Startup Toolbox

Jay Parkhill May 7th, 2008

Todd Vernon is the CEO of Lijit and wrote a post this morning that covers all the bases in angel financings.

http://falseprecision.typepad.com/my_weblog/2008/05/angel-financing.html

I won’t rehash the whole thing, but will comment on a couple of points.

Todd’s analysis of the different types of angel investors is very insightful.  In my ten years of experience advising startups, the family investor class is the most common type, but the companies that are unable to broaden their investor base beyond that seldom succeed in raising further money.

The analogy to burning cash is a good one, though I usually use winning the lottery to make the same point.  Startup entrepreneurs should be aware that at least on some level investment in a brand-new company offers about as much hope of return as lighting cash on fire, or spending $25,000 on lottery tickets.  No one makes that decision lightly.

I mostly agree with Todd about convertible note financings, with a couple of qualifiers.  First, no company should offer convertible notes if it doesn’t intend to convert them.  Todd seems to say that some people might undertake note financings intending to pay them off in cash rather than equity.  That is a terrible strategy and borders on abusive.

Second is that I have done successful note financings.  In almost every case the Note investor(s) are also participants in the equity round and are using the Notes as a genuine bridge so that the company can get some cash while completing the steps to a larger investment.  Notes usually come with warrants or other discounts from the equity round so there can be tension between the Note investors and the equity investors.  Having the same people on both sides of the deal helps immensely to smooth that out.

Good post Todd.  I am going to send a lot of clients to read your summary.

• Financings , Startups

Jay Parkhill December 18th, 2007

Being at the top of any field is incredibly difficult- impossible, really, for all but a select few. The people who do work at the top generally spend years toiling away in the trenches building their credentials before they get recognized for their efforts.

That’s why it’s even more amazing when a complete outsider is able to step in and make a significant contribution to any field. Albert Einstein may be the best example anyone will ever come up with for this- he famously worked as a patent clerk while developing his special theory of relativity.

A backlash against upstart outsiders is also to be expected. When everyone else has to put in time and years deep in the field, how is it possible for an outsider to step in and contribute at the highest levels?

All of this, plus an interest in cosmology undeterred by (or because of) my poor math skills, explains why I find the story of Garrett Lisi so interesting. Lisi holds a doctorate in physics, but divides his time between surfing on Maui and snowboarding in Tahoe. Along the way, he claims to have developed a simple “theory of everything” to unite classical physics with quantum mechanics (it is based on the “E8” mathematical concept represented in the picture). It’s a bold claim- scientists have chipped away at the idea for decades with few testable theories to show for it. The person who eventually does crack the code will probably end up on a pedestal together with Isaac Newton and Einstein himself.

Lisi’s paper received both praise and criticism, as befits an audacious claim by an unknown scholar. I certainly can’t say if he is right or wrong. The business lesson I take from it, though, is that grand claims may be easy to make, but require extraordinary proof. If Lisi turns out to be wrong his career as a physicist will probably be over before it ever really started.

I prefer a simpler mantra I picked up from an old mentor: “underpromise and overdeliver“.

• Startups

Jay Parkhill December 8th, 2007

New Cycle Capital is a new venture firm with a mandate to make money while investing in the “green economy” and underserved domestic markets. This is an area I find fascinating because it is such an intricate dance; some of my earlier thoughts on it are here.

Companies focused on a single, economic bottom line really have one big thing to think about- making money. Companies that adopt a triple bottom line approach or some variation on it are juggling almost by definition to find a profitable business that supports the non-economic goals.

I think most companies can’t really put that off very well, which is why they settle for making money in one arena and using it to do good in others. Investment funds run much the same way. The Omidyar Network, for example, cites a commitment to “creating opportunity for individuals to improve the quality of their lives”, but a quick look at its Portfolio page shows a split between for-profit and non-profit investments.

Pacific Community Ventures is a $60M family of funds trying to do things differently. Part of their mandate is that portfolio companies employ a portion of their workforces in low/moderate income communities. They invested in Timbuk2, whose bags are made by just such people in San Francisco.

The fact that PCV is not a household name may suggest that this area is a hard-to-serve niche. I’ll be watching New Cycle Capital as another entrant in the field, and hoping to see more funds taking similar approaches.

• Startups , venture

Jay Parkhill November 8th, 2007

In Founders at Work, Joshua Schachter advises new entrepreneurs to keep the product simple- do one thing and do it well, in essence. This strategy worked well for del.icio.us, which is a simple (in a good way) web tool. He built it largely on his own in his spare time while working for Morgan Stanley and that setup worked very well for him.

Mike Ramsay from Tivo, on the other hand, developed an extremely complex product (I found great humor in the section of the book where he describes the enormous back-end efforts to manage programming information for every TV service in the US, and then explains why he feels compelled to throttle anyone who describes Tivo as “like a digital VCR”) that required enormous engineering, marketing and other resources. Tivo raised significant money from VCs and went public to raise even more. Again, this has worked well for Tivo.

This pattern also reminds me of the Dick Costolo/Marc Andreesen online debate about raising outside capital that I continue to see discussed from time to time. Dick built Feedburner with a relatively small amount of outside cash, developed an excellent product with it and sold the company to Google for a solid return. Consequently, his advice to entrepreneurs is to raise enough capital to allow for a good return for founders and investors even if the business is not a home run.

Marc, on the other hand, has built two large businesses and sold each of them for over $1B- two grand slams. Both companies were heavily VC funded and Marc believes that the cash gave both businesses the wherewithal to survive difficult times, revise their business plans and ultimately become very successful. Based on his experience, then, the advice is to raise as much money as possible whenever it is available on acceptable terms.

All of these companies and people were successful, which means all of them are correct. Del.icio.us and Feedburner needed only modest capital to acheive their objectives. Tivo, Netscape and Opsware needed far more.

This brings me back to a piece of advice I picked up years ago in an entirely different context. Professional cyclist Greg Lemond wrote a book on cycling training in which he talked about one of the great fallacies of training- emulating someone else’s habits just because the person was famous or successful. As he put it “what works for ___ is good because it works for ____. That fact that it worked for ___ doesn’t mean it is right for anyone else.”

In other words, the paths to success of others are valuable for the ideas they can provide, but they are not the “right” path for everyone. Past experiences are data points to analyze, not prescriptions to swallow whole.

• Financings , Startups , Tips & Tricks

Jay Parkhill October 1st, 2007

I like nothing better than when my worlds come together. I just finished listening to a very insightful podcast conversation between Jim Holland, CEO of Backcountry.com, and Chris Grover, Director of Sales and Marketing at Black Diamond. Startups, web services and outdoor gear are three of my favorite things.

The former company is an outdoor gear e-tailer and poster child for success by bootstrapping. It was founded in the 1990s, but unlike many of its crash-and-burn contemporaries it never raised outside money. I believe this let them chip away at the online marketing puzzle. Had they raised money, hired lots of people and jumped into lots of things before the revenue path became clear, they might never have made it.

Black Diamond is an interesting example of lemons-from-lemonade. Patagonia used to make rock climbing hardware until someone fell out of a harness, died and his family sued the company. Patagonia decided to get out of the hardware business and divested it- creating Black Diamond. The company has risen from that tricky start to become the major US brand in the Euro-dominated climbing/technical backcountry equipment market.

The podcast has a lot of interesting tidbits about marketing, leadership (esp. the difference between leading and managing), compensation (don’t trust the public statistics) and other important business questions. I wanted to to interview Backcountry.com co-founder John Bresee for a Startup Review interview a few months back, but we both got busy and never quite connected. The interview covers a lot of the same ground and it’s well worth the 40 minutes spent listening.

• Startup Review , Startups , Tips & Tricks

Jay Parkhill September 11th, 2007

I am reading a great book called Founders at Work: Stories of Startups’ Early Days- it is a compilation of interviews with tech company founders, prepared by one of the Y Combinator founders. The whole book makes for terrific reading, very much like Startup Review on a larger scale.

Excite co-founder Joe Kraus makes some phenomenal observations that go straight to the heart of the startup experience. When asked “Did it seem like you were onto something huge?” he responded by saying:

The hardest part in a startup is that you wake up one morning, and you feel great about the day and you think “We’re kicking ass.” And then you wake up the next morning and you think “we’re dead.” And literally nothing’s changed.

I’ve certainly ridden that rollercoaster many times since starting my own business, and I’ve learned that it is part of the process. Everyone wishes there was a linear path to success, but there isn’t. You just keep plugging along, trying everything you can think of, and when success happens you still can’t point to a single thing that caused it- it just happened.

Good book. It should be required reading at “startup school”- wherever that is.

• Startups , Tips & Tricks

Jay Parkhill September 11th, 2007

My friend Steve Poland roped me into an advisory role with Ringside Startup- he had the neat idea to extend the idea of crowdsourcing content into crowdsourcing a business itself. We and the commenters on the site talked a lot about securities laws and ways we might be able to get some equity to people contributing ideas.

Business Week Online has just written an article about Steve and the crowdsourcing concept. It does a nice job comparing efforts in the music, sports and tech spaces, and does a compare/contrast between Cambrian House (which I have covered before) and me.

It’s the first time I’ve been quoted in a major press outlet, so I am very pleased. They didn’t even misquote me!

• Blogging , Securities , Startups

Jay Parkhill September 10th, 2007

Vosnap is a project/company that emerged from Startup Weekend in Boulder, Colorado last July. A whole bunch of people locked themselves in an office for a weekend with a goal to launch a product by the end of it.

They still haven’t launched, but that doesn’t mean it’s not a great idea. Talented people working together are fun to behold.

One trick, though, is how to properly reward everyone’s efforts. This is really a question with two parts:

1) How to value each person’s contributions relative to the others; and
2) How to issue equity to each person under US securities laws.

The Sand-Dollar-Hour System
I once heard about an alternative economic system developed in west Marin County, Calif. It involved sand dollars as units of currency, and was completely egalitarian in that each person earned a certain number of sand dollars per hour worked, whether as neurosurgeon or streetsweeper. The idea never caught on much, but it stuck with me, and the Vosnap group seems to have done something similar.

As their blog explains, they have 60 contributors, each offering different sets of skills. Rather than try to make judgments of relative importance among them (a sure recipe for collapse of the project) each person got one “share” for each day at the weekend, up to 3.

Simple enough, though it would have been better if they had been sand dollars or cowrie shells. Nobody gets it perfect, I suppose.

Crowdsourcing Cleverness
I have written previously about crowdsourcing and securities law issues. The bottom line is that securities laws aren’t conducive to doling out shares to lots of people.

However, some clever soul must have considered that if each participant is “active in the business”, then the contributors can jointly form a limited liability company in which no securities “sale” is involved. That is to say, if the equity earned is all of the “sweat” variety, then there is no securities offering, and no securities compliance issues to worry about. Note that this only applies to LLCs, not corporations.

A Little Ugliness at Tax Season, but it Gets the Job Done
So Vosnap itself is a corporation, which works well for venture funding purposes. The LLC owns 1/2 of Vosnap, Inc., and the Startup Weekend participants own their relative shares of the LLC.

Clever. The tax issues are going to be a little messy when income tax season rolls around (there will be two entities to prepare tax returns/statements for, and each LLC owner will get a K-1 partnership statement to include in their personal returns), but it gets a piece of the business to all participants and gives them some incentive to keep plugging away at it. Nice thinking.

• Securities , Startups

Jay Parkhill August 28th, 2007

I’m a little late jumping on the bandwagon about Keith’s post, now two weeks old. The logic certainly makes sense- as one type of investment loses some luster another becomes more attractive (again). I didn’t post on it earlier largely because it was so well covered elsewhere I didn’t see a whole lot to add.

But then I realized I was wrong. I have two clients raising money right now, and both have had conversations with prospective investors who are really excited about the company, but loath to give up short-term gains they see markets delivering in the next few months.

As short as the timelines can be for tech-companies to start-up, build-out and exit, it’s still hard to convince an investor he should let his money sit idle in a company’s bank account rather than generate real cash in a six-month timeframe. Startups are risky, for sure, and even in the best cases the return is 1-2-3 years out or more. It ends up something like trying to convince the investor that two birds in the bush really are better.

I’m looking forward to seeing Keith’s prediction to come true and for “hedge fund fever” to abate a bit. The calculus is still skewed toward the short-term gains savvy investors can make; when a little more of the shine comes off the apple I am hoping that investors will be more comfortable balancing “longer term” tech company bets with shorter market-based approaches.

• Financings , Startups

Jay Parkhill August 22nd, 2007

I wrote a post for Found|Read on some common complaints I have heard about working with lawyers, and how to avoid them. The title was supposed to be “How to Work with your Lawyer”, but the “with” got dropped so now it reads “how to work your lawyer”. I guess that is ok, too.

• Blogging , Startups , Tips & Tricks