Currently Obsessed» Startups

Unexpected Startup Lesson #2: Channel your Inner VC to Understand Startup Valuations

jheitzeb — Thu, 27 May 2010 09:19:40 +0000

This post is the second of a series on “unexpected lessons” learned through my experience as co-founder and CEO of Snapvine, a venture-backed mobile social networking service founded in 2005 and acquired by WhitePages in June of 2008.

Snapvine was my first experience being in the driver’s seat of the fund-raising process, and in the 3 years prior to our acquisition we raised over $10mm in venture capital.

Valuation is an important aspect of VC deal terms, and a major determinant of your ultimate outcome. Or is it? I unexpectedly found that it was more helpful to think about the company valuation as an output variable in the fund-raising equation. It hardly deserves any attention at all in the early stages. I know this sounds crazy, but it’s not.

Photo by pauladamsmith (Flickr)

The typical thought process for a first funding in an early stage startup goes something like this:

“Okay, given our forecast revenue and costs, plus a little buffer, we need to raise about $1 million to get through our first 3 milestones…”
“And given our team, progress to date, IP/Patents, benchmarking against our buddy’s recent VC terms and that other startup that is similar and just sold to AOL last week….I guess we’re worth about $5mm today….”
“Therefore, to raise that $1 million we need, we should sell a slice worth about 20% of the company”

Although this is logical, it’s not how things actually work. Once the VCs have decided that the company can be big (based on its team, product, market, etc), they are mostly focused on their future return, and think about their investment like this:

“I want to own between 30% and 50% when the deal is done, so even if there are future rounds, I’ll still have a decent chunk of ownership”
“The more money I put in, the longer the runway they’ll have, and the greater the chance of success, thus helping me to maintain my ownership and maximize my return”

Ultimately, VCs think about the future value of the company, not the valuation at the time of the financing. That’s a nice way of putting it. You can read more about this on Josh Kopelman’s post. Be sure to check out the links to Fred Wilson’s related post.

Instead of “We are worth about $5m because we have done XYZ and we need to raise $1m, so let’s sell 20%” it’s better to think about valuation as an output variable, like “Let’s raise $2mm and sell 33%, our (pre-money) valuation is therefore $4mm.”

I have to admit, the light bulb didn’t go off for me until I was negotiating term sheets. In one particular negotiation, we went from one valuation to a much higher valuation (like double) in the course of a single day and two phone calls, simply by discussing the “what if” scenario about increasing the total amount raised. The net effect was more money raised, higher valuation and the same percentage of equity sold. It was baffling at first until I realized that valuation is an output and that the focus is on future value. (To protect the innocent: we ended up going with a different investor)

I’m not going to explain the venture math (pre-money, post-money, etc) but it is something you need to know inside and out, because term sheets often have 24-hour expirations and you’ll need to be able to negotiate them quickly. Read more about deal math on Brad Feld’s blog.

For some closing thoughts, I’ll just add that:

Valuation tends to be too much of a focus for most early stage companies. Other factors such as your team, the market you are in, your ability to execute, and in fact other terms in your term sheet are much, much more important to your outcome and financial outcome than is the valuation of your company at the time of financing.
Deals come in all shapes and sizes, and seed stage funds like First Round Capital and programs like TechStars provide flexibility
Explosive growth companies and multi-time successful founders get atypical deals
The other terms (besides valuation) matter too! For example, liquidation prefs. Read Terms that Hurt (Venture Hacks).
Read up on the “unwritten terms” in term sheets having to do with exit multiples here
For bootstrappers, the math is even easier: 100% of the upside goes to you and your awesome team.

Unexpected Startup Lesson #1: Quitting the day job

jheitzeb — Mon, 10 May 2010 17:22:02 +0000

This post is the first of a series on “unexpected lessons” learned through my experience as co-founder and CEO of Snapvine, a venture-backed mobile social networking service founded in 2005 and acquired by WhitePages in June of 2008.

In the years just prior to starting Snapvine, I racked up 2 years of debt attending the MIT Sloan School of Management. School was great, but the costs were hefty: tuition, travel, the expense of selling a house and moving, the opportunity cost of going without salary for 2 years, the high cost of living in Boston and stress associated with my wife changing jobs twice to follow along.

Thus, 6 months after graduation when I was contemplating leaving my job, the risks felt enormous. My inner voice was asking:

What if we go 12 months without pay only to fail to prove out the concept?
What if we DO prove out the concept but fail to raise money?
What if we DO raise money, but fail to deliver on the vision?
What if we DO raise money AND deliver on the vision, but the business model doesn’t pan out?*
What if we fail and my wife doesn’t let me do startups anymore?**
What if my MBA classmates get 3 years into a great career while I spend 3 years for ZERO and then I have to crawl back to the corporate world begging for a job, while they are laughing at me?***

Chewing on these types of questions was totally unproductive and made me feel shitty. I’ve come to realize that doing startups is mostly an irrational choice. Just effing do it.

photo credit: divemasterking2000

After I quit my job, incredible people jumped into my world to help. Before the company even had a name, people like Hadi Partovi, Thomas Reardon, Kirsten Morbeck, Rob Williams, Rich Miner, Jeremiah Robison, Curtis Vredenburg and many others helped shape the product roadmap, recruit early employees, craft a pitch deck and introduce key investors.

The unexpected lesson: about 4 to 5 months after quitting my job I was already ROI positive in terms of networking, learning and satisfaction.

In just a few months I felt completely confident that if the startup went splat on someone’s windshield, I’d be able to find a more interesting and higher paying job that I had before. Also, compared to an MBA, doing a startup felt like an amazing deal: On one hand, an MBA (tuition alone) might run about $85,000 whereas the startup has cost me only $5,000. The salary was the same ($0) but the learning and networking with the startup was much, much greater than with the MBA.

In retrospect, jumping into the startup led to some immediate and unexpected benefits that, at least for me, far outweighed the forgone salary of my previous job and positioned me better for my future. Quitting turned out to be a zero risk move.

* Interestingly, this is probably the closest to what actually happened, and things turned out fine
** Even though we’d already had the discussion “if I do 55 startups in a row and they all fail, is that okay?” Answer: “yes”
*** I’m pretty sure they wouldn’t laugh at me if I ever failed, but I’m hopeful they’d hire me

If you want to ship, cut, cut, cut!

jheitzeb — Sat, 17 Apr 2010 23:50:02 +0000

I’m helping a startup founder who is outsourcing the development of a project. Tensions are running high on both sides as the project slips. The CEO is getting about two updates a week, mostly just “it’s ready to test now, the bugs are 80% fixed” and there’s no regular meeting. During the course of the project, “we’ve changed some features along the way.” They continue, “we are 50% done with bugs, putting us at about a month late. I feel like I should, as the CEO, do something about it to ensure it’s not a month late, what should I do.”

Here is my reply:

I would ask for better updates, like if you have a list of work items, get a list of which were done. Are they using lighthouse or similar ticketing system to track work items on their side? Do you have access? The work item list is a key tool you need to track progress and make decisions from.

First, from the tone, i’d get on the phone and clear the air. Don’t let emotions get the best of either of you. If he reaches the point of “fuck it” then you are the one that is fucked. The best thing is to be reasonable, professional and do the best you can given where you are today.

Keep in mind, most software projects are late or go unexpected places during their schedule…especially when feature requests change along the way, which is the case here.

One important thing you can do now is to eliminate features. I’m sure all the features seem important, but they are not. Trust me, most of your features can wait. Cut them out. Ask the developer which ones, if cut, would most get the schedule back on track, then you be the one to pick a subset of those — eliminate anything that isn’t absolutely critical. You are going for minimally viable release, and that means a skinny, starving puppy, not Lassie.

Bugs too. Decide which need to be fixed and which don’t.

Also, don’t sweat the look and feel. User friendly means “is useful” not “is usable”. If something is possible to get the job done, but just hard to use, consider leaving it as is for now and shipping. You can fix later.

Cut. Cut. Cut. You can fix later.

5 Tips for Conducting Successful Board Meetings

jheitzeb — Mon, 08 Mar 2010 07:56:13 +0000

I’m heading up to Vancouver tomorrow for the inaugural board meeting of a startup I recently invested in. It will be the entrepreneur’s first ever board meeting. It made me think about what I’ve learned about conducting good board meetings.

Donuts by VeganWarrior (Flickr)

1) Bring an informed point of view

Startups can be thought of as a never -ending set of decisions and risks. It’s a big part of the CEO’s job to anticipate the most important ones, think through a set of options and (importantly) prepare a point of view on the matter. When faced with a dilemma, don’t just say to the board, “okay, we have this issue and need to make a choice. What should we do?”

Instead, come prepared with what you think are the possible alternatives and your recommended choice — with supporting data to back it up. Leverage your board and your advisors to come up with the alternates in the days before the meeting, and of course be open to further investigation or even changing course based on the discussion.

2) Be upfront, open and honest

This may be your first startup, but it won’t be your last. Listen when your stomach starts telling you something is not going well in the business, or there’s something you need help on. Be up front about it. There’s no point to hiding anything or glossing over negatives.

Lay everything out and rally people to help solve. Taking a “we’re on the same team” type approach goes a long way towards building rapport and support. It’s helpful to have the people who hold the purse strings on your side, especially when the shit hits the fan.

3) Establish a template and stick to it

Much of the structure (product metrics, finances, hiring updates and so forth) doesn’t change – only the contents do. The same metrics you use to manage the business should be the same metrics you’ll use for the board presentation. If you’re spending lots of time just pulling the basic board deck data points and formatting things, it’s a sign that your metrics aren’t automated enough or you’re not looking at the right metrics day to day.

4) Send the materials out in advance

When your board members have a couple of days in advance to review the basics, then you’ll have more time to spend on the most value-added discussion during the meeting. If you find yourself awake at 2am the night before the board meeting, try blocking some time out well in advance of the next board meeting to finish your prep early.

5) Serve food to lift spirits

Studies show that eating certain foods can improve one’s mood. Enough said.

I probably should have posted this all a few days ago. I’m really craving donuts right now!

Avoid This Startup Mistake: Losing Customer Focus

jheitzeb — Sat, 20 Feb 2010 20:16:24 +0000

In 2006 when we launched Snapvine’s first viral widget and phone app for teens, it went viral overnight. We were overwhelmed with success within 3 weeks: our servers were swamped with signups – 1 million of them within the first 7 weeks. This was one of those “good problems to have” — so “good” in fact we had to turn off sign ups 25% of the time over those first few weeks. The problem was, our entire team turned into a band of maniacal database tuning, code-optimizing, high scale server junkies.

So my dilemma became: How do you take a team that’s swamped with work and make them become incredibly customer focused overnight?

Our solution? every day, print out a few hundred new user photo thumbnails and post them on the walls. As the days passed, the number of photo pages grew, and even if you were an engineer consumed with debugging some MySql indexes, you became intensely curious about the users: real people with faces, smiles. Who were they? Why were they signing up? What did they want to see next?

As a result, everyone pushed for more focus on user stories and learning more about our users and what they wanted to see next. We instituted a weekly standing focus group, sourced from Craigslist by our do-it-all office admin, and watched them use the product and listened to their reactions to our new feature ideas.

Print out your user’s photos and line the walls with them. I think any startup can use this simple technique to make everyone on the team more user focused. If you don’t capture photos as part of your product, pick some new users every day, email them and ask them to send some in. I promise, it will pay off.

Thanks to Pete Warden, Mark Maunder, Tony Wright, Dave Schappell, Bryan Starbuck, Scott Porad, Galen Ward and Fai Leong for editorial input on this post.