Who Do You Want to Be and Towards What End?

Janis Machala, Managing Partner, Paladin Partners janism@paladinpartners.com

I recently had the experience of reading two things the same week with very different perspectives: 1) A blog post by a serial entrepreneur, Mark Maunder called “Cows VS Tigers and How to Create a Tech Business” http://markmaunder.com; and 2) A book by Dan Lyons, a writer for HBOs Silicon Valley and a former technology editor for Forbes and Newsweek, called Disrupted. His book is about his experience at Hubspot, a Boston high-flying SaaS-based marketing automation company. I lived in Boston for 10 years, worked for a different time high-flying  Silicon Valley-based company, Sun Microsystems, and have been in Seattle 24 years experiencing the ups and downs of our region as it relates to our start-up region’s culture. After reading both of these I am so grateful to be in Seattle and not Silicon Valley or Boston. Why? I believe we have more entrepreneurs who are pursuing their dream of passion (Missionaries) over wealth (Mercenaries). Yes, you want to succeed and make money for your investors and the founders but not at the expense of serving your employees, customers, and business partners. I think we roll our own way and am, for one, glad we’re not wired like Silicon Valley and Boston.

Mark wrote the following in his blog. His perspective is very worth founders’ consideration for the kind of company they are starting and growing.

Areas where Mark sees an entrepreneur and investor’s goals as not aligned:

• Entrepreneur wants to keep more equity, investor wants more equity for themselves.
• Entrepreneur wants more control in the form of board seats and less or no preferred stock with its rights. Investor wants to have levers to be able to block exits, fire CEO’s, and so on.
• Entrepreneur may not want to get acquired. Investor wants an exit with a short time horizon that is low risk and easy to implement (IPO’s are onerous).
• Entrepreneur should be doing everything to serve the customer as their target market.
• Investor wants to groom company for acquisition in many cases, so growth, being a credible threat and a beauty contest is the priority.
• Entrepreneur wants to learn how to be a CEO on the job. Investors think they already know and interfere with a very necessary learning process.

What Dan Lyons’ book left me with (some things I already believe):

• Culture is not a set of empty acronyms or lingo and a culture deck does not a culture make. Whether you like it or not, Amazon, Microsoft, and Zillow have real cultures.
• Leadership is a WE game and not an I game; there was a lot of self-aggrandizing that went on at Hubspot by the founders and C-suite.
• Diversity is NOT embraced for many startups not because they are discriminatory but because their funding tilts them towards cheap (e.g., young) labor with the promise of the stock options and a fun place to work (think candy wall, beer pong, social life at work).
• Diversity is not a 16 member management committee with 2 Indian guys, 2 white gals, and 12 white guys or an 8 member board with 1 Indian, 2 females, and 5 white males. Diversity is about diversity of thought and perspectives and not skin color or gender alone.
• Transparency is an empty word that sounds good but is rarely practiced well.
• Graduated takes on a whole new meaning: crashed and burned, laid off, fired, quit and if that isn’t a tech cult I don’t know what is.
• Our industry has made over 40 as the aging out of talent; aging out is about who’s a lifelong learner, adaptable, and resilient and not what age someone is.
• We’re headed for another bubble and correction. It won’t because of lack of IPOs but because of a lack of companies building real companies with fundamentals that the public markets can embrace.

All in all, what both of these pieces show is that founders need to be clear why they are doing what they are doing and that it does not have to be done the Silicon Valley way. Let’s look at what works for the founders and its employees and customers versus what works for the funders and those who are just financial engineers not caring much about building for the long haul.

Learn about fundraising early

I had the pleasure of paneling at an event called "Dollars & $ense: Get Smart About Raising Capital for Your Business" organized by the economic development counsel of King County last week. The organizers brought in an a variety of entrepreneurs at different stages of their lifecycle and there were a few things that stuck out as we talked through the prepared questions and long Q & A afterwards....

1. Learn about fundraising early - there are lots factors to understand that lead investors to deciding if and when they'll invest. Learning these things can be done, but starting earlier is easier. Attend an educational workshop or conference, book office hours, talk to your advisors about fundraising, read blogs, engage the community, read books. The information is out there.
2. Not all information is meant for you and your business - as noted in #1, there's a lot of ways to learn about fundraising. Your job as an entrepreneur is to figure out how to best finance your venture and that means deciding which great advice to throw in the garbage and which great advice to read.
3. Find a recent financing to compare yourself to - If you've done enough of #1 & #2 to have a sketch of your ideal financing, you should be able to point to two or three companies who took a similar path recently. If you have twenty companies to point to you've done too much research and probably should narrow it down quickly, raise your round, and get back to building your company.

Raising capital takes time, it is time well spent finding the right business partners. You, the entrepreneur, will be the one hitched to the business partner who invested. You, the entrepreneur, will be the one tasked with executing on the business model that your business partner is betting on. You, the entrepreneur, need to find a partner who you can confidently embark on a journey like this with.

The Money’s in the Bank Once the Money’s in the Bank: Back-up Plans

By: Janis Machala, Managing Partner, Paladin Partners janism@paladinpartners.com I recently have had conversations with several entrepreneurs who were scrambling for investment for payroll, commitments made to vendors, or who thought they’d have a paycheck and lo and behold “it’s not going to happen this month.” This reminds me of other conversations over the past 20 years when a VC check didn’t arrive to close a round because something odd happened at the 11th hour that spooked the partner on the deal or a VC signed a term sheet without having done due diligence ahead of the term sheet and the founders were star struck over who the VC was versus what their process was and how solid was that term sheet really. What all this has led me to is two things: 1) Hope is not a strategy 2) The money’s not in the bank and can’t be spent until the money’s in the bank. I have seen too many entrepreneurs believe wholeheartedly in an angel syndicate or a venture firm and not have a back-up plan should that deal not happen. The latest case is a family office investing $1.5M into a company. A tornado hit the region where the FO Leader lived and then a family member got very sick right after that. Needless to say, that person’s focus is not on you and your company but on their shelter and family member (rightfully so). In this situation there were other family offices interested in the deal but the founder put a hold on these since this was the “sure near term one.” There’s never a sure one. Stuff happens, life happens, interest wanes. And there’s bad luck in business just as there’s good luck. When it comes to financing I have not seen very many good luck scenarios versus bad luck scenarios. That’s because you need the money far more than the investor needs to invest in your company. Always remember that. That’s why I always recommend managing investor fundraising exactly as you manage enterprise sales with all being worked but with a different probability of close for each investor. Keep as many balls juggling and moving forward as you can (oh, yes, and run your business too!) until you actually have money in the bank. And by the way, don’t accrue debt thinking you will pay that back after funding closes. Investors are not putting money in to cover the past investments but are investing in the future. How many entrepreneurs have not made a payroll, have not paid the IRS or the state tax liability on payroll, have liquidated their 401K to cover payments thinking they’d just put that money back when sales or investors come through, or have foregone any funds for their own living expenses only to find that their credit now sucks and they’re paying interest only on their credit cards and not able to refinance their high priced mortgage never mind putting their 401K funds back in place. It’s a slippery slope and one that can ruin personal relationships and founder partnerships. Again, hope is NOT a strategy. When you liquidate that 401K just assume that money will never get put back. I have seen a founder do the smart thing and arrange a line of credit secured against an asset (their home is the most typical) before they’re in trouble since interest rates are quite low on these and it’s easier to have $100K or $200K lined up before you quit your job as a line of defense against a missed payroll or a sliding fundraising date. By the way, ask your VC for a bridge loan-that’s often a good way of testing their intent versus their using the “no shop” time-frame to see if they really want to do the deal with you. If you’re an investor, be open with the entrepreneur where you’re really at with respect to funding and any snafus or issues you’re personally dealing with that might affect timing of your investment. Being honest about your probability of doing a deal will win you lots of friends in the greater entrepreneurial community. A “fast no” is much better than a “slow maybe, let’s see how you evolve.”  It’s a small town so telling an entrepreneur how long you take in your due diligence, that you have 3 issues you want to see addressed, or that you want someone else to lead the round that you like to follow will pay you back in many ways re: word of mouth from entrepreneurs recommended investors and other angels who like doing deals with you.

Key Marketing Metrics in Startup Projections

Guest article by Bryan Brewer of FundingQuest

After hearing more than a thousand investor pitches in the last 12 years, one thing I’ve noticed is the frequent omission of two key marketing metrics: Customer Lifetime Value (CLV) and Customer Acquisition Cost (CAC). I’ve even had startup clients argue that determining these metrics was not a useful exercise!

In my opinion, both of these metrics are key to evaluating the efficiency of the company’s marketing efforts. I think some of the confusion arises from the valid point that assessing either of these metrics alone may not be very meaningful. For example, if Company A is making single sales of low-priced items, the average CLV might be less than $50. On the other hand, if Company B is selling a $30/month SaaS subscription with an average customer tenure of 30 months, the result is a CLV of $900. Or Company C, selling a complex piece of medical equipment with disposable test items, might have a CLV of $10,000 or more. Taken alone, any particular CLV does not give an indication of the company’s prospects for success.

A better approach might be to consider the CLV as it compares to other companies in the same space. If other businesses similar to Company C in the above example have an average CLV of $50,000 or more, then an investor may rightly wonder if Company C will survive in that market.

The best approach to making sense of these metrics is to calculate the ratio of the Customer Lifetime Value to the Customer Acquisition Cost. If a startup sells products at higher prices, then it can afford to spend more money to acquire customers. Conversely, a company with a low CLV needs to find a very low cost way to acquire customers in order to be profitable.

The ratio of CLV to CAC is what I call the “Marketing Efficiency Factor.” For Company B in the example above, a CAC of $150 results in a healthy Marketing Efficiency Factor of 6 ($900 divided by $150). However, if it turns out that Company B needs to spend $450 to acquire a customer, then its factor drops to 2 – a position which doesn’t leave much margin for overhead and profit.

Marketing Efficiency Factor is one of numerous metrics on which you can rate your startup in my recently released Minimum Fundable Company® Test, available for free at www.mfctest.com. The test covers 20 multiple choice questions in the areas of Startup Viability, Business Model, Market Strategy, Management, and The Deal. I suggest that a company needs to score at least 50% in all five areas in order to be considered “investor-ready.” In my experience, if a company is deficient on one or more of these areas, the story told in the investor pitch will simply not hold together, and thus will not hold the attention of investors.

Minimum Fundable Company is a registered trademark of Funding Quest, LLC.

Board of Directors and/or Board of Advisors

By: Janis Machala, Paladin Partners, janism@paladinpartners.com

Since this newsletter goes to angels and entrepreneurs I thought it would be interesting to discuss start-up boards. Who should be on a board of directors? Is an advisory board a good thing?  How to use advisors effectively? I’m sharing a great piece by Steve Blank (who also has a link in his piece from Brad Feld).

People often tell me they are advising several companies but when I ask what they’re doing as part of this role it’s usually coffee once and a while with the founders.  That’s expensive equity and cost of coffee for founders. I also know from recruiting board members for the board of directors and advisory board members that every one of those individuals needs to be led and not left to figure out how to be useful. Also, don’t recruit so many advisors that you can’t possible use them to maximum effect. More advisory board names in your executive summary or on your website is not growing your value as a company or adding to your legitimacy as an inexperienced team.

I often recommend an advisory board to founders: 1) it’s great practice for learning how to lead senior executives; 2) it’s a great try out for potential board of director candidates; 3) leading an advisory board is great at preparing the CEO to chair a board of directors; 4) reaching the right industry players who can open doors to the C-Suite for B2B companies is a valuable use of a modest amount of equity; and 5) your advisory board is there for the CEO/Founders while the board of directors is there for the company (big distinction).

I’m in Brad Feld’s camp about building your board early. As soon as you take in any outside investment it’s good business practice to have outsider(s) on your board. It prepares the founder(s) in leading a board before the “big gun VCs” join the board at your venture financing stage. The outsider(s) have hopefully been a CEO and lived in your shoes. Just because someone writes a check to invest as an angel or a seed VC does not automatically provide a right to a board seat. Boards where founders are 2-3 of the board seats, a waste of critical founder talent on the wrong things. The CEO should be on the board but there’s little value to other founders being on the BofD since their equity ownership will provide sway on critical issues such as financing terms, addition of shares, hiring/firing CEO, etc. It is typical that the other founders who want to be on the board think it’s a big deal but that’s their egos talking.

I am often surprised at how little thought goes into board of directors and advisory board composition. The people you keep company with in these roles can add enormous value to your company or be a “pain in the you know what” if they are not a cultural or capabilities fit. Treat each of these roles and recruits with the same care you use to pick your cofounder or your executive team members.

Check out the new Office Hours!

Woohoo, more mentors at Seattle Angel are offering Office Hours. Ryan Porter has an incredible background as an engineer and has now been investing in young companies through the Seattle Angel Conference and the Seattle Angel Fund for the last couple of years. This is a great opportunity to meet with a young angel investor with a wealth of experience and perspective to share about building businesses, getting an investment, and designing world class software.

Join Ryan Porter on Monday at SURF Incubator!

How do you sign up? Register here.

Meet Janis Machala

Years involved in the Northwest startup community:

20 but it seems like yesterday as it's always exciting and new

Types of involvement in the community:

Board member for the WSA (4 years), now called the WTIA

President of Northwest Entrepreneur Network (3 years) and Board Member (10 years)

Board member of WA First Robotics

Co-founder of Seraph Capital, first women's angel group in the country (with Sue Preston and another 10 or so like us)

Mentor in Tech Stars, 9 Mile Labs, Microsoft Accelerator

Notable companies you’ve worked with:

Evidence-Based Practice Institute, EVRNU, Glympse, JW Secure, Koverse (currently a board member), OfferUp, Omni Retail Group, Payscale, Performant, Scale Out Software, Transform.Digital

Three things most excited about in the Northwest:

1) Women with BIG ideas starting companies and leaving BigCo's

2) The commitment to building a more diverse workforce by large and small companies

3) The vibrancy of our angel community and the growing sophistication of angels as deal leads

Ways to connect:

janism@paladinpartners.com or 425-260-5354