Elad Blog

How Pinterest Will Transform the Web in 2012: Social Content Curation As The Next Big Thing

2012-01-04T10:39:00.000-08:00

The most interesting wave hitting the social web in 2012 is social curation. This was kicked off in 2011 as Pinterest's growth was noticed by Silicon Valley and a number of companies quickly followed suit - Snip.It launched as a social information curation platform, Quora adopted boards for a similar purpose, and Fab.com launched a structured social commerce feed.

In this blog post I will discuss the evolution of social media from long-form to push-button, the emergence of social curation on sites such as Twitter and Tumblr, and the move to structured sets of curated content on Pinterest and its brethren.

But first, the meta-trend....

...Social Media: Evolving From Long Form To Push Button
In the evolution of social media over the last decade, the trend has been a move from long form content, which has high friction of participation (both on the production and consumption side) to ever lower requirements placed on a user to participate in a conversation.

1999-2004 Blogging Platforms.
Blogger (launched in 1999) and other early social media sites were longer form blogs. The bar to write content was reasonably high. These sites effectively had two separate users bases: people who wrote the content (1% or less of users) and people who read or consumed the content (99% of users). Yelp (2004) is basically a food blogging platform where reviewers will go on about how their boyfriend was mean to them during dinner, before actually reviewing the food.

2004-2007 Status Message Networks.
Facebook (2004) and Twitter (2006) transformed social media by moving from long form blogging to short form social snippets in the form of photos (Facebook) and status updates (Twitter). This decreased the friction to both producing as well as consuming content, leading to extremely broad participation by a global user base.

2007-2010 Push Button Interactions.
Some interesting organic user behavior emerged on Twitter, as users would "re-tweet" content as a way to re-broadcast another person's content to their own network. Similarly, Tumblr (2007) mixed long, medium, and short form content with an additional affordance "re-blog". Re-blogging allowed a user to repost a blog with a single button, allowing users to essentially curate content without producing any original content.

Twitter and Tumblr made it easy to re-tweet and re-blog other's content - the first step in social curation of the web (red arrow above indicates re-blog feature on Tumblr)

In parallel, push button private content curation emerged as Instapaper (2008), Evernote (2008), Read It Later (around the same time) all launched applications to allow users to collect and later read content. However, none of these services had a strong social component.

Foursquare (2009) was one of the first networks to generate social content more or less entirely off of push button interactions. By checking-in, you broadcast your location to your friends, creating content without actually needed to type a single word.

However, all of the social services continued to serve content as a time ordered stream. Moving from a stream to a structured collectible set of content was the next innovation in social media....

2010-Now Structured Sets And Social Curation.
Pinterest (launch 2010) was one of the first sites to take push button content generation (via bookmarklets and "re-pinning") and structure it into sets of curated content called "boards". This allowed users to collect content from across the web, as well as from other users on the site. In some sense it took what a site like Tumblr had been doing but transformed blog-like streams into structured, curated collections users could share. Importantly, it was easy for new users to consume these sets of content visually as structured sets, and to share these sets with others.

David King has pointed out an interesting insight - by constructing content in a structured set versus a stream, sites such as Pinterest and Snip.It have prevented stream-based sites such as Facebook from becoming a compelling place to consume the Pinterest or Snip.It content (which contrasts with e.g. Instagram or other stream based sites).

Pinterest boards are not as consumable on Facebook as stream-based sites such as Instagram, carving out a large new social media market for this behavior.

This new affordance is currently being adopted by other sites leading to all sorts of interesting behavior including:

Collecting news and information. Snip.It (2011) was an early product to allow for social curation and structured sets of news and information based content. Recently Quora (launched boards end of 2011) entered this market by adding "boards" for curating content from across the web to its core Q&A product.
Commerce. Nils Johnson (one of the smartest social commerce guys out there) has pointed out how Fab.com recently used a Pinterest-like affordance in its "feed" to drive social curation of products. (See image below on how closely the Fab UI mimics Pinterest). It is similarly likely Pinterest will monetize in a number of interesting ways on the product discovery and commerce side.
Social media. Storify (2011) has added an additional structured curation layer on top of Twitter.

Pinterest UI above, Fab.com UI below.

As you can see the Fab UI has followed the Pinterest one.

Summary: 2012 Will Be The Year of Curated Sets
2012 will likely see an acceleration of structured, push button, social curation across the web. Why? Because most users don't want to take much effort to produce content, and consuming content in a structured manner (especially photos) is also much faster. Just as the first wave of social media has transformed the consumption of information, this next wave of social curation will fundamentally change how users find and interact with content over time.

Many thanks to Nils Johnson and David King for conversations that led to some of the insights in this post.

You can follow me on Twitter here.

Stepping Back: 5 Questions To Yourself Ask Yourself About Your Startup

2011-12-26T11:33:00.000-08:00

Every year (or quarter) it is worth taking a step back from the day to day emotional roller coaster that is a startup. It is worth making the time to reset your directions and ask the "big picture" questions that can drive the success or failure of your business.

Questions to ask yourself:

1. Do I Have The Right Team In Place?

Your business has undoubtedly changed in 2012. Are there holes in your team you should fill?
What sort of org do you want in each quarter of 2012 and how do you proactively get there?
Are there people on the team who are underperforming or a bad fit? How do you remove these people from your team and when do you do it? (Hint: don't wait)

2. Do I Have The Capital I Need?

When do you run out of money? Do you have at least 18 months of cash left?
Should you raise money in 2012?

What milestones do you need to reach in order to raise money (if that is your plan)?
Who do you want to raise money from? How do you build buzz and relationships with that person now?

Can you reach profitability in 2012? What are the tradeoffs to doing so (e.g. shrink the team? ramp sales? roll out new pricing)?

3. What Should I Be Doing Less Of? Or More Of?

What are things that you spend time on that did not help you in 2012?

Can you stop doing these things? If not, can you outsource them?

Where did your team waste the most time in 2011?

How do you make sure they spend time effectively in 2012?
What was the biggest barrier to productivity for your team this past year?

In hindsight, what were the activities in 2011 that created the most value for your business?

How do you make sure your team spends its time on the most important things?

4. How Is My Product Doing?

What do users love about your product? What are 1-2 things you can do to build on this momentum?
What do users hate about your product? Do you need to fix these things?
How much traction does your product have? Where does distribution come from?
If you are early stage, are you working on the right product? When do you decide the product is working/not working and what do you do about it?

5. What Can I Do To 10X My Business This Year?

Is there a market shift happening that you can exploit in 2012? (e.g. Android penetration? Rise of Pinterest for distribution to commerce sites? Something else?)
How can you think bigger and bolder in 2012? What are 1-2 big audacious product / partnership / other goals you should swing for?
How do you focus on the big swings despite everything else you are doing?

Any other questions you think are worth asking? Let me know in the comments section.

You can follow me on Twitter here.

Other posts you might like:

10X Your Business

Benefits of Thinking Small

Are You a Visionary Entrepreneur

20 Questions To Ask Yourself Before Raising Money

Questions VCs Will Ask You

4 Ways Startups Fail

You Dont Need a Good Idea To Start A Great Company

Is Your Startup A Cash or Equity Business?

How To Choose A Board Member

2011-12-05T10:48:00.001-08:00

A number of companies I know have closed series A or B rounds recently. The entrepreneurs' next step after closing a venture round is often to finalize the structure of the company's board, including choosing the independent board member(s).

WHAT DO BOARD MEMBERS DO?
The members of your board are the most important people you will ever "hire" for the company. For an early stage company, your board will often:
1. Select the CEO of the company. This means the board may be able to fire you from the company you started. Part of the board's job is to hold the CEO accountable for deadlines, plans, and deliverables.
2. Block or push for major events in the company's life (future fundraises, acquisitions, selling the company etc.)
3. Provide great strategic advice or become pain in the butt, medling overhead.
4. Help with recruiting senior executives or key hires.
5. Teach you about nuts and bolts of the business, or processes as you scale. Depending on the stage of the company and the sophistication of the founders and their executive team, board members may help you understand the process to set e.g. your first financial or strategic plans, coach you on how to manage larger and larger multi-functional teams, or other nuts and bolts of building the business.

For later stage boards, board members will be involved with compensation committee, financial audits, etc. So the board of a company may evolve quite a bit from an early stage company to a public one. This post is focused on smaller startups (e.g. 5-200 people in size).

A great board member can add enormous value and truly be helpful to the company. A terrible board member can truly screw a great company up. Most board members are neither great nor terrible - but this post will hopefully help you avoid the terrible ones.

THE INDEPENDENT BOARD MEMBER(S)
If your co-founder is your husband/wife, then your VC is your mother-in-law and the independent board member is like your father-in-law. Just as you can't contract the mob to off your father-in-law, it will be hard to remove a director once you add one, so you should choose your board very carefully.

While some series A investors won't push for the independent seat to be filled for a while (and in some cases at all), others will push for a faster addition to the board. Steps to choosing a board member:

1. Write a job spec.
This is one of the most important people you will hire. You should write up what you would optimally want for a board member as a check list or hiring spec. This should include:
a. Experience.

Operating experience. Do you want someone who has operated a company at a certain scale or has started a company herself? Can they share process or management best practices with you? What can you learn from them?
Market experience. Is there specific domain or market expertise you care about at the board level? Are they in the information flow in ways that will give you a competitive advantage? Can they provide intros to people in the market who can help you a lot?
Functional experience. Do you want specific functional experience? (e.g. an ex CFO or VP International Sales)?

Depending on your existing board and experiences as a founder, you may or may not care about market experience, functional experience, or operating experience. Or you may be willing to trade these off as it will be hard to find the perfect person.

b. Involvement with other early stage companies (optimally as a Founder). People who have not seen a company go from 2 people in a coffee house to a multi hundred person company aren't used to all the bumps in the road that an early stage company experiences. Things will take longer and will be rougher then expected. And, unlike a large established company, momentum won't exist. At an early stage startup, each bit of execution in an act of sheer will rather than an act of momentum.

Optimally, if there is just 1 independent board slot, the independent board member would be a current or former entrepreneur.

Other successful entrepreneurs will be able to relate more closely to a founder's emotional state and provide advice based on their own experiences. They will understand both the newbie nature of being a founder/CEO and be open to answering "stupid questions" without condescension/judgment. They will have first hand knowledge of how to build a business as well as understand the bumps that are coming along the way are inevitable. Finally, successful entrepreneurs can serve as a counterweight to the VC board members in a way that benefits the company, and hence also benefits the VC (see below).

c. Personal rapport and attitude.
This is REALLY important. You as the founder(s) should have great personal rapport with the independent board member. They should be someone you feel you can trust, who you would feel good about calling at midnight on a Friday, and someone you think will be able to help you and your co-founder grow both the company, but optimally also grow personally.

The independent board member should be someone you feel comfortable calling up to ask a dumb, newbie question about your business. They should be someone that if circumstances were different, you would be excited to start a company with them.

Things to avoid on this one:

The condescending grey-haired operating executive who sees you as a "bunch of kids" & who views herself as part of the "adult supervision". This typically leads to the founder getting fired as CEO and some visionless "operator" coming in to derail the company long term.
The micro-manager who confuses being on the board and being your boss.
People doing it for the potential financial reward rather then impact/excitement about helping you build a business.
People doing it to "join a board" so they increase their own personal stature.

d. Alignment of vision.
Does the independent board member understand where you want to take the business? Are they aligned with that vision and direction? You want a common view of where the industry will evolve, and someone who will support that vision rather then second guess it. Similarly, you want someone who will take a long term view to building a great company (if that is your intent), rather then a focus on a short term flip.

Look at their background - what has happened to the companies they have started or run? Did they sell early, and if so why? What other choices have they made in their career, and how thoughtful are they in hindsight about these decisions?

e. Raw intelligence.
This is self explanatory. Some folks, such as Marc Andreessen, Reid Hoffman, and Vinod Khosla, are known for their raw horse power. Notably, the former two took board seats or made investments prior to become full time VCs.

f. Entrepreneur friendly (or long-term relationship).
A number of VCs will suggest "friend of the (venture) firm" as your independent board member. These people will often owe the VC more then they will ever owe your company, and when shit hits the fan will vote with the VC. In other words, the "independent" board seat will in reality be an investor board seat, and you will lose control of the company.

Signs that someone is a "friend of the firm" (FOF):

They have worked at multiple companies backed by the VC
They sit on a few boards with the same VCs
They are likely to get placed in their next job by the VC (e.g. VP of sales who wants to become CEO as their next job)

The best scenario is to find someone that your VC respects, but that you know is an entrepreneur at heart or will be more entrepreneur friendly. Optimally, you will have a pre-existing, long term relationship with this person that will help you trust each other as the company inevitably hits a hard spot.

Given the importance of rapport and trust in the board relationship, you should make sure to get to know people (optimally over a few months or longer) before adding them to your board. As such, you should push back if your investor is trying to get you to quickly add an FOF.

g. Respected by the Investors / VC
Part of the independent board member's role will be to remind the VC board member that they should be voting in the company's best interest (rather than the investor's own best interest). They should have the confidence and insights to push back on the VC when it makes sense to do so. The independent should help keep the VC "honest". This does not mean the independent should rubber stamp the entrepreneur/CEOs every whim. Rather, they are there to do what is best for the company and to remind the VC that their purpose should be the same.

This is easiest to accomplish if both the VC and the entrepreneur respect the independent board member. This means both of you should spend a lot of time with candidates for your board before adding them.

2. AGREE ON THE SPEC WITH YOUR INVESTORS
Once you have defined what you want, discuss it with your investor and get agreement on the spec. This helps you call bullshit on them (e.g. when they offer up a Friend of the Firm with no relevant background) and for them to call bullshit on you and keep you honest (when you suggest your best friend from High School).

3. CREATE THE LIST OF OPTIONS
Make a prioritized list of people you would most like to add to the board. If you do not know them directly, contact them via your investors/advisors or on LinkedIn or AngelList. A lot of people will reply to a random ping on LinkedIn or AngelList if it seems serious and you have e.g. good backers/investors. Your investors may have good suggestions for this list as well.

4. SPEND TIME GETTING TO KNOW THE POTENTIAL BOARD MEMBERS
You will have a lot of pressure from your investors to finalize the board. You should push back on this and make sure you take the time (many months) to find a great person to join. Just as you would not rush to hire a crappy engineer "just to fill the spot", with a board member (who will be more of a pain to remove than a bad employee) this becomes even more important.

Some questions to ask/discuss with the potential board member:

Ask them to discuss key directions for the co. Do they align with the vision and approach you want to take? Do they have key insights or interesting feedback?
Ask them how they will help the company. Where will they pitch in? What are they good/bad at providing?
What are their goals/aspirations? What do they want to do with their career or life? How does the role on your board impact this?
Ask them to do something for you. Try to put them to work and see if they will help with something relevant that they are experience in.

5. CHECK REFERENCES
What do people who have worked with them think of them? Are they high integrity? What are the helpful at? If they are already on boards, what do the entrepreneurs they work with think of them?

6. FINALIZE WHO TO ADD
Optimally you will take a "common nominates, preferred stock approves" style approach to adding the independent board member. Just like with the Supreme Court where the President nominates the Justices and Congress approves the nomination, the balance of power lies with the nominator (thanks to Naval Ravikant for this analogy).

SUMMARY
To sum it all up, choosing your board members will be one of things that could impact the future of the company substantially. You should be thoughtful about who you are adding and why, and work with your investors to take the time to be thoughtful about who you add. Once someone is on your board, they are very hard to remove.

Many thanks to Josh Hannah, Naval Ravikant, Sam Altman, and David King for providing feedback on a draft of this post.

Any other things you used to select the right board member? Let me know in the comments section.

You can follow me on Twitter here.

---------------------------
Other fundraising posts:

How To Reply to Angel Investor Intro Emails

2011-11-17T10:52:00.001-08:00

I have had a lot of entrepreneurs ask me for introductions to various investors. In some cases the entrepreneurs use their reply to the intro email as a mechanism to gain social proof, emphasize urgency, and to reduce the friction to meeting the investor and closing their round (see e.g. VentureHacks for great tips).

Unfortunately, a lot of otherwise savvy entrepreneurs don't follow up with investors well. You have to remember that every thing you do can signal to an investor a lack of urgency/interest in your company, the fact that you are taking your startup casually, desperation, or a lack of ability to follow through. Also, if you don't create urgency or a sense that the investor may miss out on something interesting, then the angel may drag their feet in meeting with you, extending the time of your fundraise.

This post is focused on the small tactics that go a long way upon receiving an introduction.

Example Of a Bad Reply To An Investor Intro

"Thanks Ivan Introducer for the intro!

Hiya Angela Angel,
It is great to meet you! Love to connect! Let me know what works!
Regards,

Elizabeth Entrepreneur"

Example of a Good Reply (tailored to an angel round with a lead)

"[moving the person who made the intro to BCC][1]
Hi Angela Angel,

It is great to meet you. As introducer said, we are in the midst of a round led by well-known investor and other well known angel is also investing[2]. We have seen really solid traction with user growth of X up Y%. [3] See below for team bios/key stats [7]

Our round is coming together quickly so the sooner we can talk the better[4]. Are you free to chat at one of the following times?[5]

Monday 2pm-3pm; 5pm
Tuesday 1:30pm-3pm, 6:30pm

We can also try to move things around to accommodate you - we have heard great things about you as a social media investor (in particular your investments in Tumblr and Pinterest)[6] so would love to connect before we close the round.

Thanks,
Elizabeth Entrepreneur
----------
Team bios [7]

Elizabeth Entrepreneur
-2008-2010 Tech lead at Facebook for newsfeed
-CS, MS degrees from Berkeley
-Side project stupidhipster.com getting 100,000 visits a month

Carl Co-founder
-etc.
"

What Is The Difference?
I added numbers to footnote the important parts of the email.
1. Move the introducer to BCC. They don't want to be on the 15 emails it takes to schedule the meeting.
2. Put social proof up front. All these great investors are part of the round! Angela angel will want to be part of the club and invest too. It also means you are more legit than the other random companies trying to talk with the same investor.
3. If you have good traction or a key stat, explain it in 1-2 lines. This is additional proof that they need to rush to talk to you.
4. Put polite pressure to chat very soon. You need to emphasize things are on a fast track for you. If things are moving slowly it suggests no one is interested in your round, which means this investor won't be interested either.
5. Add specific times. This reduces the friction to scheduling as if you leave it open ended it (a) does not convey urgency and sets up the timeframe within which you will meet and (b) makes the investor work harder to figure things out. Don't put the burden on them to suggest a time
6. Explain why the investor is relevant. This helps them understand why they are a good fit for the company. It also extends the the timeframe you can wait to meet with them if needed without looking desperate (e.g. if the can only meet in two weeks, their experience justifies you waiting for them as they are uniquely awesome for your company, rather then because you dont have other options).
7. Add team bios (2-3 lines, bulleted per team) + any key stats (if no good stats, just included bios). People will want to know who you are and why to meet with you. In some cases, even if the idea is bad they will still want to meet with you if you have a strong background. This will give you a chance in person to convince them to invest.

Hopefully, the person who introduced you already covered items 2 through 5 or 6 in either their intro, or in the email asking if the investor will talk to you. If the intro explicitly included 2-3, you can skip mentioning it yourself, but you should keep the other elements in.

You can follow me on Twitter here.

Other fundraising posts:

Holy Crap! The NY Startup Scene

2011-11-11T10:21:00.001-08:00

Every few months I take a weekend to step back and make myself a list of startups doing impressive things.

One of the things that struck me was the extent that startups coming out of NYC were included on the list for the first time. It used to be that NY mainly about AdTech and SEO-farm focused "new media" startups. These companies were often pretty underwhelming. Nowadays, NYC is definitely undergoing a web renaissance with clusters in social media and commerce.

4 Reasons The NYC Startup Scene Changed

1. Access to Capital.

There is a lot more capital available in NYC today than there has been historically, and it is now provided on "West Coast Terms".

It used to be that NY and Boston was known for ex-Banker VCs who wore ties and penny loafers and asked entrepreneurs to go on a 5 year vest. NYC has seen an influx of capital in terms of both thoughtful local VCs (such as First Round and Union Square) and angel funds (e.g. Founders Collective, Lerer Ventures), but also a larger number of traditionally West Coast focused VCs have been increasingly willing to fund NYC based companies. This includes everyone from Accel (Diapers.com*, BirchBox, Bauble Bar), Andreessen Horowitz (Foursquare, Canvas), to Sequoia (Tumblr, etc.) and more recently Greylock (Tumblr).

Almost every NYC startup I know of now makes a trip out west to fundraise, and West Coast angels and VCs have become increasingly comfortable investing across the country. In parallel, some West Coast VCs are moving to the East Coast . For example, Accel recently opened a NYC office, and one of the sharpest investors I know - Alex Kinnier, recently joined NEA on the East Coast.

Capital is now chasing the best companies no matter where they are (as long as they are in the Bay Area or NY :)

2. Anchor Companies.

In 2002 I somehow ended up with almost an hour 1:1 meeting with Don Valentine, the founder of Sequoia Capital, and the VC who personally funded Apple, Cisco, EA, Oracle and other titans of tech. Valentine and I spoke about the difference between Boston (which I had just moved from) and Silicon Valley.

He pointed out that one advantage Silicon Valley had over the East Coast was its preponderance of "anchor companies". These companies are large tech companies that recruit and import a large number of highly talented people from all over the world. These talented people then either go on to found their own companies, or to poach management or other talent from the existing anchor companies. In other words, the fact that Google and VMWare and Intel and Cisco have tens of thousands of engineers each enables the creation and *scaling* of amazing startups with high talent density themselves nearby (e.g. I have seen one estimate that about 1/3 of Facebook's engineers are from Google - which means hundreds of people have switched from Google to Facebook in a short time span).

In contrast, the number of "anchor companies" on the East Coast has traditional been pretty low (I don't consider IT departments of big investment banks as "anchors" as these organizations are not product focused). This started to change as companies such as Google built large engineering/product offices in NYC, and has allowed companies to find talent more quickly. For example, a pretty big chunk of the early Foursquare engineering team is ex-Google, while the COO of Etsy is also from Google. This increase in web product/engineering talent density in NYC helps change the dynamic and allows East Coast companies to scale to a larger size without the need to open a West Coast engineering office.

In parallel, NYC has started to get some smaller anchor companies for competencies such as commerce and more recently, social media.

3. Increased Ease of Development.

The cost and speed of development has dropped dramatically. From AWS to Django and Ruby to all the various APIs and platforms (Twilio, Stripe, etc.) a single engineer can build an enormous amount. This means a small team can wholesale execute a great product (see e.g. the early days of Tumblr, or stand-alone 1 person teams such as Instapaper.)

This lower bar to development means that despite its sparser engineering and product talent pool, NY startups can get up and running with fewer people and still pull off amazing things.

4. A Social, Design Commerce Focused Environment
People who chose to live in NYC are in an environment that is more art, design, and media influenced than SF, which jives well with the webs shift to social media. It is not a surprise that companies such as Tumblr and Foursquare have thrived in NY. Similarly, many big brands and traditional commerce companies are based in NY, which has been a boon to companies such as Gilt Group.

List of Some NYC Startups

Here are some of the startups I think are doing some of the more interesting things based in NYC:

A. Social Media

B. Commerce

Hopefully, some of these startups will get large enough to act as anchor companies and reinforce the cycle of startup creation. If these companies end up with early exits, they will never hit the scale and talent competencies that will allow them to contribute to the next entrepreneurial startups.

You can follow me on Twitter here.

*I believe Diapers.com is actually HQ'd in Jersey

Why Fewer Companies Are Successfully Raising Series A Rounds

2011-11-04T08:41:00.000-07:00

Update: Data from TechCrunch supports the post below. CrunchBase has seen a 33% increase in the number of seeds reported and a 9.6% drop in the number of series A's reported. In 2008 the ratio of seeds/series A reported were 1:1, in 2011 the ratio was ~2:1
--------------------------
One big shift in the startup scene over the last 18 months is the sheer volume of startups getting started and seed funded. If we use Y-Combinator as a proxy for the broader ecosystem (which is probably directionally correct, although YC growth may be overall higher due to increased branding as well as e.g. Start Fund and other activities) then we see the following:

GRAPH OF # OF YC COMPANIES PER BATCH*

At the same time, the percentage of startups closing seed rounds seems reasonably static to me (it may even be up). This means there are many more companies getting founded and then funded at the seed round. However, the number of legitimate VCs doing series A rounds has not increased.

This has led to a crunch at the series A level, where more and more startups are unable to successfully raise a series A.

Reasons for the Series A Crunch
1. The bar has gone up significantly for what constitutes a company that can raise series A. This is due in part to valuations going up (so series A are now often $5-10 million raises instead of $3-7 million) but I think it is largely due to the large supply of startups.

2. More startups means that there are more startups doing "merely OK" all competing for the same dollars. It also means there may be slightly more startups with high traction (e.g. if 1 in 100 get lots of traction, and there are 2X more startups, there are 2X more startups with high traction), which means the high traction startups will soak up most of the investment dollars.

All the VCs I know tell me times are getting more and more busy for them. They are seeing way more series A deals coming through their doors, but they are funding the same number of deals. This means fewer startups are successfully closing A rounds. Those startups that do close round are often further along then the average series A company was 2-3 years ago.

Return of the Bridge Rounds
So what do all these startups do that can not raise a series A? A subset sell as a team buy, a few go out of business, but an increasing number are going out for a bridge round. Basically, instead of raising $5 million, I am seeing post-seed startups raise anywhere from $500K to $1.5 millon, at a valuation somewhere between a series A and a seed valuation, with the hope that the additional capital will give them time to gain more traction or scale their business.

Q1 and Q2 of 2012 Will Likely Be Very Competitive For Series A
Many companies who raised a bridge round plan to go raise a series A sometime next year. Unfortunately, the environment may get even more competitive at that time. Given the ramp in new startups in early to mid 2011, Q1 and Q2 of 2012 may be even more competitive. You will not only have the startups seed funded in 2011 raising a round, but also all the startups from 2010 who raised bridge rounds - all competing for the same dollars.

If you add in the risk of a European financial crisis, then early next year may be a tough time indeed to raise a round if you are in the "middling" zone of traction (versus those that will flame out or be team buys). In contrast, companies with great traction, or a well connected celebrity entrepreneur, will still get chased by all the various VCs as usual.

Some Tips For Raising a Bridge Round
Given the likely high competition for series A dollars in early 2012, if you plan to raise a bridge round I would suggest:
1. Raise enough money to buy you real runway. Make sure you have the runway to hit the milestones needed to raise a series A. It will be harder to raise another bridge, and it is always easiest to raise money all at once then have to go out fundraising again 6 months later. If you think you need $500K, think about raising $750K or $1 million to have extra runway in case it is needed.

2. Diversify your investors.
Adding new investors to the mix may both up the valuation you get for the bridge, as well as expand your network for the series A.

3. Include some insiders from your first round if you can (and if they have been useful).
Having 1-2 existing investors re-up into your bridge will convince new investors to participate at a higher valuation. However, if you can not get existing investors in a bridge at a good valuation, or you do not think they have been helpful, feel free to exclude them from the bridge round and focus only on new investors.

You can follow me on Twitter here.

Other fundraising related blogs:
Questions VCs Will Ask You
How To Raise A Successful VC Round
Differences Between Funding Rounds: Series Seed, A, B, C...
Financing Approaches Most Likely To Kill Your Company
Put Your Investors To Work For You
Party Rounds: How to Get A High Valuation For Your Seed Startup
20 Questions To Ask Yourself Before Raising Money
VC Economics: Why VCs Could Care Less About Your $50 Million Exit
The 7 Types Of Angel Investors

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*Update: this graph has been updated with data from Harj Taggar, one of the partners from YC. Many thanks to Harj for the info.

Hire For The Ability To Get Shit Done

2011-09-20T08:59:00.000-07:00

I have found that the two biggest causes of having to fire an employee at an early stage startup are a lack of culture fit, and the inability to Get Shit Done. I don't care how smart someone is - if they are unable to work hard and crank out a large amount of high quality work, they will weigh down your startup.

Inability to get things done may manifest itself in multiple ways including:

Lack of urgency. Used to a large company environment where its OK if things take a few weeks longer.
Easily distracted. Heavy procrastinator.
Lazy / doesn't work hard. Some very smart people are basically lazy. Don't tolerate this.
Starts but never finishes things.
Lack of follow through - makes commitments but does not follow up.
Argumentative. Arguing incessantly about how to do something rather then just doing it.
Slow. Taking a long time to code (or do) something simple.
Perfectionist. Tendency to overdesign something and to spend 4 weeks building the perfect implementation versus 1 week building the thing that "just works" for 95% of the time. Sometimes the edge cases need to be covered, but in most raw startups this is not the case. On the business side this manifests as someone heavy on analysis, low on "doing".

Unfortunately, this is the fault of the entrepreneur and of the hiring process - too few hiring processes focus on the ability to Get Shit Done (GSD).

Screening for the ability to Get Shit Done.
Here are some ways I have used in the past to check for the ability to Get Shit Done:

Coding exercise. As part of our hiring process at Mixer Labs, we would often give people a half day coding exercise. We would see what tools they used, how they worked with the team, but also how productive they were. What was the final output of the half day, and how did that compare to other candidates? We had a few candidates that went from "did OK on interviews" to "wow, that person is great" when we saw the output of the exercise (and vice versa).
Personality.

Follow through. Did the candidate respond to every email from me quickly? Did they follow through on everything they said they would do?
Excellence. Do they spend the time to become good at anything they adopt as a hobby? Larry and Sergey at Google would famously ask about people's random hobbies to test whether they were the type of people who focused on excellence and depth of understanding.
Proactivity. Do they suggest the right next steps without prompting? Do they go above and beyond in the interview and come in ahead of time with e.g. a 5 page analysis of where the company should head?

Homework. We would give non-engineering candidates a simple task to complete between phone screen and onsite. E.g. "Come back in 3 days with a 1-page marketing plan for our product." If they did not finish this on time, or they came back with little insight / shoddy work we would not move forward with them.
Ask the candidate. I would often straight out ask people how effective they were at GSD, and how did they compare to their peers? It was surprising how honest some (very smart) people would be on this. E.g. "I am average compared to other engineers". For an early stage startup, average is not enough.
Reference checks. Ask about people's Get Shit Done ability in multiple different ways during reference checks:

What %ile of getting stuff done is this person?
How does this person compare re: GSD to their peers?
Give me an example of how this person was proactive?
How proactive is X versus their peers? What %ile is this for your company? For all people of Y-function you have worked with?
How hard does X person work?
When has X person been unable to follow through on a commitment? When has X not come through on a commitment, no matter how small?
How fast does X accomplish tasks?
How frequently does X go above and beyond what they are asked for?

With the simple steps above you should be able to optimize for people who are proactive, have good follow through, and Get Shit Done in addition to the other screens for raw intelligence, culture fit, and functional knowledge.

Other hiring blogs:

You should follow me on Twitter here.

12 Year Old Steve Jobs Meets Bill Hewlett (of HP)

2011-09-06T09:29:00.000-07:00

I was eating pho with a friend the other night and he pointed out how grateful he was to be living in the one spot on the planet where it was easiest to contribute to the creation of the products and services that are driving massive technological change across the planet. This is a big picture, technology-as-a-force-for-awesomeness perspective I had not been reminded of in some time (with all the noise of who is filing to go public, what are all the 65 companies in the last YC batch doing, etc.).

It also reminded me of how much I love Silicon Valley.

Here are 3 of the many reasons I love Silicon Valley:

1. Steve Jobs (at the age of 12) meeting Bill Hewlett (CEO of HP). When Steve Jobs was a kid, he grew up in Mountain View. HP was right around the corner and at the time was being run by Bill Hewlett, one of its co-founders.

To quote the HP website:

When he was in eighth grade, Steve Jobs decided to build a frequency counter for a school project and needed parts. Someone suggested that he call Bill Hewlett. Finding a William Hewlett in the telephone book, the 12-year-old Jobs called and asked, "Is this the Bill Hewlett of Hewlett-Packard?" "Yes," said Bill. Jobs made his request. Bill spent some time talking to him about his project. Several days later, Jobs went to HP and picked up a bag full of parts that Bill had put together for him.Subsequently, Jobs landed a summer job at HP. He later went on to co-found Apple Computer.

Think of how amazing this is. The founder and CEO of one of the major companies of the time, Bill Hewlett, got on the phone with a random 12-year-old he had never heard of. He then proceeded to personally make sure to assemble the bag of HP parts the kid needed.

I wonder if this explains why decades later Steve Jobs was then so welcoming to the 10-year-old kid with an Apple logo shaved in the back of his head, who also contacted him out of the blue. You can read the story here.

To me, this sums up the ethos that pervades Silicon Valley during non-bubble times - people helping each other out of the love of technology and the impact it has on the world. People recognizing and nurturing talent even if it comes in an unexpected form (e.g. an eventual hippie-esque college drop-out obsessed with fonts starting Apple computer). And once successful, people realizing they need to give back in turn when they are the person who can help others.

2. Netscape in a Strip Mall; Taking a Baseball Bat to a Lamborghini
I remember feeling pretty exuberant the first time I landed in Silicon Valley back in 2000. I flew into the San Francisco airport and immediately drive down to see all the great companies I had read about and/or whose products I had used. As I drove down the 101S and related roads I saw the signs for Netscape, Intel, Yahoo!, eBay, Cisco etc. (this is back before Google, Facebook, and Twitter became the next wave).

The thing that stood out most for me was, well, how understated all the buildings were for these major tech companies. They basically looked like one or two story strip malls. If you compare this to the opulent, wood-paneled, 100-story buildings most of the Fortune 500 has, you realize how the culture of a technology company is often focused on building a great product, rather then building the perception of importance. Great technology companies are too busy doing the important, to worry about looking important.

When Google was about to go public, I attended an engineering all-hands led by Wayne Rosing, Google's former SVP Eng who ran the whole Google eng organization (he was also the eng director at Apple who led the development of the Lisa Computer, Apple's precursor to the Mac). Wayne said something along the lines of "Once we go public, if I so much as see someone drive a Lamborghini into our parking lot, I am going to take a baseball bat to it." Wayne's message as I read it was "Keep your heads down doing good work- this is just one step in the long evolution of a our company. Don't get showy - we still have lots to accomplish. And lets not screw up our culture in parallel with gross displays of wealth - this is just a dumb distraction from our mission."

The people I am most impressed by in Silicon Valley still share these values. Reid Hoffman, for example, (now worth billions post LinkedIn, and Zynga and Facebook investments) still drives a Toyota.

3. Drop Outs and Immigrants.
Most Silicon Valley startup stories sound like the punchline to a joke. E.g. "An Indian, a Jew, and a boy from the Midwest walk into an empty office space..." and the next thing you know a great company is born. Many of the great technology companies were started by people who dropped out of college or grad school (Microsoft, Facebook, Google, Apple, Dell, etc.). Cultures that, at their best, ignore a person's origin and education level, tend to create the most innovation. The best ideas tend to rise to the top.

Summary: Silicon Valley Values
I guess to sum it all up, to me Silicon Valley as an ideal has the following values:
1. Understated
2. Focused on changing the world through technology
3. Egalitarian
4. Giving back to the community - Entrepreneurs and technologists helping one another out

I hope we don't lost sight of these values in the current boom cycle.

You can follow me on Twitter here.

What Is Your Startup Acquisition Offer Really Worth?

2011-08-29T07:38:00.000-07:00

I have helped more than a dozen entrepreneurs think through their exits. There are a large number of non-financial issues to consider when selling your company (your role, manager, network, impact to your employees, etc.). This post focuses solely on how to go about making a financial assessment for the entrepreneur.

In particular, I focus on items that impact the *real* versus perceived value of the deal.

1. How Long Will You Really Stick Around?
How long is your vesting period? E.g. suppose you have 2 offers:

Offer 1: $10 million vesting over 4 years.
Offer 2: $3 million vesting over 1 year.

Offer 2 is actually much better for the entrepreneur who only plans to stick around for 1 year, even though Offer 1 is much higher in total value over time.

This suggests as an entrepreneur you should never go somewhere you think you will be miserable, even if it seems to pay more over multiple years. Entrepreneurial people tend to quit more often and more easily, so don't mislead yourself on how long you can stick out working for someone else.

2. How Much Upside Does the Acquirer's Stock Have?
If you are getting stock offers, how much is the stock likely to be worth? Does it still have 10X in it? Selling to Google or Facebook when it was valued internally at $10 billion is much different from selling to Google or Facebook today. A $50 million acquisition can suddenly become a $500 million acquisition if the acquirer's stock appreciates dramatically.

3. Are You Getting Options Or Stock?
You need to exercise options, which means you pay money to convert the option into stock. For a later stage company this can be e.g. 1/3 the price of the common stock. In other words, $30 million in options may be worth $20 million in stock (assuming it costs you $10 million to exercise the stock).

Ask the acquirer what their strike price is, if they are largely compensating you with options.

4. Taxes.
How tax efficient is the acquisition? Will your acquisition be treated as long term capital gains versus e.g. cash compensation? This can change the value of the deal dramatically.

5. Is the Offer Net Cash?
Suppose you have $1 million in the bank and you are acquired for $10 million. Who gets to keep the cash? If the acquirer keeps it, you just subsidized the deal to the tune of $1 million. I.e. the real value of the deal is only really $9 million and the acquisition is worth 10% less. You should ask for the cash to be dividended out to your shareholders or use this point as part of the negotiation.

6. Other Intangibles (these matter most if the acquisition price is low):
a. Vacation Transfer. You have not taken a vacation over the last 4 years and on your company's vacation policy have accrued 6 weeks of vacation. This should either transfer over or get paid out. (6 weeks of vacation is either an extra 1.5 months of free vesting for you, or if you cash it out could be a reasonable sum depending on your salary)
b. Vacation Accrual. Some companies have seniority tied to vacation policy - e.g. if you have worked at the company for 4 years you get an extra week or two of vacation. Negotiate the transfer of this seniority for you and your employees.

Anything else you think makes a big impact? Let me know what you think in the comments!

You can follow me on Twitter here.

5 Reasons To Sell Your Startup

2011-08-22T10:04:00.000-07:00

Many entrepreneurs get really distracted when Google or Facebook or another acquirer approaches them and asks if they want to get acquired. I frequently (a) ask - why do you want to exit? and (b) suggest the entrepreneur stop talking to the potential acquirers - this is usually a huge distraction that does not lead anywhere. [aside - I wrote another blog to be posted soon on moments when you should NEVER sell your company]

When most entrepreneurs approach me for advice on how to exit their startups, I usually first ask if there is a reason they should do so. I think the following are legitimate reasons to exit a startup:

1. You are exhausted and dont want to keep going.
Sometimes you just don't have it in you to keep going. The startup has been rough on you. Your significant other left you. You can't sleep anymore. You show up at work without energy every day, and feel like you are clawing your way from morning to morning without end.

We all have periods like this as entrepreneurs (I think many entrepreneurs are a little bit manic depressive) but if you find that the startup has drained you to the point where the manic part is totally gone and doesn't feel like it will ever return, and nothing (vacations, new boyfriend/girlfriend, hiring someone to delegate to, etc.) can't fix it, it may be time to stop what you are doing and try a startup again at a later date when you have recharged.

Startups take a lot of energy and relentlessness. If you lost both of these things, it may become impossible to roll the boulder up the hill singlehandedly anymore.

2. The founding team is about to blow up.
You and your co-founder can no longer stand the sight of one another. You roll your eyes whenever she speaks (or vice versa) and spend long pointless days arguing. Who is responsible for what is eroding or you can no longer do your own part effectively.

First you should talk things through and try to work it out with your co-founder. Have a mature conversation on it. Often you can work it out. If this does not work, you can pull in a mentor, advisor, or investor to help work it through. If you find things have truly eroded to the point where you can not work together anymore you need to either:
a. Leave the company (or have your co-founder leave)
b. Sell the company if you think (a) will kill the company for some reason

3. The acquirer is willing to "pay ahead" substantially.
Most disruptive companies end up with offers that look very large at the time that in hindsight don't properly value the company's potential. E.g. Amazon's $100 million bid for Google and then Yahoo!'s conversation with Google that valued it at $1 to $5 billion.

That said, there are a number of times where an acquirer is willing to pay substantially more then a startup is likely to be worth. Reasons for this may include:
a. The acquirers equity value will likely grow substantially faster then yours will (e.g. any company Google bought in 2003 or the early team buys Facebook made). For example a $50 million acquisition by Facebook when it was worth $5 billion would appreciate into a $500 million deal value at current valuations.
b. The acquirer can get more value out of your company than you can. For example, if their larger sales force can ramp sales of your product much faster than you can you may be worth more as part of their company than as a stand alone.
c. You are in a hot space or the acquirer is desperate. Sometimes you are just in a hot market, so people will pay for you much more then you will ever be worth - especially if they are desperate (see e.g. AOL buying Bebo for $750 million).

So the big question you should ask yourself is whether you are Facebook or Bebo? :)

4. You are about to get massively crushed by a competitor.
Sometimes there is a competitor in your market who has dirty tactics or uses a truly unlevel playing field to crush its competitors. An example of this is the way Microsoft used to bundle multiple products into its O/S for free. This both (a) created instant massive distribution for these products and (b) often killed its competitors by giving away the product for free, when the competitor used to charge for it. This dried up the competitor's revenue stream leading them into a downward spiral, or the arms of an acquirer.

A great case example of Microsoft tactics lies in Microsoft versus Netscape. Netscape was eventually bought by AOL for >$4 billion.

5. You need financial security or regular cash flow.
A family member gets sick. You are about to have kids and can't afford it. You need to support your family members. There are a number of instances in which having liquidity can go a long way. There are often alternate means of liquidity (a loan with your shares as collateral, secondary stock sales, etc.) but if all else fails, an exit into a larger company may both generate cash for you as well as provide you with a stable, higher paying job.

Any other thoughts on reasons to sell your company? Let me know in the comments.

You can follow me on Twitter here.

Startups: Give Your Family Stock In Your Company

2011-08-05T10:47:00.000-07:00

One of the things I regret not doing when I set up Mixer Lab (since acquired by Twitter) was that I did not gift any stock to my family members when incorporating.

When you set up your company, the stock is really cheap (e.g. 0.0001 cents per share or the like). This is your opportunity to give your family, spouse, or other loved ones the equivalent of a tax free gift that could have a major financial impact long term (i.e. the taxes they will need to pay on the gift at this point could be either zero or very low in dollar terms).

More Tax Efficient For Your Family
Say for example you gave each of your parents and your siblings 0.25% of the company. If the company sells for $100 million this translates into $250,000 for each of them*, taxed most likely as capital gains. In contrast, if you were to just give a gift equivalent to $250,000 after the company exit the money gets taxes twice - first it is capital gains for you, then it is taxed (heavily) as a gift for them.

This becomes much more dramatic if you have a very large exit - e.g. at $1 billion the 0.25% gift could be worth $2.5 million - which means you have not only provided long term financial independence to yourself, but also for the set of people you care about.

Voting Rights
If you are concerned that the e.g. 0.5% of equity you divide amongst your loved ones will dilute your ability to control the company over time, you can ask your lawyer to give you voting proxy rights over the shares. This means as part of the gift, the family assigns the vote associated with the shares to you. So, you still effectively have the same voting block as you did before the gift.

Ask your lawyer (and tax accountant) for more details on the above as some things are pretty case by case.

Any other things people wish they had done when they first set up their company?

*Assuming no dilution from funding rounds - I am trying to keep the math simple)

You Should Read Every Word of Every Legal Doc (Especially Funding Docs)

2011-06-15T09:10:00.000-07:00

Reid Hoffman was one of my company's (Mixer Labs, acquired by Twitter) investors. One piece of advice he gave me was to read every word of every contract I signed on behalf of Mixer Labs (including the crazy ALL CAPS parts and legalese). This is one of the better pieces of advice I received.

One of the most important set of contracts you will ever sign in the life of your startup are your financing documents. I am surprised by the number of entrepreneurs who depend on their lawyers to read through and decide on key business points of their funding rounds. I will often ask an entrepreneur who is running into an issue about a key issue impacted by their prior funding rounds or employment agreements and their answer will be "I don't know".

Don't Depend on Your Lawyer to Make Decisions for You.
Often, if you ask a lawyer about e.g. a key funding term, they will say "oh yes, the term as written as 'standard'". You should never accept this at face value. Here is a common conversation I would have with my lawyer (who, by the way, was fantastic):
Me: "What do you think of term X?"
Lawyer: "Term X is standard".
Me: "What do you mean by 'standard'?"
Lawyer: "Well, 40% of the time it is written this way, and then 30% of the time it is written this worse way, and another 30% of the time it is written this more entrepreneur friendly way"
Me: "OK, lets put in the more entrepreneur friendly way".
Lawyer: "OK cool"

If I had just let these sorts of things go, our overall situation at the end of our funding rounds would have been much weaker as entrepreneurs.

Plan For the Worst Case Scenario and Clean Up Loose Ends
Given that a lot of entrepreneurs don't read their financing docs, they often don't understand what will happen in different circumstances.

Some example questions on convertible notes: What happens if your convertible note does not convert after 1 year? Does it convert into common on preferred? What happens under acquisition? Can you buy out the note of a badly behaving investor? Etc. etc.
Some example questions for equity rounds: What actions can your investors block under what circumstances (funding rounds, acquisitions, etc.)? If you hire a CEO for your company, does she get one of the common board seats or is a new seat created for the CEO? (this can strongly impact board control)

These are the types of issues that can later come back and really impact your company (e.g. loss of board control) if you do not think about them up front.

You won't think of these issues up front unless you read through all the docs.

You can follow me on Twitter here.

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Our 10 Step Engineering Hiring Process at Mixer Labs

2011-06-06T09:49:00.000-07:00

Before my company, Mixer Labs, was acquired by Twitter, I spent a big chunk of every day on hiring. A lot of entrepreneurs I help out ask about the process we used to hire a very strong engineering team and so I thought I would share the steps we would take in this post.

1. Resume screen.
We would source people from friends, engineering meetups, LinkedIn, basically anywhere we could find someone who seemed good. I think of approximately 100 resumes or profiles we looked at closely we hired 1 person.

2. Phone screen 1 - culture fit and "reasonable to set up technical call"
After choosing a subset of profiles or referrals to follow up on, I would do an initial "culture fit / is this person worth talking to" phone call or a "sell" call to people not actively looking. In some cases people did not want to leave their job (if I was reaching out to them), or they might be a bad fit to begin with. I would screen for things like:

What motivates this person? What do they care about?
What are they exceptional at?
Do they think of themselves as a generalist engineer or a specialist (e.g. FE, mobile, etc.)? We were looking for generalists.
Do they seem like a really strong engineer?
Are they excited to join a startup?
Will they be a good culture fit?

I would simultaneously try to sell the person on the opportunity, to get them excited about our company. Remember, all interviews go both ways as the candidate is also interviewing you as an employer.

These interviews would literally take 15-30 minutes and I set expectations up fron that the call would take 15-20 minutes (if someone is asked to block 15 minutes on their calendar, they usually block 30 minutes anyhow, so we never ran out of time). These short blocks of time minimized the time spent on this first screen and often I would know within 5-10 minutes if the person was worth a second conversation.

I would meet the really promising people in person for a coffee if they were somebody I was trying to convince to leave a comfortable existing job.

Of 100 people we started with, maybe 15-20 people got an initial phone calls or coffees.

3. Phone screen 2 - engineering interview.
This second phone screen focused more on engineering questions and ensuring the person was strong technically and merited an in person interview. This would take 30-45 minutes and be performed by a rotating set of engineers on our team. Different engineers had different filters / set points (e.g. some were much harder "graders" then others, so I would take this into account when scheduling in person interviews, asking the candidate to do an additional phone screen (if they seemed marginal), or dinging them.

Of the 100 people we started with, 7-8 would probably make it through the phone screen to an in person interview.

4. In person interviews.
People would come in and be interviewed by each member of the technical team for ~45 minutes. We would sometime put an extra 15 minute buffer for engineers who tended to take longer with candidates.

We asked the interviewers not to let each other know what they thought of the candidate as they came out of the interview, so the next interviewer would not go in biased. Studies have shown that sharing your opinion of person A with person B (if B has not met A) biases the interactions B will then have with A.
I asked each interviewer what they thought of the candidate over IM immediately after each interview (basic thumbs up or down). If enough people gave a thumbs down, I would cut off the rest of the interviews to save engineering time. I.e. the time of our engineering team was too precious to waste on candidates that had people think they were not strong enough for the team.

Before we had multiple engineers on the team, we would ask out strongest technical friends to come by and interview people to help us. This allowed us to ensure we always had ~4 engineers interview every candidate, even if we were just 2 founders to start with. As we scaled to past 4 people, we still had every engineer on the team met every hire.

If one of our team had worked directly with the engineer before, we would skip them past phone screens directly to an in person interview. We had *everyone* interview with everyone on the team, even truly exceptional engineers we had worked with in person before.

Of the 100 people we started with, 2-4 made it through the in person interview.

5. Discuss the candidate
We had each person write down their thoughts of the candidate before we discussed them and then asked each person for their opinion. We also asked people how they would rank the candidate against all the other candidates we had interviewed. I.e. below a certain bar they were not worth considering further.

For a while, we used to graph the stack ranked interview feedback vs years of experience to look for outliers who are stronger then average. We would pursue these outliers aggressively.

6. Half to full day work with team
We asked a subset of the people we moved forward with to come in to work with the team for a half day or full day to test their working style, how much they could get done in a day, design/engineering choices they would make, and also whether they were interested enough in us to actually take the time off to meet with us.

We would always give the candidate the same coding problem, and we would always through away they code at the end. The purpose was to test their skills and fit, rather then have something productive come of the day. At the end of the day, we would all gather around and the engineer would show us his or her work.

3 out of 4 people who came in to work with us we moved forward with to the beer test. In some cases, having someone come in to work with us made us more excited about them as a candidate (i.e. it was someone we were going to ding based on interviews, whom we kept due to their performance coding). They may have been medium on the in person interviews, but great coders who just got a lot done and were good to work with.

7. "Beer test"
We would take candidates out for dinner or beers to see if they were a good culture fit. I.e. would our team enjoy having the person around, drinking beer with them etc. In a small organization culture fit is paramount.

We actually dinged a really exceptional engineer that made a lot of grossly off color comments in the beer test. He was one of the strongest engineers we met, but felt he would be a bad fit culturally, and this only came out during the beer test.

1-2 out of ~100 people whose profiles we started with would make it through the beer test to be given an offer.

8. Reference checks
We would check ~5 reference per candidate. Only one candidate who made it to the reference check phase got dinged because of his references (we actually always tried to back channel to references the candidate did not provide, and in this case the engineer had some politically driven conflicts with others, so we decided not to hire him). As a small organization we did not want to take the culture risk, although that engineer went on to thrive elsewhere.

Great reference checking will be the subject of a future post.

9. Offer
We would make the offer to the candidate in person or on the phone, depending on our prior relationship to the candidate. I may get into more details on making an offer in a future blog post.

10. Close
Of the people we made offers too, about 2/3 to 3/4 of them accepted. Most of the people who did not join Mixer Labs, tended to stay with their existing employer. We would use a number of tools to close the candidate, including e.g. having them meet with our investors to get our investors view of why we were a good company, or we would invite the candidate to events we had at the company, such as our speaker series (even when tiny, we invited CEOs and other industry execs or entrepreneurs in to our company to give talks on their experiences. This was a really cool company perk everyone enjoyed).

Hiring is a numbers game
All numbers quite rough (e.g. 100 profiles to 1 hire is more or less what happened with us but I am pulling all the numbers from memory so they are rough estimates. I actually had big spreadsheets with all the details but can not find them) - but hiring is very much a big numbers game. You need to set up a funnel and optimize each step.

All else being equal, we chose to optimize for false negatives over false positives. We kept our bar really high, and due to this grew (painfully) slowly. But it is was worth it as we ended up with a pretty extraordinary team.

Does your company do something differently that works really well? Let me know in the comments what you do differently - I always love to hear how people approach hiring and what works and does not work.

You can follow me on Twitter here.

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Android First - A New Trend In Mobile Development

2011-05-31T10:18:00.000-07:00

In a past post on TechCrunch I talked about how to build a mobile team. More recently, I have seen a number of companies building apps "Android First". I.e. while developers used to always build for iPhone first, I have seen more and more companies (such as Heyzap and Taskos) starting off with Android first, and then expanding to iPhone from there. In some cases, companies end up focusing exclusively on Android due to the large, relatively (to iPhone) uncrowded opportunity, for example, Papaya Mobile.

Why Android First?

Ease of distribution = fast iteration. With android, you can do over the air (OTA) downloads. This means you are not locked in to going through an official app store for distribution. This may change as carriers decide to launch their own app stores in certain countries. However, on average the bar to launching and distributing an app on Android is much lower then on iOS. This openness helps to accelerate app development and distribution, and makes developers less beholden to Apple policies.
Large user base. Android's installed base has sky rocketed in the last few quarters and it is now larger then iPhone. While the handset numbers have accelerated, the number of apps and the categories covered are still weak relative to iOS. This creates opportunities for developers.
Lack of competition. Every time my girlfriend pulls out her Android phone, I ask her about apps I love for the iPhone and she has none of them. Developers have been focused on iPhone, and Android has lagged for a number of categories (e.g. games). This means there is a lot of white space to build new apps for the android platform in areas that feel more crowded or saturated on iPhone. Coupled to a large and fast growing userbase, this makes Android an attractive platform to develop for.
Worse Design = easier to stand out. Android is a less mature platform than iPhone, and has looser enforcement of UI principles. This means a well designed app stands out more on Android relative to iPhone, making differentiation on Android easier as an app developer. Taskos is an example of an application with really nice design on Android.
Less enforcement. Apple is much more aggressive about policing apps that may compete with its native applications. On Android, given the ease of downloading any app, developers can build e.g. an iTunes competitor and still distribute it without being blocked by Google.

There are obvious downsides to developing for Android (e.g. less mature advertising ecosystem, increasing fragmentation of the OS, fewer early hipster adopters, etc.). That said, I think there will be more and more "Android First" companies, and this is a really exciting and interesting trend in the mobile world.

What are the key differences / advantages / disadvantages of Android First development? Let me know in the comments.

You can follow me on Twitter here.

Update: Some other examples of Android first apps from the comments:
Kismet, Lightbox, Texty

4 Ways Startups Fail

2011-05-02T10:50:00.000-07:00

1. Run out of money
The number one reason a company fails is it runs out of money. Many of the "acqua-hires" by Facebook and Google are teams who ran out of cash looking for a home. They did not sell their company as a talent buy. They literally just get hired in with standard employment packages. One common variant of this are the various seed companies that raise a $1 million seed round and hire up a 6-7 person team prior to getting to product market fit. The company burns through the cash in a year, and then tries to shop itself to Google, FB, etc. If the sale falls through, the company shuts down and the employees get hired individually by various companies. This scenario is most common on teams with a large number of business founders - e.g. if you have 3 business founders and 3 engineers, the engineers may leave early on with trouble and the residual value of the team is low or none which means the company does not get an exit at all and the founders disperse to look for jobs.
Ways to mitigate:

Run lean. Only hire up the team when you are confident you will be able to make money or raise more money.
Raise more cash then you need when you can.
Bootstrap the company or charge for the product from day one.
Focus on having an engineering heavy team from day 1 to increase the odds of a talent buy if all else fails.

2. Team implosion
Lack of clear decision making? Founders constantly fighting? Hiring a bunch of jerks that irritate everyone? A lot of companies end up imploding due to bad team dynamics leading to a lack of clear direction, internal infighting and backstabbing, and a terrible working environment.
Ways to mitigate:

Make sure you and your co-founders have clearly defined roles and there is a single person ultimately in charge who can call the shots.
Make sure you and your co-founders can communicate openly, have mature and frank discussions (can you give each other constructive feedback?), and are aligned on where you want to take the company (does one person want to sell early and the other wants to build a long term global business?).
Have a high bar for culture and team fit for early hires. Correct hiring mistakes quickly.

3. Living dead company / lifestyle business.
Depending on your perspective this is either a great outcome (a small, lifestyle, tech business) or a terrible outcome ("living dead" startup with little or no equity value). VCs and hyperambitious founders think of companies that reach a certain scale, but never become a breakout success as the worst form of failure. Rather then fail fast and be able to move on to something else, the entrepreneur is locked into a company on a slow to nonexistent trajectory. The company spins off enough cash to stay alive and pay salaries, but not enough to grow at a meaningful rate. Additional funding is not available as the company is viewed as a small cash business. The entrepreneur feels like she can never leave ("I owe it to the employees and investors to stick around") and the VCs are stuck with a board seat that takes up a big chunk of their time.
Ways to mitigate:

Chose a large, rapidly growing market.
Always ask yourself how you can 10X your business.
Pivot from the so-so business (very hard to do) or be willing to take a small exit (may not be able to do so if you raise from VCs)

4. Bad board / investors.
Stupid things a bad board member or investor may encourage a startup to do:

Raise and burn lots of unnecessary cash leading to too high a valuation to exit and too much dilution for the founders to be incentivized.
Fire the founders and hire a "professional CEO"who takes the product/company down the wrong path.
Block an exit even when it makes sense, and watch the company get crushed by the larger player who tried to buy them 6 months before.

Ways to mitigate:

Do due diligence on your investors. Ask other entrepreneurs, angels what their experience with the investor or board member was like in the past.
Don't add people to your board until you know them well.
Bootstrap your company or raise angel money without giving up a board seat (harder to do with a venture round).

Let me know in the comments what other failure modes you think are common for startups.

You can follow me on Twitter here.

What Are The 2 Most Important Traits in An Entrepreneur?

2011-04-12T09:45:00.000-07:00

I have been noodling on what I consider to be the two most important traits in an entrepreneur, based on the entrepreneurs I have worked with (or for) who have been most successful. There are a number of traits I think can help a successful company 10X from where it would be without the trait - e.g. being a "visionary", galvanizing people around a vision, focus, emotional IQ, ethics etc. All these things are important. But they are not the real meat of the two traits that are necessary in a great entrepreneur.

The 2 Key Traits
If I had to chose only 2 starting traits in an entrepreneur that determine success disproportionately, I would chose:

Tenaciousness. The sheer unwillingness to take no for an answer. Getting things done. Not giving up. Continuing to push when lesser beings would have given up. Entrepreneurs are defined in part by when they quit, and many great entrepreneurs just keep pushing.
Raw capacity to learn. Most entrepreneurs are in way over their heads. They have a different job every month as the company scales, and they need to learn product, deals, people management, fundraising, corporate structures, legal issues, HR, PR, ... The strongest entrepreneurs I have worked with take in multiple sources of information on a topic, synthesize the information and draw the conclusion that applies to their situation, and then drive that conclusion.

A Few X Per Additional Traits That Matter

I think there are a number of additional traits then help change the outcome/impact the entrepreneur would otherwise reach by a few X, but these traits don't mean much in the absence of tenacity and raw capacity to learn. These are more icing on the cake then the cake itself. These include innate product sense, ability to motivate others at scale, emotional intelligence, charisma (which I think can also be a big negative signal for success), etc. etc. (non-comprehensive list). But if you have met a number of founders who have built truly huge companies, many of them lack a number of these characteristics. All of them that I can think of have the top 2 traits.

Product Market Fit Vs Entrepreneurial Traits

Ultimately, I think product/market fit trumps everything else. You could be the strongest entrepreneurial team on the planet, but a terrible market will do you in every time. This goes both ways, as really strong product/market fit can make reasonably incompetent people look like geniuses. The magic happens when a great team meets a great market (see e.g. Google, FB).

What do you think? What are the top few traits that the very best entrepreneurs *MUST* have?

Thanks to Avichal Garg, the super talented founder/CEO from Spool for the IM conversation that spurred this post.

You can follow me on Twitter here and on Quora here.

Is Stealth Mode Stupid?

2011-04-06T10:30:00.000-07:00

A number of people I have spoken to recently have repeatedly pointed out that being stealthy is stupid for a startup. In this post I argue for a more nuanced view - there are times (and types of companies) that you should talk about themselves a lot, and there are times (or types of products) that if possible, you should keep completely off the radar.

Arguments made against stealth mode and for talking openly about your startup

People will know how to help you. When we were working on Mixer Lab's product, GeoAPI, talking about it openly led to introductions to potential customers and partners. People knew what we were doing, were excited about it, and wanted to help.
Investors and potential employees will get into the hype. It is easier to hire people and raise money on better terms if you are a well known startup. Talking at events like TechCrunch disrupt helped Mixer Labs build that hype with the right community. Hiten Shah, from KissMetrics, is an example of someone who has done a great job at brand building.
PR may be a way to acquire customers. Hype often translates into articles, which for some businesses equates with customer acquisition. Some companies use PR as the primary vehicle by which they grow.
Example: Foursquare. Foursquare is a great example of a company that benefited from ongoing hype and PR. PR helped to drive users, as well as significant awareness of the company leading to opportunities with media partners like Bravo and brands/shops for badges and mayor specials, and their establishment as the leader in location check-ins. This in turn led to more hype so the cycle self-sustained. In the Foursquare example, it made a lot of sense to talk very openly about the success the company was seeing.

Ways talking too much about your company can hurt you

You may create unnecessary competition.

Example 1: GroupOn. GroupOn was completely off the radar for its first year or so. As a Chicago-based company, no one had any idea about who they were, or what they were doing. Then GroupOn came to Silicon Valley, and spoke to a bunch of VCs about raising a round. A number of these VCs told their portfolio companies or friends about GroupOn (and their amazing financial numbers), and a few months later there were a dozen GroupOn clones in Silicon Valley, including LivingSocial who pivoted into the space (and just raised $400 million to compete). Given that GroupOn's primary customer acquisition vehicles are email lists, social media shares and SEM, having a lot of PR hype and other types of attention may not add much to customer or merchant acquisition relative to the cost of creating competitors. Is GroupOn still the market leader through sheer execution? Absolutely. Would they have been better off with an extra year to innovate, gain share, and expand internationally? Probably.
Example 2: Google. While Google has a very open culture internally, externally Google has traditionally given very little away up front. This worked to Google's benefit with AdWords and search marketing. Search was seen as the unsexy, non-monetizable part of the web world. Companies like Yahoo! and AOL actively outsourced their search businesses to focus on more important things. In parallel, Google implemented their AdWords model and watched revenue grow at an astonishing rate. Rather then rush to launch a press release with their financials and growth rates, Google kept the news VERY quite. When the company went public, people were surprised by how big they had gotten. I remember hearing Larry Page speak about this. The way Larry put it was search was like a candy store. All of Google's competitors were initially outside the candy store, looking for all the candy, while the Google guys were quietly in the candy store, eating their fill. Being stealthy can help.

You may give away your competitive advantage. You should be selective in what you talk about. Telling the world about the two things that are really driving sales for your company may expose the week spots competitors can use to gain an advantage. Information is power.

But isn't it all about execution?

I think execution is absolutely key. It is always necessary, but not always sufficient. GroupOn and Google would not have won to this point without execution. But personally, I would much rather not create the competition to begin with. As a startup, life is hard enough already. Creating competitors for no good reason other then "execution trumps all" seems like a bad strategy. Should you be open about what you are working on? I think the answer is "it depends". Google was very open about its search engine and talking about its benefits, but initially quite quiet about AdWords. This is the right mix of open and closed.

What sorts of companies should hype things up?

All else being equal, I would err on the side of talking openly about what you are doing. Early on at Mixer Labs, we tried to be stealthy and I don't think it helped us much (and may have hurt us). That said:

If something is working at scale and you do not have any competition, and your expansion does not depend on PR/broad awareness, you should stay more stealthy. Or, you can chose Google-style, to be stealthy about how well the business model is working, while hyping up the consumer side of the product which will benefit from all the attention without necessarily creating more competitors.

In contrast, if your growth depends on PR/awareness, the market is already competitive, and you are trying to break away from the pack, tooting your own horn and talking about your success can help a lot. This is true of many consumer Internet companies whose growth is driven by PR/customer awareness or companies where establishing partnerships would benefit from the attention.

Thoughts? Comments? Examples of how stealth or hype helped or hurt a company? Let me know!

Other Related Posts:

You can follow me on Twitter here.

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Your #1 Job As CEO

2011-03-29T10:24:00.000-07:00

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:

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.
Every morning, make a list of the 1-3 things you absolutely need to get done that day.
Get those things done.
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:

You can follow me on Twitter here.
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Questions VCs Will Ask You

2011-03-23T10:23:00.000-07:00

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.

You can follow me on Twitter here.

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How to Raise a Successful VC Round or Series A

2011-03-17T10:23:00.000-07:00

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.

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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.

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

2011-03-15T10:49:00.000-07:00

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

You can follow me on Twitter here.

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

2011-03-07T10:13:00.000-08:00

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.

You can follow me on Twitter here.

Ode To The "Older" Entrepreneur

2011-02-22T10:26:00.000-08:00

If you look at a variety of fields, you see that people within certain age groups tend to do better.

Most productive ages for:
Gymnasts: teens
Mathematicians: teens to late-20s
Physicists: early 20s-early 30s
Biologists: late 30s-40s
Literary authors: 40s to 60s

This suggests that for certain types of disciplines experience matter more, while for others, for some reason, youth may confer specific advantages. Obviously, there are always exception to the rule - e.g. Schrödinger found his equation at the ripe old age of 39 or 40. However, this is meant more to focus on the average scenario rather then the exceptions.

The Biggest Software Franchises Were Started By Young People (people in their 20s)
If you look at the truly iconic software companies, they were almost exclusively started by younger people (largely people in their late teens to late twenties):
Microsoft, Facebook, Google, eBay, Amazon, Oracle, Yahoo!

This does not mean there haven't been successful entrepreneurs who started something at an older age, it is just the scale of the accomplishments seem to be an order of magnitude smaller (the difference between a $40 billion company and a $4 billion one. However, a $4 billion company is pretty darn good).

Some Pretty Amazing Tech Companies Have Been Started By "Older" Entrepreneurs
Only in the tech industry is an entrepreneur aged 35-45 potentially classified as old. Lately, I have been running into examples of entrepreneurs who have done some of their best work in their mid 30s and 40s:

Reid Hoffman - started LinkedIn in his late 30s
Mark Pincus - started Zynga at ~40
Steve Jobs - did some of his best work at Apple in his 40s
Tom Siebel - Started Siebel Systems at 41
Jim Clark - started Netscape at 50 (he also started Silicon Graphics at 38)

This suggests a few things:
i) For some reason, the largest long-term sustainable software companies are most often started by people in their 20s. I am guessing this is due in part to:

Money/stability means less to you when young (since you have a lower cost structure, no kids etc.), so you are less likely to sell out early
It takes a long time to build a major company. Microsoft took 15+ years before it became truly the dominant force in tech. Perhaps starting young gives you more time/runway to do this before other aspects of life take over.
Young people spot big software trends sooner. E.g. a college-centric social networking site (Facebook) was extremely unlikely to have been started by a 40 year old. Young people can capitalize on new behaviors as they see and experience the behavior first.

This suggests that the best time to start something truly massive is when you are young.

There Are Great Examples of Entrepreneurs in Their 30s and 40s
If you take a longer road to eventually starting a company, there is always the hope of being the next Jim Clark and doing something great.

Any other over 35 entrepreneurs you know of? Let me know in the comments section.

Related post: "Are You A Visionary Entrepreneur"

You can follow me on Twitter here.

Are We In The Inflationary Part of an Internet Financing Bubble? 2011 = 1997 (?)

2011-02-10T09:41:00.000-08:00

"I have not seen a better time to raise money for web startups since the late 90s"- Fred Wilson.

"Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves." Peter Lynch

"The only value of stock forecasters is to make fortune-tellers look good." Warren Buffet

Lately there have been a lot of articles claiming that we are not in a tech valuation bubble, and that this time "it is different". I will go through the arguments people are making, and build a case that we are potentially in the inflationary phases of an internet private company investment upswing equivalent to roughly ~1997 in timing (i.e. the bubble is in its early inflationary stage, things are still reasonably rational for later stage companies, and the cycle has not peaked). Throughout this article I will use "tech" to refer to "Internet" companies (consumer, ecommerce, ads tech etc), which is the specific subsector where the bubble is happening. "Investing" or "valuations" refers to private equities (angel and VC funded companies, again where the valuation inflation is occurring), not the stock market (which is still fairly valued). Finally, "bubble" means "cyclical upswing in the venture financing market". Just as there is a business cycle, I believe there is a venture cycle that goes through peaks (frothy/crazy valuations) and troughs (ridiculous bargains for investors).

Signs we are in the inflationary period of an early stage, internet company valuation bubble:

Round size and valuations have increased dramatically in the last 12 months.

Series A companies are raising $7-15 million instead of $3-5 million, and many of their valuations have doubled or tripled to where they would have been a short time ago. The same holds true for seed companies, that are raising more money on better terms then just 1 year before.
Similarly, some companies who were unable to raise money a year ago have now gone back and found raising money easy - but without substantial additional traction or progress as a company. This is an especially telling sign.
If this increase in valuations pushes up into later financing series B, C, D etc. a real bubble could inflate across the broader Internet sector

This is part of a normal venture cycle. Just as there is a business cycle, there is also a longer venture cycle. There have been prior boom/bust venture cycles that seem to exist on a 10-14 year cycle including semiconductors, microcomputers, the internet, and now today. Arthur Patterson of Accel Partners has a very thoughtful way of phrasing this broader set of venture cycles and the history of the tech boom/bust value acceleration cycles over time for specific sub-industries (semis (67-69), microcomputers(81-83), internet (96-99), etc.) This view suggests that this upswing in valuations is business as usual, which also means we are likely to hit a "free fall" period in which valuations come back down very quickly. (Thanks to Kevin Efrusy at Accel for conversations on Arthur Patterson's venture cycle.)

More and more people are justifying the fact that there is *not* a bubble (see below for arguments against a bubble and why I think these arguments are wrong). This reminds me of the Economist's "recession index", where increase use of the word "recession" in media correlates with a recession actually occurring, even if it is too early to call with harder economic data (which often takes time to collect and analyze).
MBAs and BD people are starting lots of companies again.

The Harvard MBA class has a crapload of people starting companies instead of going into banking. To me, swings in MBA aspirations seem to track to a perception of "where the easy money is" or, in bad times, "where the safe jobs/career paths are".

Too many hot people at tech events.

All these really good looking, non-technical people are suddenly interested in tech, or in dating tech founders (anyone attend the Crunchies after party?). Really, you want to work for, or date, nerds like us??? This is, of course, meant tongue-in-cheek. But the mix at tech events has definitely changed. Certain types of people are attracted by money vs impact and the pendulum is unfortunately swinging towards more people who are attracted by money.

3 Arguments Being Made Against The Inflation of an Internet Valuation Bubble
1. "Industry leading companies are not overvalued."
The primary argument against a valuation bubble is to point at the better known companies in tech that have raised at multi billion such as Facebook, LinkedIn, GroupOn etc. and say they are fairly valued. This argument states that since there is no bubble for the late stage, well known companies, there therefore must not be a an unjustified upswing in the valuations of earlier stage companies.

I 100% agree that these companies may be (more or less) fairly valued These are global franchises that are making real revenues/profits and will continue to thrive over the long term
Unfortunately, too many of the startups being funded today are getting valuations that suggest all of them will be future Facebooks, LinkedIns etc., which is obviously incorrect. Just because the market leaders are fairly valued, does not mean every other startup is a market leader.
Similarly, during the last bubble, a number of companies went public (and were considered the category leaders) and ended up being long term sustainable global franchies including eBay, Priceline, Amazon, and Yahoo!. These companies are still worth tens of billions of dollars.

However, a bunch of less sustainable companies rode their valuation coat tails (CMGi anyone? VerticalNet?). In the last bubble, this happened in the public markets. In 2011, it is a private market phenomenon where early stage investing is being positioned as "it doesn't matter what you pay as long as you get into the next Facebook", even though 99.99% of companies are not going to be the next Facebook.

2. "The Fundamentals have changed".
Every time there is a valuation bubble, people say "this time it is different". And to be honest, each time things really are different (see below), but that does not mean valuations are rational.

In 1998-2000, people pointed to the cheap distribution of the internet, and the disintermediation of middle men, as the reasons the Internet bubble was not a bubble. "It has never been so cheap to reach so many people with so little friction" was the mantra. And it was true. But the valuations went to irrational levels for crappy companies.
In 2010/2011, people are saying two things have changed: (a) It has never been less expensive to start a company (true), and (b) It has never been so cheap to reach such a large global audience of users before (also true).

In 1996, Yahoo! raised $1 million on a $3 million valuation from Sequoia. They had bootstrapped the startup until then, and then only needed to raise an initial $1 million in capital. It definitely cost a lot more to start a company in the 1990s. However, a number of companies got going on little initial capital (see e.g. Amazon and its friends and family round) and than raised money to accelerate what they were doing. The bubble happened when a lot of companies got way over capitalized and burned money needlessly.
The argument that it is cheaper then ever to start a company = higher valuations would make more sense if people are raising seed rounds later in the game or with more traction. But it feels to me more and more companies are able to raise money on powerpoint decks rather then prototypes (or traction). E.g. the low cost of starting something doesn't matter if you are raising money on nothing anyhow.
GroupOn proves how quickly a massive global franchise can be built these days. Other companies will undoubtedly follow, and massive businesses will be built faster today than anytime before in history. The question is, what is the ratio of success to number of startups that matter (see below) - not just whether a startup can be successful faster.
The math is interesting. It is not how cheap it is to start a company that solely matters. It is important to ask if the expected outcomes of all these additional cheap companies now differs. E.g. you could have 2X more companies, but if you have less then 2X more successes, valuations on average for a seed deal should go down rather then up (since the expected value of each company is lower). I wish I had hard data on this to be able to look at success rate versus startup number to see if this is a constant. I think this is the single point of data that would allow us to know if we are on our way up to a bubble.

3. There is *less* venture money being invested, not more. So we cant possible be in a valuation bubble.

Where this argument fails is that it is not the *amount* of capital invested that matters, it is the marginal price that capital is willing to pay that matters. For example, if the aggregate value of the stock market goes up by $1 trillion, it is not like $1 trillion in additional capital has flooded into the market. It means that there are some tens of billions of $ who are willing to pay more for the same asset. Small amounts of capital can cause big price fluctuations when prices are set on the marginal cost someone is willing to pay (argument stolen/paraphrased from Naval). This dynamic is exploited heavily in party rounds, where you bring in a small amount of price-insensitive "dumb money" to set the valuation for the entire round.
Furthermore, while *overall* seed stage investing is down, anecdotally it feels to me it is way way up for Internet companies. If a bubble exists (like most past tech bubbles prior to 1997-2000 e.g. microcomputers in the early 1980s) is sector specific.

Ways this inflationary period (if it exists) is different from 1997-2000

It is limited to the Internet sector, versus all sectors/industries. I am trying to find out more about industry-specific venture bubbles and will share information on this blog as I dig it up.
Public markets are not serving as a venture capital vehicle. In 1997-2000, companies went public before they were de-risked. This is not happening and will help damper the heights which this inflationary cycle. It is unclear to me if this private-market-only phenomenon will extend or decrease the time it takes for the valuations to come back down.

3 Scenarios For How This Plays Out:

1. Hit the wall early. The inflation of company values continues to work its way up to in private markets, but never gets reflected in acquisition prices or public companies, and the bubble rapidly deflates. In this scenario, a number of startups/investors will get hit badly, due to a lack of good outcomes and hyperinflated valuation expectations they can not meet. In this both public markets (ie IPOs) and acquirers have a strong filter on quality/valuation and the inflationary cycle hits a valuation wall.

2. Get bought for a ton. Acquirers such as Google and Facebook are willing to buy companies at these higher valuations, helping to keep fueling valuation inflation for some period. This will happen iff the acquirers either: (a) really want to buy assets who have as an alternative to raise a big venture round (e.g. "Google, we can raise $20 million at an $80 million valuation, so pay up at $80 million or you never get us") or if the acquirers valuations go up commiseratively so the acquisitions are ultimately at a fair valuation relative to the acquirers stock price. In this case the public markets still only let strong IPOs out, which constrains the outcomes and keeps things semi-sane.

3. Public market mania. The public markets start to slip through lower quality IPOs (despite Sox), and the public markets start to become more of a financing vehicle for immature companies. This is the least likely scenario and it what happened in the broader financial asset bubble which culminated in 2000. However, public market focused money can still flood into the private Internet markets via hedge funds. Hedge funds have seen great success investing in secondary markets for Facebook et al, and so are starting to get tempted to move down market and invest in series B and C companies. Remember, one hedge fund may have $10 billion under management, which is probably within an order of magnitude of *all* the capital earmarked for Internet companies by early stage VCs. And that is just one hedge fund.

BTW, if 2011=1997, this give entrepreneurs and venture investors about 18-36 months to make a lot of money if they can get liquidity, at which point we will have a tech valuation correction (assuming scenario 2 or 3 above happen). This has significant implications for entrepreneurs and how you should think about timing fundraising and potentially an exit.

Takeaways:

It is possible we are in the inflation phase of an Internet company valuation bubble (~1997 equivalent). There will be ~24 or 36 months (could be off by +/-N months) of continuing valuation craziness before the Internet private funding market crashes.

As an entrepreneur, you should time your financing events or exit strategy with this in mind
As an investor, you should think through how to continue to invest in the upswing, but make sure to not loose discipline on company/team quality as bad companies have more great exits

People who say "this time is different" always say that during bubbles. I really do believe things have fundamentally changed. However, I am guessing if you run through the math you will find that valuations have outpaced expected values. The math that can prove this is to look at the ratio of expected outcome of startups (e.g. (# of new startups) / (average outcome per startup). If this ratio is >1, average valuations should go up by that %age, but not more then that.
Market timing is hard to predict. Markets are notoriously hard to predict. I may be completely off or wrong in my arguments, or I may see evidence that changes my mind that this inflation is happening at all. But for now, this is my take on what is happening.

Thoughts? Let me know what you think in the comments.

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Should You Raise Money Before You Ship Product?

2011-02-09T09:24:00.000-08:00

I was recently asked a question on Quora about fundraising timing.

The gist of the question was, "should you really only try to raise before launch, or once you have traction, but not in between?" I.e. is it *bad* to wait to raise money until after launch if you don't have evidence that the launch will have traction?

The short answer is, "yes, but it depends."

Please note, this post is about how to time when you *need* to raise money, rather than when you *should* raise money. All else being equal, if you can avoid it, I would suggest against ever raising money. Similarly, if you can run your company very lean and keep launching products and iterating until you hit traction you should definitely do that unless there are other forces that suggest you should raise money and go big fast (e.g. Zynga doing massive raises to dominate an industry via ad buys, acquisitions, etc.).

Now, a quick aside on "traction". Traction doesn't have to mean crazy daily doubling of a user base. You could be e.g. a business to business service with a solid rate of customer sign ups. If you are a very frugal startup and the small number of sign-ups gets you to ramen profitable, you don't *need* to raise money and your leverage goes way up.

The Factors That Impact Valuation/Terms
There are multiple factors that drive better investment terms for early stage cos including:

Traction (single most important thing, especially if it is of the hockey stick variety)
You don't need the money (either are profitable or already have money in the bank)
Have a "celebrity" co-founder (see e.g. the early Quora team)
Have a lot of buzz or are in a hot space (see e.g. Path)
Competitiveness of deal / investor excitement/herd mentality (see e.g. party round mentality)
You are a known person to investors / have personal relationships already
Larger team size. This is counter intuitive (e.g. a larger group of engineers can get a better valuation than a smaller group, even with the same product/traction, despite the negative aspect of a higher burn rate).
Creating a perception of traction (more below)

If you don't have the bottom 7 items on the list, but have traction/solid growth you will still have way more leverage than 95% of the other early stage companies.

"Better" Terms Means:

Higher valuation / money raised
Less dilution
Ability to negotiate board control

The Early Stage Fundraising Curve
Success in fundraising for an early stage company typically follows the following curve:

Fundraising with traction/solid growth is obviously best. However, if you raise before launch (but with a strong demo, prototype or closed beta) you may get better terms or investors than if you fundraise many months post launch but have little or no product adoption. This can be mitigated in certain tactical ways I will discuss in another post, but in general is true. The key is to time it so that you don't run out of money a few months after a launch that lacks traction.

Raising a Round On a Prototype is Better Than Raising One On a Launched Product Without Traction
The next best time to raise money for an early stage company is if you have a working prototype or demo that shows where your product vision is heading, that you can build stuff, and that you have good product sensibilities. This is true as you may be able to raise on better (or at least equal) terms when you are in a closed beta (where you can spin as growth constrained by you), versus a live product that has been out 3-6 months with no growth. Getting equal terms earlier means you got better terms, as you got the same money/valuation/terms in a much riskier company state. Sometime you can get even better terms then if you were fully live for many months (there are a number of companies who raised while still in close beta or shortly thereafter, e.g. Aardvark and Qwiki).

This is because:

It is most likely your first product launch/iteration will result in very little adoption. Investors will look at this lack of adoption and assume the product or market are off target and not worth funding.
Before launch, investors can imagine whatever they want for your product. This is called "selling the dream". Investors can apply their own vision to your product idea, and imagine a path by which the product could be huge. After launch and a few months of slow growth, the vision will be tainted by reality. They are no longer funding a dream of success, but the cold reality of "distribution is hard"
Investors want to invest in things that are obviously working.
Investors want to invest in "fresh" companies. If you have launched and stuck around with nothing happening, then your company can appear "stale". This is especially true if you have been talking to investors on an ongoing basis (even if it is just as "updates").
If you are running out of runway, and have no traction, your back will be against a wall for the fundraise. Investors can smell desperation.

In general, as an entrepreneur, you should try to get as far along as possible towards traction before fundraising. That said, you should be cautious of running out of runway a few months post product launch, because if the product is not successful it will be harder to raise a round.

Ads Dependent Consumer Products Vs B2B
This logic is especially true for ads-dependent consumer products - i.e. having few users and a lack of real growth for a few months = a harder time for the company to raise money. In contrast, a B2B company with a few customers may be in better shape as you have revenue coming in, which decreases your burn. If you can get to ramen profitability, then you have an alternative to fundraising and more leverage, meaning better terms for you. But, most consumer companies don't have a path to ramen profitability early since their whole monetization model is based on traction/page views.

If You Don't Have Traction, Create the Perception Of It
In a future post, I will focus on tactics to successfully raise a series A round, even if you do not have hockey stick growth but have launched your product (which is what most companies eventually have to do). One way to do it is to claim traction, or point to indicators of traction even if you do not have crazy growth. Variants of this include being in a closed beta ("we choose not to grow"), showing how you are in just 1% of your addressable market and plan to expand to the other 99%, proof that media buying can drive growth cost effectively, or raise money in traffic upswings (e.g. Google lets you out of their SEO sandbox). More on this to come.

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Dear YC Company, How To Use Your $150K Uncapped Note To Your Advantage

2011-01-31T09:41:00.000-08:00

Dear YC Company,
Now that you have your $150,000 uncapped convertible note in the bank, how can you best use it to your advantage? Also, what dangers or obstacles to your business should you avoid that this money may bring?

How to use the money to your advantage: (note: *not* listed in order of importance)
1. Use the money to fuel competition in your *real* fundraise.
To take a shot at being a long-term, sustainable you will likely need to raise more than the $150K from the note (most companies these days are raising $300K to $1.5 million for their seed, with a median of $750K to $1 million). This mean that no matter what you may have to get on the fund raising wagon and spend a bunch of your time raising your seed. One of the best ways to take advantage of this money is to use it as leverage.

In particular, you can use the money in the bank as a way to:

Increase the perception of traction / shrinking supply in your round. E.g. if you are raising a $500K seed, this will already get you to close to 1/3 of the round committed. By getting just $50-$100K in small time investors (see e.g. this guide to holding a party round) and you are half way done with the fund raise. You can use this diminishing supply of available investment to push on people to close/create excitement. E.g. "We are already 50% of the way to closing our round and are worried about getting oversubscribed. We would love to find a way to work with you Miss Investor, so please let us know as soon as you can so we can save room for you".

This will create more of an auction/fast close dynamic for your round, helping you close good investors and speed time to fund raise. Be careful not to overplay this, as it can backfire if you push an investor to close too hard.

Claim that you do not need any additional money right now. "We don't really need to raise right now, but will take money on the right terms opportunistically" is a good way to put it. This will cause investors to pay a higher valuation since you have a fallback option.

Valuations have been going up in general in the last 12-18 months, and I think the convertible note will only accelerate it for YC companies (and this valuation rise will spillover to the rest of the valley soon thereafter).

2. Use The Money to Bootstrap
Frankly, it is better to not have to raise money then to have to. If the $150K can get you to a point where the business can grow off its own cash and is self sustaining (e.g. investing the money to buy your way into a network effect in a vertical) then by all means become independent of the throes of fundraising. This is especially true if you are really setting up a cash, rather then an equity, business which may require less long term investment / operating at a loss for an extended period.

3. Get more in place prior to fundraising later (this strategy can also backfire, see below)
You can use the money to get farther with your prototype or idea, or substitute cash for labor (e.g. hire a UI designer part time) so you have something more compelling to show investors to raise money on. The best possible scenario for fundraising is to have a product with hockey stick traction and spend the time that is needed to get there. Conversely, the worst place to raise money is when you have launched a product with little traction (see "dangers" below).

4. It gives you time to try a bunch of stuff. I know a number of YC companies that changed direction last minute or multiple times during the YC program. This cash provides more room to try new things before you tap into savings or run out of money.

Just as the money comes with benefits, it also brings some drawbacks or things to be cautious of: (also *not* listed in order of importance)

A. Waiting too long to raise money can *hurt*, rather then help you

Raising on a dream vs traction. Ironically, for a seed stage company it is often better to raise money pre-launch (or in closed beta), then post launch. This is because pre-launch you are raising money on a vision or a dream. Each investor will interpret the promise of the startup in their own way and imagine it growing like a weed, GroupOn-like, to a multi-billion dollar market cap within 24 months. Unfortunately, most startups actually sputter quite a bit post-launch, and it takes unnatural acts of perseverance to get to the point where the product has real traction.

If you wait to launch before you fund raise, and you don't have traction with launch, the dream is now cold reality. Investors will value you on numbers instead of aspirations, and you may not be able to raise at all. Using the money to wait it out and "get to traction" may backfire big time if the traction does not occur fast enough.

Demo day is a good forcing mechanism for investors. Many investors now scramble to invest in the hottest companies prior to demo day, as they are worried there will be more competition on demo day when all their peers can get access to the same companies. This creates a competitive environment startups can exploit in their fundraise. Waiting past demo day removes this time based pressure for a deal to happen.
YC fatigue. Some investors invest in multiple YC Companies in each batch. Some of them seem to get tired of investing in "yet another" YC company shortly post demo day as they feel they have filled their quota. This means raising early may help avoid this, or waiting for a few weeks or more post demo day when investors have had a chance to recover from YC fatigue.

B. Just because you have money, doesn't mean you should spend it.
A friend of mine's company raised a few million dollars. One of the first things he bought for this startup was a $20,000 large circular couch that "looked cool". I am guessing the couch didn't help much in making his startup successful and this purchase set a bad cultural tone that spending money on stupid things is OK. Be cautious of what you spend the money on and remember that what you do now sets your culture overall. Just because the terms were favorable, doesn't mean the money was free.

C. "Free money" is not free
Fred Wilson had a great blog post about the current funding environment and the costs of taking capital. The costs/risks/things to be way of post-taking the $150K include:

Make sure you get help and value out of the money you raised. Many of you would have been able to raise the money anyways. You now have a chunk of money whose owner may or may not be helpful to you, which means there is less room in your eventual funding round for additional angels who can be of high impact and help. You should be selective in choosing your angels and putting your investors to work for you. Only time will tell how much time/help will come with money given in such a blanket manner. That said, Ron Conway and team are amongst the best in the business. If they provide the same level of support to you as they do their average startup, than taking their money is definitely a good thing. I have also heard that Yuri Milner is quite smart. So the fundamental question is how much time/access/help they will give you in exchange for the money.
You run the risk of inadvertently giving away future rights. You now have an investor with potentially a sizable chunk of your company and potentially a pro-rata, which means they can avoid getting diluted down in subsequent rounds. As a larger investor in your future round, they may end up with information or other rights you did not mean to give them as a passive (?) investor. Make sure to write your equity financing docs carefully to block inadvertent leakage of information or other rights to this investor (unless you really want them to have it).

To sum things up, a lot of people are commenting about how these $150K convertible notes will cause angel investing to cease to exist and the world as we know it to end in a fiery ball of ruble-fueled agony. I think this is a smart move by Milner and SVAngel. This will cause a number of changes in the ecosystem, but I think a lot of them will be good for YC companies in the short term. I hope this letter to you helps you take advantage of this opportunity.

Good luck with your business. I am rooting for you. :-)
Elad

PS You can follow me on Twitter here.

You Don't Need A Good Idea To Start A Great Company

2011-01-27T09:15:00.000-08:00

I met recently with a friend of mine who has been talking about leaving Google for the last 3 years. Every time I see him he says he is just "waiting for a great idea" to leave to start his own company. I expect him to do what a lot of people do - stick around Google for another 6-24 months, and then join someone else's company. He is never going to start anything.

I think "waiting for a great idea" is absolutely the wrong way to "start" a company, and typically does not yield a startup.

Startups are not about working on a great idea - they are the relentless pursuit of doing stuff for customers.

Start a company. Don't "start an idea".

As you work on your "good idea", you will quickly find that nobody wants to use it. This means you will keep iterating on the product and potentially even the market until someone wants it. Many "side projects" or internal tools are examples of this, as they have turned into great stand alone companies or products. Blogger came out of Pyra Labs as an internal tool. Github came out of an internal tool at a startup. Yammer came out of Geni. GroupOn came out of thePoint.
The key to all the examples above were that the entrepreneurs were actually *starting a company*, not *starting an idea*. It is more important to do something, anything at all, than wait and do nothing with the hope of thinking of something great.

If it was that obvious, someone would have already done it.

There is a dearth of great ideas just sitting around without someone executing them.

Focus on a great market, not a great idea

As you iterate in a market, you will often find that the initial idea you chose is less important then the broader market you are in. A great market will always have opportunities in it. Even if the first idea is terrible you will get to know the market and its needs and build something great on your next try. In contrast a great idea in a terrible market will often fail. Don Valentine, the legendary founder of Sequoia capital (investments by him include Cisco, Apple, Atari, Oracle and EA) always says the market is the primary thing that matters to him.
Josh Koppelman calls great entrepreneurs "Heat seeking missiles" as they hone in on their target/market even if their initial course if off. Startups are exactly like this. (I always wonder what would happen if Josh's "heat seeking missiles" got into a fray with Mike Maples "thunder lizards from radioactive atomic eggs" - what entrepreneur could possibly survive the resulting explosion????)

It is all about execution. Even if you have a great idea - 5 other people will have it at the same time. This is why so many similar companies get started more or less simultaneously. See e.g. Instagr.am, PicPlz, Mopho.to, PicBounce, in the photo sharing space.

The next time you stop yourself to "wait for a good idea", don't stop yourself. Go and build something that is a bad idea in a great market, or something small but is a product you want for yourself. Iterate on it and keep pushing, and eventually you will find the bad idea has become a very good company indeed.

You can follow me on Twitter here.

This work is licensed under a Creative Commons Attribution 3.0 Unported License.

M&A Ladder: Position Your Startup To Sell it For More

2011-01-24T10:10:00.000-08:00

There is a hierarchy in the value of a startup to an acquirer. As you move up the hierarchy, potential acquirers will value you on different metrics that increase the multiple that your company is worth.

Similarly, if you can convince a company that you are at a higher value point in the hierarchy relative from their perspective, they will pay more for you.

The hierarchy is: (the higher the number, the more your company is typically worth, and the larger proportion you get up front rather then vest over multiple years)

Team Hire ("acqua-hire")

Valuation: 0 to $1 million (on a multi-year vest, per founder)
Basis for valuation: Typically the valuation is based on team size and the retention bonuses given to the team. The company is bought for the technical talent (or maybe even just 1 person), but the team is immediately dispersed and does not continue to work in the market or area they did before. Often these companies don't have good alternative options (e.g. raising a round or other strong acquisition offers) Usually founders will walk away with at most a few hundred thousand dollars each over a few years. This is a soft landing for the founders, but often investors get at best a fraction (or none) of their money back.
Examples: Most people who are acqua-hired don't talk about it publicly, or it is framed as the more valuable "true" team or tech buy.

Team Buy

Valuation: $4-$50 million
Basis for valuation: Usually $1 to 5 million is paid per engineer or team members. Median is probably $1.5-2.5 million per person, but it really depends on the acquirer, how competitive the auction around the company was, or alternative options the company may have (e.g. a funding offer from a venture firm). Usually the team has expertise in the area they will execute for the acquirer, but not substantial differentiated IP that the acquirer will use long term.
Examples: DivvyShot, ShareGrove

Technology Buy

Valuation: $10-$500 million
Basis for valuation: The purpose of buying a company for its technology is to integrate that technology into the core of what the company does (versus a team buy, where the focus is on the talent itself only, as all the tech gets thrown away). The valuation for these companies are often driven in three ways: (a) A flat premium (tech value). (b) A bump up in the value of the per-engineer multiple of a team buy In some cases this premium can be many tens of millions of dollars. (c) The creation of very strong auction dynamics, particularly if a company is bought either to fill a big technology/product gap for a company (that its competitors may or may not have), or alternatively to keep differentiated IP/technology out of the hands of competitors (which the company itself already has). Usually, technology buys do not have much of a business (i.e. lots of revenue) in place when it is bought.
Examples: Powerset, Applied Semantics, Kaltix

Business Asset

Valuation: $20 million-$1 billion
Basis for valuation: These types of acquisitions are valued almost entirely on financial models. This is the opposite of the technology buy in some ways. In this case, the company is bought either for its customers/contracts, or it may be bought by another company that thinks it can increase the revenue of reduce the costs of the company being bought. This is how a lot of "rolls ups" in private equity work - e.g. costs are reduced and revenues/distribution channes are merged or optimized. Often the valuation is a multiple of revenue/earnings, or is based on a financial model that will show the increased profits the acquirer can optimize for if it owned the asset and ran it differently.
Examples: Almost any company Demand Media or Glam have bought. Many social gaming startup acquisitions.

Strategic Asset

Valuation: $100 million to $N billion
Basis for valuation: These are uniques assets that can either alter industry structure by one player owning them versus another (e.g. Apple vs Google owning AdMob), or which multiple bidders view as truly unique/network effect based product (YouTube). In this case, valuations can get stratospheric as multiple companies drive an auction.
Examples: YouTube, AdMob, Applied Semantics

Your Goal As An Entrepreneur

Convince the acquirer that you are higher up in the M&A hierarchy. E.g. pitch a technology buy as a strategic asset, or a team buy as a technology platform.
Find alternative acquirers that view you are higher up in the M&A hierarchy. Salesforce paid up for Heroku because they viewed it not only as a technology platform, but as a broader asset with a thriving developer community which was a part of the strategic future direction of the company. Other companies with less of a focus on developers, or with a massive developer base themselves, would probably have paid less.

Notes:

All valuation ranges in this post are rough estimates. There are always outliers.
The line is sort of hazy for some of these - e.g. it is sometimes hard to draw the line between a team/tech buy once valuations cross a certain line. E.g. Applied Semantics could probably be viewed as either a tech buy or a strategic buy by Google, as it kept AdSense-style technology out of the hands of other competitors such as Overture at the time.

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Hiring Tip: Graph Interview Performance Vs Years of Experience To Spot Outliers

2011-01-05T10:06:00.000-08:00

When hiring your initial engineering team, the more tools you have to discern who the truly amazing engineers are the better. One approach we took at Mixer Labs (a company I founded that Twitter bought last year) was to graph # of years of experience vs how the person did in their interviews (this was an arbitrary scale where we rated people 1-10, focused on performance on the same set of questions, rather then raw intelligence alone.) They key is to have the same group of people on your team do the ratings, and to have the list of prior interviewees listed on the same ranking scale, so that it is easy to compare people.

To our surprise, we found that in general, the way people did on their interview roughly corresponded to the number of years of experience they had. Indeed, when you graph things out, the graph looked roughly like this:

This graph helped us quickly hone in on anyone who was an outlier on the graph (i.e. their performance/knowledge in the interview outweighed their years of experience). For example, from this perspective the person with 4 years experience who scored a "7" was a much better hire then the people with 7 or 8 years experience who scored a "7" or even an "8". The interview performance outliers also tended to be amongst the most productive people on the team once they joined the company.

This also suggests that if you do not correct interview feedback for years of experience, you may hire more experienced people who are actually more "average" relative to their work experience level then you might expect (since you would normally compare them to *all* candidates in the overall hiring pool, which consists of people with less experience).

Obviously, anyone who scored close to a "10" was worth hiring irrespective of number of years of experience. There are obviously a number of people who are both very experienced, and very very good.

Any other simple tools or tips for hiring? Leave them in the comments section.

Other posts on hiring:

You can follow me on Twitter here.

6 Startup & Tech Trend Predictions for 2011

2011-01-03T11:06:00.000-08:00

These are my predictions in terms for 6 big tech trends for 2011 (see also, "Companies That Will Buy Companies in 2011").

Let me know in the comments what you think the most exciting trends/markets/technologies will be in 2011! :)

1. Mobile photos is sooooo 2010; 2011 is the year of mobile communication apps (VoIP, contacts, SMS)

One of the big themes of 2010 was the launch of multiple mobile photo apps that each grew to hundreds of thousands to millions of users (e.g. mopho.to, picplz, picbounce, instagr.am, path). It looks like instagr.am is the early winner in the mobile photo wars within the hipster set, while picbounce has seen strong growth in other areas. Competition will continue amongst photo apps in 2011.
Just as 2010 saw the launch of multiple photo apps, 2011 will see the evolution of mobile communications (e.g. SMS, VoIP, video chat etc.). Kik, Viber, and Tango are all examples of apps that grew to >1 million users fast. In 2011, I think we will see some additional apps launch and a winner in this area start to emerge (keep an eye out for new startups like Camino Real)

2. Beyond checkins: cool new types of location apps

2010 was the year of the "geolocation wars", with a lot of hype and user growth for apps like Foursquare and Gowalla and checkin style behavior added to Facebook, Yelp, and Loopt.
2011 will see the rise to prominence of a new set of location enabled apps, that don't depend on "location broadcast to your friends" as their primary drivers. Apps like likealittle and Qrank are already innovating in interesting and cool ways in these areas.

3. Big data and object classification will be a big meme

2010 saw the funding of a number of companies setting out to classify and aggregate structured data about the world (Thingd, Factual), sites that let you collect and name items (Pinterest, Thefancy), as well as companies that provide hosted services to store and crunch large amounts of data (MongoDB, Aster Data, Riptano).
In 2011 the interest in big data and classification companies will increase (especially in the press) and continue to grow as a meme. I am guessing at least one of these will be acquired for an unnaturally high valuation by the end of 2011 / early 2012.

Three Massive, Fundamental Market Shifts
I think user behavior, or key aspects of the following three markets have shifted fundamentally, creating big opportunities for entrepreneurs.

4. MEGATREND: eCommerce renaissance

In 2010 a new suite of ecommerce companies emerged, while category leads of the new old school were acquired (e.g. Zappos, Diapers.com) while new ones were funded (BirchBox, ModCloth, BaubleBar, etc.) In parallel, recent online retailers (Gilt, ShoeDazzle, RueLaLa etc.) have ramped revenue very fast, proving that building an ecommerce company fast is now possible.
What has changed?: Buying behavior has fundamentally changed - there is a massive pool of consumers finally truly comfortable with buying goods online, and with free returns, cheap shipping, and fast delivery people are voting for ecommerce with their wallets. In addition, new models of eCommerce (flash sales, subscriptions, etc.) have been adopted rapidly, providing users with additional incentives to shop online.
In 2011 the pace of innovation and funding in ecommerce will accelerate dramatically, with craploads of companies getting funded.
New models will continue to be pioneered in ecommerce, for example subscription based bundles for monthly goods (see e.g. ShoeDazzle, BirchBox, and Foodzie).
I am personally super excited about this area

5. MEGATREND: Huge mobile user bases

Smartphones have hit critical mass with >300,000 android activated a day (this is equivalent to 100,000,000 a year!). By the end of 2011, low hundreds of millions of users will have highly functional mobile devices. This means services can now explode on mobile like never before.
Prediction: At least 5 new, non-gaming, mobile applications launched in 2011 will reach a multi-million person user base before the end of the year.
In parallel, desktop web services will also see the fastest growth ever as new apps have the potential to come out of nowhere and grow to a massive user base or revenue run rate like never before (see e.g. GroupOn).

6. MEGATREND: The Shift of The Enterprise to the Cloud Will Continue

In a recent talk, Don Valentine (founder of Sequoia Capital) mentioned that in the 1980s, he knew the computer revolution was happening so Sequoia Capital invested in a dozen or so companies (with great success) to capitalize on it. Right now, a similar trend is happening in that big components of IT services are all shifting to become cloud based services (e.g. Workday for HR management, ZenDesk for customer support, PagerDuty for IT operations, etc.)
This massive trend will continue and multiple companies worth hundreds of millions, or billions of dollars, will emerge.

Basically, 2011 will see a massive wave of innovation. eCommerce, mobile, and SaaS are 3 areas where fundmental market shifts are happening. Some exciting companies will emerge and scale fast, while new location services will wow users in unexpected ways. "Big data" will continue to be a meme, and companies in this category will likely get high valuations.

Any areas I did not mention that you think will take off? Add them in the comments section.

You can follow me on Twitter here.

Companies Who Will Buy Companies in 2011

2010-12-21T10:34:00.000-08:00

I was recently on a panel about Startup M&A / Startup Exits, and the moderator asked what companies we thought would be highly acquisitive in 2011.

Here are my predictions about companies that will buy lots companies in 2011:

Google. Obviously, Google will continue to sweep up many leading technology companies. I am guessing social, local, and ads will be areas of high activity.
Facebook. Facebook will buy a company a month or more. At a valuation of tens of billions of dollars, a $10 million buy for Facebook is equivalent to less then 1/10th of 1% of the company. Most of these will be small team buys/asset sales. There is some possibility FB will go for a $50 million acquisition, which would be quite atypical for them (ignoring FriendFeed, which up until now was a bit of a fluke)
Salesforce. With the acquisition of Heroku, Salesforce showed a willingness to bet in a big way on a new direction. With a market cap closing in on $20 billion and a pile of cash, Salesforce is well positioned to make a bunch of acquisitions. I am guessing a number of cloud platforms, and social CRM companies, will become part of Salesforce in 2011.
GroupOn. GroupOn will continue to take out competitors in other markets via acquisition, as well as build its technical bench via talent buys. There is also the potential for GroupOn to buy more mobile assets. In 2010, GroupOn acquired Qpod, Darberry, uBuyiBuy, Atlaspost, Beeconomic and many others. Expect this trend to continue in 2011.

Companies that will buy a handfull of companies:

LinkedIn. LinkedIn bought ChoiceVendor in 2010, and has sniffed around a number of other potential acquisitions. I expect LinkedIn to continue to make talent buys. Intriguingly, I could imagine LinkedIn also swooping in and making a larger ($50-100 million+) acquisition if they saw strategic value in it. I also expect LinkedIn will buy one of the many contact management and social recruiting platforms that have been emerging during 2010.
Zynga. Zynga will continue to buy social gaming assets.
Amazon. Amazon acquired ecommerce 1.0 market leaders Zappos and Diapers.com in 2010. Expect them to continue to pick up assets through 2011. Interestingly, Amazon tends to buy more of market assets / market share in key markets, rather then do a lot of small team buys like Facebook or Google. This means their acquisitions are often valued on cash flow / income projections, rather then the more semi-random variables such as "number of engineers".
Yahoo!. Yahoo! will be active in 2011 and will likely take a more strategic approach to acquisitions (e.g. buying a technology asset) rather then doing pure team buys.
Cisco. Cisco was surprisingly quiet in 2010. They will continue to buy companies in 2011, but maybe at the same pace as 2010 (e.g. 5-6 acquisitions). Thanks to labboy for the idea on hackernews.
Apple. They will probably do a small number of strategic acquisitions. Apples usually does middling acquisitions in size, but seemed to be willing to bid certain strategic assets higher with e.g. their bidding war with Google over AdMob (Google won) (Thanks to dccb)

Companies that will make their first acquisition ever in 2011.

Foursquare. As its valuation will continue to grow with its user base in 2011, Foursquare will likely make one to a small number of team buys. The company is ramping quickly and will need to balance growth with assimilating its first acquisition, always a tough thing to balance. However, given all the attention surrounding the company, a number of entrepreneurs will be excited to exit into their arms.
Square. Square is rumored to be closing a massive financing round. This round will give them currency to make a small number of team buys through 2011. Keith Rabois, their COO, has plenty of experience buying companies on both sides of the table.

Any companies I missed? List them in the comments section below!

You can follow me on Twitter here.

5 Myths To Building an Awesome Mobile Team

2010-12-15T09:37:00.000-08:00

This post originally appeared on TechCrunch as a guest post. Please note, this post is my personal view only, and does not reflect Twitter's view of the same topic. I have also added a new first paragraph for context. Thanks to the folks at TechCrunch for publishing it.

When I kickstarted Google's mobile efforts in 2004, Google's mobile team consisted of 1/4 of an engineer dedicated to maintaining an old WAP search server on the brink of collapse. Over the following months, I was involved in all aspects of getting the mobile team up and running. This included setting up a product roadmap, recruiting initial engineers (I poached engineers from other Google teams and hired externally), kicking off contacts and early product discussions with mobile carriers and handset manufacturer's, and was involved in three acquisitions (including what turned into Google Mobile Maps and Android).
----- (start TC post)

In the early days of Google’s mobile team, we needed to navigate a series of misunderstandings most people have about consumer mobile app development, and how to build a great consumer mobile team and product. Given the ridiculous growth of mobile today, many companies I know are trying to start their mobile divisions and they are making the same mistakes over and over. Similarly, many mobile consumer startups are making a series of common mistakes. This post draws on my experience building Google’s early mobile team to point out how to overcome the myths people still believe about making super successful mobile applications.

Myth 1: You need to hire mobile experts.
Reality: Hire great athletes; mobile “experts” will be useless in 6 months

The natural impulse of someone doing mobile development for the first time is to assume that mobile is somehow different from other software development. This leads to the hiring of mobile “experts”, many of whom lack solid consumer product experience. They may have worked on handset design, SMS based services, or for a large carrier. While mobile client development obviously differs from web development (since you can’t just push a bug fix to all devices), it is very similar to any other form of consumer client development.

This means that while people with deep mobile experience may bring knowledge about a specific technology or the limitations of mobile clients, they often lack the deep consumer experience that is actually much more important for the success of your consumer app.

Additionally, any specialist knowledge the expert may have had will be learned organically by your team within 6 months. This means the value of a “mobile” person will diminish dramatically over time. As with all roles, I would advocate hiring great consumer generalists to fill the spot, as they will have a much larger positive impact over time.

a. Don’t hire “mobile engineers”

The first thing people want to do is hire an “iPhone engineer” or “Android developer”. The best mobile engineers I have ever worked with were great generalist engineers who picked up iPhone (variant of C) or Android (Java) development. By focusing on hiring great engineers and having them pick up the programming language and platform (including learning its limitations) you will:

Expand the pool of potential people you can hire. Grow the team faster!
Avoid a “specialist” culture at your company. In general, I think it is good to build a culture of great generalists/athletes rather then specialists for your company. You want people who are hungry, brilliant, and adaptable, and who can move between teams and contribute to the next big thing for the company once they jumpstart your mobile efforts.
Ensure the quality of your team stays high. Your existing engineers should interview the potential mobile hires and test them on general computer science skills.

For example, on the early Google mobile team we had a PhD student from Yale with no industry experience, an expert on enterprise Java from BEA, and a research scientist at Google. These people helped form a formidable core for mobile engineering at Google.

b. Don’t hire “mobile” Product Managers (PMs)

Just as you should hire generalist engineers for your mobile team, you should similarly find a great consumer product manager to run it. The worst hiring mistakes I have seen people make is to hire PMs with telecom or handset backgrounds to run their consumer products. You need people who understand that the phone is primarily a social device—for example, people love to take photos and share them with their friends (see Instagr.am, PicPlz, and PicBounce)—and that the screens are still small, so focusing on a few key features or interactions is key.

Myth 2: Your mobile codebase is different from regular code.
Reality: Its just code. You should treat it as such.

Obviously, developing for a client app that can’t be fixed via a push to AWS has its own challenges. But the mobile codebase should be something any engineer can contribute to at any time—even if it is just to run internal test apps to try out new features.

Similarly, don’t let your team use mobile as an excuse to avoid following good software engineering practice. A good release process can apply anywhere.

Myth 3: You need carrier or handset deals to distribute a mobile product.
Reality: Focus on standard consumer distribution first, not carriers or handset manufacturers.

When launching a mobile consumer product, many companies make the mistake of focusing on carrier or handset partners for distribution rather then just putting it out there for users to try.

a. Focusing on carriers means you will build the wrong product.

When dealing with a new consumer app, carriers and handset manufacturers will have all sorts of ideas, some of which may be bad, about how you should change the product before they agree to distribute it. This will likely ruin the consumer experience. They may also ask you to support a wider variety of handsets than makes sense for you to build for. Further, all the time spent negotiating with carriers will also distract you from spending your time building things that will delight users.

b. People naturally spread great consumer products.

Think of all the consumer apps that have widespread use and adoption from scratch (Angry Birds, Foursquare, Gowalla, Bump). None of these launched with any traditional teleco deals.

c. If your app is a big success, carriers will come to you for deals.

If your mobile app is being used (or your desktop app has wide enough distribution), carriers will approach you to add your app to their phones. Think Facebook, Twitter, Google, etc…, as well as, back in the day, IM clients.

Don’t get me wrong—carriers and handset pre-installs can widen your distribution dramatically. However, as a startup or new mobile effort, you should focus on direct-to-consumer distribution first. Only deal with these intensive partnerships once you have proven traction with your core app experience and want to reach out beyond the relatively large population that discovers apps via the app store and friend recommendations.

Myth 4. You must build for all platforms from Day One.
Reality: Start with iPhone or Android only first.

One of the big fears when building a mobile property is that only a subset of the market can be addressed via each platform (iPhone, Android, Blackberry, Symbian, XHTML, SMS). These days, the best consumer apps are launching on iPhone or Android only first. This provides enough distribution/addressable devices to see if the app can gain traction. Once it gets traction, other platforms can be supported. A great example of this is Foursquare, which launched exclusively on iOS and grew from there.

In part you should choose your platform based on your market and distribution approach. iPhone or Android (as well as increasingly HTML5) are good bets for the US, and increasingly, the rest of the world. You should only build XHTML or SMS based apps if you are focused on the low- to mid-range of developing markets.

Myth 5. (Once the app launches) We are mobile geniuses!
Reality: Stay hungry and keep questioning your mobile directions.

Congratulations! You got your mobile app out the door and it is growing 50% month over month. There is an old saying that a rising tide floats all boats. The rapid growth in the overall smartphone market may make your mobile efforts look brilliant due to this ongoing, massive market shift. Make sure to challenge your team’s thinking on their mobile choices, and don’t believe the mantra that “mobile is just different”. Focus on building an awesome consumer experience and you really will end up looking like a genius.

Mobile is a huge opportunity and will be the primary way many services are accessed in the future. Hopefully as you start a new mobile consumer startup, or build a mobile team for your existing web property, with the tips above you can avoid the mistakes people frequently make for mobile app development.

----- (end TC post)
What do you think? Any other myths to overcome for mobile development and team building? Let me know in the comments.

You can follow me on Twitter here.

Financing approaches most likely to kill your company (if it is already on the edge)

2010-12-10T09:07:00.000-08:00

Too Many Seed Companies Chasing Too Few VCs
Over the last 6-12 months there have been a crapload of seed stage companies that have been funded. In another 6-18 months these companies will be running out of money, and all will be pitching the same small set of VCs at the same time. While the number of angels (and the amount they have available) has expanded dramatically, the sames does not hold for venture funds.

What does this mean for your company?
There will be 3 tranches of companies:

Superstars/Hot Companies. These are companies that have traction, and/or are perceived as market leaders, and/or are in a hot space (e.g. Foursquare in 2010 or GroupMe recently). VCs will cherrypick these companies and will compete aggressively with one another to fund them. They will have massive valuations reported in TechCrunch and long comment threads about how the company "suxxxx" and does not deserve such a crazy valuation (remember all the comments every time FB raised a round?).
Middle of the pack. These companies will not have had break out traction yet (e.g. will have 50K users), but will have built a reasonable product and have a "great team". Some of these companies will be able to raise additional capital, or be able to survive based on cash flow (and may need to cut their teams from e.g. 6 people down to the original 3 founders). Some of these will end their lives as "large small acquisitions" - e.g. sell for $5-$20 million depending on timing, technical assets, size of team, and market.
The dead or talent hires. These companies will shut down or, best case, will be "acquisitions" where the team is paid a slightly larger then normal hiring bonuses or option packages to join an "acquirer".

Your Funding Structure Today Impacts Whether You Are Middle of The Pack or Dead Tomorrow
The line between "Middle of the pack" and "Dead" will be a fine one. One of the characteristics that may tip companies from Middle of the pack into Dead is the existing cap table/financing structure of the company.

Worst Financing Structure to Have: Equity round, high price, with multiple VCs

Multiple VCs. Having multiple VCs in the round is going to lead to very bad signaling characteristics for you if your company is only doing so-so.

These same VCs who a few months earlier were competing with Superangels to get into your round will suddenly realize you did not grow into the hot company they were hoping ("We love you and the team", they will say "This is strictly a business decision. We are big fans of yours but can not invest any more")
They are used to doing $5 million investments. The $100K they invested to you does not impact their fund economics. And the opportunity cost of partner time is too high. They will not do a follow on round with you (as they can invest the same $3-10 million in a company with real hockey stick traction instead).
All the other VCs you pitch will ask why non of the 3 VCs who invested in you are driving the round. They will call said existing investors who will say "we love the team, but they just don't have the traction we are looking for".
This will kill your ability to raise money unless you are a "Hot Company". Goodbye company!

High priced equity round. The second worst thing to having too many VCs in your round and the associated signaling risk, is to have a high priced equity round.

Doing a down round (raising at a lower valuation then your last round) often invokes a lot of dilution due to the equity financing deal terms. You may go from owning 30% of the company each as a founder to a few %, depending on the terms and the next round you do.
This will kill your incentives as founders and early employees. Do you really want to work 14 hours a day for so little of the company?
Have you read your equity financing docs closely? Do you really understand all the terms? Make sure you read the section about down rounds closely.
People with low equity valuations will be fine. If you raised at a $2 million valuation, the next bump up does not need to be huge to de considered a success.

Best Financing Structure to Have: Convertible note, no VCs (i.e. only superangels and individuals)

No VCs in the round. The fact you did not include VCs (despite their promises of all the value they will add) means you have no signaling risk.
Convertible note. Many recent convertible notes are structured with a cap but no discount rate. This means if you have a convertible note with a $6 million cap, but you raise a round at a $3m pre-money valuation, the note will convert at the $3m valuation. As an entrepreneur you get diluted more then expected, but no ratchet is triggered, and no big penalty is paid.

Obviously, what financing structure you have is secondary to whether the company hits it out of the park or not. If your company is doing awesome, or is perceived as such, your existing cap table becomes pretty unimportant. However, if things are only going so-so, your past financing events can impact things a lot.

What do you think? What besides past financings can tip a company from being "middle of the road and fundable" to "walking dead"?

You can follow me on Twitter here.

6 Startup Ideas Every Nerd Has

2010-11-30T09:32:00.000-08:00

Over the years I have spent a lot of time brainstorming startup ideas with people who are (asymptotically) as nerdy as me. For some reasons, every time I brainstorm with a new set of people, the following ideas come up. This suggests that either all nerds think alike, or alternatively, that they are unsolved problems that someone, someday, somewhere, may actually come up with a variant that hits big.

So, here is the list of 6 startup ideas every nerd eventually thinks of (but never seem to quite work):

1. A "Better" Dating Site.

When you spend all your time coding, you can't help but hope there are more efficient ways to meet the opposite sex.
Most variants of these end up being ideas guys would love (you can see ALL the girls, and THEY need to reach out to YOU), but that girls would never use.
Popular subvariant: A tool that scans all the bars in the area so you can see the girl/guy ratio (or, more recently, "a mobile checkin service where guys can report guy/girl ratios". Or, "lets scrape Facebook events and Foursquare for this data").

2. A Giant, Purposeless, Unfocused Machine Learning System.

Popular subvariant: We have built this awesome recommendation engine/collaborative filtering technology we will license to sites across the web to improve buying behavior on their site, and we will take a % cut of the uplift in their revenue
Popular subvariant: Hey! Lets apply it to music!

3. Social Travel

TripAdvisor sucks! Let's have people write travel recommendations for specific sub niches (off the beaten path, traveling with a dog, cheap travel, etc).
Popular subvarient: You can also ping your friends on Twitter and Facebook to ask them to write reviews for you! (Have your friends ever really wanted to write anything for you other then a snarky comment on your latest profile pix?)

4. The Future Success of My Friends Fund Idea

Subvariant 1: What if we all promised to put in 10% of our future earnings into a fund? If just one of us does well, we will all be rich! (AKA if one of my friends makes it big, I can retire on their hard work!)
Subvariant 2: Lets approach students at the top schools and offer to fund college in exchange for X% of their future earnings!

5. Craig's List Killer

"Lets start by adding a better search interface on top of Craig's List, then make it more social, then drain all their inventory onto our own site. Aren't they a non-profit or something? I doubt they would ever block us!"

6. Gaming Mechanics Applied To X Vertical

"We are totally going to revolutionize the music/energy/healthcare/social news/forestry/plastic surgery industry by adding gaming mechanics to it. People freaking love badges - Foursquare proved that".

Any other ideas you see come up repeatedly? Leave them in the comments section.

You can follow me on Twitter here.

The Benefits Of Thinking Small

2010-10-28T10:22:00.000-07:00

In previous posts I wrote about visionary entrepreneurs, and how to constantly ask how you can 10X your business. However, many startups fail because the founding team thinks *too big* from day one, and doesn't take the time to really define the short term, immediate value their product or business provides.

In this post, I write about the opposite of thinking big - thinking small. I point out why thinking small may be one of the most powerful things you can do as an entrepreneur.

The Biggest Companies Today Started By "Thinking Small"
Think of the top internet services you use - I am guessing all of them started as "niche" products:

Facebook.

Then: An invitation-only social network for college students during a time when MySpace, Friendster, Multiply, Orkut, etc. all existed.
Now: identity management on the web.

Twitter.

Then: Group SMS.
Now: Primary information network on the web.

Zynga.

Then: Poker app when everyone knew that RockYou/Slide style apps were the future of the FB platform.
Now: Massive, highly profitable social gaming company.

Google.

Then: a search engine when 10 other search engines existed and companies like Yahoo! were actively outsourcing search since it did not have a good monetization model (brand ads were the key). However, they always wanted to "Organize all the world's information and make it universally accessible and useful". So they thought big from day 1.
Now: The primary search switchboard for the internet with multiple indices (search, local/maps, books, video (YouTube), email, Android phone O/S, etc.)
With Google in particular, they are executing on the original "big vision" they had. However, they had the discipline to start with one core product (web search) and expanded from there.

Starting Small Keeps You Focused On What Is Important
Too many entrepreneurs start with a grand premise that is impossible to execute from day one, and distracts from building a useful product.

Imagine if Facebook had said from day 1 "we are identity management for the web". What would have been a potential outcome of this mindset?

Facebook would have started as an open social network which anyone could join (vs the exclusive, school by school network everyone wanted to join.). I am guessing no one would have joined it.
They would have immediately built Facebook connect. After all, they are identity management on the web... But no one would use it as they had no members. This would have been a big waste of engineering time and a distraction for the company.
They would have hired big company VPs of Eng, HR, Product, and BD to be ready to "scale" to the massive opportunity at hand. These people would have promptly destroyed any cultural components the company had and screwed up its roadmap.

It Is OK To Build Something That Does Not Scale From Day 1
A common VC question is "how does this scale?". Ultimately, to build a large, long-term business you need to be able to take an approach and scale it. However, it is OK to start with something that is manual and hands on. The key is to have something that can be systematized and replicated over and over eventually.

Examples: Yelp needed to crack the code on getting a small group of people contributing reviews in SF before they could roll out the Yelp model to new cities. Ditto with GroupOn and local sales. Facebook with schools. Zynga learning game mechanics within individual games and then rolling them out across multiple games.

If You Want To Build Something Big, You Should Have A Path To Greatness
Now, while it is crucial to think small and to build something that does not scale, you should always keep in mind the long term path for your business or product. This path (and the end goal the path itself leads too) may continuously change as you learn more and as circumstances dictate. However, you should constantly be thinking how to make what you have even bigger than what it is.

A great example of this is Facebook transitioning from schools, to .coms, to an open social network. They needed to keep opening up to more users as they saturated their smaller markets. This forced them to keep moving towards a bigger and bigger objective - online identity management - even if this was not the original goal of the service.

By thinking small, they eventually were able to think very big indeed.

Implications: Why The YC Model Works
This post was originally inspired by a question on Quora about whether the YC model can generate big successes, despite its emphasis on "small markets" and "low risk" products. As I point out above, thinking small if often the key to building something truly huge.

Any other benefits or drawbacks to "thinking small"? Let me know in the comments section.

You can follow me on Twitter here.

Breaking Apart the Startup in the Cloud - A Dramatic Shift in Company Building

2010-10-20T11:37:00.000-07:00

Sequoia Made 15 PC Investments Early On

Don Valentine, legendary Sequoia founder and investor (Apple, EA, Cisco, etc.) mentioned that when PCs came to the forefront Sequoia made 15 investments in all the other subsystems, components, and peripherals that needed to exist for the PC to be a success. In other words, due to the new market, lots and lots of great companies were created in parallel.

A Huge Shift - Startups Who Will Break Up a Business Into Hosted Services

A similar shift is now happening as multiple services move to the cloud, and in parallel every major company has a set of web services they need to provide their customers. Things that many websites do not consider core are being outsourced to a new breed of startup. These startups take one main service that most companies don't want to build themselves, and provides it to any company that needs it.

SaaSification of Your Startup

This is accelerating as more and more components that businesses used to run themselves are being broken into SaaS services. Startups can benefit from it as now not only can you use open source software to build your stack quickly, but you can also outsource many of the components needed to actually run your business, customer service (e.g. Zendesk), and even IT ops (e.g. PagerDuty) day to day.

You can call this the "SaaSification of the startup", and I am sure this will increasingly hit large entreprises as well.

We are still early days for these sorts of services, and this is a very big opportunity area for entrepreneurs (as both inventors and users of this new type of software).

Example Services:

PagerDuty: IT Ops alerting and workflow
Optimizely, MixPanel, KissMetrics: A/B testing, web analytics
ZenDesk: Customer feedback and support
WuFoo: Online form builder
SurveyMonkey: Customer surveys
Zuora and Chargify: Billing systems, Payment collection
JobVite: Recruiting pipeline management

These services make it easier and faster for a startup to get up and running, and in parallel are potentially great businesses for an entrepreneur to found in their own right.

Any other services you think will be especially promising? Add them in the comments section!

You can follow me on Twitter here.

Are You A Visionary Entrepreneur?

2010-10-18T11:22:00.000-07:00

I think of all the entrepreneurs I have been helping out over the last year or so, 3 stand out as what I would characterize as "Visionary Entrepreneurs". These are people with a singular vision for what they want to accomplish. They view their product or company as the vehicle by which they can fulfill a messianic mission to change the world.

Impact of a visionary founder

Many startups can and will succeed without a visionary founder, but the likelihood of either a very big success (or huge flameout) goes up dramatically with a visionary founder. Visionary founders want to accomplish a big vision, so will keep doubling down on their business despite obstacles, buy out offers, and internal team issues. Visionary founders are on a mission to change the world via their product or business, and they will do whatever it takes to accomplish that vision.

Characteristics of a visionary entrepreneur

Want to change the world. The goal of a visionary founder is not to make money, impress girls (Facebook movie notwithstanding), or to shmooze with famous people. What they do want to do is either scratch a big itch they have, or to dramatically change the world (or both).

There is a singular vision the entrepreneur is following, and they will get other people on board to focus on this singular vision.
This means the visionary founder won't go for an early (or late) exit. It is not about money, it is about impact.
This means they may be maniacal about the product or service, and unwilling to relent in their pursuit of a vision. This means not everyone will like them.
Examples: Larry and Sergei from Google always talked about wanting to index all the world's info. Mark Zuckerberg (I am guessing potentially with influence from Sean Parker) from Facebook wanted to connect the world.

Willingness to take big risks. Given their focus on a singular vision, visionary founders will take risks other people won't take in order to make their business work. They will max out their credit cards and sleep on their friends living room floor in order to keep working on their business. This is one reason younger people are often more likely to be visionary entrepreneurs (they have less to lose, so it is easier to risk what you don't have - see below :)

Example. Fred Smith, the founder of FedEx not only put his inheritance into FedEx, but also famously took the last cash the company had and went and gambled it in Las Vegas in order to meet payroll.

Question the basics, an experimental attitude towards everything. Visionary entrepreneurs often question the basics. They ask why things are done a certain way and often try to blaze new paths not only for their product or service, but also in the fundamental ways their business run. They will experiment with things that more experienced people will take as a standard that should not be mucked with. This experimental attitude helps drive the creativity and innovation in the organization, although also carries the risk of distracting the organization inappropriately.

Examples. Facebook making an engineer head of HR (Chris Cox) rather then hiring an HR person for this role. Google building its own computers and networking equipment. Richard Branson starting an airline (a notoriously bad business) with the Virgin music brand. Fred Smith from FedEx having pilots help unload FedEx delivery planes.

Fast learners. Given that they question the basics of everything, visionary entrepreneurs can often be perceived as naive or inexperienced. In many cases they are. But they ramp quickly and gather information from a lot of sources to drive their success.
Youthful. Most visionary entrepreneurs start businesses when they are very young. They have a vision and they go for it. They do not talk about getting a job at Google to "learn how to build products". They go and build a product in their college dorm. They are also able to live on close to nothing and the relative opportunity cost of starting a company is small. They don't have as much experience and the baggage that comes with it, so are willing to experiment aggressively.

Examples: Founders of Facebook, Google, Dell, Virgin, Apple, Microsoft all dropped out of school.

Good storytellers and recruiters. Visionary founders constantly are roping people in to their vision and their company. They set a big goal people can rally around and attract great talent due to the strength of their personality and vision. This does *not* mean they have to be the smoothest, most charming people alive. Rather, the magnetism of their commitment and the enormity of their goal often serves as a way to get people excited enough to join up with them. They don't talk about getting to "1 million users", they talk about reaching 5 billion.

Examples. When Larry Page of Google was hiring Eric Schmidt as CEO (when Google was just 100 or so people), he told Eric he wanted to build a $100 billion company. Eric asked "$100 billion market cap?" and Larry replied "No, $100 billion revenue". At the time Google was still focused on enterprise search as its (in hindsight tiny) revenue source. Steve Jobs famously recruited John Sculley from Pepsi to be CEO of Apple by asking him "Do you want to sell sugar water for the rest of your life or do you want to change the world?"

Any other traits visionary founders have? Any examples or anecdotes I missed? Please leave them in the comments section.

You can follow me on Twitter here.

Investor - Want an Equity Seed Round? Pay For The Legal Fees

2010-10-12T10:06:00.000-07:00

I know a number of investors who would prefer investing in an equity round over a capped convertible note for a seed round. (note, this post largely refers to seed financings)

Reasons investors prefer equity rounds include:

Protective provisions and shareholder rights. There are a set of terms that protect the investor that are negotiated into equity rounds that frequently don't exist in notes.
Taxation. If the company sells, there is different tax treatment to this investment if the note converts into equity upon acquisition then if the investor held equity the whole time.
Sets the tone for the next round. Often, some of the terms in an equity seed round will set the terms for follow on equity rounds. This is often good for both entrepreneur and investor if the terms are set properly up front, decreasing the potential negotiation for future rounds.

The reasons entrepreneurs like convertible notes:

Time - they are faster. A convertible note ends up being 10 pages total between the note + purchase agreement, vs a thick stack of equity financing docs.
Expense - they cost less. (a) The entrepreneurs legal fees cost 2-3X more for an equity finaning then a convertible note, due to the increase complexity of an equity financing (and the legal time it takes to negotiate). (b) For some reason the entrepreneur is asked to pay the legal fees for the investors in an equity financing. Not sure if this strikes anyone else as ridiculous. This means an equity financing can end up costing $35-$50K. If you are raising $500K in seed, this means up to 10% of the cash raised for the business goes to pay legal fees.
Terms. See protective provisions above.

I find the fact that the company is asked to pay for the investor's legal fees in a seed equity financing to be kind of ridiculous. This should be treated as a cost of business on both sides, and each should pay their own legal fees.

Thoughts? Leave a comment in the comment section below.

You can follow me on Twitter here.

Your Lawyer and 3 Other People You Should Not Give Equity To

2010-10-08T09:30:00.000-07:00

The Hidden Costs of Handing Out Equity

Giving people equity has a number of hidden costs which may include everything from having to get them to sign off on an acquisition (depending on how it is structured, you may need 100% shareholder approval) to them having a variety of shareholder rights which may allow them to become a pain in the butt.

As an entrepreneur, I would suggest giving options/equity only to people that will be working full time at the company, and to your investors.

4 People To *Not* Give Equity

Here are 4 people founders often give equity to, even though they shouldn't.

Your lawyer. Many lawyers will ask you to give them equity in exchange for deferring fees. You should say no. They will still defer fees. If you really want the lawyer and they are unwilling to relent, give them the option to invest e.g. $25K in your next round of financing. If they still say no, find another lawyer. There are plenty of good ones out there.
Your landlord. Some co-working spaces are willing to allow you to defer rent with the deferred cash going into your financing round. Space is cheap. Equity is precious. If you really need an early space to work besides your living room, ask a friend with a startup to crash there. Or, look for a super cheap sublease on Craig's List. Or meet at a coffee house and work from there.
Contractors. Unless the person will make or break your company, I typically advise against giving a contractor equity. There are alternative ways to structure contracting work. This one is less set in stone, but the basic question is - do you really want someone who spent 2 months with your company to own a piece of it? There is a reason companies have vesting cliffs.
Your accountant. Not sure why anyone would do this.

People You May Want To Give Equity To

Your family. It is most tax efficient to grant stock to loved ones early, or to set up a trust in their name.

What do you think? Let me know in the comments section.

You can follow me on Twitter here.

10X Your Business

2010-10-04T13:56:00.000-07:00

Often when I meet with a startup I will ask them to put aside their existing product/distribution roadmap for a minute and brainstorm around a simple question -

Question 1: "What circumstances would lead to a 10X increase in the value of your product or business?"

Most product and distribution roadmaps are incremental. Do x, then y, then z, each of which has a linear increase in the value of the product or company. I think it is good to periodically get out of that way of thinking and ask what sorts of deals, adoptions, or customers would completely change the game for the company. These things should be at least borderline realistic - i.e. if you devoted a small set of resources, the stars aligned perfectly, and luck went the right way, it might, just might, work out. But you will never know if you can make something amazing happen if you don't think audaciously and actually devote some small subset of resources to just go for it.

As an entrepreneur or business manager, you should periodically ask yourself, what can create a big step function in company or user value? And then you need to figure out, how can I execute that 10X step?

Question 2: "What can you realistically *do* to accomplish the circumstances that will 10X your company?"

Can you dedicate a person to fly out and camp out for the next 6 months until you close that company-making deal?
Can you spend all your funding on acquiring users and manufacture a network effect?
Can you lobby for a partnership in a company's home headquarter's newspaper or turn their users into a lobby for you on Twitter and Facebook in order to make an impossible deal possible?

Examples of things that 10X'd Companies:

AOL/Apple deal in the 1980s. In the 1980s, Steve Case was on the marketing team at Quantum Computer Services (later renamed AOL). The QCS management sent Case to stake out Apple offices and asked him to not come back until they had an Apple deal. It took many months of living out of a hotel room, but Case eventually sealed the deal.
PayPal paying $10 a user. PayPal raised tens of millions of dollars of funding but its users base was not growing as quickly as they would have liked. Rather then sitting on the money and waiting for something organic to happen, PayPal's leadership decided to make a bold bet - spend a large portion of the funds they raised ($10s of millions) buying users in order to bootstrap a network effect. The company went on to go public before being acquired by eBay.
Microsoft/IBM deal. Microsoft famously told IBM they had an operating system when they didn't in order to win IBM's business. They then scrambled to find an OS they could quickly license from another software developer. A number of lessor entrepreneurs would have said "sorry, we can't help you". Of course, within a few years the OS franchise became the foundation of Microsoft's meteoric rise.
Google/Yahoo! deal. Yahoo! outsourced search to Google and allowed Google branding on the Yahoo! homepage. This lead to two outcomes: (a) Google had a massive spike in both traffic and data that is could use for analytics and to refine its search engine (b) The Google branding on the Yahoo! site caused non-early adopters to become aware of Google as a brand and drove significant traffic directly to the Google site. Since Yahoo! paid Google for the service, it also partially funded Google as a business.
Zynga raising a crapload of cash for media buying and "overpaying" for social gaming startups. When Zynga got started there were dozens of other social gaming startups. Zynga changed the game for itself by realizing scale is what would cause it to win. Zynga raised large amounts of money to buy scale - both via media buying (ads) as well as via buying lots of small startups for more then its competitors would pay (by projecting the future value of the assets, vs current value). One of these acquisitions turned into Farmville, their core franchise. All the other startups that could as easily have been Zynga? 99% of them are acquired for small change or are dead.

What are other examples of companies making unexpected 10X moves? Let me know in the comments.

Related post you might find interesting: Is your startup a cash or equity business?

You can follow me on Twitter here.

Put Your Investors To Work For You

2010-09-28T13:52:00.000-07:00

So you found the right mix of angels for your round, successful navigated around venture economics, and all the other issues associated with fund raising.

At this point, many entrepreneurs don't take proper advantage of all the value added investors they spent so much time and trouble courting. I.e. what is the point of having one of the super angels in your round if you don't make use of her/his help and expertise?

At Mixer Labs (a company I started that was acquired by Twitter in December), I was always pleasantly surprised by how much value meeting with our various investors brought. Just as you have an engineering team or a UX team, you should think of your investors as your investment team and find ways for them to work for you. Below are some tips for making the most of your investment team:

Investors are there to help you (not for you to "update" them). Some entrepreneurs spend way too much time meeting with each individual angel to give 1 way updates. If you have 12 investors, and are meeting with each of them monthly it means you are wasting too much time on investor communication instead of focusing on your startup. This obviously is not good.
Figure out which investors can help with what. Some investors are much better at (or more interested in) talking about the product. Others can help with hiring, setting company culture, business development or the like. Ask your angels what they are good at, and what they can help with. When the time comes to close your first employee, negotiate that business deal, or figure out the best channels by which to buy traffic, contact the right angel or investor and ask them for help.
Updates should be phrased in ways that let your investors know how they can help you. Rather then meet with all your investors regularly, the best way to keep them up to date is to send an occasional email update. These updates could simply be "Hey, we launched our alpha, sign up here and give feedback" or for later stage companies can be monthly or quarterly emails (e.g. tied to board meetings) with an update on the business. With each update, I would suggest having the 3-5 key asks you want from your investors. E.g. is there a company you need an introduction to? Some feedback on a part of the product? A key hire you are looking for? Ask explicitly for help with this at the beginning of the email.
Mini board/advisory board. If you don't have a board, you can use 1-2 of your favorite angels as a lightweight version. I.e. you can ask them to meet at some regular interval (e.g. every 6 weeks) to discuss some key things that are on your mind regarding the business. You can make these slides light, but it is still worth emailing the content a few days in advance so the angels can think through the key issues. Come prepared as you would for a board meeting - what are the top 1-3 things that are on your mind and how can they help you think these issues through? Is it the product? Hiring? Distribution? Sales cycle? Work with your key investors to work through this.

Side note: You can also do this with people who are not investors - e.g. key industry people that you know/respect who can help. In this case they can either be formal advisors or people who come in more for a one off discussion of a key topic they know a ton about.

Semi-annual investors all-hands. One thing we did at Mixer Lab was to get all our investors into one room to discuss our key issues. This is similar to the mini-board meeting described above, except we invited everyone to it.

This led to great group brainstorming, as various investors bounced ideas off of us and each other.
A side benefit is the angels get to network with one another, which they enjoyed.

Calendar reaching out to key investors. When you are working heads down on your startup, you often forget to tap into your network for help. Put a reminder on your calendar to reach out to key investors on key topics with some regularity. You can always skip actually contacting them, but it is good to be reminded.
Don't be shy. Don't worry about asking your investors for specific help. It could be an intro to a company they know, to help close an employee, or to meet to discuss the terms of a deal you are working on. You should be up front and ask for help where its needed - that is what they are there for.

Our investors were extremely helpful throughout our early days as a company. Even then, I don't think we utilized them as effectively as we could have. Hopefully the tips above will allow you to make the most of your investment team.

Any other ideas on how to make the best use of your investment team? Please add your thoughts in the comments section.

You can follow me on Twitter here.

Are You An Alcoholic Yet? Or, The Great Startup Rollercoaster

2010-09-15T15:47:00.000-07:00

This post has appeared as a guest blog on FounderDating, which brings together entrepreneurs with different skill sets to start innovative new companies.

Startups are by their nature extremely stressful. At a large company, the company itself has momentum. With a few exceptions, if one person (or team of people) were to suddenly disappear, the company will continue to coast for (potentially) multiple years before the effects may become evident

Thought experiment - imagine if the (multi hundred person (?)) Microsoft Office product and engineering team suddenly disappeared (kidnapped by aliens?). The sales team could keep pushing the existing product for many years without customers noticing. Microsoft could still generate ridiculous amounts of cash off of the product, with no one actually working on it.

In contrast, at a startup as the entrepreneur if you stop pushing, everything immediately comes to a halt.

There are times when you need to push much harder then others to get over a hump that reminds me of activation energy from chemistry. Early on these events can be exhilarating, but with time some of these high anxiety / workload moments can really wear you out. They may include things like:

Hiring the first employee
Raising money
Getting the first N users
Acquisition talks
Getting sued
Pivoting
Getting N users for the new pivot product
Figuring out a business model
Etc. etc.

As a friend of mine put it, if a year into your startup you are not an alcoholic, you must be doing something wrong.

So how to deal with all the stress? At Mixer Labs (a company I started that was acquired recently by Twitter) I tried to do the following:

Make it fun for everyone. Startups are hard work. Find key things to celebrate - e.g. for Cinco De Mayo we bought a pinata. We created our own day off in April called Numa Numa day. We did team hikes. We worked from a pub (with wifi) and drank Guinness every few weeks on Friday afternoons. We rented out a ski cabin in Tahoe for a week and did half days snowboarding and half days working. Everyone on the team was working really hard, so we wanted to make sure we found simple, cash conservative ways to reward everyone while also creating a fun environment for ourselves.
Change context to decompress. After a while, working 7 days a week is exhausting. Make sure to take a weekend off to go to another city with your significant other. Or, go see friends and do a long walk. Changing context (even e.g. walking through San Francisco Chinatown if you are in SF) will help you take a break from the constant focus and worrying entrepreneurs face.
Do your best to maintain key relationships. I had to cancel a pre-planned family trip with my girlfriend in order to work. She was super understanding (she is amazing in general!), but the startup lifestyle can really stress relationships. Try to find ways to connect with loved ones on a regular basis as their support will help get you through tough times - and will help with decompression! Buy your girlfriend flowers or take your boyfriend to Sausalito. Find a way to connect and be with one another.
Get sleep. This is self explanatory. Try going without caffeine for 30 days - it will make a BIG difference and force you to sleep when tired.
Exercise. This will help you decompress and clear the mind.
Have a hobby. This may be hard if you are working maniacal hours. However, even something you do 20 minutes a day can have a huge positive impact. By making progress on something other then the startup, you can feel like good things are happening in life even if work is especially tough.

Startups are stressful but very rewarding. If you don't find ways to cope with the stress you will burn out or blow up and the work environment will deteriorate rapidly.

What do you think? Any ideas for how to decompress or deal with startup stress besides alcoholism? Let me know in the comments section.

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The Fundingpocalypse: Your Mom Wants To Angel Invest!

2010-09-13T13:55:00.000-07:00

You know how your mom or great uncle with the car dealership really wanted to buy Yahoo! stock in 2000 so they could "get in on this thing called the Internet all the kids are talking about"? You know how that marked the height of a funding bubble?

I spoke over the weekend with an angel I know. He has been getting random phone calls from people who "want to learn to angel invest". These are people who have never started a company or worked at a startup (well, maybe Google when it was a few thousand people). They seem to have no real interest in company formation other then they know a bunch of people talking about how great it is to be an angel.

I think it is a clear sign of the fundingpocalypse. Yes folks, there is an early stage funding frenzy right now.

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Party Rounds: How The Crappy Economy, Y Combinator, Angel List, and Super Angels Have Changed Fundraising

2010-09-10T10:50:00.000-07:00

In a prior post, I discuss how Party Rounds differ from Led Rounds, and how to raise a Party Round. In this post I explain what is driving Party Rounds and discuss their implications for entrepreneurs, angels, and VCs.

In the last 12 months two big shifts have happened:

Seed valuations for many companies have gone up dramatically (e.g. 50-100%)
More and more seed rounds do not have a lead investor. I.e. the terms are being set by the entrepreneur as part of a "Party Round" (a term first used by Rafael Corrales).

As I explain below, this shift is one with implications to angels, VCs, and entrepreneurs. This shift has been in part driven by Y Combinator, AngelList, the rise of super angels and the changing economy/lack of good investment opportunities.

Why Are Party Rounds Suddenly So Common?
Two years ago, it was rare to have an entrepreneur set his or her own terms. The following things have changed:

More Angels. There are more angels actively investing in private companies today than at any other time I have seen. This is driven by three things:

Y Combinator. Y Combinator has been holding days such as Angelcon to educate people about angel investing and to connect them to super angels or others who have good advice and insights on investing to pass on. Y Combinator also invites a wide range of angels to demo days, where they have a chance to interact with and invest in startups they potentially would never have met. This opens up a whole new pool of capital and expertise for the angel investing world and I think this is a very positive trend for the overall entrepreneurial ecosystem. With increased angel demand, entrepreneur supply is worth more.
AngelList. AngelList has further democratized fund raising. By tapping into a broad network of angels for every potential investment, AngelList similarly makes it easier for entrepreneurs to raise more money from a wider range of people then they could have previously reached.
"Its the Economy, Stupid". A lot of rich people don't have a good place to put their money that will provide a great return. The stock market has been flat to down over the last N years, bond yields are poor, and there is not a good place to park cash (this is increasingly true for pension funds etc. as well as even overall venture returns are poor). This means that angel investing is a way for people with a lot of money to deploy capital with the hope of a better return. (Thanks to George Zachary from CRV for pointing this out).

Super Angel Funds. Super Angels investment strategies typically support Party Round emergence as -

Many super angels won't take many board seats (some exceptions exist, e.g. First Round Capital, Harrison Metal, and Floodgate have all taken board seats in a number of instances - they also tend to invest much larger amounts in fewer companies then the average micro VC / super angel). The reason is that if most super angels make 20-30 investments a year and have e.g. 50+ active investments, the individual super angels don't have time to sit on any boards.
Smaller capital deployments. One class of super angels invests $50-$250K per round. This means 3-4 super angels and 10-15 regular angels can invest in a $750K round. No one has enough skin in the game or individual bargaining power to set terms.
Lots of capital suddenly in the market. Super Angels have recently raised a crap load of capital to invest. I can think of $X00 million in funds that have closed recently - all this capital needs to go somewhere.

VCs acting as super angels. In order to get option value on a broader set of companies, some VC funds are investing like super angels in seed rounds. VCs are even less valuation sensitive then super angels for seed investments in which they invest small amounts (e.g. $100K), which means valuations can be driven even higher and even more capital is available for the same deals.

The net takeaway is that there is not just more money chasing the same deals, but rather, there is more money that (a) won't lead rounds or ask for a lead or board seat and (b) in some cases (e.g. new angels flooding in) doesn't understand angel economics in a very sophisticated way (i.e. most of these people will lose money in the next few years).

Implications of Party Rounds For Entrepreneurs, Angels, VCs

Implications for Entrepreneurs: Net positive.
Upside: More capital = more negotiating leverage = better deal terms and control for the entrepreneur.
Downsides:
All the capital flooding in means some not-so-great companies are getting funded. Rather than get locked in to a bad idea via successful fund raising, some entrepreneurs' time may be better spent on other products or ideas. This is especially true for the oversubscribed company that raised $1 million instead of $500K and ends up spinning it wheels for 6-12 months longer than it otherwise would have (the flip of this is it gives more time to pivot as well).
The increasing number of less sophisticated angels may mean more hand holding / time spent managing an investor who is on over his or her head - do your diligence and only take money from people ready to lose it investing in your company.
High valuations in seed rounds may negatively impact future fundraising dynamics.
In 18-24 months lots of companies are going to go under as their existing investors don't have the capital or where-with-all to re-up for the company.

Implications for VCs: Net Positive

Upside: Despite all the press about super angels vs VCs, all this capital sweeping into the seed stages is good for the venture community. I cannot think of a single major internet company that has not needed to raise multiple rounds of funding - which is where the VCs come in. All this activity means in 12-24 months VCs will be able to cherry pick the very best companies for series A/B investment. The others will likely wilt on the vine.
Downside: The valuation inflation in the seed rounds will lead to inflated expectations by entrepreneurs for their Series A. It will be interesting to see how this will play out once bargaining power shifts back to investors in later rounds (since there is a small set of collusive players in the traditional venture world).

Implications for Angels: Net negative (but they don't realize it yet)

Upside: Angels who are not as well networked now have more access to companies and investments.
Downsides:

Party Rounds are hurting angel economics. Seed rounds are starting to hit low series A valuations - but with seed level risk. A lot of small fry angels will likely lose quite a bit of money in the coming years - or their return on investment will be lower then it would have been without the Party Round dynamics.
Party Rounds also means angels are less likely to have an investor take a board seat to work with the startup on key issues.
Many Party Rounds are being done as capped notes. This means if the company raises at a valuation lower then the cap then the angel will convert at the low market cap - even though they took on all the early risk. Even worse, if the company gets acquired and there is straight conversion with acquisition, the angel will *lose* money on the exit (as opposed to an equity financing, where the angel will often get their money back).

I leave you with this quote from Keith Rabois, which has interesting implications for the above:

"The companies I have traditionally seen do best over the long term had lead investors for their seed rounds" - Keith Rabois

What do you think?
a) What other trends are feeding all the Party Rounds?
b) Is this a good or bad thing for entrepreneurs, angels and VCs?

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Party Rounds: How To Get a High Valuation For Your Seed Startup

2010-09-08T10:54:00.000-07:00

A major shift has happened in the last year - entrepreneurs have gone from led seed rounds to "Party Rounds". This shift has non-trivial implications for the venture industry which I will explain in another blog post (in which I will also explain what is causing more and more party rounds to occur).

This blog is focused on:

(a) The difference between a Led Round and a Party Round

(b) How you raise a Party Round

Led Rounds (Old Model) vs Party Rounds (New Model)

Led round. (The old model)

Who sets the terms: A single investor sets the terms of the round in negotiation with the entrepreneur. Usually the investor is one of the larger $ amounts in the round or a professional investor. Other investors then co-invest on these terms, often after being pulled in by the lead investor or the entrepreneur (the "syndicate").
Board seats. The lead investor may or may not take a board seat depending on what they and the entrepreneur decide.
Representing the investors. The lead often represents the overall set of investors in the round. So if e.g. the entrepreneur wants to sell the business, she may often discuss it with the lead investor rather then having to tie in to all investors.

Party Round. (The emerging model)

Who sets the terms: The entrepreneur sets the terms, often by bringing on smaller investors with no leverage first to get early commitments for the round.
Board seats. Board seats are usually not given out.
Representing the investors. There is typically no one investor who represents the overall investor pool. Or, a "Brand name" investor will tell the entrepreneur what investors in general may want.
Valuation: Party round valuations are often 50-100% higher then led rounds. This is due to the fact that no single investor invests enough to have the leverage to negotiate down the terms. Similarly, the way a Party Round comes together often precludes the ability to any one investor to negotiate or set the terms (see below).

The net impact of this is that an entrepreneur who before would have raised at a $1.5-4 million valuation is now raising at a $3-6 million pre-money valuation.

How to Raise a Party Round and Get a Better Valuation

In the not-so-distant past, there were a handful of major angels or funds who would lead rounds. An entrepreneur would have to negotiate terms such as valuation with this small set of potential leads. Once a lead fell into place, other investors would follow on into the deal. The small number of potential leads meant that:

There was higher likelihood of collusion amongst investors in setting price - people were more likely to know who the entrepreneur was also talking to
Entrepreneurs had fewer options from which to raise capital - which meant they had less leverage over market cap or other deal terms

Today, it is increasingly typical that the entrepreneur raises a round without a lead investor. Furthermore, the entrepreneur can get much better terms (e.g. a much higher valuation) in a Party Round as follows:

The entrepreneur finds 3-5 smaller angels willing to put in money on terms set by the entrepreneur.

These angels are typically ones who traditionally have not had much deal flow, or do not invest professionally, or alternatively, are investing more for status/to give back than for financial return. This means they are less valuation sensitive in many cases.
These investors do not have the leverage (or in some cases the interest) to negotiate a better deal.
These angels may still be value added money, or e.g. previous entrepreneurs known by more prominent angels (so they may still provide social proof beyond just the money committed).

The entrepreneur uses the money committed by smaller angels to set terms with larger angels.

By raising from these 3-6 lesser known angels, the entrepreneur raising the round now has say $200K out of $500K in capital committed for the round. The entrepreneur can now go to professional investors / super angels (who normally would have had more leverage) and say "I have set terms and have a big chunk of capital committed. If you want to invest, you need to do so on these terms".
Many institutional angels have a model in which they make 30+ investments a year. Part of their premise is by investing in a large portfolio of company, they will hit the 1 company that will return the fund many times over (e.g. the next Facebook or Google). The super angels do not want to miss out on a hot opportunity, so may be less likely to negotiate at this point.

Wrap up the round.

Once one or two prominent angels agree to the terms, many of the others (both large and small) will follow. The round is now closed and in many cases overcommitted, causing the entrepreneur who planned say $500K to raise $1 million for their seed.

I will discuss why Party Round have emerged, as well as the pluses and minuses of these rounds in another post.

Thoughts? Do you think Party Rounds are good or bad for the entrepreneur? For the investors? For the tech community?

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20 Questions To Ask Yourself Before Raising Money

2010-08-20T11:00:00.000-07:00

As I mentioned in a previous post, some startups may raise money for stupid reasons. Below are a set of questions I think any entrepreneur should ask herself/himself before raising a round.

Why Are You Raising A Round? What Implications Will Raising A Round Have To You, The Entrepreneur?

1. Why are you raising money? It is for vanity purposes or does your business really need it?

2. What would you use the money for? Is the nature of the business ultimately cash intensive? (Be creative - are there marketing, inventory, or other costs you are not taking into account?) Calculate what money is actually needed (do a simple spreadsheet of costs and revenue projected out and see how long it takes to burn the money with various scenarios).

3. What are your goals as founders? How will raising money impact these goals?

4. How do you maintain control of the company?

5. How much of the company will you end up with after N round of financing? Calculate this in a spreadsheet. Then run through scenarios - how much will your stake in the company be worth at the end of the day? (VCs often say "if we grow the pie, we all win", but if you do the math of dilution vs market cap, that isn't always true for the entrepreneur).

6. How will raising this money impact future options for the company? (e.g. will a "Strategic" investment from Burger King decrease your ability to work with McDonalds? Will the big venture round block your ability to sell for $50 million if that is your goal?)

How Much Money Do You Actually Need? What Next Milestone Will The Funding Get You To?

7. What are the implications 6-12 months out of raising e.g. for a seed round $250K vs $500K vs $1 million? (worth thinking through this very tactical point)

8. What milestone will the funding get you to? Will this milestone lead to either (a) breakeven or (b) another round of financing where the value of your company is at least 2-3X higher then the previous round? If the answer is "no", then you need to raise more money, cut costs, or do something different.

9. How do you avoid being over/undercapitalized based on the above (this is more important for larger rounds - e.g. big series A, B, C etc.)

10, How are other companies in the industry capitalized and what implications if any does this have for you? (sometimes this is misleading - e.g. look at all the facebook app companies that raised $ that are now languishing. The flip of it is if your business is dependent on buying e.g. a lot of traffic, and your competitor raises a warchest to media buy, they could soak up your marketing channels)

11. Did you add 50% padding to the number you came up with to ensure you don't run out of money?

12. What is the macro-economic climate? Is the economy growing/shrinking and what will it be doing in 6 months? A view into this can strongly impact whether your company can raise money on better or worse terms in the future (or raise money at all, if the venture markets freeze as they do at the beginning of every recession).

Who Should You Raise Money From?
13. Are you a cash or equity business?

14. Are you goals impacted by venture economics?

15. What are future financing approaches you would be willing to consider? When will this capital be needed?

16. What sorts of value do you expect the angels or investors to bring besides just cash? Can you get this value otherwise (E.g. advisors)?

17. Are there alternative sources of funding you have not considered? (Venture Debt, employees helping to cover costs, having customers pay you for development, etc. - blog post coming on this shortly).

What Do Potential Investors Want?
18. What do your investors or potential investors want? What are their motivations and why are they getting involved?

19. What would you be willing to give up in order to raise the money? Equally important - what is your walk-away point (BATNA) at which you would not raise money from these investors?

20. What is their reputation and how have they helped companies in the past? How have they acted when other companies they invested in hit rough times, or got bought?

Any other questions I should add to the list? Let me know in the comments section.

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Angels vs Superangels - What is the difference?

2010-08-16T14:12:00.000-07:00

There has been a lot of noise in the press lately about "Superangels" and how they are a potential disruptor to the early stage venture funds (see also TechCrunch article). This blog focuses on angels vs superangels and how the two work together.

Definition Of A Super Angel - Someone With An Institutional Fund

Small institutional funds. Super angels are in part characterized by the fact that most of them are effectively small venture funds who have raised money from limited partners. By "small" I mean fund sizes typically in the ~$5 million to ~$70 million range (these numbers are inexact, and depend on the number of partners in the fund). This contrasts to "angels", who are investing their own money. This means angels and superangels may have different underlying motivations in some cases.
Partnership structure. Many super angel funds started off as 1 person investing their own money (e.g. Maples, Aydin, Jeff Clavier) and morphed into a broader partnership as money was raised for an institutional fund.
Motivations for investing. Ultimately, super angels will be judged by their LPs on financial return. Given their smaller fund sizes, super angels are less beholden to VC economics so they have more alignment with entrepreneurs than traditional VCs. Many super angels also invest to give back / help out the next generation of entrepreneurs or for other reasons (see angels, below). However, it should be noted that super angels are not charitable organizations who exist to serve entrepreneurs - they do have LPs counting on them to generate a great ROI, and this is ultimately what they will be judged on.
Investment size. Super angels will each invest anywhere from $50K to a million or so in funding in a given round. There is a bit of a split between those typically investing $100K-$250K per round, and those that typically invest $500K-$1 million.
Board seats. Many of them *may* take a board seat (and *may* step down with a "full" venture round where the VCs take over the investor seat).
Value add. They often are very good at providing introductions, strategic advice, etc. See my blog post on the 7 types of angel investors for more on types of angel value-add. Many super angels are as entrepreneur friendly as they claim, but I have seen at least one act in a negative manner towards entrepreneurs repeatedly.
Upstream of VCs or co-invest in Series A/seed. Super angels may often act upstream of, our co-invest with, VCs, although they may sometimes compete with traditional VCs for a seed round. I have seen many many instances of super angels co-investing with VCs in series A. Taking a round from superangels will typically help your odds of getting a top tier VC into your series A, rather then hurt it (as recent press articles incorrectly suggest).
Lead rounds. The super angels often will help pull together a broader syndicate for the entrepreneur if useful.
List of super angel funds. This list is not comprehensive and is in no particular order. If I forgot someone - please let me know and I will add them. Floodgate (Mike Maples and Ann Miura-Ko), Harrison Metal (Michael Dearing & Erik Rannala ), HitForge (Naval Ravikant), SoftTech (Jeff Clavier), Lowercase Capital (Chris Sacca), Manu Kumar, Felicis Ventures (Aydin Senkut), SVAngel (Ron Conway and team), First Round Capital, 500 Startups (Dave McClure), Founder's Collective (Chris Dixon et al), betaworks.

Definition Of An "Angel" - Someone Investing Money On Their Own Behalf

Invest their own money. Your plain old vanilla angel is someone typically investing their own money.
Motivations for investing. Angels can vary quite a bit in the reasons they want to invest in a company. Their primary motivation for investing may be financially driven, ego driven (i.e. instead of collecting sports cars or pokemon cards, they collect startups), or to give back to the community / help out the next wave of entrepreneurs (these angels are often the best ones).
Investment size. Angels will usually invest anywhere from $10K to a few million dollars depending on their personal wealth and agenda. A typical amount to expect from an angel is $10K-$100K with $25K-50K being seen as pretty standard.
Board seats. Traditional angels will rarely take a board seat unless they are either deploying a large amount of capital (with "large" as defined as large relative to the overall round or "large" as defined relative to the angel's personal net worth.). Anecdotally, it seems that people who have worked as VCs before, or who spend most of their time these days on their investments rather then having an operating role, seem more likely to take board seats with their angel investments. Some angels may be brought in as a board member to fill the "independent" board member spot when a venture round happens.
Value add. There is a very wide variance in angel value add. While superangels are investing professionally for a living, angels are doing it for other reasons. Some angels are amazingly helpful (think Reid Hoffman or Marc Andressen before they became full fledged VCs). Others are spectacularly unqualified to invest and may be doing so because they have excess cash (trust funds, early employee at major company, your local family dentist) or excess time (ditto). Screen both your angels and super angels carefully! :)
May invest in all rounds/financing types. Since angels are investing their own money, they often have more leeway in what sorts of companies they can invest in and at what rounds (series A, B, C, etc.).
Lead rounds. A handful of especially wealthy or plugged in angels will lead rounds and in some cases have a fund in which they are the only LP. It is unclear if they should be classified as super angels or not, but they include e.g. Mitch Kapor, Ram Shriram, Russ Siegelman, Marc Benioff, Youniversity Ventures (Keith Rabois, Jawed Karim, and Kevin Hartz) and others.
List of angels. See Angel List for a good cross section of angels.

How Angels and Super Angels Work Together
Within Silicon Valley, angels will often refer deals to super angels, and super angels will often pull in angels to fill in rounds. Typically the angel/super angel networks are tight knit with the two types of investors working together. Outside of Silicon Valley, you are more likely to run into angel investors who are not very savvy about starting a business but have access to capital. These investors (finance guys, trust fund babies, etc.) can often be quite destructive to startups as investors and will be the topic of a future post.

Whether you are dealing with an angel or superangel, you should still chose the types of angels in your round carefully, as well as decide whether to let a venture fund invest.

Any angels or super angels I should have pointed out? Let me know in the comments section below.

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Is Your Startup A Cash or Equity Business?

2010-08-09T16:05:00.000-07:00

There are, broadly speaking, 2 types of ways to build value in a business.
(a) An "equity" based business in which the stock value will grow significantly with time
(b) A "cash" based business, in which the company will generate a lot of cash on an annual basis, but the value of the stock will remain a low multiple of earnings.

Figuring out what sort of business you want to start, (or, in hindsight, have started) impacts everything from whether you should raise money to how to compensate your employees. A fundamental misunderstanding of what sort of business you have can lead to mistakes that derail the success and potential of the company.

Equity Businesses

Raise money: Raise from angels, VCs, hedge funds, you name it. Usually you need to invest a large amount of cash (usually from external investors and operations) over the lifetime of growing the business before you really create value and make money at scale. Hopefully your company will do well and your returns are sufficient to meet venture economics.
Employee compensation: Biased towards options and low cash. You don't want to pay employees a lot as you will have to keep raising money. Raising money will dilute the equity, which is where the long term value is.
Time horizon: The average M&A exit is 6.5 years and most companies take many years to go public. Value is usually created reasonably later in the companies life.
Example companies: Google, Facebook, Twitter
Other key characteristics: These companies typically have a period where they are not throwing off a lot of cash up front, but rather are reinvesting in growing and scaling the business. Equity based businesses may lose money for the first few years before emerging as a cash machine as their unique position in the industry takes hold (think Facebook). Similarly, these businesses often have strong network effects, strong barriers to entry, customer lock in, or other characteristics that make the equity value of the business high.

Cash Businesses

Raise money: Focus on angels / individuals or self fund/bootstrap. The returns you are likely to expect won't justify venture returns but you will be able to pay out cash as a dividend.
Employee compensation: Pay out more of your profits in cash as equity is only a minor consideration - as the equity value of these companies is low (i.e. you can't sell the company for much to other buyers).
Time horizon: Often these sorts of business start generating cash quickly (on the order of a few months to a year - think Hot or Not).
Example companies: Most of the smaller social gaming companies. Most GroupOn clones.
Other key characteristics: Often these businesses have lower barriers to entry, fewer network effects, or are focused on small or niche markets with few buyers for the business.

Note, as companies mature they may transition from equity to cash businesses or vice versa. E.g. Microsoft is no longer a great bet in terms of stock upside, but they do pay a healthy dividend and generate a good ROE. Similarly, GroupOn is both a cash business (think of all the small GroupOn clones which are instantly profitable) which builds equity value over time via branding, distribution, and scale.

3 (Sometimes) Stupid Reasons to Raise Venture Funding

2010-07-29T13:57:00.000-07:00

I have had 3 entrepreneurs speak with me about their fund raising strategy in the last 3 weeks, and I realize that the once great art of bootstrapping a startup (i.e. building a business on cash flow rather then venture money) has been lost.

All 3 of these entrepreneurs had the opportunity to grow their companies off of cash flow alone. And while in many cases it makes sense to raise money to accelerate growth (e.g. you have product market fit and want to ramp like crazy to beat your competitors, build network effects, hire a crapload of sales people, etc.), these entrepreneurs’ reasons seemed way off to me:

Some reasons the entrepreneurs said they wanted to raise money:

“Everyone is doing it”. I spoke with one YC team that really wanted to raise money from a VC. When I pushed on the reasoning, it was purely for bragging rights with their YC classmates. I found this verging on ridiculous. You want to give up a big chunk of your company so you could tell your friends about how you raised money?
“To get expertise”. VCs can often provide great advice, discipline, and rigor to a startup. However, there may be alternative approaches to tapping in to that expertise. E.g. rather then sell 25% of your company in a seed round, why not find a few very qualified advisors or a board member? Even if you give them 1-2% each you end up giving away much less of your company.
“I want to burn the boats”. The thinking here is that a venture round would force the entrepreneur to shoot for the home run. While entrepreneurs should always think big, sometimes the venture round locks you into a big exit that you may never reach. E.g. a friend of mine started a company that was generating about $1 million a month in revenue. They ended up raising a round instead of bootstrapping the startup (after they were cash flow positive). This led them to (a) grow big and hire lots and lots of people = higher burn (b) has prevented them from selling the company when they could have gotten the best exit (c) and my friend is now sitting in monthly board meetings charting and recharting company strategies with no exit in site (the business topped out at $20 million a year in revenue). If he had not raised money he and his co founders could probably have pulled $10-$20 million each out of the company in cash by now and moved on to the next thing. I don't think his current business has an obvious path to get bigger, and he is locked in.

There are many legitimate reasons to raise venture or angel money. However, if you have a cash based business (rather then an equity business) in which you are throwing off more cash then needed for growth, you might want to think twice about what a venture round brings you and whether it is worth just bootstrapping your company.

By the way, some companies that largely grew off of their own cash flow:

Microsoft (grew largely off of cash, then raised a round with TVI late in their life)
Bloomberg (raised some money from an investment bank well after it was profitable)
Coupons, Inc (doing supposedly close to $1 billion in topline revenue)
GroupOn (raised from NEA to do something different, the pivoted and raised money largely for founder liquidity and advice)

Know of any other startups that bootstrapped their way to success? List them in the comments please :)

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Bootstrapping: Raise Debt From Your Employees

2010-07-22T11:08:00.000-07:00

When we started Mixer Labs (acquired by Twitter in December) we were not paying ourselves and did not have any cash to pay others. There were a number of people who worked for us part time while we were still figuring out what product to build. We structured things with them creatively, and this ended up being a win on both sides.

Raise Debt From Your Employees, Not Investors

Raising money from investors can lead to a lot of value in terms of advice, ability to grow the startup etc. but it is a good idea not to raise money too early. We wanted to build a prototype of what we had before going to market, with the thinking that this would increase our valuation. One way to be able to hire someone but not raise money is to effectively raise debt from the people who want to work for you.

The Option Vs Cash Approach

One of the things that was successful for us in the early days of Mixer Labs was to effectively raise debt from people working for us part time. We structured the agreements as follows:

The people working for us as consultants would accrue $x per hour worked
Upon successful fund raising, we would pay the consultants either:

Cash if they did not join the startup (i.e. whatever we owed them)
Cash if they joined the startup and wanted to get paid in cash
Options if they joined the startup and wanted to participate more in the upside of the company

This gave the consultants a potential stake in the company without creating an instant shareholder -which paying directly in equity would do (we only wanted people committed to the long term success of the company to own equity and there are a number of other reasons to want to limit the # of shareholders you have). It gave the consultant an additional reason to convert to a full time employee with funding. And it made sure that whoever worked for us got to get paid in cash when we could afford to pay them (if that was their choice).

The True “Cash Only” Approach

Another option you can follow is the split payment method. E.g. say a consultant wanted $80 an hour (using a nice round number for ease).

Pay the consultant $20 an hour now out of your own pocket. The consultant will feel sure they will make something out of working with you.
Pay the consultant $80 an hour for accrued hours when you raise money.

This is more expensive then just paying $80/hour now, but if you don’t have the cash available you pay a little more in the long run but end up with much less personal outlay up front.

Any other creative ways you have seen to get employees or contractors on board? Feel free to write it up in the comments – would love to hear other approaches….

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Older posts that may be of interest:
What sort of people should you hire for the first 5 employees
How to get your first 3 employees

Should You Let a VC Invest in Your Seed Round?

2010-07-21T09:14:00.000-07:00

During the prolonged frenzy of raising a seed round, many entrepreneurs wonder whether it is worth including one or more VCs in the seed as a part of the round (e.g. buying 10% of the company, as opposed to, say, the VC buying 25% of the company during the seed). This has a lot more tradeoffs than one would initially think and is in part driven by VC economics, which I wrote about earlier.

I usually advise entrepreneurs against including a venture fund as a small part of their seed. That said, there have been a number of successful companies seeded by a venture fund (e.g AdMob) and my own company, Mixer Labs, benefited from having a venture fund (Sequoia, who was very helpful) as part of the seed.

It is very situation dependent and as an entrepreneur you should weight the plusses and minuses of having a VC in your seed round when making the decision.

Benefits of raising part of your seed from VCs:

You have a deep pocketed investor who can, if things are going well, invest more money in the startup (although if things go well, you will be able to raise money anyhow).
Raise it fast! VCs can deploy what they consider “small” amounts of capital quickly – e.g. $250K-$500K won’t impact a $400 million fund.

o Sometimes a decision to invest this little is left to a single partner or two partners versus having the whole partnership weigh in.

o This has a downside too – VCs will happily write off this amount and may not support a startup in which they deployed so little capital

Branding. The VC brand may help you attract talent or get potential hires interested.
Advice & structure. Some entrepreneurs could use the structure and advice provided by the VC joining the board (assuming enough of the company is bought to justify partner time). A top tier angel can often fill this need as well.

Drawbacks to including VCs in your seed:

Signaling. This is the big one. When you go out to raise a series A, investors will wonder why you don’t raise the money from the venture fund that already invested in your seed.

o If the VC in the seed does not invest in your series A, other investors will view this as a big red flag – i.e. why would the VC who knows your business best not invest? This will lead to a lot of investors to pass on your company without really getting to understand the situation.

o If the existing VC wants to invest and you go to other investors to get a competitive bid, the new investors will think you are using them to merely drive up the valuation you will get from the existing investor, whom they often assume you will chose for the series A (since you already know the VC that invested in the seed). This means your valuation for the round may end up lower then it could have been.

o There are ways to navigate the issues above, but it adds friction to an already time sucking process of raising money.

If you don’t raise money from a venture fund, you can get other venture funds to more actively work for you.

o Investors always want to prove their value in case you raise a series A, so will spend time making introductions, meeting periodically to discuss strategy etc. So not having a venture fund in your round will means lots of other funds may still help you out.

Venture investors are more likely to stop supporting an early stage company if things don’t go well and the seed money is running out.

o This is not out of malice, but rather a calculated business decision on the option value of the partners time. Why have the partner spend a lot of time on a “bad” investment when there is always a new entrepreneur walking through the door. Angels may have a larger vested interest in the company or be helping out for reasons other then just financial return.

What do you thinks? Know of good examples of partial seeds by VCs leading to especially good/bad outcomes?

You can follow me on Twitter here.

VC Economics – Why Your $50 Million Exit Means Nothing

2010-07-20T09:04:00.000-07:00

A friend of mine is working on one of the coolest startups I have heard about in a while. We discussed whether he should have VCs invest in his seed round. He is thinking he may want to have the option to exit early and was curious why a VC wouldn’t want to put in $1 million for 20% of the company and get out $10 million (at a $50 million exit) – a 10X return.

The Economics of Big Funds

The reason is the economics of large funds. Suppose you are a venture fund with $500 million under management. If you are a top tier fund, you want an internal rate of return (IRR) of say 20-25% a year to your investors over the 5-10 year horizon of the fund (say 3-5 years of active investing, followed by another 3-5 years pro-rata/follow on investments in the company).

This means over the life-time of the fund, the fund will need to return $1.5 billion from investments. I.e. the VC needs to make back the original $500 million that was invested, and then make an additional $1 billion on top of that.

This calculation does not include additional details, e.g. if you charge 2% in management fees per year for 5 years, that is another 10% of the fund you need to make up ($50 million).

So, the $10 million you returned to the VC as part of your startup’s $50 million exit is 1% of the total money they need to return the fund. Clearly not worth the opportunity cost of the partner’s time who is looking to make $100s of millions per successful investment.

This is why some VCs have a “go big or go home” mentality. The $50 million base hits won’t move the needle for a big fund. This is why some VCs will push for the additional dilution of ongoing fundraising over a quick exit – a company that exists for $1 billion post dilution will still return more money to the fund than a small exit. Unfortunately many companies go under during this process.

You can follow me on Twitter here.

Fat Startup: Raise $100 Million For Your Next Internet Company

2010-06-03T17:20:00.000-07:00

(Side note - some of the thoughts below are based on conversations with Josh Hannah of Matrix Partners, one of the smarter investors out there).

One of the things I hear quite commonly is that the "old days of the Internet" were totally different from today. The claim is that multiple distribution channels were wide open (email, SEO, SEM), so it was trivial to build a business without spending any money on customer acquisition.

Although there are many companies that grew without spending a dime acquiring customers (Google, FB, Twitter), when I think back to the original Internet bubble, there were lots of companies that seemed to thrive due to their raising tens of millions of dollars to build brand and acquire users in what was a very noisy environment.

Indeed, there are a number of companies that were able to scale *because* they spent tens of millions of dollars buying users.

Examples include:

PayPal (who paid $10 per user to join the PayPal network)
Monster.com (remember the superbowl ads?)
Amazon.com (went public in 1997 and wasn't profitable until 2001, with costs here were spent on, amongst others things e.g. logistics and market share)

I think there is a fundamental class of business that could be very successful emulating the bubble days approach to building a userbase. In particular, there are a number of entrenched businesses with strong network effects (e.g. eBay) or brands (e.g. Amazon) or logistical advantages (Amazon). The lean startup approach may never overturn these apple carts. The way to challenge these incumbents is to spend a lot of money to build brands or acquire users in order to overcome these effects.

Where To Spend $100 Million?

Buy enough of a network to flip it.

What are business with network effects/liquidity needs? Examples of these are eBay & PayPal. Try and calculate the costs - how many users do you need in a network for the network to "flip" to your product? If you buy 1 million or 10 million users at $10 each can you create enough of an effect to drive the rest of the network to you?
Totally crazy example idea - chose a vertical on eBay and buy all the goods on that state/vertical pair and then resell them at a slightly lower price point on your vertical marketplace and lose $n per item. How long do you need to do this bulk buying before people start coming to you instead of eBay for this vertical?
Crazy example idea 2. Or, take advantage of media buying/intent buying and outbid everyone in a specific vertical or product category and saturate the vertical with your ads. You may lose money on every transaction, but in parallel may build enough of a brand and liquidity to sustain yourself long term.

Branding.

When Google powered Yahoo! search, Yahoo! lost market share to Google. But the results from an end user perspective were basically identical. Calculate the SEM or other media buying/lead/intent buying budget you would need to drive in N users, and then compare that to the brand building exercise and the number of recurring users you would drive in via additional channels with a big budget. What is the more economical long term strategy?

I think the whole lean startup movement has some good aspects to it, and when I was working on my startup Mixer Labs (which Twitter acquired in December) we ran very lean and mean. But I do think too many people "think lean" which often ends up also meaning "think small" these days.

So, I ask you this - who is going to raise $100 million to build the next massive Internet business?

You can follow me on Twitter here.

Startups: When & How to Fire an Employee at a Small Startup

2010-06-03T06:04:00.001-07:00

You have spent the last few months hiring a great team and finding people who are a good fit for a startup, but unfortunately even the best hiring strategy may yield members of the team that you will need to let go. In a small startup (e.g. less then 10 people), it is crucial to act quickly to get rid of team members who are not performing or are a bad fit.

If you have a 3 person engineering team, having 1 bad person saps much more then just 1/3 of overall team productivity - they take up your time to manage them more actively, they make other people less productive, and/or you dont give them the hard/crucial jobs out of fear they won't get it done or will argue endlessly about it while making excuses.

Reasons to Fire an Employee at a Startup: (not mutually exclusive)

They are not getting done what they need to get done

The employee fails to get their work done in a timely or complete manner
The code quality is low or shoddy
It is not fair to the rest of the team to carry someone who is not contributing equally
It is not fair to the employee to work somewhere they are not productive - productivity is sometimes a function of environment, and some people are just not productive in some environments. You should help them find a better home.

They are a bad culture fit, whether they are getting things done or not

The employee creates a working environment such that you and other team members don't enjoy working with them
Thy argue incessantly rather then get stuff done (in a startup, if it takes more time to argue about a feature then to implement it, you should just implement it and try it). They may be religious on technological choices, or just someone very gruff who is hard to work with. This will sap overall team productivity while you burn through your limited cash
You and the other team members are walking on eggshells around them, and you worry about asking them to do stuff because it will inevitably result in an issue

They are dishonest or unethical. I will not spend more time on this one, but these people should not be given second chances and should be terminated quickly.

Some Signs You May Need To Fire Someone

You have spoken with them repeatedly about their issues and they make short bursts of progress right after the talk and then lapse back into more or less the same behaviors
"If there is a doubt about a person, there is no doubt you should let them go"
You find yourself giving them unimportant or secondary tasks because you worry that they will not come through on (or take too long with) the important stuff
You spend more time worrying about the person and managing them then focusing on other key elements of your startup
You worry about asking them to do something, because you know they will start an argument with you about the feature, whether it is needed, etc.
You and other team members are walking on eggshells around them.
They are constantly making excuses about why *this time* things didn't pan out

The "But We Need To Get X Done First" Fallacy

There are some rare instances where you need to wait for some major milestone or release before letting someone go. If the employee is non-productive or unethical, you should let them go as soon as you realize there is a problem (that is not being corrected based on your feedback to the employee.)

Once you let a low performer go, you will frankly feel a wave of relief. You will also notice that even if the team initially reacts in surprise to the person being fired, the overall team will be much more productive. It will drive home how much this one person has been holding everyone else up, and other people will take on (and actually complete) the work that has been stalled.

If you wait too long, the team will form strong relationships or friendships to the underperforming employee, and letting the person go will be even more jarring to the people left behind. You need to act quickly and decisively.

Typically, if you are a first time manager, it will be well past the time you should have taken action that you actually decide to take action. There are always excuses and reasons not to do the hard thing (firing someone is very very non-fun).

How To Do It

If this is your first time letting someone go, talk with your lawyer as well as get advice and tips from an experienced member of your startup's network (e.g. angel, advisor, etc.) who was a professional manager before
Talk to the employee about what issues you have observed and give them concrete examples of behavior you think should be corrected.

On an ongoing basis, you should give your employees feedback on what you think is good/bad about what they are doing and be up front about issues as they occur - so if there is an ongoing performance issue this should not be a surprise

Work out a plan to correct this behavior and document it in e.g. an email.

You should give them a chance to correct an issue - set a specific timeframe for things to change and specific goals if it is a performance issue
You should document the issue to (a) ensure you both have an understanding of what is going on and (b) to protect yourself if you let someone go in case of a lawsuit around the termination (talk to your lawyer about this)

If the behavior is not changing, you will need to let the employee go

Talk with your lawyer about the documentation needed to terminate an employee
You may decide what sort of severance you want to give the employee and whether the severance is tied to e.g. the employee signing certain legal documents associated with their termination

If you let the employee go:

Be cordial, polite, but firm about the reasons for letting them go. Thank them for their contributions to the company up to that point. This is not personal and you should not make it personal.
They may ask for one more final last this-time-it-will-be-different chance to prove themselves. Don't do it. This never works out.
I think it is usually best to let someone go the same day rather then e.g. have them stay for 2 weeks to "wrap things up". Having someone who is leaving the company stick around can have a negative impact on the rest of the team. If they were not productive before, there is no reason to think they will be productive suddenly now.
Talk with the remaining team about it when the person is gone. Be up front about the reasons the person was let go but do not dwell on details or rat hole. Reassure the team about the process you went through with the employee, and explain why you think this is the right and fair outcome for everyone (including them as the people who were working much harder and getting their work done).

Letting someone go is one of the hardest things you will do. It can be an emotional experience on both sides, but ultimately it will be a key factor in building a great team and executing the startup vision you have put your heart and soul into.

Comments? Any thoughts or tips on the best ways to identify hiring mistakes and to correct them?

You can follow me on Twitter here.

Raise a seed now! Raise a series A in 12 months! :)

2010-05-06T08:55:00.000-07:00

A Uniquely Good Time To Raise Capital

The last 2 years have been pretty rough for the average entrepreneur. However, this has led to pent up demand on the capital side to fund startups. I explain below why I think now is a uniquely good time to raise money.

Events Leading Up To 2010

In 2008, the venture market froze due to the financial crisis.

Early 2009 was a bit of a "nuclear winter" with very few deals getting done and VCs sitting on their wallets.

Late 2009 led to a slate of M&A activity and some companies shutting down.

The Early 2010 VC Feeding Frenzy

This led to the following dynamics in early 2010 that will continue through mid-late 2010:

A lot of VC portfolio companies have/will shut down or be sold - freeing up a lot of VCs to take on more board seats
A number of investors are feeling pressures to do deals - they haven't invested for 1-2 years and now feel pressure from their partners and LPs to move more capital and take on board seats
A lot more startups are being founded (since the markets are beter, more people are taking risks) and funded (due to the dynamics above + companies who waited through 2008/9 now raising cash)
A number of investors will develop "investor burn out" - they will have done 1 or 2 or 4 deals and will need to take time to digest the investments they have made and to start helping the companies

What This Could Lead To - And Why You Should Raise Money in the Next 6 Months

I have been hearing more and more early stage investors say "I have done a ton of deals lately - I am looking for all this to slow down." or "I have not seen deal flow like this in a long time - it is fun but exhausting".

I think in general early stage funding will slow down in 3-6 months due to pent up demand (i.e. capital) having been met via VCs and angels taking board seats and investing in more companies in early 2010 then they expected to.

Reasons for this predicted slow down in funding pace in 6 months:

VCs will have made investments and no longer feel the pressure to "do something"
VCs/angels will have done more investments in early-mid 2010 then they planned for and will want to "pace themselves" in terms of deploying capital
VCs/angels will spend time helping new portfolio companies rather then seeking new investments as actively

All these things will likely cause the funding environment to slow down a bit relative to where it is today. So if you can raise money now, all else being equal it seems like a good option.

The Coming Post-IPO Bump in 2011

In 2011, a number of companies are likely to go public including Facebook, LinkedIn, Zynga, and (who knows?) Palantir or Workday.

With this liquidity a few things may happen.

VCs/angels will feel like there is a better exit environment so will invest more
There will be a number of companies with liquid stock who will have the currency to buy more startups more rapidly

This will lead to second funding bump in 2011, making 2011 a great time to raise the next round (assuming no macro collapses etc.)

Either way - it is amazing to see how things have loosened up compared to a year ago.

Thoughts? When do you think is the best time to raise a round?

You can follow me on Twitter here.

The 7 types of angel investors - what is right for your startup?

2010-03-27T08:16:00.000-07:00

I have been advising a number of companies with their funding rounds and a frequent question that has come up is what sort of people should they bring into their round.

The answer of course is not cookie cutter. It depends on what sort of help you think you will need most as a startup (e.g. BD intros? Hiring help? Product feedback? Help raising the next round?).

In general, I think most investors fall into the following classes (and many angels are in multiple of these categories - as are most of the people mentioned below). A good financing round, especially if it includes multiple angels/investors would optimally have people representing more then just the below:

Connectors. These people know a lot of people and typically used to work in sales or BD before becoming an angel. They can help a lot with intros or some advice on structuring a deal that will make or break a company. They are in the flow of information and deals and can provide you with competitive insights and early information on customers that is crucial to your success. Most top tier venture funds provide this function. Ron Conway and team are legendary for their span of network and the fact that they know everyone.

Product People. These people are very smart on product and can give you specific advice on UI, viral loops, etc. Note: a lot of people claim they are good at product (i.e. everyone has an opinion) but I think the set of people who are very good at this is quite small. Roelof Botha and David King are two examples of people who have excellent product feedback.

Tacticians & Builders. These are usually recent or current entrepreneurs or operators. They don't give you the banal high level advice about e.g. hiring ("always hire the best") that all your other angels will give you - they will actually make 10 intros to strong candidates and then give you the magic tip on how to close the top candidate. Most angels and investors are great at the high level strategy, but don't add much value here. This skill set is actually rarer then one would think and an important one.

Smart Business People. How do you think about what you are doing as a business? How will you make money? What pricing schemes should you try? When should you turn on monetization at all? How do you build a brand for your company and what sort of marketing should you do?

Domain Expert. This investor has worked in an operating/general management or product role in the industry you are looking at. They can give you industry specific tips, insights, customer intros and advice that would have taken you months to discover. They often decrease in value over time as you learn the industry and detail, but early on they can help enormously.

The Brand. These angels don't add much value besides having a brand name. Best case it helps boost your funding announcement. Worst case they will have terrible advice delivered with enormous confidence. Make sure to vet people before adding them to your round.

The Filler (AKA Dumb Money). You are trying to raise a $1 million convertible note and have $700K committed. You are exhausted with fund raising and want to just go back to building product, which is what you love to do. So you bring in folks who can write big checks that you don't expect to add much value. Obviously it is much better to bring in someone who can help out, but pragmatically it is good to have available capital to fill out the round if needed, as long as it is not from people who will actively decrease value. (by taking up your time with needless asks to meet up, refuse to sign documents needed to e.g. raise the next round etc. etc.)

DO YOUR DILIGENCE!

This title is in all caps on purpose. If your co-founder is equivalent to your husband/wife, this makes your board member your mother-in-law, and your other investors close relatives (cousins, uncles, etc.).

Just as the investor will do diligence on you, you will need to make sure other people the investor has invested in *love* that angel or VC. For the lead investor ask to talk to their references. For other investors do the same where possible. This is obviously time consuming, but whoever you bring on board will be helpful, or detract from the company, for potentially the lifetime of the company.

I will write another blog post later on doing diligence on investors...

Any types of investors I missed?

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