Ask the Wizard

One of the most important things about a company in its early months and years is its culture. Successful companies have a very distinct culture, a voice, a vibe that’s unmistakable. When people or processes or other entities infringe or violate the emerging culture, you have to eliminate these things at all costs.

Why is Culture important?

A distinct and vibrant company culture will postpone the inevitable insurgency of office politics and bureaucracy. All companies eventually get bogged down by bureaucracy to some degree...the key is to postpone this day as long as possible. More on this topic later.

A strong culture makes it easier for everybody involved in the company to deal with stressful situations, long hours, and other worklife pain.

Strong cultures foster better overall efforts at beating the competition. It's more fun if everybody feels like WE are winning, not just "the guy in the corner office seems to be happy that he is winning" or even worse, "look at that loser in the corner office, he thinks he's winning!"

When you don’t have a strong culture, you get:

• Bureaucracy. Without an implicit understanding of how things work around here, everything has to be explicitly articulated, documented, and instructed.

• Office politics. Companies with a very clear vibe or feel to them find that politics don’t encroach on the landscape as quickly as companies without a distinct culture. Probably because people start sniping or backbiting when uncertainty and policy are the order of the day.

• Beat by the competition.There's not as strong a desire to win, to beat the competition, because there's simply not as strong a sense of a distinctive US that's trying to beat THEM. It's fun when everybody wants to win, it's painful and boring when management wants to win and everybody else wants to get paid and find a more interesting place to work.
  

A marker virus for trouble early in a company's life is a fake culture. We've all been in these environments where the leadership is trying to force a sense of spirit and excitement into the environment and everybody can sense that it's forced. I think investors should try to look for more signs of this kind of thing earlier in a company's life. It's a sure sign of trouble.

How do you foster culture?

Frankly, I'm not sure, but I'll take a couple of guesses. You foster culture through transparency and honesty across the organization. You foster culture by being diligent about the company's external voice, so that everybody gets a sense of how we want to consistently portray ourselves in the market. You foster culture by picking the couple things you are going to focus on doing an A+ job on from day one, and then show everybody that you are committed to those things through deeds, not words.

Posted by Dick at 05:19 PM | Permalink | Comments (3) | TrackBacks (0)

In his last post, The Wizard talked about the possibly over-hyped desire to find businesses with network effects. Yes, we are going to start referring to ourselves in the third person around here when it suits us, and we may also hop back and forth between first person plural, third person singular, second person familiar, and on rare occasions, 1st person.

Anyway, I said that the way I liked to think about a company's strategic advantage was around Quantum Hidden Barriers to Entry. Let's build up this phrase. Of course, hidden barriers to entry are those great things that cause lots of people to look at what you're doing and say "that's simple, I could do that", only to realize that the more work they do to try to copy your solution or position in the market or whatever, the more they realize they are farther and farther away from what you've accomplished.

While barriers to entry are helpful if they're clearly marked, a potential competitor can size up the obstacle course and get a good sense for what needs to be done to get from point A to point B. Hidden barriers to entry are particularly helpful to your company because potential competitors will severely underestimate the level of investment and resource commitment required to compete with you. I cannot tell you how many times since we first launched FeedBurner I have heard the following comments from senior executives at large companies, industry pundits, hobbyists, and my five year old son: "We could build FeedBurner in [a weekend, three months with three people, whenever we wanted]". When you have hidden barriers to entry, you don't get too worked up about these kinds of comments because you know there are lots of pitfalls and issues and challenges that you don't understand fully until you are far enough along in development that you stumble into them and think "oh wow, now what do we do".

But there are even better hidden barriers to entry in some businesses. I'll call them Quantum Hidden Barriers to Entry. Quantum Hidden Barriers to Entry happen when you keep encountering new and unforeseen cliffs you have to scale as you move through different stages of market penetration. While hidden barriers to entry make it harder for potential competitors to enter the market, quantum hidden barriers to entry keep popping up as you move through stages of market penetration. When you are thinking about companies and markets, it's fun to think about the kinds of businesses where there might be quantum hidden barriers to entry. I think you can anticipate these when you see markets that are characterized by: spiraling complexity, market reactions to the first mover (gaming behaviors, 3rd party ecosystems, etc.), and centralized platforms

I'm probably missing a lot here and this list could be a lot more thoughtful, but right away, you can see a bunch of services that likely have Quantum Hidden Barriers to Entry in their markets. Digg and AdSense come immediately to mind for me.

By spiraling complexity, I mean that as the market progresses, there is more divergence than convergence in the problem space. Here's an example of a market that I think you can predict will have really cool Quantum Hidden Barriers to Entry: Virtual Currency Exchanges. If you're the first company to create a virtual currency exchange between say Second Life and World of Warcraft (I'm not a gamer, don't beat the hell out of me if this is a moronic example) so that people could do things buy a WoW Sword of Indifference by trading in two qubits of land in SL, you can imagine that as the market grows, there are going to be boatloads of quantum hidden barriers to entry. Certainly, there will be spiraling complexity - more games will want to participate in the exchange, international exchange rates may emerge that are different, who knows, but you can see that things will get more complex before they get more simple.

For entrepreneurs thinking about what kinds of problem spaces to attack or what kinds of markets might be most appropriate for a cool innovation you've conceived or built, this is a fun thing to think about.

I was going to call these "progressive hidden barriers to entry" but that implies gradually changing. I'm talking about going along nicely until you hit the next big cliff you have to scale, and it's not at all clear how high that cliff is (or how many more separate cliffs are between you and the guy you're trying to catch).

PostScript: I should point out that spending lots of time figuring out how you can hide land mines for those who come after you to stumble upon is never the way to build your business. If you have to cause barriers to entry, you're going to be spending more time looking over your shoulder and less time innovating and driving the market forward, and in that case you're probably only one market lifecycle from losing your place at the head of the pack in any case. Additionally, while some people may want to win at all expense, I personally don't think it's a lot of fun to win via unfair advantage, and since governments tend to hold this same view, it's probably best to leave the tripwires back there in the dark corners of your mind. It's a lot more fun to win by winning. Come back after lunch when the Wizard will toss out a few more obvious statements like "it's a lot more fun to win by winning". That's the kind of brilliant remark you will come to expect around here.

Posted by Dick at 10:19 AM | Permalink | Comments (4) | TrackBacks (0)

When asked what kinds of consumer internet companies investors like to fund, the most common refrain from the investors themselves is "companies with network effects". For those of you who still haven't unwrapped your consumer internet home game, that great seer of all things, the wikipedia, has a nice entry on the subject.

Investors like to see network effects, in theory, because the implication then is that even if potential competitor XYZ builds a better mousetrap, their lack of customers makes it difficult at best for them to gain a beachhead against you. eBay vs. Amazon and Yahoo auctions was one of the best examples of this in action. Despite on par features and huge resources they could bring to bear, Yahoo and Amazon were unable to provide sellers with the marketplace size of eBay. The sellers go where the buyers go, which attracts more of the buyers to where everything's being sold, and better features and functions don't matter against a more liquid marketplace. One could make the same argument about AdSense these days. There are ways to compete against network effects, but one of those ways generally isn't "charge the front gate of the castle".

So, when you're thinking about your company's good or service, it would be helpful to think about how you could achieve network effects, right? Eh, I don't think so. I think network effects accrue to most companies by accident, as an artifact of something they were doing that led to network effects. It's not obvious in the early days of the company where any potential network effects will come from, and even if it IS obvious, it's not at all clear that you can leverage these to your advantage. A good example of this last point is an Instant Messaging platform. Huge network effects - if I'm using AIM and Fluffy is using AIM and we both know Wiley, then it doesn't make lots of sense for Wiley to use Jabber. At least, that's the pitch. In reality what happened is that wiley used AIM and Jabber and Yahoo Messenger and then Fluffy and I started using them all as well. The first mover in a new communications space can generally monetize network effects by selling quickly before they have to drive profits (see Mirabolis/ICQ in instant messaging and Skype in VOIP), but it's not at all clear that the first mover has any long term strategic advantage that could drive value (aka profits).

So, if it doesn't make sense to spend lots of time thinking about the strategic advantage you can gain from network effects, what should you think about when you're trying to understand the potential competitive landscape for your company? Stay tuned for Strategic Advantage, Part II, in which I will describe my favorite way of thinking about strategic advantage: Quantum Hidden Barriers to Entry.

Posted by Dick at 09:27 AM | Permalink | Comments (1) | TrackBacks (0)

"Laugh and the world laughs with you. Take out the garbage, and you walk alone"
- The Wizard

I got an email from a would be entrepreneur asking if there were people or companies you could use to handle the "painful and non business related" parts of starting the company so that this person could focus on the business and product.

There are certainly companies to which you can outsource aspects of company creation cheaply and productively, and particularly if you're a very small one or two person operation that's bootstrapping things, these kinds of services can be very useful. My worry about the email, however, was with the belief that the non-product specific tasks of company formation were "non business related". In reality, the first months/year of the business are about the highest percentage of working on the product you'll get. If you're already thinking there's too much "non fun stuff" involved in starting a company, you might want to consider a) multiple co-founders so you can be product guy and somebody else can run the company or b) not starting a company.

The other benefits to tackling a lot of these non-product pieces of company creation yourself is that you might find it interesting, helpful, and even important down the road to understand the details behind things like why you'd choose an LLC over an S-Corp, what the details of your office lease tell you, why phone systems are so damned expensive, etc. Finally, even if you do bring somebody else in to handle all these "details", if you adopt a posture early on that you don't like to get your hands dirty, I predict trouble down the road including but not limited to general pain and suffering with periods of poverty, acrimony, and finger pointing. It's fine to move into a product specific role when there are more people in the company, but in the early days you're going to have to take out the garbage a lot, and nobody's going to want to hear you talk about how great it was that you just took out the garbage.

Posted by Dick at 08:25 AM | Permalink | Comments (5)

One of our investors, DFJ, has an annual portfolio CEO's meeting in the bay area. Serial entrepreneur and all around great guy Mike Cassidy spoke this year and ran through a very rapid fire presentation on launch and operating strategies. One of the questions Mike posed was something along the lines of "When you're just getting started, would you rather hire experienced veterans or extremely energetic young people who will passionately attack whatever challenge you lay in front of them?" Mike's hypothesis was that in the early days, you need to hire the right experienced people because there's just too much going on and you don't have lots of time to train more junior people how to tackle a particular role. I'm not sure I totally agree with this, although I know where Mike's coming from and obviously, he went into a lot more detail on his rationale so i'm shortchanging it a bit here.

In any case, not everybody is afforded the luxury of being able to find an experienced person for a much needed slot in the early days of the company. Maybe the market is crazy and it's impossible to find or attract the right experienced hire, maybe you're 23 and starting your first company and with only a seed round in the bank and a big vision, there can be fifty reasons you can't find the right person.

One of the things we've done a few times at FeedBurner is hire what our vp advertising Brent Hill refers to as Best Available Athlete. This is a bit of a silly analogy drawn from a term used when pro football teams are drafting college players. Sometimes there's a guy who was a quarterback in college and everybody knows he won't play quarterback in pro football, but he's smart, he's fast, he's strong, he's got a great attitude etc. Some team will select him on the bet that although they know he's not going to be a quarterback, he's the best available overall athelete remaining among the available players, and they know that a person with these qualities will work somewhere on the team.

I think this a good approach to hiring in the very early going even when there are other experienced people who fit the role. Look for somebody who's the best available athlete, ie. has the right kinds of characteristics and skills and personality/attitude for your business and the general role, and bring that person in. The other great thing about hiring the best available athelete is that your organization will shift as you grow, and it's helpful to have a couple people that can slide into somewhat different roles as you the organization shifts. I think this approach applies equally well to all areas of an organization.

It's also important to know when not to hire the experienced person who has all the "on paper" qualifications for the role. Cultural fit in the early days of the company is critical. Don't sacrifice cultural fit for grade point average, industry pedigree or any other resume checkpoints.

Posted by Dick at 08:31 AM | Permalink | Comments (1)

As I mentioned in the last post, there are about 42 lengthy articles you could write about how to fund your company, and as veteran Chicago entrepreneur Al Warms points out in a comment on my previous post, I skipped right over Funding101 - What are your goals?

I had a different context in mind for my last post, but Al's great comment merits elaboration. As Al writes, if you only think you're ever going to need a little capital and your goal is to build a small business with less than ten employees that will throw off a million bucks a year in cash every year after year 3 until hell freezes over, then you shouldn't raise a bunch of venture money. Again, as Al points out, early stage VCs are looking for a significant multiple on their invested capital, and they'd ideally like to see that return sometime in the next 5-6 years (although the multiple is probably more important than how long it takes to deliver it) so that they can deliver profits to their investors, raise another fund, fund more companies, and lather-rinse-repeat. Al notes that you should ask yourself "Do i think this could be a 100 million dollar business?" and "Am I prepared to go for it with only that potential outcome or better in mind?" when you're trying to decide how to fund your company. Of course, in the early days of a new idea, you may think the answer to both of these questions is a resounding "Yes!" and then find yourself thinking otherwise a year later. I'll add some additional points and more context to Al's questions.

First of all, if you raise venture capital, the rights of the preferred shareholders are almost certainly going to include a blocking right on sale of the company. Huh? Why would they want to block a sale of the company? Entrepreneurs frequently bristle at this, especially on a first round deal where the founder still owns 70% of the company, however, a simple example highlights why you are almost always going to see this term. You raise 2 million vc bucks at a 3 pre-money for a 5 post. The vc's own 40% of the company, you own 60% (let's ignore option pool for now). You spend a bunch of money on infrastructure and upfront legal stuff, and then Shmucky.com swoops in a month later and says "hey, i'll give you 3 million cash for your company and a 1 million dollar personal signing bonus". You think "hey, 2.8 million to me for a couple months work, hooray for me!" You see the problem. Your investors are going to have a very bad LP meeting if they get into these kinds of situations, so they are always going to make sure they have a blocking right on sale. The point being, you don't want to raise money if you've answered Al's two questions "Yes, but I'll still own a majority so I'll just do whatever I want".

Even more important is the context underlying Al's two questions. You're not really asking yourself if you think this is a 100mm business, because of course, you have no idea at this stage if it's really that big. The point, however, is that you need to ask yourself if you really think this is such a big opportunity that you're willing to take on significant risk in multiple forms in exchange for the significant capital to pursue the opportunity. Certainly, there are any number of very successful entrepreneurs who have chosen the path of smaller company with steady and growing cash flow with limited downside risk. Here in Chicago, we can look no further than Jason and David at 37Signals who have created a) a huge following with significant notoriety for themselves, b) a profitable company in a short period of time with few employees, c) limited downside risk - Jason does not have twenty million of preferred hanging over his head. He owns some significant percentage of 37Signals and he can sell the company, keep watching it throw off cash every year, add another employee every 36 months, or decide to stop working tomorrow and tell his customers he's refunding their money for the year and shutting down the operation. While the last option is highly unlikely, Jason is afforded the luxury of having it available to him since he hasn't raised a bunch of institutional capital. The company he's built suits his goals extremely well, and it wouldn't suit him to raise a bunch of money and try to grow the company to 50x its current size because Jason doesn't want to have 100 employees, he doesn't want to have board meetings where he talks about how the quarter is shaping up, and he doesn't want to shut out any future options for himself.

So we can call this Al's rule number 1 of starting and funding a company- what kind of risk am I comfortable taking on vis-a-vis my goals for myself and the business? Once you've answered this, then you can move on to my previous post.

It strikes me now that I think of it that there are lots of great examples of successful or success-in-process companies that haven't raised institutional capital, and I'll try to talk about more of those here, so that people get a better sense for the different kinds of options you have.

Posted by Dick at 09:03 AM | Permalink | Comments (5) | TrackBacks (0)

Another topic about which there's a lot to say. You've decided you need to raise money to grow your business, and you are trying to decide how you should fund it - Angels, Friends and Family, or Venture Capital. My cofounders and I have done all three, so I'll offer some quick highlights. This by no means covers the topic completely.

First of all, one quick way to think about this is the farther up the professional investor chain you move (from family to venture), the more you'll have to have the company setup in specific ways. For example, you may be able to setup your company as an LLC or S-Corp if you're not funding the company with venture money. The most obvious advantage of setting up an S-Corp as opposed to a C-corp is that the profits and loss pass-through to the shareholders on a pro-rata basis, and there's no double taxation like you get with a C-corp. Why does venture funding mandate that you create a C-Corporation? For the simple reason that VC terms will mandate that they get a separate class of stock (preferred) with rights that are different than those of the common stock, and you can only have one class of stock in an S-corporation. Note that if you haven't decided how to fund your company, you can always convert an S-Corp to a C-corp as part of a financing, but always remember, when you're talking about changing company structure, articles of incorporation, etc., somewhere an attorney is going to get paid a lot more than you think they should.

So, if you lose the tax benefits of an S-corp with venture funding, and VC's are going to insist on spending $30k to have the company's finances audited every year, why not just track down a bunch of rich folk who will buy a chunk of your common stock in a private placement? There are a couple major reasons to choose venture funding or sophisticated Angels that understand your industry if you're planning on building a big business. First of all, although all individual investors need to be accredited (legalese for "i declare that i'm a millionaire on some ledger somewhere"), and some people are more accredited than others. If the market tanks, you don't want to be responding to panicky emails wondering if you've talked to shmucky.com yet about buying the company. You want investors who will be patient through growth. VC's are always going to encourage you to keep growing when you're growing. They've got a portfolio of investments, they're managing risk across a portfolio, and they're not going to be antsy to jump off a speeding train. Secondly, as you're building the company, experienced VC's are going to have been through multiple examples of whatever strategic and tactical issues you're dealing with, and it's very helpful to have people who've fought these battles before sitting in board meetings discussing the issues. The guy who invented rollercoasters may be rich, but he might not be very helpful with your sales force automation issues. (I suppose it's sexist of me to assume it was a guy who invented rollercoasters. It may very well have been a woman, or rollercoaster may even be two words; I have not done my homework on these points).

What do I mean by "sophisticated Angels"? I'm referring to folks who have made multiple investments in your industry, understand the space well, and maybe even still have operating roles in the market.
Reid Hoffman is a great example in the consumer Internet space, and there are lots of others.

Particularly in a "bubbly" market like the one we seem to be in now for investing in technology startups, I think it's wise to look to more formal investors like VC funds and sophisticated angels for the reasons I mention above.

I wouldn't generally worry about how negatively an Angel/Individual investor will affect you in a future VC or other institutional financing. If your company is growing and strong and a winner, people will find a way to put capital to work. May cost you a chunk of money in legal and accounting fees to get everything refactored for professional investors down the road, but even the simplest financings cost too much in legal fees, so I don't think that's particularly insurmountable.

This post is only leaving out about 41 other points to consider, so we'll come back to those another time.

Posted by Dick at 03:03 PM | Permalink | Comments (1)

Veteran entrepreneur Mark Fletcher has launched a great new resource for startups and entrepreneurs over at Startupping. It will be fun to see how this evolves - as more of a social network for entrepreneurs or an advice/howto for startups - probably some combination of the two.

I will try to contribute over in the Startupping forums frequently. I think Mark has created something here that has been sorely missing, and I'm sure it will prove to be a popular resource.

Posted by Dick at 12:49 PM | Permalink | Comments (3) | TrackBacks (0)

Some great comments here right off the bat. Frank asks on a previous post,

"I am just now hiring a COO (really a co-CEO). My first hire. What are the equity amounts offered to a key non founder at the early stage (Pre Launch)? I have read 5% to non founding CEOs, and 1% to COOs. In our case, he and I will be joined by no more than a couple senior execs in the next year. Thanks for any advice."

As you might expect, the first and most important answer is "it depends", but I'll throw out some quick thoughts.

1. If your company is pre-funding and pre-revenue, which it sounds like you may be, then a single point sounds pretty darn light for a COO. Don't forget this person's going to get diluted on financings along with you and everybody else.

2. The 5% to non-founding CEO's can be the kind of equity package that a non-founding CEO might get after a round or two of financings. Again, if you're pre-launch, pre-revenue and this person along with the founders are going to form the core of the mgmt team, you could easily be thinking 4-5% for this person, some people would say more is fine too. The dynamics change dramatically as you raise money, make headway in the market, etc., but don't get caught up in hoarding founder equity at the expense of getting the right team together when you're still pre-launch. The key is to remember that this person's equity is going to dilute with everybody else's on future financings.

3.I have no idea what Canadian equities law is, and I frankly don't know US equities law that well, but note that if you haven't raised capital yet and you're pre-revenue, then you can very possibly issue this person common stock or restricted stock (instead of options) without the normal tax consequence since the stock has no perceived value yet . This is a topic for an entirely separate post, but when your stock is "worthless", there are some real benefits to restricted stock over options. Again, caveat emptor, there are loads of pros and cons to options vs. restricted stock, but something to consider at this stage (and I'm not a lawyer, if your erection lasts for more than four hours after hiring the COO, please consult your physician, and so on and so forth).

I'll say something that will become a common theme here. Founders that worry about keeping as much of the equity as possible are not thinking about things correctly. Owning 5% of a billion dollar company is better than 40% of nothing (yes, yes, owning 40% of a bilion dollar company would be best. I've only had an audience for two days and you're already predictable!). If you're only offering a point of equity to somebody that's coming into one of the most senior positions in the company pre-funding, pre-revenue and pre-launch, you aren't going to attract the best person for the job. The right person will prefer more equity and less salary, and a point is *probably* not close to the right number.

Hope that helps. Need to do a post on options vs. restricted stock. Lots to say about that.

Posted by Dick at 03:34 PM | Permalink | Comments (4) | TrackBacks (0)

Alexander Muse makes a great comment on the previous post about Outside Directors, and I was going to comment in response, but it's worth its own post. Andrew notes that FeedBurner's outside Director isn't really outside since we have some of the same investors. Indeed, Matt Blumberg and FeedBurner amazingly have three of the same investors. I actually think this has been a very good thing, although it's probably unlikely that you'll ever stumble into this same situation, and it certainly behooves you to be cautious about selecting folks where there are pre-existing relationships. Because Matt has pre-existing relationships with several of the other board members, there is a) an immediate level of respect for his opinion from day 1, b) an ability for Matt and I to communicate about investor dynamics and for our investors to communicate with me about company dynamics (eg, "you should talk to Matt about how he handled this at Return Path"). Andrew's point is important, because if you've got one investor and that investor suggests another CEO in their portfolio that you don't know, this could potentially be problematic should the outside Director prove to not be so outside.

Andrew's note also highlights a distinction that I didn't make in the previous post that it's worth making. When I say it's helpful to have an outside Director, I'm not saying this means you need to go find the most independent contrarian thinker you can find. I'm talking about companies in startup mode. You want bring in an operating CEO with whom you already have some comfort and familliarity, and preferably someone that has some understanding of your business. Matt and I knew each other prior to his joining the BoD at FeedBurner, and since he had instant credibility with three of our investors, knew the market, and operated a company in a similar but more mature market, he was a great choice for us.

Who are people I would NOT choose as outside directors in a startup? Executives from very large companies. Large companies and small companies think about things differently than small companies, and you want somebody that is intimately familiar with the tradeoffs of limited resources. You want somebody that gets the challenges of growing the company from an operating loss toward an operating profit, and you want somebody that isn't going to big company you to death. As a silly example, if you're discussing sales comp, it's not very helpful to have an SVP from Motorola sit across the table and say "well, we took the top 20 folks to Barbados for a week and that worked great!". I also don't think you want a noted academic that's not currently in an operating role. Many startups, frequently those launched by folks either still in school or just out, frequently bring in a noted professor in an advisory or Director role. I don't really think this is a great idea. Yes, it's helpful to have somebody in the room who's thinking big thoughts once in a while, but you don't want the professor of marketing sitting on the board of directors of your startup when it's time to talk about whether you should refresh the options pool. The person may be brilliant, helpful, and enthusiastic about what you're doing, but don't make them a Director. Get an operating CEO that knows all about the kinds of things you're dealing with and all about the kinds of things you're going to be dealing with.

And now, here come the emails from the academic community. Yes, I know there are a great number of academics sitting on the boards of some of the greatest companies. Google itself had the help of a trusted academic advisor in its early days. I am only referring to bringing in an outside Director onto a BoD for a startup in which the board dynamics are 100% different from the board dynamics of a large public company. You want somebody you can turn to in a meeting and say "How are you guys dealing with this IRS section 409A discussion" or any of the other 50 things that are only going to be addressable by somebody currently in an operating role.

Posted by Dick at 02:49 PM | Permalink | Comments (4) | TrackBacks (0)

Well, after a couple of introductory posts, it's time to throw caution to the wind and get contentious. One thing that I think most entrepreneurs worry about too much is control. They worry about valuation on an A round funding at the expense of other important terms (or at the expense of the right investor!), they worry about management team control, and they worry about board control. One area where an entrepreneur can really do themselves a favor is by adding one or more outside directors to the Board (where outside refers to somebody other than management team or investor). At FeedBurner, we added Return Path CEO Matt Blumberg to the board about a year ago, and I wish we'd had an outside Board member much sooner.

The CEO in a company is in a weird position because you're essentially at the center of an hourglass shaped reporting structure in which all the employees report up to you and then you report up to all the investors/shareholders (this is where everybody at FeedBurner is rolling their eyes thinking "oh boy, here comes the woe is me speech"). Since I have three cofounders, I still have people that I can talk to about assorted issues, but then again, cofounder and FeedBurner CTO Eric Lunt doesn't really give a damn if the board wants us to spend $25k to make sure we're in compliance with IRS section 409A; if I asked Eric about that, he would probably give me a blank stare and say, "I'm sorry, you seem to have me confused with somebody who cares about our taxes". Having another operating CEO on the board is a huge help. If you're a startup that's raised some money and has a board member that's the lead investor, I highly recommend adding an outside board member now, preferably another active CEO. No matter how much experience you have or how many deals you've done, you never fight the same war twice, and having another active CEO on your board will come in handy for the countless occasions when you have an organization, operations, or customer strategy point you're working through. Outside investors should generally welcome an outside director.

If you're negotiating terms with an investor on a financing and it's a condition of the financing that you add an outside board member, be sure that you negotiate for the right to nominate the director.

Posted by Dick at 10:23 PM | Permalink | Comments (1)

You could probably create a blog with nothing but "pitching your company" posts and keep it going strong for a good year or more, and this is probably the topic I get the most email/questions about from folks that are trying to figure out how to fund their company. There are a million things to say about this, but I'll try to start off by focusing on getting ready to pitch your company to potential investors and then the actual pitch when it's time to go out and raise that first round of capital. Whether you're looking to raise your first round from angels or a venture fund, there are some general ways of thinking about your pitch that are probably helpful.

Getting Ready
I've seen a lot of discussion about the relative value of business plans on some venture capital blogs. Do you need to create a business plan? Most investors will tell you that these are a great exercise because they help you collect and organize your thoughts about the business with some rigor, although investors will also generally tell you that they only read the executive summary of a business plan. I have personally never written a business plan in my life and don't imagine I ever will. I don't have any interest in writing a business plan because in the consumer Internet software market, 9 times out of 10 you don't end up building the company you thought you were going to build when you first started. The market zigs when you thought it would zag and you end up adjusting and improvising to the market. This does not mean that when you pitch your company you should say "we're going to do X, Y, Z, and then we're not sure what the hell is going to happen but we're hopeful it will be something good!"

I do three things when preparing to go out and raise money. First, you want to line up a bunch of people to talk to in a very short time. It is critical that you generate demand for what you are doing. One question you will hear at the end of most VC meetings is "what's your timing?" and you want to use this opportunity to reply that you're meeting with a bunch of folks this week and you hope to put something together quickly and get back to work on the product. You are trying to sell yourself here, and the best way to position yourself is to generate as much demand as quickly as possible. So, you want to get the list of people you need to meet put together and get meetings set up that allow you to do three or four of these meetings a day. Second, get a demo and a small pitch deck together, anything from 8-12 slides is fine, and anything more than that is probably too much. If you find yourself reading this and thinking "There's no way I can pitch everything about my product in only 8 slides", I assure you that you are wrong. Nobody wants to sit in a room and read data-packed powerpoint slides with pull quotes from Gartner Analysts that describe your market as being a 9 bazillion dollar industry in 2012. Get a short pitch deck together that tells a story. Here's who we are, here's an opportunity/painpoint we discovered, here's what we're doing about it, here's how we believe we will be able to leverage this in amazing ways, and here's how much money we need to accomplish these things. End of story. You might also include "here are the other people who are working in this space and they are focused on these kinds of things", etc.. Third, you should put together some very high level financials that outline how the business probably works over the next couple years, paying particular attention to the operating expenses in year 1. Few people are going to believe your revenue forecast for year 2, and even fewer are going to believe your revenue forecast for year 3, but it's important to highlight that you understand how the business grows, where the cost inflection points are, where the revenue/margin leverage points are, etc. Bottom line - don't go excel crazy on the financials with all sorts of goofy details but paint a simple and clear picture of what the general financials look like as you ramp up over the next year. When will you need more money, what might that financing look like, etc.

Pitching the Company
This is the fun part. If you haven't ever done this before, you're probably nervous going into your first meeting, but you're about to market test your company, and that's a lot of fun. Some of my best friends in the industry are the VC's I've pitched and some of those people have even invested in the companies. I think there are four good tips for pitch meetings.

1. Be prepared to do your pitch with either a quiet unengaged audience of 1 or an energetic, questioning and engaged audience of many. In some meetings you might get through your entire pitch and a complete demo with no questions, and in other meetings you might not get any farther than an opening demo. Whatever. Don't have preconceived notions about how these things should go. They're all over the map.
   
2. If you are pitching VC's or Angels who see a lot of deals, take advantage of this time you have to listen to their feedback. You are getting feedback not just on your product or service but how it's perceived vis-a-vis the forty other things in the market that you won't personally know anything about for month to come as these other companies get funded, launch, etc. Don't focus solely on getting through your pitch - ask your own questions, ask for clarification if you don't understand an answer, and listen. As stupid as this sounds, it can actually be hard to take the time to do this because if you're really passionate about what you're doing, and you should be, then you're going to be focused on communicating your vision and articulating how you're going to attack the market. You can learn a ton from meeting to meeting by asking questions and listening and that will help improve your pitch as you go.
   
3. Try to get to know the people you're pitching. Hopefully, you are going to have your choice of a number of potential investors if you're lucky, and you want to make sure you are working with people you like. As I say, I've gotten to be very good friends with several folks we've pitched, some of who've become investors and some who haven't.
   
4. Have fun. You are going to be pitching your company for years to come if you're successful, and to bigger and bigger groups of people, so I recommend trying to have a good time with this process. It doesn't end once you've raised money.
   

I'll say one more thing about pitching the company. In a couple of pitches people have asked me to look at lately, the entrepreneurs describe their likely exits. Ignoring for the moment that you have absolutely no idea what your "exit" is going to be or when it will be, I'm not sure that any investor would ever react positively to this as part of a pitch. At best, it comes off as naive, and at worst, you expose yourself as having some too low expectation. If a potential investor asks "how does all this play out?" well then that's another question.

Man, I need to work on some shorter posts. I'll try to mix in some quick bits with the treatises here. Still lots to say about ending the pitch meeting and follow-up.

Posted by Dick at 04:03 PM | Permalink | Comments (6) | TrackBacks (0)

I think I'll start off with some general thoughts on funding a startup and then after getting a few Introduction to Funding posts out of the way, then I can dive into more details later on term sheets from an entrepreneur's perspective. The first few posts here will be super basic, as I think there's a dearth of this kind of stuff out there in the wild.

There's been a lot of discussion the past couple years about the fact that Internet startups need less funding than they used to because hardware, software, and bandwidth costs have all come down. It's certainly true that you can successfully bootstrap a startup more easily now. 37 Signals and Bloglines are two good examples (one still private and one sold to Ask.com) of successful startups that got very far before or without raising money. There are plenty of other examples. FeedBurner investor Fred Wilson had some excellent thoughts on funding dynamics in the Web2.0 world.

The reality is that every company is different. YouTube was obviously going to be a capital intensive business with a huge bandwidth bill. Generally speaking, I would probably never spend more than 6-9 months working on a company without raising money, because I prefer to work on platforms that can be extensible to massive audiences, and if you want to build and develop extensible platforms, then at some point you're going to spend a lot of money on infrastructure. So, if you're just getting started, and you don't know much about funding or how much you're going to need or even who to talk to (angels?, VC's?, Friends and family??), what should you do? My strong suggestion is to start working on your idea without raising money and keep going until you've gotten your product or service to a state in which a) you have a good feel for whether you like its chances of success in the market (you might rephrase this to say "now that you're looking at something real, are you still as passionate or even more passionate about it?"), b) you have a very general feel for how much money you think you'll need in the next year. For the FeedBurner founders, this time period has been about 4-8 months in our last couple of startups.

There are a couple benefits with taking this initial bootstrap approach. First, once you have investors, you have some level of obligation to others than yourself and your employees. It gets significantly harder to just say "this isn't as exciting an idea as I thought it would be, I think I should focus on something else". Second, in most cases, particularly for a first time entrepreneur, it's going to be a lot easier to attract funding for a product or proof-of-concept that you can demonstrate to investors. The first two reasons for bootstrapping for a half a year or so are somewhat obvious, but there's a less obvious reason. In my opinion, you don't want to raise enough money to last you three years on your A round. The money that you raise costs you equity. Theoretically, you will increase the value of the company every week, month, year that you work on it. By raising 5 million dollars when you're only planning on burning 1.5mm the next 12 months, you are shortchanging your ability to raise the incremental 3.5 million at much more favorable terms ten months later. I mention all this because I've heard a few entrepreneurs talk about how much runway they've got, and I'm not sure that's necessarily a good thing. So, by waiting a few months before you raise money, you'll hopefully have a better feel for pace and potential burn rate and can raise an amount that comfortably gets you through the next phase of growth. The one caveat I'll mention here is that it's been my experience that even when you're capital efficient, you always spend money faster than you think you will in a startup, so make sure you raise enough to get you through the next phase of growth.

The other benefit to only raising as much as you need to get you through the next phase of growth is that companies (now speaking VERY generally!) tend to spend what they raise, unless you are particularly rigorous about being capital efficient. It's a lot easier to say "yes" to the monthly PR retainer from the high-falutin' pr firm with the great client list if you've got "extra" cash in the bank. It's a lot easier to say no if you're managing to a burn rate that's not cushioned with loads of extra cash.

The problem with advice like this is it invites comments like "but Google did one big 25mm dollar raise after their seed funding and look how well that worked". It's important to remember that you can't apply a one size fits all approach to thinking about these things. This is just a general framework for the way I like to think about getting started.

In the next post I'll talk about VC vs. angels vs. friends and family. Fortunately, I've done all three in different companies, so I there's a slight chance I will actually have some idea what I'm talking about. We'll see.

Posted by Dick at 11:45 AM | Permalink | Comments (4) | TrackBacks (0)

I'm going to attempt to get back to regular blogging in the hopes that a specific topic will motivate me to post here frequently. The specific topic I've got in mind is helping Internet entrepreneurs (particularly first-time entrepreneurs) navigate the waters of a startup. There are sixty or seventy great Venture Capital blogs out there, and only a few that look at startup issues from the entrepreneur's perspective.

I'm not really going to use this as a question and answer forum, although I get lots of email from startups, so I may occasionally post based on those emails. The title of this blog is really just something that made FeedBurner cofounder Matt and I laugh, and it also brings to mind the Wizard of Oz, in which unsuspecting Dorothy only realizes too late that the Wizard is just another jackass with stage lights. I generally subscribe to the perspective over at Long or Short Capital on How to become a Billionaire and don't want anybody to think that I've got special knowledge, so take everything I say here with a grain of salt. It's just more information that startups can hopefully use to make more informed decisions. Caveat Emptor.

First things first, I've got to get the layout nailed down here, burn my feed of course!, and then we'll be off and running.

Posted by Dick at 10:41 AM | Permalink | Comments (2) | TrackBacks (0)