Archive for September, 2008
Given the events of the last few weeks, there are many provocative questions being asked about what the subprime implosion and subsequent bailout mean to all of us. Will the bailout bring liquidity back to the market? Are we descending into the worst recession we have seen since the 1930s? Is the US secretly a socialist regime shrouded in capitalist clothes? Amongst all the questions, very few are oriented towards the startup that has no leverage and is still building product or traction into the market.
While I’m not here predicting the “bread lines” scenario, for most entrepreneurs and even us VCs, our companies are our lives. The last time around, many “whistled by the graveyard” refusing to believe things were different until it was too late. It would be irresponsible not to consider a tougher environment. The following are things to consider for any entrepreneur beginning to prepare for upcoming market volatility:
1. Cash is king once again, and is all that matters. Preserving, extending, replenishing it. If you have less than six months of cash, you need to seriously evaluate how to replenish your balance sheet. Venture is generally the last industry to be impacted from market implosions given the long term nature of LP capital commitments and horizon for our investments – raise your money now if you can.
2. Planning to hire a lot more people? Especially sales folks? Slower, more responsible growth will be cheered, but running out of cash will not generate sympathy. Rather than hiring a bunch of sales people, who may spend months to get productive and still be pushing on a rope, keep the team lean until you feel that your customers can feel the bottom. People do not make any decisions when they are worried about their own jobs. No point subsidizing commiserating Happy Hours.
3. Focus resources on a great, specific product. In a tough market, large companies are cutting wholesale. R&D groups are in disarray or not as productive because they too are worried about their jobs. Smaller companies have finite resources and are all playing the “last person standing” game. Building a narrower product that is incredible at one thing and working outward is better than building a broad set of functions in parallel. Get to the 10x customer value proposition (3x improvement at 1/3rd the cost) and start selling as quickly as you can. This will help you leave competitors in the dust.
4. If you have venture investors, ask them how much they have reserved for this investment. All responsible venture firms create budgets for how much capital a specific company will need over its life. It’s how we know how many new investments we can make. If there are no other investors out there, your existing investors will be your support structure. Their summed reserve amount is the most capital you can plan on being available to you.
5. Work even closer with your investors to define value creating events. No VC will simply hand over all that reserved cash. Start early, work with them to adjust near and longer term goals to realistic levels, and document them, so that when you visit the partnership having accomplished your objectives, they’ll have your check ready to go.
6. Check in with your local banker. Many of the emerging growth banks specifically stayed clear of any credit derivatives or subprime mortgages. Their balance sheets are strong and leverage relatively low. This market could be an opportunity for them to grow share. The stronger the relationship you build now, the more likely they could be a supportive source of venture debt or capital.
7. Maximize any existing space and avoid signing new long term liabilities. This benefits you in a few ways: first, you avoid things like security deposits that tie up cash that can be used for operations; second, the commercial markets could be affected just as much as residential ones and you could negotiate a better deal after the ripple effect hits the economy; third, it can foster a “cash is king” mindset amongst the team. Everyone is in this together.
8. Try to do deals where you get paid upfront, and avoid doing deals that require significant cash upfronts. Again, cash is king. Better to use cash for business deals rather than security deposits (number 6). EVEN better to structure a win-win partnership that allows you to operate longer, rather than letting someone else carry your cash on their balance sheet. If the only deal is an upfront cash deal, hold out a little longer. If someone else jumps in now, you’ll be there when they go away. If no one else does, people will really begin to feel pain and you might be able to structure the “death blow” deal against a competitor or lock up some invaluable web inventory for a song. The flip side is if you can get money upfront, that is worth a lot! Whether that’s prepaid inventory, annual billing terms with cash paid upfront, or non-recurring engineering that actually subsidizes your team, keep all the chips in your corner you can.
9. Quantify marketing and shift it towards DR (direct response). There is a reason why in recessions, even before Google, brand advertising pulled back but DR grew – it has a defined ROI! Examine all “goodwill” oriented marketing costs. Paid search, display advertising (esp with its recent contraction), email marketing, webinars, and other forms of spend can be a much more efficient way to generate leads or acquire customers. All of them are measureable – what better way to know if your cash is well spent?! In addition, many ad networks will do guaranteed placement or conversion deals in tough times IF YOU HAVE THE CASH. This is the Internet era, don’t let marketing spend a dime without knowing what you get back.
10. Start thinking about potential HR upgrades! Tough markets mean top candidates are much more available than normal. Think about swapping out B- employees for A+ folks. Every person in a tough market has to contribute – sharpen the blade and drive productivity!
Got any other tidbits? Feel free to post them here….Read Full Post | Make a Comment ( None so far )
I was chatting with a start-up CEO today, who had received some early inbound interest from a potential acquiror. Without any discussion of price, he asked me innocently enough, “Should I think about it?”
I started thinking about the positioning of the Company and the phase, and offered the following. I think most start-ups go through several brief natural local maxima, to borrow a calculus term, over its life (3-6 month windows of time over a 5 -7 year life) . Those maxima are periods where, on a risk adjusted basis, it may make sense to exit early. The trick is to recognize whether you are there or not, so as to know whether you are value maximizing.
To be clear, this is not a post advocating early exits. Heck, as many other people have observed, as a venture investors generally try to swing as big as possible across a portfolio of companies. As a maximizer of *company* value, however, you have to be cognizant enough to realize when you are on one of these plateaus, pick up your head to look around, and see if someone might be looking at you through binoculars from afar. You’ll always have to be “bought not sold”, and many people move from valley to valley never getting to a peak, but if you do, recognize it, assess it, and make an informed decision.
Generally, I’d say an acquisition is value maximizing if it occurs in one of three periods: the “concept” pop, the “growth” pop, and the “IPO” pop. In the “concept” pop, a company is acquired primarily for its radical vision or strategy, with no correlation to financial metrics. (This is not in the context of a bubble.) Think of a Series A company that seems to have a laser sharp vision for a particular space that many other people haven’t begun to understand. The Company usually has visionary management, early mindshare in a rapidly evolving but undefined/unstable space, and the early positioning (and PR!) to objectively call it a “thought leader”. In a normalized market, it’s probably just getting to revenue. The multiple is the highest at this stage b/c the denominator (revenues) is low; conversely the acquisition price is also the lowest because the acquiror has no reasonable financial grounds on which to pay the price. They just know this could disrupt, transform, or catapult their business and want to be on the ground floor. This is usually the $50-100MM exit.
The next major hill is the “growth” one. This would be a Company likely past its Series B, generating $10-20MM in revenues, has clear market leadership by virtue of tangible numbers like customers/partners/ASPs, and a fully built management team. In this case, a Company has built hard technology that works, has perfected how its sales machine works, and now is adding fuel to the fire. It’s probably growing at unsustainable longer term rates of 100-200%+ but can project wonderful visions of grandeur. Competition exists from a raft of “me-too” startups, but also in the marketing from large vendors as well. From an acquiror standpoint, you can start putting loose financial multiples to the Company and assessing sales channel synergies. While the multiples begin to come down relative to the first hill, only a fool would give up what seems like a rocket ship, and so the absolute dollars go way up. Exit values are usually in the $150-300MM range.
The last major hill is the “IPO” hill. The IPO hill is the company that has not only done all of the above, but has managed to stave off ALL competitors, large and small, and built a truly defensible position. The Company has not only done that, but also met the inter-steller, global galactic, worm-hole inducing bar to go public by filing its S-1! An acquiror at this point would be capitulating that they will not beat the company at its game, and moves in to take it out before it goes public. The multiples here have to come way down and likely tie to some notion of “accretive” (within 2 years) for the acquiror, but again the absolute number is much bigger. The universe of buyers is also much smaller given the magnitude of the exit. This is usually the $400MM+ purchase.
Why look to an “exit check” at each of those hills? Well, typically, those hill peaks are followed by valleys of varying depth and visibility. Doing a little more wont change the exit outlook; in fact, it’s more likely to cause you to be “in discussions” while on some kind of a non-optimal slope. And while there are always larger, more lucrative, adrenaline producing hills ahead, you have to be fully prepared with better equipment, maps, resources, and a better set of lungs, while finding enough sustenance and staving off nipping animals, before emerging on another peak again. In start-up terms, that means making sure the product works, figuring out sales cycles, successfully deploying at customer expectations, rising above the noise of ever present competitive slideware, maintaining price points, expanding the available market, raising venture capital (aka, dilution!), hiring and retaining great people, building appropriate regulatory and compliance infrastructure, and so on. All are manageable issues, but companies inevitably move downward from a plateau when getting into the weeds of execution. The numbers bear out how many make it through to the next hill.
[As an aside, it's why VCs love guys who have "done it before" - their lungs and maybe wallets are usually stronger to go the higher distances.]
How do you know you’re leaving one of these hills? I’ll save for another day if there’s interest…Read Full Post | Make a Comment ( 1 so far )