1. The Hype Cycle

2. The J-Curve (For J-Curve for Venture Startups)

Exit Point 1 -> Circa 2006. $5M-$20M exits. Acquired for technology, promise, users, eyeballs.

Chasm -> Circa 2008 or 2002. Cram down financing. Sky’s falling. Can’t pay me to take it off your hand. Men separated from boys.

Exit Point 2 -> book value = equity value. $10M - $50M exits. The long road back.

Exit Point 3 -> IPO Baby!

Question . . . how long does it take to go from founding to point 3 usually? 7-10 years?

Question . . . whats the annualized ROI? or IRR of the various exit points?

Question . . . given time required and effort invested AND risk adjusted for likelihood of failure in each step . . . where should most investors/entrepreneurs focus their exit strategy?

EDIT: Answers to above questions from Nemo

Answer… 8.5~9yrs (median time from initial equity to IPO is 8.3 yrs. Source: DJ VentureSource Q3 08 survey)

Answer…
Exit #1: 2~4x, 50~150% IRR (assuming 1.5~2yr hold, 1~2 rounds)
Exit #2: 2~4x, 30~70% IRR (assuming 3~5yr hold, 2~3 rounds)
Exit #3: 10~100x, 30~70% IRR

Answer… Exit #1. can you say cetacean celebrity?

Can’t help myself and chime in on this web 2.0 is dead thing. (joining the illustrious rank of Conway, Wilson, Sequoia, Patricof, and Benchmark.) Here is the deal, it sucks for us all - from one end of the spectrum to the other -> being laid off or pushing out our horizon on getting super rich. But in the end, its a good thing.

I was getting bored rather quickly the last 6 month and thus blogging less and less. But this recession thing is rather stimulating. I was tired of all the in-breeding that’s being going on for the last 18th month of so. But looks like its gonna stop soon . . .

In-breeding of ideas -> behavior targeted social ad network for in-MMOG rich media advertising (company name shall remain anonymous)

In-breeding of culture -> started with yelp parties, raised to the next level with digg mixers, and eventually jumped the shark with pownce launch orgies (oh and that cyprus video thing)

In-breeding of merit -> startup within a startup within a startup winning awards run by a wanna-be-celebrities judged be used-to-be-celebrities invested both by angels turned VC’s

In-breeding of entreprenuer -> serial entrepreneurship turned into parallel entrepreneurship turned into A.D.D. entrepreneurship

Burn it all down, the great ideas, strategies, and tactics will either continue to flourish, or someone will re-discover it a bit later. Its an acceptable loss. We all need a break to re-evaluate, re-charge, re-think . . . to really clear our head and come up with something original and valuable once again without the destructive group-think of the echo chamber.

In the mean time, I can always try to figure out how much longer I have to push out my retirement given the state of my 401K.

Entrepreneurs are the golden goose in the valley. Every one else is just living off the success and the failure of the entrepreneur - lawyers, bankers, consultants, VCs, employees, land lords . . . etc . . . Unfortunately, over 80% of these people are just parasites with nice dress shirts and expensive jeans. Below is a guest post on the “silicon valley entourage” phenomenon from an entrepreneur buddy who prefers to remain anonymous for obvious reasons.

Will and I were talking the other day about our experiences in entrepreneurial ventures and I went off on a rant (as I often do) about what I called “Silicon Valley Entourages.” I think Will was a little amused at my tirade so I told him I would write up what I was talking about and send it over. Most of this was composed while sitting at the In-N-Out in Kettleman City.

The reality of the situation is that although we would like to believe that there is some huge gap (no..not the central valley) between Northern and Southern California, these two parts of California actually have a lot in common from a business perspective. I have spent time working in Hollywood (at one of the studios) as well as some pretty well known technology startups in the Bay Area. With me in the Bay Area and Will in LA, I really have to ask the question, “Do LA folk or Silicon Valley folk have bigger entourages?”

We all have a perspective of the appearances of LA entourages so I won’t even bore you with what you have already seen on HBO – but what are the business implications of the LA entourage? From a financial point of view, the LA entourage is more than just the “talent’s drinking buddies.” The support structure for the talent starts with the agents, managers, assistants, assistant’s assistants, drivers, etc. These are the easy targets. The harder to see targets is all of the other SG&A – unfortunately some of that actually drives value, a lot of it is just there.

Have you ever wondered how it is possible for a film to make $500M at the box office and there isn’t anything left at the bottom line? We all know that the studio heads make a good chunk of change, but that is only a handful of folks. At the end of the day, there isn’t one big hole in the bottom of the Studio’s bucket…there is a bunch of little holes which leaves the shareholders scratching their head wondering where all the money went and an entire half of California driving around in BMW’s and eating Sushi. It is all of those people in the studios who control one little piece of information and the studio would rather pay them a modest salary than actually figure out what they are doing…basically the Milton Waddums’s of Hollywood (without the red staplers).

Yeah, so all of the smug Northern Californians are are probably thinking, “that is sooo LA…I don’t see characters like that wandering Sand Hill Road” – or do you?
I have spent the last couple of years helping to push a startup along. At the risk of sounding way more important that I actually am, the Bay Area equivalent of “talent” is all of the starving entrepreneurs sweating it out with the hopes of starting the next Google or Yahoo! (currently more so G than Y!). Really, the only difference is that rather than waiting tables at Chin Chin’s and walking around with a script to sell, the entrepreneurs are writing code at eBay and walking around with a business plan to try to get funded.

In the time that I have been sweating equity I have been amazed at the number of people that the business has attracted who have been interested in “helping out”. I know that one might say, “that’s a great problem to have…you know, entrepreneurs helping entrepreneurs build value,” but the truth is the scene actually looks something more like this:

27. INT. STARBUCKS – MORNING

A normal Starbucks coffee shop in Palo Alto.

A WOULD-BE-ENTOURAGER

I really like your idea. I know a bunch of VC’s that will fund this on the spot. This is absolutely going to be the next big thing…it is a no-brainer. This is the next killer ap poised to cross the chasm and disrupt everything. I am really excited and think we should team up in order to take this to the next level. I know exactly how I can add value

ENTREPRENEUR

(with a smile)
Great! So this is what needs to be done…

WOULD-BE-ENTOURAGER

(while checking his Blackberry)
Ummm, wait a second. I don’t think you understand my business model for what I do. Basically I need for you to show to me your commitment for this project and the incredible value that I am bringing to the project. Did I tell you that I once sat at the table next to Reid Hoffman at Buck’s? Anyway, before we get into the details of whatever it is that you want me to do…and of course I don’t know what you want me to do, but I know that I can do it better than anyone else, my standard hourly rate is $300/hour and I need to take 15% of the company. I also expect a finder’s fee for any introductions that I make to all of my buddies in the venture community. Did I tell you I am best friends with Reid?

The entrepreneur ends up paying for the coffee, getting back into his Honda Civic for the drive back to his apartment where he continues to figure out how to make this thing work. The Would-be-Entourager goes to a networking event for Java Programmers and then later crash a Venture Capital roundtable.

The truth of the matter is that of all of the people that I have met while on this entrepreneurial journey, only about 20% are actually entrepreneurs that are trying to build a business of some sort. I have experienced the other 80% as people that are trying to hop on the backs of the other 20% and extract their living out of them. Whether it be the promises for Strategic Consulting, “Introductions to Venture Capital”, or Advisory Services there have been a lot of people out there ready to join the “Entrepreneur’s Entourages.”

While not drawing a salary for the startup that I am working on right now, I actually had an “incubator” tell me that they wanted an upfront fee before even looking at the business and deciding if they wanted to take a monthly retainer and equity position for “strategic consulting.” They told us that the upfront fee was so we could prove to them that we had “skin in the game.”

Again, I have to put in the caveat – not all of the people wandering the coffee shops in the Bay Area are bad. I am good friends with many professional advisors and consultants that really are worth it. This is what makes this environment so difficult – it is really hard to tell the good from the bad from the ugly.
So the big question, “How to tell the entrepreneurs from the entourages?” Although these are not foolproof ways to separate the wheat from the chaff, my thoughts are as follows:

1. The entourages will not do anything without having an agreement in place that covers their compensation. When someone tells you that they have some great advice or connection but they won’t pick up the phone and make a call without having an agreement in place, it is usually a sign that they don’t have much. This is a sign that this person is aware that they can’t add that much long-term value to they need to lock in their deal before the entrepreneur figures this out. Something as simple as a phone call or 30 minutes of thinking should be a diminutive part of their overall value and they should be wiling to offer it up for free.

2. The more that they feel the need to talk about who they know or their past accomplishments, the more likely it is that they really are not that much of a driver of value. These are people that have a hard time even justifying to themselves their own value so they have to use proxies to do it. The smartest people that I know are the people that are confident that the content of their thoughts drives the actual value.

3. “Patented” Frameworks or Methodologies are usually a sign that the person that you are talking to is giving you answers out of a book and not out of real experience.

4. Not really listening to what your business is. The true entrepreneurs have an intellectual curiosity about new ideas and new opportunities. If you meet one of these people and you don’t instantly hear an understanding of what you are doing and initial thoughts – be wary. If you get the sense that the person instantly tries to shoehorn whatever it is that you are doing into things that he has done – be really wary.

5. The more nebulous the description of what they actually do, the more likely it is that they don’t do much. An entourage wants be sure that they do un-measureable work so you can’t tell that they are not really adding value. Things such as “Strategic Consulting”, “Introductions”, and “Advisory Services” are often a sign of an entourage member. Their hope is for a monthly fee and founders stock in order to allow you to talk on the phone with them once a week (or less).

The saddest part of this whole story is I now have a better sense of why both the entertainment industry of Southern California and the venture community of Northern California are both so inefficient. I now understand why the Hollywood Stars and Bay Area Entrepreneurs can drive as much value as they do and actually come home with less reward than you might expect. It is because of the entourages that they each group must support in their goals to actually get something done. This can also be the reason why a lot of startups fail. This is not because the entourages provide bad advice (usually they provide very little advice) but rather for much more subtle reasons. These Silicon Valley entourages will instead suck equity and capital out of the venture that could either be used to hire value driving resources for the company or provide incentive for the existing members of the team to persevere.

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.