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Friday, July 30, 2010

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FredDestin

Always such a blast.

- Decided when to double down -- you may get slightly better info but most of the time you're going to have to dump some capital when you are still in the gray zone. We call it Prove / Build / Scale and the tough bit is building some people infrastructure before your thesis is proven outside of your launch market.

- not clear on whether you want to have capacity to follow on inside your own fund or whether you want to go for a Founder Collective positioning ?

Account Deleted

Dave, I think you pinpointed the current situation well, and suggested a reasonable approach method to optimize the investment thereunder.


However, like both sides of the same coin, all things in this world have both positive and negative aspects. If the principles of economics and standardized rules are rigidly applied to startups, we can accomplish the higher success rate, but we are likely to sacrifice and lose better opportunities which might make us join "The Giving Pledge"

Thanks.

SocialMPH

What a great read Dave. I think you are so right in your take on the industry, and I love the fact that you are so open in sharing....the way you write is the way companies are starting to operate, no BS, honest, value adding. This is why people follow you, and this is why tech start ups that are lean and valuable will succeed.

Movyloshop

Hi Dave,
I'm a mobile serial entrepreneur now launching www.movyloshop.com (SaaS mobile commerce solution).
I have raised money in the past for other start ups and are not bootstrapping it on my own cause the VCs generated more problems than benefits int he past, so I complete agree with you.
But my point is: how do you manage the quickness required for product dev & mktg activites with...the slow fund raising? You can create a viable products in a short time, but it's unlikely that you put it live and get millions people on it. And raising money is a full time job that takes time...even raising small amounts.
That is why all innovations (google, FB, Youtube....) all come from the same locations where the "funnel" is working fine.
I agree that...smaller investments on metrics and smaller way outs are the future, but...at this stage is easier to create a SaaS viable solution than...having it exploding in the short term.
How would you close that gap?

Itzabitza

Also - you have a potty mouth. Why is that? Do you believe it helps get a point across? (Just trying to understand your style. I could care less about the potty mouth shit).

Itzabitza

loved the post. What would be super-duper is if you understood more what went into developing an Internet service. One WEEKEND to design/develop a service that scales up to 1M? Your points seem much stronger from the MBA view. The challenge I have is you are devaluing what it really takes product wise. THAT IS NOT TO SAY A LOT of money has been wasted on development. I agree with that. Your knowledge of product development (as noted above) loses the article's credibility.

Nathan Beckord

Fun post. I am particularly keen on your Assertion #2. Along with the shift toward "microVC" / "superangel" / "seed accelerators" / "etc." will come a rise in the importance of "micro M&A" for startups...deals that are well under the normal threshold for big i-banks, but that can provide meaningful returns to founders and angels (but not always VCs).

I think we'll see this scenario play itself out more and more, particularly in the web world: once founders have raised some angel$ (from 500Hats fund, natch), achieved product/market fit, and hit some initial traction, they'll come to a fork in the road...either swing big and raise multiple rounds of VC, or focus on a dual BD/acquisition strategy with strategic partners.

I think in many cases founders can actually make MORE money by exiting early (while still controlling a hefty share of equity) vs. going for the big score (fueled by multiple VC rounds and concurrent dilution). Plus, exiting early at $50m after 2-3 years means founders can quickly repeat the cycle, vs. hanging on for the typical 6-8 years it takes most VC backed co's to achieve.

In a nutshell, "Small VC is the new black" and "early M&A is the new exit."

(Of course, this oversimplifies things and is a very rational way of looking at it....it overlooks the hubris that many founders get when things are growing fast and they start to get courted by name brand VCs...but I'm convinced we'll see more small exit deals, particularly if some of your thesis holds true); I put a related deck on the topic of startup exit strategy up on slideshare: http://bit.ly/dnmrLH

Nice job, Dave
Nathan Beckord
ps sat at your table at S2S "Art of M&A" last week-- great panel! good times!

Account Deleted

Hey Dave, very interesting article, I enjoyed reading it, thanks! It's cool how you make fun of old VCs, and it's probably true. I'm a web developer and the startup I'm in right now has gone the "dinosaur" way, but we're a service business, which makes things a little bit more complicated.

Anyways, thanks again!

~ @kovshenin

Baba12

This fine and dandy when it comes to some product/service that runs online on a network and hardware already built and paid for by previous startups like Cisco/Intel etc.
I don't think you can develop a new materials technologies or semiconductors or bio tech ventures with this model that you put forth.
For those ventures still require a lot of heavy lifting and there are not many VC's of the ilk you mention like Y-combinator etc to fund such ideas/startups.
The kind of startups you mention take advantage of lot of the heavy lifting already done to create this platform.
I would like to see First Round Capital or USV or you invest in seed stage in Biotech startup or in a new energy technology venture.
The stakes are much higher and it is not for faint hearted, maybe Governments are the best suited to these investments, cuz private enterprise is least risk averse.

www.facebook.com/profile.php?id=663873744

The same principles apply when investing your own capital.EVERY entrepreneur considering a start up or even those considering a new business line should read this. The big established VCs will probably blow this off because the implications for their business model are too horrible to contemplate.

Account Deleted

A lot of what you say is true, and I'm unqualified to comment on the rest. But, as an entrepreneur (wannabe) it'd be nice to see it from this side of the fence. Since startup costs are low, what do I really need investors for ? Mentorship (which is very suspect, for now), connects (useful) - so I guess the "smaller" VCs will need to be more part of the team than someone sitting across a desk peering at numbers (dis)approvingly.

Swagner2

Dave:

Great points. We took a year to build out our app and business model with paying customers. We're finally nailing down the Revenue side and need to raise some money for our sales team.

Any suggestions on positioning the story at the Revenue stage (and the others) of the game to angels?

Madjammy

Very interesting article, for the most part we are in full agreement.

Here in Boston we feel as if there is a total lack of innovative early stage investment in any type of novel SAAS applications.

We feel it's not for lack of opportunities or for that matter talent, but a mindset that is closed to early stage companies with original concepts.

We find that without the site being fully fleshed out and a market already developed, there is a general lack of investment interest.

Dave are you planning on coming to Boston any time soon?

abm

ThruDispatch - turned down by every VC in the Valley after 1000 independent mobile service customers surveyed positive. This was in 05-07.

Fucking A

Zafirkhan.wordpress.com

Dave, you do a great job of analyzing the implications of the idea that web 2.0 technology has democratized startups - the cost of getting off the ground is much lower and reaching customers is more accessible.

I agree with Rick Bullotta's comment, though, that a lot of the startups who meet the criteria you've outlined tend be copycat, fad-driven companies. I wonder why tech innovation is so focused on gaming, more targeted search advertising, etc. when these tools could be used to address problems in other domains. Healthcare, for example, is devoid of interesting companies that take advantage of social media and search to bring better information to consumers.

I'd like to see a response from the perspective of the so-called "dinosaur VCs" you mentioned...

Mike Nelson

Looks like you dont have guts to take candid feedback, you deleted my comment. What do you have to cover up!

Mike Nelson

This is great post ? God save America.

Keep it simple asshole (your language), Example investment thesis - startup costs are down, hence smaller fund and I have guts to make quick decisions. If you had built worth while startup before, you would have known, what they mean by focus, focus. And also dont say exits are small, it will hurt your future portfolio, you never know.

RickBullotta

Dave, the downside of the "web-enabled insto product" mindset is that a shitload of startups are copycats. Walking through the aisles at the TechCrunch thing in NYC a couple months ago, 95% of the companies started their pitch with "we're like XXXXX, but...". Like, "we're like Facebook, but for pets". Please. Spare me.

There is a middle ground for "real innovation" that will require a bit more capital than copycats and "applied technology" startups. If we don't find a way to fund real primary research and technology innovation and are just focused on following social fads with lightweight "insto startups", we're fucked as a country over the long term.

Schumpeter rules.

100Gigabit

Venture Operating Expense will never produce the returns Venture Capital used to. Startup finance is in dire need of some innovation.

Antonejohnson

Brilliant post, Dave, written as only you could write it. You make a good case for the strategy behind my startup law practice -- "invest" in building client relationships with entrepreneurs at the pre-seed stage, before they've achieved product-market fit, doing their startup work for much lower rates than the big firms charge, with the goal of retaining and building on those trusted relationships when the successful ones reach the "double down" stage. Also, bring to bear a product-centric world view with deep specialization in one area (consumer/social Web in my case). Going after many clients at the earliest stages, who have the smallest amount of cash available to pay their lawyers, is probably the hardest way to build a practice (vs. the traditional pursuit of fat-cat corporations with huge legal budgets), but in the long run, I think it's the smartest way to thrive in the brave new world of disruptions in the VC ecosystem that you describe.

On a related note, I'd be curious to hear what you and other readers think of the Series Seed approach to streamlining documentation and reducing legal fees for seed rounds. I posted my (admittedly skeptical) thoughts at http://bll.la/55.

Paul Ward

This is a good analysis. VC will take too long to pick it up unless, as he says, they're innovative. The reason is that they distrust cheap assets. They want their money to buy expensive, protectable assets. And yet expensive and protectable are two concepts that can be separated. It's far cheaper to get a new company up and running in ways that are differentiated from a brand standpoint, and lawyer up on protecting the brand, than to do patentable stuff.

I would want a version of this article that looks at the root cause of increasing total return to shareholders. This is essentially what gives VC their exit ... it creates an argument for the future value of the cash flows that VC can sell to people whose money will replace theirs (next tranche, IPO). So, the problem to solve REALLY is creating measurable, increasing total return to shareholders.

What are the drivers for that? 1. Compelling and engaging value prop - for social media plays, this means solving a problem, engaging the imagination, architecting a user experience that is easy to adopt AND YET NOT GENERIC (god, I hate those 'don't make me think' UI people who make everything so 'web 2.0' that it's all the same vanilla cr*p), lowering barriers to recommendation, allowing co-creation and sharing, and enhancing the customer's reputation. 2. Cognitive sophistication in customer experience management. 3. Well-designed multitouchpoint ecosystem, including partner ecosystems, that are measurable. 4. Hella analytics. 5. Lots of experiments, well-designed and targeted to increase customer engagement (see Gallup and Carlson).

Done.

The rest of the argument can fit with what I outlined. Remember, the goal is NOT to make it cheaper, or to engage customers sooner, or even to get revenues. Cheap can be bad. Engaging early adopters is not enough. And revenues can be expensive - that is, you have to have PROFITABLE revenues that are ALSO early indicators of FUTURE CUSTOMER VALUE.

All that equals ... increasing total returns to shareholders.

THAT you can get funded.

Appmatcher

Great job Dave. Rackspace is hosting an event on October 7th for B2B SaaS apps. I assume your event in SanFran on the 8th would preclude you from being able to be one of the judges in our start-up session FundMyApp, but I wanted to still ask if there are any very early stage (what you call "product") firms that you could encourage to come and pitch during this session. Ping me back at andy.schroepfer [at] rackspace [dot] com.

For those reading this that have or know of a B2B SaaS application firm (of any size) that would like to attend, please contact me at the email above. Thanks, Andy

jasonspalace

SICK! You've just written the filler for many venture slide decks now through 2015...

Fuck.That.Noise.

=)

Phil_hendrix

Discovery-driven Planning and Agile Market Research - An Antidote to Doubling Down Prematurely?

Dave, good post. Should provoke a lot of discussion. I'd like to share some supporting perspectives and offer alternative solutions.

Two academics - Ian MacMillan (Wharton) and Rita McGrath (Columbia) - have examined many of the issues you raise in their discussions of innovation, uncertainty and investment. MacMillan puts it succinctly when he recommends "spending imagination before you spend your money and... engineering the risk out of uncertain projects..." In a nutshell, the process he and McGrath advocate involves 1) creating tests to probe and reduce the uncertainty ahead of investment; 2) staging the investment tranches, contingent on intermediate outcomes; 3) postponing investment until (some of the) uncertainties are resolved.

Useful sources on their perspectives include notes from a conference last month at Wharton http://bit.ly/aIihsF; a video in which MacMillan and McGrath explain the rationale and benefits of the approach, which they call "Discovery Driven Growth," at http://bit.ly/dxJdwi; their book http://amzn.to/cZeLIW; and McGrath's blog at http://bit.ly/cL1AG8. Several readers have pointed out the parallels between their perspectives (developed over the last 10 years or so) and the "lean startup" notions of Eric Ries (http://bit.ly/hSVtd) - these complementary perspectives are crucial to avoid the pitfalls you've identified.

Another important and useful resource is what we call Agile Market Research. Entrepreneurs often make bold assertions re: market potential, e.g., how the market will respond to their product, conversion rates, projected ASPs, etc. These hypotheses and others can be tested in advance of significant investment and commitments. While "listening to customers" and "build it and (see if) they will come" can be informative, more accurate methods can be used to predict market response and are recommended when opportunity costs, investment and/or uncertainty are high. Data can be obtained and a predictive model generated relatively quickly and at lower cost, compared to a market test - the model is also more robust (e.g., allows for the testing of many different configurations, price points and business models, not just one or a few). While predicting consumers's response to "very new" products (e.g., iPad; Twitter; etc.) is fraught with challenges, it's not impossible (for further discussion, see http://bit.ly/9kJ1tZ).

Dr. Phil Hendrix, immr and GigaOm Pro analyst

MikeDuda

This post validates what I've been banking on doing for the past couple years. Thanks. This made my day BIG time.

TipperaryP

Hi Dave--long time since FSV and early SVASE. What if it takes more than $100K to get to product, but less than $1M to get to revenue/profitability in 6-12 months? Is that still worth a seed investment?

Subbu4

Great post... in concert, with the sea change occurring with this startup funding paradigm, there is a shifting mentality among entrepreneurs... the best entrepreneurs are hopefully looking for the intangibles that the angels bring to the table, more so than the actual cash. That is something worth giving up equity for. As a first time entrepreneur, i really do subscribe to that thought.

We are currently bootstrapping our product development in a pre-revenue environment, after raising friends and family money 3 years ago - with those coffers now depleted. While figuring out ways to keep our operations moving forward, and always *thinking* we're so close to hitting profitablity, I'm not at all interested in diluting our equity for cash... but I'd do it in a heartbeat to get access to someone who's done it before - that's the angel that I want... I would get the best of everything without entertaining VC-level equity dilutions.

Ay_o

Well written Dave; not experienced enough to speak for the metrics you attached to each stage, but the breakdowns into stages (Product/Market/Revenue) and what to focus on in each, are useful particularly for first-timers like myself. Bon courage.

hypermark

More coffee, man! I mean that in a good way. Seriously, though, well-constructed in terms of your staging out thesis.

I think that where in practice things get potentially more complex is that in doing Seed or being a micro fund, you have to have a clear plan (and powder) on deals where you find yourself in the realm of liking the deal but being in the gray area between Seed and Series A readiness (in eyes of VCs).

You have to be clear if you are REALLY prepared to be the Lead Investor if you believe in the venture.

For VC's, I wholeheartedly agree with the Dixon analog of treating this as a Call option on Series A since they specifically want to be the lead in Series A.

By contrast, many Seed Round investors aren't prepared or capable to Lead, and that lack of preparation puts them in a position where they either drain their coffers or miss out on the double-down scenario when subsequent phases play out.

Mark

CDunnSD

Refreshing and insightful Dave. Having sat on both sides of the line (VC & Entrepreneur) I fear the once revered VCs have all but become irrelevant. Have done the dance many times with these guys and music hasn't changed a beat - while the web world has evolved exponentially.

Best of luck with the new venture.

Irina Patterson

Hi Dave,

We would like to interview and feature you on the Silicon Valley blog, Sramana Mitra on Strategy: www.sramanamitra.com

My interviews focus on seed and angel financing for entrepreneurs.

I already interviewed Mike Maples, Jeff Clavier, and many many other very smart people here: http://www.sramanamitra.com/2010/05/19/irina-patterson So, you'll be in a good company...

If I can provide any added value for you, after serious talk on seed investing, we can talk funny hats too, that is my side gig: http://mylifeandart.typepad.com/

But seriously. Could you get back with me regarding scheduling a serious talk on seed financing first, hats second. I can be found at @mylifeandart or 12irina34[at]gmail.com Thanks in advance -- Irina

Mattharrell

This makes so much sense to me. Would you say that KissMetrics's investments so far serve as a good example? It appears so. http://techcrunch.com/2010/07/22/kissmetrics-conversion-funnel/

Thanks for the insight and laughs!

Tomkuhr

LOVE the Blackjack metaphor, Dave - simple and accurate.

The more ideas that get that early, pre-market/product fit investment, the better. That's a really big hole in angel "strategy" right now.

Pennygrabber

This is a brilliant writeup! I like the points you've hit on, and how you specify how to change them for the better. As a startup in the consumer Internet space currently raising seed capital, I can attest to the Product > Market > Revenue strategy.

Although we are raising a total of $300k, the bulk of our cost will be in the Product development stage. I've been given estimates of ~$118k to have just the e-commerce engine developed. Luckily for us, once this is done, we will pretty much be cash flow positive within our first month of operation.

The one thing I am noticing across the board with the VCs we've spoken to is the prevailing sheep mentality you alluded to. It's an unfortunate fact indeed, and one that most certainly contributes to the increasing demise of the traditional VC investor, and the rise in the angel investors, and those VC who participate in early round funding. Thanks for the write up, Dave. And I wish you much success on your 500 Startups venture fund.

Bruce Christensen

Money, Money, Money...
That is all those investor types are interested in...
What about solving the problems of consumers for the benefit of the masses and....

Oh, wait.. I am interested in money too!

I agree with your suggestion that you invest early and help good solutions grow into great investments.

Alain94040

Welcome to VC 2.0: VCs with a plan. Refreshing.

Fijiaaron

You are right about the dinosaurs and asteroid, but folks like YCombinator, Techstars, etc. aren't real investors and they aren't in it for investing. They're either

A) Attention seekers who got lucky in the first internet wave

or

B) Hucksters looking to make a few bucks off of people's dreams. They don't really even care if any company they back "makes it" because they're all about collecting fees on the way up.

They'll go the way of the dinosaurs faster than the big lizards, though there'll always be a snake oil huckster trying to sell beans to people trying to sell milk cows. And it always works.

Borismsilver

Fantastic post. Feels like many tech investors are looking for bond-like risk, with early stage return and it just doesn't work that way. You nailed it -- got to invest before the traction if you want to get the right pricing.

Klochner

This reads like a playbook for the @cdixon observation that seed investing is a call option on the series A:

"Basically big VCs are spending 5% of their budget generating captive leads for their real business: investing $10M into companies at the post-seed stage."

Janhorna

A long piece but still worth of reading :)

I really share your view and would like to add a small note. What I see as a typical T-Rex behavior is a local investing, e.g. most investors invest only in the Bay area.

I like your GOAP idea where you and likes explore opportunities outside the U.S. Of course it's going to be riskier business to invest "somewhere" in Europe or Asia.

But if you, or better say any investors, go the extra mile then you can invest at really low cost compared to the U.S. values. So it might be really win-win situation for both investors and foreign startups.

Poornima

I like the point about investors knowing the space. As an entrepreneur its been hard for me to find good investors who know and understand the space I'm in (SMB) to be comfortable enough to put in small amounts of capital. I've had to bootstrap my venture for the last 7 months. In doing so I actually came to the realization that if I start to make revenue that will cover my operational costs then I don't need to take investment or can hold off and give my employees better equity based compensation. I'm wondering if there are other entrepreneurs out there who are starting to think like me and hold off on taking investment.

twitter.com/startupcfo

Dave, your diplomatic skills are as finely tuned as ever. One question: How do you structure sub $100K deals? Common? And do you do the full shareholder and purchase agreement bit? What are transaction costs on that type of deal?

Ok, that was more than 1 question

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