- Why Startups Should Raise Money at the Top End of Normal
- A TechCrunch Disrupt Proposal
- When Facebook Captured Beluga, They May Have Harpooned It In The Head
- Hornik on VC’s Secondary Mania: “If It’s Just Money, We’re All Fungible” (TCTV)
- Why The Groupon IPO Feels Like A Swindle
- OMG/JK: iCloud, gWallet, and tPhotos
- Hornik on Blippy: “Apparently I Was More Interested in Sharing Credit Card Purchases than the Average Person” (TCTV)
- David Hornik: Why Real Entrepreneurs Aren’t in it for the Money (TCTV)
- Gillmor Gang 6.04.11 (TCTV)
Posted: 05 Jun 2011 06:22 AM PDT
I have conversations with entrepreneurs and other VCs on a daily basis about fund raising, the prices of deals, how much companies should raise, etc. I’ve stopped talking about this as much publicly because it’s such a heated, emotional topic where the points-of-view are strictly subjective and for which the answers will only be revealed in the future.
I’ve decided to take all of my private points-of-view on the topic and make them public in a keynote speech at the Founder Showcase in San Francisco on June 15th.
I thought I’d post on one of the topics beforehand. It’s the one bit of advice I find myself giving to entrepreneurs most frequently these days, “raise money at the top end of normal.”
Here’s what I mean. There is an inherent value that any company has. On a public stock market that is the value that investors place on future free cash flows of the business discounted to today’s date to account for the time value of money. The more mature the company and industry, the easier it is to predict its future. When investors are feeling confident about the future they tend to bid up the value of public companies due to an increased perception that the future cash generated by the company will appreciate. The price of public stocks change instantly in reaction to news that is perceived to affect the future value of that company.
Every day shareholders vote on the value of the company by buying or selling shares. There is no price movement without one person agreeing to sell the stock and another agreeing to buy it. Stocks that have a lot of people trading are said to have a lot of liquidity, which basically means it’s really easy to get into (buy) or get out of (sell) the stock.
Private markets for stocks are the opposite. They are pretty illiquid. If you invested in the first angel round of a startup company it is usually very hard to sell your stock—usually for many years if ever at all. So how exactly are prices determined?
There is no great science to it. The earlier you invest the higher the chances the company won’t work out and thus you pay a lower price than later-stage investors. As an investor you’re trying to pay the appropriate price for your perceived risks of the company succeeding and protect yourself in the event that it isn’t quite as valuable as you had hoped. As the risks below get eliminated the higher the valuation investors are prepared to pay.
Over time some “norms” have emerged in pricing based on investors risk / return profile. The obvious thing that investors think about is making a financial return on the investment they made in your company. Early-stage investors in technology startups are only looking for growth-oriented companies that can achieve an “exit” someday—either via selling your company to a larger company or via an IPO. The former is much more likely than the latter. So investors have to have some general sense of what companies that are similar to yours ultimately sell for in the private marketplace via an M&A transaction and they have to have some sense of valuations on public stock markets to be able to back into what their potential returns on your investment might be in the event of an IPO.
For example: If you were to invest $41 million into a company (and one could assume that you owned between 33-50%) then the company is worth $82-123 million at funding. As an early stage investor you’re often planning around 10x your investment at the time you write your first check so in this case you’d be going into your investment expecting an exit of $800 – $1.2 billion. Then you can do a little bit of research and find out that very few companies ever achieve this valuation in a trade sale so you’re clearly gunning for an IPO. You’re unlikely to want to make this sort of investment with the product or the market not yet validated. The risk wouldn’t be appropriate.
Ah, but you say that for a normal-sized angel check or A round check one shouldn’t worry about the ultimate exit because he or she is getting in really early and at a cheap enough price so who cares whether one pays $5 million pre-money or $15 million pre-money—you just have to make sure you back really big companies. Well, obviously if you knew that in advance it would be big, of course that would be true. But the reality is that you’re faced with two problems: 1) the earlier the stage the riskier and thus more write-offs so you need to have enough ownership percentage in your winners to make up for the losers and 2) the earlier stage your check the more likely the company will need many more funding rounds behind you and thus you face dilution.
So rounds tend to be “range bound” where prices at the top end of the valuation spectrum often being done in boom markets (i.e. 2007, 2011) and for the hottest of companies test the top end of the range, and in bad markets for fund raising (2003, 2008) test the bottom end of the range.
There is no such thing as a uniform price. It is highly dependent upon many factors: experience of the team, type of opportunity (a big biotech or semi-conductor A round is likely to look different from an Internet A round), geography, etc. So the ranges you would expect can be highly imprecise. But to help with the explanation I’d like to put down some markers of typical Internet pre-money valuations done in major US markets (San Fran, NY, LA, etc.) while acknowledging that San Fran deals are often higher valuations due to increased competition amongst investors.
There is no value judgment in my putting up these numbers nor am I negotiating with anybody. I’m just pointing out my gut feel for approximate ranges of deals that I’ve seen with Silicon Valley having the highest valuations, NY / LA / Boston / Boulder / Seattle having valuations in a slightly lower range but comparable and sometimes significantly lower prices in markets that don’t have a healthy venture market. These are not scientific, just anecdotal and just trying to provide some transparency for entrepreneurs on what I’ve seen in the market. And of course there are always outliers.
Prices have definitely gone up in 2011 as depicted in the anecdotal chart below. Again, prices are expressed as pre-money valuations.
For me I think that investors have got to accept the new reality in pricing if they want to remain competitive in markets like we’re seeing now. As ever, prices are still determined by: quality of team, quality of product / market and competitiveness of the deal.
So when I advise entrepreneurs on fund raising I often say that it’s OK to try and shoot for the “top end of normal” for the market conditions. So in 2011 as a startup company if you can generate lots of demand you can definitely raise an A round of capital (say $3 million) at a $7 or 8 million pre-money valuation or slightly higher whereas just two years ago you would have struggled. That’s fine. That’s the deal you get when you’re raising in a good market for startup financing.
What I caution entrepreneurs from doing is raising money at significantly ABOVE market valuations. I’m a VC so I have an obvious bias. But that’s not where this is coming from. I’ve been preaching the “don’t get ahead of your inherent valuation” message for nearly 10 years. I raised my A round at a $31.5 million post-money valuation with no revenue. It was early 2000. That was market. I saw this kind of pricing when I first entered the VC market in 2007. We had companies pitching us that had almost no revenue at all and they were raising $10-15 million in capital at a $40-50 million pre-money valuation. I should also point out that while they had built their products they had limited market traction.
We passed on all of these deals and often tried to discuss the possibility of more modest amounts of capital raised and at more realistic prices. It’s hard to stop a train. One company which was raising at $40 million pre-money wrote a comment about me in a public forum saying something along the lines of “Mark worked really hard to understand our business and was very detail-oriented. But he and his firm were just too cheap on valuation.” Fair enough. But he sold within 3 years for not a huge price after having raised more than $20 million. Another firm we saw tried to raise $15 million at a $60 million pre-money with similar metrics. They did an inside round, spent a bunch of money and then went through a fire sale of the business less than 2 years later.
Here’s the problem. If you haven’t figured out product / market fit and therefore still have a highly risky business you run great risks for getting too far ahead of yourself on valuation. If you raise at a $40 million pre-money on what would in normal times have been a $15 million valuation you’re fawked if the market corrects and you need another round. To any prospective investor you look like you’ve failed even before your first pitch. Even if you have an interesting story to tell, most investors won’t want to go through the brain damage of doing a “down round,” which creates tension between them and early investors.
Finally, even if they could bring themselves to offer you a major down round, the more sophisticated investors know it’s fool’s gold. They get a cheaper price, they wipe out much founder stock value and they reissue you new options. You’ll take the money—what choice do you have? But 6 months later you’re not working past 10pm. 1 year in you stop catching early morning flights. Within 2 years you’re evenings & weekends are spent planning your next business. And the CEO they would hire to come in and run the business when you go would always be a mercenary.
So my advice: go ahead and ask for a valuation that 2 years ago wouldn’t have been likely. Use competition to make sure you get a fair price. Raise a slightly higher round than you would have previously but keep some amount as a strategic reserve. Make sure that when you need to raise your next round of funding that you are able to show an uptick in valuation that is important for new investor confidence and to maintain great relations with your early investors.
Increase price. But unless you’re already a well-known technology heavyweight be careful about raising above the range of prices that are normal for a bull market. If you’re hot, don’t raise above normal. Raise at the top end of normal.
Other topics I’m going to cover at the Founder Showcase on June 15th:
Hope to see you there.
Posted: 04 Jun 2011 06:33 PM PDT
Everyone was surprised — even Michael Arrington was left speechless and said he was “discombobulated” — after Julia Hu was proposed to onstage during her special product announcement at TechCrunch Disrupt in New York City.
Hu, CEO and founder of LARK, was near the end of her presentation when someone called out that she had one more slide left to go over. As she clicked on the last slide, she screamed as her boyfriend came running up onstage to place a ring on her finger. It was the first ever TechCrunch Disrupt proposal and we caught the whole thing on camera.
It was sweet, touching, and hilarious. For those of you who haven’t had the chance to watch yet, the proposal and the backstage interview are below.
A huge congratulations to Julia and Jeff!
Posted: 04 Jun 2011 05:50 PM PDT
When Facebook acquired Beluga this past March, it was an interesting deal for them. Interesting, because they previously had only done deals for talent. But this deal, they told us, was for both talent and assets. In other words, they were also interested in the technology behind Beluga. More importantly, the plan was to keep Beluga running. And they have. Sort of.
Over the past several weeks, users of Beluga have probably noticed some major reliability issues. These range from the mobile apps missing messages because they’re unable to connect to the service, to the service’s website being totally down. Last night, Beluga was totally down for a few hours. There was no indication why it was down, even after it came back. This has been happening more frequently. Not good.
It’s hard not to be reminded of FriendFeed. That service, which Facebook bought in 2009, also reminded live post-acquisition. While that was a talent deal, the core FriendFeed team said they were committed to keeping it up indefinitely. The reality has been that while it’s still up, performance issues and lack of continued development have driven away many of the core users (though, odddly, usage started spiking in Turkey after the deal). It’s a ghost town now. A shell of what it used to be.
And Beluga appears to be headed in the same direction. When Facebook acquired it, we were just heading into a full-on group messaging app showdown. To me, Beluga was the most promising of the new players. It had all the essentials I wanted/needed to replace SMS on my phone. And it was fast — really fast. My social circle started getting really into using it all the time.
We barely use it anymore. Again, it’s just too unreliable now.
I’ve reached out to the Beluga team to see what the deal is. I have yet to hear back, and I may not because Facebook tends to rule with an iron fist about such matters. Officially, the team was assigned to the groups and messaging teams within Facebook. While the new Facebook Messages is finally rolling out to all users, there hasn’t been any major new developments there in months either. There’s certainly no stand-alone Facebook Messages app that some of us had been hoping for — even though Google has quietly been working on one.
At the time of the acquisition, both Facebook and Beluga said that they would be providing details about Beluga’s ultimate future “in the coming weeks”. By my count, it has now been about 13 weeks. It’s time to let us know if Beluga will live, be officially harpooned, or if it will be left to drift at sea like FriendFeed.
I don’t have a good feeling about that answer. Too bad.
Posted: 04 Jun 2011 04:18 PM PDT
August Capital was doing very late stage deals when most VCs refused to. And its early 2000 era buyout of Seagate was one of the better returns in the firm’s history. So why is it mostly sitting out this round of late-stage mega-deal mania?
In the final segment of our Ask a VC on the road with David Hornik, he explains why the answer to missing out on Facebook early isn’t dumping money in at a $75 billion price tag. The firm has done three $100 million-plus deals of late, but they’re all in companies you haven’t heard of, not the handful of names we talk about all the time.
It goes back to that belief that VCs aren’t just a checkbook; that they actually add value to the companies they back. A lot of cynical or burned entrepreneurs dispute that claim already, and Hornik argues if VCs act too much like hedge funds, they risk giving those cynics more ammo.
Posted: 04 Jun 2011 03:57 PM PDT
Posted: 04 Jun 2011 03:22 PM PDT
In this week’s episode of OMG/JK, Jason and I start off with a preview of what may be coming at Apple’s WWDC event next week in San Francisco. Then we get into what Google unveiled at their NFC event in New York City last week. And finally, we talk about Twitter’s move into the photo space.
All three topics have a bit of controversy surrounding them. First of all, WWDC will not feature a new iPhone for the first time in several years. Second, it took PayPal a matter of hours to sue Google after Google Wallet was announced. And third, the Twitter developer ecosystem is up in arms again after Twitter has moved to fill another hole. Well, at least TwitPic is, for sure.
Below, find some of the links relevant to the discussions this week.
Posted: 04 Jun 2011 12:34 PM PDT
Let’s be honest: One of the reasons David Hornik actually agreed to be on camera at All Things D is that he didn’t have a startup about to file to go public any second. So we talked about some of his more high profile investments that haven’t always lived up to the hype.
Hornik explains why reports of Blippy’s death have been greatly exaggerated, and why he says the investment still wasn’t a mistake. What’s more he dishes (sort of) of the nine-figure annual revenues of another portfolio company Say Media– the love child of VideoEgg and SixApart. And he tells us about an enterprise software company that’s a budding sleeper hit.
More broadly, he argues the immediate-hit-or-it’s-a-failure misses the point of venture investing. (A philosophy Reid Hoffman might agree with after a decade-long slog at LinkedIn.)
Posted: 04 Jun 2011 11:46 AM PDT
But first, we chat about the highlights from the All Things Digital conference. Or we started with that and then talked about how the motivation for starting companies is changing in Silicon Valley, given the soaring valuations and ease of raising money.
And Hornik explains why he’s not a fan of Peter Thiel’s 20 Under 20 Program, although he admits he still hasn’t paid off his own law school education.
Posted: 04 Jun 2011 10:00 AM PDT
The Gillmor Gang — Robert Scoble, John Taschek, Kevin Marks, and Steve Gillmor — shuddered with expectant glee at Apple’s presumed iCloud announcement at next week’s WWDC event. It’s clear from all the leaks, most interestingly from Apple itself, that the record companies are finally healthy enough to move into the new streaming era. With Lady Gaga selling five times as many records as the next entry on the album charts, the numbers have strongly tipped from retail to downloads.
Amazon helped by subsidizing over a million copies at $1 a sale (8 bucks to Lady Gaga), but by next time, the market will have moved almost completely online. This gives Apple the leverage to get the TV/cable networks and the movie studios on board, with Netflix playing the Amazon role in stoking demand for streaming. Live events are last, probably following the heavyweight boxing matches of Ali and Tyson via pay-per-view but direct to Apple TV and its competitors, of which there are none. iCloud is the moment when the bits stay where they are, and the checksum becomes the value point. See you Monday for a special Gillmor Gang extra.
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