Don't Adjust My EBITDA

by Brad Feld

In my first business, we didn't have a line for EBITDA on our financial statement.  We went straight to Net Income.  We knew our cash flow from our statement of cash flows (and our bank account which we checked regularly since we were self funded.)  We never talked about EBITDA, nor did we ever feel the need to come up with things like "Adjusted EBITDA." 

Now – I went to business school so I knew what an EBITDA was – I just didn't care much about it at Feld Technologies because it didn't matter.  Cash mattered the most.  Cash Flow mattered next.  Net Income mattered a distant third (as long as it was positive every month – it got more important if it was ever negative, but it was still third.)  The list continued.  EBITDA was not on it.  This was 1987 – 1993.

Earlier this week I looked at financials for a company I'm not involved in.  Cash has been vanishing at an uncomfortable rate so I was asked by a friend who is involved in the company to dig into the financials to try to understand what was going on.

The first financial presentation I saw focused only on adjusted EBITDA.  It was sort of defined, but not really very clearly (I didn't know the dynamics of the elements of the adjustment well enough to have a good understanding at first glance.)  Cash flow was buried in one of the back pages of the financials (and not explained in the presentation.)  EBITDA wasn't really visible; Net Income wasn't really visible – it was all revenue and adjusted EBITDA.

Revenue was strong (it's a good sized company – not huge – but nice growth.)  Adjusted EBITDA is positive.  Balance sheet cash is declining rapidly month over month.  Hmmm.  That doesn't work.

I punted on the financial presentation (e.g. please don't send me your explanation – just send me your cash flow statement, balance sheet, and income statement – by month for the last twelve months – as it comes out of your accounting system.)  Easy to do – I had it quickly.

EBITDA is very negative.  However, it's still not as negative as the cash flow.  This is an equipment intensive business so about 50% of the delta was "adjustments associated with customer acquisition", 25% of the delta was capital equipment (CapEx) investments, and 25% of the delta was "other things that got rationalized as adjustments to EBITDA."

Not only was adjusted EBITDA pointless, it completely obfuscated what was going on.  However, the CFO of the company was spending all his time focusing his CEO and investors on adjusted EBITDA to explain how the business - while losing piles of cash – was really doing just fine on an operating basis "if you just didn't count these couple of things."

Last week the WSJ Journal has an article titled Profit as We Know It Could Be Lost With New Accounting Standards.  There is a potential massive overhaul in financial reporting coming (the accountants and the AICPA will need something to do in 2008 now that everyone is finally figuring out how to deal with SOX) – you can see some before and after examples here.  They are actually pretty interesting (as interesting as accounting gets – not up there with Lost or 24).  However, the first step is banishing all of the "adjusted stuff" in the financials.  Not helpful.

Selling/Acquiring a Startup: the Price Issue

by Suzanne Dingwall Williams

"How can we be so far apart on price?" is the common lament of venture-backed companies who find themselves with an acquisition offer. Here's the view of one of my clients, a US company who has been an active acquiror of early stage industry players:

In the public markets, software companies are valued at predictable multiples, this acquiror says. Companies that aren't profitable trade at 1x revenue; companies that are growing, but not profitable - 2x revenues; companies that are growing and profitable - 3x revenues. By contrast, startups and their VCs are looking for purchase prices that yield 4-5X return on invested capital, minimum, regardless of revenue. Is this acceptable?

It can be, says this acquiror, if buying the target startup can jumpstart the multiples at which the acquiror is valued. Buying into the ground floor of a market with huge growth potential may increase the acquiror's share price, making the deal worth the price tag.

But a number of factors usually work against this theory, lowering the price tag. If the target startup has technology, but not a product, the price goes down. For most acquirors, (IBM, Tekelec or Alcatel excluded), buying technology is an inherently riskier proposition. It means the acquiror must create the product, the go-to-market strategy and locate the customers who will create a viral effect for the new product before the acquisition can have any impact on the bottom line. Very few software organizations have the large, well-honed sales force and go-to-market groups to accomplish all this in a speedy timeframe.

The purchase price goes up significantly if the startup has a product with a first-rate go-to-market structure and good sales support. But even here, the offer will still be discounted if there isn't yet sufficient traction with lead customers. It is not enough to have sales; are you selling to lead customers who will create a chain reaction demand for your product in the marketplace?

If not, this acquiror argues, the purchase price again should be reduced. A premium price is payable once the viral effect has started. A lower price applies if a target startup is still one step away from a viral market.

As you plan ahead, think of where your business currently sits in the value chain for potential acquirors. Having best practices go-to-market structures(and documentation), even in their early stages, can go along way in price negotiations.

Recruitment - a VC perspective

by Nic Brisbourne

Knowing what you are looking for is critical if you are going to get the most out of an interview. I seem to have been spending a lot of time recently meeting candidates for senior positions at companies in our portfolio so I thought I'd share a few thoughts. This is an art not a science and different things work for different people - so this is just my 2 cents worth.

Firstly - the role of the VC in the decision making process is often unclear. As investors and board members we want to help our companies get the best people they can - so we want to be closely involved - yet at the same time it is not us who will work day to day with the successful candidate. For me this means the final decision needs to rest with the CEO - we can help guide that decision, and at the limit we might resist an appointment on the grounds that we could do better, but that is the way it needs to work.

If the vacancy is for a CEO then depending on their stake the role of the VC in the final decision will be much greater.

Turning to the actual interview - the first things I am looking for when I meet someone are energy, intelligence, commitment and integrity. These qualities are essential in the leaders (and rank and file) at any start-up and if the conversation turns to compromise in any of them then I start to get nervous pretty quickly.

Relevant experience, cultural fit, geography and many other factors are also very important, but a) these are often areas where management are better placed to make a judgement call than I am, and b) trade-offs are more possible.

One of the toughest things in any recruitment process is knowing when you have done enough work and seen enough people. Sometimes you are lucky enough to find someone quickly who is just perfect, but usually the reality of recruiting for small companies is that that doesn't happen. I've blogged before that taking decisions quickly in the face of uncertainty can be really helpful and I think that applies here as well. Once you have found someone who could do a great job for you my instinct would be to get them employed and working for you quickly and resist the temptation to keep searching for the perfect candidate. That way you keep momentum in your business, and you avoid the risk of losing a good candidate.

Compensation Packages in Venture-Backed Companies

by Brad Feld and Jason Mendelson

You've been offered a job at a startup. The folding tables look romantic, the smell from the Chinese restaurant next door isn't too annoying (yet), and there is a plunger in the one bathroom. The founders tell you that cash is tight but they are having lots of meetings with VCs and a financing is just around the corner. What should you expect regarding compensation?

Of all the questions that we've gotten, the most popular have been surrounding compensation. It runs the gamut from "how much do you pay X" or "how do VCs feel about deferred comp" or "what are standard compensation terms." Given all of the interest in what cash and equity compensation is, we've decided to create a series of blog posts to address the issue. This series isn't just for employees, but also founders. If you've been a regular reader of Brad's blog, then you’ll know we've partnered before in discussing such topics such as Term Sheets, Letters of Intent and 409A.

As with all of our series, but probably even more so here, please take our opinions as just that – our opinions. There aren't "right" or "wrong" answers here, every case is special, your mileage may vary, etc. There are many factors that go into determining compensation packages – it would be inappropriate to simply print this blog series, take to your next board meeting and demand a raise (especially if you work for a company we are an investor in.)

Over time we will publish individual posts on particular topics concerning compensation, including such scintillating missives as "compensation by job title"and "advice for paying outside board members and advisors." If at any time you'd like to read or print the entire series as one post, check out the "Download Our Content" feature on the upper right of this frame.

We hope you enjoy this series and welcome your comments. If there are areas that you think deserve their very own series (say – like "Angel Investing" which we are currently working on) please suggest them to us.

Explained: VC target returns

by Nic Brisbourne

I get asked a lot about the returns that we target, so I thought I'd get some thoughts down here for y'all.

The short answer is that to make good money in venture capital you need to be producing home runs and that means targeting big returns on every deal.

The numbers work out this way because in order to produce decent returns for our investors (Limited Partners or LPs) we need to be doubling or tripling our funds, i.e. returning £400-600m on a £200m fund. By the time you factor in the time it takes to invest in, grow and sell companies, the costs of running a VC partnership and our profit share even turning £200m into £600m only generates IRRs in the 25-30% range (depending on how long it takes). LPs would be happy with that, but not ecstatic, the best venture funds do better.

The other important thing to note is that LPs need to believe we can deliver these sorts of returns to justify the risk of investing in venture capital at all - the majority of funds don't get anywhere near this level.

As a point of comparison LPs can also choose to invest in 100% safe bonds for returns of c5-7% or public equities for returns nearer the 10% mark.

OK - so to generate good returns for our LPs we need to triple our fund. Doing that on a £200m fund with 20 investments of £10m would look something like this:

• Three deals making 10x returning £300m
• Three deals making 5x returning £150m
• Three deals making 3x returning £90m
• Six deals where you get your money back returning £60m
• Five deals where everything is lost

Add that up and you get 20 deals returning £600m. I tried to put this in a table for you but couldn't get it to work….

You can play about with the split between 10x, 5x, and 3x returns, or even put in a Skype like deal at more than 10x, but the underlying message is clear - to have good returns you need a couple of good home runs. Unfortunately we don't hit a home run anything like every time , so we need to believe that just about every deal we do has the potential to get us a 10x return.

VC Annoyance: Term Sheets Excluded from Closing Book

by Randall Lucas

The Closing Book of a financing is the definitive collection of all documents relied upon in conducting a financing. It will generally have a "snapshot" of critical documents before and just after the financing, such as the original Articles of Incorporation dated one day, and the "amended and restarted" articles dated the next. Other agreements such as Investor Rights Agreements and Stock Purchase Agreements are included as well.

However, much to the chagrin of analysts like myself who often have to go back to the closing book for reference purposes, the actual term sheet often is not included in the closing book! This is most frustrating, since as a practical matter it is usually more relevant to discuss "term sheet to term sheet" when comparing terms or negotiating a subsequent round, rather than referring to definitive legal documentation (I estimate that the ratio of words and pages in a term sheet to those in the definitive docs based upon the term sheet is around 1:250).

I believe this is because attorneys are loathe to include anything in the closing book that might give even a thin entering wedge of challenging the definitive docs. Specifically, if a term sheet is included, a party might contend that the term sheet was the "parent" of the documents that followed, and should therefore inform the interpretation or construction of the definitive docs.

This may be a legitimate concern, but damn it, lawyers, couldn't you just stamp: "non-binding, subject to the definitive documentation" in red all over the term sheet and stick it in the closing book??

All I Know About VC, I Learned from My Kids

by Matt McCall

"You are only as happy as your worst off kid"
   -- Parenting Proverb

One day, I was going through a bipolar moment. One of our companies was about to sell for a nice multiple on invested capital. However, later that day, another company informed us that it had lost two major customers and was in a severe liquidity squeeze. Since your attention always goes to the fire drill of the day, I jumped into crisis mode on company B while much of the euphoria from company A receded. Ironically, later that day, I was talking with a friend about children. He mentioned the quote above. You'll often find yourself, as a parent, happy that one of your children finally mastered a hard task but find yourself stressed because another is struggling due to health, friends, academics or the like.

I began to think about the children/portfolio analogy and realized that there were a lot of other common lessons. Most of these relate to how you interact or manage the deal. One of the most difficult tendencies to avoid as a venture capital is to jump to deeply into the day to day operations of an entrepreneur's business. VC's have to walk the fine line between being helpful and being meddlesome. Many of these lessons also apply to CEO's and how they manage their lieutenants.

They have to own the concept & responsibility: VC's come up with all sorts of brilliant ideas on how a business should be run. Some are insightful and come from years of going through similar situations in the past. Some are simply seagull droppings deposited from 20,000 feet up. Since VC's have leverage due to their capital and their board role, there is a tendency, at times, to try and push through an idea even if the team or CEO doesn't agree or track on it. This usually does not end well.

Just like with my kids, if they don't buy into the idea, they won't take ownership of it, they won't internalize the need and it will get done half-assed as best simply to get you off their back. Furthermore, they (kids or management) often have a better read on what the daily constraints will or won't allow and how it fits into the bigger picture. As a result, I have found it best to explain my point of view, give my reasoning, establish boundaries (see next) and let the company do what it thinks is best.

Set Boundaries, Principles & Consequences: Kids only truly learn to take responsibility, become autonomous and take ownership when they accomplish it themselves. While CEO's should have the freedom to run their businesses, they also have to be respectful of the "law of gravity". VC's have a pretty good experience base to draw from regarding "things that go boom". However, they should avoid micro-manage the team. VC's should establish, along with management, boundaries (revenue targets, cash runway, number of customers, etc), establish principles (minimize dilution, deal openly & honestly with the board, etc) and let the company execute as it deems best. The consequences for success or failure are usually pretty straight forward. This approach sets direction and expectations but allows for the CEO to take ownership and responsibility.

Let Them Fail: Parents hate to see their kids suffer. There is also an "ego boundary" expansion where the child's success or failure is the parent's also. VC's have the same issue. If the VC has effectively set boundaries, then there should room for the company to make mistakes and fail from time to time without taking the business down. Failure is a key way for CEO's to fully appreciate the different facets of "the law of gravity". As the Irish say, what doesn't kill you, makes you stronger. On the other hand, I have often found that they were right all along and pulled things off.

Offer Help & Resources: Offer but don't insist on resources. Only they know what they truly need to accomplish a task. Additionally, if they don't appreciate or understand why a resource is useful, they won't be able to take full advantage of it. Often VC's will say "you need to talk with xyz, VP of Biz Dev at Acme Inc". The VC will think that this is a key introduction, but the CEO will see it as a tangential effort and only take the meeting to please the VC (e.g. wasted time). This is like demanding that a kids see a tutor or other resource. Sometimes you have to, but you'll get your best results if they see how it fits into the big picture and why it is useful.

Let Them Come Up with Solutions: VC's should help define the problem or challenge but then ask the Company to come up with solutions or ideas. VC's had trouble resisting throwing in their opinion and recommended course of action. This skews the process and often ends up with a solution the CEO only half supports. With my kids, I have been amazed by how creative they are when given the task of solving for themselves. Often the solution is much better than I would have ever come up with.

3 to1 Praise/Criticism: I can't recall if the ratio is 5:1 or 3:1, but I do remember the childhood development folks talking about the importance of giving multiple genuine praises for every criticism. Humans feel lose or criticism significantly more than praise (lot of stock market psychology tests have demonstrated the lose aversion theory). VC's are a nervous bunch and can be quick to point out all that either is going wrong or could go wrong. It is essential to keep things in perspective and to remain supportive of the company. It is grueling out in the battlefield and the last thing a CEO needs is the "nagging" VC at home. This doesn't mean that it should be a Barney love fest, but VC's should attempt to infuse positive energy into their companies. Look for small successes, not just misses or risks.

Sparse Use of the Nuclear Button: Every parent finds that moment when frustration is so high that he/she feels the coronary coming on. Often this results, when the child has defiantly refused to do something, in the parent raising his/her voice and relying on the cliche "Because I Said So". When a parent begins to yell or threaten extreme consequences, it gets the child's attention. It also becomes less effect with each use and shuts down the communication channel and insures that the child will not internalize any of the discussion or reasoning. With a CEO, sometimes a VC will need to bring out the stick. However, once this happens, trust will begin to breakdown and information flows will likely get filtered. If this happens repeatedly, either the CEO will eventually go or the company will be sold.

Don't Make It Personal: Stay calm and try to keep emotions out of it. When my daughter was young and rammed her head into table, she was fine until I looked at the huge, purple bump forming and panicked.  She then proceeded to burst into hysterical tears. If dad can't deal with this, why should she? While a VC might fear that the ship is going down, he/she should lay out the facts, defining the consequences and jointly laying out an action plan versus bemoaning the despair. The board's attitude towards these situations will heavily influence how the CEO approaches and behaves.

While these sounds straight forward, they are very hard to comply with due to human nature. I would give myself between a C+ and an A- on these at different investments. My goal, overtime, is to move more consistently upward. That said, I won't survey the kids...

How to find and screen a good business coach, consultant?

 by Greg Balanko-Dickson

At some point in the life of your business you will hire a consultant.

Understand the difference between a consultant and a contractor

A contractor is hired to get something done that you do not have time for or not enough work for a full-time employee.

In my opinion a consultant is someone you hire to share his or her knowledge and expertise with you. In a sense they teach you what they have taken years to learn.

If a consultant has 25 years experience and they write a book sharing that knowledge and expertise, you buy the book AND read it. You will leverage that persons knowledge and compress in into the time it takes you to read and APPLY what you learned.

The same should be true of the consultant you hire. They should have the ability to teach, coach and provide leadership. In other words, transfer their knowledge and skill sets to you.

How to get maximum value when to hire a consultant

1) Be realistic with your expectations. In my opinion, the main reason for hiring a consultant is to gain a new perspective, plus access knowledge and expertise not readily available. Therefore, it is important the consultant has the ability and willingness to transfer skills and expertise.

2) Remember that you own the business. You are the only one who can make a decision, and you are the one who will be left holding the bag at the end of the day. The consultant is not there to make decisions for you, but to provide perspective, information and observations. They are also there to train you.

3) Listen to the consultant. Hear them out - ask them questions. Do not be afraid to say you do not understand what they are saying. Take in the information, ask for guidance on how to apply the information and make your own decision.

4) Provide the consultant with feedback. Let them know what you like and what they could improve on.

5) Ask the consultant to agree to identify measurable standards of performance as part of the contract. In other words, how will you be able to measure success? How will you know if you are making progress by hiring a consultant.

6) Give the consultant permission to speak his mind and tell you the truth. You do not need someone to 'tickle' your ears. You do not need a 'yes' man. The consultant should have the confidence and communication skills to challenge you.

If you do all these things and hire someone you trust and respect you will have a great experience. Most importantly, you and the business will be better off.

Start by talking to other business people who you know and respect. Ask them who they would recommend. Try your local chamber of commerce or economic development authority.

Do entrepeneurs make good VCs ?

by Fred Destin

Shantanu is stirring up the pot by making the statement that entrepreneurs make really bad VCs, in post prompted by Guy Kawasaki's Venture Capital Aptitude Test (which I think is an excellent post - essentially saying that you cannot be in venture without big scars on your back).

I think the point is "controversially well made".  God knows what makes a good VC, what is certain is that most people end up not making money and leaving the industry, that many of the great VCs are not entrepreneurs and that a number of great entrepreneurs I have come across turned out to be lousy VCs, and vice versa.  The mantra repeated by for example 3Com founder Benhamou that anyone who is not a former entrepreneur should not be in VC is just not supported by facts.

If you don't believe me look no farther than Benchmark Capital - US.  Bob Kagle? BGC then venture man.  Bruce Dunlevie fares better since he ran an operating division for Everex, but ex Goldman and private equity guy.  Bill Gurley? Ex CSFB tech analyst, with some experience as a design engineer at big names.

Shantanu points to John Doerr and Mike Moritz.  We can of course add our own Danny Rimer to the list. 

In any case I think it is always good to look at the facts before falling for some wholesale comments about the fact that only great executives can make great VCs.  Being a good VC comes from a number of factors, and not all are to be found in ex entrepreneurs.  Rules are for dumb people.

I have taken the liberty of reproducing a fantastic comment from Shantanu's blog in full, from this chap, Krishna Mony from Bombai:

• Spontaneity is an essential element in a VC DNA – that which made
  Andy Bechtolsheim write the first funding cheque of $100,000 in favor
  of "Google Inc" a corporation which didn't yet exist; Legend has it
  that Andy was getting late for a meeting and preferred it over
  listening Larry and Sergie out. I would credit it with Andy's reflexes
  than to cast it away merely as fortuitous.
• I've noticed a few traits in common in great VCs. They invariably
  recognize that the biggest sin of all is inadvertence. Not being fully
  awake. The future descends equally on everyone, but some notice it
  faster because they are always pushing the limits of their knowledge,
  asking questions and picking up on weak signals. They keep their eyes
  and ears close to the ground to hear its rumblings, gut it out and
  react.
• VCs must realize that they are essentially followers (of
  entrepreneurs’ ideas and risks that come with it) and not leaders. They
  are not in the business of taking direct risks but in partaking them.
  VCs from operational background often get confused here. Their business
  is betting on a team rather than playing in it.
• They have to be willing to place intelligent bets, and give up the
  smoothness of predictability for the non-linear upsides of intelligent
  risk taking. Not all bets will lead to success but there's hardly any
  safety in passivity either. They need to have the self confidence to
  set a direction but not the arrogance to fight the need to change if
  market conditions so require.

VC's - knowing when to quit

by Tali Aben

In the venture capital industry, there is much discussion about supporting existing portfolio companies.  When we first embark upon an investment, we do so with great enthusiasm.  We have put in hours and hours of work with the entrepreneurs, understanding the market opportunity, etc. The risks are clear, as are the rewards.

But as the newly funded company starts to execute, we often find ourselves with less-than-perfect performance. Delayed release schedules, missed revenue targets, over budget expenses, etc.  Our challenge is to identify the cause of the weak performance, and decide if we continue to support the company - or not. 

If the decision is to support, the premise is not to invest "good money after bad".  What's gone is gone and it's not a good enough reason to invest more.  Supporting a troubled company, is accompanied by a good understanding of what's causing the missed results, and an already-in-place course of action to rectify the problem. 

If we decide not to support, we risk our reputation on one hand, as well as "throwing away the baby with the bath water".

On this subject, Red Herring published an article voicing the conflicting opinions of Kleiner's Ray Lane and Sequoia's Pierre Lamond.  Certainly worth a read.

There's never a single "right" answer, and different funds have different approaches to the subject.  I suppose that's one of the reasons that Venture Capital is often described as Art, not Science. 

Knowing When to Quit

Kleiner's Lane and Sequoia's Lamond take different views on failing companies.

By Alexandra Berzon and Adena DeMonte

Venture capitalist Ray Lane said his firm likes to stand by its startups until their dying day. Pierre Lamond, on the other hand, said its best to cut one's losses as soon as possible.

Their comments highlighted fundamentally different approaches taken by two of the most prominent venture capital firms in Silicon Valley—Mr. Lane's Kleiner Perkins Caufield & Byers and Mr. Lamond's Sequoia Capital.

The issue for Mr. Lane, who spoke Thursday at the Red Herring Spring conference in Monterey, California, is the reputation of his firm.

"It's more reputation, we're not altruistic," said Mr. Lane, who added that at least half of Kleiner Perkins' portfolio companies aren't going to succeed.

"We just sold a company, it was a very small transaction," said Mr. Lane, who spent eight years as Oracle's president and chief operating officer before overseeing clean technology and computing investments at Kleiner Perkins. "We had to bridge the company three times, and now we're losing money on it. We were staying in right to the end."

"I don't know a case where we were not the last people to turn off the lights," said Mr. Lane, whose firm backed Genentech, Juniper Networks and Sun Microsystems. "The CEOs give up before we do. We have our fingernails dragging on the cliff, we're holding on for dear life saying, 'We can do something.'"

Speaking later in the morning, Sequoia's Mr. Lamond, said his firm is quicker to exit a failing company.

"The important thing in this business is that you have to cut your losses as soon as possible," said Mr. Lamond, whose firm backed Cisco Systems, Google and Symantec. "I want to be the first one to turn off the light."

He cautioned that venture capitalists cannot afford to fall in love with an idea and excuse companies that post small margins, take a long time to evaluate new products and depend on slow paying customers.

"When we've made bad investments, we didn't ask the right questions," he said. "You have to be tough with the entrepreneur and with yourself, so you're not the last one to turn off the lights."

The two men, however, agreed that there is too much venture capital money pouring in to startups. Mr. Lane said that leads his firm to require some of the companies it funds to remain in stealth mode without releasing public filings or statements.

"If we find something that will be really important five years out, and we tell the world we funded it, there will be ten more the next day with me-too strategies, and that's not good for anybody," said Mr. Lane.

Do VCs need trust your product ?

by Krishna Mony

Most startup founders approach me after their direct pitch to VCs go without a trace. Factual reasons could be many – a lousy pitch, bad timing, no homework done on target customer segment, market size, competition or made the pitch to the wrong one. But almost everyone have the same explanation – the VCs just want web apps ; they don't understand our product. As if making amends, many often confound me with this first question – Do you trust our product ?

My standard (yet honest) answer is "I would have to". Some of them are baffled at that. It's time that I set the record straight thro this post. By using it as a template, I can avoid wasting my vocal energies with the next carper that comes along.

I would never say you abandon the product of your labor in one mighty fling because half of the world found it crappy. If deep inside, you have a feeling that it's a winner, it probably is. Do not prevaricate. Rather than expecting others to *trust* your product, you must go the extra mile to disprove them by demonstrating on your own how well the market welcomes it.

Nobody, I repeat nobody will *understand* or even try to understand your product as much as you do and your customer will ; just because you are the only pair having an interest in its functionalities and outcome. A VC's interest is focused on your team's ability to market it, its scaling / revenue potential and based on that, the ultimate enterprise value. It's impossible for any VC to have mastery over every technology or product. If that's a criteria, the VC model would've never survived. For instance, it's the same John Doerr of KPCB who built the unrivalled record of backing industry defining startups in fields as diverse as Computing ( Sun Microsystems, Compaq), Software (Lotus, Intuit), Biotechnology (Genentech, Millenium), and the Internet (Netscape, Amazon).

A VC often bets on the team not on the product. He does not take the risk entirely, he just partakes in it. If the team is good, it will try, err and entrench the product in its logical destination – the customer's mind. VCs know it only too well and smart consultants know the VCs ways much better because they track the deal world closely.

When founders pop the question prematurely "do you trust my product", they have no choice but to reply in the affirmative simply because it's not the VC/consultant's business to get pleasure out of knocking an upstart cold – they just meant "if your product is indeed great as you say, let's hear it from the market". They stopped just short of elaboration of the obvious.

The founders get judgmental too soon, blame the VC mentality, self-inflict the wounds in an impulsive tirade and begin to sink in a sea of wallow even as the game has just begun. My advise - don't.

How to avoid the ax when your company gets a new chief exec

By Marshall Loeb

When a new CEO arrives at a company, senior executives start to wonder: Does this mean I'm out?

According to a new study in the Harvard Business Review, turnover among top management spikes when a company appoints a new chief executive officer. The study, written by father-and-son team Kevin P. Coyne and Edward J. Coyne, both business professors, concludes that when a CEO is promoted from within, turnover jumps to 22 percent from 17 percent; a CEO totally new to the company results in turnover of 33 percent.

But Coyne and Coyne have suggestions on how to secure your job with a new boss.

First impressions count. Most CEOs make decisions about people within the first 60 days, so you have to present yourself well from the beginning. Take the opportunity to swiftly establish your value when the new chief arrives.

Set up face time. Secure a meeting with the new boss and let him or her know about your responsibilities and how you can help achieve the vision.

Understand the CEO's style and agenda. Don't be afraid to ask your CEO directly about his or her style and the agenda for the future. You'll get the best information from the source and also demonstrate that you care about what the boss thinks.

Be honest. Don't paint a too-bright picture or a spell out a less-than-realistic game plan. You want your new CEO to know that you are not going to hide negatives.

Forget about your own agenda - your compensation, long-term plans or problems with the company. Ensure that the honeymoon phase with your CEO is just that.

A sample term sheet for a bridge note

by Andy Sack

This is an outline of a term sheet for a bridge note. I thought I'd post this so people could see a real life example.  I'm no lawyer so don't just copy and use...or if you do -- copier beware.  Also, this will probably be my last post on bridge notes for a while....I'm going to move onto other topics :-)

Issuer: XXX Corporation ("Company")

Investors: Accredited Investors acceptable to the Company which will invest a minimum of $25,000 (unless otherwise approved by the Company) ("Investors")

Type of Security: Debt convertible ("Notes") into the same stock class, share price and terms as the next round of equity investment of a minimum of $2,000,000, including conversion of this bridge financing (a "Financing").

Note Provisions

Amount of Investment: Up to $500,000, subject to increase at the discretion of the Company.

Closing: Month XX, 2007 Term: 12 months from the date of issuance of the first Note ("Maturity").

Conversion: Principal and accrued interest automatically converts if closing of next round of Financing occurs on or before Maturity, at a price equal to the price established in the transaction, minus a 25% discount; provided, that if the Company valuation immediately prior to the Financing exceeds $12M, then such discount shall be the greater of 25% or that discount which is needed to result in the Investors converting at a $12M pre-financing valuation.

If the Company is acquired prior to Maturity or the next Financing, then the principal and accrued interest automatically converts into Common Stock at a price equal to the price established in the transaction, minus a 25% discount; provided that if the Company acquisition valuation exceeds $12M, then such discount shall be the greater of 25% or that discount which is needed to result in the Investors converting at a $12M acquisition valuation. 

If the Company fails to obtain a Financing by Maturity or the Company is not acquired prior to Maturity or the next Financing, and the Note remains outstanding at Maturity, the Company shall have the option to repay the Note in full or to convert the Note into Common Stock at a $4M preconversion Company valuation.

Interest: Interest to be computed and accrued on the principal at an annual rate of 10% until debt is converted or paid. Interest will be payable at Maturity, either in cash or equity, at the option of the Company.

Additional Note Terms: Company may not prepay the Note prior to Maturity. Payment after Maturity is upon ten days prior notice to Investor.

The Notes are unsecured.

The Notes will be subordinate and junior in right of payment to the prior payment in full of all Senior Indebtedness. Senior Indebtedness consists of any existing and future commercial bank lines and equipment lease lines, along with such additional or replacement commercial loans and equipment leases that are subsequently approved by the Board of Directors.

Other Matters

Documents: Counsel to Company shall draft form of Notes.

Closing Conditions: Closing subject to execution of definitive legal documents

Three golden rules of success

By Igor Shoifot

[Editor's note: We asked Igor Shoifot for the ingredients to success in today's brutal Web 2.0 world. His photo-sharing site, Fotki.com, is profitable and continues to grow, despite taking no venture capital, and even as "thousands" of competing sites have come and gone.]

"If A is a success, then A equals x plus y plus z where work is x; y is play; and z is keeping your mouth shut." (Albert Einstein)

For several years, I've been watching numerous new media sites woosh from a proof of concept cradle right into the shining VC term-sheet wrapper. My first reaction was "they (the investors and the investees) know something mysterious that I don't." But seeing most of these well-funded companies stall and struggle, even as my own (not funded) company thrives, makes people like me write pieces like this one.

That may sound haughty, but here are some humble Musings 2.0. I'm running a profitable, independent digital media site outgrowing numerous well-heeled competitors. No claims of esoteric wisdom are made herein but it seems to me that if one is to apply these as a measuring stick, one will easily see the reasons for a specific company's success/failure.

No silver bullets. But here are some golden rules…

1. Work: get customers by resolving real pains, listen to them, create what they really want/enjoy, more importantly - co-create with them, address technological issues of scalable growth, build multiple revenue streams, greedily capture the key distribution channels by being valuable to the channels, incentivize, put low cost at the foundation of your growth and assure that growth brings business, not just eyeballs (that is, unless you are in a magnificent "real estate" business a la Youtube/Skype/Myspace).

2. Play: give customers real and compelling reasons to come back, and often, get their creativity going, make them enjoy (better: compete) expressing themselves, turn them into your best marketers by honestly serving them better than anyone and by passing as much value onto them as you can (or even more!), build viral growth mechanisms (and, no, incessant daily emails reminding your users to buy something are not a viral growth channel).

3. Shut up: If you really-really want to succeed for sure, then forget about everything else in life and concentrate on what you're building, that is, yes – on #1 (working) and #2 (playing). And, most importantly: never, under no circumstances, write ridiculous bombastic articles with titles like "Three Golden Rules"!

The truth is, nobody digging in the digital sandbox really knows what the golden rules of success in new media are (granted, those with the biggest shovels have better chances to dig out a Youtube, a Skype or a Paypal and to find/found a wonderful castle worth much more than the golden sand spent on and around it).

There are really no silver bullets as far as the success of an Internet start-up is concerned – what works magically for one situation fails in another, and those entrepreneurs/investors with most trophies on their fireplace mantles usually have more horror stories of their own to hide or tell than anybody else.

Watching the Seeds Grow Into Trees

by Brad Feld

I'm an early stage investor.  Very early.  Think "seed stage."  My favorite investments are in tiny teams of founders that I can get in a closet (e.g. one to four – a normal sized closet, not Amy's.) 

One of the seeds I planted in 2004 was NewsGator.  I met Greg Reinacker in the spring of 2004 via an introduction from one of the members of the Return Path leadership team who said "hey Brad - there's this RSS thing – it looks a little like email - you should check it out.  Oh by the way, there is this guy named Greg you should meet."

I sent Greg an email and we set up a meeting.  I spent some time poking around on the web before the meeting. I figured out that RSS was a protocol, a bunch of smart software guys had gotten into a huge war over it and a protocol called Atom, and it had something to do with the blog things that were popping up all over the place.  Other than that I didn't really get it.

In that first meeting, I spent two hours in a conference room with Greg.  The first thing I learned was that Greg was one of those rare software developers that is 100x better than virtually everyone else.  When you find a guy like Greg, you lock him in your basement, make him break up with his girlfriend, and don't let him out until you have a deal.  The second thing I learned was that RSS was a transformational protocol that has extremely broad implications. 

I often say that my analogy for RSS was SMTP.  SMTP is the protocol that begat email.  Email has been very, very, very good to me (and continues to be - witness the success of Postini and Return Path.)  SMTP:RSS as RSS:"something".  I didn't really know what the "something" was, but I knew it was something (brilliant, I know.)

We did the seed financing for NewsGator in May of 2004 and its growth has exceeded all of my expectations.  Yesterday, along with announcing a new version of the NewsGator Enterprise Server, they announced that they now have over 100 customers and 400,000 seats of its enterprise software licensed.  NewsGator now has well over a million people using some version of their software every day.  And yes – it's a real business – generating real revenue.

I've continued to plant plenty of seeds.  My garden of stuff around RSS and a theme I call the "Implicit Web" is growing nicely.  I continue to tend to it, remove weeds when necessarily, and fertilize regularly (I'll let you figure out how I do that.) 

Greg, JB, and the entire team at NewsGator – thanks for helping create a tree!  Now – let's work on the forest.  And Greg - sorry about that girlfriend thing.

Venture Capital in Canada: Ending the Silent Death Spiral?

by Suzanne Dingwall Williams

My clients are fed by angel and venture capital. I therefore care about how much financial food they have; it's a good economic indicator for whether or not I will be able to pay for both of my kids to get braces.

While there's been a VC famine here for several quarters, public discussion of the issue has been tepid at best. Thank goodness, some of our most prominent players are finally speaking out. In the last few weeks, Terry Matthews and Pat DiPietro have become the Bono and Angelina Jolie of the venture capital scene, using their celebrity to sound the alarm.

What's the nature of the crisis? Here's a sketch of what's being said:

Venture capital is fed by the limited partners ("LPs") who invest in VC funds. Historically, the pool of Canadian LPs who are attracted to high risk capital has been discrete. To bolster the industry(and the startup community), the Canadian government therefore has from time to time created vehicles such as labour sponsored funds to attract additional capital.

When there is an irrational market (1998-2000), the usual pool of LPs expands to include new players such as US LPs and institutional equity funds. The number of VCs and the amount of venture capital available to Canadian entrepreneurs skyrockets. When the market cools, those LPS retreat to later stage investing, leaving too many funds competing for fewer LPs. A consolidation of the number of venture capital investors results, until the next irrational market heats up the investing cycle all over again.

Which is where we find ourselves today. However, a growing number of people believe that this current retrenchment is not simply part of the venture capital cycle, but a death spiral for venture capital in Canada. They point to a few developments:
- LPs are now attracted by the more robust US market and are less interested in re-investing in Canadian VCs' next funds. Our best VCs are therefore finding themselves with little support for new funds for IT, software and telecom investments. This means there could be a 5-7 year gap in funding for those industries.

- US VCs continue to stay out of the Canadian market, in part because of Canadian tax rules that prevent US VCs from investing in a cost effective way. This is continuing at a time when the US VC industry is again overheating, thanks to the Web 2.0 bubble. There is a tremendous capital overhang south of the border, but Canada is not effectively accessing those extra dollars.

- There is no agreement on the right way for the government to support our own venture capital industry. At this point in the cycle, I would expect to see another legislative initiative to incent new LP activity. There are no signs of it. There is a concern that the government will instead legislate more seed investing programs of its own, which will compete with the few remaining VCs, instead of supporting them.

- There are not enough resources - tax incentives, support infrastructure,etc - to foster the development of startups into superstars.

These concerns aren't new, but the efforts to elevate discourse beyond the venture capital community are coming just in time. We may no longer be riding a market correction.

As a nation of entrepreneurs, we are failing to capitalize on the next cycle of investing currently being played out south of the border. The issue isn't going to get solved just by a small number of VCs rallying Industry Canada. It's a start, but it's also time for the investee side to the equation to join the discourse.

10x Revenues

by Fred Wilson

Companies don't really sell for multiples of revenue, but the math is easy so everyone does it.

I've read that Doubleclick sold for 10x their revenue of $300mm.

And that Right Media sold for 12x their annual revenue of $70mm.

Please correct me if I am wrong on these numbers as I am just relaying what I've heard and don't have access to the financials of privately held companies.

I believe that ultimately price needs to be factored as a function of EBITDA - earnings power. It could be the present value of future cash flows, it could be a mutiple of current EBITDA, it could even be a multiple of the cash flow that a buyer believes it can get by merging the asset into its business.

So when I see online advertising assets trading at north of 10x revenues, it makes me think that it's the latter factor at work.

I've heard that AOL monetized their acquistion of Advertising.com buy running all of their unsold inventory through Ad.com and that they got a tremendous return on investment from doing that.

So that may be the play for Yahoo! with the Right Media acquisition. And thus a multiple of current revenue or even cash flow is largely irrrelevant.

But even so, these are large numbers being paid and as a part owner of three online ad networks (TACODA, FeedBurner, and TargetSpot), I am thrilled to see these trades print.

Founder Employment Agreements: the Non-Compete

by Suzanne Dingwall Williams

One of my favourite clients is a founder who is a startup winner several times over. He is also one of the most aggressive executives I've encountered when it comes to negotiating the terms of his employment agreement. A big no for him is any clause that would prevent him from participating in any other business (as an advisor or otherwise) while employed by the startup. I once asked him why.

His rationale made sense. "Once I bring in a VC, I'm far more likely to be given a reduced role than to be outright fired," he reasoned. "That's fair. But I also need to plan ahead. If I'm not needed 150% of the time, I'm going to use my free time to jump start the next opportunity."

In his experience, this founder says, VCs are reluctant to let a founder go even after they've scaled the company and recruited professional management. "It's mostly an emotional thing for them. But even if I wait them out," this founder continues, "I'm not going to get enough runway to move the next project forward by taking the 4-6 months of severance I'm limited to." It takes 12 months or longer to incubate an idea into a good startup opportunity, he says. "So I need the flexibility to start exploring while I'm still with my current company."

To my surprise, I've seen him get this concession from VCs more than once. As long as he agrees not to compete or solicit employees. It's a good reminder that serial entrepreneurs and founders sometimes need - and are entitled to - accommodations that reflect their nature.