Both Sides of the Table 2x Entrepreneur turned VC

Be Careful not to Become a Conference Ho

by Mark Suster on October 13, 2010

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You know the type. You see them on Twitter, Facebook or Plancast plotting out their next 12 conference. You see their Tweets from airports across the globe. Look at me! I’m in Spain! Now I’m in France. Next week I’m speaking in Cabo San Lucas! They are professional conference attendees.

They are CEO’s addicted to the schmoozing.

In the industry they’re known as “conference ho’s.” OK, they’re known as conference “whores” but that sounded too harsh for a blog post. Inevitably a certain number of entrepreneurs feel compelled to attend every conference. I think I know the root cause. It can be magnetic being at conferences especially when you’re on a panel, you’re invited to a speakers’ dinner, you’re getting to meet so many new people and you’re getting so much attention.

And for all of these reasons it’s smart to selectively go to a few events here and there – particularly those that you’re likely to have the highest hit rates of connecting with people who can change your business. But there has to be a limit. In the same way you wouldn’t spend all of your day in front of your computer at the expense of customer interaction, there has to be a limit to attending conference.

I’ve heard all of the excuses from these CEOs. ”How else could I get so much BD done? I work hard on my flights and in my hotel room? I have a really productive head of products cranking out code.”

Bullshit.

When you’re not in your office on a regular basis you’re not showing leadership. You’re not setting the agenda. You’re not establishing culture, inspiring people or resolving conflicts. When you’re on the road all the time you’re not as productive. You reach diminishing marginal returns of the next person you met in relation to all that you’re sacrificing by not being in the office working.

It’s about you and the relationships you’re building. It’s about the personal schmoozing and the network that’s going to help you whether you’re current company is successful or not.

So here’s the thing:

1. I often hear the non-CEO management teams from the companies left with no leadership complaining about the lack of leadership. Leadership abhors a vacuum. So people step in and fight. Or stuff doesn’t get resolved. Or somebody else becomes the “de facto” leader of the company. If this CEO would stare in the mirror and be honest with him/herself they’d realize this. It’s not possible to be a conference ho and a leader at the same time.

2. You think that everybody is marveling at your travels, your stories, your airplane layovers, your new friends and your photo from the South of France. They’re not. I hear people mumbling about how you’re unfocused and in it for yourself. I hear investors talking about how they’d never fund somebody that spends more time in conference halls than in their office. You’re too busy traveling to hear that they’re saying this. Until it’s too late.

So my message to people who attend every conference has always been, “Do you see Mark Zuckerberg at every conference? Do you see Ev or Mark Pincus at every conference? Do you see Larry or Sergey at every conference? Name one, professional conference attendee that has built a successful software business? If you’re in the services business, looking to sell books or work in sales I get why you might spend more time at conferences.

If you’re a startup CEO – don’t kid yourself. Get back to work. There’s a team in the office in need of your guidance.

Photo courtesy of The Cha on Flickr

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Startup Sales – Why Hiring Seasoned Sales Reps May Not Work

by Mark Suster on October 12, 2010

A while back I wrote a bunch of posts on Sales & Marketing and have been meaning to get back to that theme for a while. Even if you don’t have “direct” sales I would tell you that “everything is a sale” including fund raising, hiring, getting press and doing business development. So I hope these posts will be useful to all and not just those who need road warriors.

If you’re interested in recruiting sales people, I wrote on the topic of startup sales people: who to hire & when – understanding the roles of Journeymen, Mavericks & Superstars.

Evangelical sales – Understanding startup sales people and process.

One of the biggest mistakes I see early-stage startups making is hiring “seasoned” sales professionals or hiring people too senior, too early. Here is my recommended approach.

1. Start by selling, yourself - OK not by “selling yourself” but but selling, yourself. Reminds me of Eats, Shoots & Leaves. OK, I’m still self conscious about whether a comma goes there but you get the point.

I see way too many startup founders who don’t have experience in selling and probably don’t feel that comfortable going to customers and asking for orders. This is probably because many founders are product or technology people. If this is you I think it’s really important to get over this hurdle. Spending time selling to customers is the best way to find out what their problems are and how good your solution currently is at mapping to their needs. This only works if you’re not a crocodile sales person. You learn by asking.

The mistake many startup people make is they hire a “sales person” to go out and talk with customers so they can do what they’re good at which is building product or “running the company.” Sales people are a different breed, you say. The problem is that in an early stage business there probably isn’t a perfect fit between your early product and a customer’s needs. You learn that by showing them your product, watching their reactions, asking them questions about what they’d like to see improved and then racing back to the office to talk with the team about what you’ve learned and how you can incorporate it into your product plans. Repeat this process 50 times and trust me you’ll see patterns.

I was WAY off between my book research about what the engineering & construction market would want (my first company) and what they actually wanted. I only found out through customer meetings.

Also, this goes equally for business development. How can you send some young MBA “biz dev type” out into battle to sign up partners when you’ve never met with your potential business development collaborators and heard what their goals are and how you can meet them? If you send out the biz dev guy I’m sure he/she will ink deals. That’s what they do. But you’re unlikely to yield results unless there is a close alignment of benefits for them and for you.

2. Next you need to hire “evangelical” sales people - Once you’ve started to get alignment between your product offering and what customers want you’ll need to hire a sales person or two. You should already have a good feel for the customer pain, how you solve it, how your product differs from competitors and what the acceptable price points for your product should be. If you don’t have a “base camp” understanding of these issues you’re not ready to hire a sales person. If you can’t figure all of this out then adding a non-founder sales person isn’t going to solve your problems – it’s just going to add to your burn rate.

But assuming that you do have a good starting point for sales, you’ll need to hire somebody to expand your pipeline of leads, help build customer relations and to allow you also to have some time for the hundred other things you’re responsible for like fund raising, recruiting, products, customer support, etc.

The next mistake people make is to hire people who have “done it before” in your field and from a big-name innovator in your field. So if you’re enterprise sales that might mean hiring people from Oracle, Microsoft, Salesforce or whatever who have never been at an “unbranded” startup. The skills to be successful at a sales academy company like those listed are very different than those who would work at a startup. If they left an “academy” and worked for a startup before coming to you then they’re probably fine.

The specific things you’re looking for are: intelligence, ability to think creatively, ability to work with customers on vaguely defined problems, ability to assemble an ROI business case (with a template already created by marketing) and above all else the ability to listen, summarize and follow-through. Early stage selling is way more “evangelical” than process driven. That means you’re more often than not trying to get customers to realize they actually have a problem versus their already having budget assigned for a system in your category.

It is a consultative sale. Don’t confuse that with hiring “consultants” who make terrible sales people. But a consultative sale means you need somebody comfortable working with a lack of defined structure, process or product. If you hire that person straight from a sales academy they will be hugely frustrated that you don’t have pricing sheets, high quality sales collateral, a well-oiled sales process integrated into Salesforce.com and a clear sense of why customers should buy your product.

Having somebody from an academy institution when you’re ready to scale is awesome. There are no people like this who know how to crank the sales machine once the product / market fit are aligned. But hire them too early at your peril. IMO at least.

3. Don’t bring in the big guns yet – The related mistake I see (and have made) is hiring people who are too senior. I always tell people, “hire somebody who wants to punch above their weight class” (i.e. the person who wants to next level up rather than the person who has already done it). Most sales professionals start by carrying bags. As they become more senior they take on management responsibilities such as planning, forecasting, pipeline reviews, coaching staff, etc. As they get really senior they hire people to help them with sales ops, comp plans and creating marketing collateral.

What you really want are guys like Derek Rey who is doing a tremendous job over at Ad.ly. I had breakfast with the CEO, Arnie Gullov-Singh, yesterday. He was showing me their latest products, positioning and collateral. It was awesome.

I said, “wow, I’m glad to hear that Krista is working out so well as our head of marketing.” Arnie, “yeah, she is, but she didn’t do this deck. Derek did. He talks with customers, comes home, cranks out a new deck and has it in new proposals within the week.” I was blown away by the quality. He’s on the front line and hearing what customers really want. And he rapidly iterates that back into product development to rapidly respond to customer requests and has the messages straight into our sales campaigns.

Eventually you’ll need sales “management” and either your strong early sales leader can grow into that or you eventually need to bring in somebody with professional sales management experience. Each situations is different. Some people can scale into the roll and others can’t. And some of the best sales people also don’t want to move into management in the same way that some great technical architects don’t always like to move into managing GANTT Charts, work progress and people.

4. Do many sales meetings together - Once you have your initial sales people in place you can’t just sit back and review their weekly sales spreadsheets and push them for progress. You still need to be out on the front lines together. They need to hear how you position your company and how your products will help the customers. They need to watch and gauge customer reactions. They need to learn from you and if they’re good (and if you’re open) they also need to give you feedback on what doesn’t work.

And you need to watch them pitch. Avoid the temptation to always jump in and “save” them. Take the opportunity to watch the sales process as an observer. You learn so much from being able to sit back and just watch the body language rather than having to “perform.” It’s also a vital part of sales training.

5. Don’t confuse your early sales success with a scalable sales process – Finally, once your evangelical team is firing on all cylinders and orders are starting to flow in the door, it’s easy to confuse this with your ultimate success. I was there. Once I had 4 sales reps cranking so I took it up to 10 and saw cracks in the system. What works early in a company – the evangelic sales – does not scale well.

I often hear early stage founders telling me about their initial sales successes. I’ve even gone on some sales calls with them to see customer reactions to their products. I find myself often saying to these entrepreneurs, “having watched you I can see why customers are interested in buying. You’re very personable, persuasive and you intuitively know their problems. Plus, they know they’re dealing with the company owner. Please don’t confuse that with your ability to scale this business. Once you’re no longer leading the sale it becomes much more difficult without a standardized approach. I learned this the hard way.”

And I’ll save what I learned for my next post: “Arming & Aiming.”

Image courtesy of LiberalEvangelical.org

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Please go see “Waiting for Superman” – Here’s Why:

by Mark Suster on October 10, 2010

Yesterday I went to see the film Waiting for Superman. It’s the story of what’s broken with the education system in the US. It’s an important film and the most important topic of our generation if we as a country want to remain competitive in a world that has globalized.

It’s a documentary including personal stories of people caught in the system. I’ll leave more of the human drama for you to see yourselves but telling you the premise of this film won’t ruin anything. When I watched the movie I’d like to tell you I was angry (I was) and that it made me verklempt but the truth is that the film brought real tears to my eyes that strolled down my face and I had to wait to wipe them away at the sad parts so my neighbors wouldn’t see me. I heard many people with the telltale sniffling.

It’s crushing to watch little children in America who have the same dreams as my 5 & 7 year olds and not have the ability to lead a normal life because of where they’re born. I’m not talking about the overwhelming weight of responsibility of thinking about extreme global poverty. I’m talking about little African American, Latino & rural Caucasian children in our own backyard and on whom we can have an impact without having to change the world.

I’m talking about children who have done well in k-2nd grades and then get put into a lottery system for charter schools because the drop-out rates for their neighborhood schools are north of 50%. They are often raised by single moms, grandparents or under-educated immigrant parents who want the same thing for their children that we do for our own.

It profiles one little girl who finished her course work at a private Christian school in her neighborhood but was unable to attend graduation because her mom got behind on payments. It shows a young boy being raised by his single grandmother because his father overdosed on drugs and his mom abandoned him. And his stated goal at his young age is to get an education so his kids can grow up in a better neighborhood.

Wasn’t that the American promise? Work hard, do well in school and you can have a better life?

All of the kids end up in a lottery system to try and get into public charter schools where their odds were between 5-10% of being accepted based solely on numbers.

[update: to be clear about something I've seen in feedback to me. I'm not anti teacher. If you read the appendix you'll see that. Teachers have changed my life for the better. To suggest that I'm "anti teacher" or somehow abdicate parental responsibility because I'm pro "pay-for-performance" including terminating teachers with poor records is to mischaracterize my position.]

The movie basically has the following thesis:

50 years ago the American educations system (k-12) was the best in the world. The world has globalized and there are now many countries around the world competing for the jobs of the future.
We already have a jobs gap. Workers in middle & low-income America can’t get jobs while Silicon Valley can’t get enough high-quality developers. This problem will become even more severe in the next 20-30 years if we don’t address it now.
We have doubled our national investments per child in education (in real terms i.e. adjusted for inflation) and our scores have remained flat. Pouring more money into the system isn’t helping because THE SYSTEM is broken.
They system produces students in every state that have almost no proficiency in reading and math (let along sciences). In every state the proficiency rates (people reading and doing math at 12th grade level) hovers between 20-33% and that’s for the graduates. That’s appalling.
The drop out rates in poor areas (both urban and rural) is so severe that we’re producing generations of unemployable people who have one of the world’s highest rates of incarceration. He gave a simple graph that showed that 4 years of incarceration costs tax payers approximately $130,000 per inmate, which is more than it would cost to educate that same person in a basic private school for the entirety of k-12.
This problem seems like it’s just for some random people that you don’t know because you don’t live there. It is actually a problem for us all because
- we’re paying for it in tax payer dollars down the line
- it leads to higher crime rates which is a societal bad
- we’re creating our own skills gap, which is leading to more job creation overseas
- we’re doing an injustice to our fellow human beings, many of whom never have a chance based on where they’re born

So what is the problem and proposed solutions from the film maker?

It has long been believed that people from lower-income neighborhoods can’t learn as well as middle & upper class ones due to environment issues such as problems at home and trouble in the neighborhood. The film highlights a nationwide school system called KIPP Schools (knowledge is power program) that teach only in lower-income neighborhoods. They have been around for 16 years now and have graduation rates above 90%. They have produced the only measurable increase in test schools for lower-income areas in the past 40 years on a sustainable basis. They are non-union charter schools that reward teachers based on performance.
KIPP improvements are better than those even in wealthy suburban areas including that of Woodside, California. While affluent areas produce “on average” better scores than other programs they do this by having really high calibre students at the top who bring the averages up significantly. They don’t do enough for masses of students. They put students on “tracks” where the better performing students end up getting the better teachers and more resources so the young students who don’t score well out of the gate get left behind.
The real issue according to the film maker is not with the students but with the teachers and specifically with the teachers unions. This hugely resonated with me. Having teachers unions in 2010 is so archaic and leads us to have public school systems where the best teachers are paid the same as the worst ones. How is that American? How can we let this happen to our children? The picture on the right is Randi Weingarten, president of the AFT, the second largest teachers union in the country (with 1-1.5 million members) and villan of the film.
Teachers unions have created a system by which it is nearly impossible to fire poorly performing teachers. He cites a statistic that about 1/100 medical doctors lose their licence, 1/200 layers lose their license to practice law but only 1/2,500 teachers ever loses their ability to teach our children
The teachers union guarantees two things: average pay for teachers where they’re all treated equally and tenure. The first means that a teacher who goes way beyond the call of duty earns the same as one who sits reading the newspaper all day (they showed some of these on hidden camera and the principals were unable to fire them due to tenure).

In fairness to Ms. Weingarten I’d like to include a quote from a NY times positive review of the film that was more balanced on her role:

“Many of his scenes are already out of date. New York’s rubber rooms were closed in June. The same month Washington teachers accepted a breakthrough contract, which Ms. Weingarten helped negotiate, linking teachers’ pay to their performance and making it easier to fire them for incompetence.”

The film also profile the superintendent of the Washington D.C. school system, Michelle Rhee who was profiled in Time Magazine. She tries to shake up the system in one of the most poorly run regions in the country based on proficiency of students. She proposes to increase the pay of teachers to nearly 2x their existing pay and well above the national average. She says she wants to have “the best paid teachers in the country.” In return she asks the teachers unions to give up tenure so that they can fire those teachers that have significantly underperformed over time to create room for new teachers paid by merit. The national teachers union blocked her initiative and didn’t even allow a vote
And the teachers unions are one of the biggest lobbyist groups in America. They give heavily to the Democratic party on national elections and heavily to the Republican party on state and local elections. They buy the kind of protectionism that we wouldn’t accept in any other part of our workforce.

I’m sure it’s not as simple as all that. But it seems to be the foundation of what’s wrong. This is a country that believes that you get ahead on the basis of merit-based achievements. We tell our kids this. It is a country that by foundation believes in capitalism as the best model of producing an equal society. It’s a sham and a shame that we don’t enforce the system on the education system. As the filmmaker says in his voiceover is because “we’re making this all about the adults (e.g. pay, career protection) and not about the children.” Shame on us.

I want to see America’s best and brightest become teachers because they will produce our whole next generation of leaders and innovators. But you can’t expect to attract as many of our young talented people without a system that can over reward those who perform the best.

I’m obviously not talking about the private school system in the US where teachers, facilities and students are still cranking out the top tier of society. I’m talking about the egalitarian public school system that will determine whether America remains a competitive player in the global economy when your grand children or their children are adults.

Please go see the film. And better yet if you do as Fred Wilson recommends and book your tickets via Fandango or MovieTickets and get the $15 DonorsChoose.org gift card.

*** Appendix (personal note only for those interested)

This movie has a particular appeal to me. I grew up in Sacramento, CA where nobody that I knew sent their kids to private schools. I grew up in public schools and so did my wife. Those were different times and it was a different city. We were lucky.

I had a high IQ and tested into the “rapid learner” program starting in the 3rd grade. I never even thought about it back then that there were kids who were on the “normal learner” program and how that must have felt. Looking back on it it’s clear to me that this “track system” that the movie talked about was in place and I was a beneficiary.

The obvious point of the film is that teachers make a difference and have the highest level of influence over our future success as students and as human beings. Incentivize teachers to perform at their best (through merit-based pay & training) and incentivize the best people to come into education (through merit-based pay) and you’ll improve the quality of our country’s teachers.

Our imperfect system produced some teachers that changed my life. And honestly others that completely let me down. My economics teacher, Mr. Thorn, ran computer simulations of lemonade stands in which each student had to build a local business and decide: how much supplies to order, how much to sell the lemonade for, how to respond to competition and how to change plans based on the weather. To say I found this engaging was an understatement. I poured myself into planning and I won the class-wide competition. I graduated this class and at all of 16 years old wanted to be an entrepreneur. He is the reason I majored in economics in college.

My English teachers in middle school (Mrs. Wolters) and high school (Mr. Lawrence) both helped me master the rules of writing and tap into my creativity. I know that I make grammar and spelling errors in this blog but I promise it’s through speed of writing, typing and publishing and not through a lack of knowledge. Mr. Lawrence’s high school project was to write our college essays early in the year so that we’d be done early and have written with passion and creativity. I’m forever grateful for this. From a young age I loved writing, which fueled my interests in reading, in politics and one day in blogging.

My spanish teacher, Mr. Gonzales, failed to get me interested in Spanish. But he was a geek and loved computers. So he & I would spend time after class building macros in … wait … VisiCalc! and then in Lotus 1-2-3 to help him automat the reporting of grades and attendance. As a result of this our high school typing teacher asked me to teach a course in ‘advanced computers’ to other high school students (she didn’t know enough herself) and he also helped me get a job at 17 in a computer store called Software Centre. I know that 17 year olds these days seem to all program computers but this was 1985. I was talking with adults about the differences between PC-DOS and MS-DOS about Word vs. WordPerfect about Harvard Graphics and about PeachTree accounting software. I was fast tracked. By a teacher. Yes, these are incomplete sentences. It’s for effect

And in other areas I was failed. To this day I really know nearly nothing about chemistry. Nothing! I know that sounds crazy but my teacher, Mr. LaDue, was literally as bad as the worst examples of the undercover footage in the movie. He would start the class, give us an assignment and then disappear into a side room for most of the hour. We goofed off. He gave tests that were the same as those he had always given. Everybody knew the questions in advance. It was pathetic. If all of my classes had been like that and if I didn’t grow up with active parents, I can’t imagine where I’d be today. I had the same experience with Mr. Linde in World History where every lesson was “read 30 pages” and then he’d leave the room. He cheated us and we cheated him back. But it was we who lost.

In college I stayed an extra year to get a second degree in political science (first degree was economics). I was so intrigued to read about the history of China, of the conflict in Vietnam, Soviet / US relations, the Middle East conflict, etc. These were all foundations I should have had in high school but though interest I eventually spent much time immersing myself in world affairs.

My parents … well, my mom in particular, encouraged me to get involved with extra-curricular activities. I took acting classes, music, dance and went to the theater. We weren’t “posh” but she made sure we went to gourmet restaurants & bakeries to experience new things (she eventually opened up a few bakeries and a French/Californian restaurant herself) and encouraged us to travel the world. So in addition to economics, writing & computers I had great exposure to the arts and to music.

I’m socially liberal, fiscally moderate person. I believe in merit based pay. I believe in capitalism but I also believe in a safety net. I believe the safety net is in all of our best interest in addition to being the morally right thing to do. I don’t believe in long-term welfare because they destroy incentives. I saw this first hand working in Germany and France where talented young people stayed at home in stead of working due to protectionist, archaic BS, that one day will go away. And I certainly don’t believe in teachers’ unions. I’m sorry if I offend anybody in saying this. I’m not anti teacher – to the contrary. I want our best public teachers to make a lot of money. And our worst should be fired. Public school tenure for k-12 is archaic and should be abandoned. Can you imagine if we ran our tech industry this way?

For the record, my second grade son is currently in a public school. We’re lucky that it’s one of the best in LA. We have the resources to send him to a private school. Every year we have the debate. Eventually he will go private – probably in middle school. Maybe earlier. We’re trying to work within the system. I have the same emotions as those discussed by Guggeneheim in the film.

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The Four Main Things that Investors Look for in a Startup

by Mark Suster on October 6, 2010

I obviously don’t speak for all investors. But in my experience as an entrepreneur and now spending my time amongst investors I can generalize that almost all VC investments in early stage technology & Internet investments come down to just four key factors. And they’re easy to remember because they all begin with an M: management, market, money and above all else momentum.

This post was prompted by an email exchange I had with a young entrepreneur. It’s a conversation that creeps up from time-to-time. This person had been introduced to me several times by angels and I was told that I’d be the perfect seed investor. I was interested in learning more. For a combination of reasons I didn’t end up talking with the CEO in time and the company quickly became over subscribed. That’s fine. It is probably the right thing for the stage of company.

So I wrote to the entrepreneur and said, “Congrats. Now that you’ve gotten the round done I’d love to get together at your convenience and learn more about your business so I’ll be ready well before you’re next fund raising event. The CEO said, “Not taking meetings with investors for a while (hope you understand), so lets connect again in a few months?”

I do understand. And the CEO was very polite and professional about it. And the fault for not meeting quickly in the first place was mine. I had been traveling.

I understand. But I disagree with the approach for most entrepreneurs.

Not everybody agrees that entrepreneurs should take investor meetings outside of “funding season” when they’re raising capital. They see it as a distraction and a time suck. I agree that you shouldn’t take tons of meetings and not from people who are just “fishing.” But I believe you need to identify those investors that you think will be a good fit down the line and start building your relationships now. Maybe this CEO doesn’t see me as a great fit. That’s OK, too.

But if you identify investors with whom you’d like to work here’s my advice:

1. Momentum - The number one thing that investors get their checkbooks out is for momentum. Everyone has their own definition of momentum (user numbers, revenue, channel partners, biz dev deals, whatever). But the reality is that this nebulous term people talk about that they “need to see traction” really just means that they’re not ready to invest in your company. Why? Chances are they don’t know you well enough and can’t judge your performance or capabilities. Some have “rules” – everybody breaks them for the right deal.

Imagine the “typical” deal – somebody comes into a VC’s office, they’ve never met, they’re highly referred by a friend and they’re pitching a product demo and a PPT. You’ve never met them and are asked to make a judgment in 2-3 weeks because they’re doing a road show. That might work for $50-100k but less likely for $3m unless you’re a seasoned entrepreneur, known to the VC, have some metrics that work in your favor or have built something the VC believes to be truly unique. And VC’s are tough customers. They’ve “seen it all.”

So that’s why I tell all entrepreneurs that if you want to raise money from VCs you should see them early. If I see your alpha product then I can judge how it develops over time. If you have 2 developers and the next time I see you it’s a team of 6 with a new head of products I can see momentum. If you have beta customers, new pricing plans, different positioning, more market insights, good press coverage – whatever – these are all signs that the ball is moving forward. And it is that momentum that is easier to judge than a single data point.

Some entrepreneurs have said to me, “yeah, but then the VC sees you when you’ve not yet matured and you set a bad initial perception.” Not if you manage expectations. ”We know that we’re meeting you earlier than you’d normally invest. We therefore may not have the full progress you’d expect but we’d like to meet you early so that when we’re at the stage you normally invest you’d have a chance to judge our progress.” Lowering the bar is disarming.

So imagine when the entrepreneur who “isn’t taking investor meetings” comes back for the next funding round. It’s true that I’ll have points A & B. But I would have missed a lot in between. And my “point A” is only determined by what I read in the press since we never had our initial meeting. If the company “crushes it” and has data to prove they’re doing well I suppose it hardly matters. But if they’re like most people it’s harder to measure. Almost every deal I’ve ever funded I’ve gotten to know the founders over time. I’ve talked before about how to build long-term relationships with VCs.

2. Management Team - This is really a sine qua non. Different VC’s have different calibration points on the continuum of management, product or product / market fit. I’m personally 70% management, 30% product. But for any investor it takes a miracle to get investment dollars out of them if they’re not impressed with the team. You will find some investors who will say to themselves, “I could do this deal but the CEO will need to be replaced.” Sadly, I hear that all to often. I never feel that way. If I feel a priori that the CEO can’t cut it I’m highly unlikely to invest.

Because management is so important I always tell people to make the bio slide the first in your deck. If you have good experience then the VC will be leaning forward for the rest of the presentation. If you save the punch line that you’re from the industry, did CS at MIT, worked for 3 startups, whatever, then they don’t have that powerful knowledge as part of their evaluation set.

If you haven’t read my post on the bio slide before here it is.

3. Market Size - There is a lot of talk about “dip sh**” companies these days. Mostly by early stage investors talking about getting smaller exits. But whether you’re talking with micro VCs, seed stage investors or series A,B investors they all want to believe that your company CAN be big one day. They might want you to start lean. They might accept that a $50 million outcome will drive good returns given their small investment size, low price of entry, etc.. But almost all VCs care about investing in big markets with ambitious teams. So NEVER talk about early exits, quick flips, tuck-in acquisitions, previous interest shown by acquirers, etc., during your meeting.

And make sure you have some metrics or some way of demonstrating why you believe this is going to be a really big market. As I’ve said before, “sorry guys, it’s the size of the wave, not the motion of the ocean.”

4. Money - The final M is often misunderstood. Most VCs you’ll want will want to be able to put a certain amount of money to work and will want to own a large enough percentage of your company to pay attention. There are modern investors who think differently and are willing to invest $100k as part of a $1.5 million round. But mostly when they do it’s just because they consider you part of their early stage investment portfolio where they’re less sensitive about ownership percentage. If you “take off” they’ll likely want to own more. I acknowledge that some investors have as their strategy to make lots of small bets. It’s the exception rather than the rule.

We can have an intellectual debate about whether it is the right investment strategy or not to have a minimum threshold. I’m only here to tell you that it is the case and better that you know going in. Most VCs want to own between 20-25% minimum of your company. If they co-invest with somebody else that they consider important they might be willing to cut that back to 15%. But most VCs won’t want to own 8% of your company. If they do it’s likely because they want an option to invest more later.

I’ve heard one prominent investor talking about how one of his best returns he only owns 7-8%. But that’s because it turned out to be a $2.5 billion company (and counting). So if you turn out to be THAT then people will be happy with just 2%. But for the 99.9% of everybody else know that VCs will likely allocate their time more to companies with higher earning potential over time. Don’t shoot the messenger. It just is.

And by the way, it’s OK to ask, “do you guys have a minimum ownership level that you like to hit?” Doesn’t hurt to politely get this out in the open.

BUT WAIT? All these “m’s” and you never spoke about product? WTF? What about Product / IP? That’s not an M? OK. True. It’s a P. But to make the 4 things more memorable (and thus all M’s) I had to wrap product up in momentum, which is mostly based on product momentum. But to be clear: investors care about management, markets & products. They invest in deals where they can own enough to make it worth their time - thus “money.” And all of this is wrapped up in forward progress that you demonstrate over time.

Investors invest in The Big Mo.

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This Week’s Keynote Presentations

by Mark Suster on October 5, 2010

I have often complained how much I hate sitting on panels. The reason is that conferences usually pack them up with speakers to maximize the number of high profile guests in attendance to sell more general admission tickets. So with a panel of 5-6 people and 30-45 minutes it’s hard to have a real conversation. Every speaker wants to get their points in so the conversation often lacks rhythm. And often the “moderators” are nothing more than an extra panelist hoping to score his/her key talking points as well.

In contrast, I absolutely love public speaking and am willing to speak to audiences large or small. I love the energy of sharing ideas in a coherent flow on topics for which I’m passionate. I almost always stay afterward and meet as many people as I can until the post speaking event is over. I do this because there are often people who want to meet VCs and don’t have a chance in their current roles to do so. And this is my chance to give back to all of those people for whom I don’t have enough time in the week for that “15 minute coffee meeting” that many people wants with a VC.

I don’t really proactively ask often to speak at events but I’m always open to it provided it’s somewhere that I already need / want to be. I’m hoping to speak later this year in Philly, for example, where I’ll likely be in November and/or December (also in Annapolis so maybe Washington DC and/or Baltimore?). And I’ll be in NY in early-to-mid November so if you know of anything ….

Coincidentally I was asked to speak three times in the coming week. If you have any interest come on out. I’d be happy to hang around and say hello and meet some of the people that I usually only know online.

1. Startup Matchmaking (Tues 5th Oct – Santa Monica) - The first event is tonight (Tues, Oct 5, 2010) at Wokcano in Santa Monica. The event is Startup Matchmaking Night organized by William Belk. I agreed to give up my evening at home because this is such an important topic to me. In LA we lack the same scale of technology ecosystem as they have in the Bay Area. We have tons of entrepreneurs but our technology community has historically been splintered across town and across industries. In aggregate we have a ton of great developers but we need a better feeding system into our startups. So any event that seeks to marry up great LA startups (Beachmint, Sometrics, Cramster, Factual, GumGum, Burstly, etc.) with high calibre technology people will get my time. I’m doing a short keynote tonight.

2. Caltech / MIT Enterprise Forum (Sat 9th Oct – Pasadena) - I love speaking at Caltech because you get a great cross section of some of LA’s smartest people (I think definitionally this is people from Caltech) with many people from the business community. This Saturday morning I’ll be giving the keynote presentation on “The Future of Social Networking.” (unfortunately they didn’t give this event it’s own URL so this link should only work until the day of the event.) Of course nobody really knows what the future of social networking is and anybody who claimed to know would be a shyster (yes, a little bit too close to my last name for comfort.). But for the first time I’ll start talking publicly about the debates I’ve been having privately over the past 2 years about the direction of websites like Facebook, Twitter & Foursquare.

3. Stanford’s Entrepreneurial Thought Leaders (ETL) Series (Wed, 13th Oct – Palo Alto) - Many of you will be familiar with Stanford’s annual ETL series and I feel honored to have been invited by Steve Blank to present this year. I will be giving a longer version of a presentation I gave in China earlier this year on classic lessons for getting a startup off the ground. I plan to cover the early mistakes startups make, how to maximize value for your venture, how to come up with the right idea, how to raise your initial capital, etc. It seems they broadcast these online so even if you don’t live in the Bay Area you should be able to watch this event.

I’d love to meet as many people as possible at these events so feel free to come and say hello. If you have any specific requests for things you’d like me to cover I’m happy to consider adding it to the presentations. I have my basic slide decks complete but always happy to add, amend or ad-lib.

Hope to see you!

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How to Manage Employees When They Make Mistakes

by Mark Suster on September 30, 2010

I was recently involved with a company (not as an investor) where an embarrassing mistake was made. One of the leaders took a sort of “heads will roll” approach. It’s not my company so I basically stayed out but tried to encourage him to think differently about the “punishment.” I didn’t stick around for the repercussions so I hope the process was balanced.

But it got me thinking about the topic of leadership and how to manage people through “light” and “heat” (think carrot & stick but I like my analogy better because we’re humans not animals).

As a leader you need to have both heat and light in your arsenal. You cannot lead all people all of the time through light. In my experience some individuals are the over-achievers who are looking for stars on their foreheads and thrive on constant positive feedback. For these people you need to lead through *mostly* light. There are other types of people (let’s say, prone to a bit of laziness or procrastination) who tend to be motivated more by fear of being in “trouble” and not wanting to look bad. These people are led better through a bit of heat.

I know the populist answer is to lead through only light. But as a father let me offer you this analogy. I spend a lot of the time with my kids trying to tell them things like, “if you want to be able to buy nice things in life you need to work hard” because I don’t want them to take all that they have for granted. I tend to praise their efforts as much as their results while still emphasizing the importance of actual results. I try to be a “light” daddy. Mostly.

But when they’re being naughty an “I’ll buy you ice cream if you’re good” approach doesn’t work and isn’t warranted. I much simpler, “if I have to come over there and separate you two, you’re going to lose your lego set for a week” yields better results. Not with a yell. Certainly never with violence. But with heat.

But that begs the question – what is “heat” and how do you apply it?

I always felt that the “disappointed dad” (or mom!) approach in business worked more effectively than yelling. It is crushing to somebody when they hear messages like, “I would have expected you to have planned better for this meeting. I put a lot of trust in you and I feel let down that you didn’t take this seriously enough to prepare.” And then followed with “listen, I don’t want to see this happen again. Let’s work on a plan to make sure it doesn’t. But to be clear, if I see this again I’m going to have to consider consequences.”

So my rules are:

1. Highlight the error – Best to do this after the situation has happened, not when emotions are flared on both sides or you won’t have a rational discussion or reflection. Tell the person that you’d like them to reflect on what happend so you can debrief on the topic in 48 hours. Obviously if the situation is urgent you need to put the situation right before reflecting on what happened.

2. Discuss what you would have expected – I never understood why when managers did reviews they’d say what you did wrong without a clear explanation of what they think you should have done. If you don’t have an answer for what the right process or right behavior would be then you’re not going to be very effective in helping the person to be better next time.

3. Help them plan the new rules / process to ensure the mistake isn’t repeated – Be a problem solver. Work on the new process with them. Talk about exactly what needs to happen next time. They need a map for success – not just a “this better never happen again” arse kicking.

4. Don’t immediately go back to “buddy buddy” nice guy. To be an effective disappointed dad they need to feel a little distance and a sense that “all is not OK.” This is really hard as a parent because you want to just go up and hug your kids. I feel the lesson isn’t absorbed as much this way. Think of it as “the penalty box” or a time-out or whatever. But they need a cooling off period from being in your good graces. They need to know it is not OK what happened and shouldn’t be taken lightly. But not a sense that they’re now not to be trusted. In fact, I think the best approach is if they feel they need to re-earn your trust.

5. Don’t yell. Yelling yields resentment in the receiver and often makes the message unpalatable (I have a temper like anybody. I cannot say I’ve never yelled. I got really angry with my assistant, for example, but only one time since we’ve worked together. I yelled. I had regret for weeks and we had to spend way more time working through the issue because I inflamed the situation than would have been the case if I would have kept my cool. I lost twice. I had to rebuild trust. It worked against me, not for me.)

6. Praise people publicly, but discipline people privately – If you do need to discipline people don’t try to make a public spectacle of them to set an example. People won’t learn – they’ll just think you’re an arsehole. People absorb their mistakes when they aren’t embarrassed by them.

___________________

It’s strange to me that in the technology sector we have such a reputation for yellers. Maybe it’s business in general and not just tech. When I think about the reputations of Larry Ellison, Tom Siebel, Marc Benioff, Steve Ballmer and reportedly Steve Jobs it seems like we have a culture of yellers or people who lead through fear. I’m certain that if you’re as genius as any of these people you can get away with it in spite of yourself.

People stay at companies with leaders who rule like Mussolini because they want to be part of something super successful. But it does tend to breed organizations of people who walk around like beaten dogs with their heads down waiting to be kicked. It produces sycophants and group think. And if your company ever “slips” people head STRAIGHT for the door as they did at Siebel.

I’d love to see a new generation of tech companies that don’t rule through fear.

So back to the situation that prompted the post. It actually affected me much more than the team involved or even the manager. I felt personally disappointed and let down. But I also knew it was unintentional and frankly it was already too late to fix it. And I know how hard the team involved works. In a way, while I felt bad for my situation, I felt worse for them. I’m certain they felt mortified. And that plus an action plan is good enough for me.

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What I Would Have Said at TechCrunch Disrupt

by Mark Suster on September 27, 2010

What do you get when you combine 7 panelist plus one moderator on to a stage for 30 minutes to talk about a serious topic? Answer: Not much. And that was evident on today’s Angel vs. VC panel.It’s a shame. There are real changes in the venture capital industry and it would have been fun to talk about them. I said almost nothing in the 30 minutes.

My friend Ethan Anderson put it best to me after the panel, “You probably shouldn’t have been up there. There was a fight going on and it’s clear that you were neutral and didn’t have a dog in the fight. Maybe you should have moderated, but that’s likely why the panel went how it did.” I think that’s about right. Perhaps I shouldn’t have pushed to be on the panel in the first place.

If given a chance here’s what I would have talked about:

1. The VC industry is segmenting – I have spoken about this many times before. The VC industry has different segments in it that have different fund sizes, different investment amounts and different risk / return expectations. That’s a good thing. I wrote about it here (mostly starting at point 7) and Chris Dixon wrote a great post about it here. We need people at all stages of the funding lifecycle and not just VCs. We need venture debt, factoring companies and public markets.

2. Industry change allows the entry of newer players at earlier stages – It doesn’t take as much money to launch a startup anymore. We all know that. You have an open source stack, cloud services for storage, processing & management and APIs for just about anything you want. So what took me $2 million at my first company now takes $20,000. So in the past we needed VC to really get a startup going. These days that’s not the case and it’s a great outcome for entrepreneurs and for innovation. A new group of investors have clustered around writing earlier-stage, smaller checks. That’s awesome. And people like Jeff Clavier, Aydin Senkut, Dave McClure, Chris Sacca & Eric Paley (at Founder Collective) are leading the charge.

3. There is no such thing as a super angel, only “micro VCs” - Ron Conway said what I had been preparing to say, “there’s no such thing as a super angel.” Either you’re an angel or you manage professional funds. Period. If you’re an angel you invest your own money and you have nobody to answer to except your spouse. And you can have ulterior motives like helping people or being involved with “cool stuff.” If you’re investing other people’s money you’re a professional money manager. If you invest it in startups you’re a VC professional money manager. Now we can call you a seed-stage VC or a micro VC. We can even acknowledge that you might work differently than traditional VCs. But you’re not an angel. So I wish this separate definition would go away. Stop to think about it, why would a super angel act more like an angel than a VC? A: Only because it’s a nicer branding for entrepreneurs. That’s all. You still have a fiduciary responsibility to your investors (LPs) to maximize returns.

4. Some companies should raise less money and consider early exits – We had a discussion about whether companies should raise less money and have smaller goals for an exit. Dave McClure argued passionately that since the overwhelming majority of exits are sub $100 million we need to readjust how much capital goes in. Chris Sacca talked about how a $20 million exit can change a founder’s life and that shouldn’t be scoffed at. I totally agree and have been arguing this to entrepreneurs for years. I used an analogy I heard from Michael Dougherty (founder of Jelli) recounting what First Round Capital told him, “sometimes you’re on the local train and sometimes you’re on the express train. The express train might get you there faster but there are no options to get off along the way. The express train represents raising a large VC round before you’ve figured out whether you can be big.” I agree. I always counsel young entrepreneurs to start on the local train. You can always upgrade if you sense that you’re on to something big.

5. Others should swing for the fences - Some companies are designed to be big, industry changing plays. It’s nice to see entrepreneurs who still dream of doing big things. That doesn’t mean raising huge sums up front but when you’re on to something then you step on the gas. I would never go into an investment where the entrepreneur was talking about a $20 million exit up front. That may be a great return for him/her but for a venture investor it’s not. That person would be better off raising angel money or no money. And that’s honestly OK. It’s just not a VC investment.

6. Outsized returns are produced by having a few big winners. You can’t average your way into VC success – Dave McClure talks with such disdain about venture capitalists that I think he misses the broader point. I understand why he wants to differentiate himself but I wonder if a scorched Earth strategy against the main funding source for your company pays in the long run. What micro VCs need to consider is what happens when several of your companies want to grow and require VC financing? Or when the economy turns downward and they all need financing extensions? You might be able to get several $20-50 million exits in a good exit environment but I doubt that will drive outsized returns and cover all of the busts. In most funds the outsized winners return the fund (or a large portions of it) and if you get a few of these you’re doing really well. When I look through our own returns across our many funds it has always played out this way. Our biggest winner from our last fund returned a total of $320 million to our investors across two funds. You can’t average yourself into VC success. You have some big winners and some losers. And I think that’s what Michael Arrington was getting at when he was pointing out Sequoia’s $12 billion in exits in the past few years.

7. In my heart I believe in ‘founder liquidity’ and always will – I have written about this extensively so if you want a deeper dive it is in my post on “The Entrepreneur’s Thesis” or “Should Founders be Able to Take Money off the Table?” I was a founder once. I had two kids and a rental house. My wife worked at Google so while we had good income in Silicon Valley it’s hardly the life of luxury given the costs of housing. And then you think about these millionaire VCs flying private jets, kids in private schools and vacationing in exotic locations talking about swinging for the fences. It is such a disconnect. If the company is moderately successful, growing and has great prospects for the future then a small liquidity event will help founders & venture capitalists to be aligned. The hardest thing is deciding what the right time to allow founder liquidity is. I discussed it in my post on the topic linked above.

** One small note: many VCs who got into the industry in 2001 or later have never seen a “carry” check. So many of the younger VCs who weren’t part of the heyday (late 90′s) and who weren’t successful entrepreneurs first have never had big liquidity. It’s just worth pointing that out. I think most entrepreneurs don’t realize this.

8. Price creep hurts investors. But it also hurts entrepreneurs – Mike asked people about what they were doing to keep prices down. It was obviously a joke and a reference to the supposed Bin 38 meeting. There is no way for people to keep prices down – it’s a competitive market. This is evidenced by the current price creep that we’re experiencing for early-stage deals. The only solution as an investor is to sit the market out as Chris Sacca said he’s inclined to do. At GRP we sat out 2007 and much of 2008 for that reason and we’re now looking pretty smart for doing so. We picked up activity aggressively in 2009. In public investing you can get in and out even in a bull market. VC is different.

What I wanted to say, but Michael cut me off (hey, it’s his show!) was – it can actually be a problem for entrepreneurs to raise at too high of a price. We saw this with VC backed companies in 07/08. They raised at $40 million pre-money for pre-revenue companies and when the economy corrected it became hard for them to refinance themselves. You have to be careful about “getting ahead of yourself” or you make the next financing more difficult. If you do a $1 million angel round at $6 million pre-money and hope to do a Series A round for $2-3 million that’s fine as long as you’re doing awesome against your metric goals and the market continues to be frothy. If either condition doesn’t hold it will be hard to do anything but a flat or down round. I leave it to every entrepreneur to decide but just go in armed with the thought exercise about a multi-stage investment process over time and under different market conditions.

And finally, one non VC topic.

9. Panels stink – I’ve written twice about sitting on panels and how to make the most of it. They are here and here. It basically boils down to: educate, entertain, have a dialog, don’t be boring and don’t sit on large panels (doh!). But I wrote about one other point that I wrote back in March 2010 so it’s clear I didn’t just dream this up after today’s panel. But I certainly could have written it about today. Succeeding on a panel is about pleasing the audience AND your fellow panel members (at least the ones you respect / like). No prizes for guessing who I’m talking about here (yes, I was annoyed). So here it is, your moment of zen, from March 2010 …

“Hogging minutes – The other annoying thing on panels is the “over talker” or the person who always has to answer the question first (the way that annoying kid did back when you were in elementary and high school). Don’t be a wall flower – you should get in your minutes. But don’t crowd out other people. If your goal is to sit on panels with important people and build a relationship with them you won’t achieve this by not letting them speak! (you might think you won’t do this either by being controversial – I think if you learn to do controversy with humor and tact it’s OK. Just my view.) Also, when it’s your turn to speak don’t speak for too long in any one question. People prefer snappy answers to questions.”

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Revisiting Paul Graham’s “High Resolution” Financing

by Mark Suster on September 25, 2010

When I first read Paul Graham’s blog post on “High Resolution” Financing I read it as a treatise arguing that convertible notes are better than equity. As I’m generally a believer in ‘pricing rounds’ I initially didn’t agree with the premise of the post.

Photo credit: D. Story/J. Blanchard/O’Reilly Media

I just re-read it and on second reflection, I’m surprised just how much I found myself in near TOTAL agreement with Paul. Having re-read it, I believe his real premise instead is, “Fixed-size, multi-investor angel rounds are such a bad idea for startups that one wonders why things were ever done that way.”

On this assertion, for the reasons that Paul articulates in his post, I’m aligned. Not that they’re “such a bad idea” but more that there are inherent problems for entrepreneurs in the process of raising angel money that need to be addressed.

Here’s where I feel common ground :

1. Most investors wait to see who else is investing. ”Social Proof” weighs heavily on investors in making their decisions. Perhaps it shouldn’t. Maybe one day it won’t. But it is. This leads to the problem of “herding cats” for entrepreneurs raising angel money. I talked about this in my social proof post where I gave some suggestions about how to get the early guys off of the fence. Most early-stage entrepreneurs who have worked with me (either as an angel or as a seed VC) know that I don’t rely at all on the social proof of other investors. When I’m in, I’m in.

Paul Graham’s assertion that “any startup founder can tell you the most common question they hear from investors is not about the founders or the product, but “who else is investing?” rings true to me.

2. Investors who commit early deserve to have a lower price. I’ve always believed this. I argued it in my post on how social proof helps fund raising with angel investors.

“what you really need to get an angel round together are your “anchor tenants.” These are the people who make the early commitment to you to fund your round before having any social proof. You should seek to get people who are respected by others in your field and who will therefore make it easier to raise the rest of your angel round.”

Two strategies I talked about in the post for getting your “anchor tenants” are 1) taking them on as advisors first and 2) giving early people cheaper pricing. On the former I mentioned a video that I shot for This Week in VC talking about how Farb Nivi solved this problem:

“Farb talks about how he got Rob Lord on board at Grockit. He first worked hard to get him to be an advisor to the company. From there Rob decided to make a small investment.”

On the latter:

“Another successful strategy that I’ve often recommended to people who don’t have a track record is to carve out a very small amount of seed investment (say $50,000) and offer 5 people to invest at $10,000 each at a $500,000 post-money valuation … offering the social proof you need attract great employees and ultimately venture capital investors.”

Taking it from an investor perspective (not me, angels) I think it’s totally unfair to see early angels invest, take more risk, help you get to the next level through both sweat & money, and then pay a higher price because the round had a convertible note with no cap.

Paige Craig, currently the most prolific, under-dressed, and most eligible angel in Los Angeles, sourced a hot, young startup called Gendai Games (makers of GameSalad - a platform for rapid development of mobile games). By “sourced” I mean he: went to SxSW, saw a demo, loved the concept & team, gave them a check while still in Austin, called me & helped get them into Launchpad LA, get a local investor (DFJ Mercury) to commit, shopped the deal to a bunch of LA investors, get the CEO to move to LA and brought on LA seed investors including Disney (through Steamboat) and DFJ Frontier. Phew. But that’s what great angels do.

You mean to tell me that guy deserves the same price as somebody who invests six months later? NFW. (disclosure: I’m an angel investor in Gendai Games, but not on social proof but on the relationship I built with Michael during Launchpad and the traction he’s had with major iPhone & iPad developers).

The reason I have generally been against convertible debt is that historically it was a mechanism that avoided price. People raised rounds with “a discount to the next round” or “warrant coverage.” Yes, these give cheaper prices to early angels but potentially not much of a discount if the company becomes hot. Another mechanism is “convertible debt with a cap” (max price). That’s OK, but it gives you a max (read: price!) and not a min. Why not just price the effing round? I wrote about convertible debt ad nauseam here.

3. Legal costs of early stage financing should be cheap – this is one of the final remaining arguments for convertible debt but even Paul acknowledges that this is no longer necessarily the case:

“Different terms for different investors is clearly the way of the future. Markets always evolve toward higher resolution. You may not need to use convertible notes to do it. With sufficiently lightweight standardized equity terms (and some changes in investors’ and lawyers’ expectations about equity rounds) you might be able to do the same thing with equity instead of debt. Either would be fine with startups, so long as they can easily change their valuation.

I agree on all points. If I’m investing in convertible debt I’m fine as long as there’s a cap. He’s fine with equity provided it’s cheap to paper it legally. We both believe in rewarding different investors at different prices. These days there are many lawyers that will do equity deals cheaply as long is it is a standardized, simplified term sheet, early stage, no serious investor / management debates, limited IP / customers / due diligence and as long as they perceive you as a “hot” company that’s likely to need legal services for many years ahead. (if you need advice on how to find / work with startup lawyers cheaply click that link).

4. Raising variable sized rounds – This is a hard one. Most investors don’t want to hear teams say, “we might raise $250k. But we might raise $1.5m. It depends on how much appetite there is from investors and at what price they’ll invest.”

They want to hear that you have a clear plan, know what you want, know what you’re going to achieve with the money (milestones) and know when you’re going to be out again raising money. Here’s Paul Graham again on this issue:

“… [historically] startups had to decide in advance how much to raise. I think it’s a mistake for a startup to fix upon a specific number. If investors are easily convinced, the startup should raise more now, and if investors are skeptical, the startup should take a smaller amount and use that to get the company to the point where it’s more convincing.

It’s just not reasonable to expect startups to pick an optimal round size in advance, because that depends on the reactions of investors, and those are impossible to predict.

Violent agreement. I often counsel the following: set a minimum amount of the round ”X” (for example $500k) and put a clause in the term sheet that allows you to do a second closing of up to “X” + 50% ($250k in this example) in up to 90 days post closing at the same price. This gives you the ability to get the first money in the bank while giving you flexibility in size of round.

The key is making sure the second close isn’t too high (I think 50% of X sounds about right) because you’ll be adding on that dilution to yourself & “X” investors will own less of the company. But importantly you need the “time bound” of 90 days so that “X” investors don’t feel cheated. If you take money 180 days later then those investors get more information about how you’re performing and therefore face less risk. It goes back to the issue of investor fairness. Later investors shouldn’t get a “free ride.” 90 days seems about the max to me. Often I suggest 60.

Importantly any VC investor will understand the “first close” mentality since nearly all VC funds are raised this way from our investors.

Here is where I do not agree:

1. “A startup could also give better deals to investors they expected to help them most” – That is a quote from Paul on the “high resolution financing” post. I believe you reward investors who make an early call just like on the public stock market. It is dangerous territory when the management starts rewarding certain investors because of a “perception” that they will add more value to you.

When I was raising money in late 1999 I had an investment team in Germany (I was in the UK) suggest that they should get a lower valuation than others because they were ex McKinsey guys and had better access to industry. I chuckled. We all know ex McKinsey people, don’t we? We chose not to accept their generous offer.

But the “I can help you more” argument comes often from investors. It should be used as a mechanism to decide whether to take money from that person, not whether they should pay a cheaper price. That is a slippery slope and believe me will piss off other investors way more than any perceived benefit of landing that one investor. Every investor understands the concept of cheaper pricing for committing early and taking risk. Nobody feels good about cheaper prices based on ability to help.

If somebody (excluding VCs) is truly able to help you more than others then reward them through performance-based warrants based on measurable success criteria.

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What Entrepreneurs Should do about Price Fixing

by Mark Suster on September 23, 2010

OMG. This is super funny. I wrote the post below after work. I had to race to meet my wife for dinner & a movie (we have “date night” once / week) and went to see Town (which was awesome). I figured I needed time to spell check and edit before publishing so I would hit publish when I got home. Wow! I returned to my house, flipped on my Mac and see AngelGate, The Sequel. It makes my post even more poignant.

_________________

We all know about AngelGate by now. I thought I’d try to look at it from a different lens, that of the entrepreneur. Here’s what you need to know…

As a funny coincidence I happend to have written about the topic of collusion 3 weeks prior to the fateful dinner. Asked to respond to the topic, “What collusion happens with AngelList, if any” I wrote the following:

“Um, let’s not be naive here and not think that a “form of collusion” doesn’t happen on virtually any financing round. Investors talk to each other. As an entrepreneur you should assume that.

The best behaved investors will only call if they ask you first (for reasons of being burned by this in the past when I was an entrepreneur, I’m now pretty religious about asking and being totally transparent). But the majority of VCs & Angels all speak. They might not actively “collude” and say “let’s collectively keep the price down” but in the resulting discussion pricing information will flow – whether intentional or not.

To be crystal clear – I think AngelList is awesome and I have NEVER heard Nivi or Naval ever reveal or discuss pricing information. My assertion was that information flows outside of their process. People call each other. People call their friends. They’re not in search of price fixing or collusion, they’re in search of diligence information about the company. Typical questions:

What do you think of management? How well do you know them? Have you reference them?
Have you looked at competition? How well financed is the competition? What is their market traction?
How much are they raising? How much is soft-circled (committed)? At what valuation? Convertible or equity? Cap or warrants?

So to be clear I think in the overwhelming majority of cases these are diligence calls to feel out the opportunity in which price discussions exchange hands more as a by-product of the call than the intention of the call.

This also happens with VCs. It is such a small community that it is hard to raise money by stealth. Information flows. That is why I tell people not to shop deals too widely. I’m not defending the practice (actually, I publicly loathed it) of VCs calling each other without consent – but it is. So acknowledge it to yourself and be prepared to deal with it.

I’ll give you an example of information flow at its worst. When I was fund raising for my second company we had agreed a company-wide deal with Salesforce.com to use our product. That was an important part of our “social proof” that we had built interesting technology. I asked every VC not to call Salesforce. I was concerned that too many inbound calls would put pressure on my fledgling relationship.

How did VCs respond? Two emailed Marc Benioff directly. He emailed the head of corp dev to say essentially, “who is this guy who’s telling everybody he’s working with Salesforce.com. Deal with it.” And as I’m sure you’re aware shit rolls down hill. Another group who were close with Parker Harris called him directly to discuss their views of us. I had asked them not to. They did it anyway. I didn’t work with them. Obviously.

So what is an entrepreneur to do?

My advice:

Do not mention the other VC firms, angels, seed funds, etc. to any investors that you are working with if you don’t have to. You can simply say, “At this stage I think it wouldn’t be fair to the other firms if I disclosed who they were. Some might prefer that we not.”
I sometimes ask entrepreneurs. I have never betrayed this trust. I was once cut out of a deal by a firm that didn’t know me (they were the A, I was going to be the B – they shopped the deal to a firm they knew). I swore not to let that happen again. But I don’t call without consent. I usually say something like, “I know a couple of people over there. If at some point you feel comfortable and if it makes sense I’d be happy to speak with them.”
If you have a “lead” investor agreed then the price is already set and you don’t have to worry about price. But it is still best to try and control information flow where you can.
If you get the sense that you have interested investors but are worried they might all call each other, it is perfectly acceptable to say, in total earnestness, “listen, I know that investors all talk to each other. we’re intentionally not going wide with this deal. We met with you because we like you. We’d be grateful if you didn’t discuss this with other investors without checking with us first. We’re just trying to keep the information leaks to a minimum.”
Once you’ve asked it’s pretty tough for investors to want to disregard that advice. It will happen, as I’ve outlined, but much less s0.

So is the market really colluding? I doubt it. I have many investor breakfast meetings and these often involve investors at all stages. We discuss things like what the general prices in the market are but not in a price fixing way but in a general commentary way, like “I can’t believe that guy paid 40 pre!” kind of way. We discuss deal structures. Often it’s to try and persuade people that we’ve found the right model. But I do the same thing with entrepreneurs and I do it publicly on This Week in VC.

Was the secret meeting at Bin 38 illegal? I wasn’t there but I highly doubt it was collusion. Did people say they want to keep VCs out of deal? Probably. That’s OK. It’s called competition. And sometimes VCs want to fund companies where we take the whole round and don’t mind paying slightly higher than angels want us to. It’s healthy competition. But I know virtually all of the people listed as having attended and I know them to be all high integrity people. If anything they’re fighting for the system to be more biased toward entrepreneur success than traditional VC success.

Was it collusion? I asked a person I’m close with who knows about these matters. Here’s what he said (name withheld but if wants to be public he can put it in the comments and I’ll give him attribution:

“To put it really really simply and roughly: 2 separate issues for antitrust claims: (1) abuse of (2) market power. Your question is about 1. But 2 is seemingly not at issue here. Aint no market power here, likely, depending on the definition of “market.” So if two investors even go so far as to agree to fix prices, which is issue 1, the company should say no thanks to that valuation and keep shopping for other lenders, of which there are many, to get a better price. That means there’s no violation of 2. Which means the antitrust claim sucks. Unless that room in the restaurant really did house all early round lenders in the tech space in the US. Which I doubt.”

But more than anything I’d like to plead for, in the words of my hero, Jon Stewart, we need a “Rally to Restore Sanity.” We’re all in the ecosystem together. Entrepreneurs need angels. Angels need VCs. VCs need corporations. Corporations need startups. VC’s need angels. And we all benefit from the tremendous innovation model that Paul Graham has given us in the past few years. Will it fundamentally “change everything?” I doubt it. Will it be crushed? No. The truth always lies in the middle.

[update] Is Ron Conway a great guy with good intentions in writing the letter he did? Sure. I think so. Do I agree with all his points? Not really. If you’re a seed fund that raised money from limited partners your fiduciary responsibility is to “make a buck.” But I bet his broader point was to tone down the rhetoric and stop with inside baseball. That’s probably fair. And of Dave McClure? He’s Dave. And I love him for who he is. Do I wish he’d tone down slightly? Sure. But I have never seen somebody be as tireless an advocate of the entrepreneurs for whom he works so I think it’s unfair to say otherwise.

So please watch this quick video (click on image or link above) for only 2 minutes starting at about minute 7. If you love Jon Stewart and have time start at minute 5. If you REALLY love him start at minute 2. Here it is – your moment of zen.

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Solving for Banner Blindness. Solve Media.

by Mark Suster on September 20, 2010

I think we’ve all come to accept that “banner blindness” is a real phenomenon. Sometimes you see solutions and immediately know they just make sense. Solve Media is that.

In the early days of the Internet as an advertising medium the industry organized to create “standard ad units” for which most media companies would sell their inventory. The standards were set by the IAB (Interactive Advertising Bureau), which was founded in 1996.

Normalizing ad units obviously has a benefit. But as we’ve all gotten used to the standard “banner” across the top of our screens or the “sky scraper” along the right-hand side we’ve trained ourselves not to look there any longer. Clearly these advertisements make some impact but often the effects aren’t measurable (and even when you do see something it is often subconscious and may manifest itself later as a search query in Google and therefore harder to attribute to the banner). Some companies are solving for this problem algorithmically. More on that another day.

The industry is taking different approaches to the problem. Many are starting to have Rich Internet Application advertisements (RIA) – with ads that sometimes takeover the entire screen without the users consent – classic interruption marketing. I haven’t really looked at the stats as to the efficacy of these campaigns but it’s a clear response to banner blindness.

We all know media companies are suffering as CPMs (the amount they can charge per thousand visitors) are falling, available inventory is climbing, free content and blogs are proliferating, user attention is being divided with social networks and the core media business cash cows like classified ads have been disrupted by companies like CraigsList.

So the debate in the print media world is whether or not to insert a paywall between users and content. Rupert Murdoch, owners of The Wall Street Journal, has famously come down on the side of charging for content. Some of their content is free – much is paid. The Financial Times allows you to view full articles but after you’ve viewed a certain number per month you have to pay a subscription. The New York Times also flirted with the idea when they created “Times Select,” a paid portion of their site including their OpEds. Like many users I just started reading the WaPo OpEds more. They cancelled this program.

But is there a better way? Enter “Solve Media” (there is a 101 second video that explains exactly what they do. Do yourself a favor and watch it if for no other reason than to see how to craft a really tight set of relevant messages for your product that are told in human and buyer’s terms. 10 out of 10 for this video. Awesome. I’m forwarding it to all of my portfolio companies). –> the company who made it is epipheo.

Solve Media offers a middle ground that they believe solves the problem. It certainly resonates with me. They allow content to stay free (Yah!) by having the user enter a small code before seeing the content much like you do with a “Captcha” screen to prove you’re a human. I know, I know. You prefer free AND no advertising. But that is a world where journalists don’t get fed and therefore choose other careers. I’m a huge believer in content owners being compensated. I pay for lots of content and other content I expect to be free (but ad supported).

The beauty of Solve Media’s ad unit (you can see an example at the top of this post) is that the words you enter are not randomly generated and meaningless. They’re an ad campaign. You see the picture of dirty socks plus Tide equals clean socks and enter the words “It makes sense” to see the story you want. As it turns out this drives up brand recall dramatically versus banner advertising (73% recall versus 16% for banners) and message recall from 3% to 41%. Staggering numbers.

Am I an investor? No. I just love the concept and the founder of the company, Ari Jacoby. We first met a couple of years ago and I’ve been impressed with his startup savvy and hustle ever since. Even if he is a Redskins fan He showed me this concept nearly a year ago and he’s managed to keep the company mostly under wraps while they perfected ad units, the data measurement and user experience with advertisers such as Toyota, Microsoft, Universal Pictures, Saatchi & Saatchi, Universal McCann.

And it seems some other people also think it’s pretty clever. The very smart Chris Fralic of First Round Capital is on the board and the angel list is a who’s who of early stage investments. They also raised VC from New Atlantic Ventures and AOL Ventures.

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