Tuesday, March 29, 2011

Your #1 Job As CEO

The number 1 most important thing for you to focus on as a founder or CEO of a startup is going to keep shifting over the life of the company.

If things go well while you have the title of "CEO" you may go from coder -> lead recruiter -> eng manager / product manager -> sales guy -> CMO -> acting VP product -> acting VP sales -> external evangelist -> government relations lead -> Global Tech Statesman -> Gubanatorial candidate -> Pundit -> retired old cranky guy who always complains about how much stronger entrepreneurs were "back in my day when YC only admitted 42 startups a batch".

Startups are a rollercoaster ride - every time you make it over one hump (hiring the first employee, fundraising, launching an alpha, etc.) you will suddenly see the next, new challenge looming on the horizon.  You need to stay focused on the challenge.

As a founder or CEO, you should be constantly asking yourself what is the single more important thing you should be doing for the company at any given period of time.  And then you should focus most of your time on that.  A good exercise to try:

  1. Once a week, take a step back and ask yourself what you are trying to accomplish, and what are the 1-2 most important things that will get you there.
  2. Every morning, make a list of the 1-3 things you absolutely need to get done that day.  
  3. Get those things done.
  4. Don't get distracted by the easy low hanging fruit that doesn't matter - it just wastes your time even if you get satisfaction by doing it.

In parallel to the spot roles you are playing (e.g. CMO, VP sales, whatever), the two most consistently important jobs for the CEO of a startup on an ongoing basis are:
1. Make sure you do not run out of money.  People seem to forget that running out of money is the #1 reasons startups fail.
2. Hiring and firing.  As CEO, you constantly need to be hiring the best possible people, and letting underperformers go.

Larry Page of Google is a great example of someone who throughout his career at Google has focused on #2 (well, at least the hiring part).  When I was at Google, each job candidate used to have to go through at least 8 interviews - and they all had to result in "hires" from the interviewers.  Any "no hires" and the person would not advance.  Additionally, Larry would read the feedback package, grades, college transcript etc. of literally EVERY SINGLE hire that Google hired.  I have heard of him blocking the hiring of people who e.g. got a "B" in a class he deemed to be an easy one.

I am sure this prevented some great people from getting hired at Google, but I bet it also kept out an even larger number of bozos.

This post was inspired by a conversation with Hiten Shah, who has some great ideas on this area.

Some past hiring posts:

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Wednesday, March 23, 2011

Questions VCs Will Ask You

This is the last in a series of posts about fundraising from VCs.  The first post explained how the various series of funding (e.g. Series A, B, C, etc.) differ from a seed round.  The second post focused on best practices for raising a Series A or venture round.  This last post lists the set of questions you should be able to answer (and will likely be asked) when raising a round.  Thanks to Satya Patel from Battery Ventures for providing suggestions for the list.

As someone raising a Series A, you should be prepared to answer the following questions:

1. Team
  • Who is your team?
  • Who are the 2-3 key hires you need to make for the company?
  • How do you plan to scale the team in the next year?
  • Why is your team uniquely qualified to solve this problem? What unique insight do you have?

2. Market and business model
  • What is the big opportunity you are addressing? What are the steps to getting there?
  • What is your business model? How will you make money? How big of a market is your specific market really (i.e. the market or customers from which you will extract direct value, not “Local is huge, and we are in local, so of course we will be huge”)?
  • Who is the competition? Why will you beat them?
  • Why are you uniquely positioned to win in the market?
  • What is the market structure and dynamics? How do these dynamics map against your strategy?
  • What are you doing that is different?
  • What are your customer unit economics (CPA, churn, LTV)?
  • If you are working in e.g. financial services, music, or the like you will be asked about legal or regulatory risk.

3. Product
  • What problem are you solving?
  • Why do users care?
  • How is this better than what is out there? How big of a difference is this really?
  • What are your major product milestones that are coming?
  • What are the 2-3 key things your product lacks?
  • What have you learned from the early version of the product?
  • Product demo - show me a demo
  • Product traction. What are the key metrics of use of the product? How have the numbers been changing recently?

4. Distribution
  • How are you going to distribute the product? How are you going to acquire customers?  Is this an SEO, SEM, viral, radio ads, direct mail, PR, other based business?
  • Some may ask about per customer acquisition costs and ARPU
  • What advantage if any do you have for distribution?
  • How has distribution worked so far?  What has worked/not worked?
  • What do you plan to do next for distribution?

5. Fundraise and financials
  • What milestone will the capital get you to?
  • Why do you need to raise money? How much money do you really need? Why don’t you need less (or more – another key items to think about)
  • How much dilution will you give up?  What is your pre-money target range?
  • What will you use the capital you are raising for?
  • What are your basic financial projections?

6. End game
  • Why can this be a billion dollar business?

Any other questions you have been asked when fundraising?  Add them to the comments section.

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Thursday, March 17, 2011

How to Raise a Successful VC Round or Series A

Running a Great Series A Fundraising Process
A number of companies I started working with at the seed level are now hitting Series A fundraises.   I have been helping some of them think through the process and thought I would capture some of the key components of how to raise a Series A effectively.

How a Series A is different from a Seed Round.
  • VC is an oligopoly market, Angel is a highly fragmented one. While there are literally hundreds of angels you can take money from, there are only a dozen or so venture firms that really matter. This changes the timing and approach to negotiation dramatically (See below).
  • Everyone on the investor side is a professional.  #prostyle
    • While many angels you meet with may be doing it on the side or to “give back”, all VCs are doing this for a living. Their goal is to make money for their LPs, and they have been through this negotiation many many times. Use your existing investors and advisors well.
    • Terms are more complex. If you raised a convertible note, you had a 3-5 page document you negotiated. Venture rounds such as Series A are almost always equity rounds, and you will get into all sorts of issues that will really matter in the long run for the company including board structure and governance. Study up on these key terms, as they can make the difference between your being CEO in 5 years, or being kicked out of your company. See e.g. Sean Parker help Mark Zuckerberg navigate this for Facebook.
Tactics for running a Series A Process:
1. Line up all the meetings in a short period of time.  Many seed rounds these days lack a lead investor. This means from the first check you collect to the last, you may take a few months as you round up a number of individual investors.  In contrast, Series A/venture rounds have a very different dynamic as there are a limited number of firms to talk to, and there is only 1 person you will take money from.  Similarly, VCs talk to each other a lot.  You want to limit the time period over which information will leak and VCs have a chance to collude (see below).

You should schedule all your VC meetings in as short a time period as possible. This does a few things:
  • Creates buzz. Suddenly, every VC is talking about your co at the same time.
  • Creates an auction dynamic and perception of momentum. Everyone is talking about you at the same time, so it is very credible that you have alternative options. This means VCs will give on more terms.
  • Prevents an early “no” from hurting you. The time frame is compressed enough that an early no won’t make it through all the ranks of the VC community fast enough to hurt you.
    • Makes you more confident. If you talk to lots of people, a subset of them will want to have a follow up conversation. This increases your confidence which increases both your presentation skills and negotiation leverage.
      • Prevents you from getting a term sheet too early in the process. One of the hardest dynamics to navigate is getting a term sheet from a VC before everyone else has a chance to talk with you. You end up with a dilemma – how do you keep momentum with the first investor high (in case they are your only good option) while still gauging interest from everyone else? Once a VC gives you a term sheet, they often expect a fast yes or no answer from you. Lining everyone up in a 2 week period for the first conversation helps bypass this risk to the fundraise as you will get a quick gauge of the market all at once.
      2. Create an auction.
      • Never, never, never tell a venture fund who else you are talking to until a term sheet is signed. 
        • They will call each other and collude.  A friend of mine was successfully running a fundraise until she told the two VCs interested in her company she was talking to both of them. The two VCs immediately called each other and came in with a joint term sheet substantially worse then what she had discussed with each individually.   
        • VCs talk to each other a lot.  When a company is raising a series A some VCs will literally call their friends (other VCs) and ask them if they are also looking at the company and what their opinion is. This happens with angels, but to a much smaller degree as the number of angels and their subnetworks is quite large.  Most of the traditional angels have much more fragmented networks and may not know what deals have been active or who else has taken a look. This lack of transparency helps you as an entrepreneur make a deal look “fresh” even if you have been fundraising for months.  In contrast, all the VCs know each other, and many will ask their friends if they have already passed on your company.
        • You want all the funds to be competing against one another to drive up your price.  If asked who else is interested, only allude to “the usual brand name suspects”.  Never have a venture firm “pull together a syndicate” for you. As the entrepreneur, you should be driving the fundraising process. Once you chose a lead investor and agree on terms, then you can agree to a syndicate or not.
      • Say no if people ask if you plan to build a syndicate of multiple VCs.
        • You want other VCs to be their competitors on the deal, not their allies. 
        • If 2 VCs invest in you, you will usually get 2X the dilution. Often VCs ask if you want to do a syndicate. Typically this is code that really means “Instead of selling 25% of the company for $5M, why don’t you sell 25% of the company to *each* of us, for $5M and 50% total dilution.” The exception to this is if one VC is clearly leading, and the other is putting in a smaller amount for the relationship, in which case dilution is constrained.
      • Collect all the term sheets at once.  If possible, create a dynamic by which the timing is tight enough that you get all the term sheets within a few days of each other.  This gives you optimal leverage and transparency into what each player will give you.  Don't over do this - e.g. don't meet with a partner Monday and ask for a term sheet Friday.  They won't have time to get the partnership to approve it and will drop out of the race, decreasing competition for the round.  This is one of the reasons the timing of the initial set of meetings in a short time frame is key - as you will also collect all the terms sheets within a short period of one another.
      • Go to a bake off with multiple "finalist" VCs.  Once you have all the term sheets, chose a small number of VCs that seem the most interested in your company, and create a bake off.  Even if there is one VC you really like, keep at least one or two others in the race as you negotiate final terms, in order to have a BATNA and be able to negotiate credibly.  
      3. Make the first 2-3 meetings “practice meetings” if at all possible. You know that partner from the venture fund who wont leave you alone, that you would never take money from? Make him or her your first meeting in the process. They will provide valuable feedback on your pitch you should iterate on before meeting the top tier guys you really care about.

      4. Find the right partners at the right firms to talk to. I can not overemphasize this point enough. Too many people just get intro’d “to Sequoia” or "to Accel" rather then being introduced to “the partner at VentureFirmX who has funded companies in this area before”, or “the partner at VentureFirmX who is actually helpful”.
      • Ask your angel or friend doing the intro why they think the partner is the right one. They should be able to justify why this partner is the right one. It is possible it is the only partner they know. If this is the case, you may want to try to find another lead in. However, if you lack real alternatives, go with their warm intro.
      • Make sure they are not just currying favor or trading deals.
        • Some angels will send a deal to a venture fund because they feel they owe the venture fund. For example, the venture fund helped them invest in a company they couldn’t get into otherwise, or the VC has them as a limited partner. This leads to bad dynamics for you as an entrepreneur. You are not being introduced to the best partner for you, you are being introduced to the VC partner that the angel owes something to.  Sadly, I have seen this happen too frequently.
      • You will be stuck with the first partner you meet as a board member most of the time.  This is due to the reward mechanisms a venture partnership has set up.  At most venture funds the VC who takes the lead on the startup often takes the board seat and gets a bigger share of the carry on the investment.  So their economics and incentives are skewed to take the board seat, even if another partner at the firm is a better fit.
        • Do your research. Who has a good reputation? Who undermines entrepreneurs? Who has had a string of successful exits and the confidence to not screw you over as an entrepreneur?
        • The first partner you talk with at a venture fund often “owns” the deal. They will negotiate your term sheet and try to join your board, even if partner X down the hall is a much better fit for you both personally and from a market/product perspective.  This is not always the case (e.g. Benchmark has a great reputation for trying to let the entrepreneur and the various partners choose together) but it often is.
      5. Use Backchannel to your advantage.
      • Ask existing angels or advisors to talk you up before you go into the meeting with the VC. After the meeting, if the VC is interested, have the angel help drive the auction dynamic by acting as an informal bridge to the various VCs to let them know there is a lot of excitement in the deal, an what terms they are off on. This is sort of like the behind the scenes diplomatic talks that take place prior to e.g. a summit between the US and China.
      6. Treat the pitch a product – iterate on it until it is great.
      • Make the pitch “conversational”. Don’t walk people through slide by slide. Make it more of a conversation and refer to the slides as backup material. This will make it more engaging to both sides.
      • Tell them who you are up front, and who else is on the team. This will optimally legitimize everything you say afterwards. They also want to understand who will be running the company day to day. VCs will typically ask you who the 2-3 key hires you need to make for the company are. Be prepared to answer this question.  (I have another post ready to go on the questions VCs will ask you during the Series A process).
      7. Important: Know what you are optimizing for.
      What do you really care about?  Control?  Valuation?  Expertise?  Have a check list in your head of what you want from your VC/future board member, as well as the terms that matter to you most.  Don't forget these things in the fog of the fundraise.  Make sure you are optimizing for the right thing.  Keep coming back to this during the multiple weeks it will take to get to term sheets.
      Any other tips for raising a Series A, or ideas on how series A fundraising differs from seed rounds?  Let me know in the comments section!

      You can follow me on Twitter here.


      Tuesday, March 15, 2011

      How Funding Rounds Differ: Seed, Series A, Series B, and C...

      Over the weekend, I have written a series of posts about how to raise a series A, and why this differs pretty dramatically from raising a seed round.  I thought it might help to first clarify the difference between the various funding rounds and their characteristics.

      What Is the Difference Between Series Seed, Series A, Series B and Series C-Z funding rounds?
      To some extent, the names of rounds are kind of arbitrary. E.g. in some cases a round is called “series A” simply because it is the first, or “A” funding the company has taken from external sources versus a specific stage of traction for the company. However, in most cases a Series A will reflect the stage of a company and its product.

      Series Seed: Figuring out the product and getting to user/product fit.
      • Purpose: The purpose of the series seed is for the company to figure out the product it is building, the market it is in, and the user base. Typically, a seed round helps the company scale to a few employees past the founders and to build and launch an early product. As the product starts to get more and more users, a company will then raise a series A.
      • Amounts: Typically the range is $250K-$2 million (median today of probably $750K to $1million). The high end of this range used to be more typically $1million, but we are in the inflationary period of a venture cycle, and this number may move up into the millions of dollars before we have a correction.
      • Who invests: Angels, SuperAngels, and early stage VCs all invest in seed rounds.

      Series A: Scaling the product and getting to a business model. (AKA getting to true product/market fit)
      • Purpose: With a series A you typically have figured out your product/userbase, and need capital to:
        • Figure out or scale distribution. Your users may love your product, but you have not yet optimized all the ways to build a userbase.
        • Scale geographically or across verticals. You have a product that works in one market (e.g. it works in the Bay Area), and you want to adapt it to other markets (lets launch it across the US or globally).
        • Figure out a business model. If you are a consumer internet company, you may be getting lots of users, but may not have a clear business model that is working at this point (see e.g. Instagram).
      • Amounts: Used to be $2m-$15million with a median of $3-$7 million.  Series A amounts have gone up dramatically recently to more of a $7-15million raise being typical.
      • Recent examples: Uber(cab) raising from Benchmark, Instagram's raise from Benchmark
      • Who invests: Your traditional venture funds (Sequoia, A16Z, Benchmark, Accel, Greylock, Battery, CRV, Matrix etc etc.). lead these rounds, leading to a pretty different dynamic relative to a seed round (more on this in another post).  Angels may co-invest with VCs in the A, but they have no power to set the pricing or impact any aspect of the round.

      Series B: Scaling the business.
      • Purpose:  The Series B is typically all about scaling. You have traction with users, and typically you also have a business model that has come together. If your user traction is out of control, sometimes you can raise a Series B without an existing business model, as most VCs assume you can eventually monetize large #s of eyeballs.
        • Scale your business model. You need to hire a bunch of ads sales people, enterprise sales people, or the like
        • Scale your userbase. You have a great business in the US and want to go after Europe.
        • Make acquisitions. Sometimes a Series B is raised to buy other companies.
      • Amounts: Anywhere from seven million to tens of millions.
      • Recent Examples: Although it was called a “series A” in the press (and probably on the financing docs), Angry Birds recent $40 million funding by Accel was more similar to a series B or C financing. The company already had great user traction and was making lots of money. For the company to scale its existing business, as well as move into new lines of business, additional capital was needed.
      • Who invests:  Some series B are led by the same folks as your Series A (e.g. Square and Sequoia), but also some additional firms who specialize in later stage deals such as IVP, GVVC, Meritech, DAG, etc. start to get involved at the Series B stage.

      Series C onwards: More capital to scale.
      • Purpose: The Series C is often used by a company to accelerate what it is doing beyond the Series B. This may include:
        • Continue to grow fast. You know where the profits are, but you are making the tradeoff of losing money in order to win the market.
        • Go international.  Launch your business in other markets.
        • Make acquisitions. Some people raise big war chests to buy a number of other companies.
      • Amounts: This can range from tens to hundreds of millions.
      • Who invests: This can be driven by the folks mentioned for Series A or B (see e.g. all the early stage guys who just funded GroupOn), but often other sources of capital may invest in later rounds such as private equity firms, hedge funds, the mezzanine or late stage arms of Goldman Sachs, Morgan Stanley and other investment banks, or big secondary market firms such as DST or Tiger.

      See also: How To Raise Series A / VC Funding

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      Monday, March 7, 2011

      How Can You Tell If Your Market Is A Good One?

      One of the single most important decisions for an entrepreneur is to chose the market they are in.

      From Marc Andreessen's blog on Andy Rachleff's (formerly of Benchmark Capital) Law of Startup Success:

      "The #1 company-killer is lack of market.
      Andy puts it this way:

      When a great team meets a lousy market, market wins.
      When a lousy team meets a great market, market wins.
      When a great team meets a great market, something special happens."

      So, one of the big questions I often discuss with entrepreneurs is, how can you tell if a market is a great one?

      Questions to ask yourself about the market:

      • What has changed?  Why now?  Good markets typically have something changing in them, that allows new players to enter or emerge.   For example, GroupOn was able to capitalize on a combination of a new distribution mechanism (social media shares) and merchant and consumer familiarity and comfort in selling/buying things online.  Examples:
        • Costs have fallen or price points risen dramatically.  Many SaaS services are examples of low cost approaches to existing enterprise software businesses.  Example of rising price points driving an opportunity include opening up a new oil field when costs of oil are high enough to support more expensive extraction techniques)
        • A new distribution channel has opened up.  E.g. Zynga using Facebook viral channels in the early days, Yelp mining SEO when SEO was not yet saturated for local listings, etc.
        • New technology emerges.  This usually impacts costs or new types of distribution, or creates new services that fundamentally could not have existed before.  E.g. the emergence of truly smart phones, GPS accessibility from the device, etc. has enabled services like Foursquare (local/social) to appear rapidly and take a dramatically different take on a local service.
        • A new source of customers or demand appears.  E.g. the government starts buying cryptography systems, or Chinese Internet + credit card penetration hits a high enough % for ecommerce to take off.
      • Is a growing customer base being dramatically underserved?  
        • Palantir and government data analysis is a great example of a market segment that was underserved for a long time.
        • While an overall market may be mature, certain segments of customers may be ignored by the incumbent(s).  E.g. the traditional SaaS model is to start with a lower value, early adopter community for Enterprise Software and then to work your way up to larger customers over time as your product goes up market, and large customers' willingness to go to less complex hosted systems increases with time.  Similarly, social media startups often start with a hipster/influencer base and then grow into the mainstream as the product matures.
        • The key is this user base needs to be the growing part of the market, or the early adopters.  The worst possible place to be is to focus on a shrinking segment of a market, even if it is underserved (think e.g. of launching a product for people who only want high specialized, auto-tuned, emo ringtones for their Symbian phones).
      • Is the industry growing rapidly?  A rising tide floats all boats, and this is never more true then in the business world.  When the first wave of the Internet was being built out people needed routers, servers, etc. and a number of companies such as Cisco, Sun, Ascend, and others cleaned up, growing at a ridiculous compounding rate.  Similarly, tons of  now forgotten companies went public during the micro-computer/peripherals hey day of the 1980s, as millions of consumers and companies adopted desk top computers and work stations for the first time.  Look for an industry with lots of growth, and you can often build something substantial.
      • What is the market structure?  A bad market is usually one where there are a small number (e.g. 3-5) of large players who control the market that you are selling to.  An example of this is companies who sell to big pharmaceutical companies.  There are only a handful of large global pharmas left, so if you sell them a product for a few million dollars a year each, your upside is capped in the low tens of millions.  Furthermore, given the small number of potential customers, the pharma companies can effectively squeeze a lot of the margin out of the deal as they have disparate bargaining power relative to their suppliers (since they are a big chunk of the demand in the market).  
        • A related question: Will there ever be enough customers?   Some markets are just tiny and will remain so for many years to come. Sure, you can build specialized iPhone apps for people who want to track dog sledding teams across the Alaskan tundras.  But is this really a large or growing market?
      • Is there a lot of hype or interest in the market?  Some markets get a lot of attention.  This can be both good and bad for a startup.  On the plus side, you will get a higher valuation, more people may want to buy your company, and more smart people may want to come work for you.  Downsides include too many entrants/competitors (so it is hard to be heard above the noise), too many me too products to differentiate, and in some cases overcapacity or vicious price competition that drives the margins out of the business.

      It is just as hard to build go after a small opportunity as it is a large opportunity.  As an entrepreneur, you will be working your butt off either way.  The way to maximize the return and impact on time spent is to identify something big and go after it.  It is OK to start off with a small part of a big market and to "think small", just remember to keep the big picture in mind.

      Similarly, within a given market, there will be sub-markets that are more or less attractive.  You can apply the same questions above within a given market to segment it even further.

      Other ways to assess a market?  Let me know what you think in the comments section.

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