false precision

Don’t let your Venture Financing go off the rails

I'm currently raising venture capital for Lijit and being immersed in it reminds me of a blog post I have been meaning to write for some time. Over the years being around companies trying to obtain venture financing, being on the evaluation side of deals for venture guys, and being involved in raising money myself, I have made some mental notes of when deals "went off the rails" for entrepreneurs. Like my Angel Financing post from a month ago, I'm trying to take a demonstrative path as there is plenty on information out there about "how to build a business plan" that isn't really that useful I have found.

The following are just a couple of the general derailments I have witnessed over and over. It's important to note these items are not a guarantee that things are going south, but are often indicators. When you hear yourself saying them make sure you understand what the guy on the other side of the table "may" be hearing. The thing that makes some of these examples particularly insidious is that the entrepreneur didn't even see the ditch coming, and may today still not know what went wrong.

What you said #1: We are seeking an investment of about $1.5 Million dollars and that's about all the capital we will ever need.

What may have been heard: You can't fault anyone for building something they can get profitable within the scope of $1.5M. But, there is a secret derailment within this statement. First this is often an indication that the investment or the idea isn't big enough for an institutional investor. Typical venture funds are in the $50M to $500M range and have 5 to 10 partners. Each partner can only invest in a handful of companies so that dictates they have to put between $5M and $10M into a company over its lifetime making a $1.5M investment look too small (one guy can't do 50 of these). The statement can also indicate that the opportunity is just too small, VC's want to fish in the "10x back on their money pond", if the company can be self-sustaining on that little money there is probably not much barrier to others doing it also or it can mean the entrepreneur isn't focused on the right thing (for a venture deal), making a BIG valuable thing using cash as the rocket fuel. Finally, this can just mean the entrepreneur is just a green bean and doesn't know how much money it takes to make something big, fast. Again, nothing wrong here but keep in mind you are trying to attract an investor that wants to put $5M in and get $30M to $50M out.

What you said #2: Our technology is very unique; we intend to provide solutions in healthcare, engineering and education.

What may have been heard: Very often technology based founders are very excited about the generic applicability of their invention, idea, etc. This is a normal thought process to engineering types; make something cool that can be used over and over again. However, to a VC this sounds like an excited nerd with no idea how to productize, sell, or market their idea. While your widget can do 100 things, VC's are looking for the ONE thing you are actually going to do. Personally, as a recovering nerd this one is painful for me to watch unfold live. The VC says what's your market and your strategy to get to that market, and the entrepreneur says, "it's very generic it works for everyone". They go back and forth and before you know it the train is off the tracks running down the meadow without an engineer. Good VC's - that like the idea (in spite of the entrepreneur) - will often suggest that the entrepreneur partner with a "business person" at this juncture, smart nerds will do it. Here again, nothing wrong with a unique idea that can o multiple ways, but you better lead with solid single direction or you will never get to all the others.

What you said #3: Our customers love our stuff, they embed it deeply in their products.  We help them adapt the products look, feel and functionality to exactly solve their problem!

What may have been heard: I see this one most often with scrappy entrepreneurs or consulting companies that have recently productized something and now want to sell their widget. There are two kinds of revenue to a VC, product revenue and professional services revenue. Product companies can grow revenue by selling their product into different distribution channels that scale independently of head count. Professional services associated with a product, such as customization only scales as you add people. If your business has to have lots of people to make lots of money that's a concern as the cost of sale is also very high and the profit margin is lower. Remember at the end of the day as a startup entrepreneur your product is your company and someday you will sell the company. It's very typical to sell a company on a multiple of your revenue either forward or backward looking. What happens is acquirers will apply one multiple to product revenue (say 10x) and another to service revenue (say 0 .1x). So, the same company with $50M in revenue can be worth $500M or significantly less than the amount of money you invested depending on the mix of revenue. Moral of the story, make sure your revenue mix isn't out of whack and you don't need to add another dude to make another dollar. From what I have seen, keep professional services less than 30% of revenue.

What you said #4: We provide a very attractive platform capability for our customers.  It's so good we build a host of other applications on top of it!

What may have been heard: This is another form of the focus problem and is another engineering centric thought process. Engineers think I can make this generic platform and sell that, plus I can build these cool apps on top of it that other less intelligent people "just can't see yet". The problem here is the VC hears "I have 3 businesses here, and I'm going to run them all!". Standard answer, you may have great ideas how to build vertical applications on your platform and if that's true then give some thought to *just* building the vertical application.

As with my Angel Financing post a lot of this stuff seems like common sense after you have been around for a while. It all comes back to motivations. It's important to know that Venture Capitalists have motivations and generally it's to build a high value company fast and get a high value return in 5 to 10 years. They have seen a lot of companies come and go and have the advantage over the entrepreneur that at best builds a company a handful of times in their carrier. My advice is that if starting venture backed startups is your path of choice, start making notes of what you see works and what doesn't. It's the best way to learn.

My Office 2007 committed suicide

I use Vista on all my computers. I know what you're thinking…issues. Well, your right but nothing compared to Office 2007 issues. I have basically gotten used to its daily crashes. Microsoft clearly spent a long time working on the file recovery features of Office, thankfully, as I only completely lose document occasionally.

I have a new problem as of this morning on my desktop box that may actually be a deal killer. I fired up Word to do a blog post and first I noticed everything is zoomed out to 200% as if I were a blind man or something. Hmm, well ok change that. I click the new document icon in the upper left corner and get the following dialog box.

Ok, may not seem that odd to the uninitiated but this is NOT the normal dialog box for this operation (at least on Vista)..

This is the normal dialog box on Vista (taken from my laptop as I write this)..

Hmm, I smell a Windows Update Downdate. WTF ?

Ok, if this were the only problem I could survive, but as it turns out my mouse no longer works in Word. No other applications have issues, just Word. Don't panic I say, just reboot it will be cool. Oh, wait all I actually have to do is quit word to make office crash. Again, and again, and again.. In fact it is completely hosed. Reboot, hosed..hosed..hosed..

Hmm, when do you suppose I should suspect this call..

For God sake, just raise the ticket price

I love the airlines now charging to check bags. Just what we need, MORE people trying to cram their giant bag into the overhead bin.

Please, just raise the ticket price. You're going to anyway in another week.

Techstars Reverse Mentoring with Foodzie

I just got out of a great meeting with the Foodzie founders. I invited them over for lunch for multiple purposes, all quite frankly benefiting me.

Darby my oldest daughter and her friend Emily are working for Lijit helping with some much needed testing of our service this week. As part of that I wanted to give them a feel for some of the startup thought process and the road that gets you to that point in your life. The other night I had the fortune of getting to know some of the new TechStars teams including the people behind Foodzie. Their business immediately resonated with me and I was impressed by the three founders including Emily Olson one of the female founders that are part of this year's more diverse collection.

The Foodzie's were nice enough to come by, tell us about their business and passion they have for it. We got the full download on how the passion for food slowly morphed a chemistry major and her buddies into a full blown, quit our jobs, entrepreneurs. I love stories like this and I'm grateful they took the time to share it with us.

Having been someone who looks for specialty foods from time to time on the Internet, I think this is an outstanding idea. I was impressed with the backgrounds of the founders and the mature way they look at what they are doing. Clearly, they also know how to use press to their advantage as they were mentioned in both the Rocky Mountain News and The Daily Camera.

I look forward to tracking their success over the coming months. As a benefit I got the low down on the best cookie out there and I will let you know when you can order them through Foodzie.

Photo Credit: LINDA MCCONNELL

TED is history, saw that one coming in 2005

Back in 2005 when I was first getting my feet wet blogging one of my favorite posts was my stupid experience with TED shortly after its launch. I called it Real Tragedies in Marketing, Part 1.. Well I guess the verdict is in. I love it when you see it coming, miles away :-)

Dear, Classmates.com

Your model of forcing paid subscriptions to your service to provide me ANY value is sooooo tired. (ask AOL)

I will never, ever, ever pay monthly to receive email from people..     

ever….EVER !

Indy 500 – It’s all about the drivers now

I watched most of the Indy 500 this weekend as I usually do. I admit however I kind of checked out after that LOSER rookie Ryan Briscoe jacked up Danica Patrick's car proving he can't even navigate pit lane, let alone the actual race.

It's all caught on video and Briscoe doesn't even have the class to take credit for the awesome bit of driver expertise. Briscoe is a real tool and needs to be taken out of racing. Check out this video of him trying to kill everyone.

Danica was hot off her first Indy car victory a month ago and its a shame it ended that way. I wish she would have found him on pit lane and kicked his ass, which would have been Indy entertainment at its best.

Anyway, it seemed to me that there were a lot of rookies out there piling them up this year. It got me thinking about driver <vs> technology and where Indy Car was sitting in the curve. I google'd around looking for source of data for lap speed by year for the Indy 500.

I didn't find it, but Wikipedia had a nice listing of Pole Sitter lap speeds for almost the last 100 years. I pulled the data down and plotted the results to verify what I suspected. Basically for the last 10 years lap speeds have not really increased.

I assumed that this curve meant that technology had simply run out of juice and the cars cannot be made faster. After some more googleing around the truth was more interesting. For years the IRL has been de-rating the cars to keep the sport safer.

Interestingly I think this is making the sport more fun to watch. Now it's more about the quality of the driver and less about the vehicle.

Still seems to me if you can't even drive the car in the pit lane you shouldn't be on the track..

Accidental Art

Scout 2008

Peak Oil / Hubert’s Peak Theory

Living around Boulder you can't throw a stone without hitting someone that will engage you in a lively conversation about Global Warming. I count myself as a believer in all the data but fall a little short of being able to connect all the dots to global disaster. I believe the earth is a very complex climate that is not easily modeled. Don't get me wrong, ultimately the results may be far worst then being predicted, or maybe a good deal less. In either case I'm suspicious of the populations' ability to change anything that may or may not happen in a meaningful way even if we all wanted to, which we don't.

More interesting to me is Peak Oil Theory. There is a lot of good reading floating around on this not that new prediction that soon (if not already) the world production of oil will start to decline. Compounding the problem is the absolutely known fact that the world is using increasingly more oil, specifically in high growth economies like China. Obviously in today's gasoline climate you can start to see what happens when fuel is less and less available. I personally find this prophecy is much easier to connect the dots to an immediate global disaster then Global Warming. But, to each his own prediction of doom I suppose.

A friend of mine sent me a link to a just released asset management report.. It's very interesting reading and only a couple pages, check it out.

Angel Financing

In a few months Lijit Networks will be two years old. We started the company in a fairly common way, finding employees that wanted that "ground zero" experience, having the seed of a good idea, and finding Angel Investors that would invest and keep the idea alive long enough to germinate. It wasn't easy but we got it done. A question I get a lot from new entrepreneurs is "how do you find Angel Investors?"

Many young startup entrepreneurs tend to look at Angel Investors as a group of people with more money than sense (which sometimes is true) but generally not. They give no thought to the motivations of their Angels, what their Angels should get from the relationship, or simply why the Angel should be interested in investing. Like anything, understanding your audience is half the battle. Don't trivialize your Angels Investment by rationalizing the money isn't important to them; I find that $25K is important to everyone.

I have been on both sides of the Angel Investment table. Lijit was Angel funded for the first year of its life. We raised approximately $900K from a combination of friends, family and seed professional investors. On the flip side I have made several Angel investments in other local companies – with varying success. Based on this sample set plus other random data I have collected along the way, I have established a basic way to look at Angel Financing.

Types of Angel Investors:

The Family Investor: The Family Investor is likely not really a classic Angel Investor at all but rather a supportive family member that "knows you". Their motivation is likely out of support (sometimes guilt), but their basic investment thesis is they trust you. For me these are the worst type of investor because you likely have intimate knowledge of their financial situation and whether or not they 'should' be investing. Likely, they have no inherent feel if your idea is good or not, but may have changed your diaper at one time or another and have overcome that experience to hand you a check for $25K or $50K. Personally, I like this category of investor the least because the investment is totally emotional and personal – and that sucks in business. But based on the financial situation of the individuals involved and the relationships this can work ok if everyone comes into the situation with their eyes open, but go out of your way to make sure.

The Relationship Investor: The Relationship Investor is probably one or more co-workers from a previous gig or business friends you have known for a while. They may or may not understand what your new company is doing but they have had a track record working with you. They want to be supportive, but are looking for a return. You won't lose them as friends if things go bad, but the investment for them is likely not 'trivial'. In my experience these are good Angels to have, again as long as their eyes are open going in. These people can also be wildly supportive of you in terms of finding employees and other resources.

The Idea Investor: The Idea Investor is probably very familiar with the space your company is targeting. These are in some ways the very best types of Angels because to some degree they validate your idea. There investment is based on the Idea and there is little emotion around the table (always good). If you can get them onboard they can open doors into partner relationships and just generally good advice. You will spend most of your time convincing the Idea Investor that you and team are the right people to attack this problem (as they likely don't have a strong relationship with you or the team). Often an influential Idea Investor makes a good early board member for the company.

The Once Removed Investor: The Once Removed Investor is likely connected through a personal or professional relationship with either the Relationship Investor or the Idea Investor. They likely don't know you, and they likely don't have a clue if your idea is good or bad but they have translated the trust in the investment to the person they know. This is a great way to get additional Angel Investors onboard, but without a solid Relationship Investor or Idea Investor it just isn't going to happen.

I personally have never seen an Angel Financing come together without some mix of the first three investor types plus a few Once Removed Investors. Be warned that the Once Removed category of investors will also supply the softest money in the upcoming financing. Simply put - as you verify amounts before close, the Once Removed guys are the ones that tend to "go away" or "get smaller" as the deal progresses. A friend of mine that has successfully financed several companies gave me the rule of thumb that most investors will end up being about half of what they initially committed to. This is definitely true of Once Removed Investors; I once had a $400K guy turn into $50K guy, and $50K was like pulling teeth.

Finally, there is a concept I refer to tongue-in-cheek as the Arc Angel. An Arc Angel is a Relationship Investor or Idea Investor that has a track record of success making other Angels (and perhaps non Angels) money. These people are valuable as they can be very influential attracting quality Once Removed Investors. If you can find this person and get them excited about your deal, do it.

The bottom line on Angels, spend your time looking for solid Relationship Investors or Idea Investors, they are the ones that will get you over the hump. Bring a few Family Investors along for the ride if they won't get sick on the Rollercoaster and hope that you can mix in a good set of Once Removed Investors.

Size of Investment

Next, you have to consider the size of the investment. Money never goes as far as you think it will. My experience is you need to raise between $500K and a $1M to do almost anything. Using Angel Investors to achieve this goal you are likely looking at investments all over the board but usually in the $25K to $100K range. You may have a few smaller and a few larger but in my mind you have to target having no more than 10 to 15 total investors in an Angel round. It's just too hard to herd the cats when the group gets larger than this.

Pre-Money Valuation

A friend of mine with much more experience then myself told me, Angels should get a good deal. They are putting money in at a time when presumably no one else will and they are taking a huge risk. I can't tell you how many people have said, "Yeah, but its only $25K and they have lots of money". That's total bullshit; show me someone who lights $25K on fire for no reason.

Having been on both sides of these kinds of deals, I totally agree that Angel Investing is very high risk and the road ahead as an Angel is fraught with investment disaster. Lots of wonky things can happen to the Angels when VC's come into the company including investment preferences that take away the Angel Chocolaty goodness. I have also, unbelievably, had meetings with entrepreneurs where they are indignant I won't accept their pre-money valuation on their imaginary business. I always tell them the same thing, if my money is so unimportant, do it with yours. If you feel compelled to twist the valuation screws do it in the A round with the professional investors.

Investment Mechanism

There was a period of time where nearly every startup was doing convertible financings. This is where as an Angel you invest as if the investment is a debt type financing but can convert to an equity investment based on some outcome or the will of one party or the other. I tend to think these deals kind of suck. They are usually setup to attract money fast, and often in the case of the entrepreneur are empowering some kind of fantasy that the investment could be paid off based on success of the company and he won't need to give any equity away. As an investor that's the last thing I want because that just turns my investment into a very high risk bank account. The only time I saw this work well was a company that had plenty of investors around the table and incented them to invest early to get the company jump started faster. Early investors got some warrants to make it worth their while to have their money show up to the party sooner (and deal with the risk of being the first money in). Just skip this stuff, get all your Angels aligned, do one close, and make it a pure equity round. If you aren't ready to sell equity in your idea, finance it yourself.

Liquidity

With the exception of possible investors in the Family category, Angels are not in it to finance your dream indefinably. You would not think it to be the case, but I have had several conversations with people approaching me for Angel investments who simply could not articulate how I would ever get any money back. They were so focused on getting money from people they forgot 'they are an investment', and investments have terms. Almost without exception, I don't want to own your dream, I want to make money and have a little fun along the way. If you never sell the company, I never realize a gain.

Conclusion

There are probably 5 more posts I can do on this subject but my goal was simply to put together a primer on this subject. So many people approach me not understanding the dynamics of early stage financing. Brad Feld has written good stuff in this area on his blog as well as some quality stuff on AskTheVC. Use these resources to understand the numbers, but don't forget to understand the motivations.