Quick, do you know what the following mean in the context of investors and startups?
Pre-money valuation
Post-money valuation
Vesting schedule
Cliffs
Convertible debt
Preferred shares
Participating preferred
Non-participating preferred
Profitability vs cash flow breakeven
Seed round
Series A, B, C, etc round
Cash on cash expectations
Burn rate/runway
Needless to say there is a good bit of jargon in the startup investor world. As an entrepreneur contemplating raising money, or committed to raising money, my recommendation is to spend time learning the jargon by reading the Venture Hacks archives as well as Mark Susters’ blog posts.
Earlier today I was watching a video where Mark Suster (entrepreneur turned venture capitalist) was interviewing Scott Painter, the CEO of Zag. The best part of the video was where Scott lays out his company’s dashboard and talks about the metrics that drive his business. Take a look at minutes 43-48:
In the video, as part of talking through his company’s dashboard, Scott hits on the number one reason startups can’t raise money, without mentioning it directly. The main reason an entrepreneur isn’t able to convince an investor to invest: the entrepreneur can’t demonstrate defensible, metrics-driven data on how he/she is going to build a large business. Scott’s dashboard includes the following information for the past 30 days:
Unique visitors
Active prospects
Sales (cars sold)
Revenue
While this idea makes sense, it is amazing to see how many entrepreneurs don’t fully realize it, spend a good bit of time trying to raise money, and end up disgruntled with investors by the end of the process. My recommendation is to build a story, with metrics, of how you’re going to build a big business, and then paint the picture for how the investor is going to make an out-sized return investing in your company.
What else? Do you agree?
Note that this is especially true in markets that are more conservative with startup investing like Atlanta.
Continuing the post from yesterday on the freemium business model, which elicited several comments, I wanted to offer up some more thoughts. In general, businesses are better off offering a proof of concept/free trial the majority of the time instead of a free edition of their product. With that said, here are the ideal characteristics of a product where the freemium approach works:
Ability to demonstrate immediate and obvious value (I contend most freemium products fail because it is too difficult to get value from them without serious hand holding by the vendor)
Minimally invasive product e.g. it doesn’t take over a website, doesn’t require a DNS change, doesn’t require IT people to help configure, doesn’t introduce confusing jargon, etc
Known type of market e.g. people already have expectations of product functionality like email marketing, CRM, etc
Clear value proposition and reason for upgrading later e.g. limits to key functionality, additional features, etc
What else? What are some other ideal characteristics of a freemium model?
The freemium model is a business approach where an account, typically with limited functionality, is offered for free with the hope that the person eventually upgrades to a paid premium account. I must admit that we don’t do a freemium model for any of our products (we do have a free product, Visitor ID, but that is more of a generic freebie). With that said, I have a few thoughts on the model:
Many entrepreneurs think it is the holy grail of business models only to learn that many companies won’t even use a product for free
At its core, freemium is simply a lead generation mechanism, much like open source
It is incredibly difficult to get someone to upgrade from a free version to paid version
Offering a free version of a product often times attracts a different crowd compared to a free trial
Many labor intensive items like support, on-boarding, and policing (e.g. if email marketing is involved) are expensive and difficult to scale with lots of non-paying customers
My goal is to one day have a successful freemium product, but to date the feedback I’ve received from entrepreneurs that have one is that it is much more difficult than they expected.
What else? What are some more thoughts on the freemium model?
At a lunch last week (yes, I believe in never eating alone) the entrepreneur and I were talking about places to eat. He offered up three nearby places for us and mentioned that one place was always empty at lunch time. After I asked why, he said that when they first opened they were dinner only and didn’t serve lunch. The restaurant’s early market signal that they weren’t open for lunch made it exceptionally difficult to later pivot and get into the minds of the local business people that they were an option. My friend’s guess is that the restaurant will be closed within six months.
My recommendation is to pay special attention to market signals, especially at the launch of a new business. Some signals include:
Hours of operation
Pricing
Target customer
Brand / design
I’m a fan of making decisions quickly and constantly iterating based on new information. The one caveat: take more time on decisions that aren’t reversible.
Two weeks ago I was having lunch with an entrepreneur in town and we were talking about another startup that had just closed a nice sized Series A round of VC funding. The founder of the other startup had been super successful at his previous venture and had plenty of money to fund the new venture. The question then arose: why raise professional money for a new venture if you can easily fund it yourself?
Here are a few of the reasons we came up with:
The professional money could have come from previous investors where the team had a solid relationship
The founder likely didn’t want to invest a chunk of money in the new venture since he didn’t have to (that comes with being successful — investors are much more likely to back you the next time around)
The founder could be employing the Nassim Nicholas Taleb’s Black Swan investor theory where he puts 90%+ of his money in ultra conservative bonds or Treasury bills and then puts the remainder in highly risky investments
What else? What are some other reasons previously successful entrepreneurs with money bring in investors for their next venture?
One of the reasons we’ve been successful is that Atlanta is a great city for young professionals and we’ve developed a methodology for identifying recent college grads that can immediately start adding value to our company. Many companies are leery of hiring recent college grads as they are unproven, require training, and might not work out. Well, looking at most people’s resumes, regardless of being a recent college grad, you could say the same thing. Some benefits of recent college grads include that they are more Internet savy, social media active, and energetic, on average. Plus, they are eager to learn and prove themselves.
Here’s how we identify recent college grads to hire that do a great job and fit with our corporate culture:
Determine if they have a strong work ethic demonstrated by a good GPA or challenging extra curricular activity like varsity sports or a full-time job
Give a written portion during the interview process in the form of essay questions about your industry that require research and writing skills
Have the candidate use your product and produce a deliverable that shows some competence after self-paced teaching
Look for professional and personality traits that fit your organization — one of my favorites is receiving a handwritten thank you note in the mail after interviewing a candidate
These steps have worked for us and I encourage you to try them out.
What else? What are some other strategies you use to determine if a recent college grad will be successful in your organization?
Over the past 10 years I’ve done one direct lease and four subleases for office space. Needless to say we’ve moved every couple years as we would inevitably grow out of our space. It wasn’t until the past two subleases that I came across the number one tip I want all entrepreneurs to know when negotiating a lease/sublease: ask to pay for only the space you need now and grow into the space financially by paying for more over the life of the lease.
As a startup, when looking for office space, I recommend getting the amount of space you expect to need by the last 6-12 months of the lease. So, if you’re doing a three year lease and you have five employees now, but expect to have 20 employees by the end, it becomes tricky to find the right space. Here’s an example of growing into space:
You find 5,000 square feet office but only need 1,500 sq ft at $18/yr/ft for a three year term but can’t afford that much space now and don’t need that much
Offer to pay for 1,500 sq ft for the first six months, followed by paying for 2,500 the next six months, and add another 1,000 sq ft to the bill every six months thereafter until you’re paying for the entire 5,000 sq ft
The $18/yr/ft would stay constant or increase 3% per year such that by the end of the lease you’re paying the standard asking price
Naturally, your effective rate per square foot over the life of the lease would be significantly less than $18 sq ft but you get the benefit of the space you’re going to need at a price that meets your respective company size. Plus, landlords like to develop relationships with growing companies and people like to see startups succeed as it helps the economy.
One of the serious challenges with a bootstrapped startup is determining when to expand. There’s a fine balance between having sufficient reserves in the bank and being aggressive with new hires and initiatives. About four years ago, after struggling with this issue for over a year and experimenting with different ideas, I settled on an approach I’ve been using ever since: growth plan assets (GPA).
The GPA, much like a GPA in college, is a simple number that quickly summarizes the ratio of current assets to average monthly operating costs over the previous 90 days. Here’s how I calculate it:
Add up current assets including cash in the bank and accounts receivables that are not overdue
Calculate the average monthly costs to operate the business over the past 90 days (every single penny spent that wasn’t a one-time cost)
Divide the current assets by average monthly cost to get the GPA
What else? How do you decide when it is time to invest in growth?
Earlier today I talked to an entrepreneur about his upcoming marketing program. The entrepreneur has been working on a book about his industry that attempts to educate potential clients on certain pitfalls and how the major players in the market don’t always have their clients’ best interests in mind. After talking for 20 minutes about the book and some of its contents, I jumped into the reason for the call: talking about how to handle all the leads that the book will generate.
Only a couple minutes into the meat of the conversation I realized things were awry. The entrepreneur had spent significant monies on a customized Microsoft CRM implementation, new website, marketing consultant to do market research, and still hadn’t launched the book. All the infrastructure work was in preparation for the perceived onslaught of leads that he wouldn’t be able to handle. I quickly told him that he was doing way too much pre-mature optimization of his business and that generating more leads than he can manually handle would be a great thing. Of course, this was difficult to hear but he took it in stride and agreed.
My recommendation is to not pre-maturely optimize for an expected outcome when you’re a startup and can deal with issues quickly. Launch projects early and often and iterate based on feedback. Nothing replaces gathering real information from the field.
David Cummings on Startups 