What Changes the Second Time Around?

It’s been a while since I’ve blogged but I’m trying to get myself back on it again. I thought I’d kick off on the backs of our seed investment into appRenaissance announced today.

The CEO of appRenaissance is Bob Moul, whom I had backed in his last company Boomi in 2008. They were a pioneer in the cloud based integration market and Bob led the business to a great exit in 2010 to DELL. Bob left DELL a year later to jump back into the startup world. He eventually caught the mobile bug and joined appRenaissance as CEO earlier this year. When I got the call, it was a no-brainer and we were delighted to partner together again. It got me thinking, what changes the second time around?

  1. Price and terms get figured out quickly. Seasoned entrepreneurs know the game; they know the pros and cons of too high/too low; they know the danger of running out too quickly or overcapitalizing; they don’t get sucked in by the hype in the echochamber; you don’t have to unwind all the misconceptions that exist out there. There is a tremendous clarity that allows us to virtually waste no time in coming to a handshake. Whether it was Bob Moul at appRenaissance or Chet Kanojia at Aereo, the conversation took a total of 10 minutes and we were onto building something great.
  2. Don’t need proof because the trust is there. For first time entrepreneurs, generally people like to see some evidence of execution. We want to see what you’ve been able to accomplish, before and now. The relationship is so new that it’s hard to take people simply on their word. We want to see it in some numbers somewhere. The second time around, we already know what you can do and have done before. We’re glad to take early risks blindly because the trust is there.
  3. Neither side worries about protecting outside case scenarios. You know the ones I mean… Spending a few weeks defining “Cause” and how to get a ladder of severance lengths based on that. Taking great pains to ensure you approve budget because someone might set one at zero and pay themselves insanely. Having to define exit thresholds and multiples because both sides worry about blocking (or not accepting) an exit because someone didn’t think they made enough money. In general, we never get hung up on the above, but they are real and these are the outside cases that strangers might try to protect. The second time around everyone focuses on the core issues, dealing with things that set up good governance and good mutual accountability, and knock them down easily.
  4. It’s a lot more fun. If you’ve had a good outcome with someone, it’s likely the second time, an entrepreneur will be thinking bigger, focused more clearly and will want to build longer. Bob’s goal now is no less than to build a big public software company based in Philadelphia. We love BHAGs like that – it clarifies the mission and energizes all around.

Since starting FirstMark in 2008, I am getting my first wave of entrepreneurs coming back for our second time together, and it’s fantastic. We’ve made it a point to build early, deep and longstanding relationships that make us a place to go again and again. They serve as the best references for new entrepreneurs (first time or repeat) we endeavor to work with. And I look forward to doing so in the future with the many incredible first time entrepreneurs I’m so privileged to be involved with now.

Purpose!

I was introduced to a great video around motivation by Brad Feld’s blog.  If you haven’t watched it, it’s worth 10 minutes of your time.  Much of what Brad and the video highlights is very relevant.  The primary idea was debunking the notion that pay and performance are linearly correlated.  While true in mechanical tasks, the research demonstrates that for anything requiring cognitive engagement, if pay gets de-coupled from purpose, outcomes are markedly inferior in spite of higher reward.  The talk is riveting, and I thought I’d offer a few suggestions based on what I’ve seen from our best executives.

First, create a purpose!  Many companies I meet with mistakenly assume it is so self-obvious that it is never made explicit.  And yet deciding those few words can make all the difference in the world.  Once articulated, the great thing that happens is those words can then be printed and shared over and over across a Company.  It allows purpose to be infectious and align an organization.  “Is everything I am doing consistent with our purpose?”  When everyone thinks with a higher goal in mind, it helps create a consistency of outcome.  Companies like Zappos are a great example of this.

Second, make sure you define a purpose in an aspirational way, not functional.  Purpose to me is not something that gets achieved, it’s a direction.  For example, it’s not “we want to build the best online marketing software” but “we want change the way people discover and interact online”.   Instead of “we will be the leader in online multi-player games” but “we want to revolutionize the experience, distribution and delivery of games to online audiences”.  Admittedly I spent 15 seconds thinking of these examples, but the idea is stay away from purpose that does not appeal to a fundamental emotion or create a cause of action.  The term BHAG comes to mind.

Third, find ways to reinforce the purpose and make accomplishment tangible.  Our best companies create exposure and reinforcing loops to show how individuals and the company support the mission.  Developers get introduced to customers who rave about how a new feature has shaved an hour off of their day.  Metrics are aggregated that frame how their engagement and excitement compares to other things out there.  Spontaneous community activities are highlighted and ‘shout-outs’ to individuals go company wide.  Beyond incentive compensation, people need feedback on a regular basis that they are indeed contributing to and achieving purpose.

Our best companies and leaders have a sense beyond themselves.  They create ideals that people line up to get behind.  When people believe, they will go through walls to create outcomes.  And when everyone is willing to break through walls, usually you break through mountains.  This is hard to do and requires focus to make happen, but remember even life is not that interesting without PURPOSE!

Love & Flux in a Time of Seed

I was at a panel earlier this week, when a question was asked from the audience.  “Are we in a seed bubble?”

Well, between the rise of super angels, the proliferation in micro-cap funds, and a shift in some LP interest towards the seed stage or emerging managers with small funds, it does not take a lot before we see significant changes in the available capital for seed.  Combine that with how capital efficient companies are, and you get seed stage activity at a level that did not exist before.  Admittedly, the fact that these companies can achieve material traction with much less money is a driver for the phenomenon.  But divide more dollars in the asset class by fewer dollars required per company and the output is many more companies.

What happens to those seed companies?  Typically, if a company does a good job executing on their seed round, by being capital efficient, they can quickly raise a Series A round of capital.  Some don’t need it, but generally in an era of easy “me-too”, expanding to all markets in parallel or staffing up quickly to feature differentiate usually necessitates venture capital.  The problem is that the venture industry at a macro level is in a not so healthy state.  LPs are having their own macro difficulties, and investments in the asset class are coming down materially.  Many funds from the prior climate are actively reducing fund sizes, by choice or otherwise.  And we in venture believe this actually is a good trend (at least those of us performing!).   

What does this all mean?  Combine the increasing number of seed companies with decreasing venture capital dollars, and you potentially have a tough situation.  Not every seed company that does “well” will have the opportunity to be fully capitalized.  There are only so many times a seed investor can tell a VC “no, no, THIS is really a hot deal”.  And so the bar will go up dramatically.  This is a good thing in that much better companies will get funded beyond the seed.  And in many respects the bar for a Series A deal these days will start to resemble a Series B deal.   But it also means lots of failure.

For entrepreneurs, a few things to think about.  First, think about the composition of your seed round.  Take the time to build the best network around you for information flow.  Create a good mix.  Make sure you have a strong group that can be your advocate and can give you credible advice about how to navigate the market.  Second, work actively with your seed investors to define real value creating metrics and what ‘clears the bar’.  It used to be 100K uniques was interesting, then it was 500K, six months from now it might be much higher.  Having institutional money as part of that syndicate can be helpful as we are actively in the transaction flow of real companies graduating from the seed to A and beyond.  Third, make sure you have the capital to achieve those objectives.  Don’t just take $1MM because that’s what is “typical”.  Map your capital to milestones in a disciplined manner.  This is not for investors, it’s to make sure you can grow your company seamlessly, keeping fundraising tasks to a minimum, and emerge owning a huge chunk of your business!

A Little Human Touch?

For the past decade, business on the Web has focused on driving usage and user base independent of a clear financial model.  Charging for products or services with utility was anathema to the cause of driving user adoption.  Systems were designed to create as much “automation” as possible to allow for massive scalability with minimal cost.  And given the Web as a new medium, those strategies made a ton of sense.

With viral loops and massive usage, services like Facebook and Twitter were able to create fundamental platform businesses that took the connectivity of the Internet and created “connections”.  The goal to drive audiences brought content walled gardens down, and drove a whole new generation of folks to the Web.  Automated activities like user generated content and self service models became the hallmarks of success.  Get other people to create site connect or sign up for a service, and make money off of their effort.  No better business right?  Those mantras created a stark positive value proposition and led to a huge critical mass of online activity.

But the world of usage, automation and free has some collateral effects.  Given how easy it is to start a site or a service, we now also have a world of noise.  People are dealing with the problem of excess.  Spam email, offers, products, content, tweets, updates – you name it, almost every category has infinite shelf space competing for finite attention.

That is part of the reason why I see the pendulum shifting again towards simplification, organization, and curation.  Paid content walls are going up again, as businesses identify customers out of the masses willing to pay for content with cost and create unique ways of interacting with content.  It’s not that the same perspective or content isn’t available for free somewhere on the Web, it’s that people don’t have to time to sift through and find all of it.  The same is true for products and services.  We’ve seen a number of businesses growing rapidly whose primary value proposition is not showing customers 1000s of SKUs, but a few really good options.  And automation?  Perhaps not fully.  Virtual call centers, email communication, on demand conversations all seem to be getting layered back into the equation.  Of course this will all be done in a much more efficient and productive way than ever before, but it seems to me the human touch is fighting its way back into dogma of long tail and free.

Don’t Ignore the Obvious

My partner Larry Lenihan recently passed me a great article in Wired on the neurocognitive basis on which people absorb and discard information.  The author used the famous case of two scientists who built very sensitive radios to map the emptiness of space, and kept hearing a persistent noise.  They spent years tuning their radio telescope, clearning pigeon poop off the dish, blamed it on nuclear fallout.  Eventually and reluctantly, they accepted their equipment could be right and sought an explanation from more diverse sources.  They wound up winning the Nobel prize in physics in 1978 for discovering the cosmic “noise” associated with the Big Bang. 

 There were lots of lessons to be taken away for all participants of a startup.  Much of it involves overcoming one’s own personal biases to get to real insight.  Some examples: 

  • Seek diverse opinions early on an idea, rather than hoarding it for fear of being stolen.  The constructive dialogue process generally sharpens, not dulls.
  • When hiring, focus on the references (particularly ones not provided by the candidate) and listen to what they have to say.  Don’t fall in love with a candidate in advance and use that bias to filter out the lukewarm language.  It usually means there’s more behind it they are not saying. 
  • Continually test and seek feedback.  Try to ask for the check as early as possible, because that is when you learn whether the market truly values what you implicitly believe is valuable and are spending resources building. 
  • In fundraising, don’t ignore the “nos”.  Many may not get it, but there could be good lessons learned in other situations that one should be mindful of and avoid.
  • When stuck on solving an issue, try to bring in completely fresh perspectives that aren’t stuck in the weeds.  They can look from the outside, borrowing concepts from other disciplines even in the technology space.

 Overcoming mental blind spots has become a hot new area around improving “Executive Function”.   The more we are aware of the bias, open to hearing issues, and resolving in light of them, the better the businesses we build will be.

Entrepreneur’s Guide to Surviving the Credit Crunch

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….

The Entrepreneur’s SEO – “Startup Exit Optimization”

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…