Posts from June 2011

Financing Options: Customers

I wrote in an earlier post in this series that friends and family is the most common form of startup financing. If you are talking explicitly equity investments, then that is probably true. But the most common way that startup businesses get money to get going is they sell something to someone. In this context, someone means customers.

Customers are a great way to finance a business for many reasons. First, customer financing is typically non dilutive. They want something from you other than equity in your business. Customers also help you fit your product to the market. And customers will help debug and improve the quality of the product. An early customer will give you credibility with other customers. And an early customer may spend more with your company down the road.

The most common way customer financing is done is you sell the customer on the product before you've built it or before you've finished it. The customer puts up the money to build the product or finish the product and becomes your first customer. Usually the customer simply wants the product and nothing more. At times an early customer might ask for some exclusivity on the product or even some free equity in the business, but most of the time the early customer simply wants the product from you and nothing more.

So why not take this approach with every startup? Well, it isn't always possible to find a customer who will put up money in advance of the product being complete and ready to use. It takes great salesmanship to convince a customer to buy something from you that isn't built or isn't finished. But even if you can convince a customer to do this, there are some negatives.

First and foremost, building a product explicity for one customer often makes it less applicable to the market as a whole. An early customer who provides funding to build your product will want the product tailored specifically for its needs. And a highly tailored product is often not well suited to a broader market.

Second, you risk building a "fee for services culture" in your company with this approach. Some companies build products for customers for a fee. Other companies build products and sell them "as is" to customers. The latter is the scalable model for building valuable companies. If you use customer financing, you risk being pulled into the former.

And customer financing is much more difficult, if not impossible, in consumer facing services. It is much more applicable in business facing services.

Those are the pros and cons of customer financing. If you can convince a customer to put up significant capital in advance so you can build or finish your product, you should consider it very seriously. Many great companies got their start this way.

#MBA Mondays

Subconscious Information Processing

It's fathers day and I thought I'd tell a story about my dad and something he taught me a long time ago. I was in middle school and I had a school project due the next day and it came up at dinner that I had not done the project. My dad made me stay up very late that night until I had completed it. And he stayed up with me. He made sure I understood two things that evening. The first one is obvious. When assigned something, you do it and you do it on time.

But the second thing he explained to me was more subtle and way more powerful. He explained that I should start working on a project as soon as it was assigned. An hour or so would do fine, he told me. He told me to come back to the project every day for at least a little bit and make progress on it slowly over time. I asked him why that was better than cramming at the very end (as I was doing during the conversation).

He explained that once your brain starts working on a problem, it doesn't stop. If you get your mind wrapped around a problem with a fair bit of time left to solve it, the brain will solve the problem subconsciously over time and one day you'll sit down to do some more work on it and the answer will be right in front of you.

I've taken that approach with every big problem I've faced ever since. I used this technique to get through high school, college, and business school. I've used this technique to develop a career in investing and technology. I've even used this technique to deal with our own parenting challenges.

I'm a big fan of subconscious information processing. It is why I have my some of my best ideas in the shower in the morning. It is why I write every morning right after I get up. I believe that while I'm sleeping, my mind is churning through the things that I'm trying to figure out and often the answers are back (like a batch job) when I wake up.

Thanks dad for that tip. It's been a big part of my playbook ever since. Happy fathers day everyone.

#Random Posts

Bill Gurley on Tech Markets, Capital Markets, and VC

Bill Gurley was a "blogging VC" before anyone else with his Above The Crowd newsletter back in the 90s. That has become the Above The Crowd blog. I've always been a huge fan of Bill's and whenever I read something he has written or said, I find myself nodding my head. He sees the venture business in the same way I do. And he sees markets pretty similarly too.

Bill did an interview with Business Insider recently and he said a bunch of things that are important and which I agree with. Do yourself a favor and go read it.

#VC & Technology

The Post Frequency Rule

The frequency of posts in a service is inversely proportional to the size of the post. Said another way, the longer the post, the less frequently they will happen.

Take a look at stats from the three largest "default public" social media services:

WordPress – 430k posts per day

Tumblr – 31.8mm posts per day

Twitter – 140mm posts per day (march 2011)

Of course, these numbers are also impacted by the number of total accounts and active accounts on the system. None of the three companies post those numbers publicly. Based on the numbers I've seen, the ratio of monthly active accounts to total accounts is also highly correlated to the the size of the post. The shorter the required post in a service, the higher percent of total users will be active on it.

If you want to understand the power of Tumblr and Twitter, you need to look at how quick and how easy it is to post. There are of course many other factors at work, but brevity and ease is a big part of why these services work so well.

#Web/Tech

The Chorus For Immigration Reform Grows Louder

Yesterday, Mike Bloomberg went to Washington and spoke at the Council on Foreign Relations on the topic of immigration reform. The text of the entire speech is here. I just read the whole thing and I'm encouraged and excited that the chorus for intelligent immigration reform has gotten louder. This quote was my favorite:

we must stop telling foreign entrepreneurs to build their companies in other countries

We have seen so many great entrepreneurs struggle with visa issues over the years that we were founding members of the startup visa movement. In his speech, Mike Bloomberg specifically called for passage of a startup visa provision:

A foreign entrepreneur with backing from American investors should be given a temporary visa to start a company in America. If after two or three years, the business has successfully yielded new American jobs, the entrepreneur should be allowed to continue to run his or her business and receive permanent legal status. We are a nation of entrepreneurs because we are a nation of immigrants and in the 21st century, the global economy will revolve more than ever around entrepreneurs.

Yes!

But he didn't stop there. The Mayor of our fine city also proposed the following reforms:

– A green card stapled to a diploma:

We are investing millions of dollars to educate these students at our leading universities, and then giving the economic dividends back to our competitors – for free. The two parties should be able to agree on a policy that allows any university graduate, with an advanced degree in an essential field, to obtain a green card – and a chance to help us grow our economy. We must allow these students to stay here and be part of our future or we will watch our future disappear with them.

– More H1B visas:

right now, the cap on H1-B visas and green cards is much too low, and caps on green cards are set by country. So Iceland gets the same number of visas as India. That may be fair to each country, but it’s not fair to American businesses. We should end these arbitrary limits and end the cap on the high-skill H1-B visas. Let the market decide. It’s basic free-market economics – and both parties ought to be able to get behind it.

– immigration reform for agriculture and tourism:

we must ensure that major industries, such as agriculture and tourism, that rely on those workers just starting up the economic ladder have access to foreign workers when they cannot fill the jobs with American workers. These employers want a legal work force, but our current system makes that extremely difficult. Farmers have to go through multiple levels of approvals to do basic hiring, and in Georgia, where they have cracked down on illegal farm-workers, farm owners are experiencing severe labor shortages. That’s driving up their costs and leaving crops un-harvested. At a time when food prices are rising, this is the last thing American consumers – and farmers – need.

Do yourself a favor and read the entire speech. It's not long. Mike lays out a sensible and intelligent way to reform immigration laws without getting into the contentious issues that have held back immigration reform for many years. And if you agree with the Mayor, do everyone a favor and call your elected officials in Washington and tell them you are also for intelligent immigration reform (as opposed to comprehensive immigration reform). I've done that and it has helped. Getting your voice into the chorus on intelligent immigration reform would be helpful too.

#Politics

To Science And Art

I was passing by Cooper Union the other day and was struck by the words on the front facade of its iconic building on Astor Place.

To science and art

This phrase "to science and art" has been stuck in my mind since. I've been thinking about what happens at the intersection of science and art, how science impacts art, and how art impacts science, how New York City has been blessed to be at the intersection of science and art for at least two centuries, and how much of what is interesting to me in the technology revolution of the moment, the Internet, is at the intersection of science and art.

Peter Cooper, the founder of Cooper Union, was an inventor, industrialist, and NYC resident in the 19th century. He designed and built the first steam powered train in the US. He was the "Tim Berners-Lee" of the railroad technological revolution in the US. Cooper went on to become a very wealthy industrialist and businessman and was behind the company that laid the first cross atlantic telegraph cable. He was all about technology, science, innovation, and business. And yet, when he created and endowed a free institution of higher education, he understood that it had to be for both science and art.

Science and art are seen as two very distinct endeavors and I suppose they are. But I see science and art as the yin yang of creative culture and innovation. To quote from Wikipedia, science and art are seemingly contrary forces that are interconnected and interdependent in the natural world, and they give rise to each other in turn.

I was talking to a longtime reader of this blog, Chris Dorr, last night. Chris has been working in the film industry for a long time and blogs at the Tribeca Film Festival Blog. We were talking about changes in the film business and Chris blurted out that "filmakers and software developers need to start sleeping together and it is starting to happen." Filmmaking is art, particularly great filmmaking. But the art of filmmaking has always been based on a number of fundamental scientific inventions. And Chris' point is that the art of filmmaking will continue to be impacted by scientific inventions that are happening in real time.

And science is equally inspired by art. Just check out the music playing at the all nighter coding sessions that go on at New Work City or the number of listeners in the coding room on turntable.fm and you'll see that coding computers benefits from musical stimulation.

When I look at our portfolio, I see companies like Tumblr, Etsy, Canvas, Shapeways, SoundCloud, Boxee, Kickstarter, and GetGlue that exist somewhere in the overlap between technology and art. Most of these companies are based in NYC and the ones that aren't have a strong footing here.

I was at a meeting yesterday with an economic development group in NYC. We were talking about 3D Printing, an important new technology that was "science" a decade ago. The economic development types were explaining to me why 3D Printing technology is so important to NYC. They explained that our artist and design communities need 3D Printing technology because it allows these artists to turn their ideas into objects rapidly and at lower cost. It is a game changer for artists, designers, and architects. Our portfolio company Shapeways and other innovators like MakerBot are doing just that right here in NYC.

Peter Cooper understood the importance of science and art back in the mid 19th century when he created Cooper Union. He put the two words on the facade of his building. And they remain the twin towers of innovation in NYC and all over the world two centuries later.

#VC & Technology#Web/Tech

Canvas

I posted this on the USV blog yesterday but thought I should share it with the AVC community as well.

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We are big fans of communities at Union Square Ventures. The partners in our firm have been investing in Internet communities for almost 15 years and we are constantly reminded of the power of the community. Whenever we are presented with the opportunity to invest in an emerging new Internet community, we take it very seriously.

We were presented with exactly that opportunity a few months ago by Chris Poole, also known on the Internet as "moot." When Chris was 15 years old he launched one of the most powerful Internet communities, 4chan, from his bedroom. For eight years, Chris has been operating, moderating, building, observing, and learning from 4chan. Last year, Chris recruited a small group of engineers and designers and started building a new Internet community called Canvas.

Canvas is a real-time canvas on the Internet. It is a community where everyone can come to create imagery together. It is inspired by the best of 4chan but is aimed at much more. At the heart of Canvas is the concept of remixing. Every image on Canvas has a remix button which allows users to quickly modify the image and repost it. The result are threads that are anchored by the initial image. Here are a few of my favorite examples:

Ze Frank Scribbler

Charlie Sheen – I Probably Took More

All The Things?

Redrawn Icons

4chan is famously anonymous. It is raucous, unruly, and tremendously creative. The architecture of Canvas is subtly different, and although anonymous posting is allowed, you must first register a login to participate.

There aren't any filters on Canvas. You see what is happening there in real-time. Sometimes the result is inspiring. Sometimes the result is provocative. I liken it to real world creative communities like the Lower East Side of NYC when I arrived here in the early 80s. The most interesting creativity comes from places that aren't always manicured and sterile.

Canvas is very much a work in progress. The service is still in invite-only beta and requires you connect with Facebook to register. Chris and the Canvas team are committed to building the most exciting and interesting community for real-time creativity on the Internet, and we are thrilled to be along for the ride. You can get on the ride as well because Canvas is hiring. Their jobs page is here.

#VC & Technology#Web/Tech

Financing Options: Government Grants

Governments will provide capital for startups and I've seen many entrepreneurs over the years take advantage of this form of financing. The grants are usually "free money" in the sense that they do not need to be paid back and they don't cost any equity.

But nothing in life is free. You do pay for this money in ways that may not be in your interest. The application process is usually long, involved, and distracting. And sometimes the grants come with strings attached; you can't move, you have to use it for a specific purpose, you have to hire a certain number of people with it, etc, etc.

I've seen states provide grants to do "economic development." I've seen all sorts of US Federal Government grants. The most common are Small Business Innovation Research (SBIR) Grants. But there are also grants available from various departments related to energy, health, defense, and many more. Internationally, I've seen Canada, Israel, and Slovenia provide "free capital" to startups.

In Canada, startups can get a portion of their headcount funded by the government. In Israel, the government provides grants to startups but they need to keep their IP in country. I am sure that many countries around the world provide funding of this sort. And I suspect we will see more of this sort of thing as technology based economic development becomes more important.

I'm not a fan of this form of financing. First, in principle I think that government ought to stay out of the business of picking winners and let the market do that. But more practically, I've never seen an entrepreneur change the outcome of their startup with government money. It is never enough to really move the needle and the strings that are attached usually make it uninteresting to me.

But if you would like to look into this sort of thing, contact your state and national government and ask about grants for high technology, research, and startups. I suspect you'll find some programs out there that you can tap into.

#MBA Mondays

Content Shifting Presentation

I'd like to thank everyone who contributed thoughts and ideas for the Content Shifting talk I am giving tomorrow at the Read Write Web 2Way Summit.

I spent some time yesterday and today putting together a draft presentation in Prezi. I've embedded it below. I know that the talking points are not included, but if you all have any suggestions on how to improve the talk, I'm all ears (in the comments please).

 

 

#Web/Tech

Don't Forget Your Logged Out Users

I find myself saying this quite often these days to entrepreneurs and their product teams. It's something that I've noticed working with leading social platforms like Etsy, Twitter, Tumblr, and others. Services such as these have a large number of their users accessing the service regularly on a logged out basis.

I can visit my friend Daryn's tumblog without logging into Tumblr and often do. My son can visit LeBron James' Twitter without logging in and often does. My daughter can check out vintage items on Etsy without logging in and usually does.

At some point, if you want to deeply engage, or in Etsy's case transact, you'll need to log into social services. But you can get a lot of value from them without logging in. And without divulging confidential information about our portfolio companies, I can tell you that a huge number of regular users of these and other services don't log in because they can get a lot of value without logging in.

I got into a comment discussion on Steve Rubel's blog this morning on this topic. Some social services, like Facebook, require login to access most of the content you'd want to consume there. They don't have to think so much about the logged out user. But other social services, the ones that are public by default, have to think very carefully about the logged out user because they logged out user base is huge and valuable.

I think that social services that are public by default and have huge logged out user bases, should "phantom register" their logged out users by storing activity against their cookies and building user profiles on their logged out users. This does two things. First, if those logged out users eventually register and become logged in users, this "phantom profile" can help the user get a lot of value from the service right away. And second, this "phantom registration" might allow the service to permit lightweight engagement without logging in. Lightweight engagement might be favoriting an item on Etsy, hearting something on Tumblr, or starring something on Twitter. 

There is a 100/10/1 "rule of thumb" with social services. 1% will create content, 10% will engage with it, and 100% will consume it. If only 10% of your users need to log in because 90% just want to consume, then you'll end up with the vast majority of your users in the logged out camp. Don't ignore them, build services for them, and you can slowly but surely lead them to more engagement and potentially some day into the logged in camp.

#Web/Tech