Archives for posts with tag: vc

A question that came up during my session with Andree last weekend at BarCamp Munich, was how effective accelerators like SeedCamp or Y Combinator are in helping startups receive funding.

Before digging into the numbers, I would first like to point out that receiving funding is not necessarily a good indicator for a startup’s success. And while the above mentioned programs are very different (in both nature and geographical focus) a blunt comparison might not give each the credit they deserve.

I am still convinced that both are doing a terrific job creating great startups and I highly recommend applying there to get real mentorship, exposure to great, passionate people, and accelerate your startup.

For the following analysisI used publicly available data from TechCrunch’s CrunchBase.

It should be noted that there is a minor presence of error as some companies of Y Combinator weren’t showing up on CrunchBase and others did go through funding rounds but did not disclose the amounts raised.

SeedCamp
Having been established in London about 3 years ago, SeedCamp is primarily focused on the UK and Europe. Its primary event, SeedWeek, is happening once a year in London. Due to its roots and its geographical focus, it is also not surprising that the companies coming out of this program are primarily from the UK. But the program’s outreach into other areas has created a pretty diverse roster with startups from 11 different countries.

Y Combinator
Y Combinator has been around for 5 years. Unlike SeedCamp, Y-Combinator doesn’t have fixed deadlines for application. However, Y Combinator hosts its 3-month-mentoring event twice a year. The first data points available for my analysis are from the June 2005 intake. Y Combinator is known for being an American program and hence the startups applying here are primarily from the US (with some minor exceptions like the UK).

Due to the afore mentioned differences, it should be of no surprise that the programs created a very different output in terms of startups going through their programs.

Hence, the fact that the total amount raised by Seedcamp companies was at around € 9.6M whereas this number is at about $ 135.4M for Y Combinator. To determine the spread of these rounds, I looked into the averages and the standard deviations:

What might matter more is the question about how these two programs differ in their performance. While Y Combinator is around for a longer time, the hypothesis can be made that these large amounts are due to sheer numbers. So let’s have a look at averages by plotting how many of each class were funded grouped by the classes they were in.

As is pretty evident by this chart, Seedcamp started out way more successful along this metric. But even Y Combinator shows some swings. The most recent classes should not be considered in both cases as they are both pretty young (Seedcamp’s class usually starts in September and Y Combinator’s in June).

As we will soon see, these numbers are also quite inconclusive as the spread is too big to jump to any conclusions. Going through the individual rounds and plotting these in a bubble chart provides a more visual approach, providing more helpful insights in answering the question above.

The X-axis is the program these startups went through whereas the Y-axis denotes the days between the start of the program and the first funding. I did not consider the amount these startups were receiving from the respective programs to go through the mentoring months. However, should there have been a rather large amount provided by e.g. Y Combinator, I considered this a first funding round.

Conclusion
Again, as these graphs show, both programs are doing a great job bringing out some fine companies. And Y Combinator’s quick flips (e.g. Reddit, Zenter, GraffitiGeo, Omnisio all got acquired within 6 months after going through Y Combinator) show that Y Combinator is doing a great job, accelerating companies for an acquisition.

A lot of the negativity VCs are feeling from entrepreneurs roots in the misunderstanding of why VCs keep telling entrepreneurs to grow really big and hence seem to be pushing for more and more, making them appear like slave drivers.

VCs also serve someone else
Even though there are many VCs who might make you feel that it’s their personal money they put into your startup (which, in all honesty, is usually partly true), it’s usually coming from a fund. Funds are composed of smaller sums of money contributed by wealthy individuals and/or institutions. These people/organizations usually get to know in which companies their money went but they care only about the return their money in the fund makes. In order to make the investor happy, a VC needs to generate quite an excessive amount of money over the lifetime of the fund (usually something between 5 to 7 years). And since the failure rate of each individual startup is very high, a VC pushes for everyone to make the most and compensate for the failure of the others.

It’s unsustainable to remain small
Many people think that it’s ok to have a business that is generating enough money to provide a living for oneself and maybe a family. While this model might still work in some areas, it is usually not true in today’s hyper-competitive internet market. With radical shifts happening every couple of years, a business can easily be leapfrogged and killed by competition every second. Hence, it is hard to make a point that you can provide a sustainable living for yourself for long with a small business in a niche.

The solution: grow!
So, the answer to this problem is growth. There’s always four ways to grow according to Ansoff:

As you may understand immediately, defending  a competitive edge is something very hard to achieve for a small startup with a small customer base in the long run. Diversification can increase complexity and might create other problems (organizational, economies of scale, burn rate) at smaller companies as well. So, there is basically only one of two ways: straight up or straight right, penetrating more markets with your product or expanding in your current market with new products. And this is exactly what large enterprises are seeing: small competitors that are in a niche they have not conquered before and which are cheaper to acquire than to running the risk of failing themselves pursuing the same users.

No matter which path you choose, it will always feel like an uphill battle no matter the size or age of your company. The chances of losing connection to your target market are increasing the larger you grow because of the complexity you add with more products or more people to manage. But this is exactly why startups will always have a chance in today’s market. And this is exactly why there is still a huge supply of capital from venture capitalists to this industry.

I attended Telekom’s Innovation Day a couple of weeks ago and joined a discussion on European Entrepreneurship. The other people joining this discussion were from different backgrounds: Finance, product management, startups, entrepreneurs. After a short while the discussion centered around two questions: what is the reason Europe seems to be creating less successful startups and how do you successfully start a company internationally?

How do you start a startup to become big internationally?
I think a great comment came from Sebastian Wallroth who pointed out the difference between the business and the developer perspective. Developing something to be internationalized and building something for international use might be seen differently by these two parties. I personally believe that it is important to start your company close to your initial users/customers. It is crucial to get as much feedback as possible–especially in the beginning. Facebook’s Net Jacobsson also repeated this theme at the very same event, stating that he attributes much of Facebook’s growth in applications to Facebook’s developer garage events which were held locally to strengthen the community and gain insights into what developers wanted.

Having been a software developer for several years, I know how tempting it can be to build the best, most robust and extensible application right from the start. And while I certainly agree that web applications should be built with internationalization in mind, I can also see the threats of over-engineering and getting tied up in details. Starting a company in a European country (aside from the UK most probably) almost demands rolling it out in the local language first. However, if your application has global applicability, it might be worth considering a first beta version in English.

As Julie Meyer from Ariadne Capital put it in a panel discussion earlier at that event: there are many startups which think small but then need to grow big quickly.

What about Europe?
As there are more than enough examples of highly successful European entrepreneurs in the US, the logical inference was that it might be Europe which is limiting the growth in new companies. While many agreed that the lack of sufficient seed and early stage capital might be a factor, I doubt that the underlying problems can be solved by just providing more cash for young entrepreneurs. On the other hand, I do not neglect that Germany should provide a better soil for more VCs. However, an entrepreneur who wants to work at a startup just for the salary is probably not all aware of the difficulties ahead.

I certainly believe that the attitude towards taking risks is different in Europe. Having spent two years in the heart of Silicon Valley, I am pretty sure that rewarding risk is almost unique to the most vibrant startup scene on this planet. Risk-taking is a vital part in startup life. Europe lacks this sort of entrepreneurial thinking. This thinking also includes the idea that people who have been out of the large corporate setting for some time are still able to adapt and thus capable of switching to a different working environment. Unfortunately, this is just not (yet) part of our thinking.

Selling too early?

Another, very interesting point came up shortly before the discussion ended: what about the statement that a lot of companies in Europe are not able to develop fully before being sold? The hypothesis was that a lot of investors in Europe are also still not willing to take larger risks and hence hinder greater exits. Thus, the lightning rods like the ones in Silicon Valley with high valuations are lacking and in turn not creating enough interest for people to pursue an entrepreneurial career. I found this to be a really compelling statement. Too bad it is most probably going to remain a hypothesis for the lack of actual data.

I figured that there is a great deal of confusion about valuations out there. Hence, I decided to shed some light on this from the other side of the table. I am going to concentrate on early stage businesses here. There is a great deal of books for mature companies (I personally recommend McKinsey’s book on Valuations on this topic).

Misconception #1: it’s all about other valuations
Nothing can be further from the truth. Although this might sound counter-intuitive at first, other valuations are just one piece of the puzzle. Only because a competitor might receive a high valuation does not imply the same for your business. There is a great deal of factors that make up a valuation, even more so in the early stages of a business. The reason why so many VCs state that the team is a great factor, comes from the fact that it is common knowledge that you might switch your business model around three times before you hit the right market.

Misconception #2: the higher the valuation the better
This is something that you might not realize when you’re just thinking about your first round. However, it might get back to you in the following rounds. Down-rounds, i.e. rounds in which the current stock price is considered lower than in previous rounds, may have many implications. For one, your previous investors might receive more shares due to anti-dilution clauses. But even worse: it signals that you might not have hit the target set out by your previous investors, maybe decreasing your chances of raising another round.

Misconception #3: there is a fixed formula
If there were, we would not have those nice negotiations, right? There are many tools that you can use to calculate the pre-/post-money value, the share founders get if the option pool is considered, etc. But the real valuation, determined by the amount of the investment for the share of the company, is always a plug-in number. Therefore, a tool like the Valuation Calculator should not be taken too seriously. There are some indicators (stock market prices, general market development) but they may have different value for different people.

Misconception #4: first revenue means higher valuations
The more data you have on the actual money value of your business, the more likely it is that the valuations from different people might be closer. More data points usually help assessing a business better, hence the valuation can be done more accurately. But it doesn’t necessarily mean that your valuation will rise. If you are greatly underselling your product, this might also indicate that the customer does not value the product as high as you might have expected or your ability to sell is just weak. And having missed certain milestones or not being able to expand the business is at least equally bad for a valuation.

Misconception #5: valuations are a primary business concern
It is reasonable to think that you should only pursue the fields driving most revenue and thus creating most company value. And higher revenues usually drive valuations up. Nevertheless, constant business does not increase valuation. There were a couple of companies which were once valued less than the money they had in the bank. Don’t forget: valuation alone does not help you grow your business–business does.

Many entrepreneurs are holding on to their business plans as if they were some holy book and seem to believe that an investor needs to study every passage before making a decision.

Yes, we do look at those business plans–if they exist. But just imagine how an investor works. There are several business ideas coming in each day. No matter what each individual investor is looking for, the key is conciseness and brevity. But a lot of entrepreneurs seem to forget this when it comes to Word. Switching to PowerPoint for a first contact, you will capture more attention.

I personally prefer a pitch book style PowerPoint for a first glimpse. I understand that there will be people sending in 200 slide decks with 7 pt fonts. But simply the fact that PowerPoint calls for organizing your layout, forcing you to think about what to present on one slide, and what that actually means usually helps me getting to the important pieces more quickly: does the entrepreneur understand what I am looking for in a 10 slide deck? Does he make the right inferences from the data he presents?

PowerPoint tends to keep you from drifting by giving you limited space to focus on the most important aspects–both for the people who “write” them as well as those who read them.

The best thing about PowerPoint though is that you can impress people with the professional looks of it. It is far more likely that whoever goes through your slides will be more positively affected if the data was presented in a more professional way. Furthermore, you can also use the space to use screen shots, pictures or links to videos of your product

I am still convinced that a business plan is an important document you should have. However, for a first shot, just send me your deck of slides.

Non-monetary incentives are a repeated topic whenever either one of the following two events happen:

1. We are becoming a shareholder of a company.

2. The company is falling behind initial plan and looks for other ways to compensate its staff.

No matter the motivation, the outcome is always the same: a certain amount of the company’s stock is reserved for employees. Chris Dixon has commented on this with this brilliant post on his blog:

Option pool – normally 10-20%.  This comes out of the pre-money so founders should be aware that the number is very important in terms of their dilution.  Ideally the % should be based on a hiring plan and not just a deal point.   (Side note to entrepreneurs – whenever you want to debate something with a VC, frame it in operational terms since it’s hard for them to argue with that).

So, that’s the short version–in theory. We do reserve a certain amount of shares to be put into a pool initially. The board can then decide at any point to offer employees to receive a certain amount of options. These “options” entitles the holder (i.e. the employee) to make use of the option at any time and convert the option into shares. The employees are then free to chose when to exchange their options into actual shares.

There’s two reasons we do it this way:

1. Due to German tax law, anyone joining the company at a later time need to pay a price higher than the initial share price. Hence, “giving” shares for the initial price is out of the question. And buying shares of non-public companies can become quite expensive since German tax authorities can put a valuation at the company and then re-calculate the worth of the shares–if they want.

2. In order to keep the company’s board small and easy to manage, it is in the founders’ interest, that employees don’t immediately get voting rights. As pointed out before, employees will be reluctant to convert their options into shares until the company will go public or gets acquired. Only then they can use the proceeds from the sales to cover part of their tax liability.

So, due to 1., people are incentivized to exercise their options only shortly before the company gets acquired or merged. And because of 2., the company’s board is easy to manage and can stay lean.

I am a strong believer in non-monetary incentives and I believe this model is covering all possible bases on this issue. We hence recommend doing this with all of our startups.

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