid) . The so called “killer app” or killer mashup borne out of Teqlo is probably something that has yet to be imagined (but that too is the upside of the Teqlo, that its value proposition is only limited by the imagination of the community it builts). Jotspot (not competitive but structurally similar company) tried to solve this problem by building a few example applications along with the launch of its infrastructure . . . to not only stir the imagination but provide value at launch.

Zoli Erdos has very good advice . . .

Of course your statement about describes what Teqlo is … i.e the statement is true, it fits the business … but …. does it describe Teqlo specifically?

To paraphrase . . . start with the end user and the “why’s” and end with “how” the product can serve that end user UNIQUELY, SPECIFICALLY, and BETTER. (easier said than done ofcourse!)

A few other random things to think about when putting together the “positining statement”

1. Entrepreneurs and “intra-preneurs” faces similar hurdles in getting resources for a project/venture

2. First 3 minute of VC’s or a senior exec’s time (if you are pitching an internal project) is when you hook or fail to hook him/her. Make sure you have something catchy (and important) to say.

3. It is the external version of the internal mission statement (which aligns the company and helps with resources allocation . . . ROI Metrics + Strategy + Mission = prioritization)

4. VC’s are not as technical as they claim to be . . . dumb it down for the VC’s . . . if they like the pitch they will find a “venture partner” to do more DD . . . at which time you will have plenty of time to white board out EVERTHING . . .

5. Investments pan or dont pan out usually in 3-5 years. In the mean time, VC’s needs your help bragging his latest pet investment to his country club buddies . . . the positioning statement needs to be catchy enough to impress his foursome like a 325 yard drive off the first tee.

6. It serves as the first sentence of the boiler plate at the end of every press release. And believe me, most journalists will literally just copy and paste it into their writing. So this statement will end up EVERYWHERE.

7. Correlary to 6, many hyperlinks will be built off the words in the positioning statement from these articles to your website; as a result, these words will become your keywords for search engine ranking. If you want your website to surface when someone types in “best sausage in Indiana” in Google, make sure a variation of that appears in your positioning statement.

8. Its nice to have friends in high places that you can bounce the pitch too without worrying about an investment decision . . . (VC’s preferably) . . .

9. One of the hardest things about these statements is how to balance the short-term value proposition (we are a search engine) , long-term strategy (advertising is our business model), and vision (we want to organize the world’s information) . . .

10. personally, I miss working on things like this . . . .