Seedcamp Podcast, Episode 9: Philipp Moehring of AngelList

In the ‘Seedcamp Podcast Series’ we talk with key people in the tech startup industry to hear their stories and gleam key advice and learnings from their experiences.

In this episode of the Seedcamp Founder Series, Carlos talks to ex-Seedcamp team member Philipp Moehring (now part of the team heading up AngelList Europe) about Philipp’s views on the future of Platforms, investing in Europe, and his view on how things are evolving in the tech ecosystem globally. They discuss:

  • How AngelList Syndicates works and what it means for VCs and startups
  • The future of venture capital
  • If crowdfunding investments could become mainstream
  • The common attributes of founders across the world
  • Building relationships with investors
  • Working with remote teams
  • How US investors view the European market

If the above player doesn’t work for you, you can also listen directly from our Soundcloud page.

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When Brands Differentiate – A View on Bags, Bag Brands, and Brand Differentiation

One of the topics I enjoy researching is brand differentiation. It’s amazing to see how much creativity is put into helping brands stand out amongst their competitors. In order to illustrate the point, the podcast below explores the differences between messenger bags and the rest of the industry, and how four brands have managed to carve out a name for themselves amidst tons of international competition.

One point I’d like to add is that the purpose of this podcast is merely to illustrate how the companies have differentiated between themselves amidst of sea of competitors, and highlighting how they’ve implemented this differentiation across the company and branding.

This podcast highlights the need for differentiation if you want to enter a crowded and established market.

The companies I talk about during the podcast are:
missionworkshop.com/about/
info.rickshawbags.com/the-rickshaw-story
www.timbuk2.com/content/about-people.html
www.chromeindustries.com/us/en/manifesto

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Be Nimble: Keeping Milestone Optionality

Identifying milestones for your company’s development is beneficial for an early stage startup for many reasons: the first is that planning milestones allow you to focus what you will be working on, secondly the process of identifying and planning them make you question when and in what order you and your team should try and execute something, and lastly, from a fundraising perspective (something I cover in more detail in my blog post on milestones) milestones are useful to tie together what you need to accomplish with how much money it will take to get there, and fundraise accordingly.

On this post, however, I’d like to address a very important concept that should be considered during this process of outlining and planning milestones. I call it, “keeping milestone optionality”.

The principle is very simple… even though you plan your company’s future growth and associated cash needs, you can’t lose sight of the fact that you’re a nimble startup.. not a large corporate that has to report to analysts and public market shareholders. Your nimbleness is your strength. A startup’s growth plan isn’t linear, it’s more like a series of zig zags. As such, whilst it is useful to forecast your milestones so that you have a plan, and understand your cash needs, it is also useful to look at that plan with one eye, while the other eye looks out for actions which might be more beneficial to your company than what you had originally envisaged or agreed with existing shareholders.

On my post on 7 reasons for founders to avoid tranched investments  I spoke about how a future tranche (a glorified milestone, if you will) could have a negative impact by dictating what a company should do, even if midway through its execution it turns out that it was a bad idea for the company to have that goal. For example, imagine if your plan had in place a monetization strategy (and associated revenue stream) kicking off in month 6 of your operations. Month 6 comes along and well, uptake is poor and your revenues are not coming in as expected. You have some chats with your customers and you find out that actually, the value they are getting from your product is mostly around the emerging network effect of your product, and because the network is still small, your early monetization is stifling the value they are getting because the barrier for new users to sign up is still high, and thus those that would be likely to pay are reluctant to pay.

Well, if you (or your investors) held you strictly to your original plan for the sake of ‘keeping to the plan’, you’d kill your company quite quickly, but by staying nimble and adapting your milestones to what you think should be the new direction, you might actually be better off than you would have been before. Naturally, this optionality comes at a cost, as your original plan will have changed and thus your cash burn will change and your goals (KPIs) will change as well… and that’s ok as long as you are aware how.

Good early stage investors (particularly those that invest in pre product-market fit companies) know that this kind of change mid-way through their funding is a possibility and they should be backing you in your ability to make these difficult calls even if it means a deviation from the plan they invested in. However, you should be mindful that there are many investors out there, that for some reason, still believe highly in the adherence to a stated plan. If you can, avoid taking money from them. At the very early stages in a company’s development, particularly during the pre product-market fit phase, investors should invest in you for your ability to adapt to changing and evolving circumstances, and not in your ability to predict the future 18 months in advance and stick to the plan when it clearly isn’t working.

Of course, this isn’t a recommendation to throw out all forms of planning, it still helps to create a milestone plan based around your hypothesis of growth (and relevant KPIs), cash needs, for you can’t be changing strategies every month and you need to keep an eye on cash burn. At the same time, however, you should constantly monitor whether there is another milestone optionality play coming up. If you do find, however, that you are constantly questioning your original hypothesis for growth, perhaps there is a bigger problem you are facing, but by keeping an eye open for milestone optionality events, you might fare better than if you exert uber discipline to a rigid plan that was built before you learned many new things.

In conclusion, as a founder, plan for the future, identify key milestones to grow towards, but always keep milestone optionality, particularly in pre product-market fit companies.

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Investment – Are You in Danger of Raising a Toxic Investment Round?

money

Fundraising for an early stage technology startup is always a challenge. You have to navigate many meetings with potential investors and hopefully reach agreements that make everyone happy so you can continue to work in good faith after the negotiations are over. However, in some cases, after the dust has settled in a negotiation, it isn’t always a win-win for everyone.

For example, what do all the following company circumstances have in common? (note: all these companies are real early stage companies.)

  • A founder who gave away > 60% of his company for 100K in funding in tranches.
  • A founder that gave away > 75% of his company to his ‘investors’ in a pre-series A round.
  • A company that gave away > 70% of their company for < 100K to investors, but still wanted to go through an accelerator.
  • Another company with 51% ownership to existing investors.
  • Another company where the investor offered the founders a sub €30K investment but it came over tranches across the year (as in no cash right now).

As you read the above examples, you might find these offers as ’normal’ (then this post will hopefully help you think twice in the future about these kinds of deals), or you might reel in shock as you read each one of the above anecdotes. Either way, in this post I want to highlight the concept of a ‘Toxic round’ or a ‘Toxic cap table’ in an early stage startup to help founders navigate potential investment offers and avoid getting themselves into a difficult situation in the future.

What is a ‘toxic’ round?

‘Toxic’ rounds (not a technical term) can be defined as fundraising rounds that can pre-dispose a company to  struggle to find subsequent financing because newer investors shy away from a potential investment once they find out what the state of the company’s current cap table and or governance.

Whilst it is very hard to make any judgments about the quality of investors because each company’s financing history is unique, a common view is that investors that ask for terms such as those highlighted above are usually not of the sort that one wants to take investment from. However, the focus of this post isn’t to highlight the qualities of ideal investors (if you want to read more about the ideal qualities of a new investor check out this text), but rather why subsequent new investors might shy away from investing in your company if you have taken on this kind of round in the past. Additionally, in this post I’m only focusing on founder dilution and not on other potential aspects of a company’s shareholdership that could make it difficult for new investors to invest.

Therefore, the reasons why a new investor might shy away from a company that has experienced a ‘toxic’ round in the past can include:

  1. Because the company will likely require more capital in the future should it prove successful, and potential new investors feel that the founders will be less motivated to stick with the company as the value of their equity declines over time through premature excessive dilution.
  2. New potential investors feel that current investors own too much of the company and perhaps the company has a governance issues as a consequence.
  3. Because the investors have a large stake, it brings up a lot of questions about how the company got itself into this situation. Did it happen through a down-round? Was it due to other negative circumstances which could affect the future of a new investment? The circumstances raise a lot of questions and doubt in a new investor, and considering how many investment options an investor receives per year, frankly, as a founder raising capital you just don’t need any more reasons for a new investor to reject you.
  4. In the specific case of ‘debt’ or an ‘early exit of existing investors as part of a new financing’; potential new investors can sometimes object to having the money they are putting in as part of a new round be used for anything other than to expand the growth of a company. This means, potential new investors may shy away from companies that have investors that are eager to dump their shares as part of the financing transaction or companies that have too much debt outstanding that is repayable as part of an upcoming round.

Having said the above, how do you more precisely define a toxic round? Well, a toxic round could be where either “too much money” comes in too early at a too low a valuation, or where a company is too under-valued, or both. All of these cases lead to founders being greatly diluted too early in their company’s life.

To help you visualise these potential scenarios, let’s look at the following equations:

  1. Money Raised / Post Money = % dilution to founders
  2. Money Raised / (Pre Money + Money Raised ) = % owned by the new investors

These two equations represent the same thing, the only thing that changes is the definitions, but the numbers are all the same. If you don’t know what Pre or Post money mean, check out myrecent blog post which defines some of the components of a round.

What is the solution for toxic rounds?

Knowing the above, it would seem that the solution for toxic rounds would include both raising the right amount of money AND setting the right valuation for the company early on so that as the company grows, it doesn’t find itself in a ‘toxic’ situation. If you want to read more about how much money to raise and setting the right milestones check out my following posts below:

So if that solves the ‘Money Raised’ part of the equation, how about the valuation parts of the equation (pre-money)? Valuing an early stage company is always a source of much debate and causes many people lots of stress. As I’ve described on my previous blog posts on the subject:

There are many methods one can take to arguably ‘price’ a company. However, the larger point is that no matter what method you use, it will always be subject to current market dynamics… meaning that no matter what “quantitative” method you think you are using, it is subject to the variability of how the overall market is trending… if we are in a boom, the pricing will likely be higher, if we are in a bust, it will likely be lower. It’s a simple as that.

Taking these market dynamics in consideration, take a look at a recent Fortune blog post on what the average dilution hits are in the USA for Series Seed, A, B, and C rounds. In the Fortune post, you can see the average dilution per round for the typical rounds and you can see the market dynamics over the years (check out what the 2007 recession did to % dilution per round). What you realise is that none of these rounds, no matter how big, take as much equity as the real life examples I noted above at the start of this post. Even if you consider that different countries have different country risks, the range of numbers is a multiple of 3x what is recorded over the last 6 years in the USA.

What if your investment round was toxic?

So what if you’re already in a tricky situation similar to the examples I noted above? If you find that you are in the situations described in this post, unfortunately the available solutions aren’t always easy and straightforward. The single best solution is to have a tough talk with existing investors on how to rectify the situation before new investors either walk away or make it conditional as part of their new investment. There can be many ‘creative’ solutions to solving the problem with your investors, such as investors giving back equity if founders hit milestones, but they will all seem ‘creative’ to a new investor rather than ‘clean’ if not completed before they invest; hence why the ideal solution is to work through this topic with existing investorsand help them understand that by not helping you overcome the situation, they very well may be jeopardising the long term value of their own investment. Perhaps counter-intuitive, but true. In the end, any progress you make with existing investors on fixing these situations if you are already in them, is better than no progress, no matter how tough the discussions.

I leave with you with the following thought of prevention for you to discuss with your potential new investors if they offer you a hard deal… yes, they are taking a huge risk by investing in your early stage startup, but by taking too much equity or debt too early, are they really just pre-disposing your company to failure? Something to discuss.

Originally Posted at Netocratic.com: http://netocratic.com/toxic-investment-round-2451

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How does an early-stage investor review your financial plan?

Finances

You are about to go meet an investor… you’ve read on the web and heard differing views from people on whether you need a financial plan… some say you don’t, it’s a waste of time as its all made up numbers anyway… others say, you absolutely need a financial plan… so you walk into an investor meeting full of anxiety as to whether not having something is going to reflect poorly on you or if what you’ve created (if you did create something) will be crap in the investors eyes… so what to do?

The financial plan, for most tech-focused early-stage founders, is probably one of the most dreaded bits of the investment pack to send your prospective early-stage investors. The variety of opinions online don’t help either as they just confuse the matter…

  • Do I need one or do I not need one?
  • If I build one, how do I know it is ‘right’?
  • If I build one, surely the investor will know that my numbers are all “fake” and just slash them all in half?

Let’s face it, as much as we’d like to think we can predict the future with all sorts of fancy extrapolations on growth rates… but we can’t… Considering that most people create financial projections based on assumptions of what needs to happen for an upcoming month’s worth of operating events to happen and then project from there for x number of months or years, you effectively create a series of increasingly improbable chronological events with the last event (month) in the series being effectively a function of the compounded set of decreasing probabilities, all of which are asymptotically approaching zero percent in their likelihood of happening “according to the plan”.

What’s my point? Well, that your financial plan isn’t worth much from an accuracy perspective.
So what then? If my numbers are crap, why bother with whole financials nonsense?

It is in its forensic analysis of your thinking behind the model, however, where an early-stage investor really gets a feel for how you think and how you want to direct your company in the near future. Next, it is in how your cash will be used efficiently to accomplish the mutually agreed goals.

Before we continue further, I want to clarify that I’m not going to discuss how it is that you should format your financials, or explain basic accounting principles, or how financial statements work. There are plenty of resources online that can help you with that. Rather I want to explore how an early-stage investor (well, at least myself) forensically reviews the financial plan of an early stage startup (vs. a later-stage startups where there is a historical performance record already there and with multiple years of budgets and actual figures).

So what do I mean by conducting a forensic analysis of company’s financials?

Well, I certainly don’t mean it in the sense of reviewing the financials of the startup from a post-mortem basis, but rather reviewing them with the same level of scrutiny on ‘reasons’ why things may have occurred or may occur as one sees on TV shows like CSI. Effectively, I’m looking for what are the cause & effects of each of the numbers and what are the key assumptions behind them, with emphasis on the word “assumptions”. The verbal discussion with the entrepreneur’s financials will focus entirely on their assumptions and the reasoning behind them.

When an investor is discussing numbers (which may be entirely wrong from a future-perspective) with an entrepreneur, if the entrepreneur shows a solid understanding on why the numbers are there, having a clear view of the market dynamics in which their company operates, with realistic customer acquisition assumptions, realistic hiring plans, effective use of marketing budgets, appropriate expenses for a growing company, it can have a HUGE impact on establishing the necessary credibility of competence an entrepreneur needs to inspire confidence in the investor. The opposite, seeing a financial plan with current month revenues/expenses projected five years into the future assuming linear or exponential growth in all aspects of the organization and then stated with a confidence of ‘this is what we realistically expect to happen’ can be both demoralizing for an investor if not outright humorous.

Let me share with you a little secret: With a few exceptions, you will always know your industry and its numbers better than any investor will. However, an experienced investor will ask you the right questions to ascertain whether or not you know your industry well enough to increase the probability of your own company’s success. As such, really do your homework… by homework I mean, don’t just go out and build a product and hope there will be customers. If you take the Lean Methodology approach, for example, as soon as you have customer validation, make an effort to understand the market dynamics of that customer… how many of them are there? What is their concentration? How do you reach them? Are they locked in with a competitor with some sort of monthly or annual contract? Do they buy in a cyclical pattern? Do they prefer to buy online or only from salespeople? Do they need help with setting up your product or can they use it as is? What are they generally willing to pay for other similar services? How is the market growing? Mind you that in some circumstances the ability to ‘charge’ money of your customers may not be deemed the real potential for revenues at first (think Twitter 3 years ago), but again it is how you articulate the future value that matters.

If you take all those questions and research them, what you will find are key components of what will make up the assumptions on your future revenues (or value creation objective). Perhaps your customers are only willing to buy your product during the holiday season, so you will have a hard time with cash coming into your company during the off-season. Financials that didn’t take that into consideration would look to an investor as somewhat unrealistic, not in the numbers, but in the market dynamics of your product. Take other assumptions for example, if you can only reach your customers via another party (perhaps a distributor?)… As in you aren’t directly selling to your end customer, how does that affect the time until you get cash, and the amount of customers you get all at once (or lose all at once)? How long are your customers likely to stay within your service (churn)?

Again, all of these examples are about doing your homework on how your company will operate within its industry and how it will acquire customers. The better you can explain the reasons why a number in your financial model is based on a realistic set of assumptions, the better off you will be. But look at it another way… while you are doing this exercise, you will realize whether there is actually a business that can make money (or other method of value creation) or not. For example, if you do the analysis and find that in the sector you are exploring people aren’t willing to pay and that many other competitors are giving the product away for free, and that there aren’t many opportunities to inject ‘advertising’ as a supplementary source of revenue, you may have just saved yourself a serious amount of wasted energy!

Which brings us to the next part of the homework: the understanding of your company’s expenses. If you have found a market where your product is actually capable of generating some sort of value (note again that I’m not necessarily focusing on “revenues” because there are many ways investors define what “value creation” is, whether it be a growing user base or actual sales) the next part is how do you spend your money to match that customer growth. When do you hire new sales people (and how many sales people do you need relative to a customer sale?),  when do you bring new servers online, spend on marketing, spend on new offices, laptops, etc..  Obviously the types and amounts of expenses vary from company to company, but what matters here is how they map to what you are trying to do and whether that mapping is realistic (what is your customer acquisition cost?). For example, if you have a marketing charge of $500 one month, is it realistic to expect that next month your customer sign ups will increase by 500%? Well, as I said before about the “little dirty secret”… I have no flippin’ idea, but I will expect you to tell me how the $500 will equal 500% in customer growth and I will basically evaluate the credibility of your answer. If you answer, I will buy $500 worth of flyers and pass them out, you can rest assured that I will not believe your 500% figure, but if your team’s background has a track record of low-cost viral marketing campaigns, and your answer is basically a version of that… well guess what, I might just find it plausible. I may be exaggerating the bit about having ‘no flippin idea’ as most investors will have seen enough of what works and doesn’t work to call BS, but again, if you can walk an investor credibly through your assumptions, it will do wonders for the confidence you create.

Lastly and most importantly, is the review of how the expenses map to the revenues as far as cash flow is concerned. The lifeline of a company is how much cash it has before it either dies or needs to go fund-raising again. As such, investors not only want to know how much a company needs in terms of cash to execute its vision (perhaps the subject for an upcoming post), but also on how that cash is being used. If there is a huge mismatch here or there isn’t enough time for you to reach your company’s next point of tangible progress (a validation point), this may be a point worth discussing. Much is joked about how an investor will take your revenues and cut them in half, actually an investor may outright eliminate your revenues from the overall sensitivity analysis he is doing to get a feel for how much cash your company would burn on a monthly basis at time x in your plan (you should know your current monthly burn number by heart, by the way). This is because if your company has to do a pivot or something else goes wrong, this will not only accelerate the cash drain relative to your plan, but also have an effect on when the company needs to go fund-raising again and an investor needs to take all of that into consideration as part of the investment analysis.

In summary, do your homework before you build your financial model, but definitively go through the exercise of building one. It will be hugely helpful in helping you identify how your business may need to grow in order to adapt to the sector in which it operates and how you may need to spend money in order to achieve your goals. Most importantly however, by being prepared with a thorough understanding of why everything is there within your model, the less anxious you will be when meeting potential investors… and remember, you may not know all the answers, such as how much money will it cost you to acquire a new customer, but even if you at least start with a reasonable assumption, confess that you aren’t sure about it, and then play around with a range to see if things work, that is also helpful to the investor for them to get a feel for how you can evaluate uncertain circumstances and adapt accordingly.

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