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You miss 100% of the shots you don’t take

December 15, 2009

Something I have just loved about being in the venture capital business is the people I’ve met, running businesses I did not fund.  And of those there are a few I found so relevant to my own interests, and with founders who had such passion and integrity, that I continued to meet with them well after saying “no.”  Trying to be a productive sounding board, making introductions, passing along knowledge or experience where it seemed helpful.

It’s always been such a pleasure to get the updates from these CEOs, they arrive when you least expect them and it’s exciting to see how things are developing, where the connection is no longer the possibility of financing, but a genuine interest in the business and a relationship with the CEO/team.

Dustin Hubbard of Paperspine is one of these.  His company offered a subscription service for books.  Physical books.  He  had the idea for his company after finishing a book, and having no room for it in his already jammed bedside table.  So, he planned and planned, left his job at Microsoft, started and ran Paperspine out of his garage.

Paperspine worked really well, and solved problems that people cared about.  It probably saved my family hundreds of dollars, just with my 16 year-old daughter, a voracious reader, and who routinely dropped tens of dollars at bookstores, only to read the books once.  She loved Paperspine.  She was on a five book out at once subscription at one point, and it enabled more massive reading without bankrupting her.

And while Dustin had gotten Paperspine off the ground with funding from friends and family, he couldn’t raise his next round of financing – in a market where raising money is almost impossible anyway.  But he applied himself to solving this problem with every ethical means imaginable.  Cut costs to get to break even, went back to work at Microsoft, tried to expand into ebook rentals.

Dustin and I spoke every 45-60 days, where he would walk me through his latest set of challenges, his ideas to address them, and we’d then spend the next hour testing his assumptions, plans, and brainstorm solutions.  But he always arrived prepared and ready to dive into a meaningful discussion, and sometimes I could help, other times I think he just valued the opportunity to have someone outside the company to run his thinking by.

But for many reasons, some within in his control, many outside it, he was unable to get his next round of financing.  And he seemed to be reaching the limit of how much this business was encroaching on his life, quality of life, and family.

So, last night I was truly saddened but not necessarily surprised to receive an email from Dustin, saying that he was closing the doors.  I can only imagine how hard this was for him, how heartbreaking.

And he closed off his dreams for Paperspine with the kind of grace and thoughtfulness that we should all take note of, and admire.  You should read his final blog entry, a real fitting testimonial to a worthy business, and an incredibly decent founder.  And you can see pictures of his “warehouse” in his garage, and learn more about how he took his idea and brought it to life.

His wife framed this so well, reminding him that “you miss 100% of the shots you don’t take.”

That phrase captures the essence of what it means to take an idea that crossed your mind, and have the courage to start a company to bring that idea to life.  And you bring it to life focused on why it will and should succeed, while also keeping, in a separate place, the knowledge that there are many reasons why it could fail.

Dustin, you should be very proud of what you accomplished and learned these past two years, but you should also be very proud of how you ran your company, and how you finished.  Well done, not painless, but well done, indeed.

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Posted in Business planning, chicken killer, fear of not succeeding, meaningful failure, Success, Venture capital | 2 Comments »

Preparation for a long offsite

July 23, 2009

I’ll be hiking the John Muir Trail in the Sierra Nevada mountains in California next month, which is something I’ve wanted to do my entire adult life.  The Sierras and backpacking really took root with me in high school, where a core group my friends went every summer, and continued through college and a few years beyond before losing the thread to careers and starting families.

Three years ago we restarted these annual trips, and about then I realized how much I enjoy being up in the mountains, away from all forms of electronic communication, as a way to get some perspective and some balance.

So this year I leave on August 4, and my friends and I will start down the John Muir Trail, five days later they’ll leave the trail at Red’s Meadow, and I’ll resupply there and continue on, on my own.  I’ll finish near Mt. Whitney, two weeks and 170 miles later.

And I’ve been doing a lot of reading to prepare for the trip.  Mostly trail guides, even a book on the geology of the Sierras (ensuring I will be the most boring person at the next cocktail party I go to).  But one that’s proven particularly helpful is a book called High Sierra by Phil Arnot, and it’s been great at providing detail on side trips I can make along the way.

300+ pages of detailed route descriptions, elevation changes, permit locations…in short a bunch of data and information about as “touchy feely” as the phone book.  It even has a section on “Hiking Solo” with a set of very pragmatic preparation guidelines regarding safety.   But then it went in a direction I didn’t expect, with the following passage:

“So, in a way the wilderness experience may be catalytic in bringing us to face, really face, the most important questions we can ever ask ourselves:  Am I really living the life I want to live?  Am I fulfilled in my work?  Are my relationships based on sharing and intimacy or are they primarily obligatory?  What do I really want to do with my life?”

Well, for those of us who love backpacking and being in the mountains, that set of questions told me the author truly knows his subject.  For me, these are the questions my mind gets drawn to when my “job” for the day is to traverse six or eight miles (or more) of trail at 10,000 feet, and what separates you from the beginning and end of the hike is a lot of time to walk and think.

Take the “fulfilled in my work” question.  That one’s easy.  I love my job as a venture capitalist.  I love that it requires that you think hard about strategy and equally hard about operations and execution.  You’re on a constant learning curve looking at new businesses and needing to quickly get to their essence to make a funding decision.  And when you find a business you want to fund, you get to go deep with it, for years, to help it (hopefully) succeed and grow.

But that’s the “work” part of this, and what makes my job truly fulfilling is who I work with.  Through equal parts self-selection and deliberate effort, my partners and I have created the kind of transparent, friction-free, trust-based working relationship that up until this point I had only read about.

The fact that we had all worked together before getting into this business helped, but over the past five years we’ve had to make our way through uncomfortable, difficult conversations that required egos to be set aside, and personalities to be parsed from the logic and data.  Everybody talks about this, it’s the first time I’ve experienced it first-hand.

That’s great, but actually making money in this business is getting incredibly hard.  The whole industry is in a state of transition and transformation.  Fred Wilson has done a good job explaining this, but in short, it’s taking longer to get companies sold, the IPO market is dead, and the median valuations at sale have been declining for years.  In order to generate the returns institutional investors need, you’ve got to as a firm perform well above median.

It’s daunting.  We’re doing well as VCs, but looking at the whole industry it gives you pause.  This business will be getting smaller before it gets larger, and as I’ve written in an earlier post, the old stuff gets broken faster than the new stuff is put in its place in industries who are in a state of transition.  And this is an industry in transition.

But that’s where the exciting part of this job is.  Transitions create no shortage of opportunity, and challenge.  I’m grateful I have the chance to put some more thought into this, during my long offsite.

Between now and when I “go off the grid” on the 4th, I’ll be posting on some related topics.

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Posted in fear of not succeeding, meaningful failure, Self-knowledge, Strategy, Success, Values, Venture capital | 4 Comments »

The vulnerability of a big idea

June 15, 2009

As Twitter approaches mainstream relevance, it’s also entering a period of strategic and operational vulnerability that startup companies with big ideas run into. 

By going mainstream it’s exposing the structural opportunity its founders saw years ago, but back then, only the founders and the investors were in on the secret.  There had to be a slide in the Series A deck that said  “Here’s the opportunity” and it wasn’t about building a small, derivative business.  It was about building a disruptive, billion dollar kind of company.

In Twitter’s case it’s the opportunity to redefine how people communicate, and shaping how the economics flow in and around this new communication.  It involves getting to scale, developing a third party “ecosystem” of other companies integrating with and depending on Twitter for their own success, and then monetizing all this in a compelling, huge way.  This is really hard, and the folks at Twitter are still struggling a bit with the exact business model that will do all this.

Eighteen months ago, only people in the echo chamber were exposed to the nature of the opportunity.  But today, with Twitter’s explosive growth and visibility, everyone can begin to comprehend the potential.  When Ashton Kutcher gets petulant about his million followers, when Dell trumpets that they’ve sold $3 million of products to their Twitter followers, the incumbent titans in the internet and advertising sectors, well they notice too, and they notice “threat” ahead of “opportunity.”

You saw this first with the Facebook redesign that provided a real-time status update feed a la Twitter.  A classic “fast follower” approach to someone else’s innovation. Facebook already owns a lot of people’s mindshare and time online, so the fact that they’re tracking Twitter tells you how significant the threat appears to them.  By the way, Facebook is also struggling with business model and opportunity vulnerability too, they just are further along the scale path.

How does Twitter keep eyeballs and session times growing if Facebook is just going to “fast follow” them, treating them like outsourced R&D?  This will be really hard, but let’s assume Twitter wins this round of the battle, gets to scale with a loyal and large audience for their new medium of tweets.  Do they jump out of the frying pan and into the fire?

What’s differentiated about tweets is that they flow in real-time, and finding out what’s interesting and relevant instantly has got to be worth something, and it’s so different from the problem Google solves.  Google crawls the web at a frequency measured at best in minutes, more frequently hours or days, so you could envision Twitter creating a new category Google can’t participate in. 

But what if “instant” isn’t in the end all that important.  The NY Times dug into this a bit, looking into  why Google isn’t Twitter.  And they observed that real-time search is hard and neither Twitter nor Google are currently architected to do this efficiently, or well. 

What became clear is that if you need anything other than instant, real-time search, Google can give you “close enough” search, and get closer and closer over time due to their scale.  We can all figure out who will reap the revenue rewards if all Twitter’s creates is another type of page Google can place ads on.

This kind of battle doesn’t result from incremental thinking, from safe bets.  Twitter’s vulnerabilities are proof of the significance of the idea, and what Twitter’s investors funded.  But it doesn’t mean it will have a happy ending. 

And there’s food for thought here for anyone running a startup.  Expect that you will become vulnerable to the incumbents just when you’re hitting your stride, just when people acknowledge your value and relevance.  The presence of that vulnerability is your ticket to the next round of the fight, validation that you’re headed in a worthy direction.

I dearly hope Twitter pulls this off.  I love to see the status quo up-ended, I love the mental image of apples spilling all through the marketplace as someone with a bold and compelling idea runs through, knocking the carts over along the way.

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Posted in Business planning, fundraising, meaningful failure, Strategy, Venture capital | Leave a Comment »

In defense of the echo chamber

May 28, 2009

I had two interesting conversations this week with super smart technology execs, and found myself uttering the same phrase to them, in different yet related contexts. The phrase was “…and it made me feel a million years old”. The context in both conversations was remarking on how long it takes for real, pervasive technology innovations to take root and how you reconcile that with early stage investing.

And I can’t really explain it to myself. I spent a 15 year phase of my career at companies transforming the entertainment and communications sectors, totally in the thick of the “next big thing”, and felt so urgently and palpably that we were shaping and enabling the next “normal”.

At one of those companies, C-Cube, we were making the foundational video technology that enabled the whole transformation to digital cable, satellite and DVDs. I spent countless hours with executives in these industries while we figured out how this would all work, and around 1994 I heard them tell us all that “500 channel cable” would be here, the coming year, maybe the year after that. Right around the corner.

Except it wasn’t. It only took about another 15 years.

But it never would have happened if we all hadn’t been working away, really hard and for a long time, acting, believing that “right around the corner” was really true.

I felt like I was a little smarter when I was at RealNetworks in 1999, and I heard many of these same executives talk about how by using the internet over cable (or telephone lines) they could deliver movies and 500 channels of TV the next year. Maybe the year after that.

And I remember leaving some of these meetings and telling my colleagues I’d heard this before, and it wasn’t going to work out that way, that they were “breathing their own exhaust fumes”. But I still worked really hard, and for a long time, trying to make that “right around the corner” become true too.

So here we are, in 2009, and I can order a movie from Amazon over the internet and have it delivered to my Tivo. Just ten years later, or 15 depending on whose vision of the future is the reference point.

And it struck me in the conversations I was having with the execs, that perhaps it’s not so much feeling a million years old, it’s realizing that early stage investing and startup companies places you in this strange place, where you straddle two worlds. The world “inside” the vision, where the idea is bold and the future seems right in front of you, and the world “outside” where you can look at these companies and understand it will take a decade, maybe more, for that reality to be commonplace and accepted.

There’s a semi-derogatory name for this inside world, and it’s “the echo chamber”. Most of the time it’s focused at Silicon Valley, but I actually think it’s not geographically constrained. The boundaries are more around the locus of a really big idea and a group of people who can pull it off. They get a bunch of other people to believe them, to buy into the vision – customers, partners, press, analysts – and now there’s a cohort that reinforces the belief system.

You can see this playing out, right now, with all the convulsing about Twitter. It’s been ascribed to being useful just to folks in the valley, just the people whose whole focus in life is in the development and consumption of technology most of “the rest of us” will never need or see the use in.

Kara Swisher of the Wall Street Journal wrote about Twitter in this context a year ago. And I read her column at the time and my reaction was “I’m glad she called this one out, it’s ridiculous how much hyperventilating goes on in the valley about stuff like this – it really is an echo chamber”.

But there’s nothing wrong with this, in fact it’s exactly how we ended up with Tivos at home and can’t imagine life without them, how we watch Susan Boyle shatter our expectations and assumptions about image and substance, and how a billion apps can be downloaded onto iPhones in nine months. And how we will all be tweeting and wonder how we ever communicated without it. In about ten years.

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Posted in Business planning, Intellectual curiosity, Strategy, Success, Venture capital | 6 Comments »

Slide decks and spreadsheets

March 26, 2009

This morning I came across an article in mocoNews.net about how Charmin is using a wiki to create a community cataloging the locations of public toilets in ten countries.  As the article points out, it’s not so much the magnitude of the initiative, but the direction it points for how a large CPG organization thinks about its customers and how best to engage them in a conversation about one of its brands.  It’s easy to see when they “get” this transformation and when they don’t.

There’s been a lot written about how brands should be thinking about social media, and our portfolio companies like Wetpaint, Smilebox, and Icebreaker are all deeply engaged in developing products or services enabling a richer interaction between consumers and brands.  I spend a lot of time digging deeply into the trends and subtleties driving and enabling this broader opportunity space, and understanding how important the “understanding of the audience” is to this space.

So a while ago I was asked to guest lecture at a “Top 25” university MBA program on the subject of venture capital and entrepreneurship.  It was at a time when I was travelling a lot, and was really, really busy (which is a cop-out, when are any of us not busy?).  I prepared my talk from a very “inside-out” perspective:  my observations, my points of view, my experiences.  What I didn’t do was spend time examining the course syllabus – admittedly, a brain-dead and inexcusable lapse in not just effectiveness and basic marketing but also common courtesy.

About half way through my talk I made an observation that my job was basically one of digesting information, and that it came in two formats:  slide decks (PowerPoint presentations) and spreadsheets.  I mentioned that between these two documents, you really get the essential information you need from the company, before you dig into the really useful information to help make a funding decision – your own research, your own contacts, your own scar tissue.  

A hand was raised.  The question?  What about business plans? 

I told these students that not only do I rarely come across these, when I do, it’s usually a sign that the entrepreneurs are first-time entrepreneurs, are “old school” in a not good way.  That extracting the salient information from within all that prose takes more time, and in my world, time is a  hard commodity to come by.  I thought this was a useful and helpful piece of “real world” insight.

Except that the class I was speaking to was a few weeks into learning how to write business plans. 

How was it that I was standing in front of 75 MBA students delivering a message that wasn’t “wrong” but clearly was not effective given the context.  Well, with the same arrogance and ignorance large brands who just “don’t get” social media have.

I had completely failed to understand my market and audience.  I hadn’t thought through my objectives for the talk from a perspective any other than my own. I wasn’t thinking “conversation” I was thinking “talking.”

I’m headed back to the same class to lecture again in two weeks.  I know how I will approach the development of my message: a clear set of objectives and a set of messages informed from my point of view and the context of the students and the syllabus.

But back to slide decks and spreadsheets.  As true as it may be that this business is all about digesting information, getting to the point quickly, and that business plans are no longer the mechanism to do this, communication is about by listening, not talking – whether you’re a brand engaging consumers or just someone talking to a group of students. 

I wish Charmin well; that’s not an obvious tactic they’ve chosen, and I hope it’s one based on listening, a lot.  I think it’s brilliant, and reveals an understanding of the audience, the medium, and thier brand.  I plan to be listening, a lot, when I’m in front of those students in two weeks.

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Posted in Business planning, Empathy, Failure, Intellectual curiosity, Self-knowledge, Venture capital | 2 Comments »

Seattle 2.0 Awards – Be Selfish

March 17, 2009

There are a lot of conferences in Seattle right now, and that’s a good sign – it means there’s a lot going on here in the technology sector; it means there’s enough “there” there to justify lots of organizations vying for our collective attention. 

But there are few organizations that focus just on the startup landscape, and the ecosystem that sustains and grows it, from within which we all build our businesses.

Seattle 2.0 is one of the groups that’s focused on startups.  It’s emerged organically like a startup, and it’s filling a void and meeting the needs of a defined target market:  people starting up and growing technology companies in Seattle.

It’s an organization that helps bring people together, helps foster the sharing information.  It helps shine a light on the startup “experience” – a term which was viscerally defined for me by John Jarve of Menlo Ventures as ‘the disaster that doesn’t kill you’.  Yes, experiences get shared, and that just speeds the process of company formation and growth.  A really good thing for us here.

But why should you care about the Seattle 2.0 Awards on May 7?  Well, because you should be selfish, it’s all about you and your startup for four really good reasons: 

  1. Seattle is a startup geography that matters.  We can debate the magnitude, but directionally it’s true.  We’ve created separation from Boston and Austin, and it’s now us and Silicon Valley.  You should want this to accelerate, to create a better talent pool to hire from, better ideas to exchange.  Better everything for you and for us. 
  2. VCs from the valley email me links to the Startup Index because they track it to be on top of the company formation and growth activity of our steadily strengthening technology sector.  You want them here, it’ll help you reduce risk and speed your company development.  More visibility overall, more visibility for you.  You want to be at these awards so you can meet them, you can both learn from each other.
  3. Events like this foster a network effect that’s critical to generating growth through friction-free information exchange.  It’s not just getting people together, it’s getting them together in the right context, with the right tone that enables the sharing of ideas.  Sharing ideas only strengthens them.  Get strong!
  4. And the awards matter precisely because it’s not really important who wins them, it’s the process that brings us all together that matters.  It’s asking you to nominate candidates, talking about them with your friends and colleagues, and then showing up at the event. 

So, you should go to this event, celebrate all the hard work and determination of the companies and people nominated for the awards.  But most importantly, go there to meet the other people like yourself, who are also working their butts off trying to get a company off the ground.  Go there to meet people who are eager for guidance, experience, or encouragement along the way. 

By the way, I have no vested interest, here.  I don’t know anyone at the Seattle 2.0 organization.  Never spoken to anyone over there.  I emailed them about my blog, and they were kind enough to list it, but that’s the sum total of my involvement with them.  They’re just there getting us all together, just letting the information flow.  And I like that.

I plan to be there, and I hope to run into some of you there too.  Register here

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Posted in Business planning, Intellectual curiosity, Networking, Venture capital | 2 Comments »

Guest post coming Monday

March 13, 2009

I wanted to let you know that OpenAmbition will be showcasing its first guest post, from Jenny Hall, former CEO of Trendi.com, which was a social networking destination focused on young women’s fashion that was shut down in October of 2008.  Jenny will be sharing what she learned as a first-time CEO through the success and eventual failure of Trendi.

I met Jenny the first time a little over a year ago, when she was trying to raise a Series A financing for Trendi, and for  reasons I explained to her, my partners and I were not able to fund her company.  Jenny touches on a few of the reasons in her post on Monday, but in many respects, what she describes are what many entrepreneurs wrestle with in an emerging but crowded market, where so much is learned in real-time. 

Like with many of the entrepreneurs I am fortunate enough to encounter, she and I have kept in touch, and when she stopped by my office a few weeks ago to tell me about her next startup idea, the subject of Trendi of course came up.  Jenny talked me through some of what she had learned, and how valuable the failure of Trendi had been for her personally (but not painless for her, for her employees, or for her investors). 

When we moved on to discussing her next startup idea, it was inspiring to see how much was informed by what she had learned through Trendi’s failure, how she had embraced what many would have tried to forget or move on from.  And so it seemed like she had a story to tell that the followers of this blog could relate to, find interesting, and hopefully find some meaning in too.

I hope you all enjoy it, look for her on Monday.

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Posted in Business planning, chicken killer, Failure, fear of not succeeding, fundraising, meaningful failure, Self-knowledge, Success, Values, Venture capital | Leave a Comment »

More Series B musings

March 8, 2009

In talking to a few folks since my post Thursday on the nuances of Series B financings another analogy for Series A, B, and C financings came to mind.

You can look at investing in startups like selecting who among a classroom of kids will get into Harvard; if you don’t take this (completely dangerous) analogy too seriously, there are some interesting relevant analogies.  So just for a moment, enter a playful state of mind and let’s look at the landscape.

Series A investments are like evaluating a kindergarten class and trying to select the child you think would make it into Harvard.  You could look at a whole lot of characteristics about their classroom participation and capabilities and then try and figure out who would be likely to get be accepted twelve years down the road.  But it’s very much about taking a bunch of early, early data and trying to make a long range prediction. 

[If any of you have had kids in kindergarten, the sad thing is in real life there seem to be parents doing this math for their own children.]

But to play this out, with whoever you picked you’d have enough time and resources so that if circumstances develop along the way that take the kid you’ve “funded” off-track, you’d be able to help address these. 

Series C investments are like evaluating a high school junior or senior class and trying to select the child destined for Harvard.  Now you’ve got substantive and relevant historical data about performance, capabilities, and aspirations.  You have a much richer data set, and a much shorter time horizon – one to two years. 

With Series A, anything seems to be possible when you make the investment, and you have plenty of time to deal with surprises along the way.  With Series C, you can see and evaluate a lot of the substantive date, and have a reasonably clear sense of the prospects and risks.

Series B are like evaluating a middle school seventh grader’s class, and trying to pick who’s going to be Harvard-bound.  There is a trajectory that’s been established, but you don’t have the SAT scores, the high school GPA, or the extra-curricular activities that are going to factor so heavily in the outcome.  And, it’s hard to know who will blossom in high school and who won’t.  That the sullen introspective kid in the corner may deceive you as he or she may develop the confidence and leadership to become the head of the class in two to three years.  That popular kid  vying for attention may end up having more social skills than discipline, and could flame out academically in 10th grade.

This is an entertaining thought exercise precisely because it is so ridiculous. 

By the way, I have nothing against middle schoolers (I have two myself, and think the world of them, and their friends), but it’s an awkward stage.  Taking this back to our investment stage analogy, Series B is hard because you are between the “anything is possible” world and the “we have some relevant historical data and a shorter horizon”.

I’m not saying Series B investments are bad, it’s just that they’re their own unique animal that are particularly vulnerable in the current economic climate.  Fortunately, middle schoolers, regardless of the economic climate, will be just fine.

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Posted in Business planning, fundraising, Venture capital | 1 Comment »

The nuance of Series B financings

March 5, 2009

Given the economic climate, and the implications for startups, Series B financings are going to be tough to get done;  here are some substantive and “beauty” reasons. 

Substantive reasons. 

Series B financings happen at a vulnerable stage of a startup.  The company has generally proven its core value proposition, has demonstrated it knows where to find customers, acquire them, and has begun to monetize them.  The operative term here is “begun” – they haven’t generated enough revenue to cover their burn, and likely will need another 12-24 months to do so.

What the company or the investors don’t know yet is how scalable and predictable the revenue is.  How broadly into the target market the problem really exists (and whether or not they just got lucky with those first customers in the A round), and if/where the source of explosive leverage in the business is.

But the confidence of that revenue forecast, that can matter a lot.  Startups can run out of cash more quickly than they expect because the revenue forecast shows net cash needs going down over time…which is true only if the revenue comes in as planned.  So it’s easy to get a nasty surprise here if you miss your revenue forecast; all of a sudden you’re not managing to a break-even date, but a cash-out date that’s coming at you like a locomotive.

Series B financings may have less engineering or product risk, but they can have loads of revenue and market execution risk that can be hard to get your arms around.

Beauty reasons

There are also some beauty reasons why Series B financings are nuanced.  It’s precisely because they’re not Series A financings and they’re not Series C financings.  Let me explain.

Series A financings are attractive for VCs because they’re a product of your relationships and your deal flow – a result of personal, proprietary value.  The best deals involve shiny and bold unblemished ideas, are looked at by a small number of firms, and can be highly competitive. 

Series C financings are attractive for VCs because a lot of times they involve companies who have figured out how to scale revenue and have some clarity on the leverage in their model.  The engineering/product risk is generally behind them as is the revenue unpredictability; they need capital to expand and get to break-even.  These deals can also be highly competitive, and are shiny and old, old in a good way – they’re much closer to being sold (exiting).

What about Series B?  Well, a lot of times they’re just not as pretty.  They’ve been out in the market enough to success and have some warts and have already been seen by a lot of VC firms.  There’s still all that revenue and sales/marketing execution risk.  Series B deals are tweeners – neither a shiny Series A deal with a promising unblemished future, nor a “we’re just a few years away from an exit” Series C deal.  Picking a good one is tough.

What if you’re raising a B round?

You’ve got to embrace the reality of where you’re at.  You should expect to have a fair amount of “longitudinal” metrics supporting your revenue forecast.  Metrics you’ve been tracking for quite some time that communicate fact-based clarity in generating reliable revenue.

A closely related area is to have data that examines where in your business model the leverage comes from, and how that affects the economics of your business.  This too is best done longitudinally with data collected over time (like showing a strong network effect).

Finally, you need an operating plan that spends behind revenue; increasing expenses only after revenue has increased, reliably.  This means having some clarity around the context of expense increases, tying them to product or customer initiatives; “tear-off” plans that overlay onto your base revenue/expense plan.

B rounds are nuanced, and thoughtful planning and analysis can help you navigate the nuance.

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Posted in Business planning, fundraising, Venture capital | 3 Comments »

Series-shifting, terms, and fallout

March 4, 2009

The good news in the startup landscape is that companies are getting funded, and the pace and quality of startup activity remains strong, especially here in Seattle.  This seems to be the case in the valley too. 

But the deals that are getting financed are generally “obvious” ones; series A deals where the founders have solid track records or later stage deals that have proven they can acquire customers and most importantly, monetize them.  The deals everyone would like to do. 

What about all the others? 

Well, they’re ruled by the bleak exit landscape for venture-backed companies.  Any investor looking at a good company now is doing a returns analysis using much lower exit valuations than they’d used six months ago.  The economics have to adjust downward to make the numbers (and the risk) workable.  Make no mistake, the obvious deals feel this “compression” effect too, perhaps the fundraising process moves more quickly for them.

The first “compression” effect I call “Series-shifting” – when a company that’s out raising its B round gets valued as if it were on its A.  Or a C round company gets valued as if it were raising a B round. 

Colley Godward reports median Series C valuations dropped almost 40% in 4Q08 compared with the prior 1Q08-3Q08 timeframe.  40% isn’t a bad approximation of the step-up in value you might expect from the Series B post-money valuation to the pre-money Series C valuation, based on the company’s progress in developing the business.  In today’s fundraising environment this means the market is assigning little to no economic value to that progress.  Ouch.

As an aside, this introduces some nuance into your fundraising.  The post on your last round is likely high relative to today’s market.  At an appropriate time, you need to signal that you know this and will be flexible on valuation without prematurely putting a “fire sale” sign up.  If you wait too long to signal, you’ll scare off investors who think you’re out of touch with today’s market.  There’s no rulebook for how to handle this, just experience and good judgment; the goal for both parties is to be fair and realistic, not to take advantage of either party.

There’s a second “compression” effect: terms are getting much more aggressive, reflecting today’s more conservative assumptions on returns and capital recovery.  While not painless to the entrepreneurs and early investors, liquidation preferences can be a way to let the valuation retain some “loft” while enabling the new investor to limit the downside if the outcome isn’t what everyone hoped for.  If everything goes as planned, everyone’s happy, if not, it’s the new investor who gets protected. Ouch again.

Don’t take it personally, it’s just math, not a case of predatory investors.  It’s the messy reconciliation of the business model of the startup and the business model of the investor.  If you choose your investors (or your investment) well, this is a juncture that can be navigated honestly and transparently, but perhaps not painlessly.

So now what?  How many businesses are going to be able to pass through filters that have such conservative assumptions or where new investors need such aggressive forms of protection?  The answer is, not a lot. 

As Andrew Chen also highlights, there are just too many Web2.0 businesses out there, and as with the Web1.0 bubble, a lot of these in hindsight are features of someone else’s platform, or have thin value propositions to begin with.  We’ve seen this before, and lots of companies just won’t get funded, or won’t raise their follow-on rounds.  In the medium term, a good thing for the industry, in the short term a lot of carnage will result.

Paul Holland of Foundation Capital says it well in a BusinessWeek interview “The most healthy thing for this industry would be a clearing out of people who don’t have the stomach for it.”  That applies to both sides of the table, companies and investors.

Healthy, yes.  Pretty?  No.

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Posted in Business planning, fundraising, Success, Venture capital | 1 Comment »

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