Silicon Valley Frontlines

Founders Stock Vesting - Why It's Important!

Boy, the longer I deal with early-stage tech companies the more I'm amazed by the prevalence of teams that operate without founder stock vesting. 

As you know, most startups get going with a team of two or three folks coalescing around an idea - and then spending perhaps years, with their own sweat and nothing else, developing a product or service and getting it going to the point they can raise money and scale it up. Assuming they've addressed ownership at all then they've probably agreed some split based on contribution of effort and skills, and it feels equitable (not the same as equal) to all involved. Hopefully they also set aside stock for others they've hired along the way, or contractors paid in equity and so on.

That's good, as far as it goes. Where it falls apart is if that stock hasn't been subject to a vesting schedule. In essence the ownership needs to be EARNED over the time each person has been contributing, not just given up front. In the extreme case, without a vesting schedule you have the potential for the ugly situation where one founder may just decide he's had enough and moves on, leaving his two co-founders to carry on and make the business work. Is it fair that he walks off with all his stock and is not adding any more value, while the others remain trying to make theirs - and therefore his also - worth something? Obviously not. And not only that, its a chunk of ownership not now available to recruit a replacement. 

The standard approach is to structure founders stock just like a regular stock option - vest over 4 years with a one-year cliff. And the logic is the same - you gotta stick around long enough to start with to have made a real and substantial contribution to the company and your team members. Then you keep earning more monthly as you go. Leave at any time after one year and you get to keep what you've earned - no more, no less. Have an accelerator in there in the event that the company is sold, sure. 

Obviously this approach does not, per se, apply to a solo founder for obvious reasons - but most startups are founded by teams and they must address this question. 

One objection some founders have had to putting these structures in place is their fear of the cost and complexity - and when you have no cash its hard to think about paying lawyers to do this stuff. Frankly, that's a non-issue. Reputable Valley firms will help you set this up for deferred or no fees at all, or you can simply go to my friends at Orrick who have set this up online for you for free (but consult them if these don't fit your situation). Go here to go through the Q&A process and create your Founder Term Sheet (in essence defining the founders, their ownership etc) and then here for the various legal agreements to document the deal. There are other similar sources out there if you look around. 

So now you have this in place. Lets say that helps encourage everyone to be in the boat pulling hard to make it worth something. Well, in my next post I'll discuss what happens to all this when you raise venture capital ... and it may not be what you think!

Top Ten Start-Up Mistakes. Not What You May Think! Part Two ...

Ok, here's my belated follow up and conclusion from Part 1 of Top Ten Start-Up Mistakes from the Orrick event last month!

Mistake #5: Not Recognizing When to Supplement or Shrink the Team

Founders who fear bringing in the right people at the right time are a problem. "When I find someone as smart as me then I'll bring them in" - wrong! Engineer founders generally don't know how to build sales and marketing. The culture you want determines the kind of people you hire. You should always be hiring or shrinking - but make sure the people are the right fit (don't hire guys with machetes if you are already on the highway). Personal characteristics and motivation are always the most important, not the specific skills - you can learn the latter but not the former.

Mistakes #6 and #7: Not Having a Real Plan - and Not Knowing Where You Are On Your Roadmap

A key emphasis here was to insure you figure out what type of business you are building - a big or small company, a home run or a single. This is really important because it determines much of what you do - and who you hire and whose money you take. The reality is the vast majority of startups that succeed turn out to be single. Very few ever IPO (fewer than ever). Most will get acquired if successful. And for you as a founder you may be a lot better off taking smaller money from angels or smaller vc's, controlling your destiny more and getting a larger share of a smaller business (and more total dollars) than someone who swings for the fences and even if successful gets a very small piece of that bigger business. Regardless, you need to build your business to be independent, not just to be bought. 

Always have a clear plan - but be nimble enough to change it if you need to. If revenues are less than you planned then you need to find new growth or cut expenses. This is partly why investors bet on people - things rarely go according to plan and how the people handle it is key. Knowing where you are on your roadmap then becomes key - is your hypothesis (for that's what it is) working or not? By the way - as I've written about before - tying funding to milestones is wrong, not just because its a cheat on valuation by the investor but because you may need to change the plan and the milestone becomes a millstone.

However metrics are important. Here's what we said we'd do. Here's what we did. Here's what we're going to do next. It's your feedback mechanism. Why is something drifting? Be ready to reset if needed, or take other action. Be super transparent, regular, communicative and avoid surprises.

Mistake #8: Being Penny-WIse and Pound Foolish

As a financial advisor and CFO to startups of course I have to echo the starting point on this one - the panel's statement that you need to have a good CFO or Controller. It's still a surprise to me that so many startups don't have either one - and in fact frequently don't even have a good bookkeeper or basic financial information available. The panel view was that you need someone on board who doesn't want to spend money BUT the real key is someone (CEO's are often not the right ones) who can help make the right trade-offs. After all, saving $5k a month in online marketing is a false economy your total burn is $150k/month and not spending the $5k means you take X months longer to make your target. Not having a top sales person is a bigger mistake than having a colour copier. I'll repeat a personal view here: the right financial person on board (emphasis on RIGHT) will pay for themselves many times over in better business decisions and return on investment. 

When you have raised money (see below) then have self-control and don't defocus. If your plan said you would spend $Y on marketing and you raise the money you needed then don't go spend that $Y on swanky new space instead.

Mistakes #9 and #10: Never Be In The Position Where You Have No Money; Don't Raise Too Much or Too Little

Sounds obvious. Amazing how many don't figure it out. Cash is the rocket fuel so you need to raise it. Be sure you know you much you need to get to the next key funding milestone - then raise more because it will take longer than you think to achieve that milestone. But also, raise money when you can, not when you need it. Timing is a key factor - not just in your business but when the market is more ready to supply funds is critical. 

Be forced to make tradeoffs and prioritize. Be very lean during product development and market discovery, then accelerate to ramp up the customer acquisition and returns.

Raising lots of money at a high valuation means you need to have a big exit. This will NOT happen for most companies. Solid singles (an exit in the $50 - $100m range) are a great result for most people. When raising money don't obsess on valuation. Take a reasonable valuation and focus on increasing it solidly between rounds. Down-rounds are viewed very negatively (in fact they can be the kiss of death).

Finally, raise money strategically. This means raising based not just on cash needs. You need to have in mind what business you're building over the longer haul, who the investors are and what they bring to the table that can truly help move the business froward. Yes, terms are important but get a win-win-win out of it.

Top Ten Start-Up Mistakes. Not What You May Think! Part One ...

I spent some time at Orrick's "Top 10 Start-Up Mistakes" event this morning, part of their Total Access series. Despite their size Orrick is a great law firm for early-stage companies (they have a dedicated practice for that group under Don Keller, who was partner on my first startup in the late 1990's) - unlike some other tech law firms who have become too big and arrogant for the little guys.

Panelists today were Ann Miura-Ko of FLOODGATE (formerly Maples Investments) and Howard Hartenbaum of August Capital, along with George Garrick, CEO, Offerpal Media and Gary Swart, CEO, oDesk.

As we know there is no limit to the ingenious ways people find to royally screw things up - as a start-up or anywhere else. As one panelist put it, experience is what you get when you fail to get everything else you wanted so, in lieu of learning the hard way, learn from others! In order of importance, most important to least (of the Top 10), here's what the panel said. I'll cover some of them today and some in my next post.

Mistake #1 (The Worst): Burning Your Bridges

Paraphrased, this came out more as "live by your word and act with integrity". Interesting #1, this, because its not limited to startups, obviously. In the world of startups, however, there are many inexperienced people, sometimes significant personal money at stake, lots of uncertainties and a huge amount of trust needed between investors, boards, founders and employees to pull it off.

This can cause people to behave, lets say, in a manner which is less than desirable or ethical. And outsiders sometimes take advantage of this (example quoted: Facebook's and Microsoft's habits of structuring acquisitions to offer more value to key people they want to keep going forward, vs. the deal already agreed between the investors and the founders/employees).

The point comes down to this. As you go into this with your team - all of the stakeholders - keep your word, make sure everyone feels good and properly treated and take care of your reputation. If you shake hands and then do something different it will come back to haunt you.

Mistake #2: Not Focusing Nimbly

Focus is critical in startups. Its very easy to get distracted, or overreact to outside factors. That said, the reality is that things change as you go along. So you need to be highly focused, yet nimble enough to change tack if something happens to significantly impact your plan. Fact is, many successful startups never set out to do what they ended up doing.

Ann Miura-Ko from her investments: Chegg was Craigslist for Colleges - until Facebook started doing it, so now it's textbook rentals for students; Circle of Moms was started as Circle of Friends by two young, single (no kids) guys as a way to create groups on Facebook, so when Facebook started doing the same thing they focused on Moms as one of the key active large groups that formed under their prior plan. (Hmm, notice a theme in Ann's investing??).

Focusing nimbly was also defined by one panelist as being able to say what you do clearly, in one sentence. Focus certainly, not sure about the nimble ...

Mistake #3: (Not) Letting Your Investors Become Your Trusted Advisors

This one actually focused more on developing the right dynamic between you and your Board/investors. A consistent theme was along the lines of "well, you (the CEO/Founder) are in charge and you need to run the company", with of course the caveat that if we don't like what or how you do it then we'll take you out. Reality is that you need to pay a lot of attention to who you take as your investors and how the dynamic will play out. Many investors have two completely different sides - when things are going well, and when things are not. So check out both sides with people who have worked with both sides - before you take the money.

If you need more help from your Board or investors its OK - to a point. Introductions to potential partners? Great. Taking over running the business - not good. It all depends on the timing, the relationship and the needs. Generally investors want you to listen to what they have to say, but not be told what to do (otherwise they should get someone else). So you have to figure it out but with their advice and input.

This also helps with one key point: never surprise your Board! Always keep them in the loop, knowing what's going on.

Mistake #4: Not Having Trusted (Valuable) Advisors

Naturally I like this one (becoming a trusted advisor - and earning that role - is one of the ways I help startups myself). And I agree with it because even experienced entrepreneurs don't know it all. They tend to know a few things well, and the rest has to come from around them - the team, the investors/Board and the trusted advisors.

In this case "trust" means "valuable". They need to add true value. If they are just names on paper to look good then they're just endorsements -and largely worthless. They need to be real help to you. You should hire an advisor the same way you hire an employee - carefully, with reference and other checks. Paid or unpaid, cash or stock, depends on the value and the role. 

However advisors will get frustrated and move on if you don't know how to use them, receive the advice and know how to parse and act on it. This does not mean blindly following the advice. But if you ask for advice then please accept it and decide how you will use it. And don't try and do it all yourself.

More in the next post!

Rugs to Riches - Saeed Amidi and the Plug and Play Silicon Valley Story!

If you want to get a first-hand, very intimate view of growing a successful business in Silicon Valley in the age of the internet then listen to this 30-minute segment from BBC Radio 4's In Business programme (listen online or download as a podcast). 

Actually it's the story of Saeed Amidi and his family's transition from leaving Iran prior to the revolution and, because they could not then go back, how they made their way in Silicon Valley. Saeed is now a good friend of mine as we've worked together for a couple of years at his Plug an Play incubator in Sunnyvale and the story is a great example of why Silicon Valley is the one and only Silicon Valley!

It starts with storing their family rugs in a building on University Avenue in Palo Alto - behind papered up windows - and then accidentally getting into selling the rugs after they tear down the paper. This leads to meeting successful VC's and executives of recent IPOs who want ... rugs for their mansions. Saeed buys the building (listen to how he deals with being told by Mr. Pappan, his landlord, that the building is for sale for $1 million but Pappan tells him he'll have to pay $1.2 million because he's always late with his rent) and then starts renting space to startups. Not just any startups but in part through his rug connections its to the fledgling Google, Paypal, Danger and Logitech. A few times it's mentioned that this is a "lucky building". I should think so. Foursquare is in there now! Here's a photo of the first group of Google employees in front of that building, 165 University Avenue.

Of course Saeed was not just a landlord. He was smart enough to ask for equity in each company as part of the deal to rent the space. When you look at the list you know just how smart this was!

Then the story broadens out into the bigger Plug and Play operation that Saeed has built since then, including the 160,000 square foot incubator in Sunnyvale, a former Phillips Semiconductor plant that was empty for 6 years before Saeed bought it in 2006. Plug and Play is now a vast ecosystem of startups (over 200), events, venture capital meetings, cloud computing services, Executives-in-Residence (I'm one, part time) and so on. Now Saeed is looking to broaden further, bringing startups here from all over the world - Canada, Asia, Italy, Spain, you name it - and starting to brand the Plug and Play operation into places like Singapore.

It's an American-immigrant-makes-good story. And its a Silicon Valley as the center-of-the-tech-startup-universe story. And its a we-can-help-the-world story. I love it!

Why Silicon Valley is Still the Only Silicon Valley ...

One of my LinkedIn groups, "European Entrepreneurship & Innovation @ Silicon Valley" has an active discussion thread going on about where the next Silicon Valley might be. I thought it would be interesting to share with you my own contribution to this ...

I've worked a lot with startups in Silicon Valley and have close connections with the Plug and Play incubator in Sunnyvale as well as throughout the ecosystem here. While I agree that things are steadily improving elsewhere (and Plug and Play itself is trying to expand it’s concept outside the U.S.) there is lots of evidence that creating another “Silicon Valley” elsewhere still has a long way to go.

As evidence, I’d point to the significant and rapidly growing group of European startups coming to the Valley, from Barcelona, Austria, Rome, the UK and elsewhere. Their reasons for coming here? In their home countries or generally in Europe the ecosystem of funding, expertise (particularly management expertise), talent, mindset, advisors, legal and so on is still far less well-developed than here in the Valley. The fact is that it’s still incredibly difficult to build a successful business from scratch even with all the tools and resources such as cloud-based platforms available today and a lot of it is nothing to do with the technology itself.

The SV ecosystem is still second to none in helping in the broader aspects of this. In almost every case I’ve seen the only local advantages in Europe seem to be lower cost structures (a SW developer outside Rome costs $30k a year, same as an outsourced India person and a lot less than the Valley) and government-backed loans (if you have the patience of Job). On top of which too many prospective employees in these locations just want a 9-to-5 job with benefits (not the go-for-it mentality of startups in the Valley). And labour laws prevent you getting rid of them if they don't work out.

Another example - a local VC in Spain taking the attitude of "if I invest and you leave, then the equity you already earned and vested comes back to me". So, I punish you if you leave. What kind of stupid attitude is this? Why would you join the company in the first place? I don’t know any Valley VC who will do this – or even think of doing it. Golden handcuffs inasmuch as you earn and keep more the longer you stay, and topping up the options regularly – yes, here in the Valley. But not over there, apparently.

Yet another example - you can incorporate here in the Valley overnight with the help of a top-notch Valley lawyer from Orrick (who will do this for free and a $600 filing fee). OK, his time is minimal and he wants the relationship. But try doing that in Rome or Barcelona or Prague and they look at you like you’re mad (and you would be).

If other locations are really becoming new Silicon Valley, then they would start to siphon off a decent share of the financial lubricant needed to prove an idea and scale it up as a business. Do they? I don’t think so. According to the NVCA about 276 Silicon Valley deals raised $2.92 billion in Q2 2010 versus 216 deals that raised $1.57 billion in Q1 2010. Part of a general recovery? Yes. But in bigger picture this is almost half all the VC money invested in the total U.S. ($6.52Bn) going to the few square miles of the Valley. According to Dow Jones Venture Wire “Venture investors put €1.1 billion into 289 deals for European companies during the second quarter of 2010”. Even though this is a 50% increase over last year its still saying that all of Europe raised less than half the money going into Silicon Valley. China? Raised $689m in the same 3 months. Less than a quarter of the SV amount.

So, who is winning the fundraising game? Today anyway …

Don’t get me wrong. It would actually be a wonderful thing if there were Silicon Valley's in Poland or Abu Dhabi or Kandy or Phuket (my vote). And yes it is slowly changing out there. Not just in Europe - Asia is following suit. But they’re all still a long way from being in the same league as Silicon Valley.

My prediction is actually a bit different anyway. I think the truly successful startups will become multinational early in life and stay that way. They may be headquartered and funded in one place – maybe Silicon Valley or London, develop their software in another – maybe Prague or Hanoi (with employees motivated as part of the global team, not outsourced coders who don’t give a hoot who they’re working for), partner globally and locally and be connected directly with customers all over the world. But that’s not the old 1000+ person multinational. This is 15 people in a quasi-virtual organization yet all bound together with a common identity. And of course this is how we’ll really bring the world together in the future!

Why Comerica or Silicon Valley Bank Should be your Commercial Banker - and NEVER Wells Fargo!

I was planning a post about why it doesn't make any sense for a Silicon Valley startup to bank with a main street retail outfit because, in general, these banks have no idea how to work with or support a bootstrapped or venture-backed, early stage company. In particular I was going to single out Wells Fargo because, for some reason, I see many startups banking with this particular mainstream bank rather than some of the others. Unfortunately they are useless for anything other than basic transaction processing.

I always recommend banking with Silicon Valley Bank, Comerica Bank or similar institutions which specialize in early stage, venture-backed clients and who have a vast array of services geared specifically to these kinds of companies - and people who know what they're doing and who make the effort to understand their clients' businesses and work with them at every stage, like Sunita Patel (who I think is wonderful) at Comerica. Or SVB, for example, runs frequent events for startups to meet and pitch potential investors, as well as having their own VC fund to make direct investments. Like any other relationship you need to develop it over time, but someone like Sunita at Comerica will, in my experience, help you to her fullest extent when times get tough - which is the kind of banker you need.

Unfortunately I hadn't realized until today just how bad Wells Fargo is in other areas. We recently opened a "Teen Checking Account" with Wells Fargo for our 14-year-old and received, today, our first statement. I was shocked to see a $3 monthly (MONTHLY!) service fee for this account containing the $200 my son saved up from chores and odd jobs. Check out the attached statement (full address and account number redacted) in case you think I'm making this up! Download David Smith Teen Checking Statement

Note the ironic "Let us assist you in finding the right accounts and services to help you reach your financial goals" - apparently they think my son's financial goal is to literally give them his money and never see it again. If a mutual fund bragged about a guaranteed annual return of MINUS 18% just how much money do you think they would be managing?

Here's the email I just wrote to the CEO at Wells, John Stumpf ([email protected]):

Dear Mr. Stumpf

We recently opened a Wells Fargo Teen Checking Account for our 14-year-old son. We thought it would be good for him to learn the value of saving the money earned from his chores and other activities and to start budgeting for items he's interested in buying. Seems like the right example to set, don't you think?

Imagine our surprise to open the statement of his account received today - and to find his hard-earned $200 savings hit by a "Monthly Service Fee" of $3. "Monthly", mind you. No interest credited to him, of course. So over the course of a year my son's hard-earned $200 will magically become $164. For the privilege of .... what, exactly, from Wells Fargo?

So - in fact - the message to this kid from Wells Fargo seems to be as follows:

"Hey kid, because you don't know much about money we're going to smile at you, take your money and deposit it in our big vault for your safekeeping. And then, while you're asleep, we're going to take some of it every month to pay for our CEO's corporate jet until you have none left. How about that, eh? Teach you to trust your money to a big bank, heh heh! Good luck with that college fund, by the way. Lucky for you your parents weren't suckered in to giving is that to manage as well. Yours truly, Wells Fargo Bank"

Shame, SHAME, SHAME on you!

I wasn't a supporter of the current financial reform efforts in Congress - until today. Now I am 100% for anything that hits you.

Monday morning we are closing this account and this email will be all over the internet. Not that you will care one iota ....

Oh yes, have a nice day!

Philip Smith (father of same 14 year old)

I tell you, it takes a lot to rile me up given the bizarre things I see every day in startup land. But what is tantamount to stealing a kid's pocket money really gets me going.

Relevant to this blog? I think so - because if this is the treatment a 14-year-old gets, why do you think your startup being banked by the same institution is likely to be a good thing? You should recognize that having a good banker is just as important as having a good lawyer, accountant and other advisers in all the other areas of your business. A good banker is not a commodity and if you treat him or her as such then you'll get what you deserve.

Best Practices - Have Good D&O and EPLI Insurance Coverage!

Even for startups it makes sense to carry insurance coverage against potential losses to the business, or claims that may be made against it. Unfortunately we live in litigious times and being small - and being right - doesn't mean someone won't try and come after you with some kind of claim. Obviously you try and run your startup with the proper attention to operating within the law and with the right advisors to counsel you - insurance coverage then backs you up if needed. What are some of the key areas to consider and what kind of coverage can you get?

Directors & Officers Insurance (D&O):

D&O coverage is a "must have" once you start to have people acting in Board member (Directors) and senior executive (who may or may not be Officers) capacities. The people who act in these capacities for you are going to do their best to help guide and direct the company - but given that state laws can make you personally liable for the things you do in these roles you need to provide some coverage for these folks.

A professional investor such as a VC will carry insurance for their partners who become your Board members - but you still need coverage for other Board members and the Officers, and the company needs to be the beneficiary (which it is not with VC's own coverage). Usually a company indemnifies Directors and Officers when acting in their official capacity - and the insurance coverage insures you have the capacity to follow through on this indemnification if any claims are made. If you are asked to become a Director or Officer of a company don't ever agree to this without checking that you have both indemnification AND company has the insurance coverage in place or you could be personally exposed. In exchange for your expertise and help this is the least you should expect.

What kinds of things are covered by D&O insurance? Being sued by a disgruntled stockholder who believes that he or his class of stock has been disadvantaged by a business decision to take a new round of funding, for example.

Typical levels of D&O coverage are $1 million to $3 million. Cost is maybe $5,000 for $1 million or $10,000 for $2 million of such coverage. For a small company this will seem expensive, so you and your Board and Officers need to consider the level of coverage carefully. $1 million is probably fine where you are pre-Series A, but $2 million or more is better when you've raised a full Series A or later.

Employment Practices Liability Insurance (EPLI):

Often bundled with Directors & Officers policies, this insurance covers you against claims made by employees or former employees for things like age discrimination, unfair dismissal, failure to pay sales commissions or other compensation, etc. As always, the best insurance is to operate with clear and consistent policies and procedures. But I've personally seen situations where, for example, a salesperson has been terminated for poor performance and a significant time later has come back and claimed commissions for deals closed after he left and where he was not involved in the transaction or in any efforts leading up to it. In such a case, even if you are 100% right, the cost of defending the action brought against you can be very high, so why take the chance. For a small, 15 person company, $500,000 of coverage with a $10,000 deductible may only cost $700 a year. Well worth it!

One key thing to remember. Many policies, including D&O and EPLI, are what's called "claims made". That means the policy has to be in effect when the claim is made, NOT specifically when the alleged event took place. So its no good having an EPLI policy in place when you fire a salesrep but having it lapse before he comes back and sues you a year later. You won't be covered. The good news - if you don't have this policy in place now then getting it will usually cover you for prior acts (unless you already know you're getting sued!).

With D&O, if you sell the company, ALWAYS get a "tail policy" in place. This covers you against claims made through the end of the statute of limitations period, usually 6 years after the completion of the sale, and long after your company has been subsumed into the acquiring business. Cost might be about 3x the annual D&O premium but is a "one-off" usually paid out of sale proceeds. 

Another thing. As soon as any claim is made - or someone even starts the dialogue about it - tell your broker and bring him/her into the loop. Don't go off and hire a lawyer etc. Your insurance carrier will usually take over the defence of any claim and use the specific legal expertise they have on retainer to help you.

Let me know if you need some recommendations for good insurance brokers!

The Right Skills from the Right People at the Right Time ...

With prompting from Fred Wilson's recent blog post regarding accounting for startups, my own recent experience makes me revisit the topic of finding a good bookkeeper or accountant early in your startup's life. (At this point many entrepreneurs will switch off - don't do that! You need to read this!)

Fred did his post as part of a new series of posts educating entrepreneurs on financial fundamentals. Bear in mind Fred is a V.C. - he's invested in Twitter, Etsy, Zynga (Farmville, Mafia Wars), FourSquare and so on. The man knows what he's doing - and saying. The main points in his post:

"If you have a company, you must have financial records for it. And they must be accurate and up to date. I do not recommend doing this yourself. I recommend hiring a part-time bookkeeper to maintain your financial records at the start. A good one will save you all sorts of headaches."

and

"There is always a temptation to skimp on this part of the business. It's not a core part of most businesses and is often not valued by tech entrepreneurs. But please don't skimp on this. Do it right and well. And hire good people to do the accounting work for your company. It will pay huge dividends in the long run."

I'll give you some examples in a minute that support his views - from when it hasn't been done right. But I would say that Fred also misses a key point - which is that even the best bookkeepers often need guidance, just as the best engineers, customer support or sales people need guidance and direction. In accounting this comes from having an experienced part-time CFO or financial expert on your advisory team (very part-time, maybe for equity only or a little cash). That person will help the bookkeeper and entrepreneur determine key policies like revenue recognition that invariably trip up the unwary and can really help the entrepreneur think about how to structure his sales deals, etc.

If you don't follow Fred's advice - or mine - what happens? Well, you get these real-life examples:

• A company which has misstated it's revenues for more than 5 years and which has allowed sloppy business practices to become institutionalized. And which is costing a lot of money to fix before they can get more funding. In this particular case its also clear that the lack of proper accounting raises big question marks about the overall management of the business.

• A company which has for 3 years used an under-qualified bookkeeper to "save money" and declined to get outside financial or auditor guidance. The result? Receivables on the books that sit there for years and are not collectible, revenues that don't align with underlying sales contracts, debt and equity accounting that doesn't match the company's historical financing events, inventory on the books that doesn't physically exist, non-existent accounting for a joint-venture, etc ....

• At the extreme, another Canopy Financial ....! OK, Canopy looks like a fraud perpetrated at a senior executive level. And yet paying attention with the right skills from the right people at the right time could have nipped this in the bud instead of taking the company down along with well over $70 million of investor money.

I don't really blame the bookkeepers. I blame management. And the Board of Directors as overseers of management. As a founder or CEO your job includes insuring you get this right. It may cost a little bit of money - but nothing like as much as it will cost you later if you screw it up!

The Startup Visa Act - Good News for the Valley!

Back in October I wrote about U.S. immigration policy and how frustrating this is for entrepreneurs trying to come here and start new businesses. I mentioned two European startups having challenges on this front and since then I have a third startup executive, founder and CEO Franco Petrucci of Decisyon in Italy who is now concerned about his visa situation. In Franco's case his plan is to get Decisyon's sales ramped up in the U.S. and eventually move the headquarters of the business here. If successful - and, as part of his team I sure hope he/we will be - he will create jobs here, add to the economic output of the Valley and reinvest profits. Why do we make it so hard on these people?

Well, fortunately the efforts of StartupVisa.com, Fred Wilson and many others in the VC community has resulted in some action! Last month two senior senators, John Kerry (D-MA) & Richard Lugar (R-IN), in a rare show of bipartisanship, introduced a bill in Congress to help solve this. The Startup Visa Act would grant two-year visas to foreign entrepreneurs who can show that a U.S. investor is willing to put up at least $250,000 in funding for their startup. If, after the two years, the venture has created at least 5 jobs, achieved $1,000,000 in revenues or attracted at least $1,000,000 more investment then the entrepreneur will be granted a green card - full residency status. Here's an example quoted by the VC's who supported this initiative that helped tip the scales:

"Vanilla is an example of a type of company this visa would apply to. Vanilla has two founders, both Canadian. They spent the summer in Boulder, Colorado as part of the TechStars accelerator program getting advice, help, and mentorship from over 50 U.S. based entrepreneurs and investors. Numerous investors were interested in funding Vanilla and helping them to grow their company from Boulder; however neither founder was able to give investors comfort that they could get an appropriate visa to stay and work in the US. Since then, the founders have relocated to Montreal, raised $500,000, and started their company in Canada. Today, they are adding three people to their team, all based in Montreal. If successful, they will add many more people to the team over the next few years."

Some good news out of Washington for a change, and Silicon Valley will be a big beneficiary! Check out this letter from Sens. Kerry and Lugar, and the draft of the Act being proposed:

Download Dc-startup-visa-act-2-24-10

Download Startup-visa-act_-final-final-1

Why Do Otherwise Sensible Companies Not Have CFO's?

The Canopy Financial fiasco (see my posts from late last year) highlights a very basic question (in that case, among many basic questions): "Why do so many fast growing startups not have a CFO?"

Here's an interesting table (I think it's from Ernst and Young, one of the Big 4 CPA firms, via the J. Robert Scott CompStudy):

As According to this only 17% of startups have a CFO when they have done one or fewer rounds of funding. In most cases this is probably appropriate - these companies tend to still be at the pre-revenue, product development stage and the business is pretty simple.

By the second and third rounds of funding, however, most of these companies are now generating some level of revenues and starting to grow and scale the business. Yet only 56% have a CFO. And only three-quarters of them have a CFO after 4 or more funding rounds.

To me this is bizarre. There are so many requirements piled on a business that need a dedicated CFO to help handle - revenue recognition, external audits (often a mandatory investor requirement as a condition of later-stage funding, though not always enforced), business planning and strategy, pricing, international structuring and tax planning, compensation structures, internal controls, economic models, budgeting, HR compliance etc...

So why do people not have them? I think its a combination of the following:

1. Lack of experience at the founder/CEO level. Not knowing what's important in managing the broader growth challanges of an early-stage business and the need for checks and balances, particularly in rapidly growing, multi-location companies. By the way, lack of experience doesn't just mean few years of experience. The challenge is also often true with an experienced sales or marketing executive turned into first-time CEO, for example.
2. Pressure to keep costs low and spending focused on product development and customer acquisition (sales and marketing). Unfortunately this is often encouraged by a company's Board - people who should know better about the need for checks and balances but often tend to be way too focused on minimizing unsightly or "unproductive" G&A overhead.

You have no idea how many companies I've seen over the years where some combination of these two factors has resulted in substantial problems later - restatements of financials (sometimes material enough to change an investor's view of the company's results), businesses with poor balance of resources, out-of-control compensation structures, untenable long-term economics, screwed-up equity structures, bad borrowing decisions, etc.

In the case of Canopy Financial they had, at some level, thought about the need and done some initial looking - as I know from my personal experience. But it clearly was not as high enough a priority as it should have been, and it took the appointment of new in-house legal counsel to blow the whistle on the problem. I guarantee you that a strong CFO hired a lot earlier would have discovered the problem before it escalated so significantly - and perhaps prevented it altogether.

So I know its self-serving to some extent but - please! - bring in the right CFO-level help at the right time. If its too early for a full-time person there are many well-qualified part-time people available. The cost of not doing so may be substantial - and not just the cost of fixing things. In the case of Canopy, it was disastrous.

Two Tales of "Working For Equity" ...

Working for equity only is, realistically, the way most startups have to get going. True founders - the gritty, enthusiastic, determined, change-the-world, passionate types - will do this for a long time, including well after they start paying others on staff some real cash. While there have been times in the last dozen or so years, usually during times of venture capital excess, that cash to founders, early-stage executives and other key employees has matched regular market compensation (still with the upside of the equity), this is not true in the vast majority in the start-up game.

In my line of work, consulting to a range of startups as CFO, mentor, COO, counselor and therapist, I come across many "opportunities" to work for equity only and I have a couple of current clients where I do just that. In both cases these are pre-funding companies I believe I can help and where I believe in what they do and how they do it. In both cases the founders pay themselves nothing in cash, and what little money they do have goes to other resources they need to get to a funding milestone.

These are fair arrangements I enter with my eyes open and - particularly in my role - its clear very quickly whether this is equitable or not. Compensation-wise the biggest challenge is insuring people are respectful of my time and skills (when they don't write real checks for hourly or project work they don't tend to be quite as diligent on this as one would like!).

Then you find the people who just don't get it. Recently I was offered the opportunity to help a company and the opening gambit from the CEO was "well, we can only pay equity and in your own blog you say that's OK". Er, yes, but when it turns out that you have a staff of 15, all on salaries, a $3.5m a year burn rate and your equity is worthless due to numerous recapitalizations and bridge loans from investors then either you don't get it or I'm stupid to do it.

The second example came along just this morning. Someone in my network forwarded an email to me from a recruiting firm that is quite active in the Valley. They are looking for a "a stellar CFO to be their financial lead as they build their foundation and move into fast growth" and it goes on to describe all the usual stuff about how you need to know how to scale tall buildings in a single leap and conjure up millions for the business while providing the adult supervision.

Then come the red flags: "you can be an integral person as they raise a C-round of financing" and "we're also looking for someone with the ability to work for equity in lieu of a paycheck at first". Translation: "we've blown through two rounds of funding already and we need to try and convince some sucker to work for nothing and pull our asses out of the fire".

Worse yet, the same recruiter, on their website, is posting a position for "a strong, confident and very savvy executive assistant to support the CEO" and for which they will pay $80,000 a year. The company description makes it crystal clear that this is for the VERY SAME STARTUP looking to pay nothing to the sucker CFO. What kind of client is this that has blown through the money, wants a top-notch CFO for equity only and actually thinks its OK to waste $80k a year on an executive assistant to the CEO? Hello startup, exec assistants to CEO's are out of the question, let alone for $80k! Looks like you should have hired a CFO a long time ago!

Don't get me wrong. Working for equity only is a perfectly valid way to go. But get it right:

• Make sure the arrangements are fair and equitable to all. Don't be paying yourself or others a decent salary and then expect someone else just to work for stock
• Don't mislead someone about the value of the equity. If you have $30m of preference in some manner stuck in front of the Common, then convince yourself of the value of the equity before you try and convince someone else.
• Be respectful of people's time and skills and make adjustments to the arrangement if it's no longer in balance (either way)

Good luck on that Series C raise, by the way!

Presentation Secrets of Steve Jobs!

Or, how to be insanely great in front of any audience! I found this on SlideShare and it reminds me of one of the big things I learned this year (I'll do a post soon on some of the other things). That is, realizing just how hard it is for most people (myself included) to prepare and deliver a compelling presentation.

While that's not a new revelation it certainly struck home this year when I watched dozens of pitches by startup founders to VC's in their search for funding. The vast majority - frankly - were pretty awful, and some wretchedly so. Having observed all these pitches this year I could certainly say that a significant proportion of the ideas pitched were ones which should never get funded, at least as pitched. But many did have enough merit to warrant investment to at least develop the opportunity - but even then the presenters struggled to get that across to their audience in a compelling enough manner.

It's truly a combination of an art and science with hard work. Yes, it helps if you are Steve Jobs and you have your brilliant Apple products - but, as the presentation shows, he was not always as "insanely great" at it as he is now. Very few people are pure naturals at this - and he isn't either. I tend to do the same as most people - jam up slides with bullet points for example. Check out the presentation attached from Carmine Gallo, a BusinessWeek columnist who does a good job of capturing the Jobs approach. Yes, 77 slides seems like he's going against his own advice - but you can zip through these in 5 minutes and grab the key messages easily. Which, after all, is really the point, isn't it?

Happy New Year!

Things Are Looking Up!

Well, I've been taking a little breather from the blog for a few weeks and now it's time to get back in the swing of things!

One reason for the breather - in the last few weeks things have become incredibly busy! While that's good news for me personally after such a quiet year so far, I think it's even more encouraging for the startup community as a whole.

I think we should be encouraged by the apparent stabilization in the business environment, even though problems still abound. It's clear there is improving sentiment and higher confidence and it's showing even for early stage companies. Some examples I'm seeing (I have to avoid using names due to the confidential nature of the information and the fact that I do work for each of the companies mentioned):

• One company is finding significant new interest in it's voice solutions including from a major service provider in Asia
• A software company is engaged in a new customer opportunity that - alone - could increase it's bookings this year by 50%
• A third received a favourable mention in a major trade publication and as a result is getting significant interest from big-name advertisers for opportunities in it's social network
• A fourth just closed it's first revenue deals after launching many trials earlier this year
• A fifth is accelerating it's efforts to ramp up business here in the U.S. on top of it's European successes
• I've just been approached by a company looking for help in evaluating multiple possible acquisition offers

I could not say any of this earlier this year. And it's both refreshing and welcome to be saying it now! Unfortunately this has not yet translated into closing of new funding for these companies - but you know that this kind of progress will get VC attention sooner or later.

U.S. Immigration Policy Frustrates Startups!

Fred Wilson's post a week or so ago about the problems that one of his portfolio companies has getting a U.S. visa for one of the founders rings a big bell. Here's how he phrased it - "I started my day in a board meeting with one of our companies that was started in Europe. It turns out one of the founders of that company, one that is growing and hiring in the US, cannot get back into the States right now because of a Visa issue."

I've been working with a variety of startups out of the Plug and Play TechCenter for most of this year and I guess that some 40% of the new companies coming there originated outside the U.S.. These are businesses founded by young entrepreneurs who know that they need to relocate here to tap into the Valley ecosystem of funding, talent, prospective customers, partners and access the U.S. market. Despite efforts by many governments in Europe and Asia to develop their own Silicon Valleys there is still no real substitute for being here.

This trend represents an influx of new ideas, perspectives and talents that will be part of the next evolution of the Valley - and its a wonderful thing! And guess what? These entrepreneurs create jobs here. They don't take jobs away from this community - they add to them. Yet our asinine immigration policy makes these people endure constant returns to their home countries for weeks or months on end in order to renew visas, be interviewed at the U.S. embassy, etc etc. What a waste of time, money and opportunity!

The founders of two startups I'm working with - Martin Tantow of 3scale out of Barcelona and Alfonso De La Nuez from UserZoom out of Madrid - are both back in Europe now for extended period dealing with such visa challenges. They will get them of course, but their efforts to hire people, get funding and develop their businesses here stall each time they are gone. Which helps no-one.

There is, fortunately, a grass-roots effort going on to solve this, orchestrated among others by some folks at StartupVisa.com and supported by many with Valley connections. Basically they propose to create a Founder's Visa that will take care of all this. Great idea, definitely overdue. You can contribute to StartupVisa's efforts on their site.

How Not to Get Hired!

One of my companies, UsTrendy, is looking for a technical lead for the team. As always with a startup we want the best person we can possibly find. Someone who can be the focal point for development of our online store, our site and - down the road - our analytics services and more. He/she would also work with the founding team to expand the business strategy, platforms, evaluate in-house vs. outsourced alternatives and so on. And of course our new hire must be passionate about our fashion-related social networking business and a great fit with the team.

We posted the job on Craigslist to start with because a number of folks said they had great success through that site. The job requirements are pretty broad yet there are specific things we must have - hit the link to see the posting and I've also copied it below in case the CL listing expires before you read this.

So, what happened? We received perhaps forty responses so far, universally disappointing. Here are the high ... er, lowlights:

• Most obviously, it was very clear that many people couldn't even be bothered to write a cover note. Why would you not make at least some effort to say how you're interested in the company and why you think you're a fit. I'm going to give maybe 15 seconds to my first look at each response, so you'd better have something there to get my attention.

• Of those who wrote a cover note, only a few - perhaps three of the forty - even acknowledged who we are and what we do. I'm betting that many people didn't even go look at the site. How feeble is that?

• OK, we're basically looking for an engineer. So I expect some geeky stuff in the resume. But a whole page of programming languages as your starting point? Please! We're non-geeks looking for a tech lead. I have no idea whether your knowledge of BEA Tuxedo can help us (I suspect not) but please tell us which skills you have that can actually help a business like ours. By all means give us the full list in the resume if your cover note says which of those things will the key for u and why.

• Why do you think being illiterate - or presenting yourself as if you are - is a good idea? If you can't string together some basic communication in writing then why would I think you can sit in a room and articulate your thoughts clearly to the team?

• If I ask for prior startup experience it's because it's likely to be a core ingredient of a successful match between us and the right candidate. I'm probably not asking for it because it's irrelevant, so if you don't have it you should at least say why, despite your wasted years at Sun/IBM/Computer Associates/YouNameIt, you nevetheless are convinced you are right for a startup. If you can't convince yourself you certainly can't convince me!

• If you are a recruiter, why are you sending me resumes when I say "If you are a recruiter, sorry but please don’t send us unsolicited candidates!"? Not only will I not hire your candidate but if I have their resume already I might not talk to them anymore because I don't want you claiming a fee which I don't owe you. As a candidate you should never work with recruiters you don't know well and who don't discuss any approaches to potential employers with you first - and never contact the company on your own if you are working with a recruiter who has already established contact, even if unsolicited. 

• Show me you have some passion for something, anything. Please!!

Here's our listing for the opportunity as we posted it. If you know someone that is a GOOD FIT please let me know!!

UsTrendy is a new site allowing emerging and independent fashion designers to upload their creations, have consumers, fashionistas and others decide what’s hot and what’s not, and then market and sell their products. In less than a year we have more than 7,000 designers and 300,000 designs loaded, making us one of the largest sites in the space. We’re ramping up the consumer side of the business rapidly through initiatives to increase awareness, attract and retain visitors and keep people coming back.

Longer term we’re looking to create a fashion destination site, develop retail analytics services, targeted advertising and other revenue-generating opportunities directly through the site and through partnerships.

We have a ground floor, hands-on opportunity for someone to join us in a senior software engineering capacity. We are flexible on the right title – more important are the key things you would bring to the table. 

You will have a proven track record in software development in a rapidly growing start-up environment – with all the opportunities and challenges that brings. You will participate actively with the team to develop the vision and strategy for the business and translate that into the site, services, databases etc we need to make it happen.

You will be our technical lead and the primary interface with our small development team in Argentina (Spanish language is a plus but not mandatory).

You may be determining our architecture and platform approach one day – and programming the next! Key technical abilities include web development, ecommerce, database development and analytics. If you can tapdance while balancing a spoon on your nose, that’d be great!

At this stage of our development it’s important that we bring on people who are self-starters, highly motivated and a good fit with the team. We truly believe that the sum is greater than the parts and that a great, passionate team with complementary skills can achieve far more than we can even imagine. We are currently based in the South Bay and it’s important that you be located with us to achieve the chemistry and teamwork we seek. 

If this sounds interesting to you – and you meet most, if not all, of our criteria – then please contact us! We look forward to hearing from you. (If you are a recruiter, sorry but please don’t send us unsolicited candidates!)

Startup Staffing - How to get it Right!

A friend of mine asked me to given him some advice last week about responding to a job offer from a startup which he felt was too low. I was happy to do it and he just wrote to me saying he was able to get the cash side of the offer increased by 13% using my advice. One of my better returns-on-investment after an hour's work! Which got me thinking yet again about startup staffing, some of the challenges and how to get it right. In my friend's case the start-up was getting a good software QA manager but for a while really looked like they might blow it.

I've written many times about how this is a great time to start and staff a new tech business. Here are a few tips about how to get it right, culled from my own experience and talking with many entrepreneurs and investors. In no particular order:

• The right skills at the right time are important. But above all make sure who you hire is a great cultural and personality fit. In a startup there is no question that the whole is greater than the sum of the parts. Someone who is not a good fit can be toxic to the team dynamics and I can't think of anything that makes that worthwhile. The tone of the business and it's culture will be set by the initial team, so make sure that dynamic works well from the get-go.
• Even if you attract a founding team working for equity only to start with, you'll eventually have to start paying cash. These days, yes, you can get people for less cash than before. Whatever you're offering, make it equitable with other team members and pay people what they're worth (to the company - if there's a mismatch there then you're not right for each other anyway). Even if you think they will never find out, in a small company its not worth the risk of losing a good person who is inequitably compensated. Of course, thinking someone will never find out is the wrong philosophy anyway. Some (very few) companies post the compensation of every person in the company for all to see. Even if you're in the majority that don't, think about how people would react if they knew this information. Would they thing so-and-so was worth it or someone else was underpaid?
• A top notch software developer is worth 10 average developers. Unless they're not a good fit. On the other hand the really good developers will cost you - because among their many alternatives is the choice of working for themselves on the Next Big Thing, rather than for you. Of course you don't pay them 10x an average developer - but you do want to recognize your stars and, frankly, get rid of the average or below-average people. No, this is not contrary to my advice above. Done properly, recognizing stars can still be done in an equitable manner with the rest of the team. Don't confuse equitable with equal!
• Make everyone part of the team and incent everyone with equity via stock options. In one of my prior startups I found that the office admin in Prague was the only person in the company without stock options - so I got her some options as soon as I discovered this. Another executive said to me "she's just an admin, so why bother?" Well, I tell you, everyone plays a part in success. They cash compensation reflects the level of value but (in the long run) you would never dream of not paying them cash. Why wouldn't options work the same way? By the way, that executive I mentioned - prime example of the toxic employee ...
• If you have multiple locations, particularly outside your home country, then work hard to make everyone feel like members of the same team. At that same prior startup above I would insure that I made regular visits to Prague and each time I would do a presentation to the entire team (about 40 people) about the company's development, how their work was helping, etc. And we'd usually have a teambuilding event as well. That same toxic executive I mentioned wouldn't even join those meetings when he was there at the same time. What kind of message is that?
• Share information with everyone. The goals of the business. The key metrics and how you're doing. The issues. The more people know, the more they can take the initiative to fix things.
• Sales. If you don't get customer traction eventually you're dead in the water - you won't raise money or attract good people. Marketing is creating awareness and sales opportunities. Selling means closing deals. Getting the transaction over the goal line. In a startup everyone has to be selling and know how to sell. But be sure you have closers on the team. That could be the CEO or anyone else ...
• Outsource the stuff that is not core to your value proposition. Check my prior posts but, again, don't bring things like accounting, HR, etc. in-house unless you've exhausted the the capabilities of good outsourced services.
• Don't think that because you don't have cash you can't hire anyone. You'd be amazed at what a few founders and equity-based employees can achieve over a very short space of time if they truly believe.
• Finally, address problem situations quickly. That could be anything from compensation to work environment to a toxic employee. Yes, if I'd been CEO I'd have fired that executive I mentioned above - even if I was to lose the experience and other contributions I'd be gaining immeasurably in many other ways.

Tranched Investments Are Bad for You!

I've heard a few people talking recently about taking larger sums of money - lets say $3m - from an equity investor where the investor is proposing to tranche the investment (or where the entrepreneur thinks they might). Typically that means meeting certain milestones to trigger the next chunk of cash. I hate this idea. Why?

• Well, first of all the investor can be sending you a negative message about their confidence in you and your ability to execute by holding the money. And its distracting to everyone - you should be working with your investors closely anyway to get the right things to happen in the business and that's the real objective.
• Secondly, things change rapidly in the startup business and you need to change with them - so a milestone set today to be achieved in six months may be obsolete in three months because of some external event. Then what? Keep driving for it so you get the money? I don't think so.
• Thirdly, a VC could decide at any time not to put the additional money in. Lets say they committed the tranches before the recent market crash. Then with the crash their outlook has changed and investment plans rethought. Now they say they won't put in the next tranche even though you hit the milestones. Maybe they want to renegotiate the valuation down due to those external events. What do you do? Sue them? Again, I don't think so. Suing investors is never a good idea if you want to raise money in the Valley again.
• Worst of all, what's really happening is that the achievement of these milestones is in fact increasing the value of the company each time, but your investor's equity is all valued at the historical date when you signed the term sheet. So you just took more dilution than you would have if you took two smaller rounds of funding - one at the beginning and one new one later after achieving the growth.

What do you do instead? Well, you bite the bullet and take less now and plan on doing another, separate, raise later. With that $3m example above, take $1m or $1.5m now and raise more at a (hopefully) higher valuation in a year.

Back in March I wrote in a post that I didn't think financing a startup with debt rather than equity makes any sense unless its to bridge to an equity event you have a high confidence level will happen. Otherwise you just build a pier to deeper water.

In general I stick by that. But there is an exception (every rule needs one!) that I support. In a very early stage startup it can make sense to take initial money, perhaps $300k, from an investor in the form of a convertible note instead of equity at that time. A convertible note is a loan from an investor that is intended to get you going and to bridge to a later equity funding event. As part of the terms the investor can convert the note to equity at a discount, maybe 20%, to the subsequent round preferred stock price. Fair enough - they took the risk now to invest at that later valuation so they should get that break.

When would you do this? Typically, where you need some cash in to get to some proof point or milestone to then get a full equity round done. Your investor likes you and your ideas, but you have no customer traction yet although you're going into beta with a few prospects. You need six months to complete that process and covert the betas into paying, reference accounts. That is a big step because it gives your first real proof points of your value proposition - and makes you more fundable.

In this case maybe the $300k is sufficient to get you to a $1.8m equity raise (including the note converting) in a full funding round later at a $3m pre-money valuation. That's better than taking a $300k equity raise now at a $1.2m valuation and then another $1.5m at a $3m valuation later. A convertible note helps do that with less dilution. One other thing - it avoids the need to address valuation questions today. The company will be valued at the time you get a term sheet for the future round in six months. Its much harder to do two equity rounds six months apart and justify an good increase in valuation over that time. So delay that discussion with a convertible note! An investor will like it because it gives them more protection than equity, it's a smaller amount to risk initially, but gets you going and maybe proves their confidence in the overall opportunity.Of course, if you don't achieve your goal you will owe the money back - but with no ability to pay it off it will become another negotiation anyway.

The Case for Optimism - Plug and Play in BusinessWeek

For the last four months or so I've been working out of the Plug and Play Tech facility in Sunnyvale as an Executive-in-Residence. Not quite the same thing as the EIRs at venture capital firms who are typically executives of prior portfolio companies looking for their next portfolio company gig, and paid by the VC in the meantime. At Plug and Play I pay rent and get no salary - but I do get a great opportunity to develop relationships with many of the 200 or so start-ups based there, leading to potential consulting, interim or advisory roles, and perhaps the next full-time situation. Oh yes - and i have to pay Plug and Play a cut on any consulting with these companies. Costly? Yes. Worth it? Yes. Great place to be; very interesting opportunities and the chance to help companies who really need it. Good blog material too!

One thing I like about Plug and Play - it is a hotbed of optimism. Everyone here - even though struggling to raise cash and find customers in the current environment - is pursuing a vision or a dream and doing whatever they can to make it happen. You have to like the energy and drive and some of the ideas are terrific.

This week BusinessWeek has published a whole series of articles titled "The Case for Optimism" and Plug and Play is prominently featured in the segment "Keeping the Faith in Silicon Valley". Nice article with a good profile of Saeed Amidi, the founder of Plug and Play. The business is his brainchild and is primarily successful in its mission as a result of his energy, vision and networking. And its a lot of fun to be there and part of it.

Valley Update - Funding, Capital Efficiency, Planning and Areas of Investor Interest

Spent the evening yesterday at SVASE's "Raising Capital for Early-Stage Technology Startups" event and I thought it would be worth sharing some of the thoughts from the three panelists who shared some great insights! They were

• Susan Mason, General Partner, ONSET Ventures
• Matthew Price, Sr. Associate, Nth Power
• Carol Sands, Founder & Managing Member, The Angels’ Forum and The Halo Fund

In no particular order, some of the key takeaways - all of which make great sense:

• "Capital efficiency" is paramount in this market. Meaning that the less cash you have to raise to get to breakeven/cash flow positive the better it is for investors, founders, management and employees. And therefore the cash you have also needs to be managed in the most effective manner possible.
• Yes, lots of portfolio companies have been through significant restructurings and downsizings to make the cash last and become more capital efficient. In many cases this has been a great thing as it has forced people to look at their businesses much more critically. This has been very timely as we've seen startups finding the external market has caused them to fall 6 - 9 months behind on their plans, though many are now getting back on plan.
• There will be a big shakeout in the VC business, in particular with those who have not raised additional funds or capital in the last 2 - 3 years (to be clear, all the above HAVE raised capital and are not in this situation!). The ripple effect on their portfolio companies will be substantial and ugly.
• We're seeing a return to real "sweat equity" with startups - which is a good thing!
• Good VC firms are still investing. Many are also looking much harder at how that equity gets leveraged or enhanced - partnerships, channels, even grant and government monies (which Silicon Valley companies have traditionally ignored but I see many European companies pursuing quite successfully)
• Silicon Valley startups have also not traditionally sold to the government - rethink that!
• Your financial plan needs to assume that not everything goes perfectly. In fact it needs to presume that many things will not go according to plan. Therefore always take as much money as you can now because you never know. Your financial plan is not just about having gas in the tank, but about "de-risking" the business. When you have cash you have options and can manage things going wrong. When you don't you have no options. None.
• If you're very early stage look at pre-seed convertible loans and other creative financing strategies - a bridge loan to a syndicated financing round etc (but as I've said before, make sure its a bridge, not a pier!). Get your suppliers and customers to help finance the business. 

Susan Mason, particularly, also did a great job of pointing out some market areas and opportunities she thinks are very interesting for investors:

• Monetizing data real-time
• "Everything" as a service - SAAS, Cloud Computing, PAAS, etc
• Enterprise 3.0 - for example, free, ad-supported network management tools
• Security as a service
• Financial payments infrastructure
• Internet gambling - when it becomes (inevitably) legalized here as it is in many other countries
• Virtual goods-based companies
• Mesh sensor networks with recurring revenue models
• Medical devices that speed up diagnostics or provide custom or personal medical solutions via your genetics

Three Keys to Startup Success ... Monetization Strategy, Effective Marketing and Management

Three things keep showing up as critical to getting a startup on the road to success - Monetization Strategy, Effective Marketing, and Management. Ok, yes, cash helps too. But you won't get cash without being clear how you'll use it to execute well in these areas. A good, working product or service? Of course - but history is littered with great ideas and good products that never went anywhere because people didn't know how to turn then into successful businesses.

Success in the near term may be getting enough funding to enable the next stage of a company's development. This may be completion of the initial product, build out of the team or gaining initial marketplace traction. In the long term it's building a sustainable, profitable, growing business with a large market opportunity (unless you're building a lifestyle business - which looks a more and more attractive option these days!). So what do I mean with these three things that are so critical to getting on that road to success?

Monetization Strategy

As I've noted before, with certain exceptions (Twitter, at least for now; YouTube - though not for much longer), having a clear, well thought out and tested monetization strategy is critical. "Tested" ideally means people paying real money for your product or service and who will be reference accounts (ones that a VC can call and talk to) - or, if you're still very early, credible people who will say "yes, if you produce that I'd buy it and here's what I'd pay". Its highly unlikely you're going to be a trailblazer in your monetization strategy. Leave that to Google, Salesforce and others. But you ought to know what others are doing and how you play off key trends and examples in the marketplace - term software licenses instead of perpetual, scalable subscription-based services rather than fixed fee, micropayments (many  payments of small amounts) and so on. See my post from May 8th for more!

Effective Marketing

For many of the startups I've seen pitch this year the biggest near-term challenge is getting known and then getting customer traction in the market. "Who are you and why should I care?" is a major barrier - but when you solve it you are in great shape! In a pitch I saw last week from a very exciting startup, UserZoom, being able to say you have eBay, Monster, Shell, Novartis and others as paying, happy customers in less than a year from starting their service is the most compelling thing you can have when raising money. Fortunately these days the options for creative and cost-effective marketing targeted at getting that initial adoption are better than ever. See my post from April 11th for more on marketing spend - what's worth it and what's not. 

Management

Although it's an old axiom in the VC business - that VC's invest in management teams - it rings even more true today when money is scarce. Why? Because VC's know that great management teams are far more likely to execute effectively, with fewer mistakes, and find ways to turn good ideas into successful businesses with the least amount of cash investment and lowest risk. The VC money is the lubricant - but its people who have to make it happen. Regrettably, many inexperienced founders have a hard time understanding that the best thing they can do is hire people who have been there, done that - but that's what it takes and what a VC will look for. Find and hire the best people you can to help turn your idea into reality - these days those people are even more readily available than ever before.

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• Chris Anderson on "Free" at Global Business Network (edbatista.com)

Is Your Financial Model Ready to Meet Your (Prospective) Investors?

As I work with some of the startups here in the Valley looking for early-stage funding, one of the weak spots in their approach to investors is the financial model they've developed. Or - in some cases - not developed.

No matter how exciting the idea, how great the buzz or how wonderful the management team, your pitch to investors has to show how you will build a business that will be big (if it won't be big then it won't be attractive as an investment now), and will generate profits. This is not slapping together a few numbers and hoping for the best. The financial model you develop needs to show that you know how you'll monetize the idea (generate revenues) and what resources it takes to develop a robust product or service, generate customer awareness, close deals, get the customer up and running, keep them happy and scale up the business. Most importantly, it will tell an investor just how far the cash they are putting in will go - and it had better be far enough to give the company a strong shot at getting to the next fundable stage.

To explain how all this works, how to put together a compelling model and what to look out for in the process I've been presenting a workshop to CEO's of early stage companies. Here's the how I define the process for developing the model:

The last part - validating the model - is often overlooked by early stage companies. If you really think you'll be bigger and more profitable than, say, Salesforce.com or Google was after 4 years then by all means say so. But for mere mortals in business you probably want to set goals that are a little more realistic and then explain to your prospective investors how this compares to where the other companies were at similar stages in the past.

Hint: if those "comps" are now public companies you can go to their SEC filings and type in "S-1" (without the quotes) in "Filing Type" and you'll find 3 - 5 years of financial history prior to their IPO. Often this takes you back far enough to see a few years that will overlap with your model. Here's the S-1 filing for Salesforce from late 2003, with data going back to their inception in 1999 (page 23)

Here are some of my tips for success with your model:

To get a copy of my full presentation please download a .pdf of the materials. By the way, the orientation of this pitch is towards the companies I primarily work with - internet, ecommerce, software and related companies. A fabless semi company or a telecom equipment company will have, by necessity, a more complex model but the principles still apply ...

Download Startup Financial Models - Philip Smith

If you have any questions or comments, want me to come explain this to you - or just need some help - please let me know!

What's Your Monetization Strategy?

Image by ZeroOne via Flickr

In talking with venture capital firms and with the startups that pitch to them there are many key areas to emphasize in a business plan. I'll be posting about some of these over the next few weeks.

One such area, however, is your "Monetization Strategy". At various times in the recent past - coinciding with the formation of a bubble or pending market bust - investors have not cared about this. It was all about "eyeballs" or "land-grabs" or whatever the then-fashionable euphemism for forgetting about how to be a business person and real investor. Fortunately - with a few exceptions such as Twitter (where it will still come) - investors and business people have returned to basics and now want to know "how will you turn this idea into something someone will pay for, and what will be the resulting revenue stream?"

However it can be very complex if, say, you're a software company or a web-based services company. Your software licensing model may be the traditional (a.k.a. outdated) expensive perpetual licence and annual software maintenance contracts. A perpetual licence gives the buyer the right to use the software in perpetuity but you'll need to pay 20% or so of the original license fee per year to the seller to access support, get upgrades, bug fixes etc (ie: to insure it still works).

These days its highly unlikely - impossible, really - that you'll get funding (or market traction, come to that) for a startup software company with a perpetual license monetization strategy. In part that's because there are far better alternatives - for customers, investors and for you. Term licenses bundled with maintenance in essence take a software rental approach. You still take "delivery" of the software and have to install it at your site; however you use the software for a defined period of time for a set fee - or for a variable fee that might be based on number of users, transactons processed or whatever. Obviously you can renew the license when the term is up (though you will not typically guarantee what the price to the customer will be when that happens). A big advantage for an early stage seller is that its typically easier to get the customer to adopt your solution than with a big upfront fee - think of this as the leasing model for a car, vs. a cash purchase.

More common now is an "on-demand" or "software-as-a-service" ("SAAS") delivery and monetization model. The customer doesn't install the software at all. They log into a web-based service you've set up - which can be very customized for them - and they pay by usage, number of seats (individuals in the company using the service, etc). No other license fees, no ongoing "maintenance", underlying software is always up to date (because its completely run and managed by the provider as service on their platform). This is a great model because its easy to understand and sell, it scales from one user to thousands without any changes or upgrades, etc.

Many other monetization models now exist, thanks to the on-line nature of many businesses. Advertising-supported models have become a huge factor, with Google, Yahoo! and others being such major players, and hosts of other companies providing tools, services, channels and so on around this. So much so that there has been major dislocation in all of the previously off-line, ad-reliant businesses - newspapers being an obvious example. 

So what's your monetization model? In my next post I'll consider some of the factors to think about as you develop yours!

Raising Startup Funds in Today's Environment ...

Whether its one guy/gal with an idea or a more developed business ramping up rapidly, one thing they all worry about is cash. Funding. Where - in this environment - is the money coming from to move the idea/product/technology/business to the next stage?

Because I have a track record (I've raised over $80m in venture capital in the last 10 years for a range of startups) - and because I'm a finance guy - founders and execs in startups tend to turn to me for help in figuring this out. Well, there's no magic wand, that's for sure.

Consider the range of traditional funding sources at various stages and what's going on out there. In the rough order from very earliest stage to the later stage funding rounds, here's what its like out there now:

Friends and Family:

These are the traditional backers of the Next Big Thing to help Johnny get it under way. With a group you might raise $100k or so. However my guess is your Mom, best buddies and Uncle Bill have all seen their home values collapse, their 401k's beaten up and their own jobs disappear in the last year. Not a great environment to invest in your latest harebrained idea, really.

Angels:

A traditional Valley source for a few $100k's. However many of these have also seen a big drop in personal wealth. But they are more risk tolerant than Mom, and probably understand the idea and the opportunity a lot better than Uncle Bill. And at least you won't have to face them at the Thanksgiving dinner and explain why there's more than one turkey in the room. Still pretty hard though ...

Alpha, Micro-Cap and Seed Stage VC's:

Better. Collectively, perhaps with Angels, you might still raise up to $1 million or so. Stiff competition for the cash. But they are "risky idea" stage investors and the money is still out there.

Series A Venture Capital:

So your idea has turned into technology and thence into a product/service. And, wonder of wonders, its getting traction in the market. Assuming you've checked all the boxes - team, market opportunity etc etc - then this is still a viable source. Here we're in the $1m - $3m range these days.

Venture Debt and Equipment Leasing:

As I've said before, don't borrow unless its a clear bridge to a next equity funding event. Otherwise its a pier to jumping into much deeper water than you really want. But don't worry, no-one is lending anyway.

Strategic Investors:

These are the big corporations who might invest as much as a few $m for the right opportunity. Still possible these days, particularly with a real strategic partnership. Problem is, in true shortsighted American business knee-jerking, many strategics have pulled way back or have even moved to stop any new investments in this environment. These are the same companies now downsizing or divesting the acquisitions of the last few years in a "change of strategy" because the "market environment has deteriorated rapidly". Don't get me going ....

Series B, Series C etc etc ...

Hard, hard, hard. You'd better have the engine running on all pistons ...

Tough? Yes, of course. But you know what? This is STILL a great time to start a tech business. And there is money out there. But you need to really work hard to earn the right to have it

Financing Your Startup with Debt - Good or Bad Idea?

Image by DanielaNob via Flickr

If you're an early stage company at some point you may consider financing your business with debt as well as - or instead of - equity.

There is no simple right or wrong answer about taking on debt as, with so many things in startup land, it depends ... on the company's stage of development, the availability of other funding sources, etc.

And as usual with banking, the less you need it the more available it often is.

Over the next few weeks I'll explore some of the factors to consider in looking for and taking on debt in your startup.

However, remember that debt is not like equity and there is a requirement of regular repayment of the principal along with the interest.  At some level its the same as a mortgage on your home - you repay principal and interest monthly (perhaps starting after some months of grace period) and therefore you need to be comfortable that you will have the ability to repay this debt even if the value of your business declines. You therefore need to be very comfortable that the reason to borrow is to use the loan as a bridge to a key event or milestone - a sale of the business, completion of an equity funding round, achievement of consistent positive cash flow in the operations of the business, etc.

I am not a fan of borrowing to generically "extend your runway". Unless you have a clear and achievable goal with a high probability outcome that the debt will bridge you to, then you will have simply created a pier and when you plough into the water you'll be in a lot deeper than when you were dabbing your toes in at the water's edge!

So, Rule #1: Use debt only to build a bridge, not a pier!

There are (Far) Worse Places to be Right Now!

A few years ago Paul Graham (now with Y Combinator) wrote some pieces about Silicon Valley and whether it could be reproduced elsewhere, and pointed out some of the things that make the Valley what it is. When it comes down to it, though, he rightly says its about people. The right people. Specifically, rich people (aka investors) and nerds. And specifically young nerds who are attracted to the universities, the environment, the lifestyle, the buzz and the general nuttiness. Even the investors don't want them to be somewhere else - Valley investors want them here, close by where they can reach and meet them at any time.

This struck me again today at a visit to Plug and Play Tech Center in Sunnyvale. To be successful, a huge number of startups from outside the Valley - from Europe and Asia - are trying to establish roots here because they know if they want to take the tech world by storm they have to be here. Many of them set up at Plug and Play, and there are many more that set up somewhere else in the Valley. To me this is a huge thing - despite the recession, despite the economy, THIS IS WHERE TECH PEOPLE WANT TO BE!

There are, of course, a lot worse places to be. ORC Worldwide and Business Week just last week published a study on the World's 50 Worst Places to Work, "based on a set of criteria that includes levels of pollution, disease, political violence, and availability of goods and services". I don't necessarily agree with the list, but I am pleased that some I think of as terrific places to work (Prague, for example) are no longer on the list. Anyway, here are the top 10 worst places and if you're in the Valley then be glad you're here. I am!

The worst: Lagos, Nigeria
2. Jakarta, Indonesia
3. Riyadh, Saudi Arabia
4. Almaty, Kazakhstan
5. Mumbai, India
6. New Delhi, India
7. Nairobi, Kenya
8. Bogota, Colombia
9. Ho Chi Minh City, Vietnam
10. Chennai, India.

.... and a bunch more Chinese and Indian cities follow.

How Long is a Piece of String?

One of the questions always asked about start-ups and growth stage companies is around the size a G&A function needs to be to support the business effectively. It is rather like asking "how long is a piece of string?" Well, it depends ...

It depends on the business you're in, its stage of development, its ramp up rate, its geographical coverage and factors such as the strength and depth of the management team. My rules of thumb, which I'll expand on and explain in future blogs:

• Keep it small. Duh! Same for anything that is not a core asset to the business. Core assets are the technology, the brand, the customers etc. Not G&A. But make sure its good enough for where you are now and - eventually - scalable enough for where you're going
• Outsource as much as possible of the basic transaction processing and bookkeeping 
• Outsource human resources - including the benefits function
• Don't spend too much on space
• Develop a relationship with a good audit firm
• Get a good insurance broker. But not for benefits ...
• Have a good law firm - but don't use them too much
• Get good market compensation data (not for G&A, for the whole company) and develop a compensation structure early
• Make sure the systems are in place to match the business you're really running and automate wherever possible
• Make sure that G&A really reflects G&A - not a bucket of spend that belongs to Sales, Marketing, Development etc.
• The key early stage hire - the best Office Manager you can find!
• At the right time, get a good Controller or Finance Manager
• The CFO role is different ...

"Outsource" doesn't mean then hiring a bunch of contractors instead. It means using some of the great services out there that will not only support you now but scale to support you in the future. Some examples:

• Corefino, a Silicon Valley early stage company that supplies on-demand (on-line) bookkeeping services
• Trinet human resources outsourced services

More on all of this soon!