Are you ready to ride a rocket?

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The New York Times has a very long, detailed article by  Erin Griffith on the sins of venture capital entitled More Start-Ups Have an Unfamiliar Message for Venture Capitalists: Get Lost.

Neither the writer nor the many founders quoted seems to realize that venture capital is for the very, very, very few – about .1% according to a post on Quora. As I was told by a veteran vc investor in one of my companies years ago, “Venture capital is the most expensive capital you can get as a founder.” VCs are focused on two things: growth and exits. Venture capital is rocket fuel: go for it only you are prepared to ride a rocket, which will either reach escape velocity or crash back to earth – in other words go public/get acquired or go bust – don’t even consider it.

Frankly I consider most of the article to unrealistic whining. As Josh Kopelman, a venture investor at First Round Capital, an early backer of Uber, Warby Parker and Ring, said,  “I sell jet fuel,” he said, “and some people don’t want to build a jet.”

Some companies that have raised vc money have realized they want to step off the jet.

Wistia, a video software company, used debt to buy out its investors last summer, declaring a desire to pursue sustainable, profitable growth. Buffer, a social media-focused software company, used its profits to do the same in August. Afterward, Joel Gascoigne, its co-founder and chief executive, received more than 100 emails from other founders who were inspired — or jealous.

“The V.C. path forces you into this binary outcome of acquisition or I.P.O., or pretty much bust,” Mr. Gascoigne said. “People are starting to question that.”

For those of you wise enough to avoid the vc grow fast or die rocket ride in the first place there is some information on new ways to fund startups or ways to undo vc funding.

In September, Tyler Tringas, a 33-year-old entrepreneur based in Rio, announced plans to offer a different kind of start-up financing, in the form of equity investments that companies can repay as a percent of their profits. Mr. Tringas said his firm, Earnest Capital, will have $6 million to invest in 10 to 12 companies per year.

Earnest Capital joins a growing list of firms, including Lighter Capital, Purpose Ventures, TinySeed, Village Capital, Sheeo, XXcelerate Fund and Indie.vc, that offer founders different ways to obtain money. Many use variations of revenue- or profit-based loans. Those loans, though, are often available only to companies that already have a product to sell and an incoming cash stream.

But the reality is that these new ways to obtain startup funding are a drop in the bucket. Founders who can’t finance their companies through customer revenue must look to friends and family, angels, angel groups, bank loans or maxing out their credit cards if they want to avoid vcs.

The reality is that vcs and other investors have realized they can make more money pouring investment into later stage unicorns like Uber than they can by investing in raw startups, which is making life more difficult for the early stage companies I mentor.

But the laws of investment are much like the laws of physics, you might be able to bend them, but they can’t be broken. Create real value and someone – customers or friends and family, angels, whomever – may pay for or invest in that value creation engine. Too many founders I see are focused on raising money, not value creation. It’s a bit like a pro football team focused on the Super Bowl before they have even won a game.

Raising capital for a not-for-profit company

newmanitarianwebsiteheaderI’ve worked with and for a number of not-for-proft companies in my career, but I’ve never been responsible for raising the capital for their operating costs. Aside from writing several successful grant applications for the Watertown Free Public Library, I’ve not raised a significant amount of capital for a non-profit. But I am familiar with the various approaches which I’ll recap here as they may be helpful to those few startups that choose the non-profit route. We see very, very few non-profits at MIT VMS, though many of the startups are focused on social impact.

One major difference between for profits and non-profits when it comes to raising capital is that non-profits have no stock to sell. So that eliminates investment and no return on capital – period. No vcs, no angels, no convertible debt. So how do you raise money?

The most important thing to keep in mind is that non-profits must get a 501 (c) (3) designation from the IRS. In short this enables donors to deduct their donations from their income taxes. It is very hard to raise capital for a non-profit without a 501 (c) 3 classification from the IRS. Unfortunately in my experience it can take 6 months or more to get the charitable designation from the IRS. There is a workaround as founders can route donations through another 501 (c) (3) corporation. Startups in Massachusetts affiliated with MassChallenge are able to use MassChallenge in this manner. However, it is just a short term fix. It appears that the current partial government shut down may affect the IRS and slow down 501 (c) (3) applications or halt them completely until the federal government fully reopens.

So where does a 501 (c) (3) corporation go for funding?

Friends and Family

This tried and true method of fund raising has been used by for-profit companies forever. While friends and family may feel better investing in a charitable organization those funds are not really an investment as there is no mechanism for a return, it’s really a charitable donation.

Foundations

Foundations like the Bill and Melinda Gates Foundation grant billions of dollars every year to non-profits. However, there are at least two problems with foundation grants. One, many of these grants are one-time grants. It is difficult to get multi-year grants. So that leaves non-profts in the position of having to constantly raise money. The other issue is that typically foundations work by the calendar: applications must be submitted by fixed date each year, applications may then take months to be reviewed and more months may go by before a check is cut to the “winning” grant applicants. Many foundations have terms and conditions around their grants and may also require periodic reports on how the grant money is spent.  Preparing and administering foundation grants requires a lot of work on the part of founders. Understand the opportunity cost before embarking on a quest for foundation grants.

Government grants

The best known grants in the tech world are SBIR grants. These Small Business Innovation Research grants can provide valuable support for a startup. I even knew one entrepreneur who had financed his entire company with multiple SBIR grants. I would encourage every startup, not just non-profits, to consider filing for an SBIR grant. Government granting agencies can move even slower than the IRS and require more detailed applications. I would encourage every non-profit to hire someone with deep experience applying for and administering foundation and government grants. They should be able to more than pay for themselves, especially if they are working on a part-time, project basis.

Donations

Wealthy people typically have their own foundations or what is called a family office. I would encourage founders to study up on family offices as many invest in startups and/or make donations to non-profits. Large corporations may set aside a portion of their profits for charitable donations. They key is finding these offices and if possible getting a warm introduction to their administrators.  Again, your non-profit must have a 501 (c) (3) designation to work with a family office.

Work for hire

Just because you are a non-profit it doesn’t mean that you can charge for products or services. It just means that any excess capital beyond your operating costs has to get plowed back into the organization – which could even be salary increases for your staff.  If your non-profit possesses a particular skill such as training teachers, you can run training workshops and charge their parent organizations a fee for the workshops.  You could even develop a product, such as a portable water purifier, which you could sell and use the proceeds to support your organization. Grant making organizations and individual donors tend to look favorably on startup that generate revenue, as donor organizations do not want to be the sole source of support for a non-profit. Similarly they don’t like be the first money it. Thus generating some revenue can be the first money in and encourage foundations to look more favorably on your grant application.

Products

Their is nothing to prevent a non-profit from making and selling products. In fact my absolute favorite charitable organization is the Newman’s Own Foundation, set up by the late actor and run by his daughter. Not only do they give grants they also have created an entire product line of excellent food products – we especially like Newman’s Own salad dressing and frozen pizzas. They have reached a milestone of $535 million in donations!

Non-profts should act like for-profit startups in that they need founders, a fleshed out management team, a great business plan, traction, a customer acquisition plan, etc. One nice thing about non-profits is that while they do compete for grant money, in general they may well be more collaborative and cooperative with other non-profits.

This post would be incomplete without mentioning the Social Innovation Forum, They are a greater Boston organization that helps startups raise capital and increase their social impact. I’ve had the privilege of working with them on founders’ presentations and SIF is an excellent organization which I highly recommend to Boston area non-profts.

My last word on non-profits is that you should acquire and use a .org domain name. .com signals a for-profit company, .org signals a non-profit. Since web and social media are so important in today’s marketing you want to make sure you are viewed as a non-profit from the get-go.

 

 

 

Kryptonite for founders – the down round

 

venter

Entrepreneurs are by nature optimistic and first time founders even more so. But once you have raised Series A, B, or C rounds there’s a dark side to taking VC money: the down round.

The number one goal of VC-backed companies is not customer satisfaction, market share, gross revenues, or social impact: it’s growth in the company’s valuation.

The lead investor in any round of financing sets the valuation of the company. Given the many variables involved and unlike real estate, the very few comps, this is a black art. But so long as founders push for growth their capital needs may well outpace their revenue, meaning that they need a cash infusion. While there are other ways, such as a bridge loan, typically VC-backed companies raise another round, which means selling enough shares at a sufficient price to meet the company’s needs, typically for 18 months or more.

For each new round the value of the company is set in order to derive the price per share for existing investors, who may want to invest to maintain their percentage ownership position, or new investors who are eager to get into what to them is an exciting deal. So what’s the down round and why is it kryptonite for founders? A down round occurs when investors purchase stock in a company at a lower valuation than the previous round. The causes of a down round are not only bad news for the company, they are worse for the founders who are almost certainly going to have their ownership diluted, as rare is the founder who is both willing and able to invest enough in their company to drive maintain their equity position.

Causes of down rounds

A down round is a last resort if a company needs cash and can’t draw on a credit line or land a bridge loan. There are several reasons for a down round.

Failure to meet milestones or metrics

Milestones and metrics vary from growth company to growth company, but a major reason for a down round can be a failure to meet milestones that may have been set at the previous round. Milestones can range from gross revenues, gross margin, and market share, to shipping a new version on time. This is why founders need to be conservative when setting milestones – under promise and over deliver. But beware of what the VCs call lowballing – knowingly setting goals that are so very easily met that they can be called layups.

Emergence of competitors

Given how cool entrepreneurship is these days and how universities are fueling the startup fire by not only offering many courses in entrepreneurship but they are also setting up incubators or accelerators, running business plan competitions, and even making grants (equity-free money) to student-led startups. So I tell my mentees that however unique their idea may seem to them, the odds are that some other startup somewhere – and that now includes Israel and western Europe these days – is working on the same thing, or something very similar. And competition doesn’t only come from other startups – the vogue for innovation in large companies has generated internal startups and new product initiatives. While one can use sources like Techcrunch to track competitors, your competition may well be in stealth mode – operating under the radar of Internet media companies that track the startup world. Before you start your company you need to do a thorough web search for competitors. But that’s necessary, not sufficient. Monitoring competition has to be an ongoing task. The simplest way to do that is to set up Google alerts. In addition, success will attract copy cats. This is why investors are so fixated on sustainable competitive advantage and unique selling proposition.  Be prepared for competition and be ready to explain why you will continue to grow due to your competitive advantages, be they patents, exclusive distribution agreements, large customer base, high switching cost for your customers, price advantage, superstar management team or any combination of advantages.

Previous rounds were overpriced

Investors hate to admit it, but they are like lemmings. They are eager to jump on the latest thing, be it crypto, block chain, deep learning, robotics or artificial meat. Flooding a sector with capital can result in valuations that were driven more by competition amongst VCs than true market value. While a rising tide raises all boats a falling tide can leave many boats stranded on dry land. “Market corrections” in your sector may cause your investors to stick to your previous valuation or even lower it as they come to their senses about whatever wave they thought you were riding.

Down rounds rarely make the news. But today’s article in The Wall Street Journal Genomics Startup Human Longevity’s Valuation Falls 80% sub-titled Fundraising round this week values company co-founded by genomics pioneer Craig Venter at about $310 million; aiming for a turnaround is the story of a down round. Genomics latest round  represents an 80% decline from its previous valuation of $1.6 billion – that’s a real haircut!

But down rounds aren’t simply confined to a lower valuation, they also often come with harsh terms and conditions as well.

This round also includes onerous terms that promise priority payment in case the company shuts down or sells itself, and a so-called ratchet that would reset the share price investors in the new round paid if the company has to raise future capital at a lower price, according to the filing. Such terms are rare in venture-capital financing, and typically imposed on companies struggling to find new investors.

According to analysts at the law firm Fenwick & West, 9% of venture financing in the third quarter were down rounds, up rounds represented 78%. Simple math tells us that 13% of rounds were at the same valuation as the previous round – resulting in dilution for all involved unless they “buy up” to maintain their percentage ownership.

The genetics firm Human Longevity is a case study of the fallout from a down round:

As the company has continued to burn cash, its workforce has dropped to around 150 from roughly 300 people at the end of 2016, according to one of the people. And its chief executive officer, chief medical officer and chief operating officer all departed in 2017, according to their LinkedIn profiles.

Dr. Venter, who helped sequence the first human genome, relinquished the chief executive role at the beginning of 2017, resumed it in December, then stepped down again in May, according to company statements. He remains a shareholder.

So how can founders avoid down rounds? As mentioned above, you can start by not getting greedy on the valuation of the Series A round. But mainly by continuing to hit benchmarks and continuing to grow important metrics (versus vanity metrics like page views). Founders need to realize that they have stepped onto the hamster wheel of VC-backed companies: get big fast and then get acquired or go public. The pressure on the company will be unrelenting. So before you take VC money, which is the most expensive way to fund a startup, investigate your alternatives. The best use of professional investor funding is to scale your company, meaning you have nailed your target customer, your business model, your competitive advantage, and the ability of your infrastructure and cash on hand to keep up with the needs and demands of a rapidly growing customer base.

One of the failed initiatives of Human Longevity is a real red flag to founders who think that data is the new oil and they will get rich drilling for data.

But key facets of its business didn’t develop as planned, say people familiar with the company. It had hoped to sell analytics to pharmaceutical companies as they increasingly incorporated genetic sequencing into drug development, these people say. But drugmakers have been slow with the new technology and wary of sharing data, they said.

If you are counting on revenue from the data or analytics your company generates you need to be very sure that it really has value, and to whom. Too many founders I mentor seem to assume that all data has value – not true.

The old medical saw that An ounce of prevention is worth a pound of cure holds true for down rounds as well. The best way to avoid them is to carefully manage both your cash flow and be able to make accurate revenue projections. Your goal every day should be increasing the value of your venture, whether that’s by becoming more capital efficient, selling new products  to old customers, raising prices or inventing new products.

Down rounds should be something you only read about, you never want to hear that phrase  from the mouths of your CFO or your investors!

Pitch deck contents

pitch desk

Here we go again with what to include in your pitch deck. Must be the pitch season. But Alejandro Cremades Forbes article Pitch Deck Template: Exactly What To Include is not only the most comprehensive, but each item is also well-commented. But I’ll attempt to add a few annotations of my own. His article includes links to two decks worth reviewing: one from Peter Thiel and the other from an Uber competitor that raised $400 million.

1) Your Company Information

It continues to surprise me how many founders forget something slightly more specific that company information: your contact information. They get the company name, tag line, and even logo on the first slide, but often forget the rest. But I suggest leaving the contact info for the last slide. You don’t want the audience trying to scribble down your email and web site while you are trying to present to them.

2) The Concept

Others call this The Idea or even The Big Idea. Your tag line ought to be the teaser for the big idea, which has to be engaging. The rest of your pitch consists of convincing your audience you will make them a lot of money by implementing your big idea, assuming they will fund you, of course!

3) The Problem

As I’ve noticed elsewhere, this needs to be a both a big and a prevalent problem if there’s going to be a big market in solving it.

4) The Solution

Enough has been said about this!

5) Market Size

Many founders either forget or just don’t know that VCs are aiming to build billion dollar companies, not million dollar or even 100 million dollar companies. The big winners need to pay for all the losers, which can be 70% of a portfolio. Think big or don’t even bother to pitch VCs.  And may founders also neglect to include the growth factor of the market. Yes, the market for family sedans is large, but it’s shrinking! Investors want a growing market, not a static or shrinking one.

6) The Competition

Don’t forget to include how your customers are attempting to solve the problem now, especially if it’s a home-brew or cobbled together solution. The status quo is your biggest competitor, not some other company. People hate change. Why? They are scared of it. The devil they know is preferable to the devil they don’t.

7) Competitive Advantages

Here’s your chance to explain why those customers who hate change are going to love your product so much that they will adopt your product by the zillions, at least. What clearly differentiates your product or service and why does that differentiation appeal to the market enough so that they will pay you enough for it to make at a profit?

8) The Product

Very short videos have begun to replace live demos (usually too risky) and static images (too dull ). You shouldn’t need more than 60 to 90 seconds. And keep in mind, years of TV watching has conditioned viewers to expect broadcast level quality. Either deliver that quality or purposefully make it look home-made, like the back of the napkin sketch that raised $10 million. Don’t get lost in features or benefits. Focus on how your product solves your customer’s problem in amazing fashion!

9) Traction

If I only had one slide besides the Team it would be this one. Investors are risk averse. Few have the guts to take a flyer on any idea, even a ground-breaking one. They want and need validation. Validation comes first from users. They are the most important. Get enough of them, as Google and dozens of other companies proved, and you will make money. But it’s important that they use your product early and often. And the key to traction is virality, either through social media or good old fashioned word of mouth. Without virality the cost of customer acquisition usually make a consumer product unprofitable. If you have an enterprise product you can worry less about virality and more about having testimonials from influential customers.

10) Business Model

The important thing is you have a model! Precision is less important than logic. Your model needs to make sense. Innovate with your product or service; attempting an innovative business model as well is a very high risk path.

11) Basic Financial Forecast

Metrics are much more important than spreadsheets. Key metrics are cost of customer acquisition, lifetime value of a customer, customer churn rate, your burn rate, break even point, amount of capital needed to reach profitability, etc.  As written elsewhere, the assumptions behind these numbers are more important than the numbers themselves.

12) Other Investors

Again, investors are risks averse. Again, they are looking for validation of your business. Aside from paying customers, other investment in your venture shows validation. Even friends and family is much better than just your sweat equity.

13) Use of Funds

This is a highly strategic slide, as it depends on how much money you are trying to raise. The rule of thumb is your raise should last you 12 to 18 months, but projecting your burn rate can be very difficult, as the cost of marketing and sales – customer acquisition – can grow very quickly. And when your product or service is mature enough is another tough judgement call, as is what you consider compelling traction. Spend a lot of time figuring out how much you need to raise and how you will invest (not spend) it in your venture.

14) Who is Involved

My only difference with the author is that in my experience investors want to know who the team is long before sitting through 13 other slides! Putting this right after the solution gives you the opportunity to explain why the experience and expertise of your team is ideally suited to delivering the solution you have just described.

15) Thank You

Yep, here’s the place for your contact info. And I agree with the author you want to end your presentation on a positive note, be that a testimonial from a beta tester or a good quote from an analyst or the media.

Alejandro Cremades is a serial entrepreneur and author of best-selling book The Art of Startup Fundraising.

The toughest task in tech – valuing a startup

comps

I’ve seen this problem for decades. And up close and personal when it came to the difference between the founders and the VCs when it came to valuing my startups.

Yes, there are all kinds of present value models you can run on a post-launch, revenue-generating company. And being about as far from a finance guy as you can get I haven’t spent much time with them. My advice to founders is generally the same advice my real estate agent gave to me: rely on comparables. But comparables for startups can be much harder to find than those for houses. Even so, pricing for houses can be just as contentious as pricing of companies, though in real estate it’s between owners and realtors, in startups it can be between owners and owners. Lots bloodier!

With that very brief preamble I’m going to attach a PowerPoint startup valuation model that is the best tool I’ve seen. It is courtesy of a fellow mentor, James G. Wilson, CEO of Zeabio, who shared this with us at a Post-Doctoral Students Association mentoring meeting.

In true mentoring fashion of the five slides two of them Questions, Capital, Valuations and Risks and Expectations, lead with questions.

Like any good model it’s no better than its assumptions and it’s up to you to input those assumptions, they don’t come pre-packaged with the presentation.

Couple use of this model with good research into comparables and you will at least have a head start on the startup valuation task. Good luck!

startup valuation.ppt

 

How do you know we are in a tech bubble?

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One highly correlated indicator of tech bubbles is the size of corporate venture capital market. It’s directly correlated with the size of the investment bubble in my experience. I remember a VC telling me with a sardonic look on his face, that corporate venture gets in when the market is high and abandons it when the market for tech companies slump. “They buy high and sell low,” he said with a smile.

While The Wall Street Journal article Defense Industry Adds Venture Capital to Its Arsenal is nominally about defense companies, its statistics apply to corporate venture as a whole.

The corporate venture-capital market has more than doubled over the past five years. American companies made more than 1,200 deals worth a record $34.3 billion in 2017, according to the National Venture Capital Association and PitchBook.

Corporate venture is an often overlooked source of capital for entrepreneurs. I’ve written about The pros and cons of taking corporate VC money previously and the balance hasn’t changed. However, according to the Journal:

Alongside traditional players such as tech firms and drugmakers, a growing array of manufacturers—from power-tool maker Stanley Black & Decker Inc. toGeneral Motors Co. —is sifting startups for technology that could ensure their future.

What’s interesting about the new entrants is their interest in AI, autonomous vehicles – think General Motors – and other areas that could lead to new manufacturing processes and storage technologies, changing the way companies design and produce. Energy storage is another key area for corporate venture.

“There is an ongoing collision of the tech world with industrials,” said analyst Rob Wertheimer, at Melius Research LLC.

There are three opportunities for startups with respect to the industrial giants joining the venture world: raising capital, joint ventures, and acquisition.

From the viewpoint of the established companies they are looking for innovation and an injection of entrepreneurial culture. But as a founder you need to keep in mind that these companies move at a much slower and more deliberate pace than startups and a far more risk averse. So while joint ventures may look attractive, be prepared to be very patient. Taking their capital can seem advantageous as strategic investors are less price sensitive. But they usually won’t invest beyond a single round and can try to bend your direction to suit their needs.

If you sell your company to one of these large companies be prepared to join their culture.

“Suddenly, I was one of a thousand lab coats,” said a former Lockheed executive whose small firm was acquired by the defense giant before it launched its venture arm.

And be aware that most acquisitions fail. Two former 3M executives advised the leader of Stanley Black & Deck’s board as they developed their venture-capital arm that “3M wrote off half its ventures!”

Your best case in dealing with an acquisition is to sell your technology assets, not your company. That’s a far easier deal to cut with corporate M & A executives as they are not faced with the difficult task of valuing a company and then integrating it into their firm. And you and your team won’t face being strangers in a strange land and can go on to build new breakthrough products.

Mentors play key role in global network of smart cities

leading cities

The Leading Cities’ AcceliCITY program is growing operations in ten countries and an international network of mentors, investors, and partners with ready access to decision-makers in city governments.  The goal of the program is to connect a startups directly with business users and provide the proper channels and know-how to deploy in cities.

What is most interesting about this contest is that semi-finalists will be selected to participate in a month-long virtual mentoring program. And the finalists will receive support from local mentors and globally recognized Smart City experts.

According to Michael Lake, founder and CEO of Leading Cities, the new AcceliCITY model is unmatched in terms of need and potential reward. “Cities have an amazing opportunity to capitalize on a technological revolution but are finding it a challenge to identify and properly vet these new technologies. AcceliCITY provides a common ground for growth by matching entrepreneurs with expert mentors, understanding best practices for doing business with governments, and gaining access to investment funding.”

Applications are available here.

This contest is well worth entering as the competition will provide capital from a network of investors as well as the tools and knowledge of how to do business with cities.

If you are interested in becoming a mentor follow this link for some background information and an application. You need to have expertise in one or more of fourteen areas. Mentors will not only be expected to provide the traditional advice, guidance, and feedback so startups but also to serve as speakers in either AccelCity’s web-based programming or at Boston Bootcamp workshops.

So whether you are a startup whose product is a fit into the smart cities program or a mentor with relevant experience, check out the AcceliCity Global Smart City Startup Competition.

There’s an excellent presentation here.