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Why Does It Matter That McCain Doesn't Know How To Use A Computer?

Watch this and you'll know why...

Financial Modeling Tips For Early-Stage Startups

In the very earliest stages of a company building a financial model can seem like a pointless task.  After all, how can I possibly forecast the future?  Garbage in, garbage out, right?

Wrong.

Building a financial model is an important milestone in the life of a successful business.  It means that you have focused in on a particular revenue model and sized the scope, schedule and budget for achieving your business goals.  Having the model gives you the ability to identify, delegate and manage specific tasks while being able to tie them to the big picture.  It gives you an answer to questions like, "why do we have to release v1.5 next month?" and "why can't we buy a booth at this trade show?" 

Don't fall into the trap of thinking that a financial model is "for the investors."  It is, in fact, for you and your team.  It's how you will eventually make money and achieve your dreams.  So with that background, here are a few tips on financial modeling:

1. Don't reinvent the wheel.  Financial models and the basic building blocks thereof are readily available online and through friends and colleagues.  Don't waste your time trying to reverse engineer the fully burdened cost of employees, hosting and facilities.  Instead, use actual costs from comparable startups.  One of the best examples of comparable data is from Redfin posted by Guy Kawasaki.  There are many other good sources.
2. Start from the output and work backward.  For your initial model, you could easily create a 10MB model with 50 worksheets and Monte Carlo simulations, but it will never see the light of day.  Save this for later.  Instead, start with the output first, which in this case is a 30-50 page PowerPoint deck and pro forma financials (income statement, cash flow statement and balance sheet).  You can begin by developing a "blank slide" presentation as well as pro forma financials.  For the presentation, you'll want to identify each key driver of your business on the revenue and cost sides.  On each slide, you should be able to write one sentence or a couple bullet points that explains the key driver.  For the pro forma financials, focus on what line items you will be showing and the period of time over which you will be forecasting.  Once you have these templates, then get to work building the simplest possible model that allows you to reasonably complete the slides and financials.  Your model should have an "assumptions" worksheet that allows you to tweak the key drivers you identified earlier.
3. Be conservative.  There is nothing worse than raising money based on a wildly optimistic plan you hoodwinked some investor into believing.  You won't last past the first year as CEO (and deservedly so) because you'll end up missing plan badly.  It's not sandbagging, it's called reality.  There is a lot of pressure to build a model with $100MM of revenue in Year 5 because that's what VC's fund, but most businesses cannot realistically project this.  If your car has a 4-cylinder engine, don't enter it into a drag race...instead focus on raising money that matches your realistic expectations for the business.
4. Vet your output with trusted third parties.  Once you have your model (remember the output is not the mambo Excel spreadsheet, but rather the presentation and the financial statements) you should set up a few sessions with some experienced entrepreneurs and investors.  Go through the model and be brutal.  At my last company, we called this process "8-Miling."  If you've seen the movie 8-Mile, you know that the climactic scene at the end of the movie has Eminem saying everything bad about himself to his competition instead of letting them say it.  Do yourself a favor and 8-Mile your business before potential investors do it for you.

Community Manager

Here's a cool opportunity at an early-stage startup that aims to change the world.

Viridus is an online, members-only network focused on corporate sustainability.  Full-disclosure: I started the company. We provide a forum for tips, tools and advice by and for business professionals.  While many have defined "green collar" jobs as those jobs involving alternative energy, we believe every job can be a green collar job--it's how you do the job that makes it green or not.  IT professionals should be thinking about energy consumption and asset recycling, facilities managers should be measuring and reducing their carbon footprint, buyers should be factoring sustainability into their procurement processes and the list goes on.  Viridus provides a forum for business professionals to share best practices and collaborate on practical solutions.

We're looking for someone to join our team either part- or full-time.  The person who would be the most successful and get the most out of the role is someone who is passionate about business and the environment, is a "digital native" and is outgoing online.  If you or someone you know are interested, please feel free to contact me.  No need to send a resume (unless you want to)...better still is to point us to your blog, community or other online presence.

University of Michigan Wins Solar Car Rayce

The University of Michigan won it's fifth national championship in solar car racing.  Almost 20 years ago I cut my entrepreneurial teeth on this project at Michigan (winning our 2nd championship).  The rayce is similar to the Tour de France in that it is divided into several stages over 10 days and about 2400 miles from Austin, TX to Calgary, AB.  Michigan opened a commanding 9 hour lead over the second place finisher, which I believe is the largest margin of victory in the history of the event.

These cars take tens of thousands of volunteer hours to design, build and test plus millions of dollars (solicited from sponsors) and a lot of blood, sweat and tears over several years.  Congrats to the entire field, especially Michigan.

There are a lot of lessons to learn from this team/event.  I'll write more on that later.  In the meantime, you can learn more about the team and the North American Solar Challenge from their websites.

The Science & Art of Term Sheet Negotiation

I recently got some comments on a blog post I did a while ago from Yoichiro "Yokum" Taku, a partner at Wilson Sonsini Goodrich & Rosati and the blogger behind Startup Company Lawyer, on my post about evaluating one or more term sheets.  By the way, SCL is a great blog and I highly recommend it as a resource.  If you're looking for a quick education on startup legal issues so you can have an efficient conversation with your own attorney, this is the place to go.

Yokum gave me the following feedback:

At first glance, my initial feedback is that you have overvalued the RORFR/Co-sale and (non-cumulative) dividend rights.  All deals have a ROFR/Co-sale and they are rarely invoked as a practical matter.  West coast deals have non-cumulative dividends, which makes a dividend preference meaningless.  Also, I think that the relative weighting of liquidation preference and anti-dilution is a bit off.  I think that liquidation preference is significantly more important than anti-dilution.

This got me thinking that I should repost my original treatise and see what folks think.  So have a read of the below post.  What do you think?

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By the time I was in the 9th grade, I had been playing chess for a few years (as in I knew the rules) but I didn't play seriously and more often than not I lost.  Then one day at the library (remember, pre-internet) I happened to find a book on chess.  So I read the book and almost overnight I became one of the chess "stars" in high school.  In one of the funnier incidents, I started playing chess during lunch hour and was "hustling" money which on one occasion resulted in a kid pulling a knife on me after I relieved him of a few bucks.  True story.

What was it in that book that allowed me to take advantage of the situation?  Well, there was a lot of basic stuff, some general rules and even some strategy, however, the most useful bit of information, initially, was a table on the relative value of pieces.  You know, a pawn is worth 1, a knight/bishop 3, rook 5, a queen 9 and the king "infinite" unless it's the endgame then it's more like a 4. Experienced players have a "feel" for this from many games played and they can also break the "rules" by, for example, sacrificing a queen for a rook to get better position.  But these are all things learned from experience and best not tried by a novice.  If you are new to the game, you have no idea.  When you are starting out, having some rules of thumb can make all the difference between winning and getting hustled.

What does this have to do with negotiating term sheets?  Well, I think a lot of newbies get hustled when negotiating term sheets because they don't know the relative importance of the various terms.  Have you heard the joke about the VC who says, "I'll let you pick the pre money valuation if I get to pick the terms?"  My goal here is to provide a framework that gives relative value of various terms on a term sheet and allows you to compare them on two dimensions: economics and control (or as my friend Noam Wasserman likes to say, "rich" versus "king"). In the same way that a chess grand master doesn't need rules of thumb from someone else, if you're a seasoned negotiator of term sheets then this is probably equally useless.  And no, this is not based on any academic or scientific study.  It's based on my own experience and, more importantly, that of a few other experts like Dave Kimelberg (Softbank's GC). 

In my view there are 12 important terms on a typical Series A / B term sheet.  Yes there are other terms and yes sometimes they are important, but if you go with the thesis of keep it simple, then 12 is the magic number.  In terms of rating, the rich/king differentiation is important as different people are after different things so depending upon your motivation you may be inclined to pay more attention to one column than the other.  So without further adieu, below is a table showing them as well as the relative importance:

Term	Rich	King
1. Investment / price	10	-
2. Board of directors	-	8
3. Option pool refresh	10	-
4. Preemptive rights	1	3
5. Andi-dilution protection	5	-
6. Registration rights	1	1
7. Drag along rights	1	5
8. Right of first refusal / co-sale	5	-
9. Dividend right	5	-
10. Liquidation preference	7	-
11. Protective provisions	-	8
12. Redemption	1	-

Here a 10 means it is really important to get as favorable a result as possible on this term, a 1 means it is not so important and a "-" means it doesn't apply (i.e. a zero).  The cool thing about having something like this is you can use it as a tool to compare term sheets (provided you can determine how favorable or unfavorable each individual term is...more on that below). 

The next part of this post is to provide a range of typical results for each term which will give you a means to rank each term in each term sheet with a "1,3 or 5" where 1 is "unfavorable", 3 is "fair" and 5 is "favorable."  If you aren't already familiar with the terms in a term sheet, you should check out the model term sheet (basically a template) put together by the National Venture Capital Association. They have other model agreements too, but you will see with the term sheet that they include various options, some discussed here.  Below is a scale for each of the 12 key terms across the two dimensions:

1. Investment/price.  I think there are two ways you can rank price.  One is to rate it relative to your expectation and another is to rate it relative to similar companies (in terms of stage, geography, sector, etc.).  If you don't have comparables, you can fairly easily get them, for example Dow Jones puts out a quarterly survey of VC deal terms which includes pre-money valuation (send me an email if you want a copy).  If you're less than 80% of your benchmark, that's probably unfavorable, if you are within +/- 20% than that's fair and if you're over 120%, then it's favorable.
2. Board of directors.  This term comes down to simple math.  If you give up and don't have control of the board, that's unfavorable, if it's tied, call it fair and if you control it, that is quite favorable.  BTW, the reason I didn't rate the board control a "10" on the "king" scale is because even when you give up control, your board members are bound by fiduciary obligations to the firm, i.e. they can't do whatever they want.
3. Option pool refresh.  Often time this will show up as a separate term in the term sheet, however it is actually just another bite at the apple in terms of price. Traditionally there is a refresh pre-deal so that after the round the company can execute on its hiring plan without needing to expand the pool for 12-18 months.  You will have to develop your hiring budget if you haven't already.  Given that benchmark and your hiring equity budget, I'd say less than 12 months is favorable, 12-18 months is fair and more than 18 months is unfavorable.
4. Preemptive rights.  As you know, preemptive rights give your investor the right to invest in future rounds.  This is of moderate economic value, however you are giving up some control of future financings.  There is remarkably little variation in how this term gets negotiated, probably because of its relatively low importance in the grand scheme.  I'm told the only area that gets negotiated is whether the investor has an "overallotment right" whereby they can take a portion or all of the pro rata of another investor in the same series who didn't participate.  That said, unless something unusual is in your term sheet, it's probably a 1 for rich and 3 for king.
5. Anti-dilution protection. Anti-dilution is a pretty important economic term.  In terms of the range of possibilities, no anti-dilution would be a 5, broad-based weighted average would be a 3 and full-ratchet would be a 1.  I think the vast majority of deals end up as broad-based weighted average. Very few deals avoid it altogether, but it can be done, particularly in later stage or very hot deals.
6. Registration rights.  Reg rights have some economic value and in theory you do give up some control, but in reality they're close to worthless.  You can push on these and most investors will give in when pressed. You can negotiate when the right kicks in and cutbacks.  But bear in mind that investors will love it if you waste time negotiating this because it is not an important term.  Unless something unusual is going on, I'd rate this a 1 on both dimensions.
7. Drag along rights.  Most deals include drag along rights and like many of the other terms, the key is in the voting thresholds.  I rated this a 1/5 on the rich/king scale. In terms of economics the issue is with regard to a sale of the company where the preferred stock, because of special rights, is indifferent to a deal that would be better for Common.  However, the bigger issue is on the control side of the equation where you could get dragged into a sale that you don't want to do.  So in terms of rating both the economic and control sides, I would say that if the thresholds are such that a single investor can unilateral drag along, that's a 1, if it takes 2 or more investors that's a 3 and if it takes investors plus either a neutral party or Common (you) then it's a 5.
8. Right of first refusal / co-sale. I rated this a 5 because this is essentially a "lock-up" on the founders stock which seriously affects liquidity and thus value.  It doesn't really affect control issues.  If you read the actual section of the stock purchase agreement that describes this term it's several pages of bureaucratic procedures for a sale that in the real world you can't imagine ever occurring (which they don't).  As a result, the only real counter party for selling common stock is the other investors or the company with the investors approval and they're all quite likely to low ball.  Unfortunately, I've never heard of avoiding this term completely, so in terms of how to rate it, I'd say that if you can negotiate a right to sell some portion (say 20% on an annual basis) you're at a 5 otherwise if it's a standard lockup then you're at 3.
9. Dividend right.  I rate this a 5 on the economic scale.  In terms of the range, there is no dividend which is a 5, then there is a simple interest dividend which I'd say is a 3 and a 1 would be a compounding dividend.  For some reason, the dividend rate has been 8% ever since I've seen term sheets.  You can negotiate the rate, but the bigger battle is whether you pay a dividend and how the rate compounds. 
10. Liquidation preference.  This is a very important economic term that doesn't have any importance in terms of control.  The issue here is during a sale, how do investors get paid out.  I'd say about 1/3 of deals have a preference at 1X but no participation, another 1/3 have a preference with a cap and participation and the balance a preference with no cap plus participation and that's pretty much how I'd rate it, i.e. 5 for 1X preference/no participation, 3 if with a cap in the 2-4X range and 1 if with no cap and participation.
11. Protective provisions.  This is very important from a control perspective but not so economically. While there are a ton of these protective provisions, the key ones relate to sale/merger of the company and future rounds of financing. As with other control rights, the key is in the voting thresholds so I'd assess this the same as 7 (drag along rights).
12. Redemption.  Finally, we get to number twelve, redemption rights.  This is an almost worthless economic right.  I've never seen or heard of this being exercised and most investors will acquiesce if you push on this.  Unless you see something unusual, I'd rate this a 3.

Ultimately the individual rating combined with the overall importance of each term will allow you to create a weighted average total for each term sheet on both the rich and king dimensions.  While you wouldn't want to make a decision to take an investment on this alone, it will give you a basic idea of where the strengths and weaknesses of particular term sheets lie.  It also gives some tips for negotiating.  For example, you don't want to waste your time negotiating redemption rights and attorney's fees and instead, you want to go to the core of what's important to you on the rich/king scale.

For more tips on how to negotiate with VCs, read this post, 10 Tips On Negotiating With VCs.

Finally, I'd love to hear feedback from folks.  How would you change the ratings?  Are their other key terms?  Feel free to comment on this post or send me email.

Expensive Gas Is Good

I've been saying this for a while and when I do most people look at me like I'm crazy.  But it's true.  The problem isn't that gas/oil is expensive, but rather that we're addicted to the damn stuff.  Thomas Friedman has a good op-ed in today's New York Times explaining:

When a person is addicted to crack cocaine, his problem is not that the price of crack is going up. His problem is what that crack addiction is doing to his whole body. The cure is not cheaper crack, which would only perpetuate the addiction and all the problems it is creating. The cure is to break the addiction.

Instead of drilling offshore and waiving taxes on gas, as some have proposed, we ought to be raising taxes on gas/oil (of which some of those revenues should be rebated to lower income folks hit hardest by the cost) which will destroy demand while providing an incentive to entrepreneurs and others to develop viable alternatives.  It's no coincidence that the cost of a gallon of gasoline in France is about $9.00 and the fact that 78% of the electricity generated in France is nuclear. 

On a related note, kicking the carbon-based-fuel habit is going to be the biggest new business opportunity in the history of humankind.  If you're advising your kids what to study or thinking of a business to start, look no further.

Environmentalism Goes Mainstream

I saw this picture in an article about a German company signing a contract to produce wind energy in Africa and I just had to share.  What's happened over the past few years is that, what used to be an industry driven by passion and personal motivation has turned into a huge financial opportunity.  As a result, it's brought together two groups you never would have expected: tree huggers and Wall Street.

I suspect this odd-couple marriage of convenience is going to have a few bumps after the honeymoon period wears off.  I bet that there are a lot of projects that will be mis-managed due to inexperience and a lot of money will be invested and wasted.

Startup Failure: 7 Deadly Sins

Blogger, investor and entrepreneur Roger Ehrenberg has written one of the best post mortems of a startup failure that I have ever read.  He's able to do this partly because he's a stand-up guy, because he is an excellent communicator and because he has done well enough in life that he can give the straight story instead of the politically correct story.

Roger was co-founder of Monitor110. He helped raise $20MM in VC over 4 years before concluding the return just wasn't there.  In his after action report on the demise of M110, he identifies and expounds upon 7 deadly sins that doomed the company:

1. The lack of a single, "the buck stops here" leader until too late in the game
2. No separation between the technology organization and the product organization
3. Too much PR, too early
4. Too much money
5. Not close enough to the customer
6. Slow to adapt to market reality
7. Disagreement on strategy both within the Company and with the Board

Ever first-time entrepreneur should read Roger's post...it's like that video they used to show in high school of the aftermath of car accidents.  Roger, thanks for the wisdom!

Startup Marketing Advice

Mike Speiser has a great post over on his blog on how to trick out Google AdWords.  I've found that AdWords takes a lot of patience to make it work.  Anyway, Mike's got some good tips.

Coolest 2GB ThumbDrive Ever

You can read the review here.

Venture Capital Is Changing

This is something you wouldn't have seen from a VC even a few years ago.  Kudos to Altos Ventures for cutting against the grain.  While they might risk leaving some money on the table by supporting a founder "too long" I'm sure they'll more than make up for it by endearing themselves to entrepreneurs and better deal flow.

FriendFeed As FoeFeed

Here's a practical tip on how to use the new web service called FriendFeed to solve a real business problem: opposition research.  Every startup "tracks" news from or about their competitors, usually in the form of an email sent to a few folks within the company with the subject, "Did you see this?" 

Well FriendFeed allows a single person or a group of people to aggregate information and share it with each other (publicly or privately).  It's more than just copy-paste, FriendFeed allows users to permanently track specific feeds (like a competitor's blog) as well as one-off stories (like a TechCrunch review).  FriendFeed allows users to track all kinds of media (blog, video, pictures, etc.) from scores of sources (Flickr, Typepad, Youtube, etc.) and usability is superb.  Users can view the feed as a web page or RSS feed and multiple "rooms" (feeds) are easily configurable.

So do yourself a favor and fire your $10K per month PR firm that provides you with daily news snippets and build your own FoeFeed.

What's The Safest Seat On An Airplane?

Popular Mechanics has an article on the results of a study of airline accidents in the last 36 years and came up with the following: it is safest to sit in back.  Amazingly the survivability rate is almost 70% in the rear compared to 50% up front.  I guess there is some advantage to being in steerage...  For more tips on how to survive a plane crash, read this.

Ethics Test

Opinion Polls & Market Research

Here's a hypothetical situation.  You've been working with a VC for a while.  You've gotten through a lot of business diligence and there's one last pitch to the partnership before you get a thumbs up/down on getting a term sheet.  The CEO and head of sales are able to attend in person, but you (founder) have a scheduling conflict so you are participating by phone. The pitch goes off okay.  You can hear the meeting winding up with your team mates leaving the conference room when all of the sudden, the VC partners immediately jump into a vigorous discussion of the merits of the presentation, team, company and whether they should offer to invest.  It's clear that they do not realize you are still on the line and they have no real way of finding out if you are or are not. What do you do?

Political Social Networking

I just read this article in the New York Times about how the Obama campaign has dramatically advanced the use of social networking in politics.  It's an interesting read.  The article talks about how the Obama campaign hired Chris Hughes, one of the four founders of Facebook to run its online effort.  The article also talks about how the McCain campaign is playing catchup by launching McCainSpace (I wonder if the Facebook/MySpace angle was intentional?).  Anyway, the author didn't have kind things to say about the McCain campaign's foray into social networking so I took the bait and went onto JohnMcCain.com and clicked on the "Join McCainSpace" link.  So how surprised was I when I got the following "page load error"

Ouch!  Bad SSL certificate.  That's embarassing...