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I was in the bathroom this morning catching up on all the blogs (via Feedly) that I hadn’t read this week since my head was in a bunch of other things. I came across one from Nic Brisbourne (Forward Partners) titled I’m a stock picker. I wish he had called it “This Unicorn Thing Is Bullshit For Early Stage Investing” but I think he’s a little more restrained than I am.
My original title for this post was “How Can This Be A Billion Dollar Company and other bullshit VCs ask early stage companies.” It was asked by VCs to several companies I’m involved in last week. While I get why a late stage investor would ask the question when the valuation is in the $250 million range, I really don’t understand why a seed investor would ask this question when the valuation is in the $5m range.
Now, I’ve invested in a few unicorns in my investing career, including at least one unicorn that went bankrupt a few years later (I guess that’s a dead unicorn.) But I’ve also invested in a number of companies that have had exits between $100m and $1b that resulted in much larger returns for me, both on an absolute basis as well as a relative basis, than unicorns have for their later stage investors.
I’ve never, ever felt like the “billion dollar” aspiration, which we are now all calling “unicorn”, made any sense as the financial goal of the company. Nor have I felt it made sense as a VC investing strategy, especially for early stage investors. We never use the phrase “unicorn” in our language at Foundry Group and while we aspire to have extraordinarily valuable companies, we never approach it from the perspective of “could this be a billion dollar company” when we first invest.
Instead, we focus on whether or not we think we can make at least 10 times our money on our investment. Our view of a strong success in an investment in a 10x return. Our view is simple – we don’t really view anything below 3x return a success. Sure – it’s nice, but that wasn’t a real success. 5x – now that’s nice. 10x – ok – now we are in the success zone. 25x – superb. 50x or more – awesomeness.
We also know that when we invest in three people and an MVP, we have absolutely no idea whether this can be a billion dollar company. Nor do we care – we are much more focused on the product and the founders. Do we think they are amazing and deeply obsessed with their product? Do we understand their vision? Do we have affinity for the product? Do we believe that a real business can be created and we can get at least a 10x return on our investment at this entry point?
I recognize other VCs have different strategies than us, especially when they are investing at a later stage. Applying our model, if the entry point valuation is $100m or more, then you do have to believe that the company is going to be able to be worth over $1 billion if you use a 10x filter. But in my experience, most later stage investors are focused on a smaller absolute return as a threshold – usually in the 3x to 5x range. And, very late stage / pre-IPO investors already investing in companies worth over $1 billion are interested in an even smaller absolute return, often being delighted with 2x in a relatively short period of time.
So, let’s zone this in on an early stage discussion. Should the question “how can this be a $1 billion company” be a useful to question at the seed stage? I don’t think so. If it’s simply being used to elicit a response and understand what the entrepreneurs’ aspiration is, that’s fine. But if I asked this question and an entrepreneur responded with “I have no fucking idea – but I’m going to do everything I know how to do to figure it out” I’d be delighted with that response.
Did you know Twitter is going public? Of course you did – it’s all the mainstream media could seem to write about last week after the now infamous twitter tweet about it.
We’ve confidentially submitted an S-1 to the SEC for a planned IPO. This Tweet does not constitute an offer of any securities for sale.
— Twitter (@twitter) September 12, 2013
After all the speculation about valuation, who owns what, what it’ll price at, how much money will be made, is Twitter growing or shrinking, what is a tweet after all, will their stock symbol be TWIT?, and all the other nonsense that seemed to consume the business press, I noticed a perplexing thread from some people expressing how indignant they are they Twitter is going public in secret.
I watched it play out and tried to understand what people were reacting to. Eventually, I realized it was two things. The first is a misinterpretation of the JOBS Act and what a confidential S-1 filing actually is. Somehow there was the view that there wouldn’t be the normal public disclosure prior to Twitter going public, which is just incorrect. The second was some weird reaction to Twitter suddenly being “secretive” and a view that this was in fundamental philosophical conflict with what Twitter is.
After four days of chatter about this, Dan Primack wrote the first definitive article I saw that made sense of all of this titled Twitter’s IPO will not be done in secret. As is typically the case, Dan wrote a super clear and fact based article about what was going on with the confidential filing, how it would work, and why – in Dan’s words – “Twitter’s decision to file confidentially is neither bad nor good. It’s largely irrelevant.”
I won’t repeat Dan’s awesome article – go read it if this topic interests you.
Having been involved in numerous IPOs, I can tell you that the JOBS Act confidential filing process is a great thing and improves the overall process of taking a company public. Anyone who has been through taking a company public knows that there are numerous steps between the first S-1 filing with the SEC and the final filling where the SEC says “ok – you are ready to go public now.” This process is almost never smooth, is unpredictable in terms of timing, and often ends up being an bizarre and byzantine interactions between the SEC, accountants, lawyers, investment bankers, and management team members who scratch their heads and realize that the process isn’t really making anything any clearer, it’s just racking up massive fees for the lawyers and accountants.
The end result is a fully vetted S-1 filing. When a company has this cleared by the SEC, it is ready to go public. Prior to the JOBS Act, you made your first filing before any feedback from the SEC and then spent the next three to six months wrestling with the SEC – on their time frame and their rules – to get the filing finalized. If you didn’t time it right, you’d have to do new financial disclosure. If the SEC was slow because they had a backlog, it would take longer. If the SEC didn’t agree with your auditors on revenue recognition, you’d end up in a crazy escalating set of discussions. And – each amendment to the S-1 (basically a new filing) was done in public, so everyone – including your competitors – got to see everything that was going on. And dissect it. And criticize it. And analyze it. And act on it. And say anything they wanted about it.
During this time, you were in a “quiet period” so you couldn’t say anything in response. Your competitors attack you based on data in your S-1 filing through a plant in an article in the WSJ – nope, you can’t say anything. The NY Times writes a long article and misinterprets a bunch of the data – nope – silence. A blogger tears you apart for something buried on p.123 of the S-1 which ends up getting changed in a future filing anyway – nope silence.
Or worse – for some reason the IPO window closes and you don’t go public. You withdraw your filing. But the public data is still out there for everyone – especially your competitors and customers to see. Oops.
Under the new rules you do all of this work to get to a final filing in confidence. You make it public three weeks before you go on the roadshow. You make all the documents public, but the only one that really matters is the final one. The sausage got made in private and now you are ready to go public. All the expected articles come out. Everyone dissects all the data. But you are ready for this since you are now ready to go public.
I’m glad Twitter used the new confidential filing process. We’ve already used it for companies in our portfolio, and will continue to. In a few years, the process of taking a new company public will be much cleaner as a result. And while there will always be a huge amount of noise around the process, especially for high profile companies like Twitter, at least there will be a clearly defined timeframe for all the pre-IPO noise.
For all of you out there who are wondering, Amy is doing fine. We’re in Boulder, she’s happy, in some pain, but enjoying the delightful impact of Percocet, and making her way through MI-5 Season 8. Thanks for all of the support, emails, and kind words.
I’m about to head out for a five hour run (broken into three separate segments) in preparation for the 50 miler I’m doing in April after I help her take a shower (which ordinarily I would be excited about), but first I thought I’d write some thoughts about a call I had with an entrepreneur yesterday.
The call was about a potential financing he is considering. I’ve gotten to know him some from a distance over the past year and am impressed with what he’s created. He originally just called me for advice on his financing strategy but I started the call by telling him I was interested in exploring leading a round, would be willing to give him advice also, and would quickly tell him if I was dropping out so he could flip me into “advice only mode” if we weren’t going to end up being a potential investor.
We had a wide ranging conversation over an hour about the current state of the business and how he’s thinking about the financing. Several times over the course of the hour he sounded defensive about a particular issue – well – not defensive, but uncertain. He’d frame what he thought was a negative in the context of the way he’d heard it from a previous potential investor (let’s call them BucketHead Ventures) who hadn’t gotten to a deal with the company in the past.
One of these was around churn – he asserted that one of the clear weaknesses of the business was the high churn rate. I pressed him on what he meant and we went through some numbers. He didn’t have a high churn rate at all – in fact, his churn rate after a customer was paying for three months was minimal. The problem – described by BucketHead Ventures as “high churn” – was a combination of what happened in the first three months and BucketHead’s inability to do cohort analysis, so BucketHead looked at absolute churn on a monthly basis rather than on a cohort basis.
In my head, I thought to myself “bucketheads – they pretend to understand businesses like this but have a total miss at a basic level.” The entrepreneur understood the miss, but had internalized BucketHead Ventures feedback and was letting it color his view of his business. And, more importantly, it was making him gunshy. Instead of articulating a powerful story about low customer acquisition costs with minimal downstream churn, he lead with “the worst problem with the business is our high churn rate.”
I see this all the time. While some entrepreneurs think all VCs are bucketheads (they aren’t), other entrepreneurs think all VCs understand this stuff (they don’t). Even ones who seem to be experts, or should be experts, or claim to be experts. Especially the ones who claim to be experts. Often, they are just bucketheads. Listen to their feedback, but don’t let it make you gunshy if you think they are wrong.
I’ve always had mixed feelings about the importance of a company announcing a financing in the absence of any other activity. “Dear World: We Just Raised $X From Investors A, B, and C.” Ok, but so what?
In my book, there is only one real reason for this – to attract new potential employees: “We’ve just raised $X and are hiring 20 people including types A through types Q – see our jobs page at jobs.companyname.com and apply now.”
Unfortunately, very few funding announcements are focused on this for two reasons. The first is the stupid one – many entrepreneurs get tangled up in the ego dynamics of a financing (“look ma – we raised money’) and lose sight of the notion that raising money is just one tiny step on the path to success. In my book, once you’ve completed a financing, take a deep breath, tell everyone in the company so they know how much money is in the bank, and then get back to work creating amazing things for your customers.
The second is less stupid, but is something I see over and over again, even with companies we are investors in (and we know better). When you do a financing, you file something called a Form D with the SEC. This process is fully automated which means it is easy for our friends like Dan Primack at Fortune to see any new filings that are made. Dan was one of the first people I knew who regularly published Form D info – it’s now spread widely across most of the VC-based publications, but I’ve give Dan credit for being the most diligent with this (and with many other things he reports on.)
Once you’ve filed your Form D, the data is available on Edgar with a simple search. There are other ways to get it as well since there are plenty of services that republish Edgar data with a better UI for searching. Regardless, the info on Form D is out there on the web.
Some VCs I know claim that you don’t have to file a Form D. Having researched this, I think it’s a dumb move. Most credible attorneys that work with corporate securities, especially those in the VC industry, will insist that you file a Form D if you have more than one investor, or if you have investors in more than one state. In our world, we just tell companies we invest in to file it and not worry about it.
This takes us back to the beginning of the post. For some reason, some companies want to keep their financings quiet. That’s fine – just file your Form D and say nothing about it. It’ll get picked up in the daily VC publications, like Term Sheet and VentureWire. Maybe it’ll end up on TechCrunch if you’ve got some famous investors that they like to write about. And, if your local paper is on the ball, it’ll show up there also. But it’s meaningless – “Joe’s Company Raised $X From Investors A, B, and C according to a filing with the SEC.” Next.
But if you are going to announce your financing, do it right – in conjunction with your Form D filing. Have your jobs page up. Make it clear that you are hiring. If you have substantive stuff to announce around the financing, say an acquisition, a major strategic partnership, or a new product release, announce it at the same time. Substance matters here – the more the better.
Make your noise for a day – and then get back to work creating amazing things for your customers.
My friend Paul Kedrosky – who spends some of his time as a Senior Fellow at the Kauffman Foundation – has a thoughtful short video (as part of the Kauffman Sketchbook series) on where entrepreneurs get their money. While it’s easy to get confused and think that VCs are the center of the financing universe, Paul reminds us that most entrepreneurial companies are funded by the entrepreneur’s savings, cash flow, credit cards, friends, and family.
It’s a creative three minute video with plenty of meat to it.