BeyondVC

Standard investor update for startups

I remember when we hired a new CEO for one of our portfolio companies and my tip to him was to overcommunicate.  We had a few large VCs on the board and a number of high-profile angels that could also help in various ways.  His job was to keep everyone up-to-date but also to know how to get help when he needed it and from whom.  Given today's excitement over seed investing it is not uncommon for many of today's entrepreneurs to have 5-15 investors in any given round.  How you effectively communicate with your investors is an important priority that if done right will give you major value add while also not taking too much of your time.

In order to help our new CEO, I reached out to all of the other investors, and we all agreed that if we all spoke to him a few days a week about the same information that he would not have time to run his business.  In addition, this would be redundant for the CEO since most investors were asking for the same basic information.  In the spirit of streamlining information flow, we worked with the CEO to put together a weekly email to provide us with the key metrics the company tracked along with departmental updates on key high priority projects.  We weren't asking the company to create something they shouldn't already have (key metrics, departmental priorities, cash balance) but rather we just wanted the data shared on a timely basis.  Over time, we all found that when we did speak with the management team that we did not have to spend a half hour gathering information but rather we could get right to the point and actually discuss the whys or hows on certain sales numbers, metrics, or prospects.  In the end, we were all much happier and more productive since we had the same baseline of information and could focus our energy on productive and deeper conversation on the business stategy rather than gathering basic data.

Over the last 6 months I have made a number of seed investments and have shared the following company update with them. Each CEO has had their own minor tweak but this should give you a sense of what investors may be looking for and how it can help you streamline your communication and focus on how to extract value from your many investors.  If you choose to update weekly then obviously it will most likely be a shorter piece with maybe only the cash burned and current cash on hand as the financials.  If you choose to send out a report monthly then it may be more like the form I have uploaded on docstoc. 

One other important note I forgot to highlight is that since many companies I invest in are web-based and therefore many of them have real-time metrics I can track.  Michael Robertson who started Mp3.com and Gizmo5 (sold to Google Voice) had one of the best real-time dashboards for tracking his business.  I could see number of downloads, minutes used, new paying customers, etc. whenever i wanted to by logging into the system.  Other companies have created an investor wiki or use status.net (full disclosure-a BOLDstart seed investment) or other communication platforms for investors to share ideas and information.  I only imagine this will even get only better in the future.

Anyway, enjoy and I hope to hear some feedback on what is missing or what may be too much information.

Standard investor update for startups

4 Types of CEO Behavior when Dealing with Boards

As I have stressed over the years, it is imperative for board members and their management teams to have open dialogue.  If you are a CEO, I encourage you to share more rather than less information.  One of the best tools that a number of our CEOs use is a weekly email summarizing by department what their goals are and what they have accomplished during the week.  In fact, they even share that email internally so everyone in the company knows what is going on.  For board members this eliminates redundant questions and allows us to focus on the issues at hand instead of fact gathering.  And yes, everything is in there - good or bad.  I have written some prior posts on this topic such as "Communicating with Your Board" and the "VC-Entrepreneur Relationship."  Along these lines, I would also say that I have observed that CEOs tend to fall into certain patterns of behavior when dealing with their board.  To that end, I have attempted to summarize some of these patterns and the pros and or cons related to them.

1. Yes-Man: This is pretty self-explanatory.  Whenever the board tells the CEO to go into a certain direction, he/she does.  If it means the board telling the team to launch a Facebook or iPhone app just like everyone else, then they do it.  Initially for the VC this may seem great but in the long run this can be quite detrimental to the company and value of the business.  If the VC/board member is dictating everything from strategy to product features, then what is the CEO and management team doing?  At this point, you are running the company and not the entrepreneur.  What this means is that it is time to get a new CEO.

2. No-Man: The No-Man is the CEO who gets ultra defensive whenever a board member asks for information or provides thoughts on how to help create more value for the business.  He/She always says no at any board suggestion and many times does not even have a good reason for saying so.  They say no simply because they don't give a crap about their board and they want to run the show and take zero advice. Saying no is not necessarily a bad thing as many board suggestions may end up having you chase your tail but as a CEO I would encourage you to use some tact when dealing with your board.  That is where CEO behavior #4 comes into play.  In the end, if a CEO is a No-Man then ultimately the board will replace him/her in the long run because it will be impossible to work with one another due to the hyper-defensive stance taken by the CEO.

3. Yes but No: This is one of the worst behaviors.  The Board asks the CEO to research a certain path and the CEO agrees.  The Board checks in 2 weeks later and nothing has happened.  The CEO consistently tells the Board it will do something but his/her actions are the complete opposite.  In fact, this inaction is really a Big F-U to the Board and tells us the CEO has no spine to disagree with the Board and probably does the same with his management team.  This kind of behavior is simply unacceptable and ultimately results in dismissal as well.

4. Open-minded: This is the best type of behavior.  This type of CEO usually says No immediately when something doesn't make sense and gives reasons why.  When he/she agrees with a suggestion, it is duly noted as well.  Finally, when this CEO does not understand something, he/she agrees to research further and get back to the board.  No our feelings are not hurt if you say no.  In fact we will respect you.  At the same time, we may have a few nuggets of wisdom to share as well so keeping an open mind is beneficial to all.  And if you don't know whether you agree, researching further can only help get a better answer.  This behavior is definitely conducive to a strong board relationship and will keep you in the CEO seat longer.  Yes, this does not mean that you can execute but this is definitely one measure of the many that board consider in their CEO success profile.

Ok so I outlined 4 CEO behaviors when dealing with boards, only one of which is positive.  At the end of the day, the Board-Entrepreneur relationship is a give-and-take one.  Both sides have to be willing to express their thoughts (diplomatically) and have an open dialogue.  The Board does not know your business better than you and if you disagree, tell us immediately.  If you agree, tell us immediately as well.  We all don't have time to waste and dancing around a topic does not help anyone get a better result.  As an entrepreneur, guide the board as well-tell us where you need/want help.  This relationship will have friction at times but don't let it get personal.  Friction is good-that is how everyone gets to a better decision point.  I hope this helps.  Remember the management team is running the business, not the board, and the board is there to help guide you strategically and make sure you don't make the same mistakes we have seen from numerous other companies.

Google acquires portfolio company Gizmo5

Congratulations to Michael Robertson and team at Gizmo5 for all of their hard work and perseverance!  There is not a lot I can tell you about the future plans for Google Voice, but I do believe it is important to look back to see how we got here.  We made our investment in Gizmo5 (aka as sipphone and gizmo project) in early 2006.  What Michael and I shared was a vision of openness for the VOIP and IM World.  As I wrote on a blog post in January 2006, consumers want what Google and Gizmo5 will hopefully provide in the near future:

At the end of the day consumers don't care about protocols, they just want it all to work seamlessly and easily, and they do not want to be on their own island for communications.  What I want is one identity or phone number that works on any IM network, VOIP network, or even integrates with my PSTN and cell phone identity? 

Between 2006 we definitely had some ups and downs but through it all two big decisions helped us get here today.  First, we drastically cut the burn rate before the nuclear winter and decided to focus on getting to breakeven.  Being capital efficient and reliant on viral marketing certainly helped us grow our business and stay lean and mean.  Secondly, when Grand Central came out with their single phone number we decided to integrate Gizmo5 into their service.  Of course since both Grand Central (now Google Voice) and Gizmo5 were SIP compliant and based on open standards it certainly made that process quite trivial and easy. 

Fast forward 3 1/2 years to today, and all I can say is that I look forward to seeing what Google Voice will bring into the future and whether true openness can trump Skype's proprietary protocols.  It also seems like the vision of one number for PSTN, VOIP, or cell identity I wrote about long ago will become a reality.  One last thanks goes out to Maurice Werdegar and the team at Western Technology Investments (WTI) who provided Gizmo5 with venture debt and worked closely with us in the tough times to restructure our payments.  I would work with these guys any time.

Occam's Razor and the current state of venture

I have made many posts in the past about focus and doing more with less, and as I continued on this path it reminded me of Occam's Razor, the idea that the simplest explanation to any problem is the best explanation.  Of course Occam's Razor can get more complex but over the years it has been associated with the idea that "less is more."  And when I apply this philosophy to the current state of venture, I can see many applications of this theory.

From a VC fund perspective, there has been much discussion about how venture funds have become too large to deliver outsized returns.  First with the lack of an IPO market it is much harder to generate $1.5b for investors on a $500mm fund then it is to deliver $300mm on a $100mm fund.  Secondly having too large a pool forces VCs to invest much larger amounts of capital into companies pushing up valuations and also exit hurdles for success.  Finally, as I have written in the past, I have learned firsthand the problem of giving companies too much money too early.  It can lead to a growth at all costs mentality, a lack of focus which means chasing too many opportunities at once, and a lax attitude on how to generate revenue. Enter Occam's Razor as it seems that the new trend is for smaller groups of GPs to form smaller funds to be able to invest in earlier stage companies.  With the new operating model of capital efficiency, a little amount of money can go a long way and help VCs generate excellent returns at much lower valuations.  Having a smaller fund allows VCs to write smaller checks and take advantage of the current market.

From an entrepreneur's perspective, Occam's Razor can be applied to many different avenues. As we all know, a great entrepreneur must be able to effectively allocate his scarce resources of time and money to fulfill a market need.  The longer it takes to develop a product that the market wants means that it will cost more money and that it also opens the door for a competitor to step in before you.  If you look at the current Internet and SAAS market, the idea of "release early and release often" certainly fulfills the Occam vision.  Rather than spend cycles creating the perfect product with every bell and whistle, many nimble startups have focused on a more reductionist theory of releasing an often simpler product quickly with the idea of getting market feedback for the next iteration. 

Occam's Razor also applies to how an entrepreneur should operate his business.  Don't pursue too many markets at once, focus on what is delivering the most return for the dollars invested, and hire people and scale your business when you absolutely have a repeatable revenue model.  I have been burned like many others by aggressively building out a sales team too early without a repeatable sales model.  In addition, from a sales and marketing perspective, we have seen a movement to more of a frictionless sales model where there is less hands-on interaction with customers selling and delivering a product.  This would include customers being able to go online and sign up for free trials or download software versus having an expensive direct sales force sell million dollar licenses and one month of professional services to install a product.  Finally and most importantly, the idea of less is more certainly applies to raising capital. With the rise of open source software and cloud computing, companies can now get started with less dollars and scale more cheaply and efficiently than before.  As all entrepreneurs know, raising less capital means retaining more ownership.

In summary, it is becoming increasingly clear that Occam's Razor and the idea of less is more will continue to spread as the cost of technology continues to decrease, as entrepreneurs get even more efficient in building businesses, and as a non-existent IPO market and the factors above lead more VCs to create smaller more nimble funds to capitalize on the new market realities.

Cover the basics before you raise capital

No matter how many times I told my friend that he needed to get a deck together for a potential capital raise and model out some thoughts on market sizing and financials, I ran into resistance.  It was not because he didn't think it was important or that it mattered.  It was because he was understaffed and going 60 miles per hour trying to get a product released.  I can understand that pain but at the same time, if you want to raise capital from anyone, you need to have the basics covered.

Fast forward 6 weeks from that last conversation, and we ended up having a meeting with a "friendly" VC to receive some market feedback on where his company stood and what needed to get done to raise capital.  And sure enough, it didn't take long for my friend to be questioned on the revenue model, potential market size and opportunity, and how long the cash would last.  Of course, he did have some strong answers but they were not what the VC was looking for - it was not quantitative enough.  We all know that coming up with market sizing and revenue forecasts for a startup is as accurate as the weatherman predicting the weather.  That being said, VCs want to understand the logic behind the numbers as much as the numbers themselves. 

Overall the meeting went as I suspected it would - a VC who was very interested in the product but also highlighting the fact that the revenue model was not clear.  The kiss of death for me on the revenue side was when the entrepreneur said that he would monetize the company like Facebook and Twitter.  Hmmm?  We all know that Facebook and Twitter are unbelievable web phenomenons and suck up incredible user attention.  And yes I am sure that Twitter will find a way to monetize the stream of data flowing through the system and I am sure that Facebook has tremendous value.  That being said accumulating users and worrying about revenue years from now is yesterday's news.  Unless you have tremendous scale when you show up at a VC's door, then don't bank on ad revenue as your only revenue source.  We have seen the market numbers-overall online ad revenue declining but search revenue increasing.  In addition we all know that social apps on the consumer side have incredibly low CPMs and that you need massive numbers to turn into a business.  So if you want to get funded, you better have a clear answer on how you will make money and either be implementing that model today or in the short-term.  What VCs are looking for is a revenue model today that makes sense - this can include premium subscription revenue, analytic revenue, and even lead generation revenue, but don't ptich massive scale and advertising as your go-to revenue souce 24 months from funding.  You will be shown the door quite quickly.

Positioning and pitch decks for startups

A friend of mine is putting together his first deck for potential investors.  In typical startup fashion, they launched a product, got a number of users, and then iterated several times to improve the service.  With the product in the hands of tens of thousands of users, they started getting inbound requests from larger organizations who were willing to pay for customized and private group related services.  While Version 2.0 will be released to the greater world in the next 6-8 weeks, you may be interested in what I had to say about the pitch deck. 

IMHO, a great pitch deck is concise (15 slides) and highly focused.  And in the deck I like to see the following points covered (yes, this is my preferred order):

1. One/Two sentence pitch for company -value proposition (1 slide)
2. Brief history - founded when, capital raised to date and from whom, capital needed in new round (1 slide)
3. Who/Team - give me some context of who you are, your backgrounds, success/failures so I can get an idea of your ability to deliver and surround yourself with experienced talent, also include any board members or advisory board members that may be relevant (1 slide)
4. What's the problem? - too often I see pitches where the entrepreneurs dive right into the product and I scratch my head thinking why in the world we need another lifestreaming service or social network or ad network (1 - 2 slides)
5. How do you UNIQUELY solve the problem? - solving the problem just like everyone else is not exciting.  You need to show how you solve the problem UNIQUELY and ultimately deliver a 5-10x improvement for the customer in terms of ease of use/functionality and cost.  What this boils down to is your simple product pitch. (1-2 slides)
6. Product/Tech - make sure to tell me about your secret sauce or core tech that enables you to deliver a unique service - screen shots, overview, etc - could be good time to go into demo in a live meeting (1-2 slides)
7. Customer traction - is product in hands of customers?  if so, how long in market and share some data on users or beta customers or customers (1-2 slides).
8. Market size/Competitive Overview - how big is the market and how do you come up with that number - how are you positioned in the market - show graphically maybe by offering or value proposition (this is where you get your typical top right hand corner Gartner like quadrant).  A sin is to tell me you have no competition (1 - 2 slides)
9. GoToMarket Strategy - how will you grow quickly and in a capital efficient manner?  How will you sell your product - online, direct, or indirect sales?  any potential partners signed or game changing partners that will help you deliver?  (1 slide)
10. Business/Revenue model - show me that the economics of your business work - note that single digit gross margins will get you thrown out the door pretty quickly (1 slide)
11. Financials - yes I know for early stage customers it is at best a guesstimate but give me an idea of how this will grow, what the revenue numbers look like over the next 3 years to give me an idea of how the business scales, and ultimately it helps me understand the true cash needs for the business to get to breakeven (1 slide)
12. The financing round - lay out the dollars you are asking for, how it will be used, and how long the cash will last (1 slide)
13. Milestones-what milestones have you hit so far and what do you plan on realizing during the next year with the new cash (1 slide)

Ok, pretty basic and that's it.  For those of you have triskaidekaphobia or fear of the number 13, it's ok as it is a lucky number in our house since my wife was born on the 13th.  Anyway, if you cover all of these points the deck should be about 15 pages in length and provide a great overview for potential investors.  One other point that I want to highlight is that how you position your business is key.  Take a look at this post from April 2004 titled What Aisle, What Shelf. You need to make sure that your audience gets where you fit in the ecosystem quickly and how you are different from what else is out there.

UPDATED: One item I forgot to mention: in this world of constant digital bombardment, you must figure out how your product or service becomes a "must-have" versus a "nice-to-have" solution in a customer's daily life.  If you are a "must have" with minimal substitute products then people will clearly pay for what you have.  If you are a "nice to have" in a world of many substitute products even though you may get some usage you will never be able to monetize that base. 

Be prudent but don't panic!

The alarm bells are ringing in Silicon Valley and start-up land today with Sequoia Capital and Ron Conway telling companies to prepare for the economic meltdown and to raise cash by cutting their burn.  This is not new news as being in New York we started to feel the real economic impact in mid-September as Lehman melted down and as Merrill Lynch was bailed out by Bank of America.  This is all prescient advice and something I have been espousing to my portfolio companies for awhile - see my last post from mid-September on Doing More with Less, a mantra that all startups should live by.  All that being said, it is not time to hit the panic button.  Don't go out and fire everyone wholesale and skinny down just because everyone else is. Do it because it is right for your business and because all of your leading indicators tell you to do so.  Do it the right way by not making a 20% cut across the board but by thoughtfully thinking about your business, your priorities, and where you need to focus your capital and resources to grow your revenue but conserve cash.

The good news is that many companies I have seen have learned their lessons from the last bubble bursting and rather than subscribe to the "if you build it they will come" model have turned towards the "release early and release often" model of gaining customer traction sooner rather than later and at much lower costs than before.  As I look at the current landscape, obvious areas of concern are any companies with high fixed costs and heavily reliant on direct sales whether it be advertising related or enterprise related.  It is clear that for these big ticket sales that many corporations are in the mantra of doing nothing rather than doing something and that startups should adjust their budgets accordingly to reflect this reality.  For those companies that live by the frictionless sales model and that are capital efficient with a low fixed cost base, take another hard look at your organization and priorities and haircut unneccessary expenses.  Once you do all of that and feel that you have 18+months of runway, look on the positive side as there will be many great people on the market.  Yes, cash is king and if you have it and conserve it, there will be some phenomenal opportunities to pick up some great talent.

M&A - it ain't over till it's over

The economy is clearly slowing down and the IPO market is nonexistent.  As I have always said, this is the time to hunker down and tweak your business to get your model right.  If you are interested in exiting today, M&A continues to be the only viable path along that front.  Having been through a number of acquisitions and potential acquisitions through the years, one point I must remind you of is that any deal isn't over until its over.  On the surface, this seems so obvious.  And yes, once a term sheet is signed and a price and general terms are agreed to, you are in great shape.  But recently, through discussions with other VCs and entrepreneurs, I am hearing about more situations where strategic buyers may significantly change the deal terms after more serious due diligence or even potentially walk away from a deal.  This can be especially painful if you have spent a number of months meeting with the strategic and going through due diligence in lieu of running your business. Trust me, this happened to one of my portfolio companies last year and reasons cited can include we had a change of strategic priorities and or look at the economy, there is no way we can value you like we did when we started the deal.

While I can offer you no protection from this happening to you, all I can say is to be prepared and skeptical, be willing to walk away, and make sure that you both do enough diligence and meet with the right decision makers before you sign any term sheet and embark on the extended process.  Once the term sheet is signed, run like hell to get the deal closed because the longer a deal lingers the more opportunity there is for it not to happen.  Keep the hammer down and always have next steps and a defined timetable.  In addition, to the extent that the strategic acquirer has made other aquisitions in the past, I would try to leverage your personal network to reach out to some of the VCs or entrepreneurs involved to get a flavor for how the strategic will run their due diligence process and what doozies or surprises the strategic throw at you.  Before you start spending your money from the acquisition, remember there is a lot that can change and that probably will change so keep that in the back of your mind as you go through the process.

What do I see in venture through 2010???

The Jordan Edmiston Group recently asked me and a few other VCs a few pointed questions about the future for circulation in their July Client Briefing.  As an aside, I worked with JEGI two years ago and they did a fantastic job helping us sell Moreover Technologies to Verisign.  They understand the media and online world, are well connected, and work diligently to get the job done.  Anyway, here are the questions and my response:

Even though there is uncertainty in the credit markets, a stalled IPO market, and few billion-dollar plus M&A transactions, the investment activity level and appetite for quality businesses in the middle-market continues to be vibrant. Venture Capital firms continue to invest in companies that are providing answers to key disruptive market forces and are exiting those investments via M&A. The Jordan, Edmiston Group, Inc. (JEGI) solicited a handful of key VC executives for their responses to the following questions:

1. What are the key market forces you believe will impact your venture activities through 2010?
2. How do you envision capitalizing on or responding to these market forces?
3. How is the environment changing for deal exits (e.g., IPO vs. M&A)?

(My answer is pretty consistent with what I have been blogging about during the last few years.  Here is an excerpt from the briefing and if you are interested in reading more and some of the other VCs responses, you can get it here)

We are continuing to move to a broadband connected world, where everything that we do on a device increasingly lives in the cloud. Our business applications, our music, our videos, pictures, and messaging will be easily accessible from any device, any time, and anywhere. We will continue to see new cloud-based applications and services, and data-driven services will play a larger role in this new world. There will be some great opportunities to invest in companies that take existing data and run algorithms over these streams of data to deliver better and more targeted advertising, personalized recommendations and search, and better overall services for end-users.

One of the next phases of growth and large revenue opportunities will be driven by what is captured every time you click on a page and move from site to site. How companies use this data to improve a user’s online experience is the next game changer. What I love about these kinds of opportunities is that algorithms scale, have high gross margins, and are highly defensible. With our computing world living in the cloud, there will be a whole new generation of mobile applications that leverage the increased computing power and faster broadband speeds that are offered today.

Mobile carrier voice revenue is declining, and data revenue is the next huge growth area for carriers. However, data revenue cannot increase without applications that drive usage. Obviously, there are concerns about carriers’ “walled gardens”, but I see a future where carriers increasingly provide open access to allow innovative apps to drive data growth. In addition, as mobile devices become better, cheaper and faster, we will see an increase in the number of users accessing the web from their wireless devices, as often as they do from their home PCs.

Capitalizing on Disruptive Market Forces
Dawntreader Ventures will capitalize on these disruptions by investing in the entire food chain, from infrastructure layer to the apps and services that touch the end-user. This includes investments in companies like Greenplum, which is powering the back-end data warehousing for a number of high profile Internet companies for targeted advertising; and Peer39, which provides semantic advertising solutions by using natural language processing and machine learning. This technology enables the company to go beyond keywords to understand page meaning and sentiment, to deliver the most effective display and text advertising to end-users.

Exit Strategy

Unfortunately, the market for IPOs is currently “dead”, but it may reopen in 2009. M&A continues to be strong for the right companies that fit a strategic hole in an acquirer’s portfolio. In the end, I continue to tell my portfolio companies that if you focus on what you can control (growing and managing your business), then the external factors (exit strategy) will take care of themselves. However, if you try to force the issue and shop your company, that shows a sign of weakness and more often than not will result in a fire sale. Companies are bought and not sold. For strong, well managed companies, opportunities will always present themselves, as long as you can avoid making desperate decisions.

To read some other VC responses and to get an update on the state of Interactive M&A, I suggest getting the JEGI briefing here.

Raising capital and meeting expectations

What I like to tell portfolio companies is that on average it will take 6 months to raise capital with some cycles being shorter and some being longer. Given that, it is imperative for a company to start thinking about its next round well ahead of time and the milestones it needs to hit to have the right momentum to get potential investors excited. One area that I would like to caution entrepreneurs is being too aggressive on the milestones and revenue forecast, particularly in the near term.

Let me explain. Like any other VC, I love to invest in companies going after big markets with huge revenue potential. That being said, I also like to see plans grounded in reality as well. Rather than get me excited, showing a revenue ramp from $1mm to $17mm to $65mm will actually do the opposite for me, raising more questions and concerns than general excitement. Along those lines, it is also imperative that when you share your plans with investors that you are pretty confident that you will realize your milestones or hit your numbers in the next 6 months as investors like to see if you can deliver on your promises. One cardinal sin is being overly optimistic in the near term and falling flat on your face in the due diligence process. It is much better to position yourself in a way that you can meet and exceed expectations during the due diligence process than the other way around. When this happens the rest of your forecasts become more believable.