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Recently I was talking to an entrepreneur who was launching a new product and wanted to talk through a few ideas. As we drilled into his product it was clear that there were a number of well-funded competitors already in the market. When I mentioned this, he didn’t seem phased and said that they are “rolling into a crowded market.”

Here are a few thoughts on rolling into a crowded market:

• If it’s a market that’s saturated with legacy technology, the new technology needs to be 10x better (not just twice as good) to get people excited about changing
• If it’s a green field market (customers are buying this technology for the first time), the solution needs to be compelling enough to get them to try it out (the number one enemy is no decision or no action — the status quo)
• The go to market strategy needs to be strong enough to beat the competition, assuming a solid product (better marketing, stronger sales team, differentiated partner program, etc)
• Sufficient resources need to be in place (or low burn) to spend enough time figuring out the market dynamics and a strategy to win
• Pick out a niche that’s winnable yet relevant enough whereby the product can be expanded to a larger market

Startups roll into crowded markets all the time. With a solid product and strategy, crowded markets are still readily won.

What else? What are some more thoughts on rolling into a crowded market?

Every day I get the opportunity to interact with a number of entrepreneurs. Entrepreneurs are great in that they’re always dreaming and seeking the next great idea to improve their business. After hundreds of these conversations, I’ve found one question that continues to be my favorite: what have you learned recently?

• Entrepreneur: We’re working hard to improve our product.
• Me: Great. What have you learned lately?
• Entrepreneur: We’re scaling out our sales team.
• Me: Cool. What are some things you’ve learned lately?
• Entrepreneur: We’re having a hard time finding a great software engineer.
• Me: Finding the right person is hard. What have you learned recently?

Of course, I don’t ask the same question over and over. I do look for ways to both gather ideas personally and share things that have and haven’t worked for me. I enjoy learning from entrepreneurs by asking what they’ve learned lately.

What else? What’s your favorite question to ask entrepreneurs?

Last week I was talking to an entrepreneur that’s in the process of raising money. Naturally, I asked what he planned on doing with the money and got the expected response: hire 10 new team members including software engineers, sales reps, one support rep, and one customer success manager. Awesome, now for the hard question: how many of the positions do you already have candidates lined up and ready to go? Answer: 0.

Here are a few thoughts on building a recruiting pipeline prior to financing:

• Recruiting without a hard and fast start date is harder than normal recruiting, but still the same process (word of mouth, referrals, LinkedIn, social media, recruiters, etc)
• One challenge is expectation setting around timing of when the financing will close and a potential start date, especially if the candidate has multiple offers
• Recruiters can be a good resource and understand the role of fundraising in startups along with nurturing candidates
• When money is raised there’s an expectation to put it work quickly, and hiring is often the largest area of investment

Entrepreneurs would do well to build a recruiting pipeline prior to financing so that they have great candidates lined up that can come on board as quickly as possible.

What else? What are some more thoughts on the idea of recruiting candidates in advance of having the resources to hire them?

After yesterday’s post Sell 20% of the Equity Per Round of Investment, I received a number of good comments about other factors that affect the equity splits between non-investors and investors. Overall, the main idea is that entrepreneurs often sell too much of their company too soon and should plan for multiple rounds of financing. Now, there are a number of things that affect equity percentages in a startup:

• Pro-Rata Participation – Do the existing investors continue to participate pro-rata in subsequent rounds? Almost all investors require the option to continue putting money into a company to keep their ownership percentage in subsequent funding rounds.
• Preferred Stock Preferences – Preferred stock, which is commonly sold to investors, often requires that it get paid back first before anyone else makes money. Sometimes, the preferred stock has a preference on it such that the investor gets a multiple of the money invested and then their percentage ownership of the company (e.g. they get a higher percentage of the financial proceeds, compared to equity ownership, until a certain amount is met).
• Lines of Credit – Many venture banks, like Silicon Valley Bank and Square 1 Bank, ask for warrants in the range of .5% to 1% of the company as part of the loan.
• Stock Option Plans – Typically, a new stock option plan and pool of equity is created after each funding round thereby diluting all shareholders.
• Boards and Advisors – Independent board members and advisors to the startup are often compensated with equity in the range of .1-1% (board members earn more than advisors).

Of course, this doesn’t include the entrepreneurs, team members, and investors that own equity as well. Equity dilution is a normal and standard part of the startup world and it’s important to understand common items that influence it.

What else? What are some other items that can dilute equity in a startup?

Back when we tried to raise venture money for Pardot in late 2009, we reached the term sheet stage with a number of investors. One of the investors that we talked to really wanted to invest $5 million in the company at a $7 million pre-money for a post-money valuation of $12 million. Divide 5 into 12 and you get 42% — the investor wanted to buy 42% of the business as our Series A round. After building a spreadsheet of different scenarios, especially taking into account the growth rate at the time, it was clear that we were better off not raising money and growing organically. Selling 42% of the business with our first round of financing didn’t make sense.

After talking to other entrepreneurs and reading about best practices online, my advice to entrepreneurs is to not sell more than 20% of the business per round, with 25% OK on occasion, if needed. The biggest reason why is that it’s likely there will be more rounds of financing in the future, and each round compounds the dilution to the entrepreneurs. Here’s how four rounds of financing works out selling 20% each time:

• Round 1 – 80% non-investors and 20% investors
• Round 2 – 60% non-investors and 40% investors
• Round 3 – 40% non-investors and 60% investors
• Round 4 – 20% non-investors and 80% investors
• Note: Investor ownership will be slightly reduced by new stock option plans as well as pro-rata non participation

If the amount the investors buy each time increases to 30% or 35%, you can see how little the non-investors have at the end. Now, if the company sells for a billion dollars, everyone is happy. In reality, most exits are for less than $50 million, making it ideal for entrepreneurs to minimize the amount of dilution for each round of funding knowing that most venture-backed startups raise multiple rounds.

What else? What are some more thoughts on the idea that entrepreneurs should sell roughly 20% of the equity per round of investment?

While I’m not a fan of putting much time into an exit strategy (see When an Exit Strategy Discussion is Required and The Best Exit Strategy is to Not Have One), it is important to align expectations with investors around the ideal exit outcome. Now, it might seem like investors want to make as much money as possible, but the reality is that many investors, especially institutional investors, have a target rate of return (e.g. 20% per year or three times the cash invested within a few years).

As an entrepreneur, the ideal exit needs to be discussed with investors. Here are a few questions to think about:

• Are the investors looking for an exit that returns the entire fund?
• Are the investors looking for a deal that will return 10 times their money?
• Are the investors looking to return at least 10% of their fund on an exit?
• Are the investors requiring blocking rights on the sale of the company unless they generate a certain return?

For an entrepreneur that has a personal goal of selling the company for $25 million and pocketing $5 million, it wouldn’t make sense to raise venture money from a big firm at a large valuation. On the other hand, if the entrepreneur raises money from angel investors or a family office that wants to make 5x their money, it could be a good arrangement assuming an appropriate pre-money valuation.

Entrepreneurs would do well to discuss the ideal exit with their investors.

What else? What are some more thoughts on discussing the ideal exit with investors?

Recently an entrepreneur signed a lease on a new, much larger office and was surprised to learn that the media knew about the deal. Now, the media didn’t learn about the deal the following week or the following day. No, the media was leaked the deal the same day the ink dried. Crazy, right? Why is the commercial real estate industry so eager to share info with the media?

Answer: commercial real estate brokers and the media help each other. The media wants breaking news and compelling stories. Commercial real estate brokers are one of the first people to know if a company is expanding, shrinking, or relocating. Leasing agents at buildings interact with a number of businesses as they evaluate lease options and most don’t have a non-disclosure agreement in place. When an entrepreneur is about to sell his or her company, they have to get the owner of their lease to agree to assign the lease to the new acquirer, and now a commercial real estate broker knows a deal is about to go down and passes it on to the media.

In turn, the media shares information back to the commercial real estate brokers for the same reasons. Brokers want to know about potential deals, especially if they can get a head-start on chasing down a new prospect before the news breaks to the public. Brokers make money when a deal gets done. No deals, no money.

Entrepreneurs would do well to understand the relationship between the commercial real estate industry and the media, especially as their business grows and goes through changes that involve office space.

What else? What are some more thoughts on the relationship between commercial real estate and the media?