Posts from March 2010

The Meetup Trade

David Brooks, New York Times columnist, has a piece up called The Sandra Bullock Trade which talks about how fame and fortune are no match for a good marriage. I agree with David on that one and consider myself very lucky to have found such a wonderful person as The Gotham Gal to spend my time on earth with.

Brooks goes on to cite research about things that make us happy and things that don't. And of course, money doesn't make us nearly as happy as solid relationships. But I was a bit surprised by this finding:

According to one study, joining a group that meets even just once a
month produces the same happiness gain as doubling your income.

Our portfolio company Meetup.com is a bargain because you can join any group you want for free. It may cost you a small fee to attend the meetup but many of them are free to attend too. If you want to test this "joining a meetup group is better than doubling your income", go here and find one and see what you think. 

Cash Flow

This week on MBA Mondays we are going to talk about cash flow. A few weeks ago, in my post on Accounting, I said there were three major accounting statements. We’ve talked about the Income Statement and the Balance Sheet. The third is the Cash Flow Statement.

I’ve never been that interested in the Cash Flow Statement per se. The standard form of a cash flow statement is a bit hard to comprehend in my opinion and I don’t think it does a very good job of describing the various aspects of cash flow in a business.

That said, let’s start with the concept of cash flow and we’ll come back to the accounting treatment.

Cash flow is the amount of cash your business either produces or consumes in a given period, typically a month, quarter, or year. You might think that is the same as the profit of the business, but that is not correct for a bunch of reasons.

The profit of a business is the difference between revenues and expenses. If revenues are greater than expenses, your business is producing a profit. If expenses are greater than revenues, your business is producing a loss.

But there are many examples of profitable businesses that consume cash. And there are also examples of unprofitable businesses that produce cash, at least for a period of time.

Here’s why.

As I explained in the Income Statement post, revenues are recognized as they are earned, not necessarily when they are collected. And expenses are recognized as they are incurred, not necessarily when they are paid for. Also, some things you might think of as expenses of a business, like buying servers, are actually posted to the Balance Sheet as property of the business and then depreciated (ie expensed) over time.

So if you have a business with significant hardware requirements, like a hosting business for example, you might be generating a profit on paper but the cash outlays you are making to buy servers may mean your business is cash flow negative.

Another example in the opposite direction would be a software as a service business where your company gets paid a year in advance for your software subscription revenues. You collect the revenue upfront but recognize it over the course of the year. So in the month you collect the revenue from a big customer, you might be cash flow positive, but your Income Statement would show the business operating at a loss.

Cash flow is really easy to calculate. It’s the difference between your cash balance at the start of whatever period you are measuring and the end of that period. Let’s say you start the year with $1mm in cash and end the year with $2mm in cash. Your cash flow for the year is positive by $1mm. If you start the year with $1mm in cash and end the year with no cash, your cash flow for the year is negative by $1mm.

But as you might imagine the accounting version of the cash flow statement is not that simple. Instead of getting into the standard form, which as I said I don’t really like, let’s talk about a simpler form that gets you to mostly the same place.

Let’s say you want to do a cash flow statement for the past year. You start with your Net Income number from your Income Statement for the year. Let’s say that number is $1mm of positive net income.

Then you look at your Balance Sheet from the prior year and the current year. Look at the Current Assets (less cash) at the start of the year and the Current Assets (less cash) at the end of the year. If they have gone up, let’s say by $500,000, then you subtract that number from your Net Income. The reason you subtract the number is your business used some of your cash to increase its current assets. One typical reason for that is your Accounts Receivable went up because your customers are taking longer to pay you.

Then look at your Non-Current Assets at the start of the year and the end of the year. If they have gone up, let’s say by $500k, then you also subtract that number from your Net Income. The reason is your business used some of your cash to increase its Non-Current Assets, most likely Property, Plant, and Equipment (like servers).

At this point, halfway through this simplified cash flow statement, your business that had a Net Income of $1mm produced no cash because $500k of it went to current assets and $500k of it went to non-current assets.

Liabilities work the other way. If they go up, you add the number to Net Income. Let’s start with Current Liabilities such as Accounts Payable (money you owe your suppliers, etc). If that number goes up by $250k over the course of the year, you are effectively using your suppliers to finance your business. Another reason current liabilities could go up is Deferred Revenue went up. That would mean you are effectively using your customers to finance your business (like that software as a service example earlier on in this post).

Then look at Long Term Liabilities. Let’s say they went up by $500k because you borrowed $500k from the bank to purchase the servers that caused your Non-Current Assets to go up by $500k. So add that $500k to Net Income as well.

Now, the simplified cash flow statement is showing $750k of positive cash flow. But we have one more section of the Balance Sheet to deal with, Stockholders Equity. For Stockholders Equity, you need to back out the current year’s net income because we started with that. Once you do that, the main reason Stockholders Equity would go up would be an equity raise. Let’s say you raised $1mm of venture capital during the year and so Stockholder’s Equity went up by $1mm. You’d add that $1mm to Net Income as well.

So, that’s basically it. You start with $1mm of Net Income, subtract $500k of increased current assets, subtract $500k of increased non-current assets, add $250k of increased current liabilities, add $500k of increased long-term liabilities, and add $1mm of increased stockholders equity, and you get positive cash flow of $1.75mm.

Of course, you’ll want to check this against the cash balance at the start of the year and the end of the year to make sure that in fact cash did go up by $1.75mm. If it didn’t, then you have to go back and check your math.

So why would anyone want to do the cash flow statement the long way if you can simply compare cash at the start of the year and the end of the year? The answer is that doing a full-blown cash flow statement tells you a lot about where you are consuming or producing cash. And you can use that information to do something about it.

Let’s say that your cash flow is weak because your accounts receivable are way too high. You can hire a dedicated collections person. You can start cutting off customers who are paying you too late. Or you can do a combination of both. Bringing down accounts receivable is a great way to improve a business’ cash flow.

Let’s say you are spending a boatload on hardware to ramp up your web service’s capacity. And it is bringing your cash flow down. If you are profitable or have good financial backers, you can go to a bank and borrow against those servers. You can match non-current assets to long-term liabilities so that together they don’t impact the cash flow of your business.

Let’s say your current liabilities went down over the past year by $500k. That’s a $500k reduction in your cash flow. Maybe you are paying your bills much more quickly than you did when you started the business and had no cash. You might instruct your accounting team to slow down bill payment a bit and bring it back in line with prior practices. That could help produce better cash flow.

These are but a few examples of the kinds of things you can learn by doing a cash flow statement. It’s simply not enough to look at the Income Statement and the Balance Sheet. You need to understand the third piece of the puzzle to see the business in its entirety.

One last point and I am done with this week’s post. When you are doing projections for future years, I encourage management teams to project the income statement first, then the cash flow statement, and then end up with the balance sheet. You can make assumptions about how the line items in the Income Statement will cause the various Balance Sheet items to change (like Accounts Receivable should be equal to the past three months of revenue) and then lay all that out as a cash flow statement and then take the changes in the various items in the cash flow statement to build the Balance Sheet. I like to do that in monthly form. We’ll talk more about projections next week because I think this is a very important subject for startups and entrepreneurial management teams to wrap their heads around.

How To Defend Your Reputation

Mike Arrington has a timely post up today titled Reputation Is Dead: It's Time To Overlook Our Indiscretions. He says:

Trying to control, or even manage, your online reputation is becoming
increasingly difficult. And much like the fight by big labels against
the illegal sharing of music, it will soon become pointless to even try.

It's a good post and a really good discussion to be having right now. Go read the post.

I agree that controlling your online reputation is becoming increasingly difficult. But I do not think it is pointless. Reputation is everything and there is a way to fight back. I talked about it in a post a few weeks ago called Own Your Online Brand.

I care deeply about my reputation and have defended it vigorously when others have said things about me that are untrue. But you can go one step further with social media. You can establish your reputation and others will stand up for you as well.

Here's an exchange on Hacker News that happened a few weeks ago.

Hacker news convo

This person fnid2 has an axe to grind about me and has been doing it frequently at Hacker News. You'll see that Mark Essel, an active member of this community, took the time to come to my defense.

So while I agree 100% with Mike that defending your reputation is getting increasingly difficult because of social media, I also believe that social media is the key to defending it and maintaining it. If you want to hear more of my thoughts on this topic, read the Own Your Online Brand post where I explain in more detail.

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Does Rest Of World Matter More Than The US?

I spent some time on Comscore this morning looking at US vs Rest Of World traffic for some of the largest web properties. Here are the stats for Feb 2010:

Google: 890mm worldwide visitors, 745mm non US – 84% non US

Facebook: 471mm worldwide visitors, 370mm non US – 78% non US

Twitter: 74mm worldwide users, 53mm non US – 72% non US

I suspect Facebook and Twitter will both end up north of 80% once their internationalization efforts are fully realized. Facebook is a lot farther along that path than Twitter but it seems like Twitter is growing like a weed outside the US right now. This is a Comscore chart of Twitter's non-US traffic through February 2010.

Twitter non US 

The conventional wisdom is that international usage cannot be monetized as well as US traffic and that is certainly true. But with >80% of your potential users outside of the US, I think the web sector needs to start working harder on international monetization.

Even if international traffic could only be monetized 25% as well as US traffic, when your international traffic is 80% of your total traffic, you would make as much money internationally as domestically. So that's a lot of potential out there to be tapped.

And of course, not every international market is equal when it comes to monetization. Markets like western europe and japan monetize very well today. Emerging markets like the BRIC countries (Brazil, Russia, China, and India) should be big opportunities for monetization this decade. Other markets may be tough for years to come.

What this means to me is that web services that are highly international today should invest in fully localizing their user experience and then start thinking about monetizing outside of the US. Start with local partners and then start putting people on the ground in your best international markets.

There's a lot of money "rest of world" and I suspect that will only be more and more true over time. So we should start building web businesses with that in mind.

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Startups Get Hit By Shrapnel In The Banking Bill

There is a big banking reform bill working its way through the Senate right now. It is sponsored by Chris Dodd, Chairman of the Senate Banking Committee. It has a long name I can't remember, so I'll call it the Dodd Banking Bill.

What does a bill attempting to regulate the banking industry have to do with startups? Well unfortunately, it contains two provisions that are quite problematic and hurtful to entrepreneurs and startups. They are:

1) Changing the definition of a "qualified investor" in angel and venture deals. Not just anyone can invest in a startup company. You have to be a qualified investor. A qualified investor is currently defined as anyone with a net worth of over $1mm or net income of over $250k. Dodd's bill would increase that to $2.3mm and $450k respectively. And then index those numbers to inflation.

2) Eliminate the existing federal pre-emption over state regulation of "accredited offerings." Angel and venture financings could be regulated state by state creating a fairly burdensome set of rules  and regulations that each financing would need to be subject to. Currently there is a federal pre-emption that makes getting these kinds of deals done fairly easy.

I have no idea why either of these provisions ended up in a bill designed to regulate the banking industry. Entrepreneurs and startups don't use banks to finance them. They get their initial capital from angel investors and then VCs as they grow. This system works well, did not blow up in 2008, and is not in need of reform of the type Dodd wants to throw at us.

In fact, what we need is to eliminate all accredited investor requirements for small investments of up to $25k. Why does someone have to be a millionaire to invest in a friend's startup? I understand that we don't want someone mortgaging their home, or betting their entire life's savings on a startup. But for a small amount, like $25k, we should not be regulating angel investing.

My dad sent me an email the other day pointing out a news story about an incubator in Texas that was cranking out startups and creating jobs. He told me that he believes that the work entrepreneurs and the people who work with them (ie me) are doing is incredibly important to the health of our economy. He's right and we need to explain that to Chris Dodd and his friends in the Senate. If they are going to reform accredited investor regulations, they should liberalize them, not constrain them further.

I'll get on the phone and call my Senators and Representatives. Hopefully you'll do the same. This is nonsense.

UPDATE: Irene left these details in the comments which will be helpful when you contact your representatives:

The section numbers in question are Sec. 412 for accredited investors and Sec. 926 for federal pre-emption or Reg D.

Link to pdf of bill: http://bit.ly/duxjSr

Link to TechFlash article with more info on possible influences: http://bit.ly/96uuEx

UPDATE #2: Dan Primack of PE Hub has just posted that congress is listening to all the uproar over this. Maybe we'll get to keep things the way they are. But I am still going to make the case that we need an exclusion for small investments made by non-qualified investors.

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The Personal Touch: Social Media Style

A few weeks ago I wrote a blog post about the way I plan to setup the voice service in our new home.

I'd link to that post but I'm typing this out on my blackberry at 30,000 feet on my way to San Francisco this morning.

That post generated a lot of comments. I can't go online and check but I recall it was close to two hundred.

The discussion helped me out immensely and I want to thank everyone who contributed to the discussion.

In particular, I took away two big things; try to use mobile as the primary voice service in the home, and use ATAs as a bridge between traditional telephony handsets and SIP/VOIP.

Both of those takeaways are going to make it into whatever we end up doing.

I still plan to use a cloud PBX provider to host and route our numbers and calls and provide dial tone to the non cell phone handsets in our home.

There were about twenty such providers suggested in the comment thread. I have made a list and am working my way through them.

Three of the suggested providers actually weighed in on the comments. All three avoided pitching their wares and simply offered a name and number to call if I wanted to learn more.

I thought that was a great move by all three and as a result, they are at the top of my list to check out.

I may end up going with some other provider in the end but the social media smarts exhibited by these three providers impressed me and is an example of how social media can and should be part of every company's marketing strategy.

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Bidding Andrew Goodbye

I'm on vacation this week and trying to keep work to a minimum. And I've got a post up on the USV blog today bidding goodbye to our colleague Andrew Parker. So I simply going to link to that post.

It's an interesting post because in addition to talking about how great it has been to work with Andrew, I explain a bit about how we think about staffing our firm. If you have any comments, please leave them on the USV post.

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The Startup Visa Bill Debate

I'm on vacation this week skiing with my family. I got back from the mountain yesterday afternoon, checked in on email, made a few phone calls, and took a quick look at Techmeme. I saw a headline that said "The Startup Visa Act Must Be Stopped" and I noticed that the post was written by a member of the AVC community, Pascal-Emmanuel Gobry, and that is was running on Business Insider.

I know Pascal. We met once briefly and I engage with him regularly here and also on Tumblr. He's a smart and thoughtful person. So I read his post carefully, thought about it, and slept on it.

Pascal's arguments against the Startup Visa Act are:

1) You have to find investors to get a Startup Visa

2) Once you've obtained a Startup Visa, your personal founder's risk goes up

3) It's bad for investors because the best foriegn entrepreneurs will self select out of this program

Those are all valid arguments and I appreciate that he is raising them. But to suggest that the Startup Visa Act "must be stopped" because of them is ridiculous.

Let me tell you a story. In the summer of 2008 I met one of the founders of Zemanta in London. I heard the story about how two of the founders had won 2007 Seedcamp and how they had started a company in Ljubjiana Slovenia with the funds they secured from Seedcamp. I was by that time already a Zemanta user and really liked the product. Seedcamp and the other seed investors offered our firm the opportunity to join the seed round and we did in the fall of 2008.

In early 2009, I suggested that the two founders move, at least temporarily, to the US so that they could build out the business side of the company here. They did so, but only on a tourist visa. And when that tourist visa ran out, both of them had to go back to Slovenia and wait a long time to get a more permanent visa. Both are now back in the US building the business, but the time they were kept out of the US was a critical time in the business and the company suffered from having them away. Time was lost and you can't get that back.

Had the startup visa act been the law of the land, they could simply have applied for and been awarded a startup visa right after securing their seed funding. None of this would have been an issue.

The startup visa is not just for entrepreneurs, like Pascal, who are thinking of starting a company in the US. It is also for the entrepreneurs who have already started a company and want to build their company, or part of it, in the US.

Pascal is thinking about this a binary choice and it is not. We have a suboptimal visa system here in the US for entrepreneurs. The startup visa will not solve all the problems. It is not a perfect solution. But it is a very good idea and it should not be "stopped." It should be made into law. Then entrepreneurs like Pascal can decide if they want to take advantage of it or not.

While I do not appreciate the headline that Business Insider put on Pascal's post (much as I don't like the headlines they sometimes put on my posts when the re-run them), I do appreciate the debate over the Startup Visa Act. Anything that is going to become the law of the land should be subject to debate.

So in the spirit of debate, here are some more posts on the startup visa act:

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The Balance Sheet

Today on MBA Mondays we are going to talk about the Balance Sheet.

The Balance Sheet shows how much capital you have built up in your business.

If you go back to my post on Accounting, you will recall that there are two kinds of accounts in a company's chart of accounts; revenue and expense accounts and asset and liability accounts.

Last week we talked about the Profit and Loss statement which is a report of the revenue and expense accounts.

The Balance Sheet is a report of the asset and liability accounts. Assets are things you own in your business, like cash, capital equipment, and money that is owed to you for products and services you have delivered to customers. Liabilities are obligations of the business, like bills you have yet to pay, money you have borrowed from a bank or investors.

Here is Google's balance sheet as of 12/31/2009:

Google balance sheet 

Let's start from the top and work our way down.

The top line, cash, is the single most important item on the balance sheet. Cash is the fuel of a business. If you run out of cash, you are in big trouble unless there is a "filling station" nearby that is willing to fund your business. Alan Shugart, founder of Seagate and a few other disk drive companies, famously said "cash is more important than your mother." That's how important cash is and you never want to get into a situation where you run out of it.

The second line, short term investments, is basically additional cash. Most startups won't have this line item on their balance sheet. But when you are Google and are sitting on $24bn of cash and short term investments, it makes sense to invest some of your cash in "short term instruments". Hopefully for Google and its shareholders, these investments are safe, liquid, and are at very minimal risk of loss.

The next line is "accounts receivable". Google calls it "net receivables' because they are netting out money some of their partners owe them. I don't really know why they are doing it that way. But for most companies, this line item is called Accounts Receivable and it is the total amount of money owed to the business for products and services that have been delivered but have not been collected. It's the money your customers owe your business. If this number gets really big relative to revenues (for example if it  represents more than three months of revenues) then you know something is wrong with the business. We'll talk more about that in an upcoming post about financial statement analysis.

I'm only going to cover the big line items in this balance sheet. So the next line item to look at is called Total Current Assets. That's the amount of assets that you can turn into cash fairly quickly. It is often considered a measure of the "liquidity of the business."

The next set of assets are "long term assets" that cannot be turned into cash easily. I'll mention three of them.  Long Term Investments are probably Google's minority investments in venture stage companies and other such things. The most important long term asset is "Property Plant and Equipment" which is the cost of your capital equipment. For the companies we typically invest in, this number is not large unless they rack their own servers. Google of course does just that and has spent $4.8bn to date (net of depreciation) on its "factory". Depreciation is the annual cost of writing down the value of your property plant and equipment. It appears as a line in the profit and loss statement. The final long term asset I'll mention is Goodwill. This is a hard one to explain. But I'll try. When you purchase a business, like YouTube, for more than it's "book value" you must record the difference as Goodwill.  Google has paid up for a bunch of businesses, like YouTube and Doubleclick, and it's Goodwill is a large number, currently $4.9bn. If you think that the value of any of the businesses you have acquired has gone down, you can write off some or all of that Goodwill. That will create a large one time expense on your profit and loss statement.

After cash, I believe the liability section of the balance sheet is the most important section. It shows the businesses' debts. And the other thing that can put you out of business aside from running out of cash is inability to pay your debts. That is called bankruptcy. Of course, running out of cash is one reason you may not be able to pay your debts. But many companies go bankrupt with huge amounts of cash on their books. So it is critical to understand a company's debts.

The main current liabilities are accounts payable and accrued expenses. Since we don't see any accrued expenses on Google's balance sheet I assume they are lumping the two together under accounts payable. They are closely related. Both represent expenses of the business that have yet to be paid. The difference is that accounts payable are for bills the company receives from other businesses. And accrued expenses are accounting entries a company makes in anticipation of being billed. A good example of an accounts payable is a legal bill you have not paid. A good example of an accrued expense is employee benefits that you have not yet been billed for that you accrue for each month.

If you compare Current Liabilities to Current Assets, you'll get a sense of how tight a company is operating. Google's current assets are $29bn and its current liabilities are $2.7bn. It's good to be Google, they are not sweating it. Many of our portfolio companies operate with these numbers close to equal. They are sweating it.

Non current liabilities are mostly long term debt of the business. The amount of debt is interesting for sure. If it is very large compared to the total assets of the business its a reason to be concerned. But its even more important to dig into the term of the long term debt and find out when it is coming due and other important factors. You won't find that on the balance sheet. You'll need to get the footnotes of the financial statements to do that. Again, we'll talk more about that in a future post on financial statement analysis.

The next section of the balance sheet is called Stockholders Equity. This includes two categories of "equity". The first is the amount that equity investors, from VCs to public shareholders, have invested in the business. The second is the amount of earnings that have been retained in the business over the years. I'm not entirely sure how Google breaks out the two on it's balance sheet so we'll just talk about the total for now. Google's total stockholders equity is $36bn. That is also called the "book value" of the business. 

The cool thing about a balance sheet is it has to balance out. Total Assets must equal Total Liabilities plus Stockholders Equity. In Google's case, total assets are $40.5bn. Total Liabilities are $4.5bn. If you subtract the liabilities from the assets, you get $36bn, which is the amount of stockholders equity.

We'll talk about cash flow statements next week and the fact that a balance sheet has to balance can be very helpful in analyzing and projecting out the cash flow of a business.

In summary, the Balance Sheet shows the value of all the capital that a business has built up over the years. The most important numbers in it are cash and liabilities. Always pay attention to those numbers. I almost never look at a profit and loss statement without also looking at a balance sheet. They really should be considered together as they are two sides of the same coin.

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