Category: Investing

If you read the normal tech startup and venture capital blogs and news sites, it’s easy to think that West Coast investors in the Bay Area have unbelievable deal flow and never have to leave the region. Then, if you look at the 10-20 largest venture financings each year in major cities like Atlanta (and plenty of others), you’ll see that a good percentage, if not most, of the money came from California VCs. If the Bay Area is so great for deal flow, why does so much VC money from the West Coast go into deals outside their region?

Simple: VCs are trying to make the most money possible, and they believe the deals they invest in outside their region are better than the deals they looked at in the Bay Area. Most VCs only do one or two deals a year, so when they invest in a startup in a different state, it’s because they believe they’ll generate a better return on their investment when compared to the other options. Being a top-quartile VC is super hard (making 3x cash-on-cash is much harder than it seems) and the best ones know that there are great startups all over the country (and world).

Great entrepreneurs and startups are everywhere. The next time you read about a Bay Area fund leading a deal outside their region, know that it’s because they believe it’s a better opportunity than the ones they looked at locally.

What else? What are some more thoughts on why West Coast investors invest outside their region?

Recently I met with an entrepreneur that’s working on a new marketplace idea. We talked for a bit and I challenged some of his assumptions and gave anecdotes from other industries. Then, when it came to the “ask” about investing, I explained that raising money simply on an idea with no traction is nearly impossible. The best thing to do: figure out how to get the app built and customers loving it.

Here are a few thoughts on traction required for investment:

• Use a service like Upwork and have a simple app built
• Once built, sign up customers to prove the value
• Figure out the necessary amount of traction to be desireable (categories of initial traction for five types of startups)
• Build relationships with investors in parallel (see Invest in Lines, not Dots)
• Know that most startups don’t raise any money

Traction is a critical element for raising money, and entrepreneurs would do well to focus on getting the product right and customers on it first.

What else? What are some more thoughts on traction being required to raise money?

Bing Gordon, a General Partner at Kleiner, has a great post up titled How To Craft A Concise Pitch Investors Will Care About. Entrepreneurs spend a tremendous amount of time on their executive summary, but not enough time thinking through things from the investor perspective. One place to start is by thinking through questions investors will ask each other after the pitch.

From the article, here are seven questions investors ask after a pitch:

• Do you seem like a great entrepreneur?
• Who is the competition and how do you stack up?
• What are your team’s assets?
• What have you accomplished to date?
• How well have you managed your resources?
• How big is the market you are targeting?
• How protected can your business be?

Entrepreneurs would do well to go through these investor questions in advance of a pitch and think through how the answers will be assessed.

What else? What are some other questions investors ask after a pitch?

Growing up, I heard the phrase “you’re more likely to get hit by lightning than win the lottery” many times. Both have extremely low odds and are unlikely to happen (as an aside, I know a local real estate developer that’s been hit by lightning twice — talk about crazy low odds). Well, for entrepreneurs looking to raise money, there are fewer Series A rounds per year than people that win $1 million or more in the lottery per year according to well known investor David Hornik:

Entrepreneurs and the media alike love to talk about how much money startups have raised because it’s public and definitive. Well, in reality, 99.9% of startups that try to raise a Series A round fail. Yes, friends and family rounds are common but a Series A round from an institutional investor is actually quite rare.

Entrepreneurs would do well to nail the 8 metrics questions for raising a Series A and focus on the appropriate initial traction for their business. Oh, and remember, that vast majority of successful entrepreneurs never raised a Series A round.

What else? What are some more thoughts on the rarity of raising a Series A round?

After reading the Notes from the Atlassian S-1 IPO Filing again, there’s one element that truly stands out for the proposed $3 billion company IPO: the two founders own 75% of the company. That’s simply unheard of for venture backed startups. Atlassian has been incredibly capital efficient and only sold a relatively small percentage of equity when they raised money. When raising money, there’s no set percentage that venture capitalists purchase, but it’s generally 15-35% of the company each round of financing.

Let’s look at the difference of three rounds of financing selling 15% of the company each round vs selling 35% of the company each round.

Selling 15% per round and assume no pro-rata and no extra dilution from new stock option pools:

• Series A – Investors own 15%
• Series B – New investors own 15% plus existing investors own 12.75% = 27.75%
• Series C – New investors own 15% plus existing investors own 23.6% = 38.6%

Selling 35% per round and assume no pro-rata and no extra dilution from new stock option pools:

• Series A – Investors own 35%
• Series B – New investors own 35% plus existing investors own 22.75% = 57.75%
• Series C – New investors own 35% plus existing investors own 37.5% = 72.5%

So, a startup with three rounds of low dilution owns 34% more of the company vs a startup with three rounds of high dilution. While there’s intense focus on the amount of money startups raise, there’s much less discussion about what percentage of equity was sold to raise that money.

Entrepreneurs would do well to place more consideration on percentage of the company they sell to investors, especially in the context of raising multiple rounds of financing.

What else? What are some more thoughts on high and low equity dilution scenarios?

Atlassian, makers of popular software engineering and management tools, just released their S-1 IPO filing. Almost 10 years ago I used their JIRA issue tracker software and have been a fan ever since. Atlassian is known within the tech entrepreneur community for hitting $100 million in sales with no sales people — pretty amazing. In addition, they raised a $60 million Series A in 2010, which is large by today’s standards, and was incredibly large back then.

Here are a few notes from the Atlassian S-1 IPO filing:

• To reach this expansive market, we distribute and sell our products online without traditional sales infrastructure where users can get started in minutes without the need for assistance. We focus on enabling a self-service, low-friction model that makes it easy for users to try, adopt and use our products. (pg. 2)
• More than 5 million monthly active users of the products and more than 48,000 customers (pg. 2)
• Revenues (pg. 2)
  • 2013 – $148.5 million
  • 2014 – $215.1 million
  • 2015 – $319.5 million
• Net Income (profits! – pg. 2)
  • 2013 – $10.8 million
  • 2014 – $19.0 million
  • 2015 – $6.8 million
• Free Cash Flow (pg. 2)
  • 2013 – $47.1 million
  • 2014 – $65.0 million
  • 2015 – $65.5 million
• Core values (pg. 4)
  • Open Company
  • No Bullsh*t
  • Build with Heart and Balance
  • Don’t #@!% the Customer
  • Play, as a Team
  • Be the Change You Seek
• In fiscal 2014 and 2015, our research and development expenses were 37% and 44% of our revenue, respectively. (pg. 14)
• 1,259 employees as of June 30, 2015 (pg. 14)
• We have in the past experienced breaches of our security measures and our products are at risk for future breaches as a result of third-party action, or employee, vendor or contractor error or malfeasance. (pg. 15)
• We believe that a critical contributor to our success has been our corporate culture, which we believe fosters innovation, teamwork and an emphasis on customer-focused results. (pg. 22)
• The dual class structure of our ordinary shares has the effect of concentrating voting control with certain shareholders, in particular, our co-chief executive officers and their affiliates, which will limit your ability to influence the outcome of important transactions, including a change in control. (pg. 29)
• Great products x Low pricing x Automation = High volume (pg. 82)
• Build great products -> Keep prices low -> Low prices necessitate volume -> Volume means we sell to everyone -> Selling to everyone means we sell online -> Selling online requires transparent pricing and easy trial -> Easy trial means we need to build great product. So… (pg. 82)
• Web site visitors have the opportunity to try our products for free and we generate on average more than 6,500 such evaluations per typical business day (pg. 83)
• Equity ownership positions (pg. 114):
  • Co-CEO #1 – 37.7%
  • Co-CEO #2 – 37.7%
  • Accel Partners – 12.7%

As far as I can tell, Atlassian will be the first publicly traded software company with no sales team and no product price negotiations. Because the company is controlled by Co-CEOs with their special voting stock (and huge ownership positions!), they’ll be able to operate with a long-term view and focus on steady, profitable growth indefinitely. This is not your typical software company.

What else? What are some more thoughts on the Atlassian S-1 IPO filing?

Last week I was talking to an angel investor that had invested in a couple idea stage startups and he mentioned that he was also interested in small private equity deals. Curious, I probed deeper and asked what a small private equity deal looks like. He responded that it might be a startup with $500k in revenue. Hmm, I realized we were talking about different things. Here’s how I see it:

Angel Capital

• Idea stage through seed stage
• $0 – $1 million in revenue
• Not profitable
• Minority stake
• Insanely risky
• No debt component

Venture Capital

• Early stage through growth stage
• $1 million+ in revenue
• Not profitable
• Minority stake
• Very risky
• Moderate debt component

Private Equity

• Growth stage
• $20 million++ in revenue
• At least $5 million in profits
• Majority stake
• Moderately risky
• Heavy debt component

So, the gentleman I was talking to was really looking for angel deals where the company was in the seed stage instead of the idea stage. Angel capital, venture capital, and private equity are all very different and each serves its own purpose.

What else? What are some other differences between angel capital, venture capital, and private equity?

Earlier today Square, a payment processing and financial technology company, released their S-1 IPO filing to the public. Square is especially unique in that it’s CEO is Jack Dorsey, who’s also the CEO of Twitter (imagine founding and running two billion dollar tech companies at the same time!).

Here are a few notes from the Square S-1:

• In the 12 months ended June 2015, over two million sellers accepted five or more payments using Square (pg. 2)
• We define a quarterly cohort of sellers as the group of sellers that are approved to accept card payments with Square in a given quarter. On average, our payback period has been four to five quarters. (pg. 2)
• Net revenue (pg. 3):
  1H 2015 $560.6 million
  2014 $850.2 million
• Net revenue without transaction costs and the Starbucks account, which is going away in late 2016 (pg. 3):
  1H 2015 $198.8 million
  2014 $276.3 million
• Losses (pg. 4)
  1H 2015 $77.6 million
  2014 $154.1 million
  2013 $104.5 million
• Combining payments, point-of-sale systems, financial services, and marketing services (pg. 7) – Note: Square is really building a small business operating system to run all aspects of the business from payroll to email marketing — that’s a big idea.
• From Jack: I believe so much in the potential of this company to drive positive impact in my lifetime that over the past two years I have given over 15 million shares, or 20% of my own equity, back to both Square and the Start Small Foundation, a new organization I created to meaningfully invest in the folks who inspire us: artists, musicians, and local businesses, with a special focus on underserved communities around the world. The shares being made available for the directed share program in this offering are being sold by the Start Small Foundation, giving Square customers the ability to buy equity to support the Foundation. I have also committed to give 40 million more of my shares, an additional 10% of the company, to invest in this cause. I’d rather have a smaller part of something big than a bigger part of something small. (pg. 24)
• Accumulated deficit of $473.2 million (pg. 26)
• For example, in the three months ended March 31, 2015, we recorded a loss of approximately $5.7 million related to fraud by a single seller using our payments services. (pg. 27)
• Mr. Morley contends that he was an equal partner with Jack Dorsey and Jim McKelvey in the business enterprise that ultimately evolved into Square, and that Mr. Dorsey and Mr. McKelvey breached their alleged oral joint venture agreement with Mr. Morley by excluding him from ownership in Square. (pg. 39)
• Founders equity ownership (pg. 176):
  • Jack Dorsey – 24.4%
  • James McKelvey – 9.4%
• VCs equity ownership (pg. 176):
  • Khosla Ventures – 17.3%
  • Sequoia Capital – 5.4%
  • Kleiner Perkins – 3.0%

Square is an impressive company that’s using payment processing — handling good old fashion credit cards — as the gateway to run many aspects of a regular small business. Look for Square to become more like Intuit (owner of QuickBooks) with a variety of services and less like a credit card processing company over time.

What else? What are some other thoughts on Square’s S-1 IPO filing?

Earlier today I read through 32 executive summaries of startups that are presenting at Venture Atlanta later this month. Most were good, a few were sub-par, and several were excellent. After reading the executive summaries, here are six things entrepreneurs should do to make them better:

1. Minimize Jargon – Every industry has jargon and terminology that is cumbersome and alienating to outsiders. Figure out how to minimize the jargon and provide a clear message.
2. Don’t Cram Too Much – Two pages is never enough to cover every important point. Regardless, don’t shrink the font and try to cram so much in that the most important points get lost in the verbiage.
3. Be Visual – If there’s a visual element to your story — chart, diagram, etc. — incorporate it into the executive summary to break up the monotony of text. Customer logos are a great visual.
4. Use Strong Words – Investors need to believe that the startup will be wildly successful. Words that are weak like “plans”, “hopes”, and “wants” should be left out.
5. Reasonable Revenue Forecasts – Too many executive summaries showed sales of $20M+ only a few years after founding. While it’s technically possible, the reality is that revenue forecasts should be more reasonable and less inflated.
6. Keep it Balanced – Spending one paragraph on the market and four paragraphs on the competition doesn’t make for a balanced executive summary. Find a rhythm and keep it throughout.

Executive summaries are a key part of the startup world and should be crafted with care. Follow these six ideas and make them even stronger.

What else? What are some more ways to make executive summaries better?