Get advice from a VC on securing early stage financing

This is a great article with sound, hands on advice for folks looking to secure early stage venture capital. It has lists of key quesitons you must be able to answer and has a very practical approach to what needs to be in place. This isn't the end all be all of information, but its a succinct, clear place to start!

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A VC’s tips on securing seed and series A financing
February 12, 2010 Carl Showalter 6 Comments

(Editor’s note: Carl Showalter is a general partner with Opus Capital. He submitted this story to VentureBeat.)

While the economy is finally showing signs of life, securing capital for early-stage ventures hasn’t gotten any easier- so it seems timely to let start-up owners in on the criteria by which they will be judged.

Each year our firm typically reviews more than 2,500 companies seeking seed or Series A funding and invests in between six and twelve. Here’s how we judge a young company’s viability.
First of all, we evaluate deals on three axes: The team, the market and the technology or product.

• We want a team with domain expertise in the market space—individuals who can see the opportunities in that market before they are apparent to others and can use that vision to become early movers in the market.
• We want the company to be targeting a market that is nascent or even nonexistent. It needs to be a market the entrepreneurs believe will, at some point, grow rapidly, creating an opportunity for the company to move faster than any incumbents.
• The company needs to have a product with some level of defensibility – something that’s not easily replicable once the market becomes more obvious to others.

In addition to these primary criteria, there also has to be a scalable business model that can generate interesting valuation multiples over time. Having a good way to make money is not enough; a high-growth market to support it and a team and product that can take advantage of that market opportunity are essential.

The next step is to ask hard questions across these three axes. If you’re in the hunt for capital, here are some of the questions you’re likely to hear:

Team

1. Can the founding team succinctly and consistently articulate the company’s business opportunity?
2. Can they succeed in an unstructured environment? Are they comfortable with uncertainty? If the founders are from large companies, it’s helpful if they have some sort of track record in taking risks or starting something new.
3. Do they have a demonstrated ability to stay focused on the critical objectives?
   
4. Do they have the ability to challenge conventional wisdom and think differently? This is perhaps one of the most significant hallmarks of an outstanding entrepreneur.
   
5. Do they have a roadmap for the company culture? Surprisingly, many founders never consider this.
   
6. Do they understand the value of frugality and the need to ruthlessly prioritize spending?
   
7. Do they have realistic expectations of their positions in the organization and how that will evolve? In other words, are they comfortable with potentially not being a chief executive? This very issue can break up even the best of companies.
   
8. Is there a shared vision for the future of the company and its liquidity event? In this economic climate it’s more important than ever that company founders are focused on building a company for the long term.

Market

1. Is there a market that can grow exponentially to create an opportunity for a new entrant? “Exponentially” is key here. Solid growth may just not be fast enough to enable success.
   
2. Is there a scalable business model?
   
3. Is there a low-cost go-to-market plan relying on reasonable and realistic distribution channels? Lack of low-cost and scalable distribution is another small company killer. Are there large partners who could help reduce the cost of customer acquisition?
   
4. Are there three or less startup competitors vs. many?
   
5. Has there been some validation of the market opportunity, whether through a pilot or beta, or through research? Actual testing or feedback on a prototype by customers is always preferred, but for systems and semiconductor companies, research may have to suffice.
   
6. Do they have the ability to capture the imagination of investors as to why this could be a really large market opportunity? Are they convincing as to why they could be the market leader in the space? If they can’t capture the imagination of investors, it’s unlikely they can capture significant market share with customers.

Product

1. Is it simple to articulate and understand?
2. Is there a clear value proposition about the pain point or problem it’s solving and why this product or technology will uniquely address that need? There must be enough of a problem that customers are willing to risk buying from a startup.
3. Is there intellectual property or at least some “secret sauce” that makes it defensible? Patentable concepts are desired but not required.
4. Is the intellectual property free and clear from previous employers or others?
5. For a company selling a product, are the projected gross margins more than 50 percent?
6. Will the product be available within 12 to 18 months? Product should be in development, not just at research stage.

Despite what could still be considered a tough fundraising environment, early-stage venture capital investing is alive and well. If your start up meets the criteria outlined here, you should have no problem securing funding.

New Incubator in Berkeley, CA

http://venturebeat.com/2009/07/15/berkeley-ventures-new-incubator-breaks-from-summer-program-model/

Berkeley Ventures’ new incubator breaks from summer program model
July 15, 2009 Camille Ricketts

Berkeley Ventures, a new Bay Area incubator for early-stage companies across tech sectors, has just launched with a unique offering: unlike Y Combinator or TechStars — incubators that run three-month programs — Berkeley will provide startups with ongoing support for up to two years.

In addition to providing $5,000 to $10,000 in seed money to some startups (in exchange for a 3 to 9 percent stake in each company), the Berkeley, Calif.-based firm will also house companies rent-free for three months, run mentorship programs, and offer discounted access to marketing, legal and technical advisers. Its members will also have the option of staying in the firm’s 8,400 square-foot space for discounted rent after the first three months until they are capable of relocating.

The incubator is emphasizing its 10-minute proximity from the UC Berkeley Campus and San Francisco as major advantages for prospective startups. It says it has connections at the university, as well as nearby Stanford to help its portfolio companies assemble strong, knowledgeable boards. It also hosts regular events where fledgling managers can meet each other and advisers, and of course investors. On specified Investor Days, startups have the chance to present to angels and venture capital groups.

Berkeley Ventures says it is looking for a diversity of startups for its flock, cutting across high tech, application development, cleantech, Web 2.0, finance, gaming, mobile and social networking.Companies from anywhere in the world can apply, but must be smaller that six employees to be eligible.

While it still reviewing applications for its first batch of startups, it has already recruited an impressive crop of advisers, including Jeff Braun, founder and CEO of Maxis before it was acquired by Electronic Arts, Anthony Patek, an attorney from Cooley Godward and Kronish, and Joel Serface of Kleiner Perkins Caufield and Byers, who works closely with the U.S. Department of Energy.

Got your cocktail/elevator pitch ready?

Some good solid advice on how to be ready for the well known cocktail (or elevator) pitch opportunity. It always surprises me how hard it is for entrepreneurs to explain their companies in a minute or less. If you can't do it, you certainly can't expect your advisors or exisiting investors to do it. Even bigger companies have a hard time with the short speech too.

Work on it, and practice - it helps!

http://blogs.wsj.com/venturecapital/2009/06/11/winding-up-for-the-cocktail-pitch/

June 11, 2009, 9:44 AM ET
Winding Up For The “Cocktail Pitch”

By Scott Austin
Say you’re an entrepreneur at a cocktail party snacking on some trail mix when you strike up an innocent conversation with the guy next to you who turns out to be a venture capitalist. He’s interested in hearing more about your company - are you prepared to make the pitch?
Mark Suster, a general partner at Los Angeles-based venture capital firm GRP Partners, appeared on the Fox Business Network yesterday to help new entrepreneurs develop what he calls the “cocktail pitch.” As he stated in the Fox interview:

“You know that you’re going to be faced with this cocktail party pitch scenario a lot of times in your career. It’s not just pitching a VC - you bump into a potential customer, you bump into a business partner, you bump into a journalist who wants to cover your story…what are you going to say? You need to practice that so it rolls off your tongue with energy and excitement. If it’s the first time you’re saying it, or you haven’t practiced it, it’s not going to sound very good.”

I’ve embedded the Fox Business clip at the bottom of this posting for your viewing pleasure. Suster also recently blogged about this topic, and with his permission, I’ve reprinted some of his tips below. If you’re a new entrepreneur, Suster’s advice is very helpful. For more on this topic, please check out Suster’s blog or the original post in which he also advises what topics the pitch should cover.

1) Show energy & enthusiasm – Passion sells. Show energy and excitement. Get your game face on. Make an impression. This is your shot and you have my attention. Don’t waste it on low energy, mumbling, limp handshakes or lack of assuredness. I’m not saying go “over the top” in your excitement, but enthusiasm for your idea is contagious. If you’re shy or introverted I don’t expect you to be something you’re not – it will come across as insincere. But at least practice your pitch enough so that you can say it with gusto.

2) Be human (no jargon, give me examples) – Most people who pitch me use jargon. I have a simple philosophy. If you can’t explain to me what you do in simple terms I assume that you don’t know what you’re talking about and you’re hiding behind terminology to sound more intelligent. The most difficult of topics can be explained in human terms. I like people to use real world examples. When I talk about my recent investment in RingRevenue I like to talk about the problem that affiliate networks have selling high value products. I call it the “treadmill problem”. If I want to buy a treadmill I won’t click and order over the Internet when a treadmill costs $3,000 or more. I want to speak with a sales rep to understand the 8 different models and which I should buy. With RingRvenue affiliate networks can track calls like Internet sites track clicks. Explaining this in “treadmill” terms I believe puts a human face on the issue.

3) Use numbers - Numbers speak. And they help convince people that you know what you’re talking about. In the RingRevenue example the pitch goes something like this: ”The highest that a product costs in an affiliate network is $200 because above that price people prefer to call a sales rep rather than buy online. Affiliate marketing is a large market already: $10 billion of goods sold through this channel of which the networks make fees of $2 billion. We think we can increase goods sold through this channel by 10x making it a $100 billion channel.”

4) Tell me what you want from me – In marketing or sales terminology we call this a “call to action” and I’m surprised at how few people incorporate this into their pitch. What is your goal in telling me about the virtual reality game you built that targets teens? Do you want me to meet you at some point in the near future? Do you want to approach me in 6 months but just want to be on my radar screen? Do you want to follow up with me via email to find out who invests in $250k deals in Southern California? Close by telling me what the next steps are or how I can help. Please don’t always make it a meeting for next week if you aren’t immediately fund raising. It can be as simple as, “I just want to say hello and tell you what we do so that I can speak with you next year when we’re raising money. Do you mind if I drop you a quick email with my contact details?”

5) Be prepared for the deep dive discussion if I engage – If you’re pitching me the Cocktail Party Pitch you had better be prepared for a deep dive. I might have just been thinking about investing in a self-service retail kiosk company so the fact that you have a product like this is great. I can cover the “Deep Dive” another time, but one bit of advice now … don’t do all the talking. I remember a friend from Australia had a saying that always stuck in my mind. He said, “that chap is a crocodile. All mouth an no ears.” Selling is about listening, asking questions and peppering in commentary. The Elevator Pitch is as much about selling as it is about pitching. So if you get beyond first base (the first 1-2 minutes) get ready for two-way dialog.

Smaller is Better in VC, really?

Another interesting article on the changes in the VC industry from the NY Times BITS blog. The people that are quoted here are all truly the elders in our industry - in my nmind, they speak the truth. How does that shake out for startups and related service providers? I think we all better get used to smaller...


http://bits.blogs.nytimes.com/2009/06/05/venture-capitals-elders-say-think-small/?scp=1&sq=venture%20capital%20think%20small&st=cse

June 5, 2009, 7:45 am —
Venture Capital’s Elders Say Think Small
By Claire Cain Miller

Venture capitalists who began investing in the 1960s have seen the industry transform any number of times. Their advice to today’s venture capital firms: think small.

In the good old days, venture funds were $100 million at most, recalled Alan Patricof, founder and general partner of Greycroft Partners, who backed America Online and Apple Computer.

“I personally believe and I think the evidence proves that the venture industry has gotten too big, the funds have gotten too big,” he said. In order to invest their enormous amounts of capital, venture capitalists end up choosing companies that are not sufficiently disciplined or capital-efficient, he said. And because firms have invested so much money, they depend on taking their portfolio companies public to get great enough returns, at a time when I.P.O.s are few and far between.

“Our biggest challenge today for venture capital is to think smaller,” said Mr. Patricof, who recently wrote an essay on NYTimes.com on how venture capital has changed.
In the 1960s, when venture capital was virtually unheard of, most investors were family offices and only tens of millions of dollars were invested in start-ups each year, recalled Franklin “Pitch” Johnson, who backed Amgen and Applied Biosystems. That grew to hundreds of millions of dollars in the 1970s, a few billion in the 1980s and $100 billion in the 1990s, when “we knew it wouldn’t go on,” he said.

Much of the huge influx of money in the 1990s came from pension funds, which saw the returns that endowments and foundations were getting from venture capital firms’ Internet deals and wanted in on the game.

Paul Denning, chief executive of Denning & Co., a private equity consulting and fundraising firm, remembers a time in the 1990s when he encouraged a venture capitalist to visit the big pension funds but the investor refused, saying he did not want their money. At the time, Mr. Denning thought he was misguided. “Maybe he was right,” he says now.

Investors in venture funds cut back after the Internet bubble burst and today venture capitalists invest about $30 billion a year, though that is still too much, Mr. Patricof said.
Not all of the venture capitalists who invested alongside him since the 1960s agree that smaller is better. Richard Kramlich, who invested with Arthur Rock before co-founding New Enterprise Associates in 1978, has one of the biggest funds in the industry, with $8.5 billion in committed capital.

His firm sometimes incubates tiny companies with small amounts of money, as it did with Data Domain, which went public last year. It also invests large amounts of money in later-stage companies that need to grow, as it recently did when it invested $45 million in Workday.
“On one hand, it’s great to experiment, and on the other hand, we have to have the capacity sometimes to do” big investments in companies with a lot of potential, he said.

Note to Founders: READ THIS

Wow - I really hate being the continual bearer of bad news, and in general we pretty much know the info in this article from the WSJ, but seeing the numbers in front of me continues to make me wonder when the VC/Startup equation will begin to turn around.

The scary part below is: "Founding CEOs kept a median of under 3% of their companies’ shares in 2008, down sharply from a high of over 10% in 2002. At the same time, nonfounder CEOs’ ownerships have remained at just more than 1%."

Its a lot of work for only less than 3% of the company...but hopefully this smaller piece is of a bigger pie (that's a whole other story!).


http://blogs.wsj.com/venturecapital/2009/06/03/founding-ceos-keeping-smaller-stakes-as-companies-go-public/
June 3, 2009, 7:11 PM ET
Founding CEOs Keeping Smaller Stakes As Companies Go Public

By Venture Capital Dispatch
Jay Miller of Dow Jones Newswires filed this dispatch:

Founding chief executives are keeping much smaller stakes as they take their companies public than they did seven years ago, according to Presidio Pay Advisors.


The firm’s analysis found that investors are returning to a more rational financial expectation of companies looking to raise public capital. Companies are now taking an additional two to three years to file for an IPO. As a result, founder CEOs’ stakes are suffering greater dilution, likely because of less favorable term sheets or additional rounds of financing needed to get to the IPO.
In 2008, median company revenue, market capitalization and net income at IPO were at the highest levels since Presidio began collecting the data in 2002.

“Today, very few companies go public with limited revenue and nonexistent net income,” says Brandon Cherry, a principal at Presidio. “The prevailing IPO profile has shifted to a company with healthy revenue and positive net income, which is significantly affecting how compensation is delivered.”

That is a marked shift from earlier in the decade, when an Internet and technology start-up’s IPO highlighted the prospect of profits and even revenue in lieu of actual results. That approach worked in the early days of the commercial Internet, when just about any Web site could be semiplausibly touted as the next Wal-Mart Stores Inc. or AT&T Corp.

According to the compensation consultant’s study, founding CEOs kept a median of under 3% of their companies’ shares in 2008, down sharply from a high of over 10% in 2002. At the same time, nonfounder CEOs’ ownerships have remained at just more than 1%.

Presidio also discovered that the mix of options and common stock has shifted toward options, which have no downside risk for executives. That change could create a potential disconnect between the interests of executives and investors, the firm warned.

$500K is the new $5 Million: Good article on First Round Capital

Good article on the ins and outs of First Round Capital and some of the other well known angels/seed funds in the valley.

The most accurate insight in the article: "$500,000 is the new $5 Million"

The Future of Tech May 21, 2009, 5:00PM EST
'Super Angels' Shake Up Venture Capital

As large VC firms cut back, a hungry bunch of seed-stage investors are helping entrepreneurs get their ideas off the ground
By Spencer E. Ante

Earlier this year, as the stock market plunged, most bankers and other financiers hoarded capital and throttled back on new deals. But not Josh Kopelman. Even in the bleakest months, the co-founder of the venture capital firm First Round Capital hustled after startups to write them checks.

Take one sunny morning in February. Kopelman sits in the San Francisco loft of First Round's West Coast office across a table from Gary Briggs. A veteran entrepreneur, Briggs just took over as CEO at Plastic Jungle, a startup building an online marketplace where consumers can buy, sell, or trade gift cards. "There's about $40 billion of unused gift cards on retailers' balance sheets," says Briggs, so focused he doesn't touch the salad ordered in for his lunch.

Kopelman hops up to sketch on a whiteboard. He wants Briggs to describe in detail how Plastic Jungle makes money. "So you get a fee here?" Kopelman asks, drawing a thicket of lines and figures. The CEO explains that with each sale or transfer of a gift card, the company takes a commission. The VC ends the meeting by saying he wants to "kick the site's tires" and confirm retailers' willingness to sell cards on the site. A week later, First Round agrees to pay $1 million for an equity stake.

Even faced with a financial world aflame, Kopelman and a wave of new investors are running straight for the fire. It may be bravery or foolishness, but they're funding startups and entrepreneurs at a time when almost everyone else is holding back. In the latest sign of conflagration, venture capital investment plummeted 61% in the first quarter, to $3 billion, the lowest level since 1997. Only $169 million of that went to companies seeking their first round of venture money, what's known as seed-stage investments.

Kopelman thinks the problems in venture capital go beyond the recession. He says many old-line firms have gotten too big and unwieldy to build innovative companies the way they used to, and many angels, individuals who invest in startups, don't have enough money to back most high-tech ideas. Kopelman and a band of up-and-comers are championing a different tack. They want to reinvigorate venture capital by taking it back to its roots, when firms were smaller, more nimble, and more likely to help startups get off the ground. "I don't think a lot of people have been entrepreneurial about venture capital," says Kopelman.

Besides First Round, these "super angels," as they're called in the industry, include Baseline Ventures, Maples Investments, and Felicis Ventures. They're pushing ahead and financing startups even as big-name venture firms cut back and conserve capital until the economy improves. First Round Capital has quietly become the country's most active seed-stage investor, outpacing such marquee names as Sequoia Capital and Kleiner Perkins Caufield & Byers. In fact, First Round bet on the online personal finance site Mint.com after Sequoia took a pass on the deal—and watched the startup blossom into a rival to Intuit (INTU). "They took a risk on a 25-year-old kid," says Mint.com chief Aaron Patzer, who's now 28.

Kopelman's aggressiveness stands in sharp contrast to the accepted wisdom on Sand Hill Road, the heart of the venture business in Silicon Valley. Last fall Sequoia gave a presentation to its portfolio companies, entitled "R.I.P. Good Times," urging them to slash spending quickly. It was a defining moment in the downturn: Many venture firms took it as a wake-up call to shut struggling startups and halt most new investments.

Kopelman could pay a steep price for moving in the opposite direction. While he has a track record of strong returns and is considered a rising star in the venture field, he has never faced the risks he does today. Not only does he confront the usual challenges of startups but he also could get tripped up by a litany of economic problems. "Investing in young companies is always risky," says Josh Lerner, a professor at Harvard Business School. "Investing in young companies during a time of enormous economic uncertainty is particularly risky."

Getting the venture model right may be crucial for the U.S. economy, whether it's done by Kopelman or someone else. Over the past 60 years the money and expertise provided by venture firms has led to the creation of thousands of companies, including Intel (INTL), Genentech (DNA), FedEx (FDX), and Google (GOOG). A study by the National Venture Capital Assn. found that U.S. venture-backed companies generated 10 million jobs and 18% of the nation's gross domestic product from 1970 to 2005.

FLY ON THE WALL
Kopelman got an early start in the business. His grandfather, Herman Fialkov, founded chip pioneer General Transistor and later started the venture firm Geiger & Fialkov. Kopelman interned at the firm the summer after he finished high school, tagging along with his grandfather to board meetings and to hunt for deals on Long Island. "I was the fly-on-the-wall note taker," says Kopelman.

Now 38, Kopelman crisscrosses the U.S. twice a month from his Philadelphia home to look over 2,300 potential deals a year and stay on top of companies he's backing. We first met over lunch in a Manhattan eatery. As he sat down, Kopelman argued the traditional venture approach is fundamentally flawed: "When you look at the math of venture, I think it is broken."

Kopelman grabbed a napkin and began scribbling. Venture firms raise money from institutional investors and wealthy individuals in discrete funds (usually known by such names as First Capital I, First Capital II, etc.). To give a fund's investors a 20% annual return, the firm needs to triple the money raised within a six-year period, Kopelman said. For a $400 million fund, that means returning $1.2 billion to investors. Since VCs typically don't want the risk of holding more than 20% of the companies they invest in, they have to help build a few companies with a total of $6 billion in market value. But in the past few years only a handful of companies have sold or gone public for more than $1 billion. "You sit there and say, 'Holy crap, that model doesn't work,' " said Kopelman.

What's a venture capitalist to do? For Kopelman and other super angels, the answer is to get small. Over the past five years they have launched funds with $100 million or less and financed hundreds of companies, including Facebook, Digg, and Twitter. Ten years ago, when it cost $5 million to launch a startup, firms such as First Round couldn't exist. But thanks to plummeting technology costs, Kopelman & Co. can help companies launch products today for less than $1 million. "Five hundred thousand is the new $5 million," says Mike Maples Jr., who founded Maples Investments three years ago.

Super angels still aim for billion-dollar exits, but their model doesn't hinge on home runs. Instead, they can profit by hitting singles and doubles and reducing their strikeouts. First Round's second fund, raised in 2007, was $50 million. So Kopelman needs to return $150 million to the investors to hit a 20% annual return. His firm has done better than that: Its first two funds have generated a 35% annual rate of return after fees, says one investor in the funds. Among its successes: StumbleUpon, a Web recommendation tool bought by eBay, and search engine Powerset, acquired by Microsoft.

Established venture firms argue that the super-angel model has limits. Michael Moritz, whose Sequoia Capital backed Google, Cisco Systems (CSCO), and Electronic Arts (ERTS), says big venture firms can do certain kinds of deals that smaller ones can't. With $1 billion, for example, you can back capital-intensive startups in green energy or explore deals in China and elsewhere abroad. Still, super angels play an important and growing role, Moritz says. "My guess is more of it happens over the next few years because of the dearth of financing [for early-stage deals]," he says.

NOT FOR THE FAINTHEARTED
Kopelman's strategy—and strong returns—have won him deep-pocketed supporters. The endowments at Yale, Princeton, and Northwestern universities signed up for First Round's third fund, a $125 million vehicle raised last year. Another backer is Christopher A. Douvos, co-head of private equity investing for the Investment Fund for Foundations, an investment adviser for nonprofits. He agreed to put tens of millions into the third fund. Still, he says there are clear risks to investing in such early-stage deals. "You have to have courage to invest in this strategy," Douvos says.

One day this spring, Kopelman lines up back-to-back-to-back meetings in his San Francisco outpost. The loft has tall ceilings and a foosball table. After interrogating a young entrepreneur in the first meeting, Kopelman quickly lets him know his idea needs refinement. "There's one thing I've learned about entrepreneurs' business plans," he says, bringing the meeting to a close. "Every one is wrong."

Kopelman would know. His early experience in venture capital gave him the confidence to hatch a startup while still an undergraduate at the Wharton School of the University of Pennsylvania. He took the company public in 1996 when he was just 25. In 1999 he left to start an online marketplace, Half.com, for used books and videos. A year later, eBay (EBAY) bought Half.com for $312 million.

Today, Kopelman sees a wealth of opportunities in building businesses on information freely available on the Web (what he calls "data exhaust") or ones that are disrupting markets with cheaper Web technology. After the first meeting, Kopelman settles in to brainstorm with one of those disruptors. Kevin Reeth is CEO of Outright.com, a provider of online bookkeeping software that just launched its first product.

In this exchange, Kopelman switches roles, becoming more parent than prosecutor. After Reeth explains his main challenge is customer acquisition, Kopelman suggests hiring a marketing exec and launching a guerrilla marketing campaign. The idea: Set up a Web site,
canyougetconfirmed.com, that would play off of the troubles former Senator Tom Daschle ran into when Obama nominated him for a Cabinet post. The site would lure customers with free tax tips. Reeth likes it.

Kopelman and partner Rob Hayes adjourn the meeting and scramble to make a flight to Southern California. An assistant hands them their bags, tickets, and travel info, and they whirl out the door. "Welcome to Josh's world," says the assistant.

STRESS-TESTING BUSINESS PLANS
In March, Kopelman meets with Jose Ferreira, chief executive of an online education startup called Knewton, at its spartan headquarters in New York's Greenwich Village. Knewton sells LSAT and GMAT prep courses online, in competition with giants Kaplan and Princeton Review (REVU), but its aim is to use the Web to offer better teaching for less money. Whereas textbooks provide the same material to everyone, Knewton has developed an adaptive technology tailored to the strengths and weaknesses of each student. Knewton is betting its software may be adopted by publishers and other education companies.

Knewton's board has already approved two partnerships, including one deal to license its technology to a rival company. Ferreira wants to cut more deals. But Kopelman says he is concerned that if Knewton does more deals it will spread itself too thin. Tension fills the air. "The most powerful word a CEO can say is no," Kopelman tells Ferreira.

"What happens if Princeton Review comes to us and wants to make a deal?" asks Ferreira.
Kopelman does not budge. "It's worth going to Boston to see them," he says. "But promise me you won't sign anything. I want to see deal points." Ferreira agrees.

Kopelman knows First Round needs to keep taking risks. That's why his firm just launched an event called Office Hours, a sort of American Idol for aspiring entrepreneurs. Several times a year, First Round will offer anyone the opportunity to get 10 minutes with Kopelman and his partners to stress-test their business plan. "We think it's important when a lot of VCs are cutting back that we get out there and see as many people as we can," he says.

One recent gathering took place at Live Bait, a watering hole in New York's Flatiron district. An intern at the firm asks everyone to sign a log-in sheet. It's first come, first served. At 2 p.m. Kopelman orders a sandwich at the bar, sits down at a table, and starts talking. First Round partner Howard Morgan grabs another table. The atmosphere recalls the informality of the early venture days, when firms such as Sequoia and the Mayfield Fund would meet at the Mark Hopkins Hotel in San Francisco for lunch and bat around ideas.

Entrepreneurs arrive, then mill around the bar. By 2:45, 35 people have showed up, including two who drove 90 minutes from Philadelphia. "My hands are cold," says Yasmine Mustafa to her partner, Aaron Hoffer-Perkins. "That means I am nervous." The duo are quitting their jobs to launch a company that helps bloggers make money from their sites.

When the intern says it's their turn, Yasmine springs up and the two walk over to meet Kopelman. Ten minutes later they head back to the bar for a drink on First Round's tab. "It was awesome," says Yasmine. "It actually spawned new ideas, which is what we want before we develop the product."

"Always fast, always to the point, no B.S.," adds Aaron.

I check in with Kopelman around 3:15. With the deep troubles on Wall Street, Kopelman says he's surprised at the level of entrepreneurial action in New York. "It's going great," he says.

Peering down at his notebook, Kopelman says he has already met with eight entrepreneurs and heard two original ideas. "Several ideas we are going to follow up with," he says. Then he quickly heads back in to meet more entrepreneurs.

Great deck for startups on how to present at investor events

This is a great deck on how to present in a very time condensed format and win. The idea is not to focus on your technology or how great it is (we know its great!) but to focus on who will pay for it, why they will pay for it, and why they won't spend money with another company to solve this problem.

I've seen so many startups over the years try to cram everything into a short 5-10 minute presenation at every event imaginable. You don't need to say everything at this first shout out to investors. This is a sales pitch for you - just get them interested enough to ask for a meeting. That's really all you can ask for!

http://www.webyantra.net/2009/05/22/excellent-resource-how-to-make-pitches-at-startup-showcase-events/

What are we all striving for - shareholder value?

Some interesting thoughts for the long weekend on how to not get caught up in the eternal pursuit for more money. I have to agree with Jack Welch - "Shareholder value is a result, not a strategy".

Questions I Wish VCs Would Ask Entrepreneurs (Hint: They’re Not About ‘Shareholder Value’)

By Upendra Shardanand - Fri 22 May 2009 08:38 AM PST

Upendra Shardanand is the Chief Executive Officer and Founder of Daylife, which helps publishers add content and inventory without additional staff or engineering. He also co-founded Firefly Network, a spinoff from his work at the MIT Media Lab, and sold the company to Microsoft (NSDQ: MSFT) in 1998. Upendra was the founding partner at the venture firm The Accelerator Group, and was the Director of Technology at Time Warner (NYSE: TWX).

Several years ago, when I was with the Accelerator Group, we were in discussions with a music-industry executive about a music-related venture. At some point he e-mailed a request: He wanted my colleagues and me to send him a list of our favorite bands. A slightly puzzling request, but we complied – who doesn’t like doing a top-10 list? Afterwards, he shared that he was very pleased with our answers – not one gun-toting, life-of-crime musician on the list! Apparently, he had no desire to work with dangerous acts. Life is too short to get shot.

As odd as that question may have been, it was honest and a nice change of pace from the normal litany of questions one gets from partners or VCs. By now I heard hundreds of investor pitches, and every investor seems to be reading off the same crib sheet. They’re all very focused on how best to maximize shareholder value (as opposed to avoiding getting shot, or some other criterion).

It’s long been accepted that the singular objective for any company is to make everyone money. The more the better. And I’ve been in many a discussion where it seems the wisest way to cut to the chase on a strategic business decision is to ask, “OK, but what will most maximize shareholder value?”

So it was interesting to see Jack Welch recently say: “On the face of it, shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy … Your main constituencies are your employees, your customers, and your products.” (I’d personally add suppliers, partners, the environment, and society at large.)

Some buy a trickle-down logic and argue that if it’s good for the shareholders and makes good business sense, then you will end up taking care of all other stakeholders.

Really? In an age where investors and management can get out quick, leaving all the other stakeholders holding the bag, what we end up with is Enron, AIG and Tyco. Those companies may be the extreme examples, but for a long time in the tech industry we’ve had a setup where every dot-com investor and entrepreneur could exit fast and buy that Ferrari, without necessarily having built anything of lasting value. Perhaps more innocuous then Enron, but no less a wasted opportunity to do something truly great.

And companies are like snowballs being rolled down a hill: Once they’ve been pointed in a direction, it’s really hard to change course. A company’s mission only gets watered down with time, its resolve weaker with age.

Perhaps in this era of Obamanomics and global cataclysm, where the maxim of endless growth fueled by endless consumption is being questioned, we’re starting to reset a bit, and the dog is starting to wag the tail. Perhaps we’re starting to see job hunters pursue purpose over money.

Perhaps publications will find new ways to keep score besides who raised how much and who exited for how much. Surely there are metrics other than the dollar by which to judge companies? (Read these words of wisdom on the value of the right metrics from RFK Jr.).

As exit opportunities become scarcer, perhaps entrepreneurs will start attacking hard, long-term projects with real benefits as opposed to get-rich-quick schemes. I once congratulated one of my investors, Scott Heiferman, on the success of his young company Meetup. I was deeply impressed whenever I spotted a Meetup group at a café or Whole Foods cafeteria, and I kept seeing them more and more often. But Scott was visibly irritated.

“Brands or anything that really lasts or matters often take decades to build. We haven’t done anything yet,” he said.

And perhaps boards and VCs will take Jack Welch’s advice and depart from their scripts and start viewing shareholder value as a result, not an objective. I’ll give a discount on the deal if any VC ever asks me questions along the lines of, “what do you do to make your office a fantastic place to work?” or “would you disclose the identity of one of your users to the Chinese government” or “who are you fighting for?”

The things we read, the colleagues we keep, the investors we have. Picking them carefully will determine the measures by which we’re held accountable. Life is too short to get shot.

Very interesting deck on Customer Development

I don't usually write anything but the most brief comments here but this time, I'm going to put out some thoughts on a recent deck by Steve Blank on Customer Development. This terrific deck starts with a basic premise: More starups fail from a lack of customers than from a failure of product development. Those of us who've spent time with seed and early stage startups know for a fact that this is true.

But as Steve mentions, we have no processes to manage customer development. There are tons of resources available to manage the product development process, but the key driver of success, customers, is left out to dry.

He goes on to talk about the First Customer Ship (FCS) date as the goal for startups, which as we know from experience, is generally the case. but I totally agree with him when he says, "You don't know if you're wrong until you're out of business/money".

Download the deck and read his ideas on how to fix this serious problem. He's wise and its great advice.

http://www.stanford.edu/class/msande273/resources/Stanford%20steve%20101805.pdf

More bad news from TechCrunch on the state of startups and VC

http://www.techcrunch.com/2009/05/18/crunchbase-data-rocks-too-bad-the-q1-numbers-suck-our-report/

CrunchBase Data Rocks. Too Bad The Q1 Numbers Suck. Our Report

by Michael Arrington on May 18, 2009

We’re all glad Q1 is behind us.

Silicon Valley and the start-up ecosystem certainly was not immune to the general economic malaise. The TechCrunch sweet spot, early-stage start-ups, was particularly hurt.

The number of start-ups getting started was down 65% vs Q1 2008. We saw just 184 new start-ups formed, down from 546 in 1Q 2008.

Start-Ups Founded: January 2008 - March 2009Source: CrunchBase
Early-stage start-ups are working hard to do more with less. The average number of staff at new start-ups founded 1Q 2009 was 6, down from 8 a year ago. How do we know? It turns out that there’s a wealth of interesting facts that we can glean from CrunchBase, our structured-wiki startup directory and primary data source for TechCrunch Research. What else did we learn from CrunchBase?

The $3.1 billion in venture capital financing was down 50% from Q1 2008, though up nearly 25% from Q4.

Venture Capital Financings: January 2008 - March 2009Source: CrunchBase
Here’s the thing, transaction volume was weighted heavily to Series B and later stages of investment, suggesting that VCs were focused on providing additional resources for their top portfolio companies as opposed to new deal flow. By example, only four of the startups founded last quarter also reported the closing of outside funding.

Venture Capital Financings by Stage: 1Q 2008 vs. 2009Source: CrunchBase
(Excluding the New York Times’ $250 million bailout raise by Carlos Slim), the biggest consumer web and mobile financings were: obopay ($70M), Zag ($70M), Twitter ($35 million), Omniture ($25M) and Pocket Communications Northeast ($25M.) Monetization businesses received attention: Tremor Media ($18M), Offerpal Media ($15M) and AdMob ($12.5M.)

Perhaps most telling of all, no acquisitions were announced by Google, Microsoft, Yahoo!, AOL, or Amazon. We can’t remember a fiscal quarter where none of these companies announced even a small transaction. In total, $1.6 billion in M&A was reported for the quarter, down from $11.9 billion in Q1 2008.

M&A Transaction Values: 1Q 2008 vs. 2009Source: CrunchBase
There were a total of 82 exits announced for the quarter, and the number of exits was actually higher than the 73 reported Q1 a year ago. In 2009, dealflow was tactical and modest in size. The two big deals of the quarter were Autonomy’s acquisition of Interwoven for $775 million and Cisco’s acquisition of Pure Digital Technologies (aka the Flip) for $590 million.
M&A lTransactions: January 2008 - March 2009Source: CrunchBase

Despite a number of executive departures and hirings, we’re still waiting to hear new news from big internet media. After budget cuts are complete, what will be the sources of future growth? There is a vast sea of start-ups available at newly rationalized prices.

See the report table of contents and table of exhibits here.

This is a GREAT article on differentiation

Great article from David Shen on MeToo startups. Differentiation is a huge key to success in startups - there are some terrific ideas in here.

http://www.dshen.com/blogs/business/

May 12, 2009
The Problem with Early Stage Me-Too Product Startups

I believe the universe of internet businesses has become extremely crowded in the last few years. In the early days, you could come out easily with something new because there weren't that many competitors out there. Now, it's hard to find somebody who isn't working on something similar to what you're thinking about. So competition is fierce and many times you'll find entrenched competitors with a lot of product inertia and a great head start.

The other huge problem is on the consumer side. Consumers are deluged by new products and services all the time. They have overload and just keep to the products they know best, and need to have a really good reason to change and move from another service to a new entrant. We saw this first in the past with email addresses; Yahoo Mail users were hesitant to move because the cost of changing your email address was super high and thus user retention was very high. Now add what makes up our digital lives on services like flickr (all our pictures that we've uploaded for half a decade now), or facebook (our friends are all here, plus their interconnections), or linkedin (our business connections are all here, plus all their historical connections). The cost of moving has become so high because we've invested so much time and effort into those services and we don't want to redo that, let alone adding the cost of learning a new service.

As an early stage investor, I've found that this makes picking companies exponentially harder and it's a shame. I meet a lot of smart entrepreneurs with some really great ideas, but then I do some research online and find that there are others who are working on something similar or in a close enough space to be competitive. Then I start to get worried about their prospects.

You can find tons of books on the subject of competition and winning despite having entrenched competitors. In general, I have found that entrepreneurs are doing what they should be doing to attack a crowded market. These are things like (my thanks to Andrew Chen for helping me with this list):

1. Innovate on the product experience (ie. Posterous vs. Wordpress).
2. Business model changes, where you are going free (or freemium) for a product that's usually subscription (or fixed charge).
3. Changing the market where you're going long tail instead of hitting the larger market (ie. casual games versus hardcore games).
4. Change in distribution model, where you are delivering something as a service rather than a download, or bundled into an existing thing (ie. Facebook app) instead of a standalone thing.
5. Change in branding. An example is where you cater to an upscale prestige market or niche market instead of a mass brand, or vice versa like taking a niche product and making it available to the masses.
6. Create a business that is better, out of a larger part of another business (ie. Lefora created a message board hosting product for those who don't want all the bells and whistles of a full social networking product).
7. Innovate on design, which appeals to those who want a similar product but one that looks/feels better.
8. Offering more features on a product, or customization on product.
And the big, traditional way of taking a new entrant into a crowded market:
9. Mass advertising to gain broad awareness and induce trial and adoption of new product in face of existing competitors.

So I am not saying it's not possible to win against a crowded marketplace. My issue is with early stage startups: in order to win in a crowded marketplace, early stage startups often don't have enough resources to last long enough to compete effectively and win. While a lot of the above can be implemented, growth time is limited by whether or not you have enough capital and revenue to survive until you run out.

To me, if you're developing a me-too product, it's ultimately going to boil down to a marketing game more than in any other situation. You can develop the best product or service, but if nobody knows about it because they're busy using something else, then you're still dead.
So distribution for a me-too product is critical. In the past and present, large corporations could do this because they had lots of money to launch large advertising campaigns. They knew distribution channels and could insert their new product there. They had contacts in their market and it was straightforward to get word out that they had a new product even if it was similar to existing products.

As a new startup, you may not have those channels and contacts established, and certainly you don't have money to spend on advertising plastered on the Superbowl, magazines, online, and elsewhere.

However, once you finish your product using one or more of the strategies above, you need to jump to strategy number 9 as soon as possible and get it out to consumers. You don't have time to wait until people notice you; you need to get noticed.

Some possible ways of doing this:

1. Buy advertising. As an early stage startup, this is the least viable unless you somehow have enough money to do this. Lead gen advertising can be better than CPM based advertising as you'll be able to pay only on a referral, but still this costs money. Let's move onto cheaper alternatives.

2. Marketing that involves barter space. You trade something of value for advertising space on their side. Something of value can be advertising space on your site, or donation to their cause for charities.

3. Word of Mouth Marketing. Contact bloggers, magazines, users and get them to try and talk about your product. Getting in the NYTimes is a big traffic driver, as well as many other national circulation magazines. Online publications like CNet and The Huffington Post can also be great. Twitter is also a great up and coming means for getting your word out.

4. Get distribution partners. Existing companies can add your product on their sites and can help you promote it. This is usually in deeper partnership such that it goes beyond just buying ad space. You look for exclusivity in contracts and features that your product has that enhance an existing company's product and prestige.

5. Viral marketing. This is a very hard avenue to execute, which is to start with a few users and then it blossoms outward to many. Determining how your product can be viral can be an elusive game and if you don't hit on it early, you could waste a lot of time tweaking and hoping that something you create will be virally popular and spread.

In working with a few startups, I am disheartened by the fact that the importance of distribution is still not well understood. The leading thought is that "if I build something great, then everyone will come find me." Unfortunately, that is rarely the case in this crowded marketplace, and most early stage companies don't have enough time to let people just wander around until they find out about the product.

They did not do enough work to go out and contact bloggers. They didn't go out and try to woo corporate partners to see if they would help them get their message out. They just waited for users to come and they didn't come in great enough quantity to support their business by the time their money ran out.

So don't let your product fail simply because you can't induce trial. Remember, you have developed a me-too product, one that users already have a solution for and switching costs and barriers may be too high for them to take action to look for a better solution. You need to get them to know that your solution exists, and attract them to try it out - and since you're an early stage startup, you need to do this ASAP to give yourself enough time to let consumer adoption grab hold and ultimately take off, all before your money runs out.

Great pointers on positioning your startup for acquisition - today's only real exit option...

This is a short but VERY good and practical article on positioning your startup for acquisition. The pointers at the end are right on the money!

----

May 4, 2009, 6:32 PM ET
Want To Position Your Start-Up To Be Acquired? Follow These Tips
Venture Capital Dispatch HOME PAGE »

By Scott Austin
Last August, Hewlett-Packard Co. signed a letter of intent to pay $360 million cash for LeftHand Networks Inc., a venture-backed provider of storage systems. A few weeks later, Wall Street’s collapse sent the economy in a tailspin and threatened to knock the screws out of the deal.
But after a two-week pause the two sides got back together and in November closed the acquisition on the same terms. Asked how LeftHand was able to command the same price despite the uncertainty created from the financial markets, an investor in the company said, “Maybe it’s because every Sunday I went to church and lit candles. Faith and religion are very important in the sale process.”

Jokes aside, LeftHand was able to hold its ground because it had proven itself valuable well before Hewlett-Packard offered to buy it. H-P had been reselling LeftHand’s software on some of its servers for nearly three years, and realized it couldn’t do without it.

The deal signifies the importance of setting up strategic relationships with possible acquirers, especially in this environment, said the aforementioned investor, Matthew McCall, a managing director with Draper Fisher Jurvetson Portage Venture Partners.

“When you’re hair’s on fire as a corporation, you’ll try anything to make the pain go away,” he said. “Now’s a great opportunity [for start-ups] to enter partnerships, distribution agreements, and dialogues with larger corporations.”

McCall was on hand at the National Venture Capital Association’s annual meeting in Boston last week to provide some pointers on how start-ups can position themselves effectively for a possible exit. McCall, who says his firm has scored 10 exits in the past 18 months, offered a few “key elements” that have helped his portfolio companies exit the past couple of years:

-Form a strategic relationship with a potential buyer. “Companies that have been successful in this enviroment are great at identifying who the strategic players are out there that would rather see you alive versus dead. Some of our portfolio companies are aggressively approaching them as a sugar daddy, as a protector in the market place. They’re going to them and saying, ‘We’re going to get a production line out for you, but getting lease financing is very difficult, would you do that for us?’ And we’re seeing some of these guys come up with corporate lease lines for them or helping guaranteeing those lease lines.”

-Look at it from the acquirer’s perspective. “Too many people try and sell from the position of fear. Especially in this marketplace, instead of saying, ‘How can we sell this?’ you need to get into their shoes and say, ‘Why do they need to buy it?’ One of our most successful sales in the last year happened because this was a critical piece of the buyer’s portfolio. You could see this was a hot part of the market, that they didn’t have a strong position in it and there are two or three competitors. If you can identify that and position it accordingly, you’re in a great position.”

-Identify the alternatives. “If you’re the clear superior company in the market and there are no alternatives, you’ve got leverage. If you’re the No. 2 or 3 technology out there, you can push as hard as you want, but they’re going to push back on you. And then at the end of the day they could buy one of your competitors and could really put you in a bind.”

-Make sure at least two mortal enemies are bidding on your start-up. “We had a company that was looking to sell, and went to a potential acquirer and said, ‘If you don’t move now, so and so will.’ They said, ‘Go ahead sell to them, we’d love to kick their ass in the market.’ About three weeks later we engaged their mortal enemy - the two had a Coke/Pepsi type of relationship. Two weeks later, we signed a letter of intent and closed it in six [weeks], at twice the original bid.”

10 reasons why startups fail

Great advice from our old friend Jolly. Its always important to take a few minutes to remind ourselves of this type of info. I happen to think #2 and #3 are super important.

VENTURE CAPITAL
Top Ten Reasons Why Startups Fail
--> Mohanjit Jolly, Executive Director, Draper Fisher Jurvetson India , March 17, 2009

Entrepreneurship is for those with thick skin, and sheer tenacity to be able to hear lots of “no’s” but not be deterred.

Jolly’s Volley
I think most people are aware of the fact that very few startups actually succeed. That’s precisely what makes entrepreneurs a rare breed. While knowing the risks, entrepreneurs follow their passion, try to change the world and hope for wealth creation for themselves and their shareholders.

It’s the potential for that proverbial home-run (or a Sixer in cricket talk, I suppose) that drives entrepreneurs, especially technology entrepreneurs (and VCs) to get into the game in the first place. But, for a combination of reasons both within and outside one’s control, startups fail. The list below is one compiled by my colleague, Tim Draper. I have tried to add my own little twist to give it some Indian spice and colour. So, here goes…

1. Startups run out of cash: One can argue whether that’s the cause or effect of failure. Often, startups are too optimistic about when their product is going to be accepted by the market (the hockey stick that entrepreneurs and investors alike often talk about). I used to have a professor in Business School who was a turnaround specialist hired by large corporates in the US to help float a sinking ship, and actually have them become viable businesses.

He used to say, “You can run out of wives and girlfriends, but make sure you never run out of cash”. I am guessing the latter will automatically lead to the former in most cases. But all kidding aside, there are often times when the entrepreneur is either too naive or highly arrogant when dealing with the situation of “cash crunch”.

On the former, he/she is busy fighting other fires that he/she simply underestimates how long the cash will last (sales cycles are longer than expected, for example, or customers are more price sensitive than expected). I have also seen the latter, where an entrepreneur will not heed advice from Board or advisors (in terms of cutting the burn) simply because he/she thinks that his/her company is too valuable for the investors and other stakeholders to let die, and they will bridge the company. More often than not, the entrepreneur is wrong. In tough times, investors become a lot more disciplined about letting go of the non-performers, and not putting good money after bad.

2. Founders don’t have complete faith in each other: They fight instead of delegate, trust and verify with each other. This is a tricky one. I often tell entrepreneurs that great companies are founded not by an individual but teams (2 or more founders). Gates and Allen, Brin and Page, Yang and Filo, Jobs and Wozniak and the list goes on and on…It’s important to have one founder who is outward facing (customer/business centric) while another who in inward facing (operations centric).

But there has to be a clear delineation in roles and responsibilities, so that one doesn’t step on the others’ toes. The other aspect is to be brutally honest with each other, and actually have a transition plan, as a company scales. More often than not, founders are great at the early stages of a company, but a new seasoned management team is necessary to scale the business to tens of millions of dollars and beyond in revenue.

Sometimes, I have found myself in situations where two buddies who founded the company are no longer capable of running the company (i.e. the company has grown to a size beyond what the founders can handle). The truly remarkable founders/CEOs are ones who realise when they are no longer right people to be at the helm of the company.

They often step aside, or take on a role of a chairman/evangelist and let a more seasoned CEO steer the company forward. But for a variety of reasons, ranging from “giving up control”, to “title creep (still needing to be CxO)”, to sheer ego, founders end up in a tiff with each other or with the Board. Let me give you a specific example. There is a company where two co-founders (Founders A and B, close friends for many years) started a company with operations and market in India, while they were still in the US. The plan was for them to move to India. But for a variety of personal reasons, Founder A simply could not make the move to India. Founder B, as a result, ended up doing most of the work.

Even though founder A was no longer contributing, founder B did want to let him go due to the long personal friendship. Founder B, as a Board member, has a fiduciary responsibility to do the right thing, and let his buddy go (since he was no longer actively contributing to the company). The unvested equity held by founder A was no longer working towards creating value for the company. Founders often have a hard time choosing between a fiduciarily responsible decision and an emotional personal relationship. By having a detailed conversation around roles and transitions at the onset, founders (who are also good friends) can avoid awkward situations downstream.

3. CEOs hire weak team members: This is partially related to the previous point. Strong CEOs sometimes try to carry everyone with them rather than hiring people who stand up on their own. Again, there may be team members who are dear friends, but may actually not be the best person for the position. CEOs need to do what’s optimum for the company and the shareholders, not their friends or their ego.

Most successful CEOs will utter the following words “always surround yourself with people smarter than you”. Again, if entrepreneurs are honest with themselves and actually adhere to that mantra, they will build a strong company, and an equally strong culture of hiring better and hiring smarter. Many CEOs or executives, due to either ignorance or arrogance, end up settling for weaker team members.

The reason for hiring strong team members is simply that they will question the status quo, and the traditional way of thinking. They will be a resource for the CEO and the Board to help determine the company’s overall strategy. For startups with constrained resources and continuous threat from incumbents, there needs to be a team with a combination of smart out –of-the-box thinking/questioning, scrappiness and uncompromising tenacity. Often founders, who are junior from an experience standpoint, do not want to let go of a lofty title. My recommendation is that one would often be much better off working at a director or manager level for a seasoned VP or CxO from the outside, than try to learn on the job as a CxO or SVP themselves.

4. They want to do too much: Usually, successful start-ups figure out a narrow niche that they can dominate and then expand from there. This is where the bowling pin analogy is helpful. Often entrepreneurs face a dilemma of “appearing big enough” to a VC especially during a fundraising discussion, but at the same time being able to focus on a particular segment of a market. There is also a balance between being flexible/nimble as a startup, but at the same time not looking completely lost or defocused.

Often, startups have to experiment and try a variety of approaches to products, channels, business models, but they also have to make sure that there is discipline and analysis behind the decision making. Bottom line: stay focused, become dominant is a very targeted segment or vertical, and with that success as foundation, expand into adjacent areas. Entrepreneurs should paint a long term big picture, in terms of a game changing vision, but be laser focused in their execution, especially when starting up. Admittedly, this is easier said than done (as with most of my articles).

5. They go after too small a market: Selling ice to Eskimos is a trivial but poignant example. You may have the best customised ice sculptures, but it doesn’t mean a whole lot if the market is either too small or non-existent. This is often the case when entrepreneurs develop a technology looking for a problem, rather than developing a product having researched a market and determining that the opportunity exists, it’s large and customers are willing to pay for the right product or service.

Another way of looking at this is to see how much “better, faster, cheaper” one can make a solution compared to something that already exists. Trying to improve existing solutions by 10 or 20% doesn’t usually have an impact. Order of magnitude impact in terms of price/performance is a lot more interesting. Having said that, companies often are created not to address an existing market, but one that is anticipated to emerge.

In India, for example, several companies were created and funded prematurely relying on broadband penetration that was supposed to happen in India. Examples around mobile video or location based services are other areas where current market is tiny, but they will emerge. A very tough question to answer is one of timing – Should a startup wait for a market to be ripe, or build a solution while guesstimating market maturation. I am more a proponent of the former, since there is quantifiable opportunity that often does not require behaviour change, and complete customer education. There is a reference in terms of incumbent products/technologies against which the startup can measure its own offering, in terms of being significantly better, faster and/or cheaper.

6. They don’t charge enough from their customers to survive: They often think their VCs are their customers and that a nice VC pitch is all they need to make to get more money. There is no better cash source than happy, marque price-insensitive customers. Just like many other challenges faced by a startup, determining a business model and more specifically pricing is one of them. Although it’s ok to provide a discount for the early alpha/beta customers, it’s usually not the right move to compete based simply on pricing.

Also, it’s crucial to have a very good idea of costs of creating and delivering one’s product or service, so that pricing and margins are enough to sustain a growing company. Tha aforementioned is an obvious statement, but one would be amazed at how often entrepreneurs don’t actually have a good handle on their margins. In India, which happens to be a more price sensitive economy than most, it’s extremely difficult to start with a low price and raise it over time. The reverse will likely be true. Bottom line: base the pricing on a quantifiable ROI to the customer, and have an incredibly capital efficient production and distribution base. Margins tend to shrink, not expand, as offerings get commoditised over time.

7. They hire too many people up front: Too many mouths to feed too early can sink a company. Keep a low burn until you have your business model in place. In some businesses it is crucial to have a team in place to be able to deliver the product or service. There is usually training involved, so people do need to be hired slightly ahead of revenue. But often, especially in good times, startups hire too many people prior to having clarity of the business model or revenue visibility.

Having a high burn without either having a product/service to sell, or a process to deliver that particular product or service, is the number one reason, in my mind, why startups fail. Startup investments happen in tranches or series of funding that are usually tied to a company hitting specific milestones. But if the burn is high, those early product milestones are not hit in time, and companies have an incredibly difficult time raising additional capital.

On the technology front, early hires are usually engineering centric to develop and refine the product. Once the product is getting close to market release (as alpha/beta), that’s when sales, business development and customer facing hires come into play. The aforementioned is a slight generalisation and seems fairly obvious, but one would be amazed at how frequently this particular mistake is made, often by seasoned entrepreneurs. I have had experience with several companies where, due to the economic/market environment, a RIF (reduction in force) had to take place.

What’s more amazing is that in most cases, after the RIF, the company’s performance did not suffer in terms of revenue, and bottom line improved drastically. Lesson learned: companies can be much more capital and team efficient than they realize. Often it’s only after a startup goes through the over-hiring and then laying-off cycle that entrepreneurs realise that they truly can do more with less.

8. Sheer luck (or lack thereof): Startups can and do get broadsided by competitors, new technologies, big companies changing direction, regulatory environment etc. This is one that squarely belongs in the category that’s completely “out of one’s control”. Startups’ success depends on a blend of luck and skill.

One can argue about the percentage splits between the two. In India, this point may be more true than most places, given the regulatory environment that exists in many sectors. And given the mood of large organisations like the RBI, SEBI, or the various ministries and their dynamic mandates, startups can either tremendously benefit or completely get clobbered by the decisions made. In India, there are grey areas around topics like Service tax, which can cause significant burden or relief depending whether a company is liable or not.

Given my aerospace background, I had a chance to see direct impact on technology companies catering to the defense sector getting tremendous benefit when the Republicans were in the White House vs the Democrats. Finally, often cash rich incumbents can simply play a loss-leading pricing game to crush a startup.

9. They don’t work hard enough or fast enough or smart enough: All those little decisions add up to an outcome. Awareness of the market dynamics subtleties are ignored or not analysed/understood as well as they should be. It’s important, for example, in India to realise that this is primarily a cash based economy, and on top of that a pre-paid economy. So, trying to enter the Indian market with a credit card based purely online subscription model, may not work, especially if the product or service is to be delivered to a broad consumer base.

DFJ has companies in our portfolios who have faced the very same challenges, so the nimble startups have to keep their finger on the market pulse and continuously adjust (without throwing darts in the dark) based on market feedback. Although not often the case, there are times when startups get a bit complacent. This could be due to over confidence in the technology, or on the other extreme, due to fatigue, especially if the company has been going on but been relatively flat for a number of quarters or years.

Sometimes technology entrepreneurs get a bit detached from their eventual customers, not realising that the needs of the market are changing, or the customer behaviour is morphing and as a result the product also needs to change. Lack of that adaptation, or not doing so fast enough, can also lead to a dire end. Let me give another hypothetical example. If a company relies on acquiring online merchants to be able to provide a service like search engine optimisation, or an advertising network to an online publisher, then it’s crucial to have a process in place to be able to add those merchants seamlessly and quickly if the business is to scale. Yet, if that company has an Oracle like culture, and the QA process for every merchant addition takes 8-10 weeks, the company is doomed.

10. They don’t take enough risks: Some start-up entrepreneurs think that they should operate as though they are big companies. This is wrong. They will never beat Microsoft or Google at their own game. They must get creative and do things differently, even at the risk of embarrassment. The incredibly successful entrepreneurs are those who thought monumental, not incremental.

11. Bonus point (buy 10, get 1 free, recession special): Entrepreneurs get greedy. This may be ironic coming from a VC. The sole focus of the entrepreneur should be to create a large profitable long term entity. The big pain point for the entrepreneurs, and understandably so, is around dilution that they suffer when raising capital. That concern often leads to sub-optimal decision making.

For example, especially in times of financial uncertainty like today when valuations tend to be lower, founders/promoters tend to take less money to minimise dilution. My advice to entrepreneurs is “when offered capital, take it”. It’s almost always better to take more capital than less because it usually takes longer and more capital to hit key milestones.
Bottom line: Entrepreneurship is for those with thick skin, and sheer tenacity to be able to hear lots of “no’s” but not be deterred. Having said that, passion alone cannot guarantee success and due in part to reasons given above, startups fail. What’s equally important to realise is that it’s “ok to fail”.

I am obviously not implying that one should stride for failure. Silicon Valley is filled with entrepreneurs who failed their first and even second time before they finally had a success under their belts.

The learning involved in going through a rough startup experience can be tremendous. In India, I feel a sense of risk aversion among entrepreneurs where a stigma still lingers (whether real or perceived) around failure. I think only when that viewpoint changes, will we start seeing truly monumental ideas coming out of India, rather than the incremental “low risk, low reward” variety.

Starting up with a friend: What could possibly go wrong?

a bit of a long article but the concept is important and the points made are very true. i'd add a few things to the list but its a good start for folks who are in this position.

http://danieltenner.com/posts/0005-starting-up-with-a-friend.html

Posted on March 11, 2009
by Daniel Tenner

It seems like a fool-proof plan: start up with a close friend. You’ll get along (obviously), and you’ll get to share the exciting, fantastic, scary experience of starting up with someone you care about. It’s not a bad idea, but there are a few caveats that you should be aware of before you proceed.

When I started my first company with one of my closest friends, I expected things would go very well between us. We understood each other in ways that would take years to build up (and did take 10 years). We knew each other, and we knew we could rely on each other. We were prepared to have many surprises along the way — starting a business is always going to be a scary adventure.

What we weren’t prepared for was that the main problem would come from us and the dynamic between us.

What happened, in brief
I’m not going to go into all the details of what exactly went wrong, for a number of reasons (among them, it would be a one-sided account and inherently unfair on my friend and first cofounder). The long and short of it is, we had different expectations about the business. I left my safe, comfortable corporate job to work on it, so I needed it to succeed, or else I would find myself back in the corporate world. By contrast, my friend had already started several companies and was comfortably well off, so he didn’t have the same expectations and requirements.

It turned out we have a different definition of “the business isn’t working out”. For me, it was working out if it was making enough money to cover my expenses. For my friend, it wasn’t working out unless it was making enough money to also add to his existing wealth and thus justify the time and effort which he poured into it. Both those views were correct, but because we knew that we understood each other, we didn’t realise that our views were different until that difference had grown into a huge misunderstanding.

This core divergence of views could have been resolved easily if we’d known about it and discussed it ahead of time, but we didn’t know about it, so it festered and turned into dozens of other misunderstandings, so that by the time it finally became clear what our main divergence was, much of the damage was already done and it was entangled in a huge mass of emotional misunderstandings.

This almost cost us our friendship. We got through this thanks to the help and mediation of another very good friend, who helped us to communicate to each other how we felt, so that we could move forward together rather than against each other.

I’m glad to say the mediation worked, and we’re still friends (perhaps even stronger than before). Nevertheless, I learned some important lessons from this.

1. Make your agreements explicit
The first lesson is to keep agreements explicit. It’s not enough to think that your friend understands what you think: make sure he does by discussing it openly with him. As my mediating friend phrased it, “unspoken promises” have a tendency to turn into broken promises (which are always hard to swallow). Avoid unspoken promises.

Here’s an example of a really bad thing to keep implicit: “We’ll only call it quits if the business is bankrupt and can’t raise any more money.” The promise here is that we’ll keep going until the very end. This may seem obvious to one party in the business, but it may not be so to the other. One partner could, for instance, feel that the time to call it quits is when the business has 3 months of cash flow left. Another may feel that it’s worth going deep into credit card debt territory before giving up.

Don’t make this mistake: keep those agreements explicit.

2. Detail your agreements
Once you make some agreements explicit, it should become clear that you need further discussion to figure out exactly what your explicit agreement is. Don’t be afraid to do this. It’s not “too early to discuss this”.

Here’s an explicit agreement that’s not detailed enough: “We want the business to make a lot of money”. Really? How much are you happy with? 10’000 pounds a month? A million? What is the definition of success? It’s almost certain that you and your business partner have different views as to what “a lot of money” is. Being on the same page about what you expect out of your business will ensure that you don’t pull in different directions when things are going well. Think of how mortifying it would be to find out that your partner wants to pull the plug when you think that the business is successful.

3. Don’t be afraid of discussing the bad stuff
There are a number of subjects which seem almost embarrassing to discuss when things are going well. For example, “What if one of us decides to pull out?” Your first reaction to this topic might be “What? We’re barely getting started, and already we’re talking about what happens if one of us pulls out?”

The reality is that people’s life circumstances change through time. They get married, or decide to leave the country, or get engrossed in a different pursuit, etc. Many things can get in between a founder and his start-up. Similarly, many things can go very wrong with a start-up. When those things do go wrong, or when one of the founders decides to pull out, is not the time to discuss these things. You need to discuss them with a clear head when no one is thinking of pulling out and the business looks healthy and hopeful.

When you discuss your start-up’s future, do not be afraid to talk about the disaster scenarios. Also, when you negotiate what will happen if a partner quits, don’t be so sure that it won’t be you.

4. Write things down
There are two reasons to write things down: first, people’s memories of conversations are faulty. Writing things down also ensures that there is no disagreement, later, about what was decided. You don’t need a long document for this — even just one or two pages describing your agreement is enough to avoid later misunderstandings.

The second reason is that people may think they have reached an agreement when in reality they never agreed about the details. Once you put something in writing, you give it a certain air of finality that teases out those last remaining disagreement. Basically, putting an agreement in writing is like putting a new piece of functionality in code. Until it exists in that form, it’s just vapour.

Halfway through my misunderstanding with my friend, we thought we’d figured out a way forward. I wasn’t sure that we were both thinking the same thing, so I made the effort to put it in writing, in the form of a business plan. When my friend read it, and understood more clearly what I meant, he recanted, and the agreement fell through. It’s a good thing that it fell through, because it would likely have resulted in even more problems later on if we’d gone through with it based on our flawed understanding of each other.

5. Don’t make it work at all costs
Yes, I know this is your friend that you’re starting up with, and this is your great opportunity to start your own business. However, if, in those discussions, you find that there’s an intractable disagreement, don’t fall into the trap of thinking that the most important thing is to smooth things over and start the business.

Starting up with someone is almost like marrying them (temporarily), in a way. You’ll be talking to them almost everyday, and possibly even more than with your significant other. You’ll be working on a “baby” (your business) for many months. It’s a big commitment, basically, and much like any other kind of significant commitment, you shouldn’t go into it if you think there are major problems, because those problems will only get worse.

6. Don’t assume things will get better with time
It’s easy to rationalise away big problems by assuming that things will get better with time. In some cases, they will, but in a majority of cases, they won’t. What this means, for example, is that you shouldn’t assume that your inexplicably small share of the business will magically grow to 50% later on. This is even less likely to happen if the business is working well (if the business isn’t working out, chances are it doesn’t matter anyway).

Sample questions
This article wouldn’t be complete without a list of questions that you might go through and discuss with your cofounder. Use them as a guideline or as a checklist, as you please.
What do we both mean by “the business is successful”?
What do we both mean by “the business is not successful”?
What happens if one of us needs to voluntarily pull out, for any reason?
What happens if one of us cannot work on the business anymore, for involuntary reasons?
What are the conditions under which we’d call the business a failure and pull the plug?
What is plan B for each of us if we do pull the plug? Are we both prepared for that plan B?
What do we expect of each other, both in terms of responsibilities and in terms of attitude and effort?
What is and is not an expense? What is the maximum amount someone can spend on an expense without checking with the other? (from Sebastian Marshall)
When and how will profits be distributed? How much will be reinvested? What will the reserves be? (from Sebastian Marshall)
What happens if one partner needs cash and the other wants to reinvest it into growth/expansion? (from Sebastian Marshall)
How will you handle it when (not if) the hours each partner is working are unbalanced? (from Sebastian Marshall)
This is not a final list by any means, but it should at least provide some starting points to make the implicit explicit. If you have other suggestions, please do add them in the comments below.

Conclusion
I don’t regret starting that business with my friend, but I do regret not clarifying those kinds of questions upfront. It would have saved me a lot of worry. If your business is struggling, you don’t need the additional pain of seeing your friendship unraveling under the stress of accumulated misunderstandings.

So, do yourself a favour, and set out to:
Make your agreements explicit so that you don’t break implicit promises
Detail your agreements so that your promises are clear
Don’t be afraid of discussing negative scenarios, so that you don’t add the stress of misunderstanding to already bad situations
Write things down so you’ll remember
Don’t make things work at all costs, so that you don’t spend the next years living with a deal that’s not acceptable to you
Don’t assume things will get better with time, so you’re not surprised when they don’t