A Public Service Announcement

I keep seeing entrepreneurs that complain to me after the fact that they took an investment with bum terms. It comes in many different ways, usually something like, “here’s my cap table what do you think?” or “I have this term sheet what do you think of the terms?”. The terms are usually appalling. But the entrepreneurs asking don’t know this until it is too late, they signed the documents, they spent the money, and now they want advice raising the next round.

It looks like I’m not alone. If you can’t figure out this is war. This is information warfare. I forget that I work with a lot of great investors. They look for deals that work for them, their portfolio, for their investments and the potential investments. But I long ago realized that my interests and the interests of existing investors or potential investors were not always in my interest, particularly when things start to go bad. I wish all investors were as honest as Brad Feld with their desired investment rights. But there are bad investors out there. They look to use an information asymmetry to gain greater advantage over uninformed entrepreneurs. It allows them to buy large ownership percentages at reduced rates with additional rights that are not always in the favor of entrepreneurs. They tell entrepreneurs that it is ok, their capital brings additional non-dilutive government capital and the entrepreneur will have the cash to grow. They are trying to maximize their returns by exploiting the information asymmetry.

And I don’t like seeing people being exploited.

Clark Stanley's Snake Oil Linments

It is not the first time that someone has used both simple and sophisticated tactics to take advantage of people. Part of the creation of the Securities Exchange Commission to allow, in this case, the US government to bring civil actions ” against individuals or companies alleged to have committed accounting fraud, provided false information, or engaged in insider trading or other violations of the securities law.” Before the enactment of the commission, consumers were protected by “blue sky” laws, but Investment Bankers Association told its members as early as 1915 that they could “ignore” blue sky laws by making securities offerings across state lines through the mail. Many investors are money grubbing capitalists and that’s the way I like it. But as an entrepreneur the only person looking out for you is you. So rather than  leave yourself ignorant and uninformed it is your responsibility to reduce the information asymmetry. After all, it is your company and…

Knowing is half the battle

The person that is responsible for your success and the success of your company is YOU!

So stop blaming bad investors. Stop blaming lawyers. Stop blaming others. You need to take proactive steps to reduce the information asymmetry

  1. Get educated
  2. Due diligence on your investors
  3. Participate and share

1. Get educated

Fifteen years ago, this information was very difficult to access. The first book that I read about venture capital was High-tech Ventures: The Guide For Entrepreneurial Success that was written in 1991. Part way in to my second venture (I was employee number 6 for the record) John Nesheim released High Tech Start Up, Revised And Updated: The Complete Handbook For Creating Successful New High Tech Companies in 2000. This was my early education about venture capital, high potential growth companies. But most of the lessons came from the school of hard knocks. But things have changed. There are a tonne of resources available to entrepreneurs.  Here is a short list:

This is your business. You are taking outside funding. You need to understand what is happening in the process and why.

2. Due diligence on investors

The investor is doing diligence on you and your company. They are going to talk to your previous investors, your employees, your customers and maybe your prospects. They will take to people in their circle of trust to learn about the market, expected performance metrics, and your reputation. It is incredibly important theyunderstand the risks and accretive milestones before presenting you to their investment committee.

“I will not let my investors screw me” – Scott Edward Walker

You must do your own due diligence on the investor before taking any money. This is going to be a partner in your company. It has often been described as a work marriage. You should need/want to understand more about this person, the firm they work for, and how they treat their existing companies and CEOs. Go for dinner, have a glass of wine, talk about your company, and figure out if you can work with this person for the next few years. Talk to other CEOs that they’ve invested at a similar stage as your company. Talk to the ones that succeeded, to the ones that failed. Talk to the people that the investor sends to you to do diligence. There are so many tools to expose social relationships that didn’t exist: LinkedIn will allow you to send InMails to past CEOs; Clarity allows you to connect with a lot of entrepreneurs and mentors that have a connection with the investor; AngelList is a great tool for discovery but it is also becoming a great way to see investments and help you in your diligence.

the diligence factor was that I knew them, but had never taken money from them. It’s hard to know how people are going to react when they are at risk of losing money because of something you are directly responsible for until you are actually at that point.” – Brandon Watson

3. Participate and share

The above resources are amazing. However, I often learn best from the examples of others. I learned a lot from Mark Organ at Influitive. Mark shared stories about the good and the bad decisions he made in the early days at Eloqua. You learn a lot when you share a hotel room on the road as grown ups.

There are formal meetups like Founders & Funders. But seriously in order to have the trust, you need to get out of the office and the formalities of these events. The conversations come over a poker game. But you’ve got to put yourself out there, be vulnerable, and find people that can teach you something.

CC-BY-20  Some rights reserved by slightly everything
Attribution Some rights reserved by slightly everything

I believe so much in this that I’m renovating my house. I want a big kitchen for family dinner. All of my startups will be getting an invitation to Sunday night dinner. Why? Because I’m betting my family’s future on them, and I want them to be a part of the family.  This includes the ones that I’ve invested in already and any of the companies that I’m looking at investing. I want them to hang out. I want them to help each other. Share metrics and tactics. I want them to tell you that I’m slow to invest. I’m slow even after I’ve said yes (but I hope they understand that it is because sometimes I have to do some consulting work to have investment dollars). (Now I just need the renovations to finish).

Feeling screwed?

I’m starting to think about publishing shitty term sheets, depending on the risks our lawyer identifies, with investor names. I’m not sure public shaming is right model, and my lawyer might tell me it is not. But I think that we need to elevate the conversation we as entrepreneurs are having with each other and our investors.

I’ll be publishing prospective term sheets in the next few days.

Reach out if you want to share.


Hot Shit List 2013

Copyright Muppet Studios

It’s the time of the year where we either make you a hero or we make you hate me a little more. As stated in the previous comments, this could very well be The List of People That David Crow Wants to Be Associated With (but I think I established that is a different list). Either way, the commenter is correct, the list is something and it is highly suspect and by no means complete. If you don’t like the list, leave a comment. If you think I left genuinely left someone off, leave a comment (ps suggesting yourself, either demonstrates your overly inflated ego or you might not realize that your suggestion by itself if a reason to be left of the list). I’m open to being corrected and having the list added to.

Past issues of the list include 2011 and 2012.

For 2013, the list is divided between those we expect to break out (Breaking Glass). And those that are taking it to the next level (Going Big). Basically, you will be hearing from or about these people over the next 12 months. So everyone get in a circle, it’s time for the 2013 instalment of the Hot Shit List.

Hot Sh!t List 2013

Breaking Glass

Going Big

The icons are courtesy of Anil Zaimi, though I haven’t spent the necessary time to make this work with our stylesheet and theme in WordPress.

Hardware and Startups

[Editor’s Note: This is a guest post by Gideon Hayden LinkedIn , associate at OMERS Ventures and previously founder of Tradyo. Full disclosure: I work with Gideon at OMERS Venture and I have tracked his progress at Tradyo with his partner Eran Henig over the past few years.]

CC-BY-20  Some rights reserved by jurvetson

“You know, one of the things that really hurt Apple was after I left John Sculley got a very serious disease. It’s the disease of thinking that a really great idea is 90% of the work. And if you just tell all these other people “here’s this great idea,” then of course they can go off and make it happen.

And the problem with that is that there’s just a tremendous amount of craftsmanship in between a great idea and a great product. And as you evolve that great idea, it changes and grows. It never comes out like it starts because you learn a lot more as you get into the subtleties of it. And you also find there are tremendous tradeoffs that you have to make. There are just certain things you can’t make electrons do. There are certain things you can’t make plastic do. Or glass do. Or factories do. Or robots do….

And it’s that process that is the magic.” – Steve Jobs quote as quoted by Travis Jeffery of 37 Signals

The lifecycle of consumer hardware startups is undergoing a rapid transformation (see Chris Dixon’s Hardware Startups). Consider the well known Pebble Smartwatch; the first example of a company that perhaps unintentionally used crowdfunding to demonstrate demand for their concept long before they had the ability to produce it at scale. The $10.7M raised significantly decreased the upfront risk for the company, allowed them to avoid dilution by avoiding traditional financing methods, and decreased their inventory risk due to this ability to accurately forecast demand before production.

This change in the stage of demand generation represents a new paradigm for hardware startups. Whereas before they likely had to build and scale manufacturing prior to generating demand for their product, they can now accurately forecast this simply by gauging reactions to a proof of concept video.

However, the purpose of this post is not to highlight all the good stuff surrounding this method of funding for hardware startups; I think those are largely well known and accepted. Instead, I’d like to address what other impacts this change has on the lifecycle and trajectory of a company.

Exploring the Impacts

Firstly, with large surges of excitement and accompanying pre-orders surrounding these campaigns, a company has to jump from a conceptual and iterative stage to become an operational company thereby skipping a lot of crucial steps in between. Perhaps one of the most important steps they must skip is the pricing strategy for each unit. Without sufficient vision into QA, returns, defective products and COGS, they can’t accurately work these costs into the price of the product. Furthermore, if we look solely at the numbers, the outlook for the company is bleak as they’ve already locked into a certain price with their pre-orders, as well as a specific timeline, and this can end up costing the company huge amounts of money down the road.

See below to visualize this change:

Old World:

Team → Concept → Seed → Prototype → Financing → Design/Manufacture/QA → Iteration → Pricing of product → Pre orders → Distribute

New World:

Team → Concept → Seed → Prototype → Pricing of product /Timeline commitment → Video launch → Pre orders → Financing (maybe) → Design/manufacture/QA → Distribute → Iteration

In the new world, companies price their product very early on, and jump from video launch to production. This places them on a trajectory that perhaps they aren’t ready for.

Let’s consider other impacts of this change:

  • Risk is transferred from the company to the consumer
    • In the old world, consumers saw a pre-order to launch time of 2-3 weeks. In this model it changes to around 9 months to 1 year.
    • The increase in time from demand generation to product in market is far longer in the new world. No Kickstarter hardware campaign has brought their product to market in less than 9 months from the close of their pre-orders – meaning consumers have to wait far longer than they’re use to for the product.
    • The 9 months to 1 year is long in terms of time from pre-order to time of distribution, but actually very short when we put this in the context of the stage of the company and the typical time between conception of a product to larger scale distribution.
    • Effectively what this means is the risk is transferred from the company to the consumer. In the old world, companies would have to take shots in the dark and validate their concept after an upfront investment in manufacturing. Today even if the product is a flop consumers will have to pay.
  • Less appetite from consumers for second chances
    • Whereas in the past consumers may have given hardware products second chances (see Jawbone UP V1 vs. V2), by the time these products are in the consumers hands there may be less interest and far less enthusiasm to give the product a second chance.
    • The amount of time from showing intent to gratifying their demand is so long in this case, that they may have even written it off even by the time they receive it. All this means is you better strike some resonance with the consumer on this first push.
  • Feedback Cycle Lengthened
    • The cycle between launch and iterations to the product is far harder to manage in this model. By the time you’ve scaled operations feedback is just beginning to roll in – and you may lack the resources to implement the needed changes to the product.
    • Perhaps the more important feedback cycle in the new world has become the software iteration cycle that sits on top of the hardware. Often this takes a backseat as scaling manufacturing is a massive task unto itself, but in today’s world, this is where the real value stems from.
  • Shipping incomplete products
    • As mentioned, much of the value stems from the SDK attached to the hardware and providing the infrastructure to allow developers to build applications on top of the platform.
    • With an underestimation of the time required to scale manufacturing, SDK’s often take a back seat and the products ship with limited functionality – far more limited than demonstrated in the concept videos.
    • Furthermore by accelerating the demand, companies often miss out on the experimentation/iterative phase of prototype development. They commit to a timeline and have to choose a solution before they may be ready.
    • With the demand to scale operations so quickly, the QA process inevitably takes a hit as well and can result in higher costs down the road.
  • Discovery and experimentation phase cut
    • In the new world, the video launch occurs before scaling of production happens. This process can teach a company a tremendous amount, but because they have often committed to a timeline and promised a certain product, they’ve locked themselves into something that is great conceptually, but may not be feasible in reality.
    • This discovery and experimentation phase is shortened greatly, and as Steve Jobs mentioned, this is the process that is magic.
  • Inaccurate Timelines
    • 84% of kickstarter/pre-order projects will miss their deadlines.
  • Threat From Incumbents to Pick Off Technology
    • Proven demand with an inability to act allows bigger competitors to jump in and launch competitive products really quickly – seeing this now with Apple/Sony and Pebble

One of the classic problems that lead to startup’s demise that we hear of all the time is pre-scaling. Companies start building out the core features of their business without truly knowing what they are. As they increase their burn rate to high levels, their margin for error becomes extremely low by the time they reach market. If that initial product doesn’t hit a nice trajectory, they’d better find it fast because the cash in the bank will only last them so long before they have to raise again, and if they haven’t proven anything by that time, it likely won’t be an attractive prospect for investors resulting in a down round, or worse.

This is not to say that this new process is a negative shock to the ecosystem, quite the opposite actually. I think crowdfunding and proof of concept similar to that of concept cars spurs innovation and creativity, and encourages new entrants to shoot for the stars; something we always need more of.

However, the risks of the new world have not yet been explored in depth, nor have they actualized as many of the relevant companies are still very young. Many processes like QA and iterative industrial design inevitably decrease in quality and leads to lower quality products shipped, higher cost of returns, and inaccurate pricing of the product; a dangerous game to play.

Crowdfunding and pre-orders is definitely a good thing, but perhaps we need to recognize where along the lifecycle of a company this process exists, and what exactly it proves. It does not mean the company is successful, but merely represents one proof point out of many needed along the journey to building a great company.