How do you deal with dilution?


good uglyOnce a venture has moved beyond friends and family money and convertible notes or SAFEs, the fundraising option is down to one method: selling equity in the company. And once you take that route you will need to deal with your and your teams’ ownership all being diluted, e.g. ownership in the venture will go down in direct proportion to the amount of money you raise. (The only exception being if you or your co-founders have enough capital to invest in the company alongside the VCs – rarely if ever the case.)

The Techcrunch article by Bernard Moon Dilution: The good, the bad and the ugly is highly recommended reading for those founders raising a Series A for the first time. Bernard Moon is co-founder and partner at SparkLabs Group, a network of accelerators and venture capital funds.

Bernard very helpfully provides the cap tables for three different valuation scenarios which I won’t reiterate here. What I will do is pull out some good advice from the article and add some of my own.

Number one is that most VCs insist on a 20% employee stock option pool. So everyone in the firm will take dilution from the pool immediately. Note that the venture takes this dilution, not the VCs!

Another key point for those who have raised money through convertible debt or a SAFE is that the cap on valuation from those instruments is NOT your company’s valuation for purposes of raising money by selling equity. So don’t get too focused on that valuation when negotiating your valuation with an institutional investor.

Secondly, as Bernard writes, “you need to create investor interest while generating the least amount of friction to quickly close your round.” Welcome to the world of tradeoffs – you’ll be making many as you build your company.

Founders are faced with the Goldilocks problem: if you raise too little money you may well run out of cash before getting your company to the important milestone of positive cash flow. You don’t want to be in that position. But you can also cause problems if you raise too much money. For one thing, you may have sold too much equity at a price much lower than it will be after you hit a major milestone or two. Companies, like people, tend to live up to their incomes, so too much cash is easily spent. Raising enough money to get to a major step up in valuation in your Series B financing round, plus a 20% contingency, should be your goal.

The rule of thumb is that you should raise enough capital to last between 12 and 18 months. Why? For two reasons: one, fund raising is very time intensive, especially for the CEO and is a major distraction for senior management. It also generates anxiety amongst the staff. (How much will I be diluted?) Secondly, your valuation on your series B financing is going to be based on your accomplishments and value added since your Series A. You need to give yourself enough time to hit meaningful milestones.

Your goal should be to have two or more term sheets. Competition drives valuation. If you have a hot startup there will be competition for your Series A. And sometimes T’s and C’s (terms and conditions) vary between investors. Be careful to analyze the terms of the investment and what preferences the investor expects to receive in addition to their equity ownership.

Keep in mind that the founders’ equity upon closing a Series A can go up if the Board later decides to award additional shares to the founder for exceptional performance.

Finally, it’s not all about valuation and percentage ownership. As I was taught by Alan Bufferd, treasurer of MIT and a two-time investor on the part of MIT in my startups, “Everybody’s money is green.” Meaning what value add does your investor bring to the table: Stellar reputation? A great network? Proven help in recruiting world class talent? Ability to syndicate deals with other top flight firms? A partner who will champion your firm far past the Series A closing? High marks from other founders who have taken investment from this firm?

Remember, a small slice of a very, very large pie is much preferable to a large slice of a tiny one! Your job is to bake a very, very large pie!




What’s a mission statement? And why do you need one?


I’ve written previously about vision and mission statements. Today’s post will focus on mission statements with thanks to John Boitnott, author of the excellent article How to Write An Unforgettable Company Mission Statement, subtitled It’s your best and earliest shot at telling employees and the world what you’re about.

What is a mission statement? Very simply it is a statement of purpose for your venture. I discussed this last night in my final presentation to the group of post-docs I’ve been mentoring for the summer. Your venture needs to have a reason to exist. It’s important that you convey this mission clearly and concisely to inform all the stakeholders in your venture: other partners, staff, investors, vendors, the press, analysts, et al. Mission statements help create alignment, a critical success factor for startups. As I’ve previously written:

My vision for Mentorphile is that virtually everyone may need to become an entrepreneur, as the future of work is changing dramatically from globalization and automation. My mission is to help founders succeed by sharing what I have learned from my experience both founding startups and mentoring dozens of founders.

I like to see mission statements of the form “We help X accomplish Y [by doing Z]” Who you help are your customers, how you help them is your product or service. Here are the four criteria John Boitnott lists for a mission statement, with my annotations:

  1. It should be inspirational. It’s the founder’s  job to inspire his team and all other stakeholders in their venture. Your mission statement should fill all who read it with the urge to follow your venture, wherever it leads.
  2. It should be succinct. My rule of thumb for mission (and vision) statements is that you should be able to wake up any staff member in the middle of the night, ask them what the company’s mission is and have 100% recite the answer correctly (then go back to sleep!) The long and complex mission statements often seen with large, legacy corporations fail this test every time.
  3. It should be timeless. The lifetime of a company’s mission statement should be measured in years, not months. Bill Gates’ original mission statement was to put  Microsoft software on every PC in every home and business. Note that he missed mobile! Microsoft’s mission is far more generic these days: “To empower every person and every organization on the planet to achieve more.”
  4. It should reflect the company’s values and purpose. See my post Values: the bedrock of startups. Document your venture’s values before you tackle your mission  statement.

So how do you go about crafting a compelling mission statement. I’ll follow Mr. Boitnott’s list with my own comments.

  1. Address your key stakeholders. See the list above. Note: this should be true of all your  marketing communications.
  2. State your purpose. Why does your business exist? Why did you start it? If your answer is “To make a lot of money” go back and try again. I like Tesla’s mission statement: “To accelerate the world’s transition to sustainable energy.”   That covers both its cars and solar panel businesses.
  3. Use specific, simple language. Again, this is true of all communications, not just mission statements. No business nor technical jargon allowed!
  4. Infuse it with spirit. This is a tough one. But I like this quote from the article:

Try to infuse a bit of that can-do human spirit and energy, and don’t be shy about making bold declarations. One of the best ways to motivate a team is to set a lofty yet attainable goal, then declare it out loud.

5. Don’t needle your statement to death. I don’t agree with this one. Crafting a mission statement that hits the above criteria is hard work. Keep at it. And don’t involve a committee; that’s how you get those long, unwieldy mission statements from legacy corporations.

Before you launch your mission statement make sure you test it out with people who know the company, but weren’t involved in drafting the mission statement. Note that mission statements are completely different from taglines, which are often cute and catchy, but have short shelf lives and are subject to frequent change.

Start out by Googling the mission statement of companies you admire.  For example, here’s Apple’s: To bring the best user experience to its customers through its innovative hardware, software, and service.




Building a business by solving your own problem

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I’m a sucker for startup origin stories. They can tell you a lot about both the founder and the venture. As a mentor I usual start off meetings asking what prompted the founder to start their venture. But the origin stories I like the best are the ones where the founder is trying to solve a problem that they themselves experience. Then the question becomes how many other people have that problem and can a business be built on providing a solution. The article on CNN Business by Michelle TohThis startup helps you find any place on the planet without an address is a great example of such an origin story.

The story of London startup what3words begins with what3words CEO Chris Sheldrick, a former live music organizer. Sheldrick often grew frustrated at poor addressing when he needed to drop off equipment at a convention center or direct a band where to go, Jones said. I had this problem myself when I worked in the sound reinforcement business and often had to struggle to find the right place to load in our equipment at an arena or concert hall. As Giles Jones, the company’s chief marketing officer put it, “Everybody’s got a story of where location has not been good enough.”Addresses “either didn’t exist, they weren’t accurate enough, or they were really difficult to communicate.”

Sheldrick’s first attempt to solve the problem was using GPS coordinates, but the numeric combinations were difficult to remember or share with others. But he managed to cognitive leap about six years ago. “There was a dictionary on the table, and they were like, ‘I wonder how many different words it would take to build a system using words,'” Jones said.

By combining a problem he’d been living with for years, with the observation that a dictionary contains thousands and thousands for words, Sheldrick arrived at an answer to his problem. By combining about 40,000 words in groups of three you can map out specific building entrance, such as at a shopping mall. The company divides up the world into 57 trillion squares, each uniquely identified by a three word address.  The app then opens up another mapping app, such as Google Maps, which then can direct you to the address.

Ok, so far we have a personal problem combined with a unique solution. But how does what3words make money? The app is free to use for the public and non-profits but the company plans to make money by licensing its code to businesses that want to integrate it with their systems. To quote Michelle Toh:

Two of what3words’ investors are logistics firms. Germany’s DB Schenker and the UAE’s Aramexare using the startup’s technology in their systems to help delivery workers know exactly where they’re going, a way to save time.

Other partners are using it to showcase new features on their platforms.
German automaker Daimler (DDAIF), another what3words backer, has adopted it in some of its cars’ navigation systems, letting passengers input three-word addresses by voice.
Another company, theSouth Korean messaging app Kakao,has used what3words as a way to invite users to discover new fishing spots that were previously off the grid.
It turns out that one of my mentees has a venture in the logistics business. I’ll be interested in hearing from him if he sees potential for what3words with his target customers.
There are a couple of interesting lessons embedded in the what3words origin story. While many successful startups might seem like overnight successes, in reality founders often live with a problem for years before finding a solution. Any they may try multiple solutions until hitting on one that works. The other lesson is more subtle: pay attention to your environment. It was observing the dictionary that led to the insight about using a unique set of words to define a location. You never know where a solution to your problem might be lurking, so keep your eyes, and your ears open!

What’s the average age of the successful entrepreneur?

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The media has done an excellent job of promulgating the myth of the whiz kid entrepreneur, likely galvanized by Mark Zuckerberg and the monumental success of Facebook. The typical Silicon Valley success story leads with the Stanford student, or better yet, a Stanford drop out, who raises millions of dollars to build a world changing company.

And from where I sit, mentoring students and recent alumni of MIT, the myth certainly seems true. Even the alumni skew to being less than 30 years of age. I’ve yet to see a faculty member and I think perhaps only one or two staff have appeared in my ventures to be mentored queue.

Of course, I’ve seen studies showing that startup founders tend to be far older than the Mark Zuckerbergs of Silicon Valley fame, but I largely dismissed those studies as they included founders of small, no-growth businesses like pizza shops and dry cleaners, not the fast growth startups I’m used to working with. These studies showed that owners of small businesses tended to be in their late 30 and 40s.

However, new research by the economists Pierre Azoulay of M.I.T., Ben Jones of Northwestern, J. Daniel Kim of the University of Pennsylvania and Javier Miranda of the United States Census Bureau, provides the first systematic calculation of the ages of the founders of high-growth start-ups in the United States.

This research is highlighted in The New York Times article Founders of Successful Tech Companies Are Mostly Middle-Aged by Seema Jayachandran.

After stripping identifying information, the government provided the researchers with a data set including 2.7 million business founders. The researchers calculated that the founders’ average age was 42. And for the founders of the 0.1 percent fastest-growing firms, the average age was 45. Firms that were successful enough to have an initial public offering or be acquired by a larger company showed the same pattern: Their founders were generally middle-aged.

The bulk of the article focuses on Tony Fadell, founder of Nest Labs, father of the iPod and key player in the development of Apple’s iPhone. His story is well worth reading about. But unfortunately the author misses a key point about entrepreneurs and why their age averages out to 42 years: I wager that a large number of successful entrepreneurs are serial entrepreneurs. Serial entrepreneurs often try, but fail at their first or even second startups. But they perform the number one job of the founder: to learn. And they apply that learning to their following startups and thus avoid many of the mistakes first time founders make. It is unfortunate that the census data the study relied upon did not provide data on how many businesses these founders started or co-founded.

Back in the last century the received wisdom amongst VCs was to be leery of funding founders who had already tasted success. They reasoned that successful entrepreneurs would lose that lean and hungry drive so necessary to building something from nothing. Now, three decades later, venture capitalists learned what Hollywood knew years ago: better to back a director who made one film that flopped that someone with no directing experience whatsoever. I’d venture to say that there is now a positive bias in favor of serial entrepreneurs, successful or not. In fact many VC firms have “entrepreneur in residence” programs to bring their successful founders in house in the hopes that they will help the venture firm spot winners or even start a new company, to be backed, of course, by the hosting VC firm.

So what’s the lesson in this new study for founders? If you are young you can leverage the bias in favor of youth: risk-taking mindset, raw problem solving capability and pure energy. And if you are headed towards middle-age, or even there already, you should position yourself as older but wiser, with great examples of how you have learned from experience. Either way, founders are the product – the best investors put their money on great founders, not great ideas. Great ideas are cheap, not so great founders. Finally diversity  wins when it comes to teams. So if you are a recent graduate make sure your co-founders have experience working in startups and in tech companies. And if you graduated some time ago, then play up your experience and look for younger teammates. As I say to my mentees, marketing is 90% positioning. As a founder you are marketing and selling yourself constantly: to investors, employees, partners, the media, vendors and others. Play to your strengths and build a team that can cover for your weaknesses.

Study shows value of mentoring for startups

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Mentoring for startups is now an international phenomenon. Today my Google alert for “mentoring startups” delivered a very worthwhile article for anyone contemplating entering a mentor program. North West Startups Struggle to Navigate Investment Landscape by Patricia Keating of Tech Manchester (England) highlights a couple of areas where startups say they are weak and where mentoring can help: raising capital and managing HR functions.

An in-depth survey of tech startups and mentors in the North West reveals that many of the region’s new businesses lack knowledge of how to raise investment, with less than a fifth saying they feel confident doing so.

Findings showed that just 19% of startups felt they had good knowledge or confidence in raising investment at the beginning of the 12-month programme, although this rose to 58% by the end.

More than 50% of startups felt they lacked knowledge and confidence in ‘creating a pitch deck’ and ‘pitching’ at the outset.

Tech Manchester is an organization that helps support tech startups. Their report “details the journey of 86 mentor/startup partnerships within its mentoring programme, measuring levels of confidence and knowledge among startups at the beginning and end of the programme.” It certainly would be helpful to see a similar study on U.S. based mentoring programs like TechStars or MIT Venture Mentoring Service.

Tech Manchester director Patricia Keating said: “We saw the biggest increases of knowledge and confidence in raising investment and pitching to investors. Speaking from experience, the language around investment can easily exclude people who haven’t encountered it before. We’ve shown that you can have a significant impact with a few lessons on how to approach investment and pitching.

This jibes with my years of experience at MIT VMS and the MIT Sandbox fund. The startup that doesn’t ask for help raising capital is by far the exception. Yet founder’s knowledge and experience with investors varies widely, with the majority of first time founders lacking any experience at all.  Many have the dangerous idea that they are “giving a way a chunk of their business” in the words of Patricia Keating. I teach my mentees that they are selling their equity in return for capital to finance their business – they aren’t giving away anything!

But investing wasn’t actually the weakest knowledge area of Tech Manchester’s founders, that area was managing people.

Keating added: “A large proportion of founders have never managed people or been party to HR processes within their previous roles, so it remains the most significant knowledge gap among startups. Through the programme we ran sessions on making a first hire and best practice in recruitment, onboarding and people management, bringing the percentage of startups that were confident in HR from 13% to 45%.”

Coincidently MIT VMS announced  a new HR workshop for its founders, run by Calvin Aird, senior VP of TJX company.

The article concludes with a testimonial from a mentee in the Tech Manchester program:

 “I didn’t know anything about the different investment pathways when I joined Tech Manchester. The process of getting funding can be expensive and it’s difficult to know who to trust, so it’s critical to have an impartial third party to give advice or recommend others who can help.

“It’s clear that there is a knowledge gap around the different funding options, but being in the mentoring scheme gave me the tools and knowledge to understand exactly the type of investment my business needs to target to move forward.”

When I mentored at Social Innovation Forum I was struck by how one of my founders evaluated the success of her financial literacy program for inner city entrepreneurs: she measured their confidence in their financial knowledge both before and after their participation in the program, showing a major increase in confidence of these first time entrepreneurs. This is a very simple, but effective way to measure the impact of programs conducted for entrepreneurs.

Keep your eye on your unit economics!


Unit economics are the direct revenues and costs on a per unit basis. For a consumer Internet company the unit is a user.

CAC – Cost of Customer Acquisition – what does it cost you to acquire a customer?

Repeat Rate – how often to your customers come back i.e. to your web site or your app?

LTV – Lifetime Value – how much will a customer spend over the total time they use your product or service?

For a raw startup all three metrics are pure projections, which are rarely worth the bits it takes to present them. But once your product has launched and you have developed sales traction, you need to keep track of these numbers, as they are the key to scaling. For early stage companies CAC will always be high as a percentage of operating expenses. The objective is to drive this number down over time through economies of scale and more efficient marketing.

Conversely you want to drive the Repeat Rate up. If customers only come to your ecommerce site once a quarter, unless you are selling something very expensive, the LTV, Lifetime Value will be too low. In other words if the CAC exceeds the LTV you have a money losing venture!

As your company goes from raw startup to product launch to revenue generation to break-even these unit economics should all be improving: CAC should be going down, Repeat Rate going up, and LTV going up. Investors will study these numbers, along with your financial assumptions, when deciding whether or not to invest in your company. You will want to provide them with a graph of unit economics on a monthly basis, along with other metrics such as total revenue, gross margin, and operating costs.

While the customer represents a unit for a consumer internet company, the staff member can represent a unit of operating costs, as salaries and benefits are the number one cost in high tech companies. The simplest ratio is company revenue divided by headcount. This ratio needs to increase as you scale and increase efficiency of operations. A mature software company should have a number in the range of mid six figures per employee. However, the current use of large numbers of contractors by many tech companies has driven the typical ratio of revenue to number of full time employees far higher than in the past.



Managing your board of directors

Silhouettes of Business People Discussing Business IssuesFirst time entrepreneurs seldom give enough thought to their Board of Directors, many don’t have one until forced to after raising a series A round of investment. That’s what prompted my first post about BoDs. Before we get into how to manage a BoD let’s just spend a minute on the makeup of a BoD. Experienced founders know that the BoD has hiring and firing power over the CEO – the CEO reports to the BoD. That being said, Series A investors will take as many as one or two Board seats if there are two vcs investing. Generally they will allow two founders. Because no one wants paralysis of the venture through a 50/50 split of the BoD its in everyone’s interest to add a fifth independent Board seat. That should be it until you raise a Series B and C at which time you may need to add another investor and/or outside Board member. But I was taught to keep Boards small; the smaller the Bod, the easier it is to manage, which is the job of the CEO.

What is the value added of your Board? That depends on the added value of your investors whom you have chosen. The Forbes article buy Chaka Booker, Your Board Of Directors: Managing Their Gift And Their Curse, provides a good answer:

Board members generally have a depth of experience that has exposed them to a range of problems in a variety of contexts. As a result, their minds move quickly. They understand patterns. They ask questions you don’t have answers to and provide suggestions you hadn’t considered. They have an uncanny ability to poke holes in your thinking and mend holes in your strategy. This is their gift.

Here are Chaka Booker’s tips on managing your BoD, with my annotations based on experience serving on half a dozen boards:

Boards don’t focus on execution.

The role of the board is strategic, not operational. Typically they are freer to explore strategic alternatives because they are freed from the weight of execution. You need to be open to these ideas, even if they generate stretch goals. Keep in mind you and the BoD are typically on the same side of the table: how do we best create value in our venture?

Boards don’t need details. Until they need them.

That means that while you may only present the absolute minimum amount of detail to support your business case, be prepared to have all the details that went into your decision in the appendices to your BoD presentation.

Always “pre-wire.”

I learned to brief each member of the BoD before the Board meeting from Sigrid Reddy, who was the Director of the Watertown Free Public Library where I was assistant director. She either met personally or had a phone call with every member of her Board of Trustees (the non-profit equivalent of a BoD for a public library) to preview any potentially controversial topics and find out where each member stood on them. There should be no surprises at your BoD meeting if you have done your pre-meeting prep properly.

As I’ve written elsewhere, founders need to get their Board members to work for them, either en toto or as individuals. This means you know the experience and expertise of each BoD member as well as how likely they are to help, if asked. Too few founders realize that their BoD is a valuable resource that they should manage just like other resources – capital and human – under the CEO’s purview.

But don’t just rely on a conversation, make sure you send a brief memo along with the list of agenda items to each Board member well in advance of the meeting. Don’t make assumptions that they understand all the issues or even that they are going to back you if the issue comes to a vote. Test your assumption in that f2f meeting or phone call.

Keep in mind that your directors are usually extremely busy people, so get them in the habit of dedicating a block of time with you before your BoD meeting. Also don’t assume Board meetings are simply a formal necessity whose function is to rubber stamp your decisions. You should welcome being challenged on your assumptions by BoD members. And you should work to generate a spirit of camaraderie amongst the directors. Helping the BoD function as a team rather than a group of individuals will turn them from spectators to active participants in your venture – again, at the strategic level. The only operational functions the Board should play are to interview high level candidates – at your request – and to help in raising capital through their connections.

If you have zero experience building and managing a BoD I suggest you mine your contacts for a CEO who has that experience and is willing to share it with you. There really is no work experience that can substitute for the important task of building and managing your Board.

Finally keep in mind that being a director these days probably carries more risk than back in the last century when I was founding companies. You may need to invest in D & O (Directors and Officers) insurance if you have a key Board member who won’t serve without it. Directors have a fiduciary responsibility to shareholders, so if your venture goes sideways they bear some exposure to litigation from shareholders. D & O insurance is expensive, so try to avoid it unless you have so much capital from your seed or first round that it’s a very manageable expense.

To those of you who haven’t raised vc money, keep in mind that your lead investor will also be a Board member, so your due diligence on them and their firm is doubly important.