Skip to content →

Tag: startups

Advice VCs Want to Give but Rarely Do to Entrepreneurs Pitching Their Startups

I thought I’d re-post a response I wrote a while ago to a question on Quora as someone recently asked me the question: “What advice do you wish you could give but usually don’t to a startup pitching you?”

  • Person X on your team reflects poorly on your company – This is tough advice to give as its virtually impossible during the course of a pitch to build enough rapport and get a deep enough understanding of the inter-personal dynamics of the team to give that advice without it unnecessarily hurting feelings or sounding incredibly arrogant / meddlesome.
  • Your slides look awful – This is difficult to say in a pitch because it just sounds petty for an investor to complain about the packaging rather than the substance.
  • Be careful when using my portfolio companies as examples – While its good to build rapport / common ground with your VC audience, using their portfolio companies as examples has an unnecessarily high chance of backfiring. It is highly unlikely that you will know more than an inside investor who is attending board meetings and in direct contact with management, so any errors you make (i.e., assuming a company is doing well when it isn’t or assuming a company is doing poorly when it is doing well / is about to turn the corner) are readily caught and immediately make you seem foolish.
  • You should pitch someone who’s more passionate about what you’re doing – Because VCs have to risk their reputation within their firms / to the outside world for the deals they sign up to do, they have to be very selective about which companies they choose to get involved with. As a result, even if there’s nothing wrong with a business model / idea, some VCs will choose not to invest due simply to lack of passion. As the entrepreneur is probably deeply passionate about and personally invested in the market / problem, giving this advice can feel tantamount to insulting the entrepreneur’s child or spouse.

Hopefully this gives some of the hard-working entrepreneurs out there some context on why a pitch didn’t go as well as they had hoped and maybe some pointers on who and how to approach an investor for their next pitch.

(Image credit – Someecard)

Leave a Comment

The Four Types of M&A

I’m oftentimes asked what determines the prices that companies get bought for: after all, why does one app company get bought for $19 billion and a similar app get bought at a discount to the amount of investor capital that was raised?

While specific transaction values depend a lot on the specific acquirer (i.e. how much cash on hand they have, how big they are, etc.), I’m going to share a framework that has been very helpful to me in thinking about acquisition valuations and how startups can position themselves to get more attractive offers. The key is understanding that, all things being equal, why you’re being acquired determines the buyer’s willingness to pay. These motivations fall on a spectrum dividing acquisitions into four types:

four

  • Talent Acquisitions: These are commonly referred to in the tech press as “acquihires”. In these acquisitions, the buyer has determined that it makes more sense to buy a team than to spend the money, time, and effort needed to recruit a comparable one. In these acquisitions, the size and caliber of the team determine the purchase price.
  • Asset / Capability Acquisitions: In these acquisitions, the buyer is in need of a particular asset or capability of the target: it could be a portfolio of patents, a particular customer relationship, a particular facility, or even a particular product or technology that helps complete the buyer’s product portfolio. In these acquisitions, the uniqueness and potential business value of the assets determine the purchase price.
  • Business Acquisitions: These are acquisitions where the buyer values the target for the success of its business and for the possible synergies that could come about from merging the two. In these acquisitions, the financials of the target (revenues, profitability, growth rate) as well as the benefits that the investment bankers and buyer’s corporate development teams estimate from combining the two businesses (cost savings, ability to easily cross-sell, new business won because of a more complete offering, etc) determine the purchase price.
  • Strategic Gamechangers: These are acquisitions where the buyer believes the target gives them an ability to transform their business and is also a critical threat if acquired by a competitor. These tend to be acquisitions which are priced by the buyer’s full ability to pay as they represent bets on a future.

What’s useful about this framework is that it gives guidance to companies who are contemplating acquisitions as exit opportunities:

  • If your company is being considered for a talent acquisition, then it is your job to convince the acquirer that you have built assets and capabilities above and beyond what your team alone is worth. Emphasize patents, communities, developer ecosystems, corporate relationships, how your product fills a distinct gap in their product portfolio, a sexy domain name, anything that might be valuable beyond just the team that has attracted their interest.
  • If a company is being considered for an asset / capability acquisition, then the key is to emphasize the potential financial trajectory of the business and the synergies that can be realized after a merger. Emphasize how current revenues and contracts will grow and develop, how a combined sales and marketing effort will be more effective than the sum of the parts, and how the current businesses are complementary in a real way that impacts the bottom line, and not just as an interesting “thing” to buy.
  • If a company is being evaluated as a business acquisition, then the key is to emphasize how pivotal a role it can play in defining the future of the acquirer in a way that goes beyond just what the numbers say about the business. This is what drives valuations like GM’s acquisition of Cruise (which was a leader in driverless vehicle technology) for up to $1B, or Facebook’s acquisition of WhatsApp (messenger app with over 600 million users when it was acquired, many in strategic regions for Facebook) for $19B, or Walmart’s acquisition of Jet.com (an innovator in eCommerce that Walmart needs to help in its war for retail marketshare with Amazon.com).

The framework works for two reasons: (1) companies are bought, not sold, and the price is usually determined by the party that is most willing to walk away from a deal (that’s usually the buyer) and (2) it generally reflects how most startups tend to create value over time: they start by hiring a great team, who proceed to build compelling capabilities / assets, which materialize as interesting businesses, which can represent the future direction of an industry.

Hopefully, this framework helps any tech industry onlooker wondering why acquisition valuations end up at a certain level or any startup evaluating how best to court an acquisition offer.

Leave a Comment

How IPOs are Doing in the Public Markets

After reading my last post on what the decline in recently IPO’d startups means for the broader tech industry, a friend of mine encouraged me to look closer at how IPO’s in general have been performing. The answer: badly

Recent IPO performance vs S&P 500 over last year

The chart above shows how Renaissance Capital’s US IPO index (prospectus), which tracks major IPOs in US markets, has performed versus the broader market (represented by the S&P500) over the past year. While the S&P500 hasn’t had a great year (down just over 10%), IPOs have done even worse (down over 30%).

Leave a Comment

Crowdfunding: Hardware Startups Beware

Hardware startups are one area I spend a fair amount of time with in my life as a VC, and while I love working with hardware companies, it should go without saying that hardware startups are incredibly difficult to do. They require knowhow across multiple disciplines — software, electrical engineering, industrial design, manufacturing, channel, etc. – and, as a result, have challenges and upfront capital needs that most software/web companies lack. This has led many angels and VCs to be wary of investments involving building hardware so its no small wonder, then, that many hardware entrepreneurs have turned to crowdfunding websites like Kickstarter and Indiegogo to try to raise funds for development.

While crowdfunding can be a great fit for certain projects, I think early stage hardware startups should beware. Yes, crowdfunding sites can generate upfront capital that can fund development, but unlike traditional equity/debt investments (like the kind an angel or VC or bank will give you), “crowdfunding capital” has a particularly onerous type of “string attached”: it’s a presale.

Obviously, the entrepreneurs trying to raise crowdfunding capital want to push their projects towards real sales – so why might a presale be a bad thing? For hardware companies:

  • Raw production costs are a major percentage of sales – so even if you raised $1 million, you probably are going to be able to keep max $500,000 after the cost of materials/manufacturing
  • These pre-sales are oftentimes discounted – so you are generating lower margins on each unit making these particularly painful sales to make
  • Except in a few instances, the number of presales tends to not be high enough to meaningfully change the cost of manufacturing (i.e. upfront tooling costs or supply procurement) – which further eats into the amount of capital you have left to deploy on development since you probably have to pay the low volume price
  • It means you need to keep to some level of deadline. There is a risk that you won’t make your own deadline and there’s also risk that the time pressure might lead to tradeoffs (leave out a certain feature or asset, run fewer tests, etc.) which could hurt your reputation since the public will be getting its first impressions of your company based on that initial launch.
  • It publicly commits you to a particular product even if you learn that your initial idea is wrong or needs tweaking.
  • It tips off the market and potential competition earlier since you likely are doing this at a point before your product is ready and need to provide a fair amount of detail to get supporters.

In the end this “capital” ends up being a very real “liability”, and is a big part of why serious hardware startups that do crowdfunding almost all go back to the traditional VC/Angel community – it is simply not practical to scale up a meaningful hardware business on crowdfunded capital alone.

That said, there are definitely cases where it makes sense for hardware companies to use crowdfunding – and they are cases where the above problems are irrelevant:

  • If your cost of production is tiny relative to the price (think pharmaceuticals, software, music, movie, etc. – trivial cost of production per unit sold)
  • If you’ve already completed the vast majority of development or managed to get capital from another source and are simply using crowdfunding to either gauge customer interest or raise publicity
  • If your intention is to raise money from a VC/angel using a crowdfunding success story (that you’re positive you will get) to show that a large market exists for your product
  • You couldn’t raise money from VCs period and have no other choice

In the first case, a very low cost of production means that more dollars raised can actually go into development, irrespective of volume of production and discounts. In the second case, the pre-sale becomes a good thing: a market signal or a heavily publicized pre-sale for a product which is/is almost done. The third is very risky – because I would maintain its nigh impossible to know if a crowdfunding attempt will “go viral” and even if it does, you are still left with the liability of these presales that you need to fulfill. The last is self-explanatory :-).

If you are an aspiring hardware entrepreneur, in almost all cases your best bet will be to go with traditional equity/debt financing first. Obviously, I am in part biased by my current choice of profession but while VCs and angels can be annoying to deal with and raise money from, the lack of the pre-sale liability and their potential for connecting you with potential hires and partners makes them a much better fit.

Got any questions? Disagree? I want to hear from you!

2 Comments

Tomorrow’s Pets.com

petscomToday, it seems perfectly obvious that building an internet business to sell pet food to customers where shipping and logistic costs (let alone advertising costs, etc.) wiped out any chance of profitability was an idea doomed to fail.

But, was it obvious at the time? While some folks will claim they knew all along, the market evidence suggests that most people had no clue: after all, the company raised over $110M in capital from Hummer Winblad, Comcast, Amazon.com, and others. It went on to successfully IPO in 2000 and at one point employed over 300 people. If it was such a terrible idea, it seems that it took quite a while for people to catch on.

This isn’t to specifically pick on Pets.com – quite the opposite: when you work in technology, there is oftentimes so much change and uncertainty around the future that its not obvious that the “emperor has no clothes” until its too late, oftentimes driven by entrepreneurs, career-seekers, and investors willing to pile on to make sure that they “get in on the action before its too late.”

And therein lies a very interesting question: what are the ideas/companies that have generated a ton of traction today which will become “duh, stupid” Pets.com ideas of tomorrow?

Examples of companies that flew high once and “obviously” crashed afterwards (most of the Dot Com bubble companies, many of the Cleantech bubble companies, some prominent consumer internet companies, etc) suggest that ignoring economic realities is a common refrain. Many of the failed Dot Com bubble companies and many of the challenged consumer internet companies relied primarily on drawing eyeballs to their websites/apps without figuring out how to make money enough on them to recoup their costs of marketing & advertising. The cleantech companies, similarly, gambled wrongly on government support and on their ability to make their technologies competitive with conventional systems.

But, the danger of generalizing from this type of thinking is that are plenty of examples of huge companies which succeeded despite bleak economic pictures in the early days. Amazon.com is a particularly noteworthy company that aimed to grow first before worrying about profitability (something it continues to do in a number of new businesses), not generating profit until late 2001, 7 years after founding, and over 4 years after it went public. Considering the company is worth over $100B today, compared with roughly $400M when it went public, it would seem blindly paying attention to the immediate economic picture would’ve cheated you out of a very impressive investment.

The truth is that I don’t have a good answer to this question. Studying what led to the failure of past startup models can be very informative in terms of how to think about other businesses, but the truth is that we aren’t likely to know until it hits us. Who knows, maybe in a few years “Big Data” or “Mobile advertising’ might all be revealed to have been terrible businesses…?

I would love to hear any thoughts on the subject in the comments below.

(image credit – Pets.com sock puppet – RightStartups)

One Comment