VI

Three questions came up after the last bootcamp session. The third is associated with general selling (this applies to both selling your product and selling an investment in your company – which can be considered as a product).

As a product manager, it was my job to provide sales training each quarter to the new sales reps.  I found that 25% of the time was spent training the reps on the product – but only it’s features, functions and benefits. The other 75% was spent on competition, competitive differentiation and customer objections.

Over time, I’d been called by sales reps with every customer objection imaginable.  (In sales management I’d never accept that a there even *existed* a reason for “not buying”, I’d always turn it around to ”we haven’t yet been able to establish the product’s value proposition”.

(Tip. Use that concept liberally when you are dealing with sales!!!!)

If I was pitching an investor for an investment in my business, I’d start by really understanding *all* of the value propositions that can constitute a “win” for an investor.

Obviously investment size, coupled with your (negotiated) valuation will serve as a basis for establishing the investors return. But I’d also look for all other “value” that can help create a “win”. Being the first, or the biggest, or the one with the most prestigous board, or even the company with the wildest launch parties may represent “value” to the investor, give them a “win” and help sell the deal.

Then I’d have someone try to sell me the investment.  I’d list every objection I could come up with, as to why I wasn’t going to invest. (You be surprised at how, with your inside knowledge, you’ll be able to come up with a very comprehensive list.)

I’d then reverse seats again, listen to the objections, and develop rebuttals to them.  You’ll never get all of them, trust me some really strange objections come out of the woodwork during sales negotiations, but you get a great start.

It also helps when you’ve been in the barrel a few times. Nothing develops sales experience like sales experience!!

Three questions came up after the last bootcamp session. The second is:

“I’ve been talking to potential investors, but keep getting surprised when I think we have a deal. What am I doing wrong?”

Whilst this (and the following post) are way beyond the scope of the bootcamp, it’s worth touching on a couple of points that may be helpful.

“Negotiating” is really just another way of saying “selling”. Selling (as opposed to taking orders) involves some exchange of value between a seller and a buyer, and an explicit or implicit win-win. If the seller can convince the buyer that the value the buyer is receiving is greater than or equal to the value they are giving, then it’s a win for the buyer. If it’s also a win for the seller, it’s a deal!!!

In an investment negotiation the entrepreneur is “selling” the risk-considered value of the return to the investor, and the negotiation is usually around differences in opinion of valuation and risk.  The entrepreneur is likely to have a higher view of the valuation and a lower view of the risks than the investor.

Now, when the investor is a VC, a win can mostly be created when (s)he has a favorable return on their investment, and the points of negotiation are usually valuation and equity position.

But, “win” can encompass more than “return”.

In any buying/negotiating situation, people “buy” for all sorts of reasons; ego, prestige, power, etc. And closing a sale is – to a greater or lesser extent – about understanding what constitutes a “win” for the buyer, that also enables a “win” for the seller.

In an investment negotiation, a “win” can be more that financial return for a VC.  In a down round or a down economy, a “win” maybe an egregious valuation – just because they can!!

Similarly, a “win” for an angel investor can be all sorts of things – power, publicity, position.

And sometimes a “win” for an entrepreneur that’s running out of cash is simply being able to stay afloat.

Three questions came up after the last bootcamp session. The first is regarding P&L’s and their role in business plans and operational plans.

P&L is a set of financials that are required for both the business plan and the operations plan. However they serve fundamentally different purposes in each plan.

In a business plan, the P&L is a 5-year overview of revenue and expenses. The goal is to create a financial picture for investment and exit valuations, and determine cash/investment needs. It’s a very much top-down approach, and I’m perfectly happy seeing it driven from market share acquisition rates. I’m also perfectly happy to see expenses “bucketed” in general accounting categories; like R&D, Marketing, Sales, and G&A and be derived as a percentage of revenue. To do this with credibility, it’s essential to have previous (and possibly extensive) experience with actual business operations to get really comfortable with operating expense percentages. Lacking that experience, an excellent proxy would be to look at the annual reports of your three closest competitors, or companies in the same industry space, and use *their* operating expense percentages as plugs for these values.

Just as a note, that exactly what I look at in due digence anyway.

On the other hand the P&L in an operations plan *is* a real budget!!!  It’s bottoms-up from the actual level you care about. Personally, I don’t care to breakout paper clips or pencils, but rather just lump those things into a general account of “Office Supplies”. And if that is less than 5% of you operating expense budget roll it up into a higher level category until it reaches that percentage. That gives you ~20 expense categories to manage, and ensures you are not majoring in minors.

BTW. Once you have a budget for four quarters, roll that into your business plan, and use it as a base to roll forward your projections for the next four years.

From a new report by Deloitte.

We briefly scratched the surface of the dozens of potential terms that could be included in a  term sheet, but I wanted to emphasise a few points from our discussions.

1. In most cases the “terms” in a term sheet (or more accurately in the Investor Agreement – which is the legal document) are not *law* but contractual conditions that become binding upon successful completion of the agreement. As such, the writer of the terms can ask for anything they want.  Just because a clause in the agreement is titled “Liquidation Preferences” doesn’t mean that is “boilerplate” and there’s not some little twist in there that make its different than you expect.  Golden rule – always read the fine print!!!  And if you don’t understand the fine print, or sometime, even if you think you understand the fine print, ask an attorney.

2. Terms in term sheets are like vestiges of DNA – they served a very important purpose at some stage, under some set of conditions, or as a result of some catastrophic event, and are just carried along  – “in case”.  The result is two-fold.  (a) Terms sheets always seem to get bulkier and (b) just because there’s something in a term sheet that looks horrible, doesn’t mean that you can’t negotiate it away, or down to more agreeable term.

3. Terms can be fundamental or fads, depending upon the economic climate, legal situation or political temperature.  As many of you are aware, there is very contentuous but very real legistlation on the books that would treat VC carried interest as ordinary income verses capital gains.  That has the potential of having a real impact on VC  net income, so – even though I have no idea what – I’m expecting significant chance in terms to “compensate”.

Finally, one of the reasons for spending a whole session on one or two of the elements in terms sheet was to get you all to be become smartreprenurs.  The challenge is that you get involved with two possibly three or four term sheets in you lifetimes.  I’ve seen probably twenty.  One of the values of @StartVI is the aggregationof deal experience and the accumulation of specific knowledge that will help individuals.  So?  Start asking questions and sharing issues?  It’s the “consequences” of terms that you need to be wrapping your heads around, not the specific interpretation.  As we discussed on Wednesday, the financial impact of Liquidation Preferences can be negotiated for a better valuation.  If someone is asking for high multiples of  Liquidation Preferences *and* a low valuation, either they don’t know how it works, or they do and they’re counting on the fact that *you* don’t.

Next week @Start\UP bootcamp, we’re going to be looking at strategies and plans for getting investment. Of course, a significant proportion of that will be what VC’s are looking for in a company and business opportunity, but equally, we will be covering what a company should look for in a VC. In most cases I preface the following comments with “if you have a choice”, but “if you have a choice in which VC to take investment from” then it’s important to do as much due diligence on the VC as they will do on you. A relationship with a VC if like a marriage, except its usually easier to get out of a marriage!
I strongly recommend that startups dive into the VC’s web site. It’ll give the “nut’s and bolts” – things like investment philosophy, industry/sector focus, stage and typically round size. It’ll have a list of active and past portfolio companies, and usually the resumes/CV’s of the partners.

But that’s all the “selling side” of the VC. It’s best to dig into the “buying side”. What do founders in the portfolio company think, was it a good, bad or ugly experience. Are there biases, preferences? Landmines to avoid?
There’s a interesting “reputation” web site – www.thefunded.com – that provides a vehicle for anonymous feedback from founders, both those that were funded and those that were rejected. Typically, it’s usually the dis-satisfied that are the most vocal, and this site has had its fair share of “VC arm twisting” to get their reps up. But it DOES have feedback on a number of Irish and Northern Irish funds (Crescent Capital, Enterprise Equity (Irl and NI), ACT, QUBIS). There may be some value in the comments.
In the interest of help startups make a decision “if they have a choice”, I’m looking to start a “form guide” on Irish and Northern Irish VC’s, something a little more objective that typically “bitching”. I’m looking for considered feedback for anyone who has experience with (good or bad) any VC on the island.
Here’s my initial thoughts on the questions I look for opinions on
(all answers on usual scale 1-5, 1 is low/bad, 5 is high/good)
1. How responsive were they? (Returning calls)
2. Did they respond when they said they would?
3. Did they make decisions quickly?
4. Do they have operational experience (P&L) to offer?
5. Have they been part of a startup?
6. Have they had an executive position in a multi-national corporate?
7. Have they invested their own money?
8. Did they inspire confidence that they could add value to your startup?
9. Did they encourage or discourage you?
10. Would you take them for a drink, socially?
Please let me know if the answers to these questions would help budding entrepreneurs evaluate VC’s – “if you have the choice”.

There was very lively discussion tonight at @startvi on the, seemingly, blind requirement, for startup software companies to have patents. Rather that repeat the discussion here, let me summarize.
Patents do almost nothing for software startups, and do a lot of actual harm via the opportunity cost (in time and money) to gain an illusion of “defensible IP”.
Anyone requiring that a software startup has, or applies for, a patent earlier than one year before their anticipated exit either (a) doesn’t know software, (b) doesn’t know the software business or (c) doesn’t know the investment business.

(Title idea stolen for @cimota blog)

I was attracted to a post over the weekend from Steve Blank. In particular, this caught my eye … “business plans are a poor planning and execution tool for startups”.

I agree 100%.

I also agree with much of Steve’s reasoning, but not all. Without being repetitive, I thought I’d summarize Steve’s points, and add my own opinion.

Steve states that Business Plans (my caps added for reasons that will become obvious below) are for big, mature companies and not for startups.

Yes! Yes! Yes!

My first introduction to Business Plans was in the late 70’s, working for an international mainframe manufacturer, and rolling out a new product line in EMEA. This was a detailed product launch plan, that – mostly because it was in vogue – we called a Business Plan. Well it DID have demands forecasts, pricing, manufacturing costs, gross margins, sales projections, P&L and cash flows. But it ALSO had very detailed plans for every organization in the company that needed to do anything to launch the product; the particular part numbers assigned, configuration models, BOM, shipping instructions, warranty, support tools, contract additions, sales training, collateral, and commission plans – the whole enchilada. It was an “everything you need to do to launch a product” and if you were a product line manager – as I was then – it WAS your business.

Another quote from Steve’s blog – “A business plan is the execution document that large companies write when planning product-line extensions where customer, market and product features are known. The plan describes the execution strategy …”

Yes! Yes!

And my final quote – “In the early days of venture capital, investors and entrepreneurs were familiar with the format of business plans from large companies and adopted it for startups. Without much thought it has been used ever since.”

Yes!

It is urban myth that those with no real experience of starting a startup blindly promulgate as the basis for entrepreneurship and a key element of success.

This is where I digress from Steve’s reasoning, and rather than step through his, I’ll lay down my opinion.

First, without a business plan your idea will (most likely) fail. I don’t mean a Business Plan, I mean a plan for you business … it’s not an execution document. It a plan of what your business will do and why it will do that , not how it will do it – or at least not to the actual execution detail. It can be written in 10 pages with approximately 2,000 words. Its goal is to describe the strategy, not the tactics.

Second, its goal is to get investment – OK that’s a simplification, but serves the points that follow. What does an investor look for? A hot product, in a big market, with a team that can deliver, and where they can make money. If you can’t describe that in 2,000 or less then you don’t understand your business (paraphrasing Einstein).

Third. Don’t sweat the small stuff. I’ve seen Business Plans from companies that didn’t have a product yet, but knew how much they were going to spend next year on office supplies! That’s called “majoring in minors”. And you’d probably be surprised by what I consider “small stuff”. As a rule of thumb, I’m not interested in seeing any expense item that is less than 10% of revenue.

Finally. You DO need an execution document. It’s called an Operations Plan. It will describe very facet of your business operations; the product development plan, the support plan, the maintenance, the operations plan, the manufacturing plan, the marketing plan, the sales plan, the HR plan. It’s something you review every month – if you’re a startup. It’s how your startup operates, but it’s not a Business Plan.

This was a question asked by “Rutherford” earlier this week. This is an interesting subject that needs its own post.
The context of the quest was in respect to “they spin a new dynamic around the product concept, it gets traction and suddenly people are ‘getting it’.”
Firstly, I don’t think that it’s given that Silicon Valley always “gets it”. Many VC’s passed on Google, FB and Twitter. And some have jumped into the Google, FB and Twitter wannabes like lemmings. And journos in SV are much the same as elsewhere; their job is to provide “perspective” or “opinion”.
Don’t take away the impression that Silicon Valley can do no wrong. There are hundreds of screw ups, lots of bets lost on stupid products, and miles of copy written about dumb ideas. It’s just that one doesn’t dwells on them, or treat a mistake as a failure. People here are willing to try new things quickly, and dump them just as quickly if they don’t work out. And then switch to the next new thing. Look at the recent iPad launch; it would be interesting to compare the miles of favorable copy verses negative copy written on it. In the end its just opinion and we – all of us – get to decide whose opinion we agree with.
It also helps that we, here, are lucky to be exposed to new stuff all the time. Checkout an interesting location based iPhone app called Stalqer. I only learned about it when I was introduced to the founder/developer in a bar two months ago. It’s handy when you live less than a block from Twitter headquarters.
Now take everything that that’s a positive for Silicon Valley, and ask yourself – “how dies that compare to Northern Ireland?”.
I hope that answers the question you asked

One of the challenges in only having three hours per session, is that, to cover all of a subject, you need 2 or three sessions. Last week, we looked at Cap Tables and Dilution, and last night we looked at VC arithmetic. Next week we’ll pull it all together with investments and valuations. But, being the smart little buggers you all are, some of the questions last night could only be answered after we had all these elements in place.
I thought it may be helpful to summarize some of that discussion and make sure we’re well structured to nail this in the next session (or two).
Thus far we talked about ownership (and dilution) in terms of number of shares owned as a percentage of number of shares issued (not share authorized). But, it’s a very small step to turn ownership into a percentage of company VALUE. Simply take the number of shares and multiply by share price. Either is perfectly fine, and both will come to the same answer, but monetary value (i.e. shares * share price) is what you will be dealing with when you get into negotiation with a VC (or angel), or even looking at the value of public companies.
These two characterizations are identical.
If you own 200,000 shares out of 200,000 shares issued, you have 100% ownership. If you then sell another 100,000 shares for £20,000 you now have 200,000 shares out of 300,000 issued, which is 67% ownership, i.e. you were diluted by 33%.
Another way to say that is: if you are selling 100,000 shares for £20,000, then the share price is 20p (£20,000/100,000). At a share price of 20p, the company is worth (i.e. valued at) £40,000 (200,000 shared issued * 20p). You just increased the worth( Value) of your company by the money you got in from the investment (£20,000) so its NOW worth £60,000. Since you own £40,000 (your 200,000 shares at 20p) of this company valued at £60,000, you now have 67% ownership, i.e. you were diluted by 33%.
Eureka!
And, BTW, we’ve just covered pre-money valuation, money-in, and post-money valuation. But we’ll go into it for real next week.