Steven Cox - Founder of TakeLessons. Build Something You're Proud Of

How are you going to make a profit in your startup?

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I read an interesting post from Mark Cuban today on the problems of startup success using a free model. Back in the 90's when I was cutting my teeth around web/tech, the mantra we heard from VC's was "get big fast", and "eyeballs are everything", and "don't worry about making money, we'll fund you", and "you can get a higher valuation if you're NOT producing revenue".

All of these statements seemed odd to me. I do understand the value of first-mover advantage, but what are we in business for if we can't focus on providing value that people will pay for?

Mark argues that the company that is successful on being free will feel the need to continue to build bigger infrastructure and hire more people because the next 'free' thing is right around the corner. This means they never learn to be lean and protect themselves in downturns. In order to stay competitive with the next free thing, they'll spend too much money and lessen their ramp time. 

"The more success you have in delivering free, the more expensive it is to stay at the top. The more success you have, the more important it is to management to remain successful.  The more important remaining successful is to management, the more money they will spend, the more chances they will take, the more infrastructure they will build, the more people they will hire.  All of the things that will prevent them from staying lean, mean and flexible. All of the things that distract them from innovating within their core competency."

I live in downtown San Diego, and across the street from me, a new restaurant just opened. Based on a reliable friend in the local restaurant scene, I know they spent a total of $2.5 to $3 million to open the doors. This is about the same amount of money raised by a web quasi social networking company I'm familiar with. The difference is that starting day one, the restaurant had customers lined up willing to pay $50 - $75 for it's service. The web company, now two rounds of financing and three years into it, is still not charging for their service, and I question whether they have anything that people will actually pay for. Now that they've done a series A and B, I doubt if the founding team even owns the majority of their company. Thus, the entrepreneur has locked himself into a job.

(As a side note, I absolutely believe in raising money for growth. Once a model has been proven, it makes sense to accelerate the earnings, and normally, this takes additional capital. The difference is that at this stage, the company has been given the task of figuring out customer demand and iterating their model quickly. Those that succeed are able to find the model that works and begin to place their efforts towards amplifying their processes.)

I just have a different way of looking at things. I speak to entrepreneurs all the time that want in the game simply to cash out. There's more thought to the exit than there is to service needed to provide the exit. It's rare that I hear them say, "here's the value I provide to my most loyal customer". Just like in the 90's, it doesn't make sense to me.

Unless you are starting a company for the sole purpose of flipping it, it is my belief that the company should have a clear revenue model rolled out soon after launch. This means you may have to build slower and have to execute on a customer-centric strategy. The revenue generated will give you a longer launch-pad and the company that you've toiled and sacrificed for will remain in the hands of the people most passionate about its success.

Top 100 Most Connected Venture Capitalists

From Techcrunch - here's a list of the top 100 most connected VC's. Did yours make the cut?

Here are the top 10:

1. Draper Fisher Jurvetson
2. Sequoia Capital
3. Accel Partners
4. Intel Capital
5. First Round Capital
6. Dag Ventures
7. New Enterprise Associates
8. Kleiner Perkins Caufield & Byers
9. Benchmark Capital
10. Ron Conway

Whom You Know Matters: Venture Capital Networks and Investment Performance -

Seeking Venture Funding? Have a Clear Understanding of your Financials

Recently, I've discovered the blog of Robert Ochtel. He's an author and a serial entrepreneur with over 25 years experience. He's also raised over $50 million for his businesses, and started VentureBlue, a national Angel network. And, he's just up the road in Carlsbad, CA.

Robert wrote a post explaining why entrepreneurs should be comforatble and intimately involved in the company financials. Most VC's hail from business schools and if they have not ran a company themselves, they do know how to analyze financial statements. So it becomes paramout that the entrepreneur be able to explain the projections and the assumptions underlying them.

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Don't defer your financials to someone else. You can have mentors help you with it, but it's important that you, as the CEO, understand the key variables that shape your business. By doing so, you can understand why your projections were off (which, in most cases, they will be).

"When presenting to venture capitalists, the CEO of your start-up company needs to be an expert in all aspects of your company, including its financial statements. It is not a good idea, as the CEO of your start-up, to defer the financial statement related questions to your CFO or another third party. As the CEO, you are the one where the “buck stops”, so venture capitalists expect you to be able answer any and all questions regarding your start-up company’s financial statements. Therefore, as an entrepreneur you need to study your company’s financial statements from an investor’s point of view, including being able to recite the underlying assumptions of your financial statements. If you cannot do this, you will not get far with the venture capitalists and your ultimate goal of securing funding."

Read Robert's post here

Related articles

• Being an Entrepreneur in the Great Recession (unionstreetmedia.com)
• Venture Capital: It's a Downer (blogs.wsj.com)
• Entrepreneurial DNA: Do You Have it? (blogs.harvardbusiness.org)

A VC Gets On Board with Profits, Not Revenues

I found this story from Fred Wilson, Union Square Ventures. I've always found his posts to be thoughtful and useful:

"I think that's an important part of the economics of the web that are left out of most discussions of Internet business models. Yes, we are turning analog dollars into digital pennies in many cases. But we are also doing the same thing on the cost side, maybe even more so. And I think that "operating leverage" is going to create a lot of value."Read the Whole Story at A VC, Jan 2009

From Techcrunch:

It looks like its going to be a tough 2009 for start-ups looking for an A or B round. Only 55 funds have raised capital, compared to 78 funds from a year ago. This will trickle down and offer less availability for younger companies looking to get their ideas of the ground.

See post from yesterday. Seek to prove your model on your own dime and with sweat equity. Then, seek expansion capital rather than proof-of-concept capital. Also, look to friends and family (maybe a rich uncle) that believes in you. Remember, at a start-up stage, most people are betting on the jockey, not the horse.



Always On is Happenin'

I had the pleasure of meeting Marc Sternberg, President of Always On earlier this week at the San Diego Venture Group. If you're not familiar with the network, Always On is an excellent resource for young and emerging companies to network and learn financing deal structures.

Here is an example of a quality post from Always On contributor Brad Feld. This post guides you through what a VC terms sheet looks like. Good reading.

Debt vs. Equity

I do not know a single internet-based company that decided to use debt vs. equity as a main source of working capital. Perhaps it's because most companies need a fair amount of capital, and there isn't a proven business model yet. In this scenario, equity financing makes perfect sense.

But what about internet companies with revenues and low overhead? Would working capital debt (guaranteed by our wonderful government - SBA) work just as well? Sure, you have to pay it back, but with a 5-7 year payback term and rates so low, it should be considered. And, you're not selling off the company to finance your working capital.

I'm going to further explore this and will post back my findings.

Venture Hacks — Thoughts on Adam Smith’s Letter to Graduating Y Combinator Companies

Venture Hacks has great commentary on Adam Smith's letter to Y Combinator companies.

Y Combinator is a mini-incubator that focuses on getting very early-stage companies access to seed money, technical and business advice, and other things that help raise the probability of getting to market.

One particularly enlightening part of the post included the discussion of traunching. While I don't know the correct definition, it seems a lot of term sheets are written with the ability for an investor to re-price their investment later. That would suck...

"Tranches are generally stupid. They have zero upside and catastrophic downside.At best, tranches give your current investors a right to invest at yesterday’s valuation if your company is doing well. If your company is doing poorly, your investors will figure out how to get out of their obligation to invest."

Link: Venture Hacks — Thoughts on Adam Smith’s Letter to Graduating Y Combinator Companies.

Is Your VC Acting Irrational?

Here's a logical, enlightening post by Bill Burnham on understanding why your VC may be acting like a ding-dong.

The takeaway is that while your company is the absolutely most important thing in YOUR life, the reality is that you might not be that important to the people you've decided to jump in bed with. This isn't anything to whine about, this is just life.

Bill gives some helpful advice on both the financial and organizational reasons your VC may be pushing for a quick sale, turning down a good opportunity, or leaving you for dead. You can't blame them. At the end of the day, everyone has their own best interest in mind. It's human nature.

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