Posts from entrepreneurship

Dumbing Things Down

I had lunch with Milton Pappas yesterday. Milton and his partners at Euclid Partners taught me the venture capital business in the mid/late 80s. We got to talking about mentors and I asked him who taught him the venture capital business. He told me General Georges Doriot of American Research and Development taught him a lot in the late 60s and early 70s. Milton and his partner Bliss McCrum started Euclid in 1971.

As we were talking about biotech, an area Milton loves and invested heavily in, he told me that he ran into so many people in that sector who were brilliant but could not communicate what they were working on simply and crisply. He returned to Doriot and told me that the General had advised him that “I don’t care how brilliant an entrepreneur is, I won’t back them if they can’t explain themselves simply and in a manner everyone can understand.”

That rings true to me. It is not enough to understand something that others don’t understand. At some point you have to convince people that what you are doing is important and they should join your company, buy from your company, invest in your company, and write about your company. I like to call this “dumbing things down” but it doesn’t have to involve simplification (although that is one way to do it). It could also involve creating effective analogies, describing a future state where the technology is in mass use, or some other technique that makes something complex easy to understand.

One of the essential techniques in bringing technology to market is simplification. Dumb things down. It’s super important.

eShares

This post is self serving to some degree as USV is an investor in eShares. But in the world of VC and startups there isn’t much that is more broken than cap table management. eShares fixes that by putting the entire cap table online and allowing your company to issue new shares and options directly from the platform. It’s kind of like writing checks directly from your accounting system. Everything gets recorded and there are no missing stock certs or broken promises.

I explained this to one of our portfolio companies last fall around the time we made our investment in eShares. One of the co-founders replied via email “we don’t need that, our cap table is all in a single spreadsheet.” A month or two later, as we were doing a round of financing, when the lawyers were doing their diligence, it came out that our cap table spreadsheet was missing some shares that had been issued but not recorded. I had a good laugh at that because it is always the case that something is not recorded. A perfect cap table is very rare, unless you are using a tool like eShares.

The VCs and angel investors aren’t hurt so much by this because our investments are large and mistakes made on our shares are easily caught. Employees are the ones who have the most to gain from eShares because they are the ones whose issuances are most often missed or not properly recorded on a cap table and these mistakes can go on for a long time before being caught. This causes issues in terms of exercise price changes and tax issues for the employee.

If you are starting a company, do yourself a favor and start building your cap table day one on eShares. If you have been managing your cap table in a spreadsheet for years and are tired of doing it that way, talk to eShares. They will help you “port” your cap table to their system. That’s part of the onboarding service they provide. And then you can start issuing shares the way you’d imagine it would be done in 2015. The way most companies is doing it is circa 1900. I’m serious about that.

If you want to learn more about eShares, contact them here.

VCs as Gas Stations

I was at an event the Gotham Gal had last night for her portfolio. I was asked a number of times “when is the best time to raise money?”. In general, I believe the best time to take money is when it is being offered. To some extent, VCs are gas stations and you should fill up when it is convenient.

I don’t drive that often, and when I do mostly drive electric cars, so gas stations are not a common place for me. But when I do drive a gas powered car, I tend to fill up my car when it gets below half a tank and I use stations I like and are convenient for me.

I think this analogy works to a point for VC fundraising. You should raise money when you still have a fair bit of cash in the bank. Driving around on fumes frantically trying to find a gas station is not a great idea. Raising a round when you have a month of cash left isn’t either.

I don’t shop around for and drive out of my way to the best priced gas station. I am happy to fill up at a fair price at a place that I like and is convenient to me. I would apply the same rule to raising money. Don’t shop for the very best deal, particularly if it means an elongated fundraising process and time away from the business. If a fair deal is being offered by a firm you like and trust, shake hands, close the deal, and get back to the business.

The place the gas station analogy breaks down is that for the most part the gas is same from gas station to gas station. That’s not true with VCs. You can buy really bad gas and you can buy really good gas from VCs. Some VCs can kill your company. Some VCs can propel your business forward. And some VCs will leave you alone.

So choose your gas wisely when shopping for the VC variety. And fill up when you’ve got a half tank and you are passing by one of your favorite stations.

Lifestyle Businesses

Yesterday in the comments Elia said:

I sure wish we wouldn’t call non-VC fundable opportunities lifestyle businesses. It sounds like the person working on that business spends his days on a beach somewhere in the sun and collects the checks that come in. Just because it makes less money than a VC invested business doesn’t mean it isn’t still a business that takes lots of work.

We don’t have a good term for these types of businesses yet. Independent or indie is the best I’ve heard so far. Maybe, Fred, a post here and this community can come up with a great name we can all use?

I had never thought that the using the word “lifestyle” to describe a business that was too small to be interesting to an investor was derogatory. But I can see Elia’s point.

There is, however, a difference between what we’ve been calling “lifestyle” businesses, and “indie” businesses. My friend Bryce has launched an effort to fund “indie” businesses. As I’ve understood it, an “indie” business is one that might be large enough to support a significant investment but the founder wants to remain independent and therefore has no desire to exit and thus taking VC investment doesn’t work.

I touched on all of this is my ten ways to be an entrepreneur presentation (video, deck). Most of the entrepreneurial ventures I describe in that presentation are not backable by VCs. Only the last three (the startup, the breakout, and the company) are.

So I would define things this way:

Lifestyle – too small for VC, but will generate enough annual cashflow to be a great business to own and operate

Indie – might be large enough to justify and provide a return on a VC investment, but the desire to retain control and remain independent makes VC untenable for the entrepreneur

VC Fundable – large enough to justify and provide a return on a VC investment and the founder is willing to exit at some point and provide a capital gain to the investors

So with all of that in mind, I would like to ask a final question and then take this discussion into the comments. Is the term “lifestyle business” derogatory or dismissive in any way and do we need to find a better term for that kind of business? And if so, what should we call them instead?

Numbers Can Ruin A Good Story

As I was reading Josh Kopelman‘s excellent post on the seed boom and Series A bust, I got thinking of some words of wisdom Mike Arrington once shared with me. He said “numbers always ruin a good story.”

What Mike meant by this is you can raise a seed (or Series A) on a story. But at some point, you will have numbers; users, user growth, revenues, and revenue growth. You will also have a burn rate. And those numbers will become the thing you are judged on and your nice story will be “ruined” by the numbers.

Now this is not always true. You might be one of the few entrepreneurs on a real rocket ship and your numbers will be your friend. If that is true, raise while the numbers are great. Because they might not always be.

But, particularly at the Series A stage which Josh’s post is all about, the numbers aren’t always so great. And your story will conflict with the numbers. And so you’ll have to change the story to reflect the numbers. Because you can’t change the numbers to reflect the story you really want to tell.

It’s a painful experience. But as Josh explains, it’s like skinning your knee as a child. Painful but necessary.

Building Enterprise Networks Top Down

Most people that are in the VC and startup sector know that USV likes to invest in networks. And most of the networks we invest in are consumer facing networks of people. Peer to peer services, if you will. The list is long and full of brand name consumer networks. So it would be understandable if people assumed that we do not invest in the enterprise sector. That, however, would be a wrong assumption.

We’ve been looking for enterprise networks to invest in since we got started and we are finding more and more in recent years. There is a particular type of enterprise network that we particularly like and I want to talk about that today.

Businesses, particularly large ones, build up large groups of suppliers. These suppliers can be other businesses or in some cases individuals. And these suppliers also supply other businesses. The totally of this ecosystem of businesses and their suppliers is a large network and there are many businesses that are built up around making these networks work more efficiently. And these businesses benefit from network effects.

I am going to talk about three of our portfolio companies that do this as a way to demonstrate how this model works.

C2FO is a network of businesses and their suppliers that solves a working capital problem for the suppliers and provides a better return on capital to large enterprises. Here is how it works: C2FO has a sales force that calls on large enterprises and shows them how they can use their capital to earn a better return while solving a working capital problem for their suppliers. They bring these large enterprises onto their platform and, using C2FO, they recruit their supplier base onto the platform. They also bring all the accounts payable for the large enterprise onto the platform. Once the network and the payables are on the platform, the suppliers can bid for accelerated payment of their receivables. When these bids are accepted by the large enterprise, the suppliers get their cash more quickly and the large enterprise earns a return on the form of a discount on their accounts payable. C2FO takes a small transaction fee for facilitating this market.

Work Market is a network of businesses and their freelance workforce. Work Market’s salesforce calls on these large enterprises and explains how they can manage their freelance workforce directly and more efficiently. These enterprises come onto the Work Market platform and then, using Work Market, invite all of their freelance workers onto the platform. They then issue all of their freelance work orders on the Work Market system, manage the work, and pay for the work, all on Work Market. Work Market takes a transaction fee for facilitating this and many of Work Market’s customers convert to a monthly SAAS subscription once they have all of their freelance work on the platform.

Crowdrise is a network of non-profits, the events they participate in, and the people who fundraise for them. Crowdrise’s salesforce calls on these events and the large non-profits who participate in them. When a large event, like the Boston Marathon, comes onto Crowdrise, they invite all the non-profits that participate in their event onto the platform. These non-profits then invite all the individuals who raise money for them onto the platform. These events and non-profits run campaigns on Crowdrise, often tied to the big events, and Crowdrise takes a small fee for facilitating this market.

I hope you all see the similarities between these three very different companies. There are several but the one I’d like to focus on is the “they invite all the ….. onto the platform”. This recruiting function is a very powerful way to build a network from the top down. And once these networks are built, they are hard to unwind.

We don’t see many consumer networks built top down, but we do see a lot of enterprise networks built top down. And we are seeing more and more of them. It is also possible to build enterprise networks bottoms up (Dropbox is a good example of that). That’s the interesting thing about enterprise networks. You can build them top down or bottoms up. And we invest in both kinds of enterprise networks.

The top down enterprise network is a growing part of the USV portfolio. We like this approach to building an enterprise software business and it does not suffer from the “dentist office software” problem. Which is a very good thing.

Basketball, Startups, and Life

When you watch the San Antonio Spurs (or the Atlanta Hawks this season), you get a sense of a system at work on the court. There is chaos, the players are moving and cutting all over the place, and then a pass is made to the open man and an uncontested layup results. It’s like magic.

My partner Andy wrote a post about chaos and startups a few days ago that briefly touches on basketball. He talks about the Zen Master Phil Jackson:

Phil Jackson believed this too. He wrote “the road to freedom is a beautiful system.” The winningest coach in NBA history believed that his success was developing a framework for his players to guide the dozens and dozens of decisions that they have to make each game, each play. He actually believed then, that his job as a coach during games was just to watch. If he had helped the team develop the right framework, then his role would at its optimum – at decision-making time – simply to sit back and let them process.

Andy’s point is that those advising and investing in startups should do the same – help the startup team develop a framework for making decisions and then sit back and watch them do it.

One thing I know for sure is that those who advise and invest in startups cannot and should not meddle in the day to day decision making. It’s harmful and hurtful to the startup and those that lead it. So operating at a higher level, helping to set the framework for decision making and then sitting down and watching the game be played, is certainly the way to go. Of course that doesn’t mean abdicating the responsibility to have the right team on the court at the right time. Coaches do that and advisors and investors should too.

MBA Mondays Reblog: Sunk Costs

The Gotham Gal and I made a decision recently where we had a bunch of sunk costs. It reminded me of this post and I am going to reblog it today.

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Sunk Costs are time and money (and other resources) you have already spent on a project, investment, or some other effort. They have been sunk into the effort and most likely you cannot get them back.

The important thing about sunk costs is when it comes time to make a decision about the project or investment, you should NOT factor in the sunk costs in that decision. You should treat them as gone already and make the decision based on what is in front of you in terms of costs and opportunities.

Let’s make this a bit more tangible. Let’s say you have been funding a new product effort at your company. To date, you’ve spent six months of effort, the full-time costs of three software developers, one product manager, and much of your time and your senior team’s time. Let’s say all-in, you’ve spent $300,000 on this new product. Those costs are sunk. You’ve spent them and there is no easy way to get that cash back in your bank account.

Now let’s say this product effort is troubled. You aren’t happy with the product in its current incarnation. You don’t think it will work as currently constructed and envisioned. You think you can fix it, but that will take another six months with the same team and same effort of the senior team. In making the decision about going forward or killing this effort, you should not consider the $300,000 you have already sunk into the project. You should only consider the additional $300,000 you are thinking about spending going forward. The reason is that first $300,000 has been spent whether or not you kill the project. It is immaterial to the going forward decision.

This is a hard thing to do. It is human nature to want to recover the sunk costs. We face this all the time in our business. When we have invested $500,000 or $5mm into a company, it is really easy to get into the mindset that we need to stick with the investment so we can get our money back. If we stop funding, then we write off the investment almost all of the time. If we keep putting money in, there is a chance the investment will work out and we’ll get our money back or even a return on it.

Even though I was taught about sunk costs in business school twenty-five years ago, I have had to learn this lesson the hard way. Most of the time that we make a follow-on investment defensively, to protect the capital we have already invested, that follow-on investment is marginal or outright bad. I have seen this again and again. And so we try really hard to look at every investment based on the return on the new money and not include the capital we have already invested in the decision.

This ties back to the discussion about seed investing and treating seed investments as “options.” Every investor, if they are rational, will look at the follow-on round on its own merits and not based on the capital they already have invested. But the venture capital business is a relatively small world and reputation matters as well. Those investors who make one follow-on for every ten seeds they make will get a reputation and may not see many high quality seed opportunities going forward. Our firm has followed every single seed investment we have made with another round. In most cases, those investments have been good ones. But we have made a few marginal or outright bad follow-ons. We do that for reputation value as much as anything else. We measure that value and understand that is what we are doing and we keep those reputation driven follow-ons small on purpose.

When it is time to commit additional capital to an ongoing project or investment, you need to isolate the incremental investment and assess the return on that capital investment. You should not include the costs you have already sunk into the project in your math. When you do that, you make bad investment decisions.