BitTorrent: Most disruptive technology that has been squandered!
August 7, 2008
Back in 2005 I wrote a post titled, “BitTorrent = Disruptive Technology” where I reported that Dixon Doll lead an $8.75MM investment in BitTorrent. I suggested, “This investment is a SURE THING!” Of course there is never a sure thing. P2P (and others) is reporting that BitTorrent is laying off 12 of 55 employees (most in the sales department).
Om Malik called the company, ‘the Cisco of the digital content revolution’, but little did he know that BitTorrent would forgo their infrastructure/technology roots and go for retail by attempting to build an online media store called the Torrent Entertainment Network. These guys have THE most distruptive technology solution (i.e. distributing content by having everyone share the burden, versus putting the data in a centralized place we all try to access at the same time), but they are NOT retail gurus like Apple (iTunes) or Amazon. Maybe these layoffs are a good sign, a chance for the company to return to its core function - changing the way digital content is stored and delivered.
Should you pay your VC to ______ ?
August 7, 2008
Fill in the blank with anything including: conduct diligence, provide consulting or sit on the board. Jason Mendelson from ‘Ask the VC’ was asked the following question last week:
My company is backed by VC firm to whom we also pay a $2k/month “consulting fee.” We have raised approximately $2MM from them in a Series A. Is that type of consulting payment typical in an early stage venture?
Jason’s answer was an unequivicol, NO! explaining, “I’ve never worked with a reputable VC firm that charges their companies to help them succeed.” Several months ago I heard a rumor about a local venture capital ‘fund’ that was charging companies they were interested in funding a fee to conduct due diligence. More recently I learned that an acquaintence of mine went to work for the ‘fund’ so I had a chance to ask, “Do you really charge for due diligence?” The immediate answer was, “Yes, but if we decide not to do the investment the startup gets to keep the diligence.” The acquaintence, who I really like, was dead serious and didn’t see the problem the practice. I didn’t press too hard because the person just finished their MBA and this is their first job in venture capital (I hope they don’t read this post).
My stomach churned as I could imagine budding writers paying someone to ‘publish’ their book, or aspiring musicians paying someone to ‘produce their record’, or an inventor paying someone ‘evaluate’ their invention. Of course, there are legitimate people in these businesses (and I suspect my acquaintance is legitimate), but I think it is a big mistake to do business this way.
Anyway, these sort of venture capitalists are taking two bites at the apple. Venture capitalists shouldn’t take a fee from their investors AND a fee from entrepreneurs, ever. Jason explains, “As a venture capitalist, we are paid a management fee by our investors that is our “salary” and we receive a percentage of the profits (called “carry”) on our fund. We don’t get paid to sit on boards and certainly it is not appropriate for them to “round trip” your investment capital by paying themselves part of it. I would wager to guess if their investors knew they were doing this that the investors would revolt.”
Where to Locate Your Startup
August 6, 2008
So I got sucked into the 37signals live broadcast on ustream yesterday thanks to twitter. The session was, for the most part, a Q&A with Jason Fried and David Heinemeier Hansson spanning topics from server architecture for their products to their philosophy on startups and running a business.
If you’ve ever heard any of the 37signals crew talk before, you know that they have a strong opinion of just about everything and aren’t afraid to tell you what it is.
So it was interesting when a viewer posed the question of where should they locate their startup? Is it necessary to make the move out to “the valley” in order to be successful?
David responded adamantly against the need to move out to the west coast and in fact, stated that if you’re looking to build a real business and not just flip some startup, then Silicon Valley will most likely have a negative influence on your company.
While I don’t necessarily agree with all the points he made, I do agree that you can stay right where you are and do just fine! This is especially true for web/internet software startups.
Reason number 1: Put money into your business instead of moving expenses and a high cost of living once you get out there!
Chances are you already have some pretty good connections in your local area that have taken time and effort to develop. These are valuable contacts that you can go to when you need their expertise, advice, or help. Why throw that all away and start from scratch in an entirely new location?
Entrepreneurial communities are springing up and growing like crazy near major metropolitan areas around the country and chances are you are closer to one of these than you are to Silicon Valley. Just look at the huge strides communities like Austin, Boulder, Boston, Seattle and so many more.
Another big reason to stay put is you will most likely have less competition for resources like quality people, investment money, office space etc. where you are than if you try and move your company.
The bottom line is why make things harder for your startup just so you can say you company is based in the valley?
Now with all that said, there are exceptions to every rule and it just may very well be that relocating your startup to the west coast could be the right move. Or even relocating somewhere else where your particular industry does well. For instance, Ontario, Canada has implemented some major initiatives to incentivize Clean Tech companies to come to their province.
If you are just getting off the ground with your startup and considering a move out west (or anywhere else), I would urge you to reconsider and think about the many advantages of staying put (especially if you are here in Dallas!).
Startup Incubator Roundup
August 6, 2008
After my post on DreamIT ventures, I came across a couple other startup incubators and thought I should write a post summarizing all the seed/pre-seed funds I could find.
Luckily before getting too far, I came across this post on ReadWriteWeb that has most of them listed out for your convenience already.
Here are a few that weren’t on the RWW list that are similar, or at least interesting:
Location: Pittsburgh, PA
Investment: $25,000
Stake Taken: 3%
Companies Funded: Unknown
Next Application Deadline: Oct 15, 2008
Location: Seattle, WA
Investment: $10,000 to $250,000
Stake Taken: ?
Next Application Deadline: Open Applications
Location: Your City!
Investment: 54 hours of craziness
Stake Taken: n/a
Next Application Deadline: Day Startup Weekend is in your city
Legal Tips for Your Startup
August 6, 2008
In my opinion there are two really daunting challenges every entrepreneur faces with their startup; navigating legal issues like corporate structure, operating agreements, etc, and financial/accounting issues like dealing with sales tax, income taxes etc.
With either issue, it is generally worth your while to pay a quality, well-referenced professional to get things smoothed over for you.
The problem? Generally, it will cost you a pretty good chunk of change. When you’re just starting out, and low on cash, you may not want to pay high consulting fees just to get yourself up to speed on everything you should be concerned with. So what’s the solution?
Well, I was excited to meet Ryan Roberts at this week’s Dallas Startup Happy Hour. Ryan runs his own law practice and focuses on corporate law, securities and mergers & acquisitions. He also happens to be the author of The Startup Lawyer, a blog about the legal issues surrounding startups and entrepreneurship.
Ryan has authored many helpful and insightful posts on topics like pre and post money valuations and what they mean, how Series FF stock can provide founders liquidity at funding, why investors like C corporations more than other business entities and much more.
Some of you might be thinking, well I’ve heard all that before, and maybe you have. However, I’ve noticed that Ryan really tries to get across the “why this is important and you should know about it” rather than just rattling of the details of how corporate mergers work, etc.
So, if you have some legal questions and are looking for some tips and information for your startup, you should check out The Startup Lawyer.
Getting funded means getting fired
August 6, 2008
You might be surprised to learn that 50% of venture backed startups fire their ceo/founder within the first year. Of course, if you happen to be a ceo/founder of a venture backed startup you won’t be surprised.
When I received my first term sheet (from Austin Ventures) the signature block included the title, “Interim CEO”. The good news? They were upfront, I was out the door as soon as they could find a worthy replacement. I kept looking until I found a venture capital firm that would back ME and not my 50 page business plan.
Peter Ireland has an interesting post title, “The Dreaded Lunch Invite from Your Venture Capitalist” about this topic. Peter quotes Barnaby Federer of the Wall Street Journal:
“If you ask a VC what value they add, and you get them after a few drinks, they’ll say, ‘We replace the CEO’ “, he said. And that, he indicated, does not vary with the economic climate.
He goes on to explain how the process (of firing the CEO) starts:
t usually occurs in this manner. The venture capitalist invites the founder out for a friendly lunch. During the meal the venture capitalist brings up a new person who would benefit the company greatly through his connections or industry experience. The venture capitalist explains that although this person is not available to serve on the management team, he could probably find the time to serve as a director. Yes, it would mean making the board larger than originally agreed to by everyone but this guy is a “star”. The founder wishing to please his venture capitalist reluctantly agrees to the change in board size. The new face turns out to be the extra vote the venture capitalist needed to make wholesale management changes. Within a week the board has fired the founding team and replaced them with friends of the venture capitalist. Oftentimes the new board member assumes the CEO role.
His advice is to stick to your guns. Hopefully your lawyers helped you negotiate a deal whereby you had a balanced board ~ fight tooth and nail to keep that balance. NEVER GIVE IN! Peter offers this advice:
The best tactic to employ when faced with this offer is tell the venture capitalist that you 1) can’t recommend someone for a board seat until you are satisfied that they can make an actual contribution, and 2) that since the board is working well it would be preferable to compensate this person–once they have made a tangible contribution–with consulting fees instead of a board position. Finally, if you sense a strong negative reaction from the venture capitalist you can be assured that there’s trouble brewing in River City and it’s spelled with a capital “T”. He will always have a Plan B for pink-slipping you and it won’t be pleasant. Call your lawyer immediately, and I mean your lawyer not the company’s.
I originally wrote this piece some time ago, but thought it was worth reprinting. Hope you enjoy…
Sumo Review: Urban lounge gear is big in japan
August 6, 2008
Several weeks ago the Sumo guys offered to send Big in Japan a couple of their Sumo Omnis if I would post a review on my blog. They describe the Omni as:
This super-sized pillow by Sumo is the ultimate solution for all your relaxing needs. We’ve come up with 10 ways to use it, but some people say we lack imagination! It’s a crash mat, lounge chair, loveseat or floor pillow to name a few, but the possibilities really do go on. Sumo Beanbags are made from space age rip-proof nylon and come filled with top quality Sumo Beads. Omni is 4.5′ x 5.5′ and it only weighs 18 lbs!
Anyway, it is not really a bean bag, but that is the closest thing I could compare it to. Normally a bean bag sort of collapses when you sit on it, the Sumo seems to retain its shape once weight is applied. The website says it is filled with polystyrene balls. Somehow they behave differently than a traditional bean bag. Should you buy it? Feel free to stop by our coworking space and give them a spin. The Sumo guys might be willing to let us do a raffle at the next Startup Happy Hour so maybe you could win one there?
Masha and Nesrin tried them out (see pictures below) and both agreed they were comfy. Anyway check them out - and thanks Sumo for our omnis.
Startups can be too clever by half too!
August 6, 2008
This morning I heard a pitch from an entrepreneur who spent 10 minutes describing his opportunity (I actually thought it was interesting) and 30 minutes talking about how our investment return would be tax free. He had it all figured out, we would be able to completely avoid taxes on the huge returns he would provide. His pitch reminded me of another deal I looked at earlier this year. Again, this business model had merit and I might have been interested except that the founder kept explaining that my original investment would be 100% guaranteed through a complex insurance structure (it was so amazingly complex and valuable he had applied for a method patent on it). This entrepreneuer spent 10% of his time talking about the opportunity and 90% of his time talking about the insurance deal.
In both of these cases I was completely distracted from the startup and focused my attention on the tax/insurance scheme. Perhaps these schemes were meant to distract me from the weaknesses of the plans, which they might have, but it didn’t really matter as in both cases my ’scam’ radar went on red alert. First, if you are willing to defraud the IRS you wouldn’t be too scared of defrauding me. Second, there is no such thing as a ‘risk-free’ investment, period.
My advice to entrepreneurs: Focus on your business. Let someone else suggest the insurance/tax schemes. Sure, there are great methods for legally reducing tax liability and there are great methods for estate/trust wealth preservation, but again there are experts accomplished in both of these areas. I would cautiously listen to these experts only AFTER you have earnings to shield and/or risks to avoid. Even if you are an expert in these areas, focus on YOUR business. Don’t distract the investor.
My advice to investors: RUN AWAY.
Startups and Trust ~ a complex combination. . .
August 5, 2008
I would be willing to bet (assuming your name isn’t George Bush) that none of of your co-workers or employees would be willing to stand between you and the line of fire. I contend that you can’t rely on people to ‘do the right thing’ when their job is on the line. Life isn’t like a television series or a movie, more and more people live paycheck to paycheck and any disruption in their job/career could be devastating. Why am I bringing this up? It is important to understand that your ‘work-friends’ are not your high school buddies or battlefield brothers in arms. No one is going to take a bullet for you, acts of selfless courage are the exception not the rule. Don’t expect it and plan for what seems like betrayal. I don’t mean to come across as negative or as paranoid as I may seem. Let me put my advice in context and tell you about my own experience.
Are you thinking about starting a business, but aren’t ready to quit your day job? Join the club. When I came up with the idea for LayerOne I was working full time for a major telecom company. I hooked up with a colleague and we started the company. When my manager’s manager found out I was immediately fired. As an employer I completely understand his action, he didn’t have much of a choice. Of course as an entrepreneur I wanted a chance to explain why my startup was synergistic with my role at the telecom company (i.e. it solved one of our major problems). I didn’t get a chance to explain, but that isn’t the point of my post. At the time I was devastated, not for losing my job, but because at least three people betrayed me (two that I trusted explicitly and one that I thought I was casual friends with). Over time I realized that I wasn’t betrayed, but instead these people were acting in what they felt were their own best interests.
The whole incident happened when my manager, who happened to be my colleague’s brother-in-law was out of town on business. He knew about our ’startup’ and gave us approval because it would improve his sales numbers, of course we needed to keep our activities discrete. My partner and I managed different territories, but we worked very closely on several accounts. Our peer, who was more of a sales person than either of us, knew about our little operation and evidently was jealous. He may have even thought that it would negatively impact his own sales numbers (I know this after talking to him years later). That week, while I was at lunch he took my company laptop, which had a number of ‘incriminating emails’ on it (i.e. LayerOne stuff) and showed it to my manager’s manager. The manager called my colleague and me into his office and confronted me.
I had several quick decisions to make. First, should I try to explain that my manager knew and had approved of my ’side-business’? I might avoid getting fired, but I suspect manager’s career wouldn’t have been helped. Second, I wondered if I should mention that my partner was my colleague? Between the two of us we were generating more than 75% of the sales for the branch; could he really afford to get rid of both of us? Maybe not that day, but I suspected that he would end of firing both of us once he had replacements (and everyone is replaceable). Finally I decided, my face beat red, that I would take 100% of the bullet and instead of feeling sorry for myself I would make my side-business, my real business. It was a huge step, but it only took me five minutes to take.
Later that day I started to second guess my decision. I was pissed that my colleague stood silently as I was fired. He didn’t try to defend me, he didn’t acknowledge his role or the fact that his brother-in-law had approved our little operation. Once my manager learned that I was terminated he didn’t mention to his manager that a) he knew about our operation or b) he approved it as it increased his sales. He simply apologized to me, suggesting he wished he could have been there. To stand silently by as I was terminated? I was angry, but I kept my anger to myself. As time passed I realized that everyone was simply practicing CYA; loyalty doesn’t enter into the question when a) your wife is pregnant, b) you are buying a new house and c) you can’t find another job. Could I blame them? No, but I learned an important lesson ~ trust people, but trust them to act in their own best interest. This isn’t to say that some people act in selfless ways, but don’t count on it ~ be pleasantly surprised.
Ultimately I hired my colleague, my manager and even the sales guy who turned me in to work for LayerOne. In doing so I was able to put my original anger and frustration behind me. I still had not learned the lesson I am trying to express in this post ~ “You can’t rely on people to ‘do the right thing’ when their job is on the line.” Remember my colleague? A couple of years later he had one more chance for redemption. He knew that one of our board members was lobbying to get me fired, but instead of telling me he kept quiet. I shouldn’t have been surprised, he simply acted in his own best interest once again. Most people act out of a sense of fear, not out of a sense of abundance. As an entrepreneur you are almost predisposed to exploiting risk, but as an employee you are trained to stay out of trouble, keep your nose clean and not to rock the boat. The good news that being an entrepreneur is hard and isn’t well suited for most people. I hope this post is helpful, I am afraid it is too long and somehow doesn’t capture exactly what I am looking to offer.
Dallas Startup Happy Hour Tonight!
August 4, 2008
No matter how many times I post the reminder, I get emails, tweets and IMs asking, “where is the link to the startup happy hour?”. I won’t blog again today so that I can keep this reminder on the top of my blog:
Reminder the Startup Happy Hour is this Monday at 5PM. See you there? Please RSVP HERE.
Are you interested in connecting with the local startup community? We are working to build a vibrant startup community here in Dallas every bit as interesting and dynamic as San Francisco, Boulder, Boston or Austin. The first step is engagement.
The first Dallas ’startup happy hour’ went so well we decided to make it a regular thing (every other Monday). We hope to see you at the INFOMART High Tech Bar at 5PM. If you need directions or help finding us feel free to call me at 214.550.2003 or if I am not available try our help desk at 214.550.2002 (during business hours only).
Upcoming ‘Startup Happy Hours’ (always on a Monday between 5PM and 8PM):
August 4th, 18th September 1st, 15th, 29th October 13th, 27th November 10th, 24th December 8th, 22nd
Please RSVP on Upcoming HERE (we are trying to keep the group under 50 people). Directions HERE. The ‘Startup Happy Hour’ is sponsored by SpringStage. If you are interested in sponsoring an event please contact me (Alexander Muse) at 214.550.2003.
How I lost $20,000,000+ in 18 months!
August 4, 2008
If I had to come up with a single reason I started this blog it was to share my own ’startup’ experiences; the most cathartic of which was a post I wrote in 2005 titled “LayerOne: My Biggest Failure!“ Around 1,000 people read the post back then, but my readership has grown in the last three years to between 50,000 and 75,000 unique people; readers who never heard the story. I believe some of the most important lessons one can learn are taught by failure and failure is something I have an MBA in. I thought it might be valuable for those of you who haven’t heard the story to take a peak into my dirty laundry:
I was interviewing a candidate for Big in Japan and I asked him what his biggest failure was. He answered the question thoughtfully and at the end of the interview, as I always do, I asked the candidate if he had any questions for me. His first question, “what was your biggest failure.”
Most of us (well mainly me) have a hard time talking about our failures. I had to think for a minute and then the answer was obvious. In 1999 I founded a telecom company called LayerOne. It was the hieght of the private equity - venture capital funding wave and I caught one of the last waves. The idea was to create pooling points of local haul, local and internet connectivity and charge carriers for connecting between each other. I ran around the country (Sandhill Road, New York, Austin and of course Dallas) looking for private equity. Almost 100 venture capital and private equity groups were not interested in my idea…
I was only 28 years old so I had no idea how bad the odds were that I could raise the money to fund my idea so I rented a loft near downtown Dallas right above the Genesis Hair Salon (you could smell women getting permanents in the afternoons). I polished off my business plan and hired a lawyer from the Austin office of Wilson Sonsini and a secretary. Finally I found a group of investors willing to fund my idea. My series A was $11,000,000.00 on a $22,000,000.00 premoney valuation (not bad for a first time CEO with a business plan and a loft). The round was led by Crest Communications with additional investments from Soros Private Equity, Cabletron, and ADC Telecom. Soon I was off to the races hiring a team to help me build my dream. One of my key hires was detailed in Money Magazine here. I found a small, under funded competitor that was willing to sell and jump started our rollout.
I made every mistake in the book (I had a lot of help making the mistakes). By the summer of 2001 we were well on our way to meeting our goals for the completed ‘pooling points’ but we had not been able to raise the second round that would enable us to complete our nationwide buildout. We had leases across the United States (even a few options on spaces in Europe), but not enough money to build them out. Our original investors were trying to raise their second fund (a fund they never closed) and everyone was scared of the telecom space. We managed to raise another $9,000,000.00 to ‘bridge’ us to the ‘big’ round. Our lead investor, Crest Communications, had a relationship with First Union and suggested that we use their bankers to help us raise our second round. Their effort was extensive (scores of meetings in New York, Chicago and San Francisco), but ultimately unsuccessful.
So I reverted back to my old strategy, call everyone myself and set meetings. Most everyone turned us down, but finally we got a term sheet from TL Ventures for $40MM ($60MM short of the total amount we would need to get to break even). Everything looked like it was going to work out. But soon it became apparent that there was a big catch in our term sheet? TL would need to find (actually I would need to find) other investors to fund $30MM of the $40MM. Our existing investors would come up with $10MM bringing our total to $20MM, but finding the other $20MM seemed impossible. Nortel blew up in the summer and of course Enron crumbling did not help. We were in big trouble. Neither TL or us could find the last $20MM needed to close the round (and no they would not close without the total $40MM).
El Paso Energy had started a telecom business and talked to us about acquiring the company. It seemed like a good option should the fund raising effort fail - something I was getting more and more worried about. We received a term sheet from El Paso that would return 100% of the paid-in equity our investors had made and provide jobs and options to the management team (i.e. me). This was not a great option, but as we would be out of cash by July it seemed like the prudent thing to do. Our investors (Crest) decided that the deal was unacceptable and that we should pursue other options (including the TL deal still on the table). Next, we were contacted by Universal Access about a potential acquisition. We finally came to terms, but the deal did not make sense to us. The deal was for stock (UAXS was traded on the NASDAQ) worth around $5MM and out of the money warrants valued with Black Schoals at something like $20MM. It seemed to me that the warrants would NEVER be worth anything, but on paper this deal looked better than the cash deal offered by El Paso. We signed the deal and Universal Access covered our payroll in June. The deal never closed. By the time the deal was dead El Paso was out of the market - they were paralyzed by the Enron debacle.
So the only option seemed to be Chapter 11. Ug! I was sick to my stomach - bankruptcy was not a good thing to have on your resume. So I started running around looking for capital to fund a reorg. I found two groups who were interested in the deal. We figured it would take $2MM to buy the business in a 363 asset sale and $2MM to get it to break even. We were going to take the sites that were cash flow positive (or near positive) and a reduced staff 12-15 employees and run the business. By the end of August 2001 we had the sale and successfully bought the business out of Chapter 11. We were in bankruptcy for around 30 days - one of the quickest in the history of our jurisdiction. So on September 11th 2001 I was headed to Hughes and Luce to sign the closing documents with our investors so the money could be transferred to the court for the sale. You might recall that the most deadly terrorist attack on our country happened on that day. I figured the deal was dead… But the next day we closed and LayerOne II was born.
The impact? Most of our investors (only three stayed in the new deal) lost everything - $20MM down the drain. LOTS of employees hated me (I assume they still hate me). This was the lowest point in my life. I was able to salvage the business for our clients, a few original investors, a few key employees and my family - but the majority of our investors and vendors paid the price of MY failure. I can blame a lot of folks, but ultimately it was my failure. How did it turn out?
Actually, fairly well. We were able to turn a profit in a few months and grew profits by around $20-30K per month for a couple of years. By 2003 we had made several investments outside of LayerOne and I made the decision (with more than a little help from our investors) to take over operation of Architel and LayerOne was positioned for sale. It took about a year, but LayerOne sold to Switch & Data for a 600% return for the investors ($4MM to $22MM in less than four years). It wasn’t Google but it was a big swing for me. I learned a lot, made a lot of mistakes and ultimately became a better businessman and hopefully a better person as a result.
Understanding early stage VC returns
August 3, 2008
Earlier today I posted my advice on ‘reasonable pre-money valuations for startups‘ and then I ran across Fred Wilson’s post titled, “Venture Fund Economics: Gross and Net Returns.” Sun Tzu suggest understanding your opponent and Fred, as I have come to expect, has revealed the keys to the kingdom. Have you ever wondered how a fund is put together? how much the partners make? how much the limited partners make? how many deals a fund is going to invest in? how much money they plan to invest in each deal? I recommend reading his post (all of his posts for that matter).
Reasonable pre-money valuations for startups
August 3, 2008
On Thursday I was chatting with a seed-stage company from Dallas. The founders have raised approximately $250,000 and are closing in on their beta release. They are in the market for $2-3MM and are getting ready to start visiting venture capital firms around the country. They asked me for advice on what pre-money valuation they should ask for. They began talking about discounted cash flows and market comparables and my head began to spin. My advice: I suggested that if an investor asked them about valuation that they simply suggest that ‘valuation isn’t as important to them as finding the right partner.’ Then turn the question around, ‘based on your experience, what would you think was a fair valuation range?’ After meeting with several investors I suspect you will have a very good idea what the ‘market’ will bear for a deal like yours.
Of course, no one ever listens to my advice, so here are some things to think about: The operable word, valuation, in the phrase ‘pre-money valuation’ is really a misnomer. Typical angel or venture capital investors aren’t really attempting to determine ‘value’, but instead they are attempting to determine ‘price’. This is an important distinction. Consider the value of crude oil versus its price today - they have little in common.
David Berkus’ valuation method as described in Winning Angels suggests:
- Sound idea = $1MM to company’s value
- Prototype = $1MM to company’s value
- Quality Management Team = $1-2MM to company’s value
- Quality Board = $1MM to company’s value
- Product rollout or sales = $1MM to company’s value
The Ottawa Capital Network has an interesting explaination of price versus value:
More casually, “value” is what something is worth and “price” is what you get for it. Here are some of the reasons why the two results may be materially different:
- Fair Market Value is calculated in a “notional” market, while Price reflects the real world;
- Fair Market Value assumes equal negotiating ability between the parties, while Price is affected by different negotiating strengths;
- Fair Market Value assumes both parties have equal knowledge, while Price reflects differences in information or assumptions;
- Fair Market Value assumes there are no “special purchasers”, while Price may reflect the influence of a purchaser that has a unique incentive;
- Fair Market Value assumes neither party is under compulsion to transact while, in reality, vendors are usually under some financial pressure to sell, and one or both parties are acting on emotion; and,
- Fair Market Value assumes there are many buyers in the “notional market”, whereas in reality there are often only a few that often confer.
Notwithstanding this important distinction between “value” and “price,” most discussions on the topic inherently use the term “value” to refer to “price.” Just remember though, all discussions on value really refer to price – i.e. what you can get for your company, not what it is worth. With the higher risks inherent with earlier stage companies, the valuation methodologies are much more subjective than the methodologies used for Later Stage companies.
According to VentureOne Research most seed stage pre-money valuations are between $2MM and $5MM with seed-stage investors receiving 20% to 30% of the company for investments between $500K to $2MM. The Ottawa Capital Network explains how valuations are determined:
Given the relatively few possible outcomes, Seed Stage investors typically use very simple valuation methodologies. Some of the reasons for a more simple approach include:
- The final pre-money valuations will be within a narrow band and will be more affected by negotiating strengths than “mathematical” determinations
- Many Seed Stage investors recognize that much of the company’s business plan and product concept will likely change over the next few years
- With so much “uncertainty” and perceived risk, Seed Stage investors typically rely on more “intuitive” or subjective valuation models and support their subjective views with reality checks (i.e. due diligence) in a few key areas
- Seed Stage investors also recognize that, without a lot of substance in the companies upon which to do meaningful due diligence, they should be able to reach an intuitive assessment relatively quickly.
- Many Seed Stage investors recognize the “subjective” nature of their Seed Stage investment decisions and expect a high “mortality rate.” To offset this exposure, most Seed Stage investors are prepared to invest in one or two more financing rounds for the more promising investees.
Here are a few “data points” supporting the above summary observations:
- MIT Entrepreneurship Center: Research Findings February 2000: Seed stage technology ventures were typically US$500,000 to US$3 million. Pre-money valuations greater than US$5 million required an extraordinarily compelling story.
- The Tech Coast Angels: Website: “we look for pre-money valuations below US$5 million”, Presentation March 2002: “sweet spot” for investing is a pre-money valuation of US$1.5 million to US$3 million.
- Sand Hill Angels: Website: invest US$250,000 to US$2 million at a valuation of less than US$5 million.
- New Jersey Entrepreneurial Network Angels: Presentation: Valuation of US$1 million to US$5 million, for 20% to 30%
- Winning Angels, Amos/Stevenson (Noted Book): Most Angel investors want pre-money valuations between US$2 million and US$5 million, with US$2.5 million as the “sweet spot”
Venue is important!
August 2, 2008
This is the location of my first startup. We began on the second floor in the back in about 1,000 square feet. Ultimately we expanded taking over the entire second floor (total of 2,000 square feet) housing around 25 employees before we left. It was crazy fun. Folding tables and scores of power strips. Our new coworking space got me thinking about how ‘where you start your startup’ can set the tone for your business. Focus on the service/product and don’t worry about your space. Worry about the space AFTER you have either customers or investors. I wish there had been a coworking space back then…
Why Whitebox Matters Now
August 2, 2008
When we started building Whitebox we had no idea that a) it would take so long to build and b) how relevant it would be. First let me explain what Whitebox is.
Whitebox provides financing and collection for extended automobile warranties. We began by building a web application using Ruby on Rails to provide automobile dealers to generate electronic contracts. We then built an ACH collection engine that enables us to collect monthly payments directly from the borrowers checking account. Our solution electronically connects the dealer, the agent, the warranty company, the consumer and the bank.
Whitebox focuses on a fairly small niche of the extended warranty business, automotive dealers who own their own extended warranty companies. They have a very keen interest in ensuring that as many of their cars include an extended warrant as possible. We learned that 10% of cars sold are purchased by consumers who do not qualify for financing for their extended warranties. Whitebox advances the cost of the warranty and then our system ensures that the monthly premiums are collected and remitted to the dealer. Last week we launched our application and this week we begin rolling it out to 500+ dealers (it is going to take all year to finish even if we don’t run into any trouble). If we are successful our goal is to have our software used in 2500 automobile dealers by the end of 2009.
Why does Whitebox matter now? New car sales are now at a 16-year low and credit agencies are cutting back on new car loans and leases. This means that fewer consumers will qualify for the additional financing necessary to purchase extended warranties. It also means that more used cars are going to be sold increasing the overall need for extended warranties.
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