Burn Rate During a Startup’s Early Stages


Burn-rateInvestors hope to see from the startup’s cash management during its early stages to be spartan and reasonable during its early stage operations. An investor would be anxious to see a startup burn through cash too quickly on high salaries or marginal furniture or equipment.  But recently, I noted an IoT software company that had burnt through $7 million in one year.  I asked directly the CEO how many employees he had, and he replied that he employed 28 members with its principal office located in Santa Monica.  That meant that the company’s early stage monthly operations cost about $650k, and given the number of employees, that seem to suggest very high salaries of about $200k per employee. The company was requesting another round of $15 million from the investing audience.  I calculated that this Series B funding would last less than 2 years given the burn rate  — not very long for a software company.  Any potential investor would be intimidated by the idea that his percentage holdings would quickly be reduced by additional investors in the short run when that Series B would be exhausted.

In another example, a Silicon Valley company founded by a young entrepreneur who, after receiving over $30 mill. In initial funding, rewarded himself with a Ferrari.  Mind you that the company had neither a product nor a website and its employees accepted generous stock options to balance their reduction on annual salaries (while its founder toured with his Ferrari).  The act was so controversial in the local newspapers that the founder returned the car, but of course, at a substantially reduced book value.  Another company’s founder decided to place the office in Beverly Hills, populate the office with espresso machines, games, etc.  And this company had neither a website nor a product as well.

Putting greens in an office (yes, I have witnessed that!); a Mercedes sitting in the parking lot for the Founder while he had recently laid off his 20 person team (And, yes, during Christmas!); leasing cars rather than using your own, etc.  These are a few examples revealed during due diligence that show a founding executive’s failure to manage investors’ capital during the early stages.

Even a Los Angeles fintech company, which presented at a May 2018 family office luncheon, raised recently $30 mill.  How did he celebrate?  The CEO decided to take about 20 member team to NYC to visit the NY Stock exchange. Let’s do the math: hotels, flights about $30k; lost management business development time about 1 week.  Fortunately, I didn’t buy into this company.  Even my informant, also located in Los Angeles, thought that this behavior was strange. It also means that the company will flounder once that capital evaporates. These are red flags foretelling poor cash management and oblique priorities.  All these companies did and/or will close their doors eventually.

The point to these examples is the underline the importance to conserve your Series A or F&F funding as much as possible – treat it like you will not get another round for a long time.  When I hear about early-stage companies buying expensive Aero chairs at $700 a pop, I saw them being auctioned off a year later by the bankruptcy court. In contrast, I recall that when my early stage company where I played the role of CLO/COO, the desks came from Home Depot were unfinished doors with saw horses supporting them, with cheap Ikea chairs.  And, as I related before in an earlier blog, out of 300 companies, this company survived and successfully filed an S-1. I believe that the cash conservative approach contributed to the company’s later success.

Early stage companies must exercise an impecunious lifestyle with whatever cash being spent on operations and marketing. Focus on business development and efficient operations. Delay paying off lawyers or accountants and reduce costs on marginal items. When I played the role of interim President of early-stage companies, I always attempted to cut expenses on furniture and rent without jeopardizing day-to-day operations.  In one instance, the landlord informed me that a former tenant abandoned chairs, desks, and conference tables, and I gladly took them – saving the company thousands.  In another company, we had an agreement with the Wall Street law firm to only pay 20% of the bills and the balance would be covered upon the IPO. So there are many angles to control expenditures without impacting quality.

That brings me back to the $7 mill. burn rate for a software company with 28 employees. I found that number rather high, given what I have seen in the past for companies with similar products and personnel.  We all review the burn rate in the context of personal experience, similar companies in specific industries.  Minor variances from 5% to 15% are acceptable.  But any variance over 100% is highly suspect.  Earlier recited statistics claim that early stage companies fail from lack of capital.  I counter by stating that the capital deficit failure lies in the founder’s inability to control expenditures.

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Regulations? What regulations?


suitcases

A recent Yahoo news announced the death knell of two startup companies:

“New airline rules regarding smart luggage claimed their second victim this week. Raden announced that it was shuttering after the largest American domestic carriers said they were imposing rules on battery-powered suitcases, disallowing those that contain non-removable batteries and forcing passengers to remove batteries from the rest before boarding. The rules are making smart luggage a major hassle for passengers and posing a serious challenge to manufacturers. Luggage-maker Bluesmart announced earlier this month that it was ceasing operations because of the restrictions.”

And just a few days earlier, I heard from the leadership of 2 other startups in very different industries where I felt that they did not consider the regulatory risks that would stop the growth of those startups like a truck hitting a stone wall. But the CEOs brushed off my comments as if immaterial.

The California lean startup methodology is very bare bones in comparison to fully developed business school textbook strategy.  But this lean approach ignores other factors that severely impact a business, most importantly the regulatory.  In the so-called smart luggage business lines, these companies did not consider the risks that the batteries would be banned by the airlines for safety reasons.  It is nice and convenient for a suitcase battery to be available to recharge electronics or provide some smart, intelligent service. Sounds simple and attractive. But batteries blow up.  And now the product will no longer be manufactured.

Young companies can make such mistake.  Bankruptcy would be the solution costing the initial investors’ capital. Older, more established companies cannot afford such errors.  In the case of Verizon, I reviewed many conversations among the senior managers relating to a backup battery required for the fiber optic lines in the home.  They discussed the potential risks of installing those batteries.  They searched exhaustively for means to mitigate those risks.  Fiber optic installations costs several thousands per home.  However, product liability risks originating from a defective battery would add to the capital expenditures.  Such a risk would not break Verizon but could cost billions in shareholder lawsuits, if litigation came up from damages or even mortality from fires. Airlines felt the same exposure.

Yet, I am frustrated listening to the pitches of startups ignoring critical, fundamental regulatory risks. These are material risks that can impact severely the valuation or simply place the company in receivership. In one week, I spotted 2 companies with huge regulatory issues that will shut down the companies. The most recent one dealt with a means to handle efficiently in a pareto optimal approach to deal with kilowatt distributions within smart grids.  The theory makes sense in a perfect world where there is one regulator, smart grids, and regulated renewable energy policies. Alas, the U.S. market is not that perfect. There are 51 public utility commission regulators throughout the U.S. Smart meters would have to be installed in homes and commercial districts.  In California, the PUC forced the utility companies to install such meters. Many states have a long way to go. I doubt that this startup company can meet milestones when the U.S. energy markets are balkanized and have not adopted new regulations to facilitate renewable energy markets.  A key component is the installation statewide of smart meters, without which one cannot measure input/output of kilowatt hours.

Another startup originates from Southern California with an online app to facilitate banking for the unbanked populations. Each transferor of funds would receive a fee for the services.  When I heard that from the CEO, my alarms went off.  Fees represent incomes.  The IRS requires that the intermediary companies report such income. But, since the app is targeted for the un-bankables, then there would be a reluctance to provide social security numbers for the target market customers who might not have any or prefer not to have any identification.  From personal observation, many Southern Californian Hispanics are not yet U.S. citizens.  And the intermediary involved in each transaction may face financial penalties for not complying.  First, the IRS will issue subpoenas. Second, the Service will demand records on every transaction.  Not a place to be.  But the founder CEO brushed that regulatory concern aside, stating that they had enough lawyers.  And every point of the transaction had been covered. Lawyers are dime a dozen, but good lawyers represent less than 3% of their numbers.  So his answer did not impress me.

Again, a simple thing —  a review of whatever regulation that could have a critical impact on the business. Such knowledge is gained through the efforts of due diligence.  Many lean startups ignore those issues, maybe from youthful hubris. Then they claim that the regulations don’t apply to them, the rules are outdated – Theranos attempted that futile approach.  And every time I hear the startup CEO claim the same refrain, I can fairly predict that the company will shutter its windows in due time.

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Cryptocurrencies, tokens, and securities


cryptocurrency

This week I heard the presentation by a former chairman of the SEC pointing out how ICO/token issuers can avoid the scrutiny of the enforcement division of the SEC.  And only 3 weeks ago, I sat in the audience listening to three early-stage companies promoting the sale of such cryptocurrencies in  a wide gamut of crypto-industries – a portfolio approach of acquiring various crypto-issuers to diversify risks; a non-profit company that supplies tents to NGOs that accepted token purchases; and, a third, where tokens are applied to only real estate investments. So I was all ears what this attorney had to say.

The former chairman pointed out 3 ingredients to avoid the SEC clutches.  The first was fairly obvious, that the transaction has to demonstrate no fraudulent indicia. The issuer should be transparent and clear. The second, similar to the first, is that the transaction does not originate from a money laundering scam. The third and final characteristic I personally thought humorous and ironic, that the ICO had been issued not as a money-making enterprise and the company has stated so to investors and the SEC!  Otherwise, the tokens and cryptocurrencies would be labeled as “securities” and should be registered as such.

I found the last point humorous since EVERY ICO/token issuer does so to raise capital.  Not to assume so would be ridiculous.  Each ICO/token must deliver an ROI to attract investors. The first presenting company solicited cash investments to invest in a token mutual fund with the assumption that, when bitcoin has skyrocketed, why not these tokens?  The second company had a strange proposal that would lead investors to believe that a nonprofit would generate tokens that can later be distributed in the marketplace and then increase in value!  And the third presenter seemed peculiar as investments in real estate tend to follow one criterium: location. Mortgages, furthermore, are not denominated in cryptocurrencies – cash is king.

So what kind of companies seek investors for their cryptocurrencies?  As I have observed, I identified two major categories.  The first are companies that are not able to raise one dime through Venture Capital or private financing.  I have encountered scores of such companies.  Many are run by imperfect management teams – strong on engineering, weak on marketing. Some have convoluted engineering schemes that have not shown any traction or even proof of concept.  Many of these companies sprang from Eurasia, hungry for capital.

And what cryptocurrency offers to software engineers?  A software code that generates a virtual currency in exchange for cash. Outside of the electric bill and some programming hours, a company can raise millions of dollars – real currency, and many have. Further, there is no loss to corporate governance, no international barriers.  Just a promise that the cryptocurrency will increase in value as if bitcoins. Interestingly, the former SEC chairman indicated that the SEC’s jurisdiction ends at the U.S. borders.  Any such foreign investments are high risk and cannot be afforded the protection by the SEC.

The other group falls into the “new, new thing” category, adopting a new trend or wave that supposedly attracts investors.  Bitcoin’s volatility priced bitcoin as high as $20k.  Everyone else confused bitcoins with other cryptocurrencies/tokens and assigned the prospects of high valuations for these other tokens.  Frankly, that was a fairly misplaced understanding of these digital currencies.  Hundreds of millions of dollars have been raised regardless.  And the SEC has issued scores of subpoenas in return.

Since these cryptocurrencies are not shares or stocks, the issuers relate that the biggest return and liquidity will be achieved through a public markets trading platforms.  For the common and preferred stock, it is the IPO. For the tokens, the public markets. However, stock valuations are held up by institutional investors.   I don’t foresee the same for tokens and ICOs. Note that Spotify’s direct listing clearly shows that sock values behave negatively when not supported by institutional investors.  There is considerable financial literature to bolster that argument.

Meanwhile, law firms are charging about $40k to$50k per company to help them design “legitimate” tokens and cryptocurrencies, although I struggle how these financial digital instruments are not securities. Other filings such as Regulation A can cost as much as $1 million.  Even though the former SEC Chairman claimed that the SEC needs to adapt to new technologies, I don’t think that the label of tokens/ cryptocurrencies would change the main characteristic that they still are securities – nothing different except the investors cannot have  access to financial records or dividends.

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How to make huge bucks as founders and early investors through an unprofitable, public company? Look at Spotify and the first IPO player at that game, Viatel.


 

 

Just this week, Spotify went public directly priced at $132 a share, even when, with revenues of US$5 bill., it sustained losses of $1.5 bill. One analyst even gave the buy target at $180 a share!  (At this writing, the stock was floating around $163 a share.)  When I spoke to a financial journalist friend, who did author an article of Spotify’s direct listing, I reminded him about another company with a similar financial profile of losses that yet went public, my old employer, Viatel.  Like Spotify, it went public even though suffering losses since Day 1, it also went public in a very heated tech IPO market.  And never did the company reach profitability until it filed for bankruptcy and was finally delisted.  Viatel, a company, whose public valuation was marked at U$2 bill. was sold at auction for $25 mill. First, let me go about discuss Viatel history and then address the similarity between that company and Spotify.

As a CxO of Viatel, I had access to all corporate and financial records of the telecom startup, Viatel.  I knew that the founder lent the Colorado company $250k, paid back by later funding rounds, and the founder’s father in law and the founder owned all outstanding shares. The company offered “call-back” international call services to foreigners attempting to call the U.S.   At that time, because of huge disparities of international regulatory markets, it was cheaper to call from the U.S. to Argentina, than vice versa.  So Viatel applied a software switching platform that allowed a foreigner to call the U.S. as if the caller was in the U.S.  Note that the differential margins were noticeable as long as the foreign carriers maintained international toll charges substantially higher than the U.S.

The other part of this equation is to note that Viatel had to purchase large volumes of international minutes at fixed prices from the U.S. established facility-based carriers such as AT&T, Verizon, MCI, and Sprint.  The key word is “facility based.”  Viatel was a reseller of minutes from these facility-based carriers.  Facility-based carriers had invested billions in a complex, engineering networks of submarine cables, radio towers, switches, and landlines. Therefore, these carriers can control their underlying costs, amortize the hardware, and manage the infrastructure with over 400k employees. (Note that Viatel personnel never amounted to several thousand throughout its short history.)

Not so for Viatel, as this reseller carrier can only control pricing to its retail customers, which it did by selling the minutes way below what it paid to the U.S. based carriers.  Why?  To underprice the foreign carriers such as Telecom Argentina, Viatel had to sign up customers with better than 20% price differentials. That led to a very high explosive growth of new customers month to month that attracted investors such as George Soros.  However, the model only works if investors are willing to finance more and more losses that paralleled the growth that allowed Viatel to standout from over 300 other competitors in the same callback space. In fact, the faster the company sold minutes, losses ballooned.  Meanwhile, the founder not only paid himself over $500k in salary but also sold his father in law’s and personal Viatel equity for millions prior to the IPO to other investors and made millions.  The founder stuffed his pockets richly from a company never making a profit from greedy investors.

This profit loss model seemed even peculiar to others outside of the U.S. Once I had been registering Viatel in Argentina where I had been required to provide proformas for the last three years.  The regulator called me and asked me how this company was still operating with these bleeding losses.  What could I say?  That Soros, Goldman Sachs, Comsat and others kept throwing millions to this loss leader to later exit through an IPO?

So, let’s accelerate the Viatel history after the IPO.  Wall Street was not so forgiving after several quarters, so the Street canned the Founder.  (As a side note, the Founder was an extreme braggadocio in the same vein as Donald Trump.  When I first met him, he claimed to have a successful real estate company and then later, founded a company with a “cure for AIDs”.  I was skeptical of both since I witnessed lawsuits from his real estate partners for misappropriation of funds, and I had not seen NIH announced any cure for AIDs at that time. Now he was a telecom “visionary.”) The reason behind this antecedent discussion was that he would hire senior staffing with little or no background in the telecom industry.  His de facto replacement at Viatel was an IT guy with zero telecom experience after the IPO.

But now this new management team of a publicly traded company became desperate.  The founder and early round investors walked away with hundreds of millions. The last guys in the musical Wall Street chairs faced a dilemma: The so-called disparity margins in international calls reached increasingly asymptote to zero between each country’s international call tolls as all carriers worldwide reduced their international toll calls to market prices.  As a non-facility-based carrier, Viatel had limited options on controlling its cost structures.  Their solution?

Viatel had only one card left: become a facility-based carrier.  Now we have a “team” with zero telecom experience while not knowing what it takes to get there.  A trans-Atlantic submarine cable costs half a billion to build and $50k a month to maintain it.  And we are not even discussing “last mile” solutions to bring a call to someone’s phone.  In Paris, it costs about $1 million just to dig a street for every kilometer. Verizon has over 240k employees staffed with thousands of engineers.  Viatel, on the other hand, was populated by telecom wannabees swimming underwater.  In other words, Viatel’s team was incapable of managing and building a telecom network.

Yet, Wall Street gave it another chance with half a billion dollars of debt to build infrastructure and, indeed, Viatel contracted the construction company, Bechtel, to build “Circe” a land European based fiber ring. That ring finally brought the whole Viatel company down—yes, facility-based infrastructure is important but includes many components – last mile solutions, grids, international cable, long distance cable, wireless towers, etc.  Partial infrastructure solution was not enough, and the company failed to satisfy investors and lenders and closed its doors after 2 years as a public company.  All throughout its existence, Viatel never reached profitability.  Its “team” led the company to its downfall and billions of dollars were lost to banks and institutional investors. Sill, the early stage investors and Founder made a killing.

So why do I give the sobriquet Spotify, Viatel II, to my writer friend?  First, like my earlier blogs, I refer to check off the 5 T’s when evaluating tech companies.  Here, the Spotify founders are programmers entering the music business. Unlike Napster, it demonstrated that their model would compensate the content providers, AKA, the music industry, the labels, musicians, producers, with a streaming model.  Note that the former Spotify board member, Sean Parker, was a Napster co-founder, who made his $2 bill. fortune not as Napster founder but as a Facebook President.   Napster had similar legal controversies as Viatel, in that it was charged for illegal services. (In the U.S., Viatel was charged for providing international telecom services without an FCC license.  The case was litigated under my supervision and Viatel did win.  Napster did not.  To allow users to listen to music without paying royalties to the music industry became illegal.)

To software programmers, the world is populated by simple coding consisting of grammar and syntax. Beyond those software instructions, the rest of the world is irrelevant. What do the Spotify founders know about the music industry?  Do they know the inner workings of Sony, Warner Brothers, or Columbia records?  Like the telecom industry, the music industry is sui generis – its overall management and development of talent has decades of experience and hundreds of thousands of staffing to support and fostering musical talent.   But not Spotify.

One interesting Spotify team member, its CFO, came from Netflix, another streaming enterprise. Netflix, like Viatel, just redistributed DVDs in the mail-order business and then moved on to streaming.  But streaming someone else’s content has its limitation – one must pay royalties.  Solution: create or finance your own content and create a more profitable portfolio of content.  Then, of course, you are competing directly against Paramount, F/X, Hollywood. And the Netflix business development team must reflect that. That is the Netflix solution for improving its margins.

Besides reviewing the Spotify team, one must look at the initial investors.  Prior to the IPO, Spotify had only 74 investors ranging from Goldman Sachs to Lakeview to Sean Parker. In other words, at the time of the IPO, these investors split over $20 billion of valuation. That is so like Viatel where few can liquidate their holdings from an unprofitable company in the short run.

And Spotify’s runway for initial investors to sell its stock holdings was extremely short through the direct listing.  My theory behind Spotify’s reluctance to go public with underwriters comes from the fact that pre-IPO shareholders can sell their stock from day 1 without incurring the SEC sanctions to hold off selling holdings for at least one quarter under the standard IPO rules.   Spotify claimed that they would save millions by not using underwriters. And truly, that is what happened:  Sony sold off quickly about 17% of its holdings within a few days.  The founders made a “Viatel-like” killing.  (By the way, this approach resonates another Viatel like P.R. excuse.  When E&Y moved its due diligence from Viatel to its Founder prior to the IPO, the Founder announced that he was moving the Viatel headquarters from NYC to Madrid, claiming it was the “center” of European telecom, although all submarine cables land in the U.K.  The true story was that the Founder had never paid U.S. taxes and Spain has no extradition treaty with the U.S. Another P.R. falsehood.)

Now, like Viatel, Wall Street will only provide a short tether of a few quarters for Spotify to reach profitability.  And now it faces several challenges.  Can it compete with infrastructure?  The telecom equivalent in IT is handling data centers. Amazon and Google/YouTube – both already streaming content – own and operate many data centers costing about $60 million each, in the U.S. and internationally. Like Viatel’s Circe, Spotify would have to invest considerable capex to improve that part of its profit margins.  Then it would have to convert its management team from software programmers to hardware guys – a major managerial stretch, just like Viatel.

Then there is the Netflix route – create content. That would mean moving corporate operations from Lichtenstein (not Sweden, since it is incorporated in Lichtenstein!) to Los Angeles – the mecca for the music industry.  That would be a major challenge for any company.  For a company that infringed copyright owners, now it must abide by them.

Another Viatel approach is to expand internationally, another mistake learned too late by Viatel through Circe.  Spotify could consider China and India, containing 30% of the World’s population.  But it should heed the lesson learned by Uber rather expensively that incumbents founded and managed by locals will defeat any new entrant.  Uber spent over $2 billion of investors’ money to attempt to dislodge competitors if its “technology” was somewhat superior. That dog did not hunt.  Nor will it for Spotify when both China and India already operate with Spotify-like companies.

How about hardware add-ons being promoted by Spotify?  Remember the Spotify team?  A bunch of software guys.  Wait, does not Apple manufacture hardware for decades?  Wait, does not Apple also distribute musical content?  But, wait, does not Apple hold innumerable patents in its hardware industry? That strategic route does not bode well for Spotify.

Had Spotify been making a profit prior to its IPO, I never would have considered Viatel being analogous to Spotify. It took Wall Street a couple of years post-IPO and continuous Viatel financial losses to take away the keys from Viatel.  How long will Spotify reach that barrier?

 

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Does Technology alone make a Company?


pexels-photo-257736.jpeg

While conversing with a VC analyst, she claimed that she had a team of 21 Ph.D.s to evaluate the merits of a technology. She seemed impressed but critical of their evaluations since they were extremely conservative.  I thought that a heavy reliance on their opinion should not be the right strategy to evaluate a startup’s business plan.  For starters, there are so many technologies within many industries that even 21 doctorates could not possibly cover every underlying technology.  That would be my first concern.

I did remark that technology is one component in evaluating a startup’s business plan. In my simplified format, I describe 5 “T”s, with technology being one T of the evaluation or 20% of the total picture.  The other Ts –Ten-fold, Team, Traction, and Terms – should be incorporated with equal weight. (Note that I discuss these terms in earlier blogs.)  One can allocate points to each criterium and then used a minimum scale to establish a screening process.  In other words, those startups that score over 75 points would be screened further.

I, of course, apply a more rigorous analysis that includes the multiple bullet points in defining “strategy” when closer introspection is demanded. When one views the details, then one can finally make some intelligent decision.  The “technology” is a factor but not the final determining factor in assessing the value of the startup.

Going back to my introduction, one can then realize that a heavy reliance on 21 Ph.D.s might sound impressive at first. But when compared to the other factors, it plays a smaller role. Let’s play some scenarios.

In Silicon Valley, I once interviewed a Ph.D. holding over 50 patents.  His problem?  As an academic, he had never managed a business.   The words, marketing, and finance have not been part of his lexicon.  His technology might be interesting, but to market, technology is another skill set. I remind many people that the best Silicon Valley company, Apple, had been run by a college dropout, Steve Jobs, who had a keen sense of marketing. Wozniak offered the technology but, without marketing and Jobs, there never would have been “Apple”.  In fact, I observed the terrible obsession with patents throughout Silicon Valley.  One such SV company, Theranos, raised over $800 mill. on such IP claims.  What that fiasco – the founders were indicted for fraud — proves is that patents do not mean that the actual patents do work.  Patents alone do no create companies.  Other factors do.

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Year 2017, Conferences, and the Competitive Environment


 

Badges

 

 

When sorting through the many badges from 2017 conferences and meetings I attended (and I have had just as many temp office passes as stickers not in this lot), I suddenly became aware how much time I invest to listen from experts in disparate fields from biotech to cybersecurity.  Or the many startup presentations that are soliciting funds. Yet, I don’t regret those many hours.  It is impossible to learn new and exciting trends by just going through websites or Googling.

 

 

 

Conferences, meetups, and exhibits present a broader perspective on trends.  And these events and meetings provide a lot of information in the competitive environment and hints to new technologies.  So this custom to attend the many conferences and meetings applies to potential investors and entrepreneurs. Even Steven Jobs drew his inspiration from such visits, including the Xerox PARC development of the computer mouse.

 

As the new year begins, I am noting the explosive proliferation of conferences on ICOs and cryptocurrencies.  Is this a bubble or the beginning of a new trend? I have witnessed portfolio approaches to these instruments, either investing the instruments or the companies.  I look forward to seeing what interests me the most.

VC firms sift through hundreds of business plans, sometimes exceeding 1,000.  Out of that many views, VCs only invest in a handful, about 6 or so.  It is a difficult process.  In contrast, the entrepreneur believes he/she is terribly unique – no competition.  That is far from the truth.

 

Just recently, I asked the co-founder of another company in his space – combining e-commerce and blockchain.  I was very familiar with the other player, and know directly the CEO.  That company has raised hundreds of millions, pieced together different acquisitions, to supply predictive information on the clients’ consumers.  Maybe I spend so much time on the many conferences that make me aware of the other companies out there.  But I also assume that the entrepreneur should be setting the same example of competitive analysis – a major component of drafting business strategy.  Maybe this startup might survive or succeed. Not knowing the potential opponents makes that less possible.

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The Pink Elephant in a Fund Raising Presentation


pink elephantsWhile reviewing the presentation from a U.S. company raising a Series B or C financing, I quickly jumped into the team description and spotted a mistake in the academic credentials of one member of the executive team – it stated that the team member acquired a J.D. (or law degree) from the very same college I attended. I identified this error since my alma mater, the last time I checked, does not grant law degrees, just B.A.’s (with some smaller population of M.A. degrees).

In earlier blogs, I do state that the average investor looks for mistakes. If the startup is looking for any funding, the startup team must review its materials no different from a company filing an S-1 registration. Any mistake, however small, in an S-1 registration could represent expensive, potential shareholder lawsuits.  Why?  Any potential shareholder would conclude that the company misrepresents its critical information to attract funding.  And, in the startup environment, the same sensibility arises from a potential investor.

I don’t see that any different from the level of detail should apply to even startup companies seeking capital.

What would be my initial concern? First, that the name of the team member was simply a “name,” inserted into the team package, who is not truly managing the day to day operations of the company. That individual never bothered to check his background C.V. in this investment package. And, if that is true, what about the other team members? And there is the possibility that the team member is not even aware of the insertion of his name within the investment package.

Another way to look at this mindset comes from a friend, who did considerable due diligence on early-stage investments in Moscow and his comments to me on his experience there.  He related to me that whenever a person visits his Moscow office for an interview for a potential investment, he can claim that he works at a company that may or may not exist, or has a position in a company that may or may not exist, and provides a name that may or may not exist. Again, as I have related before, fundraising is all about credibility.

The banker who invited me remarked that the error was corrected, but how will I forget a presentation that includes a “pink elephant”?

Another mistake or misrepresentation originated from an Indian e-commerce company seeking an expansion round of capital. One slide contained the logos of several well-known U.S. companies like Fedex, claiming a list of clients.  During the conference call with the CEO, I asked whether Fedex and other brand name companies were actual clients. (I became suspicious since its revenues did not reflect that customer base.) The CEO admitted that they were not clients.  I demanded that he remove those logos.

And I recalled my legal work with S-1 registrations on my responsibility to make sure that the information contained in the S-1 was true and correct.  My concern is the possible legal headache of shareholder lawsuits originating from any kind of misrepresentation.  In this case of this e-commerce company, any sophisticated investor can identify these errata. And then he/she would pass on the deal.

Whether the startup company is seeking $500k or $5 million.  The accuracy and veracity of the presentation materials do matter.  I have encountered companies facing frustrating months of reaching out to investors without looking into their own presentations.  One Silicon Valley company reached to over 80 VC firms with faulty materials in its analysis of market shares and growth potentials.  I asked the founder, did anyone reply?  He said “no”.  Now he wasted considerable time and resources that would have been better off by vetting the accuracy of the presentation materials.  He returned to work again for Apple.

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