500 Startups demo day

I crashed my first demo day today at 500 Startups.  As with all good things, it came about via a stupid coincidence.  I’m an investor in 500 Startups, but hadn’t yet managed to get myself on the official LP mailing list so I had no idea an investor day was coming up.  I plopped down in seat 10A on the Alaska bus to San Jose, and of all the damn coincidences, my good friend and cofounder from Ontela, Brian Schultz, had the seat next to me.  I asked him what he was up to and he told me he was headed down for 500 Startups demo day.  I zipped off an email before the flight attended shut me down and had an invite by the time we hit 10k feet.

500 Startups is an interesting beast.  The fund has $29MM under management with over 250 investments, only half of which are in the valley.  Companies came from as far as Japan (cloud data processing) to Brazil (educational test coaching).  Here’s some of the companies that stood out to me:

TinyReview was super cool – like instagram + twitter + yelp.  You go somewhere, take a picture, and put 3 extremely short lines of text on it – two or three words per line, tops.  Looks like fun, good traction, and the service just feels like something people will enjoy playing with.  But I’m skeptical of the positioning as a review site.  My top use for a review site is to recommend stuff – not actually clear to me how you use microhaikus to find a great restaurant, unless you’re just reading a lot. It looks like a great creative palette but not like a great reviews site.

The concept behind Spinnakr is great.  They do lots of crazy analysis on a per-user basis and help you customize your content for the actual human being doing the visiting.  Bit creepy.  But the pitch is golden – a job site can highlight jobs that are relevant to you.  A news site can bubble up information that’s relevant to you.  They make a strong claim that the big sites are doing this already, so they can bring the same tools to the little guys.  The founders have a cool background too – fundraisers from politics who are experienced with targeting and what it does.

Switchcam is, in their own words, “blowing people’s faces off”.  These guys scoop up a bunch of online videos of events and stitch them together.  Imagine watching a video of a concert, as filmed through a dozen camera phones – complete with pans, cuts, and even the ability to grab the director’s chair and pick your “camera angle”.  Love the technology.   Not so in love with knowingly hosting large quantities of pirated content, and automatically categorizing it for easy takedown notices.

MeMeTales has a special place in my heart because they’re an ex-Seattle company that I mentored in the first Seattle Founders’ Institute class.  Maya is awesome, and she moved the company down to the valley (boo, hiss) to take 500s funding and really grow the business.  They’re doing online and mobile storybooks for kids – great growth, and spectacular stickiness with an average session length of 29 minutes.  The books look great; I was particularly partial to “Richard was a Picker”, about boogers.

Postrocket says they’re like SEOmoz for Facebook.  In English, they optimize facebook posts to make it more likely that a given post on Facebook gets seen and “like”‘d.  I didn’t catch quite how they do this, but they have a great story that includes dropping out of college to go on a 46 hour Boston-to-Palo Alto pilgrimage to the valley to start the company.

Fitocracy gets marketing: they’re about fitness, so they showed photos of the founders, before/after, chubby/sleek, XXL-t-shirted and… yes, shirtless.  The only thing they left off their pitch (and I can’t believe they did) was their own XKCD comic (http://xkcd.com/940/).  Nice way to game-ify fitness.

GoVoluntr has the distinction of being the only startup pitched by an actual Got Milk ad model.  But they had a great pitch: former Starbucks guy has hard numbers that community involvement drives growth and revenues.  So they get businesses to donate products and services to people who are volunteering, and provide tools to help volunteers track their engagement and pick up perks from participating companies.

All in all, a solid showing – 32 companies, plenty of which show loads of promise.  Great work to Dave and team!

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Companies that would do best without venture capital

I just got the following email.

Subject: Small taxi company looking to expand

Hello,

I run a small taxi company outside of Boston Massachusetts. My community has been targeted for casino development and I am looking to expand my business. Could you possibly provide some advice on how to find venture capital?

For someone who lives in the startup world, this looks pretty silly.  But I’m sure I’d say a lot of silly things if I were getting in to the taxi business, too.  So I figured I’d point him to a simple explanation of why taxi companies (actually, services companies in general) aren’t appropriate for VC.  I did the Google thing for a bit to find a good article.  And no luck.

Well, you know what they say: when the internet fails you, make more internet.  Here, then, are a very good set of reasons not to take venture capital (or – why venture capital won’t take you).

1.  You want to build a profitable company

First day of Founder’s Institute I ask how many people want to raise venture capital.  Most of the hands go up.  I then ask who wants to build a profitable company.  Again, most hands go up.

The funny thing about this is – VCs don’t actually like their companies to be profitable.  Someday, sure, but not on their watch.  You see, profitability means that the company wont grow any faster.

This seems odd, but think about this for a minute. At the early stages, a company may be making money, but it’s almost certainly investing every penny it makes back in to the business.  If it has access to outside capital (e.g. a VCs), it’s investing more than it makes.  And that’s exactly what VCs like: companies that can grow at amazing speed, and never slow down their burn rate to amass cash.

They like this for two reasons.  First, VCs want to invest in companies that can grow explosively.  That means huge markets, executives who can scale up a business fast, and a willingness on the part of management to double down on a winning bet – over, and over, and over again.  Second, because it means the company keeps coming back to the VC for more money on positive terms.  That means the VC keeps getting to buy more and more of the growing concern.

Of course, this is something of an over-broad generalization.  I’m required to include one per post or I lose my startup blogging license.  In fact many venture backed companies are profitable, it’s very impressive to bootstrap your company to profitability in a few months before raising outside investment, etc.   But if you are excited about a profitable business that can cut you giant dividend checks (not that most VCs can even accept divided checks  - long story), realize that VCs will not be pleased with that approach to running the business.  They will want you to plow those earnings back in to the business.  And when the day comes that a VC-backed business generates cash faster than it can effectively spend it?  They sell the company, or IPO (which is technically also selling the company), or replace the CEO with someone who can spend faster.

A taxi business should be run for profits.  That’s not VC style.

2. Your business has reasonable margins

As a general rule, VCs don’t like reasonable margins.  They are exclusively interested in outrageous margins.  Ludicrous margins.  We’re talking about sneering at 50%, and hoping for 80%, 90%, crazy astronomy stuff.  Venture capital is all about investing a little bit of money to create a business with massive scale and huge multiples – investing tens of millions to build software that then can be duplicated or served up for virtually nothing extra per-person with a total market size of billions.

In particular, VCs don’t like businesses that are people-powered.  Software businesses are awesome, but their evil twin – software consultancies – are near-pariah to VCs.  If adding revenue means adding bodies, they don’t like it.  In fact, enterprise software companies, which can tread a fine line between software consulting & software development, sometimes get really creative to come down on the right side of the line.

So the rule of thumb is that VCs like product companies: software, drugs, cleantech, and so on.  And they don’t like the manufacturing, service industry, and consulting businesses that often are just a tiny shift of business model away.

Every new taxi requires a… well, a new taxi.  And a new taxi driver.  Not the right business for VC.

3. You are going to double your investors’ money

I’ve covered this before, but VCs really don’t want to double their money.  Strange though it sounds, their economics make that look like a failure.  They need to target a 10x return on their investment, and that means – depending on stage and fund size – that you company has to grow to somewhere in the hundreds-of-millions to billions range to be interesting.

That means taking your taxi business from $20MM in annual revenue to $40MM just doesn’t do it for them.  Particularly because the valuation multiples on the aforementioned lower-margin businesses are smaller.

4. VCs probably don’t want to invest in you

Here are the people VCs really love to invest in:

• Entrepreneurs who’ve already made them lots of money
• Their closest buddies

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You’ve got a little schmutz on your logo

I was just creating an account on Sprouter today and started poking around a bit. It’s a nice site, in the vein of Quora or OnStartups Answers. But something about it seemed just a tad… off.  Amateurish.  And then I realized what it was.

Honey, you've got a little schmutz on your punim

These are the fateful words my mother would utter right before licking a napkin and going in for the cleanup.  A kid’s adorable with raspberry juice on his face, but your business should put its best foot forward.  JPEG artefacts are not adorable, and while most visitors won’t notice them consciously, it just mucks up your image.  (Update: commenter grishick points out that Sprouter has polished up their logo right nice.)

Allow me to demonstrate.

Schmutzy JPEG:

Let me get that off your face:

Not a dramatic difference, to be sure.  And I made it a bit more egregious by cranking up the JPEG compression on the first version, although I’ve seen worse.

But it’s funny the subtle cues that signal “Real, grown up company” versus “Raspberry-stained toddler company”.  This one’s cheap and easy to fix.  Use your logo as a PNG, which offers lossless compression, and not a JPEG (or, heaven forfend, a GIF).  Go check right now.  Check the properties of the header on your home page.  PNG images across the board?  Good to go.  JPEGs?  Have a little chat with your designer and get the PNG versions.

One minor point: JPEGs offer better compression in some circumstances than PNGs, so keep an eye on your page load times.  But most logos compress well as PNGs, often better than as JPEGs – this may wind up as a win too.

So wipe the schmutz off your logo.  Your bubbe will be so pleased.

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Don’t ask for introductions to investors

Raising money is hard, and there’s no way to screw it up faster than going around asking, “Hey, could you introduce me to some investors?”  It’s sort of like when, on the second day of school, a goofy freshman asked me if I could introduce him to any girls.

Reason 1: Not every investor is the right investor for you

Asking for introductions to “investors” marks you as someone who doesn’t really know what they’re doing.  An investor/company match is very specific, and if you want to find your fit, you’re going to have to figure out what you’re looking for.

Most investors specialize in certain fields.  Some will invest in early stage companies, some later.  Some will invest in entrepreneurs they’ve just met; some will only invest in people they’ve known for years.  Some require a track record and grey hair; some like betting on smart people straight out of college.  Some invest big, some small.  Some do just a few investments a year, some do hundreds.

Furthermore, investor styles differ.  Some give you tons of room to maneuver; some like to work closely with you.  Some offer tons of help and advice; others are just about the cash.  Some will want regular updates; others don’t like to be bothered.

Before you start looking for investors, figure out what kind of investors you want, and what kind of investors will want you.

Reason 2: It’s lazy and rude

Somebody has to be the matchmaker.  That means thinking about your startup, then comparing it to every investor your contact knows and decide if it’s a fit. The right person to do that (or at least take a first pass at it) is you, since you know your company best, and only you know who you’ve already talked to.  You do this by researching your contact on Linkedin to figure out who they know, then researching those investors to see who’s a good fit.  Check their website, their portfolio, their blog – get a sense of what they look for, and cross them off the list if they already have competing investments.

Sound like a lot of work?  It is.  That’s why you should do it, not your friend.

Reason 3: They’ll give you a crappy introduction

Asking for an introduction from someone who doesn’t know you well yet never works.  If you haven’t pitched your contact and sold them on how awesome you are, there’s no way they are going to convince an investor to take a chance on you.  That’s because they’re going to have to tee up the intro, and if the nicest thing they can say about your company is that it “sounds interesting”, the intro isn’t going to go anywhere.  You want them super-jazzed about what you’re doing, and more importantly, you want them to be able to deliver a summary of your company in one or two sentences.  So give them the pitch and ensure they love it.

Note that this all implies that you can summarize your own company in one or two sentences.  This deserves an article of its own.  Actually, it deserves a book of its own, and that book is “Made to Stick”.  If you’re stuck, go read it.  But I digress.

A great investor intro is about conveying enthusiasm.  So you need to sell them, then give them simple tools to sell the investor.

The right way

Step 1: Do your homework.  Before you meet your contact, have an explicit list of 1-4 people you would like an intro to.  And this is definitely about people – it’s better to ask for an intro to Bob Smith than it is to ask for Acme Investors.

Step 2: Pitch your contact first.  Treat them like an investor, even if they’re not.  Good first-pitch rules apply: don’t teach them; tease them.  Show them just enough to get them to want more.  Be sure to hammer your one or two line summary a few times so they know it.

Step 3: The ask.  Say, “If you wouldn’t mind, I’d really appreciate introductions to A, B, and C.  Can I shoot you an email with a one paragraph summary of the business that you can forward along?”

Step 4: The reach. NOW is when you say, “And are there any other investors you can think of that I should be talking to?”  You’ve done your homework, they know about your business, it’s OK to ask them to ponder a bit to see if you missed any one.  And it’s easy for them to say,  ”No, your list is great” – you’re not obligating them to come up with any one.

Step 5: Followthrough.  Immediately after you step out of the meeting, send separate emails – one for each invitation request – that say something like:

Hello <contact>!  Thanks for taking the time to talk today.  Your perspective on the business was really helpful.  I appreciate you offering to connect us with <investor> – feel free to forward this email to <him/her>.  I’m including a brief description of us below.

<<brief description of business>>

Again, do one per investor, so they can easily forward each one to the right person, hopefully along with a little note that says you’re not a bozo.

Fundraising is hard

Look, I’ve been there.  Fundraising is daunting.  Actually, terrifying.  You want to be able to just get it done, so you imagine that it’s possible to just ask around, meet some nice people, wow them with your charm/business plan/demo, and get on with building your company.  And sometimes it is.

But it’s usually not.  And the teams that invest the most in fundraising seem to have the best results.  (Well, the teams with huge traction or great resumes have the best results, but if you’re killing it on those fronts, you’re already cashing investor checks). If you’re a new team with a demo and a dream, you’ve got a lot of work cut out for you.

So don’t shy away from it.  Learn your network’s network, ask for smart and specific intros, and you’ll meet your dream investor soon enough.  Happy fundraising!

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How to handle a VC who flies First

I’m continuing to enjoy Brad Feld and Jason Mendelson’s outstanding book, “Venture Deals”. On page 106 (of the Kindle edition, at least) they address an issue that’s very minor unless you’re dealing with it: board members who like to live large on the company dime.

VCs will charge all reasonable expenses associated with board meetings to the company they are visiting. This usually isn’t a big deal unless your VC always flies on his private plane and stays at the presidential suite at your local Four Seasons hotel. In the case where you feel your VC is spending excessively and charging everything back to the company, you should feel comfortable confronting the VC. If you aren’t, enlist one of your more frugal board members to help.

This advice is great, but things can sometimes get hairy – you may not have a frugal board member who wants to challenge your large-living board member on the topic.  I had a similar situation at a past company, and while it never occurred to me to ask another board member to help, we came up with our own solution.

Without placing any blame, we wrote up a reasonable travel expense policy for the company.  We then brought it to the BoD and asked them to approve it.  I explained that expenses were getting a little out of hand, and we wanted to reign things in.  I then said the magic bit – “Since this will apply to everyone submitting expenses, including me and any other board members who are traveling, I wanted to have it officially adopted by a board action.”  It was approved without any fuss.

The policy clearly stated that, for example, that the maximum reimbursement was the cost of full-fare coach.  So when a first class ticket came in, we priced how much the coach ticket would have cost, and that was the amount of reimbursement sent.  The board member’s admin asked why the full reimbursement wasn’t included, our comptroller explained, and the whole thing was quietly* solved with no bruised egos.

*some might say passive-aggressively

Postscript: Some folks in the comments have shaken their firsts at VC’s greedy ways.  I should note:

1. This person was a really great guy, and I’m sure wouldn’t have done this if he knew how much it bugged me (part of why I wanted to spare him the embarrassment of confronting him about it).
2. It’s possible that he didn’t know about it; he had an admin, and admins will often handle upgrades (complimentary ones). Many see their job as taking care of their boss, not their boss’s portfolio, and may book first (while the VC thinks they just got a comp upgrade).  I’ve known this to happen at least once.
3. People like to dig on VCs, but the ones I know are almost entirely great folks, which is saying a lot for a job that consists of saying no to 99.9% of the time.

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What to do when an investor asks you for your business plan

I’m digging in to Brad Feld and Jason Mendelson’s outstanding new book, “Venture Deals”. It’s full of both thoughtful analysis and commonsense wisdom about how to make a financing successful.

In one section, they discuss the “business plan”:

“We haven’t read a business plan in over 20 years. Sure, we still get plenty of them, but it is not something we care about as we invest in areas we know well, and as a result we much prefer demos and live interactions…. However, realize that some VCs care a lot about seeing a business plan, regardless of the current view by many people that a business plan is an obsolete document.

They go on to caution you:

Regardless, you will occasionally be asked for a business plan. Be prepared for this and know how you plan to respond, along with what you will provide, if and when this comes up.

Unfortunately, this is where the topic ends – they don’t tell you what to do when an investor requests that you conjure an obsolete 30-page document from the ether and send it to them that evening.

A straightforward executive summary

I’ve been in this situation, and it’s very disconcerting.  With my first company, Ontela, we pitched about 70 VCs for our Series B.  More than half of those were in person, and not a single one asked for a business plan.  We talked to dozens of VCs (I didn’t keep track of how many) during our Series A as well, and got zero business plan requests.  But during Ontela’s seed round, when we pitched probably 100+ angels, it came up more than a few times.

Whenever it did, we (“we” was usually my cofounder Brian Schultz and I; Charles Zapata, the third cofounder, was busy building product) were somewhere between guilty and scared.  Guilty that we had skipped something that was clearly important, and scared we’d look like idiots.  There was a lot of hemming and hawing before we figured out a foolproof solution.

Whenever an investor asks you for your business plan, send them the same damn packet you send to everyone else.  In our case, that was a 3-page “executive summary” and a dozen slides giving an overview of the business with some screenshots of the product (it was mobile, and 2006, so there wasn’t any easy way to send them a demo). Don’t apologize and don’t mention the business plan.

We did this at least a dozen times and had precisely zero complaints.

One final note: investors who want business plans are probably not your target market, if you’re founding a high growth technology startup.  We had lots of great followup conversations with the angels who wanted them, but ultimately none of them turned in to investors.

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A Twitter, a Hoverboard, or something in between

There are two very special types of startups that you should know about: the Twitter Startup and the Hoverboard Startup.  If you’re one of these and don’t know it, you’re going to screw up your pitch.

Imagine walking in to hear a startup pitch its goods.  The CEO gets on stage, clears his throat, and starts talking about the number of teenagers in western countries, and their per capita disposable income.  As he drones on about trend cycles and market prediction, you rudely glance at the company summary and it says “Foot-propelled play device with gravitational repulsion field for friction minimization”, and you realize that he’s trying to pitch you a hoverboard.

You’re thinking about this:

and the slide he’s on is this.

You seriously don’t care about his viral strategy or exit strategy, you just want to know if he’s invented the secret of levitation.  If he has, you’re pretty sure the rest will follow.  If not, then… well, then you’re going to have some stiff words with the “friend” who suggested you meet.  A Hoverboard Startup is one where the problem is screamingly obvious, but the solution is prohibitively hard.  The only real question in a Hoverboard Startup is – how good is your solution?

Now imagine a second pitch.  Someone charismatic and exciting is painting their vision of a new future.

“Facebook has hundreds of millions of users.  But you know what?  It’s too complicated.  Here’s what we’re going to do.  First, we don’t host apps any more.  They’re distracting and a security risk.  Second, we get rid of pictures.  Too much storage.  Third, we get rid of profiles, or at least all but one sentence of them.  We also get rid of school and work affiliations, skip all the new stuff like location and checkins, and pretty much kill all the privacy settings so everything is just public by default.  Won’t that be AMAZING?”

You look confused.

“What’s left?”

“Well, you can friend people.  But of course we removed the feature where they have to confirm that you’re friends, so we’re going to rename it to either ‘following’ or ‘stalking’, we haven’t decided.  And you can post status updates to your wall. But we decided to cap those at 140 characters.”

“That’s it?”

“Yes.  It’s going to be huge!”

Now think about the questions in your mind.  You’d probably look at the technical chops of the founders, consider that what they’re trying to do is a tiny fraction of the complexity of Facebook, and assume that it’s not going to be very hard to solve the problem technically (you’d be wrong, of course, but that’s besides the point).  You’d just be sitting at there, staring in wonderment, going, “Why the hell would anybody care?”

In other words, this startup is the exact opposite of a Hoverboard Startup. A Twitter Startup is one where the solution is straightforward, but it doesn’t appear to actually solve any problem.

Now most startups are neither fish nor fowl.  Both the problem and the solution seems intuitively reasonable but neither one is totally proven.  But recognize if you’re a Twitter Startup or a Hoverboard Startup:

Twitter Startups

• Instagram (What exactly is the market for mobile photoshop filters?)
• AirBnB (Really, how many people want to sleep on an airbed?)
• CueCat (Do people want their own personal dedicated hardware barcode reader?  Oops – no, they don’t.)

Hoverboard Startups

• EnerG2 (Yup, if you can make batteries that hold twice as much juice, people will buy them.)
• Mint (If it were somehow possible to make personal finance like 500 times easier, then people would want that.)
• Steorn (Free energy?  Yup, that would be nice, if it were possible.  Wait! It’s not.)

If none of these apply to you – congratulations, you’re a normal startup.  Use the standard pitch deck template, and divide you’re time accordingly.  But if you’re a Twitter, you can almost skip the demo – you want to show customer research and traction, because the only thing they’re going to want to know is if anyone gives a damn.  And if you’re a Hoverboard?  Well, you’d better be levitating by the third slide, or your investor is going to be out of there.

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Why I sold my startup, Sparkbuy, to Google

Shortly after the sale closed, John Cook interviewed me about the experience.  He did a great job of transcribing all of my verbal gems, like “Maybe that is an economic way of looking at it, or something that I am unfamiliar with.”  I’m not even sure what that means.

It was the best I could muster in the middle of a crazy, exciting, wild time.  But looking back, I realize that there’s an important question there and I didn’t do it justice.  Selling a company can be a very lonely decision, so I want to revisit John’s question and share my thinking with others who might be making the call.

It was a great deal for the shareholders

Most VCs don’t care how long your company takes to show a return – they don’t get to re-invest proceeds of their deals, so if you exit early, the money sits in a bank account earning interest for years instead of contributing to their returns.  Since my investors were angels, they would look at the exit on a time-adjusted return basis.  Or put simply, if I could give them back their capital plus a great return in just six months, that could be a terrific outcome.

It was our #1 choice of acquirer

Most startups are acquired.  Actually, most startups fail – but of those that are successful, most are acquired.  Given that an acquisition was, one way or another, the most likely outcome for Sparkbuy, I compared Google to a list of about a dozen other potential acquirers.  They were at the top of my list.  If was going to go to work for The Man, I was more excited about The Man being Google than anyone else.  The employees (both of them!) felt similarly.  Even the investors appreciated the bragging rights of having a portfolio company sell to Google.
Further, the people who I would be working with were amazing.  Scott Silver has always been one of my engineering leadership idols.  After trying to recruit Phil Bogle to Ontela I knew I wanted to find a way to work with him.  While I’ve never been excited about having a boss again, Nick Fox was someone I actually knew I’d enjoy working with and learning from.

I was excited about pursuing the Sparkbuy vision at “Google-scale”

The Sparkbuy product was launched out of a personal frustration with consumer electronics shopping, but the problem is much broader.  It’s just hard to find reliable, accurate, unbiased, quantitative information about products.  Search engines favor old prose over fresh data.  Sparkbuy was about helping consumers make better decisions.

The team I’m working on now is taking that opportunity to the next level.  With business development resources, the Google brand, Fortune-100 budgets, and an appetite for giant risks, we can tackle problems at a broader scale than ever before – making consumer purchasing easier, better informed, safer, and faster.

Working a real job sounded like a good idea for a while

After eight years at startups, the idea of pulling a steady paycheck for a few years was seductive.  Some personal events, while ultimately amounting to nothing, made me feel like having great health insurance wasn’t a bad idea either.  (Soapbox sidebar: health insurance reform is key to promoting entrepreneurialism and small businesses in this country!)  I loved the idea of keeping a more regular schedule, and spending a bit more time with my family.

The money was life-changing

While I’m not in the position of my good friend Rand, who’s gone on the record saying that his life savings is $25,000, I was not previously wealthy.  The Ontela/Photobucket merger was a spectacular deal for all parties involved, and I didn’t take any cash of the table – I’m still 100% invested in Photobucket.  That means the Google sale accomplished three lifelong goals for me: allowing me to set aside enough to pay for my twin toddlers’ college educations, funding my wife and my retirement account, and giving us a financial cushion that means I’ll never have to work at a job I don’t love. It also meant that, overnight, I can pay some karma forward and start investing in startups that I’m excited about (more on that soon).

I get to swing for the fences

Some people are wired for the “billion dollars is cool” kind of risk that folks love to write articles about.  I wasn’t, at least not until I figured out the aforementioned three problems.  At least I was in good company, though – my new great-grand-boss, Larry, famously tried to sell Google for $1mm and failed.

But this lets me play the Shawn Parker game without regrets.  When I start my next company, I can swing for the fences.  Or self-fund it and do something that I love, without worrying about maximizing shareholder value.  Which brings us to…

The company was in a great position to raise money, but I didn’t want to

As the CEO of a startup, I’m dedicated to pursuing value for the investors who’ve extended me their trust.  One of the primary inputs to my decision making is how best to create value for shareholders over the life of the company – it’s not the only consideration in decision making, but it’s a big one.

One of the reasons I founded Sparkbuy was that I was excited to try a different way of building a company.  While I was at the helm of Ontela (now Photobucket), we raised over $30mm.  That’s a ridiculous amount of money.  We had a lot of fun and accomplished some amazing things along the way.  I worked with a team of fantastic people and was never happier than when I was going in to work to spend time with them.  If I had it to do over, I’d do it the same.

But I find there’s two type of people in the world – those who like refining one thing over and over and getting really good at it, and those who like trying new things.  You can guess which category I fall in to.  I wanted to try something different – a smaller raise ($1mm), angels instead of large VCs, and growing organically based on revenue.  That’s what I did with Sparkbuy, and it was a good decision when I made it.

But markets continued to heat up to a fiery glow.  The valuation of comparables in our space was shooting through the roof.  Competitors were raising rounds in the double-digit millions.  It was becoming increasingly clear to me that the best strategic decision for the company was to raise a large financing round at a lofty valuation and grow like crazy – but I wasn’t particularly excited about doing that.  In other words, what I thought was best for the company wasn’t what I, selfishly, wanted to do.

If I hadn’t sold, I would have raised money, and I didn’t really want to do that.

It was time to spin up a B2B strategy

Much as Sparkbuy’s direct-to-consumer website was winning rave reviews from users, there was new and substantial interest was on the part of other companies.  We were getting offers to do long-term deals with Fortune 500 companies that would generate huge revenues over a period of years.  Of course, pursuing those would have required raising a bunch more money.  Once again, this was what I did at Ontela; and once again, while it was fun, I wasn’t excited about pivoting Sparkbuy in that direction.

The biggest risk was still ahead of us

The bigggest challenge for any consumer startup is how to profitably acquire customers.  We knew from the start that this was the largest risk factor for Sparkbuy, and with the launch of our beta (a month before the sale), we were just starting to dig in to this problem.  I had a list a mile long of initiatives to drive profitable growth, but in the end all you can do is experiment and iterate, and it can take a long time to find the magic.  Our value as a company wouldn’t hit a new inflection point until we solved this problem, and it was a long ways off.

To sum it all up

Some of my investors were overjoyed.  Some of them were sad that Sparkbuy would never grow in to its own.  I’ve been called a sellout, and people have told me that I epitomize what’s wrong with entrepreneurs outside the valley.

It’s all cool.

I don’t claim my decisions are right for any other company, or anyone else.  This was not the hardest decision I’ve ever made.  It wasn’t even in the top 10.  There were a lot of moving parts, but at the end, it was simple.  Google hit my “life changing” number, provided a great return for my investors, gave me and my coworkers terrific jobs, and made it all happen six months from the day we were incorporated.  I’ll have other companies some day, and I’ll play them differently.  Your decision, should you be called on to make it, may be quite different – but I hope it leaves you feeling as lucky as mine has!

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Open letter to Mike Arrington: Please stop investing in startups

Hi Mike,

I’m one of your customers.

We don’t really know each other. We’ve chatted at a few events, you’ve covered some of my antics, but I’m mostly just a guy who reads TechCrunch a lot. I find it’s a pretty good place to see what’s important in the industry. And you and your team do some damn fine reporting on things the world wouldn’t know about otherwise.

I am product guy, not a media critic. But I’m a big believer that economic incentives shape behaviors in subtle and unmeasurable ways. And I think your decision to make investments in startups is going to make TechCrunch a worse product.

I can’t tell you exactly how. Are you going to be a little more likely to ignore competitors to your companies? Cover them, even when they’re not newsworthy, to show you’re not biased? Feel compelled to pull or throw punches, either to support or prove you’re independent of the companies you deal with?

I don’t know. But I think it’s going to happen, it’ll be subtle, and it’ll make TechCrunch worse.

I’m not making demands or threatening to leave. Just making a request, from one product guy to another: journalistic independence is a great feature. Please don’t cut it.

Best wishes,

Dan Shapiro

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The only wrong answer is 50/50: Calculating the cofounder equity split

(Note: there are great conversations about this article happening at Geekwire and Hacker News)

The question of equity brings out the most fundamental differences, perceptions, and values in an aspiring startup.  In fact the equity question, more than any other, may strangle a young company before it can even get started.  And that’s a damn good thing.

But before we get in to that…

Who’s a founder?

Facial hair alone proves insufficient to determine founder status

As straightforward as this question sounds, it’s a tricky matter.  The founder moniker is black and white, but the situations are all shades of gray.  Setting aside the philosophical question and focusing on the more useful economic one, though, there is a simple approach: founders are people who take a very particular kind of risk.

There are, quite roughly, three stages in every company’s life:

1.  Founding.  The only money the company has is what you put in.  You are getting no money out of the company.  The company will probably fail, and you will lose all the money you put in, plus the lost salary, plus you have to find a new job.

2.  Startup.  The company has money, either from investors or from revenue, and they give you some of that money every month.  Your salary is less than what you’d get at a big company.  50/50 the company fails and you have to find a new job, plus you’ve lost the difference between your startup salary and the BigCo salary.

3. Real company.  You get “market” salary.  It’s unlikely the company fails, and if it does, your downside is limited to  unemployment.

The rule is this: if you’re working for a company that’s so young it can’t pay you, you’re a founder.  If you are drawing a salary on your first day at work, you’re not.

What’s a founder worth?

A founder is defined by the inability of their company to pay them (or anyone else) for anything.  A founder’s primary job, then, is to get their company some money – either by raising investment or by generating revenue.  So a founder is valued by two things:

1) Their contribution

2) The market

The first of these is fair.  The second is  economics.  Both are essential.

And now, the formula

Of course, there can be no right answer – but this one’s not so terribly wrong.  To start out with, give every founder 100 shares.

Somebody’s got to get things started (5%)

Some startups are born running, with all founders on board from the beginning.  But others come from one leader who recruits the others.  You may or may not take the CEO title, but if you’re the one who rounded up the cofounders and talked everyone in to getting things done, add 5% to your holdings.  If you were previously 100/100/100, you’re now 105/100/100.

You know. For kids.

Ideas are precious, but dwarfed by execution (5%)

It’s a lie to say that ideas are worthless and execution is everything… but it’s not too far from the truth, either.  If you’re the founder who brought the original concept to the table, increase your share holdings by 5% (so if you had 105 before, you now have 110.25) Note that if the idea is implemented, or patented, or otherwise has some execution behind it, then…

The first step is the hardest (5%-25%)

Creating a difficult-to-replicate beachhead can give a fledgling company direction and credibility.  It can help with revenue and with financing.  If you bring a concrete start to the table – a critical, filed patent (not a provisional), a compelling demo, an early version of the product that isn’t quite there yet, or something else that means much of the work towards financing or revenue is already done – you get a boost of 5%-25%.  The key variation here is, “How much closer does this get us to revenue or financing?”

CEO gets more (5%)

Common situation: the split is 50/50 so that neither party controls the company.

Well, if you don’t trust your CEO with the majority of shares, you’re founding the company with the wrong person.  Market rate for a great CEO is higher than market rate for a great CTO, so the CEO job gets a bit more equity.  This isn’t fair – the work isn’t easier or anything – but it does reflect some market realities.

Fulltime commitment is expensive (200%)

If you’re working fulltime while your cofounders are working part time, you’re the pig. You’re working more, and you’re risking a lot more if the project fails.  Furthermore, part-time cofounders are a big minus to someone considering an investment.   Their equivocating will be expensive.  Add 200% to the shareholdings of all the fulltimers.

Reputation is the most precious asset of all (50%-500%+)

If your goal is to get investment, some people make that much easier.  If you’re a first-time entrepreneur partnering with someone who’s successfully raised VC dollars, that person is a lot more investable than you are.  In the extreme, some entrepreneurs are so “investable” that their involvement is a guarantee of raising funds.  (It’s easy to identify them: ask the investors who know them best “would you back them no matter what they do.”  If the answer is “yes”, then they are that kind of super.)   These super-preneurs essentially remove all the risk of the “founding” stage, so you should expect that they get the lion’s share of the equity from this stage.

This point doesn’t apply to most founding teams, but when it does, expect the super-preneur to take 50%-500% or more, depending on just how much more significant their reputation is than their cofounders.

Treat cash like an investment (varies%)

Ideally, each investor contributes an equal amount to the company.  That, plus their labor, earns them their “founder shares”.  It’s possible, though, that one founder may put in significantly more.  The price for that is high, since it’s the earliest, riskiest investment.  That founder will get more equity; to determine how much, talk to a good startup attorney about a reasonable value for your company and work from there.  For example, they might say that your company could reasonably be valued at $450,000 for investment purposes, so a $50,000 investment would merit an additional 10%.

There are more structured ways to do this, ranging from revolving credit lines with interest and warrants to convertible debt that converts in to common shares.  But these all mean increased legal bills and, more importantly, complex cap tables – something that can scare off outside investment.

The final accounting

At this point,  you’ll have something like 200/150/250.  Just add up the shares (600, in this example) and divide each person’s holdings by that number to get their ownership: 33%, 25%, 42%.

If you have equal shares, you did it wrong

A couple of years ago I was asked to give a talk at a continuing education series for attorneys.  I asked to see the class list, and opposing counsel for a deal I was working on was being there, so I figured it was probably a good idea to do it.

I asked them what to talk about, and they helpfully replied “startups”. I pressed for more detail. “You mean like generic startup experiences?  Legal issues startups face? Advice for attorneys?”

“Yes, exactly like that!” came the enthusiastic reply.

Clear direction in hand, I started musing on the early days of Ontela.  Our company started as just two of us, Charles Zapata and I, brainstorming in a basement.  We covered a ton of ground – generating a million ideas an hour, each better than the last, on everything from business concepts to core values to better ways to file expense accounts.  No matter what came up, we either agreed, or quickly resolved our differences.  Life was good.  We split the equity 50/50.

It wasn’t until six months later, when we’d quit our jobs and committed our savings, that we nearly destroyed the company with our first real argument.

The advice I gave the lawyers was this: “The most common cause of startup death is founders who can’t resolve their differences.  Nobody hears about it; they just pack up and go home before the company ever had a chance.  If there’s one thing you can do to help your clients – really help them – it’s to get the hard questions on the table early and help them work through them together.”

Mark Suster talks a bit about this in this four minute video clip about “the co-founder mythology“.

Solomon was unavailable

50/50 isn’t a business decision, it’s a compromise

You need to get used to hard questions.  You need to get used to trusting each other.  You need to get used to the idea that you’re not all equal.  You need to have the difficult discussions about responsibilities, contributions, roles, and compensation.  You need to do  it before you make commitments to investors and employees.  And if you find that the only way you can get a decision made is by compromising – then you need to stop now, before the price of failure climbs higher.

There’s no way around it – you’re going to have to split the baby, but it doesn’t require the wisdom of Solomon to get it right.  Take your time, keep a level head, and remember: this is just the first of the decisions you’ll be making together for the rest of your company’s life!

PS: Joel, you’re awesome, but I couldn’t disagree more

Joel Spolsky is one of my favorite authors.  He wrote a thoughtful piece about the same subject that reaches very different conclusions.  Here’s why his article is wrong:

• It confuses “easy” with “fair”.  If you’ve had two successful exits already while I’m doing my first startup, it’s easy but not fair to split it 50/50.  It’s fair but not easy to reach a more accurate split.
• It advocates avoiding conflict so you don’t “argue yourselves to death”.  That’s exactly the wrong approach: if you’re going to argue yourselves to death, do it now when you don’t have investors and, worse, employees (“Mom and dad are fighting again”).
• It gives too much equity to employees who are drawing salary, at the expense of the founders.  The majority of founders work without salary for companies that ultimately fail.  Employees are at least guaranteed a salary.  The difference in risk is monumental. Nivi provides a lot more detail here explaining why founders should get a lot more stock than employees.
• It doesn’t reflect market realities.  A typical Series A allocates 20% for the employees.  Joel’s model has 33% for the employees, which means just 33% for the founding team.
• IOUs are nearly worthless.  Most companies don’t succeed in raising money or getting profitable.  Of those that do, many investors will require that IOUs be waived as a precondition of investment.  A $1 IOU has an expected value of nickels.  The right solutions are either convertible debt (for investment) or equity adjustments (for anything else).
• It’s worth noting that, by the way, Joel is spot on that founder vesting is required in any cofounder situation.

Joel’s already successful.  I believe this is his first startup with cofounders and investors.  This looks like a great, idealistic set of ideas – but it’s economically unsound, and doesn’t reflect the majority of the market out there.

Note: I’ve only founded two VC-backed companies myself, so I’ve vetted this analysis with a bunch of folks to access a broader experience base and make sure I’m not out in the blackberry brambles here.  That said, a few VCs (including Fred Wilson, one of Joel’s investors) have chimed in to endorse Joel’s analysis, so perhaps he’s not so crazy either.

Thanks to Bill Bromfield, David Aronchick, Galen Ward, Joe Heitzeberg, Rand Fishkin, Sarah Novotny, and Tony Wright for providing feedback on drafts of this.  Mistakes, overly broad assertions, and incendiary observations are mine, not theirs.

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