Don Dodge on The Next Big Thing

Startup founders can have their cake and eat it too

Back in the day Venture Capitalists were  king makers. They decided who got funded, facilitated strategic partnerships, and brokered M&A transactions for their portfolio companies. The world has changed...a lot. Evelyn Rusli wrote an insightful story for the New York Times about how startup founders are more in control now. Angel Investors are willing to invest more at higher valuations, and Private Equity investors are willing to invest huge sums at later stages and allow founders to cash in some of their stock. VCs are left in the middle with much less power.

Now startup founders can "have their cake and eat it too". They can get the funding they need to start or expand their company, AND maintain ownership control, AND take some money off the table by cashing in some of their stock before an exit. This is a big change.

Traditional Venture Capital (VC) investors would invest $1M to $3M in a Series A and take 40% to 60% of the company. More importantly, they would take Board seats, and sometimes control the company. Sometimes the BOD would replace the founders with seasoned executives, and later take on additional rounds of financing that would dilute the founders ownership to minimal levels. The VCs had all the power. Not anymore. From Evelyn Rusli's the New York Times story;

“For the next-generation opportunities around the Internet and social networks, I believe the biggest opportunities will be driven by young founders who maintain their C.E.O. positions,” said Jim Breyer, an early investor in Facebook and a partner at Accel Partners.

Angel Investors, "Super Angels" and some forward thinking VCs like Founders Fund and Accel Partners changed all that. Angels are typically wealthy entrepreneurs that have started and sold several companies. They are founders themselves and identify with the startup founders. Ron Conway, Mike Maples, Aydin Senkut, Jeff Clavier, Paul Graham, Brad Feld, Dave McClure, Paige Craig, and lots of former employees of PayPal, Google, Facebook, etc. are very active Angel investors. Often they can invest enough to cover what would have been a traditional VC Series A round.

Later stage investors like Yuri Milner (DST), Founders Fund, and Andreessen Horowitz are willing to invest from $50M to hundreds of millions in private companies at very high valuations. In the past only an IPO could support such high valuations. Not anymore. Now later stage investors are investing at billion dollar valuations and allowing founders to cash out some of their stock. In the NYT story, Andrew Mason, founder of Groupon says;

“By taking money off the table, you’re expunging a big source of risk, allowing you to focus on the interests of the company you’re building instead of your own,” said Andrew Mason, the 30-year-old founder and chief executive of Groupon. He said he was able to sell some of his shares in D.S.T. Global’s initial Groupon investment, a $135 million round last April.

Still Not Easy - Plentiful capital, and low cost of startup resources like Open Source software, cheap hosting, and pay as you go services, has made it fast and cheap to start a company. That doesn't mean it is easy. Far from it. It may be easier to start a company, but it is much harder to be discovered and gain traction with users and customers. There is a lot of competition for user attention.

There is another disruption happening in Press, PR, and startup promotion. The traditional PR agencies are of diminishing importance. The press editors don't have the king maker power they once had. The old line startup conferences can't charge the high prices they once did. Social media, blogs, Twitter, and Facebook are changing the way startups market to their customers. Techcrunch Disrupt, Ycombinator, Launch Conference, and TechStars provide a grand stage for startups to strut their stuff for little or no cost. That is disruptive.

All these changes have put more power in the hands of the startup founder. That is a good thing.

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Startup founders can have their cake and eat it too

Back in the day Venture Capitalists were king makers. They decided who got funded, facilitated strategic partnerships, and brokered M&A transactions for their portfolio companies. The world has changed...a lot. Evelyn Rusli wrote an insightful story for the New York Times about how startup founders are more in control now. Angel Investors are willing to invest more at higher valuations, and Private Equity investors are willing to invest huge sums at later stages and allow founders to cash in some of their stock. VCs are left in the middle with much less power.

Now startup founders can "have their cake and eat it too". They can get the funding they need to start or expand their company, AND maintain ownership control, AND take some money off the table by cashing in some of their stock before an exit. This is a big change.

Traditional Venture Capital (VC) investors would invest $1M to $3M in a Series A and take 40% to 60% of the company. More importantly, they would take Board seats, and sometimes control the company. Sometimes the BOD would replace the founders with seasoned executives, and later take on additional rounds of financing that would dilute the founders ownership to minimal levels. The VCs had all the power. Not anymore. From Evelyn Rusli's the New York Times story;

“For the next-generation opportunities around the Internet and social networks, I believe the biggest opportunities will be driven by young founders who maintain their C.E.O. positions,” said Jim Breyer, an early investor in Facebook and a partner at Accel Partners.

Angel Investors, "Super Angels" and some forward thinking VCs like Founders Fund and Accel Partners changed all that. Angels are typically wealthy entrepreneurs that have started and sold several companies. They are founders themselves and identify with the startup founders. Ron Conway, Mike Maples, Aydin Senkut, Jeff Clavier, Paul Graham, Brad Feld, Dave McClure, Paige Craig, and lots of former employees of PayPal, Google, Facebook, etc. are very active Angel investors. Often they can invest enough to cover what would have been a traditional VC Series A round.

Later stage investors like Yuri Milner (DST), Founders Fund, and Andreessen Horowitz are willing to invest from $50M to hundreds of millions in private companies at very high valuations. In the past only an IPO could support such high valuations. Not anymore. Now later stage investors are investing at billion dollar valuations and allowing founders to cash out some of their stock. In the NYT story, Andrew Mason, founder of Groupon says;

“By taking money off the table, you’re expunging a big source of risk, allowing you to focus on the interests of the company you’re building instead of your own,” said Andrew Mason, the 30-year-old founder and chief executive of Groupon. He said he was able to sell some of his shares in D.S.T. Global’s initial Groupon investment, a $135 million round last April.

Still Not Easy - Plentiful capital, and low cost of startup resources like Open Source software, cheap hosting, and pay as you go services, has made it fast and cheap to start a company. That doesn't mean it is easy. Far from it. It may be easier to start a company, but it is much harder to be discovered and gain traction with users and customers. There is a lot of competition for user attention.

There is another disruption happening in Press, PR, and startup promotion. The traditional PR agencies are of diminishing importance. The press editors don't have the king maker power they once had. The old line startup conferences can't charge the high prices they once did. Social media, blogs, Twitter, and Facebook are changing the way startups market to their customers. Techcrunch Disrupt, Ycombinator, Launch Conference, and TechStars provide a grand stage for startups to strut their stuff for little or no cost. That is disruptive.

All these changes have put more power in the hands of the startup founder. That is a good thing.

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If they aren't ready to listen, it doesn't matter what you say

Every salesperson knows this, but many entrepreneurs don't. If they aren't ready to listen, it doesn't matter what you have to say. Saying it five different ways won't help. Saying it louder, faster, more often, or getting other people to say it for you won't help either. Better to move on to the next opportunity, and come back to this one when they are ready to listen.

This is true for pitching VCs (Venture Capitalists), potential partners, strategic acquirers, customers, prospective employees...and just about everyone else. One young entrepreneur told me it was true of dating too.

So, why is it always a surprise to us when the other party won't listen? Well, we believe so much in what we have to say that we can't imagine anyone not wanting to hear it...and act upon it.

When I worked at Microsoft I would often find new startups that were doing amazing innovative things that could really add value to what Microsoft was doing. If the timing was right, and the product group was ready to listen, things happened very quickly...and successfully. I remember when I first saw Xobni I knew instantly that this would be great for Microsoft Outlook. I immediately sent a note to the top people in the Outlook group. They responded the next day and met with them the following day. Within a week or two Bill Gates was demoing Xobni to thousands of people on stage at the Microsoft Office Developers Conference.

Then there is the normal case. A year or two later I met the people from Gist. I was impressed. Gist had a great collaboration product that worked nicely with Outlook email. Gist captured all the relevant data, from lots of different sources, about a person in context of the email in front of you. The founders previously worked at Microsoft. Brad Feld, a personal friend, and well known within Microsoft, was a major investor. So, this should be easy, right? Wrong. The product group was not ready to listen. No matter what I did, or who I talked to...nothing.

Fast forward 18 months. I bring Gist to Google and they totally get it. Yesterday Google made an announcement about Gmail Contextual Gadgets. Gist (and Xobni) were part of the announcement. So, the people at Google are smarter than the people at Microsoft, right? Not really...maybe in some cases...but that isn't why it worked. It happened because the timing was right. They were ready to listen. Google had a product announcement coming up and needed ISV products to showcase.

I must say that Gist and Xobni both pulled off amazing engineering feats to get this done within days. They worked around the clock to meet an impossible schedule. The people at Google were amazed they did it. Now, Gist and Xobni could have said "Forget it. I have been down that road before and no one listened. I'm not going to turn my world upside down for you guys". They would have been completely justified in saying that. But, they saw opportunity and pounced on it.

So, why won't they listen? Lots of reasons. They could be totally heads down on a product release driving like crazy to a deadline. They could have other priorities that trump this one. They could have a similar idea already in the works. Or, they just simply aren't interested.

Things change with time. In the past I have taken a company or idea back to a group six months later...and they loved it. What changed? They were ready to listen. They were actively looking for ideas or solutions to problems they didn't know they had six months earlier.

Lesson for entrepreneurs - Focus on people that immediately get it. It won't be obvious to you who they are or where to find them. They will self select. They will react positively almost immediately. Pitch to everyone you see..all the time. You never know who will "light up" on your idea and want to help you. This goes for investors, customers, partners, potential employees, etc.

Don't waste time trying to convert someone who isn't ready to listen. Move on to the next prospect. Go back to the doubters later with a fistful of customers or partners. Or better yet, let them come to you...when they are ready to listen.

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Start a company in a recession? Absolutely!

Now is a great time to start a company. Why? Because great people are available to join you, VCs are loaded with cash, and office space is available cheap. Everything is cheap and readily available in a recession.

Paul Graham says "If we've learned one thing from funding so many startups, it's that they succeed or fail based on the qualities of the founders."  "Which means that what matters is who you are, not when you do it."

In good times all the really great people are busy doing fun projects...and not available to join you in a startup. In bad times projects are cut, people are laid off, and big companies retrench to improving the existing stuff. New projects don't get any budget. So, great people get bored and start looking for the Next Big Thing...a cool startup.

Raising money is a little harder, but not much. Good teams with good ideas can always get VC/Angel funding. In fact, VCs are sitting on tons of cash right now...and they want to invest it in hot new startups. Many VCs are reluctant to dump more money into an existing startup that is struggling, but will invest in a new startup idea. The promise is always more appealing than the reality.

Everything else is cheap and readily available too. Office space is always cheaper and more available in a recession. Existing companies will sub-lease space really cheap to offset some costs. Computers, software, networks, desks, equipment...everything is cheaper.

Expectations are lower during bad times so it is a good time to be in development mode, building a product, getting an audience, and starting a tiny revenue stream.

Customers are willing to try new things to save money in bad times. When things are going great they don't want to take risks on a tiny startup. If you can save them money in bad times...they are happy to deal with a startup.

Go for it! Now is a great time to build your great idea into a company.

Billions of VC Dollars in Boston

Commonwealth Capital held their annual open house this week at their Winter Street offices on "VC Hill" in Waltham. VC Hill is to Boston/Waltham what Sand Hill Rd is to Silicon Valley...the center of Venture Capital for the region.

Commonwealth Capital recently closed on a large new venture capital fund. Longworth Ventures, another Boston/Waltham based VC firm, also recently closed a new fund. In fact, over the past year or so, several Boston firms have raised over $2 Billion in venture capital. While the financial markets on Wall Street are in a panic, the venture capital community in Boston is strong, with billions of dollars to invest in innovative startups.

Boston based VC firms that have raised funds over the last year or so include; Flybridge Venture Capital, Spark Capital, Fairhaven Capital, Commonwealth Capital, Longworth Venture Partners, Battery Ventures, 406 Ventures, Ascent Venture Partners, and Staley Capital. The total funds raised exceeds $2 Billion. If you look over the past three years the funds raised in Boston exceeds $10B, with giant firms like Polaris Ventures, Highland Capital, and General Catalyst raising huge funds.

Microsoft is making a big commitment to innovation in Boston area as well. Microsoft has established a campus at One Memorial Drive in Cambridge, strategically located right next to MIT, just across the river from Boston.

The company has established a new research lab there under the direction of Jennifer Chayes and Christian Borgs that will work with MIT, Harvard, and other area universities to further strengthen the research community in Boston.

There is also a group called Microsoft Startup Labs, a kind of internal idea incubator for quickly building and testing new products and services. The lab, under the direction of Reed Sturtevant, is recruiting a top notch team of developers and former entrepreneurs.

There are several other Microsoft groups at the Cambridge campus including a UC design team and the App Virtualization team. All of them are hiring.

See Microsoft Careers for a complete listing of job openings in the Boston/Cambridge area.

It’s Microsoft’s intent to work closely with Boston area universities, research labs, and the venture capital community to ensure the Greater Boston area remains a vibrant center for entrepreneurship and innovation.

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Ycombinator startup demo day Boston 2008

Y Combinator provides seed stage capital and a 10 week startup boot camp for budding entrepreneurs. At the end of the 10 week session Y Combinator invites VCs and angels to an investor day / demo day. Today YC unveiled 20 new startups to about 80 Boston area VCs and investors. Scott Kirsner (Boston Globe) and Roger Krakoff (Sigma Partners) are pictured here in the first row.

The companies covered areas like; a startup job site, video conferencing, cloud database software, a site for students, a news aggregation service, photo-sharing, social browsing, POS customer satisfaction surveys, white labeled social news, audience response software, music distribution, green certification, site creation for small business, a mobile-focused Evite competitor, a secondary ticket market, an event site, and a comment crawler.

These companies are only 10 weeks old, so some haven't launched yet and are still in stealth mode. Here is a summary of some of the companies that have launched.

Frogmetrics - puts touch screen devices into the hands of customers to get accurate, real-time feedback at the Point Of Sale. Frogmetrics measures customer satisfaction, employee performance, and advertising effectiveness to tell businesses what their customers think about products, services, and employees. Survey response rates typically exceed 85%.

The software aggregates data from unlimited locations, highlights significant trends, and helps companies gain insight into business performance—instantly, from any web browser.

Posterous is dead simple blogging by email. Just send text and attachments to post@posterous.com—no signup and no setup. You can photos, audio, video, documents, and rich text. Posterous automatically sets up a blog for you, then sends you an email reply with the URL address of your new blog.

TicketStumbler - a site to find and buy tickets to sporting events. Similar to StubHub, except TicketStumbler aggregates tickets from all the various ticket resellers. You can search by date, price, location, etc.

Best line of the day came from the TicketStumbler presenters "People go to Facebook to "poke" friends or some useless thing. People come to TicketStumbler to buy tickets. We make money on every sale."

Anyvite - Similar to Evite, a way to create events and invite guests. Ideal for the small to medium events. Simple to use. Guests can use email, SMS or IM to be notified of new events, and to respond without even visiting the site. Anyvite’s fully integrated mobile interface gives users the freedom to create and manage their events at any time and from any place.

Job Alchemist - a site for online recruiting, launched Startuply, a startup-specific job site, in July 2008. New sites targeted to specific industries and communities can be launched and populated in as little as 30 days.

Their next product will be JobSyndicate, a distributed affiliate job network. Companies put recruiting bounties on jobs, and anyone can use the widget technology to advertise these jobs on their site. When a publisher sources an applicant who gets hired, they get half the bounty: a payout of $2-10K or more.

There were several other interesting companies that I can't talk about yet because they are still in stealth mode. The 20 companies this year were very polished and business focused. The Boston area VCs are paying attention to Ycombinator now.

Some of the VCs I talked to included; David Hornik (August Capital), Fred Wilson (Union Square Ventures), David Beisel (Venrock), David Baum (Stage 1 Ventures), Rich Lavendov (Avalon), Roger Krakoff (Sigma Partners), Neil Sequiera, David Orfao, and Joel Cutler (General Catalyst), Eric Hjerpe (Atlas), Jeff Glass (Bain Capital), Bijan Sabet and Rob Go (Spark Capital),  Saar Gur (Charles River Ventures), Jonathan Seelig (Globespan Capital), and Jo Tango (Kepha).

Dharmesh Shah (HubSpot), Bob Buderi (Xconomy) and Scott Kirsner (Boston Globe) attended the YC Demo Day and wrote reports on their blogs.

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Why VCs say no 99% of the time

Venture Capital investing is a very tough game...and very lucrative if you are good at it. Part of my job at Microsoft is working with VCs, so I have learned a lot about the way they think...and why they say No to 99% of the deals they see...and still end up making investments that fail.

Fred Wilson has another great post today on Venture Fund Economics which I covered in my previous post. After posting that I remembered a blog post by Jeff Bussgang, of Flybridge Capital Partners. In it Jeff explains why VCs want to see every new startup...but say no 99% of the time.

"As one wise old VC once told me, "the trick in this business is to spend very little time on a lot of deals, and then a lot of time on very few deals."  In other words, see everything to be a better investor, but exert a very tough first filter so that you only spend time on very, very few deals.  In my experience, a typical VC has the bandwidth to actively "spend time" or actively work on only one to two deals at any given time and perhaps 10-20 in a year -- as compared to those 300-500 they get exposed to."

What are the odds? - VCs are exposed to about 500 opportunities a year. They spend time seriously looking at about 20 companies a year, and invest in two or three. So, they say no about 99% of the time.

We all say no 99% of the time - I would guess that every one of you reading this blog have a stock portfolio with 5 to 10 individual stocks or mutual funds. There are more than 5,000 publicly listed companies to choose from, and another 5,000 mutual funds. But, out of 10,000 possible companies you chose 10 to invest in. Why? Why did you reject the other 9,990 companies? Obviously there are more than 10 good companies to invest in. Other investors chose to invest their money in the other 9,990 companies...why not you?

We invest in people we know and companies we understand - We do this in our own personal investing, and VCs, with rare exceptions, do the same when they make decisions. We all say no 99% of the time, and we reject perfectly good companies, but we invest in things we feel comfortable with.

Here is the painful fact; even after being very picky and saying no to 99% of the opportunities...we still invest in failures about 33% of the time. VCs do it all the time, and if we look dispassionately at our own personal investment track record...we probably do too.

Find the right VC match - Don't be too quick to change your strategy or company pitch just because the first batch of VCs rejects it. It is all about finding the right VC that is interested in what you are doing and comfortable in the market space. Don't waste time trying to convince a reluctant VC. Move on and spend the time finding the right VC for you...that "gets it" the first time. There are at least 1,000 VCs in the USA. They all have different investment tastes...just like all of us do. Go for it!

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Why VCs look for 10X returns - What you need to know when pitching a VC firm

VCs want to invest at least $5M in startups that have potential 10X returns. That is because it takes as much time to manage a $1M investment as it does to manage $5M. Secondly, every startup looks like a winner when they write the check, but Fred Wilson suggests that 33% will fail, 33% will break even, and 33% will be big winners. VCs start out hoping for a 10X return on every deal but average about 3X to 4X after all is said and done.

VC Firm Partners - If a VC firm raises a $250M fund they will probably have 5 partners in the firm, with each partner managing about $50M. If they invest about $5M in each company over several rounds, then each partner will sit on 10 company boards. That is about all a single partner can handle and still do a good job for the portfolio companies.

VC Firm Investors - VC firms raise money from Limited Partner investors like insurance companies, pension funds, university endowments, and wealthy individuals. These investors know that venture investing is risky and expect higher returns to compensate for the risk, typically 3X their money over the 10 year life of the fund, or a net IRR of 30%. More on this later.

VC Firm Economics - VCs usually take a 2% - 3% annual management fee and 20% to 25% (carried interest) of any capital gains on exits. So, when you take out the VC fees and gains, and factor in the LP investor expectations, what does the VC fund have to return? Fred Wilson of Union Square Ventures did a great post on this and provided some real numbers on his model.

There are a lot of numbers here, but if you study them carefully they explain almost every question you might have about how a VC firm works.

VC Fees and Gains - Note that on a typical $100M fund management fees can take $20M off the top, so there is only $80M left to invest. That 2% annual management fee over the 10 year life of a fund really adds up. Also note that if the fund returns 4X on invested capital (4 X $80M = $320M) that the VC gets 20% of the gain or $44M ($320M - $80M = $240M, less the $20M in fees = $220M. The VC gets 20% of that gain or $44M.

On a $100M fund the VC gets $20M in fees and $44M in gains over the 10 year life of the fund. Now you know why everyone wants to be a VC.

VC Limited Partner Returns - In this case the LPs invest $100M and get back $256M, or about 2.5 times their money. Because they invest their money over the first 4 years of the fund, and collect their returns over the last 5 years of the fund, their Internal Rate of Return (IRR) averages about 30%.

What does this mean to entrepreneurs? - When you pitch to a VC you need to show the "potential" for a 10X return. The truth is that no VC knows which company will return 10X and which one will fail and lose all the money. Believe me, if they knew...they would only invest in the winners. Like I said, they all look like winners when they write the checks.

VCs will not invest in startups that address a small niche market, or companies that are profitable but don't look like they can bring 10X returns. They are not interested in potential 4X returns because they know that on average 66% of all investments will either fail or break even. If a company starts out looking like a 4X return, chances are, given the long VC history, it will break even at best. It is like probabilities in poker.

So, here is the inside secret to all of this. Build your plan on a 10X return, expect a 4X return, and hope you don't end up in the 33% failure category.

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The 7 deadly sins and 10 lessons of a failed startup

Failure is part of the maturing process in the startup world. If you haven't failed...you aren't trying hard enough, or you aren't  "pushing the envelope" far enough. I have always said "Success is a terrible teacher. Success masks over flaws that may hurt you later."

Roger Ehrenberg - the co-founder of Monitor 110, wrote a story on the lessons he learned from this recently failed startup. [found via Fred Wilson] He lists "seven deadly sins" that lead to their demise.

• The lack of a single, "the buck stops here" leader until too late in the game
• No separation between the technology organization and the product organization
• Too much PR, too early
• Too much money
• Not close enough to the customer
• Slow to adapt to market reality
• Disagreement on strategy both within the Company and with the Board

In my opinion there are two key reasons Monitor 110 failed; first, no clear CEO leader, and second, too much money. Trying to run a startup as a group of friends or make decisions by committee will never work. Too much money allows you to waste time, ignore danger signals, and continue down a wrong path for too long.

More Lessons - But here is the story of GameClay, another startup failure at the other end of the spectrum. They didn't raise any VC money...and still failed. [Found via Jeremy Liew]

1. If your idea starts with “We’re building a platform to…” and you don’t have a billion dollars in capital, find a new idea. Now.
2. It’s a marathon, but it’s a marathon made of sprints
3. Initial conditions matter. A lot.
4. Developing in a vacuum never works.
5. Beware the chicken and the egg.
6. Prototype any 3rd-party libraries that you’ll be depending upon, before you base your product on them.
7. If you’re doing anything other than building your project and getting users, it’s premature.
8. The product will take longer than you expect. Design for the long-term.
9. People have an incentive not to crush your dreams. Take everything they say with a grain of salt.
10. Know your limitations.

Building a startup is the most difficult, and most rewarding, thing anyone can do. Sometimes you can even make some money at the end of it all. There are so many things that can go wrong it is a miracle when a startup actually makes it.

It is important to celebrate our successes, learn from our failures, and value them equally. Failure is important...because success is a terrible teacher.

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IPO market ups and downs - Q2 worst in 30 years

Not one single VC backed company went public in the 2nd quarter of 2008 according to the New York Times. The last time that happened was 30 years ago. However, 2007 was one of the best years for IPOs since the dot com bubble of 1999. Such are the cycles of VC investing and IPO exits.

	Investments	Returns
Year	VCs	M&A	IPO
2001	$32.1	$16.8	$3.5
2002	$22.1	$7.9	$2.1
2003	$19.6	$7.7	$2.0
2004	$22.4	$15.4	$11.0
2005	$23.7	$16.0	$4.5
2006	$25.5	$17.1	$5.1
2007	$29.4	$25.4	$10.3
Totals	$174.8	$106.3	$38.5

Fear is temporary, greed is permanent. We are in a "fear" cycle now. There is fear in the public IPO markets due to slow growth, high oil prices, and recession fears.

VCs continue to raise funds and invest aggressively. Last year VCs invested nearly $30 Billion, the most since 2001. VCs have a long term view. They don't expect their investments to pay off for at least 5 years, sometimes much longer.

Fred Wilson has an interesting post today that includes this 10 year chart of the Dow Jones Industrial Average for the 1970s.

The Dow tanked in 1974 when OPEC put on an oil embargo that caused wide spread shortages and gas prices to sky rocket. The 70s were a dismal decade for business and investing. The Dow hovered around 900 and hit 1,000 just twice in the decade. It is hard to imagine now with the Dow around 12,000, but we have seen massive swings, up and down, in the 30 years since the last oil crisis.

Is this IPO market "goose egg" a one time thing? Will M&A transactions remain strong? What do you think?

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