Requiem For A Unicorn

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This post originally appeared in TechCrunch.

Marc Andreessen has said that there are 15 companies per year that generate 90% of the returns for VCs. Startups jockey for position in the “Billion Dollar Club.” In the world of startups we don’t have the S&P 500, we have the “Unicorn 50.”

Fab was once a member of this unicorn club. Founders Jason Goldberg and Bradford Shellhammer appeared on magazine covers. The company was a fixture on “most innovative” lists. Fab raised $336 million dollars in total funding, including a recent $150 million dollar round which valued the company $1.5 billion dollars. Now, in what can only be called the largest flash sale in history, Fab is reportedly being sold to PCH International for $15 million dollars, or just 1% of its former value.

Stories of outsized success are inspiring, but the disproportionate attention paid to these mythical beasts is detrimental to the broader startup ecosystem. This obsession with founding and funding unicorns has driven VC funds to become billion dollar behemoths, and as a result, ignore smaller, though still very promising, companies.

I call this kind of startup a “thoroughbred.” They’re impressive organizations that have the potential to change the lives of their customers and employees, but differ from unicorns in that they are “only” likely to exit for $100-500 million dollars. Some VCs see these companies as too small to concern themselves with, but there is something fundamentally broken in the startup ecosystem when funding a company that sells for a quarter billion dollars is an unattractive prospect.

Thoroughbreds can be lucrative

Personally, founding and selling a thoroughbred company proved to be life-changing. In 2003, Eric Paley and I raised $8.5 million dollars for our company,Brontes Technologies. Our goal was to digitize a part of dentistry that hadn’t changed since Egyptian times. We developed a hand-held scanner that allowed dentists to create 3-D models of their patient’s mouths and 3-D print crowns and fillings. We didn’t get our faces on the cover of Forbes, instead we spent most of our time on the (un)glamorous dental trade show circuit. In 2006 we sold the company to 3M for $95M, generating an excellent return for our investors, and for us.

The proceeds of the sale and our entrepreneurial learnings served as a springboard to start Founder Collective.

Bigger isn’t Always Better for Entrepreneurs

In the five years since we started the fund we’ve seen a dramatic growth in the number of venture capital funds and the amount of funds they have under management. This surplus of dollars means that any attractive category of companies—think of subscription ecommerce in the wake of BirchBox or daily deals after Groupon—will quickly have 3-5 venture-funded startups competing for investor dollars, customer attention, and resumes for key hires. Each company will raise more money than the previous one and an arms race for everything from Adwords to office space will ensue.

Not Every Market is Winner Take All

The problem with trying to attain mythical status is that there can only be one. Raising huge amounts of funding locks you into a binary outcome—you’re either worth billions or you go bankrupt.

First wave web companies were built on the strength of network effects that rewarded companies like Amazon and Ebay with near monopolies. This has led many to believe that there’s bound to be a single winner in any tech category, but not every market has a winner takes all dynamic.

Apple and Android co-exist. In adtech, dozens of very successful companies deliver solutions to brands and publishers. Even in the slow moving dental industry we had a venture-funded competitor that also enjoyed a sizable (~$200M), but non-unicorn exit shortly after ours.

Forget the Fairy Tales, Focus on Being a Thoroughbred

Not everyone has to be running a unicorn to build a great company, recruit a great team, or to raise capital. It’s hard to ignore the pundits, but just like in politics or sports, sometimes it’s the best thing one can do for their sanity. Focus on your customers, co-workers, and your venture capital strategy and there’s a good chance you can build a life-altering business that’s rewarding personally and financially.

Fred Wilson’s post about Capital and Success says it well – one shouldn’t correlate fundraising to likelihood of success. Nor should you focus on whether or not you’re a founder/investor/entrepreneur at a “Unicorn.” Remember even unicorns can be a mirage as Webvan, and now Fab demonstrate.

Strategic Investors – You’ll Have Sold Your Company. You Just Won’t Know It.

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According to CB Insights, 30% of fundraising dollars in Q1 2014 was from strategic (or corporate) investors, with corporate VC funds participating in 15% of all rounds. The discussion invariably comes up at Board Meetings when a fundraising process is begun. Legendary VC Ted Dintersmith of CRV once said to me, about taking capital from strategics, “Be careful. You’ll have sold your company. You just won’t know it.”

These days, a new class of investors, corporate funds like Google Ventures and Intel Capital, operate more like a financial VC than typical strategic investors. Nonetheless, I’ve been on the receiving end of strategic investments for nearly all of the companies I co-founded, and I’ve learned a lot. Ted’s words still ring true today.

Below are some examples and lessons learned.

Example #1 – Handshake.com & SBC Communications (1998-2001)
In ‘98 Handshake built one of the first online booking and scheduling platforms for small businesses (from hair salons to house cleaners). Not far from Handshake’s offices in Marina Del Rey, CA was a corporate skunk works projects called Smart Pages. Smart Pages, a wholly owned subsidiary of SBC Communications, was formed with the distinct purpose of developing a “next-gen Yellow Pages.” SmartPages and corporate parent SBC Communications seemed eager to do a deal with Handshake. So, roughly one year from our A round, we closed a $20M financing at a $100M valuation (despite virtually no revenue and only a basic product).

My lessons learned at Handshake:

Valuation hypnosis – Don’t be bamboozled by sky high strategic valuations, they create issues for future financings – we would have been better off with a lower valuation from a conventional VC

No fairweather fans – Some strategic investments are used to justify corporate side projects or to tell a “story” to Wall St (in this case, that SBC was hip to the web). When winds shift, the strategics aren’t always around to help. Often their investment vehicles are the first to go.

Example #2 — Brontes & a large private co. (2003-2010)
Brontes Technologies (sold to 3M in 2006) developed a 3D scanner and digital workflow software for dentists. Our strategy early on at Brontes was to get close to potential investors, partners, and acquirers, but not too close. As we were getting ready to raise our Series B, conversations heated up with a large, privately held dental products company. We had had discussions with other players, but felt that taking capital from most industry players would have limited our exit options (fortunately Ted Dintersmith was on our board!). Playing hard to get paid off with the other potential strategics. The Series B fundraising process catalyzed the M&A process and we ultimately sold the company.

We learned:

Everyone wants to join the club that won’t have them – Strategic investor interest can sometimes be parlayed into an M&A process. (turn them down as investors and they may want to buy the company even more)

Keep your enemies close (but not too close) – Be careful of whom you share information, some parties will use it to learn but have no intention of investing or acquiring despite their overtures.

Example #3 — Sample6 & Chevron Tech Ventures (2011+)
Sample6, spun out of BU and MIT, develops a technology for rapid detection and elimination of harmful bacteria in a wide variety of applications. Early on at Sample6, we were eager to explore applications in oil & gas and thus took Series A capital from Chevron Tech Ventures. However, over time, we determined that the right applications for the technology were in the food and water industries, not oil & gas. This took some of the bloom off the rose for Chevron.

Our mistakes were:

Figure out what you want to be when you grow up – We took strategic money too early- before we had really firmed up the company’s ultimate use case. We let strategic interest drive the initial explorations of the company instead of focusing on where the highest value could be created with the technology.

Crossing signals – There can be real signaling risk in taking strategic money early as well. Since we no longer were executing oil & gas applications, future investors always wondered why Chevron was invested in the first place.

I’m not suggesting that companies should never take strategic or corporate money under any circumstances. Just tread carefully – understand how the strategic’s fund (if there is one) is set up, how the managers are compensated, and speak to other portfolio companies. Strategic capital is typically best used in later rounds from investing companies that have a neutral spot in your market, and, where there is a true champion from the operating team.

Cats in the Cradle: Aging in the start-up world

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There’s a funny thing about age in business. It swings quickly between being your greatest asset and seemingly overnight, a major liability. It’s a factor on all sides of the table. Despite the lesson that we learned in Kindergarten about “not judging a book by its cover,” we all do it. Age impacts fundraising, business development, sales, hiring and more.

Spring 1999

The moment I walked into the room of blue blazer clad venture capitalists, I felt like such a kid. I was at least 15 years younger than the youngest guy in the room. I just graduated from college and had no real business experience. Fortunately for me and my other 22-year old Handshake.com co-founders, it was the beginning of the dot com era. It was a moment in the venture ecosystem when youth was a huge advantage (like today). The mantra was “new (read as: young) industry” is disrupting “old industry.” The younger, the better. I could get meetings with senior execs of many public companies. We secured $3 million in funding within a few weeks of presenting our business. Youth had its advantages. That was, until the bottom fell out of the market in the fall of 2000. Then youth, mine included, turned into a major liability.

Fall 2003

Eric Paley and I were fundraising for Brontes Technologies. We were rejected more than 30 times by VCs. We were often branded as “freshly minted MBAs,” (not a compliment) and we didn’t look the part of your typical Boston med-tech founding team. Neither of us had gray hair nor were we career dental industry executives. One VC asked us, “Which one of you went to dental school?” Our age was totally working against us. We later brought another founder aboard, an experienced tech CTO who, incidentally, had grey, thinning hair. Sure enough, we closed the Series A.

Spring 2011

When I first started fundraising with my co-founders for Sample6, I thought I would be viewed as perfectly ripened. I was mid-30s and had a company “exit” behind me. I later realized that the perspective really depended on who I was talking to. Some VCs perceived entrepreneurs to be in their primes when in their mid-20s, like professional athletes, others prefer older founders. And with the upswing in IT investing (as opposed to med-tech), youth was particularly valued. Had I become a washed-up entrepreneur?

Today

I always thought I’d switch over to the venture side sometime in my 40s. It seemed like an older person’s game. That was until a trusted mentor of mine confessed, “Venture is a young man’s game, just like the start-ups we invest in.” That was all I needed to hear. Everything requires hustle in the end. So, at 37, I became a VC.

As a VC, I hear pitches almost every day. I would say the majority of the founders that pitch me are younger than me, though, there’s quite a bit of variability. When I feel the need to put a founder at ease, I make a joke about my age (I find self-effacing humor to be disarming). I often think about founder-business fit when evaluating an opportunity. So, if someone is in their 40s or 50s and talking about their idea for a social networking or dating app, I am negatively biased. Not sure that it’s the right bias, but it exists.

My advice is that one should be self-aware of how they come off in the room. Are you noticeably older/younger than the others? Either way the old adage is true – if you can’t hide it, flaunt it. Make a joke about it and get everyone to look past age and focus on substance and not, in my case, the dwindling number of hairs on your head.

From the front lines of a NYC office hunt — Our new home at 580 Broadway

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580 Broadway – After build out

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580 Broadway – Before build out

I’m proud to say that Founder Collective has a new home in NYC. We’ve just moved to 580 Broadway in Soho. We’re thrilled. But getting here wasn’t easy. Here’s what I learned while out on the hunt for new space.

Set your parameters clearly at the outset, and conduct the search with several brokers at once.

When we started our search we anticipated looking primarily in the Flatiron and Union Square and we expected low $40s per sqft. The market proved to be much more expensive (and tight) than we expected – especially for small footprints of 1-2,000 sqft in downtown Manhattan. Within 48 hours of listing, a desirable spot had several offers. We fell in love with a slick, top-floor space on 23rd St that, amazingly, was on budget. We put the offer in as soon as we returned from the showing, and it was too late. Because we asked for a three-year term instead of the five the landlord was asking, we lost out to another bidder.

After losing 23rd St, we decided to expand the southern border of our search to Tribeca despite that it would add to the team’s collective commute. Broadening the search helped, and we got more firm on budget and specs. We tracked everything on a Google Doc, checked 42floors.com religiously and worked with several brokers concurrently. The best brokers were hustlers who called us the minute they saw a space available that they thought we’d like.  We also found that the best brokers knew the landlords well, and they often had the inside scoop on a given building.

Startups (and others) should consider sharing or subleasing.

Subleases and office shares are ideal for the start-up. Its often best for the start-up to be the roommate. Security deposits required by some buildings can be 6 months or more depending on the credit history of the company (often on the larger side for early stage companies). For a fast growing company, or a super early stage company, this can be prohibitively expensive and a major drain on cash. More established companies (Series B/C+), or venture funds in our case, have better financials and thus can negotiate lower security deposits. Additionally, companies that are taking larger footprints (>5000 sqft) also typically have more room to negotiate rents, security deposits and build out costs. In one instance, we have 2 portfolio companies moving in together to distribute costs and end up with better space at a better deal (often the larger the footprint, the better the deal).

Don’t fall in love and don’t over-optimize

Searching for an office is pretty similar to searching for a home or apartment. It’s a grueling process that mixes the emotional with the rational. The emotional side (the “feel” of a space, how it impacts one’s commute etc) is hard to separate from the rational (budget, size, price per sqft etc). Just like searching for a home, however, one must temper the temptation to over-optimize. Real estate, particularly in NYC, is filled with trade-offs. Find the best place, move in and get back to business.

 

Investments over dinner and board room – Angels v Seed Funds

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(embarrassing picture from an old Newsweek article)

Eric Paley called me one evening to talk about an angel deal he was looking at. I was cooking dinner with my wife when he phoned. We talked about whether behavioral psychology could really work in convincing consumers to reduce their energy consumption. Eric had known the founders for years and thought the world of them, and I had gotten to know one of them, and figured the business was a bet worth taking. While still cooking, I agreed to invest with Eric and Dave Frankel. That investment, Opower, is my best to date.

It got me thinking how different angel investing is from my role as an institutional seed investor. I no longer make investing decisions while cooking, and that’s just the start.

1000s of companies vs dozens

As an angel investor, I saw a dozen or two companies per year. For the better part of my angel investing career, I was running a business so I didn’t have time to meet hundreds of start-ups. Thus, my context was very different. My first year as an angel, I looked at a med device company, a sports nutrition company, and a restaurant business. I had very little context on any of these. In some sense, ignorance was an asset and thus it was easier to make a quick decision with limited data. There was no time or means to “get smart” in a given space, so if I didn’t get the gist of the business in the initial pitch, I didn’t invest. (that year, I invested in none which was a mistake!)

Founder Collective receives thousands of opportunities per year and we take about 1000 pitches. We track our “venture” funnel in a CRM (jerry rigged Salesforce.com). The minute I see a company that’s intriguing, I can see if we’ve met them before and ask my partners what they think. Usually one of them will have knowledge about the space or related companies. Thus, the context around each deal is much more developed when we make an investment.

Angels pursue passion, invest in the network (and mostly ignore valuation)

When you’re investing your own capital, you can invest in stuff you’re passionate about. Noted angel investor Andy Palmer pays particular attention to the healthcare space, and Joanne Wilson favors women entrepreneurs in the industries she knows well. I invested primarily in my network – virtually everyone I invested in as an angel was someone I knew.

In the seed fund world, investing is our business. We can’t just invest in industries or people that we know. (If so, I would only invest in dental companies!) We make 20-30 investments per year. There simply wouldn’t be enough opportunities. That isn’t to say we don’t have high conviction and enthusiasm for the stuff we fund, its just that we need to explore a myriad of opportunities. Additionally, while some more experienced angels are price sensitive, as a fund, we are much more focused on valuation than I was as an angel. Angels don’t need to think about IRR, mainly cash on cash return, but as a fund we’re measured on it.

Follow on support

I did very little to check in on my investments. Often times, I wouldn’t even be aware of follow-on financings. These investments were for fun and hopefully a little extra “alpha” for my personal portfolio.

As a partner at Founder Collective, I’m responsible for keeping my partners up to speed on our companies. In turn, we have to keep our investors (LPs) updated on the performance of our companies. We discuss them at our annual meeting and they receive regular reports on their value. There’s a benefit here, which is our portfolio gets the benefit of help not just from me, but from the whole FC team and sometimes, even our LPs.

The increase in the universe of angels and seed funds is a good thing for entrepreneurs, but with so many options, fundraising has gotten more complicated. Entrepreneurs today can sequence their fundraising, and graduate from Angel to Seed Fund to Series A fund, etc. This provides the entrepreneur with more options along the way, even for those starting companies in the dental industry!

 

SXSW observations (party meter is at 7)

After a few days running around Austin, I jotted down a few of my observations.

International flavor
Maybe it was the fantastic mix of Korean kimchi and Mexican tacos that I ate last night, but I sensed an international vibe to SXSW. I heard numerous accents and languages spoken throughout the convention center. Prior to the conference, I received invites from dozens of groups outside the US hosting events. The Silicon Valley culture has definitely permeated the globe (nobody carries that torch better than Dave McClure). Moreover, the Whatsapp acquisition has led the generally inward focused tech community to understand the value of a global userbase.

Medtech is mainstream 
I saw connected health devices of all kinds. One example was Wello, an iPhone case that captures your vital signs. Another interesting one was Push Strength, a wearable that ensures you’re exerting the ideal amount of power when lifting weights. The R/GA accelerator in NY hosted its demo day in Austin as well, featuring a handful of intriguing connected devices. I still believe we’re in the early innings as it remains ambiguous as to how  consumers will use this information in our daily lives.

Commoditization of hardware is fast
I was in the market for a battery recharger (juice pack) and was able to pick one up that can charge my phone 2x for $20. I was shocked how cheap it was. It was a reminder that despite barriers to entry, hardware can commoditize quickly. Larger companies or companies that know how to access Asian manufacturing can produce similar quality stuff quickly and cheaply. It’s another reminder why upstart hardware companies must leverage software as their differentiator. I wouldn’t be surprised if we see lots of low-cost wearables in coming years.

SXSW fatigue
The conference was as energizing as ever. However, I noticed that some of the entrepreneurs and VCs I would have expected to attend, did not. I  heard someone say “The valley is over SXSW.”  While that didn’t feel to be the case, we did find that within the FC portfolio, fewer founders attended than in previous years. I suppose they’re all heads-down focused on growing their businesses instead of loading up on BBQ!

Tech party meter stands at 7
When I started Handshake.com in 1999, I remember attending a party on a huge yacht that served lobster and top shelf drinks.  A well known band performed on the deck. Those types of events were the mainstream in those days. While the parties at SXSW this year were  swank, and enthusiasm ran high, it didn’t feel over-the-top like I remember from 1999. On that metric, I’d put the tech party meter at about a 7, so I suppose we’re okay … for now.

No immunity: Start-ups and litigation

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I long thought that litigation was the exclusive domain of lawyers, large companies and criminals. Who would want to pick on a poor, helpless start-up? The reality is, sadly, that our litigious society has entered the domain of the early stage company.

Legal Battlefronts

The disgruntled “friend,” collaborator or employee

I sometimes call this the “Social Network effect” after the Facebook movie. Usually, the litigant feels slighted and entitled to equity or cash. These cases are especially challenging because they become personal, rather than rational. The biggest sticking issue is equity, because often the litigant is seeking equity for some early collaboration (perhaps classmates that brainstormed an idea in their dorm room). While its generally understood that equity is for one’s forward-looking contributions, this principle can be hard to establish in a jury trial. This makes these cases especially tricky even when the company is 100% in the right. This should be a reminder to all founders to get stock allocations set and locked in the beginning to avoid future disagreements.

IP litigation

Perhaps inspired by patent trolls, I’ve seen an increasing number of larger companies sue any or all upstarts that threaten its core business. Given the number of very generic patents that have been issued over the past decade (many in software), it has become increasingly easy to demonstrate some sort of violation, especially to a less-than-sophisticated judicial system.

Smaller companies generally have only one product to sell, and without the ability to sell that product, have no business. Furthermore, most start-ups cannot afford the distraction and therefore, most boards advocate settling cases sooner than later.

Innovation ahead of regulation

This type of litigation is in the press seemingly everyday. Uber, a portfolio company, and Aereo are well-documented examples where municipalities or other groups sue the company for violation of certain regulations. The reality is that most regulation hadn’t taken into account the existence of new technologies (as in Uber or Aereo). Instead, protectionist politicians that wield significant influence try to shut down these new services before regulation catches up to innovation.

Selecting Counsel

Representation selection signals to the other side a great deal about your view of the case. For example, if the start-up hires a large firm, the other party knows that high rates are being paid and thus may believe a higher settlement is likely.  That said, if the start-up is fighting “bet the company” litigation, its advisable to use a big firm despite the signaling risks.

On the other hand, if you’re fighting a lawsuit that is a nuisance but doesn’t jeopardize the very being of the company, its advisable to use a smaller, less expensive firm. Remember that investor dollars are being used to fund litigation, which is among the worst ways an investor (or an entrepreneur) can envision spending his/her company’s capital.

Budgets

I’ve seen our companies spend tens of thousands to over a million dollars in legal fees. Each case is unique, but my experience has been that the vast majority of cases settle close to the trial date. In these cases, generally hundreds of thousands have been spent. This isn’t altogether surprising given that it takes time for both parties to realign their expectations. If a case does go to trial, the costs almost certainly will be at or north of $1M for all fees leading up to and including trial.

Venture investors are increasingly familiar with litigation. The start-up founder/CEO needs to be transparent about the situation and the facts, and keep the Board closely updated on the process. Unfortunately, the wheels of justice turn slowly and often the biggest expense paid by the company is the time and distraction.