Why is seed funding down when VC funding is way up?


As a mentor, I work exclusively with early stage companies. When these companies go out for funding they are looking at friends and family, angels and angel groups or VCs that fund seed rounds.

Unfortunately as the Wired article ‘Blitzscaling’ Is Choking Innovation—and Wasting Money, sub-titledVCs are making bigger bets on fewer startups. It’s this unconsidered, money-slinging strategy that led to Uber’s and Lyft’s dud IPOs seed funding is down even while total VC funding is way up.

VC investments last year set an all-time record in the US of $132 billion. This sounds like great news for founders. But deal size has been steadily growing. Do the math, bigger deal sizes equates to fewer deals. As the author, Leonard Sherman asks: why has the number of seed funding rounds—the entry point for most entrepreneurial journeys—declined so sharply over the past five years, despite the fact that the cost of launching new ventures has never been lower?

In 2000 Leonard Sherman’s company needed only one institutional funding round of $15 million to launch his company. But here’s the difference between almost 20 years ago and today. Then virtually all that capital was consumed by the need to buy and maintain servers and storage devices, to write highly customized code for every business process, and to build market awareness through expensive, inefficient mass marketing channels.  Launching that same venture today would probably cost 90 percent less, thanks to modern enabling technologies: open source computing, rapid wireframe and product prototyping tools, contract manufacturing, fulfillment-as-a-service, web-store design, cost-effective social media customer targeting, and cloud-based services like Amazon’s AWS, Google’s Cloud Platform and Microsoft’s Azure.

So that sounds like great news for founders, and it was for the 15 years of the new millennium, as the number of angel and seed deal rose steadily. But:

over the past five years, entry-round investments have declined by more than 40 percent, while average deal sizes have risen. The primary reason is that early-stage VC funds generally have found it more lucrative to place fewer, bigger bets, rather than spreading investments more thinly. This practice delivers a big win when the bets pay off—particularly for seed VCs with higher ownership stakes. But now, more than ever, entrepreneurs find themselves folding for lack of seed funding.

This is the driving reason behind the decline in seed stage deals. That, as well as new sources of capital making huge bets, like Softbank’s Vision Fund’s $300 million investment in dog walking service Wag. But that’s peanuts compared to Softbank’s $10 billion funding for co-working office-space startup WeWork.  (However, WeWork’s losses are accelerating even faster than its revenue growth.)

This flood of late stage capital into relatively few companies leaves less money for riskier bets on startups. But having vast sums of capital does not guarantee business success. Today’s VCs would do well to look back to the successes of companies based on the strength of their technology and business models, not venture capital: the total VC capital raised by Amazon ($108 million), Google ($36 million), and Salesforce ($64 million) prior to their IPOs and subsequent value creation would barely register as a single supergiant round in today’s blitzscale funding environment.

The poor IPO performance of companies like Uber and Lyft, which both raised billions of dollars in VC financing, might help turn the tide against late stage mega-financing and perhaps more VCs will look to spreading their risk by investing in more seed stage companies, which can ultimately provide enormous returns as have Amazon, Google and Salesforce. Until then founders would do well to look at various alternatives to VC funding such as angels, angel groups, crowdfunding, convertible debt, SAFEs, strategic investors, grants like SBIR, incubators, royalty-based funding, and such novel, nascent funding sources as digital tokens and the JOBs act.

For a bit more detail on alternatives to VC funding take a look at the attached presentation I gave last night to a sub-group of the MIT Post-Doctoral Association on different ways to raise capital: Financing a Startup

When to be strategic versus opportunistic


Virtually every early stage founder has to be opportunistic, meaning they pursue chances offered by immediate circumstances without reference to a business plan or strategy. Why? Because every startup needs staff, needs customers, needs funding, and for most founders there is only a relatively short runway, meaning that there is only so long they can go without any income. Sweat equity can only take you so far.

Examples of being opportunistic are hiring the guy from your university’s B-school who you met at a networking event as your VP of Business Development. Hiring is very easy; firing is hard. Being a founder is lonely and taxing, so adding another founder seems like a great solution to both problems. There are two problems with this opportunistic decision: one, the founder rarely has developed an org chart and hiring plan for their venture and prioritized hiring by position. And second, it is rare that startups need a VP of Business development. They need a VP of Sales; but many MBAs consider sales below them, thus try to join startups with a fancier title and a less quantitatively judged job.

Founders need to make better decisions! But how?

As Jeff Bezos writes, there are two types of decisions:

Type 1 decisions are not reversible, and you have to be very careful making them.

Type 2 decisions are like walking through a door — if you don’t like the decision, you can always go back.

The mistake many startup founders make is to habitually use Type 2 decision-making process to make Type 1 decisions. These companies are likely to go extinct before they get large enough to make the opposite mistake: using the heavy-weight Type 1 decision making process on most decisions, including many Type 2 decisions. The end result of this is slowness, unthoughtful risk aversion, failure to experiment sufficiently, and consequently diminished invention.

Type 1 decisions include hiring for your senior team and key individual contributors; taking on an investment that doesn’t give you the right to buy out the investor on acceptable terms; entering into exclusive deals with partners or vendors; entering into contracts with no termination date or a weak or non-existent set of termination terms and conditions.

Type 2 decisions include your company’s name and its logo; where you locate your offices; your company’s tag line; and hiring contractors.

The way to make Type 1 decisions is to be strategic, meaning you identify the company’s long terms goals and the plan to achieve them. Type 1 decisions should fit your plan. Otherwise known as a business plan. At various entrepreneurial programs at MIT, such as I-Corps, the business model canvas has replaced the PowerPoint presentation which in turn replaced the 20+ page text-heavy traditional business plan of previous generations.

One of the most important balancing act of the many founders must undertake is between short term and long term goals. It’s fine to be opportunistic on taking a sublet on an office or accepting friends and family investment. But taking an angel investment is moving the needle up to strategic, though you can make them reversible. Once the needle hits VC investment you are firmly in strategic territory and better have thought through the long term consequences to taking investment from this particular firm.

Decision making is a huge part of a founder’s job. For additional help on decision making see these six posts on Mentorphile.



What’s missing from “Rise and Quick Decline of the First ‘Killer App’


visicalcThe Wall Street Journal article 40 Years Later, Lessons From the Rise and Quick Decline of the First ‘Killer App’ subtitled Remember VisiCalc, the world’s first spreadsheet? Today’s tech giants do, and that is why they buy up and invest in potential competitive threats is accurate as far as it goes, but misses two very important points.

I joined Software Arts in 1980, the year after it launched VisiCalc, the first electronic spreadsheet. And I was there when Mitch Kapor’s Lotus 1-2-3 for the IBM PC became the standard spreadsheet in business, until it too was eclipsed, this time by Microsoft Excel, now the long standing spreadsheet standard.

Most of the founders I work with can’t remember VisiCalc because they weren’t even born 40 years ago! I find I have to be very careful in the examples I give from my 39 years in the tech industry, as for example I found out the hard way that no one in my mentorship cohort has even heard of Alan Kay, esteemed computer scientist. So if you are up for learning a bit of personal computer history, read the WSJ article on how VisiCalc was developed for the Apple II and by the time it was ported to the IBM PC which took over the business computing market, it had been virtually totally replaced by Lotus 1-2-3. There were a lot of mistakes made at Software Arts, but I’m going to focus on only two of them.

While Christopher Mims gives Mitch full credit for going from VisiCalc’s Product Manager at what was then called Personal Software, to being king of the personal software marketplace with Lotus 1-2-3, he leaves out very important experience Mitch had which drove the success of 1-2-3. Mitch was quick to realize that VisiCalc users wanted to be able to plot graphs of their spreadsheet models. He went on to develop a program called VisiTrend/VisiPlot that imported VisiCalc files and created a variety of charts and graphs. He later sold it to Personal Software. Graphing became the “2” of 1-2-3 and helped it become the powerhouse of spreadsheets (#3 was a flat file database). Mitch was no novice in the personal computer industry having created two programs of note before VisiTrend/VisiPlot: Tiny Troll, a graphics and statistics program, and Executive Briefing System. While neither was a killer app, he gained vital experience in user experience design and graphics, his contribution to 1-2-3, which was programmed by Jonathan Sachs.  Software Arts never added graphing to VisiCalc because it was too busy developing new programs, like TK!Solver, rather than learning from VisiTrend – nor by buying it, as Personal Software did.

The meta point that Mims misses entirely is my saying, “When the platforms change, the players change.” I doubt that is original with me, but I don’t know who said it first. Be that as it may, it has proven true over the past 40 years.  Microsoft was the early leader when personal computers were called “microcomputers” as it developed the killer app for the Altair, the first microcomputer, by porting the BASIC language to it. That lead to a significant business for Microsoft in developing programming languages for the personal computers like the Apple II, Radio Shack TRS-80, and the Commodore Pet.

VisiCalc was the king of the first true platform, the personal computers that succeeded the Altair and knocked Microsoft out of its leadership position by being surpassed by Lotus Development Corporation.

But Microsoft drove the next business software platform by creating Windows for PCs, thus providing the graphic user interface for the IBM PC and its many clones. Mitch and Lotus missed this opportunity, as it was too busy developing 1-2-3 for IBM’s operating system, OS/2 which proved to be a loser, as Microsoft totally took over the operating system market with Windows.  The platform change from DOS to Windows left many developers behind. Microsoft rode Excel, which it had developed specifically for Windows, to overtake Lotus as the world’ biggest software maker.

But the platforms changed once again when Apple unleashed the iPhone. But Steve Balmer, then Microsoft CEO ridiculed the iPhone, as did Bill Gates. Thus Microsoft totally missed the platform change to mobile, where Google now dominates by volume, though Apple dominates by revenues. Microsoft totally gave up on their mobile software development efforts when it became clear that they would be a distant number three to Google and Apple, at best.

And why did Mark Zuckerberg acquire Oculus for $2 million dollars before it had even shipped a product? Because he was afraid the next platform would be virtual reality (VR) and he didn’t want to miss that platform change as Software Arts, Lotus, and Microsoft had missed the previous platform changes.

My estimation is that VR will not become the next platform, but perhaps AR in the form of stylish glasses may make an impact. Wearables seem the most likely next platform for individuals. What’s next in terms of business and social platforms – your guess is likely better than mine.

Why talent is the ultimate competitive advantage

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Most founders I mentor are very early stage and unfortunately they tend to fixate on their idea to the neglect of building a team to execute it. Perhaps this shouldn’t be a surprise, as my mentees all come from MIT, a school of engineering. But it does surprise me how little thought is given to organizational design, recruiting plans, compensation and everything else that goes into building a world class team. Of course, ideas are important as are markets. But execution is what wins and it is the very rare founder who can execute solo – mainly an inventor who licenses their invention to another entity that brings it to market.

Diane Bryant, who spent 30 years at Intel then went to Google for a short time is now on the advisory board of a company called OWNZONES. She was interviewed in an article in Forbes.

Her three responsibilities as an advisor at OWNZONES are:

… I’ll be applying my three decade plus global and Silicon Valley technology experience to recruiting of top-tier talent, connecting OWNZONES to instrumental industry partners, and advising on their investments to further simplify the digital video supply chain.

Note that number one in her list is recruiting top-tier talent. And this Q and A with article author Johan Moreno explains why:

JM: When growing and scaling a business, what is one thing you have realized that money cannot buy? 

DB: Talent.  The best talent is not motivated by money, but rather by the opportunity to drive personal impact, work with others they admire and can learn from, and achieve team success.

The first limiter of every start-up I’ve advised is talent. The ideas are plentiful, the funding is available, the market is ripe.  Talent is the scarcity.  The best leaders attract the best talent. A leader’s job is to be a strong and compelling communicator of the vision and path to success, and then create meaningful and fulfilling opportunities for the employee to contribute and develop.

The caliber of talent that OWNZONES CEO Dan Goman has amassed is truly impressive and a key factor in my decision to join.  The technical domain expertise is deep and expansive, spanning cloud architecture, cloud-native application development, artificial intelligence, and video processing. Coupled with the technology expertise is an extensive knowledge of the media and entertainment industry and its market leaders. The foundation for business success is talent, and there’s no stronger a foundation than at OWNZONES.

If you take nothing more from this post than the bolded first sentence you will have absorbed a valuable lesson from a high tech industry veteran. To the best of my knowledge, Apple did not pay above market salaries during either of Steve Jobs’ reigns. In fact, they may have paid slightly below market rates. But what they offered was, in Jobs’ immortal words, the opportunity to “put a dent in the universe.” Apple was a mission-driven company and that mission, to make computing accessible to everyone by simplifying the user experience, was attractive to the the best talent in the world. And as the best talent want to work with the best talent (not just leaders, as Diane Bryant says, but as peers as well.) One of Steve Job’s many talents was the ability to spot talent and as a world-class sales person, to recruit world class talent. Burrell Smith, one of the key hardware engineers on the original Mac, was pulled out of the service  division by Jobs.

Google is another example of a company where recruiting world class talent was so important that one of the two founders interviewed virtually every new hire for years to ensure that only the best, brightest and most driven were hired.

Finally, as I explain to my mentees in search of capital, investors tend to rank the team as the number one criterion in making an investment. Not the idea. Ideas are cheap. World class teams are expensive and rare. A world class team will reject a poor idea and pivot to a better one, as Slack pivoted from games to corporate collaboration and communications tools.

There’s additional wisdom in Diane Bryant’s interview, but I like to focus on one main point in my posts and the main point from her interview is hire the best. Don’t settle. Give as much attention to building your team as to building your product.

What’s the difference between customer satisfaction and trust?

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I have to admit to being a fan of Elon Musk and Tesla (not so much of The Boring Company or SpaceX). I always root for the underdog and there have been several notable auto industry entrepreneurs who went up against Detroit, including Tucker and DeLorean.  Both, like others before them, while critically esteemed, couldn’t compete in a capital intensive business against entrenched competitors.

But Elon Musk already has surpassed both men in influence and accomplishments, though the financial status of Tesla seems precarious. Musk continues a non-stop stream of innovation and outrageous Twitter tweets. (If only John DeLorean had Twitter! Watch for the upcoming movie about him, Framing John Delorean starring Alec Baldwin.)

But following Tesla is more than just following my pattern of rooting for underdogs; I’ve learned a lot of things about innovation and management from studying Musk and Tesla.  For example, today’s article in Forbes entitled Tesla Motors Tumbles In Key Trust Measure by Jack Nerad. First of all, while familiar with the auto industry’s measurement of customer satisfaction, ranging from Consumer’s Reports to J. D. Power, I had no idea that there was an outfit reporting on customer trust in auto manufacturers. But there is, AMCI, which just released its 2019 Trusted Automotive Brand Study (TABS). If you are interested in Tesla, read the full article, but what really interested me was Jack Nerad’s disquisition on customer satisfaction versus trust. There’s insight that’s truly valuable for founders buried in this article about Tesla.

One factor that hurt customer trust in Tesla has been its pricing. Thousands of people are still waiting for the Holy Grail, the much touted, but non-existent $35,000 Tesla model 3. It’s worth quoting the dictionary definition of trust:

trust | trəst | noun1 firm belief in the reliability, truth, ability, or strength of someone or something: relations have to be built on trust | they have been able to win the trust of the others. acceptance of the truth of a statement without evidence or investigation: I used only primary sources, taking nothing on trust. the state of being responsible for someone or something: a man in a position of trust. literary a person or duty for which one has responsibility: rulership is a trust from God.

Note that reliability and truth are the keywords in the definition. Tesla has violated trust by its unreliable pricing and frankly, false advertising, with respect to the model 3’s pricing. But doesn’t Tesla rate highly in the Consumer Reports customer satisfaction survey? It has, but quality problems associated with the steep ramp up in production of the model 3 has also eroded Tesla’s customer satisfaction ratings. But what is the difference between trust and customer satisfaction and how do they relate? Heres what Ian Beavis, AMCI Global’s chief strategy officer told forbes.com in an exclusive interview:

Beavis sees trust as being of a “higher order” than satisfaction, a metric that includes satisfaction but goes far beyond it. Because customer satisfaction has been scrutinized for decades now, most brands are fairly good at executing on it, but the AMCI strategist now believes satisfaction is a cost of entry. Satisfying people is just not enough. Based on the hypothesis that emotions beyond satisfaction are the real drivers of customer loyalty and brand enthusiasm, AMCI identified trust as a facet of the buyer-seller relationship worthy of study. And the study revealed that developing and maintaining customer trust is a very, very powerful thing.

If I heard this rather vague comment from a mentee my first question would be, “Can you give me a real world example?”  And Ian Bevis not only gives one, but two examples. And he uses one of my favorite means of helping an audience understand a new concept, analogies:

“The analogy I use about satisfaction versus trust is is the absence of illness doesn’t mean a person is fit or healthy,” he said. “Another analogy I’d use is you don’t get a serious relationship because you’re satisfied with dating someone. It takes love and trust to build longterm relationships.”

So it’s clear from these two examples that trust is indeed a higher order metric than customer satisfaction. The term that doesn’t get defined in the article is “brand.”  I define brand as a product or company’s distinctive identity that is a strong competitive asset; the stronger the brand, the higher the level of trust. For example, I’ve been an Apple customer since the days of the Apple II, and Apple has earned my trust through the brand identity of simplicity, elegance, ease of use, and innovation. I’m not always a satisfied customer of all its products, for example the Apple Cube, was an elegant looking flop. But their values and reputation are so strong that they can quickly recover from the occasional misstep in customer satisfaction.

What’s missing from the article, perhaps as an exercise for the reader, is how do you measure trust? Customer satisfaction has been measured for years by surveys, accepted as valid and reliable. I’ll be looking for articles on how to measure trust. In the meantime I would venture two metrics:

  1. Pre-orders of new products – Tesla must have set a world record with its number and dollar value of Model 3 pre-orders. Planning to buy a product before there are any reviews or even customer word of mouth certainly represents trust.
  2. Used product value – the higher the used product value the greater the trust in the key word: reliability.

Do you even measure trust? And if so, how?

Dilution: a 4-letter word for founders


Like it or not, virtually all tech startup founders will face dilution, the erosion of the percentage ownership in the venture they founded due to having to sell off their equity to finance the venture.

The article Dilution: The good, the bad and the ugly by Bernard Moon is a recommended tutorial for founders before you begin the process of raising capital. Keep in mind the source, Bernard is a VC at SparkLabs Group. If you want the VC perspective on dilution for founders their experience of investing in more than 230 companies is well worth reviewing.

For those of you not needing Bernard’s math through possible seed rounds to how future rounds dilute your ownership, I’m going to just highlight some words of wisdom to keep in mind regarding valuation, perhaps the most contentious issue both for founders   and investors (it’s a zero-sum game). While Bernard does a good job of defining a Good Series B (excellent execution) versus a Bad Series B (poor execution or mismanagement; product too early or too late; longer than projected sales cycles or market forces outside the founders’ control) he avoids the nightmare scenario I’ve posted about previously: asKryptonite for founders – the down round. 

As noted previously, trying to predict revenues for a startup is exceedingly difficult. But you should know your operating costs and be able to predict them with a reasonable degree of certainty, especially fixed versus variable costs. Typically founders are too optimistic and underestimate both the time and funding to ship their first product and to generate customer revenues. No matter how much contingency you build into your numbers things will just cost more and take longer – that’s just the way it is.

But there are two things you need to focus on in your projections:

  1. How much capital do you need to last 12 – 18 months?
  2. Will this amount enable you to hit the milestones needed to raise your next round?

Fund raising is extremely resource-intensive for the CEO pitching innumerable investors, so I’d err on the side of raising enough capital for 18 months, even if that results in somewhat more dilution. If you fall short of your projections, be prepared to answer these investor questions:

  1. Did you overestimate your sales’ ability?
  2. Was your capital efficiency significantly lower than projected?
  3. Is there really a large (and growing) market for your product?
  4. What mistakes did you make? What should you have done differently?

Investors are looking for founders who learn from their mistakes and use that learning to course correct. Humility is in store if your falling short is due to mismanagement or failure to execute.

There are two ways to gain a reasonable valuation and avoid undue dilution:

  1. Execute on your plan – hitting major milestones
  2. Competition generates value – have at least two term sheets

Here’s a great quote from Bernard:

Your goal is to create investor interest from multiple firms while generating the least amount of friction to quickly close your round. It might be a difficult balance between knowing your value but respecting what investors are looking for, but don’t kill your fundraising efforts by not being flexible on valuation. Remember, it’s not all about the money and your ownership percentage. If one of our portfolio companies had a term sheet for a $10 million pre-money valuation from an unknown family office or an $8 million pre-money valuation from a top-tier venture capital firm, we would tell them to take the lesser valuation, even if it’s a smaller gain on our books.

Having raised multiple rounds for VC-backed companies, I can attest the wisdom of Bernard’s words. But there are a few things I would add. First of all, know whether your first investor has deep pockets and is prepared to participate on future rounds if you hit your milestones. Angels and strategic investors may not. It’s not a good signal for new investors if institutional investors don’t participate in future rounds – you better have a very good reason. There are other ways to raise money, such as venture lending and warrants, that may work for you depending on if you have a capital intensive business with hard assets. Even if you don’t hire a full-time CFO I highly recommend you have the help of an experienced CFO to help you prepare your financials (and determine concomitant dilution!) for various scenarios. The return on investment in paying a savvy CFO can be 1,000X or more. When playing with VCs you want to try to level the playing field as much as possible. Your Board of Directors should have experience raising venture capital and be able to provide not just contacts, but valuable perspective and insight on the fund-raising process.

Finally, be careful to manage the expectations of the senior team and anyone else with options or restricted stock. They are all going to expect a step-up in your next round of financing – in fact they are counting on it to get them on the road to building their personal wealth. Much  better to under-promise and over-deliver.

Pros and cons of building on platforms


As I’ve written previously, a lot of my founders aspire to creating platform companies. But many don’t pay enough attention to what it takes to create an ecology of developers around a platform and the many platforms out there already competing for developers’ attention.

But there’s another route developers can take – develop for a popular platform, like Slack. In fact it’s clear that Slack aspires to be the workOS of the enterprise.

The article Why we’ll see more startups built on platforms like Slack by ANDREW KIRCHNER on VentureBeat provides a very good list of the pros and cons of taking of such a pilot fish strategy.

  • Pro: You’re fishing where the fish are – I consider customer acquisition as the major challenge for most tech startups. As I tell my engineering mentees, I believe engineers can build just about anything, but I don’t believe they can sell just about anything. The goal of a platform is to be a demand aggregator. Instead of your venture spending gobs of money finding customers you just have to present a compelling proposition to the customers of your chosen platform. Still a challenge, but much less expensive. The key to success is choosing the right platform. Years ago Evernote was hot; now it’s not. Today it’s Slack, but tomorrow it could be something still incubating in someone’s garage. You also need to make sure there’s a match between your competencies and the tools your chosen platform provides. Choosing an integration-first product like Salesforce is similar to choosing iOS or Android or Windows or Mac – but far more complex, as there are at least two orders of magnitude more would be platforms to choose from than operating systems.
  • Pro: No extra login for customers Estimates put the total number of cloud products per enterprise at more than 1,000! Who wants to deal with even 10% of those logins and passwords?!
  • Pro: It’s easier and cheaper to get to market. By developing for a platform you can use their UI and save lots of development time and effort. Plus you eliminate 90% of the learning curve for your customers. Much, much more efficient for a small startup to join an existing ecosystem of a giant than to go it alone. 
  • Pro: You’re immersed in the culture of your clients. This is the weakest argument, but certainly you want to choose a platform that shares your values.
  • Con: Smaller customer pool. The total size is not as important as the growth rate. You want to choose a platform with a high growth rate, not one that is stagnant or even shrinking. It’s not as simple as a pure numbers game. You are going to have to predict the future – just like any other startup – by picking a winner.
  • Con: You may struggle for visibility.  This is an issue of timing. Getting in early with a platform gains you visibility, but increases your risk. Apple’s App Store and Google Play with their millions of apps, make invisibility the norm, as they are mature platforms. So once again you have to pick wisely, a young but growing platform versus a larger, but mature platform.
  • Con: You’re at the mercy of the platform. Some platforms, like iOS and Windows, have years of experience and teams of engineers supporting their ecosystems. But others, like Twitter have even shut down their platforms after a period of time. So once again you have to measure risk versus reward and choose wisely.

Let’s face it, startups are risky. Typically investors consider there to be three risk factors: technical, market, and team. Riding the wave of an existing platform can do a lot to reduce the technical and market risks. But that path introduces a new type of risk: your chosen platform may not grow or may even shut down to outside developers.

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