Thanks to the stronger Canadian currency, turns out the Globe and Mail’s Mathew Ingram bought both Google and TechMeme recently.
What on earth am I talking about? Read this: Mathew has taken over TechMeme and Google.
And relevant to this, I think this post gets the bod for Crazy Post of the Day, the images, arrows and comments are gold.
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WatchMojo NewsletterThe title of this post, Of VCs and Men, is a play on John Steinbeck’s book, Of Mice and Men.
For the record, it does not suggest that VCs are rats, au contraire, it implies that they’re caught in a rat race against one another to find the best entrepreneurs, products, companies and markets… and because of that, sometimes, some of them tend to act, well, less than gentleman-like.
Aim for the Sky
Some time ago, a number of prominent and smart fellas asked if business plans mattered? I recall one statement by VC Paul Kedrosky that was remarkably insightful, because it was coming from a VC and was candid.
After Twitter raised financing by Fred Wilson’s Union Square Ventures, Kedrosky observed:
VCs are professional nit-pickers. Give them something to find fault with, and they’ll do it with abandon. I generally tell people to come to pitch meetings with less information rather than more. Sure, you’ll get pressed for more, but finesse it. Presenting a full and detailed plan is, nine times out of ten, a path to a “No” — or at least more time-consuming than having said less.
Profits are a different issue. Being profitable too soon gives investors, rightly or wrongly, an idea of what the margins are on the business, as opposed to what they could be in some perfect world. As a result, it takes a mighty force for them to not start wading in with discounted present value worksheets, and the like, thus hammering your valuation and generally making funding much more complicated (and equity consuming) than if you were wildly unprofitable.
Revenue Go Home
A lot of people disagreed with that, some even said it was reminiscent of the 1999 mentality. Regardless, it’s not a wrong observation. Mayfield’s VC Raj Kapoor recently observed that valuations are tricky for companies that start to show revenue (let alone profits), because you go from being valued from a growth and user perspective alone to being valued as a function of revenues… and that means that your value falls, only to rise to the pre-revenue levels if revenues and growth maintains. I am paraphrasing, of course, because this is something he said at the recent Tech Crunch 40 shindig that Michael Arrington and Jason Calacanis put on in San Francisco. Either way, Kapoor is deadly accurate as well.
Enter the Fundinistas
This past week, Om Malik wrote something on fundinistas: companies that seem to be in the business of raising money, or in his words “the ones who raise venture capital relentlessly“: Brightcove, VideoEgg, etc., to name a few.
Just yesterday, Helio raised, what $200M? Helio generates revenue, in excess of $100M, but it does so at a very high cost, hence the capital injection.
Understanding Fundraising and Valuations
When you raise money, you have to give would-be investors a sense of how big your opportunity is, how big of a piece you will be able to carve out, and what kind of return that works out to the investor. But for the financier to become your investor, you have to agree on a valuation.
In my first screenplay (which I never produced because I started Mojo Supreme), I refer to the thorny discussions between VCs and entrepreneur on valuations as such (Michael and Marcel are two partners and entrepreneurs):
MICHAEL
Talking valuation with a VC is like talking money with a hooker. You know you have to at some point, but you prefer not to.
MARCEL
Come again.
MICHAEL
The difference is that with a hooker, you have to ask before the act because otherwise, you get in trouble with the pimp. But you have to ask because she will sleep with you anyway. It is your prerogative to turn her down after she tells you the price.
With VCs, the problem is that it is their prerogative to turn you down 9 times out of 10. If we ask them to talk valuation, we turn them off. Get it, we’re the whores… so let them bring this up.
Of course, we’re not really whores; the difference is that we don’t have any pimps to defend us, so we have even less leverage. By not talking valuation, you turn the table and gain some value, they have to bring it up, so in order not to offend us, they will probably offer us more… ideally anyway!
But the point is, sooner or later, you need to talk value. Otherwise, you tend to invest a lot of time to find out you are not on the same page, or worst yet, in the same universe.
In other words, investors need to have a fuzzy idea of what will the exit come in at. An exit can be a sale or an IPO.
The answer to that, my dear friend, will be based on your revenue, costs, profits, multiples, and comparable deals. But while all of the analysis in the world won’t do, is tell you how likely all of your assumptions are.
Valuation has a lot to do with recent deals, but it also has a lot to do with demand and supply: the two sides (company and investor) have to determine some kind of clearing price for the asset. Ultimately, it comes down to how much the investors want to give up for a given level of cash injection.
A Wide Array of Investors
In fact, this reminded me of comments made by Gorilla Nation Media’s co-founder Brian Fitzgerald after GNM raised a whopping $50M from private equity investors Great Hill Partners earlier this year.
Side note: Great Hill Partners invested in IGN, the company that bought my last company; and Brian and I have worked together in the past, so ’tis indeed a small world.
Anyway, referring to the nuance between VCs and Private Equity investors, he said:
Venture firms are usually early stage. Venture guys have a tendency to want to come in early, buy a lower valuation and swing for the fence. They make a lot of very small investments and they take more of a ‘carpet bomb’ approach. They’re going to drop $1.5 million into 40 different plays with the hope they’re going to grow these companies to a level where they’re going to come in for a second round or they’re going come back and bring in other VCs or PE groups. They’re looking for the YouTube hit, they’re looking for the MySpace hit. But at the end of the day, you look at their fund and there’s 17 losses and two hits, which make up for all the losses.
PE groups traditionally don’t operate that way; they’re much more methodical and they make bigger investments and fewer of them. They have to make sure that every one of those businesses is a hit. PE firms also tend to buy in at a higher, more favorable valuation because they’re only buying into businesses where they see a big exit opportunity.
They’re not looking at it like [VCs do], ‘I’m going to put $2 million in and we’re going to sell for $20 and I’ll make 10x.’ PE firms say, ‘I’m going to put $50 million-plus in and I’m going to sell for hundreds of millions and I’ll make a 3x – but that 3x is going to amount to a lot of money.
(my comments on that deal, original Paid Content story where I am taking this quote).
Not All Investors are Created Equally
Clearly, VCs and PE firms are at different ends of the spectrum, but they’re also increasingly clashing, too. And, with the number of billionaires at all time highs, angel investors are also clashing with VCs, too. And, if that were not enough, companies with high stock prices and heaps of cash are getting into the investment game, too. Facebook recently launched fbFund, and they are neither public (thus no stock currency) nor do they sit on boatloads of cash, yet.
The point is: yes, the investment community is not homogeneous, but it’s not all that different either.
What Fitzgerald’s comment alludes to is that it is very different to size up an opportunity in the seed, early, mid or late stage of a company’s growth, as he states: “PE firms also tend to buy in at a higher, more favorable valuation because they’re only buying into businesses where they see a big exit opportunity”.
Determining Your Future Earnings
This now brings us to Kedorsky’s comment, because younger firms that are growing quickly and need growth capital have to tell their story. And, like all large tales, that’s all it is, a story. Sure, there are always validations in that story, but ultimately, it boils down, like Sequoia’s Roelof Botha recently stated in a panel at TC40, to making sure the VC’s greed overtakes and outweighs his fear. Mr. Botha’s comment was equally candid and true.
The problem for a company’s management is simple. The typical dilemma is as follows: suppose, hypothetically of course, that I wanted to raise money. Should I:
- sell the VC on the fact that our revenues are boundaryless, as Kedrosky suggests? I could actually do that and not feel guilty, since our syndication network is on its way to giving us a reach approximating 99.9% of the Web… and our revenue thereof will be a function of that reach, revenue sites make, out cut of the revenue, and our library of content.
- project tangible revenues, but very bullish ones that even I know are not realistic, but would, as Botha says, get the VCs greed to outweigh his fear?
- be moderate and reasonable… with revenues that I could hit with one hand tied behind my back but risk doing what Kedrosky suggests we entrepreneurs should avoid.
- be conservative… with revenues that I could hit in my sleep after a late night partying binge but definitely run the risk, as Fitzgerald says, to turn off a VC because the return might not be 10x, but 5x only?
Here’s the thing, unlike many entrepreneurs, my background is neither in technology nor creative, it’s in sales! I know how to sell quite well… and have, so when I say “we’ll do X”, I know, in fact, that we can do 1.25X, if not more.
I’m not worried about finding revenue spots and opportunities. I’ve self-funded the company hitherto and while the working capital has come largely from underneath my mattress, it’s also come from actual sales, folks.
So that’s my dilemma.
Do I:
1- become what I criticize (fundinistas) and BS a would-be investor to raise money to the tilt and worry about what to do with it later?
2- remain honest, candid and realistic and come up with numbers that are very attainable but risk the VC balking at the opportunity?
3- remain very conservative so that the VC and I both look really good but then (I’d presume) definitely risk them losing interest…
Therein lies the VC route issue: VCs aim for the fence, more power to them.
But they’re lied to (maybe not on purpose) so much by eager entrepreneurs with little sales experience with numbers that don’t add up, so when they see realistic numbers, they discount those too and then see the opportunity as way too small.
What Would Hef Do?
This is indeed a damning dilemma. What would you do? Well, while you ponder what you would do, I can’t help but think back to one Hugh Hefner. I never read Playboy or anything, but I did work in a convenience store in my teens, so I became acquainted with all magazines. It was thus fitting, then, that at the age of 21 I began working at an online men’s magazine, with Hef’s Playboy being one of our indirect competitors.
While Playboy.com was the largest paid site, we grew ours into the largest free, ad-supported site. Anyway, in addition to being the VP of sales and company spokesperson, I was also a columnist and the resident interviewer. Naturally, as a lad mag, I always wanted to interview Mr. Hefner, but as a competitor, we were not fortunate enough to get one. Eventually, when Playboy celebrated its 50th year anniversary and the PR machine was turned on, I got a call back from Playboy’s publicist, and he granted my wish.
In that interview, I asked Hef many questions… but one statement he volunteered, out of the many sexier comments that stuck with me was the following: “When I was young, I was called Honest Hugh. Honesty and ethics are more important than being successful…”
It was odd, because that’s what I think, too. Hugh Hefner left Esquire in 1952 - after being denied a $5 raise - to start Playboy in 1953. By sticking to his guns and remaining honest and ethical, today Playboy boasts a stronger brand than Esquire, but, well, nudity would do that for a magazine, I presume.
Mind you, Hearst Publications is much larger than Playboy Enterprises, and I personally prefer Esquire, frankly, but that might be because whipping out a Playboy magazine in a plane is so not socially acceptable.
Anyway, I recall Hef’s career move quite well because he made the switch at the age of 27… that’s how old I was when I left my old online magazine employer to start Mojo Supreme (though of course, I got into online video, search, etc., and not a competitive magazine.
It’s Your Life…
Ultimately, when I reflect on the lessons offered by Messers Kedrosky, Fitzgerald, Botha and Hefner, I think the one thing that stands out is, indeed, to me anyway, “honesty and ethics are more important than being successful”, and I like to think I’ve accomplished a good level of success for my 29 years that it’s not like I am going to take a turn to the dark side now.
And, if that means that my decisions will make me live with the consequences, which include but are not limited to:
- living in a mansion in California,
- having a personal chef on call 24/7,
- dating not one but 7 women 1/4 of my age, and
- my main professional duties include selecting gorgeous women to photograph in the nude, mind you,
then that is something that I am willing to face.
PLAY
