Many years ago, I enjoyed one of Guy Kawasaki’s first books, “Reality Check: The Irreverent Guide to Outsmarting, Outmanaging, and Outmarketing Your Competition.” In his classical humorous and cynical style, he could reset your dreaming in a moment. Here is a sampling of ten themes from the book that I think are just as relevant today as they were then:

1. The reality of starting. It’s not going to get better – it already is. Startup folks are like medieval monasteries: always convinced that paradise is just ahead or that things only recently got worse.
2. The reality of raising money. The closest real-world analogy to raising money is speed dating. That’s right: In five minutes, people decide if they are interested in you, just as in bars and nightclubs. This isn’t right, and it isn’t fair, but it is reality.
3. The reality of planning and executing. If you think raising money was the hard part, you’re in for a surprise. Raising money is easy and fun. The real work begins when you have to deliver the results you promised.
4. The reality of innovating. Many people think that innovation is easy: You sit around with your buddies and magical ideas pop into your head. Or your customers tell you what they need. Dream on. Innovation is a hard, messy process with no shortcuts.
5. The reality of marketing. Everybody wants to do the fun stuff: shuck and jive with the beautiful people, and create fun marketing campaigns. More accurately, marketing is the process of convincing people that they need your product. That’s not so easy or fun.
6. The reality of communicating. Entrepreneurship is an outward-focused activity. It requires that you communicate with others in all the modern modes. Every one is a skill you need to master. All it takes is reading this book and practicing for twenty years.
7. The reality of competing. If you don’t compete with anybody for very long, it may mean that you’re trying to serve a market that doesn’t exist. The question of defensibility is one of the toughest for an entrepreneur to answer. A good answer is not to stop moving.
8. The reality of hiring and firing. These are black arts for most people. Few people are trained for either, and most depend on their gut. They believe they won’t make hiring mistakes, so will never have to fire anyone. Wrong; and mistakes hurt people and you.
9. The reality of working. In the beginning, startups are like a clean sheet of paper: nothing but opportunity and upside with a chance to make meaning and change the world. Then the reality of work sets in. Building a success is hard – damn hard, actually.
10. The reality of doing good. At the end of one’s life, you are measured not by how much money you made, but by how much you’ve made the world a better place. Successful entrepreneurs often switch to non-profits and social entrepreneurship for real impact.

Of course, there is much more, but I think you get the idea. I also hope these themes don’t send a totally negative message, because the book is funny as well as thought provoking. I do believe we all need reality checks to face our challenges head-on, so that we can deal with them and survive, rather than just float along in the clouds until our dreams evaporate.

This post originally appeared on Startup Professionals Musings

The series started here if you want to read from the start.

Or the Cliff Note’s version:

• Open Source & Cloud Computing (led by Amazon) drove down tech startup costs by 90%
• The result was a massive increase in startups & a whole group of new funding sources: both angels & “micro VCs”
• With more competition in early-stage many VCs are investing smaller amounts at earlier stages. Some are going later stage to not miss out on hot deals. I call this “stage drift.”
• The opportunities for tech startups today are more immense than they’ve ever been with billions of people now connected to the Internet nearly all the time.

But …

Downsizing Venture Capital
The venture capital business itself is going through an even more fundamental change than just the entry of a new category at the earliest stage. The industry is shrinking back to a mid-90?s level in terms of both dollars and numbers of firms.

The doubling of the industry size was caused by the euphoria of the dot-com bubble and since funds take 10 years or more to dissolve the bursting of the funding bubble has taken its time. We all know the result of the over-funding of the asset class – poor returns in aggregate for the industry. The best firms have still delivered results, though.

So what’s happening now is the elimination of funds that probably should never existed as well as the questioned relevance of some older firms that failed to find good succession strategies or remain relevant.

That’s certainly good for our industry in terms of future returns for investors but I would argue also for entrepreneurs. In the last 90?s it was impossible to charge fair prices for products & services in a market where you had 5 competitors giving away free products to acquire “eyeballs” and fueled by an excess of venture capital.

A normalization of the venture capital market will bring more rational valuations over time but should produce more stable companies and better returns for VCs and LPs. It doesn’t feel like that now because we’ve entered a mini bubble in pre IPO valuations for a segment of the tech market but this, too, shall pass.

The Coming Brick Wall
What I’ve started to observe is that we’re certainly headed for a bit of a brick wall for early-stage companies. The explosion in number of startups coupled with the decrease in numbers & dollars of VCs portends this.

As an industry this is probably OK. Creative destruction is what drives capitalism and innovation. Some startups won’t make the cut but those founders will have developed invaluable skills and will join the ranks of the survivors. I’m proud to see this creative destruction happening more prevalently in the US right now because it gives me comfort that we haven’t lost our footing in terms of global innovation.

I would argue that the explosion in startups and the coming brick wall will continue to create compelling opportunities for venture capitalists. As an industry we have more startups feeding into the top end of our funnels from which to evaluate and choose the most prudent investments. The coming brick wall will ensure that valuations reach their natural limitations and return to normalcy. The coming brick wall will produce more second-time entrepreneurs whom we can fund that will bring real experience to the table in their next businesses.

I know that a brick wall is a rather nasty metaphor, but it’s not all bad. Like any market that overheats we will have the negative collateral damage but also the blossoming of the next wave of innovation and returns.

Borders, Normalization & The Continued Relevance of Venture Capital
My prediction for what comes beyond the brick wall?

• Continued high pace of startup innovation. The lower costs & lower barriers to entry support this. Also break-out companies like Rovio and NewToy that grew big without much capital will continue to encourage young entrepreneurs to try
• Increased reluctance of angel investors to fund any new hot team based solely on the “social proof” of who else invested. Brick wall = lost money for early-stage capital primarily concentrated on angels. I’ve been on-record here for a while.
• Return to focused strategy for investors where Micro VCs have a more established position in their market and traditional early-stage VCs become more comfortable waiting for products to be completed as FOMO (fear of missing out) subsides
• Hedge funds and growth equity firms returning to their traditional segments of the market

Basically, I believe that each market participant brings strengths relevant to their stage and I don’t believe in huge stage drift. The software industry is changed for good and the next decade will truly be dominated by the open cloud and open platform companies that embrace this. And the IT segment of the Venture Capital industry will continue to evolve to meet the market needs, not vice-versa.

Brick image courtesy of Fotolia.

This post originally appeared on Both Sides of the Table by Mark Suster.

If you don’t want to read that post, the summary is:

• Open source computing drove computing costs down 90%, which spurred innovation in technology
• Open cloud led by Amazon with their AWS services drove total operating costs down by 90%. This led to an explosion in startups.
• Amazon in turn led to the formation of an earlier stage of venture capital now led by what I call “micro VCs” who typically invest $250-500k in companies rather than the $5-7 million that VCs used to invest.

These trends have put pressure on traditional VCs. Some have done earlier-stage deals and done well. Others have chased earlier-stage but lack the skills or relationships to do this effectively. Some have moved into later stage investments in an effort to “put logos on their websites.”

People are moving into everybody else’s space.

Everybody seems to want what everybody else has. You know the old saying from Harry Met Sally, “I’ll have what she’s having!”   This will continue while we’re in a tech bull market and I predict will wane when we’re not.

The Blurring of Investment Lines
With new micro VC entrants into to early-stage investing plus increased competition from angels, incubators and the like – traditional VCs have taken notice. So VCs spent a couple of years experimenting with earlier-stage investing, which is OK. The best of them: Spark Capital, USV, Foundry Group also understood that how they worked with these management teams was changing and I believe firms like this will continue to excel at early-stage investing. There are also others.

I would put my firm, GRP Partners in with the group working with teams in different ways. But obviously I’m biased.

I believe some VCs have entered the early-stage market as simply an option on future financing rounds. I doubt this will end well for those VCs or for the entrepreneurs they backed. I don’t think purely option-based investing in startups suits the long-term brand of the investor.

The other major trend seems to be pulling in the opposite direction.  As some of the last generation of startups have gotten bigger many VCs have also chased later-stage investments that were traditionally dominated by growth equity or mezzanine funds. It is less clear to me that this is a smart strategy but we’ll see over time. It feels more opportunistic than an “investment strategy” to me. It’s one thing to invest in a later-stage (say a C round) to help with growth, it’s another to fund companies who are already valued in the billions. Will public investments come next?

And of course hedge funds and growth-equity funds can’t resist trying to get earlier-stage exposure again. As I said, the traditional investment lines of stage-based investors has blurred.

But all of this is normal and we saw it all in the late 90?s. In a bull market many players see drift in their activities. In a correction the best people focus exclusively on their core competencies. I think Micro VCs are best at what they do, A/B round investors ought to be mostly A/B round investors and late-stage investors out to focus on companies that are already profitable and growing rapidly. Hedge funds out to be, well, hedge funds.

The LP Community Hasn’t Yet Caught Up
As I’ve started to get to know the other side of the VC industry lately (the people who invest in VC funds or “LPs”) one thing has occurred to me. As a generalization LPs seem to recognize this general trend requiring less capital to start businesses and are arguing for smaller VC funds. That’s wise. But most LPs don’t seem geared up to fund new entrants in the Micro VC category.

Many LPs want to write checks of $10 million or $25 million because they themselves have billions of dollars to manage. And the more “small checks” they write, the more VC managers they have to manage. They also often don’t want to be more than a certain percentage of a fund.

So if a VC wants to raise a $30 million Micro VC fund and if an LP doesn’t want to be more than 15% of a single fund, the math collides. Maybe Micro VCs will get larger and emulate a multiple-partner strategy like True Ventures or First Round Capital. I think some will do this.

Others will want to stay small. My best guess is that new LP funds will be set up in the future to service Micro VCs. So far I only know of one that has set up a focused LP fund to focus on this strategy. Hats off to Michael Kim of Cendana Capital – the first person I’ve spotted who focuses just on Micro VC. And no prizes for guessing that he’s getting into some of the best Micro VC funds. I think people who invest in LP funds ought to take notice of Michael’s leadership position. (disclosure: I’m an advisor to Michael’s fund. But I only agreed to do this because I know he’s really on to something others haven’t yet spotted.)

The Explosion in Early-Stage Innovation
The Amazon AWS-led revolution of startup innovation has led to a massive increase in the aggregate number of startups. This in turn has fueled incubation programs like YCombinator, TechStars, 500 Startups & many more to help early-stage teams launch businesses led by most technical founders who are getting coaching from seasoned management teams.

In addition it is much easier to get distribution than it was in the pre Facebook, pre iPhone world. It is not uncommon to see a team out of Utah, Texas or for that matter Finland with 8-10 developers build iPhone apps that get 10?s of millions of downloads and doing hundreds of millions of monthly page views.

All of this innovation is awesome and there have even been new online tools such as AngelList to help entrepreneurs raise money more easily from angels or early-stage funds. Much credit for the mindset of keeping companies lean, having them launch & experiment on products and trying to “find product / market fit” goes to Steve Blank (author of the much respected Four Steps to Epiphany) and Eric Ries, spiritual leader of the “Lean Startup” movement.

The explosion of startups coupled with lower costs to build in the early days and the freely available capital at the sub $1 million funding level has led to a lot of talk about whether the old Venture Capital model is still relevant. It’s my judgment that VC is as relevant to helping today’s startups become large businesses as it was 20 years ago but perhaps the skills of VCs themselves have to adapt.

I believe that most companies can exist in the experimentation mode for 3-4 years. They should start “lean.” If they hit a product / market fit (meaning you suddenly see a massive uptick in usage and/or revenue) then these companies need to go “fat.” If they don’t the industry titans around them will eat their lunch.

Enter VC. You can’t scale a large business quickly on your $500,000 alone. The Venture Capitalists can help these young founding teams scale their engineering departments, develop business development relationships, deal with onslaught of PR, handle executive management challenges, etc.

Not to mention providing the capital for growth. People who believe that you can easily build a huge company quickly for just $500,000 are mistaken.

The other argument against venture capital is that all of these new startups can exist on their own without ever raising venture capital and they can build meaningful, but small businesses. I acknowledge that is true for some segment of the market and there’s no shame in having a $15 million / year, 15% growth business churning out 20% annual profits. In fact, that’s pretty awesome. But that will be the minority of these startups.

For those that do survive without VC because they figure out how to make enough revenue, many of them will be “ramen profitable.”

Ramen profitable is good while you’re in search of a more scalable business model but is not sustainable for most companies in the long term. Most ramen profitable businesses achieve profitability because the founding team is paying themselves very little and hiring almost no staff. This can be sustainable for a young team for 3-4 years but beyond that the teams start to fracture. Some people get married, have kids, want to buy a house or simply get lured away by the next hot idea.

In either case, venture capital will remain an attractive option for teams who want to pursue their business ideas and scale.

The final post focuses on the coming brick wall that I see in Venture Capital caused by a massive increase in seed-stage & angel deals couple with a reduction in the number of VCs by 2/3rds.

This post originally appeared on Both Sides of the Table

I believe the changes to the industry will be lasting rather than temporal change. Venture capital is in the process of its own creative destruction with new market entrants and new models of innovation at the precise moment that our industry itself is contracting.

I will argue that when the dust settles, although we will have fewer firms, each type well end up more focused on traditional stage segments that cater to the core competencies of that firm. The trend of funding anything from the first $25k to funding $50 million at a billion+ valuation is unlikely to last as the skills and style to be effective at all stages are diverse enough to warrant focus.

I will argue that LPs who invest in VC funds will also need to adjust a bit as well.

Rewind
When I built my first company starting in 1999 it cost $2.5 million in infrastructure just to get started and another $2.5 million in team costs to code, launch, manage, market & sell our software. So it’s unsurprising that typical “A rounds” of venture capital were $5-10 million. We had to buy Oracle database licenses, UNIX servers, a Sun Solaris operating system, web servers, load balancers, EMC storage, disk mirrors for redundancy and had to commit to a year-long hosting agreement at places such as Exodus.

Open-Source Software & Horizontal Computing
The first major change in our industry was imperceptible to us as an industry. It was driven by the introduction of open-source software, most notably what was called the LAMP stack. Linux (instead of UNIX), Apache (web server software), MySQL (instead of Oracle) and PHP. Of course there were variants – we preferred PostGres to MySQL and many people used other programming languages than PHP.

Open source became a movement – a mentality. Suddenly infrastructure software was nearly free. We paid 10% of the normal costs for the software and that money was for software support. A 90% disruption in cost spawns innovation – believe me.

We also benefitted economically from a move to “horizontal computing.” What this meant was that rather than buying really expensive UNIX servers (and multiple machines in order to handle redundancy) we could buy cheap, replaceable servers for compute resources.

As our needs grew we could just add more cheap boxes and as boxes failed we could just chuck them out. We had to learn how to be better at “load balancing & replication” – meaning how we managed data across all the boxes since they weren’t centralized on one box.

These two trends had a major impact on the computing industry from 2000-2005 but the effects weren’t yet felt by the VC industry.

The Emergence of “Open Cloud” Infrastructure
The biggest change in the software industry beyond open-source was “open cloud.”

When we talk about cloud computing we have to be careful to differentiate between open cloud (services the are provided solely to for the economic purpose of building a cloud business) and the “platform cloud” where certain service providers offer cloud services wrapped around their core product. These are very different.

Platform cloud players like Salesforce.com provide compute resources so that third parties can build applications that integrate with its core product. That’s awesome for users of Salesforce.com or companies that want to cater to them but less awesome for pure startups that want independence and are really just looking for cloud infrastructure. Facebook is a “platform cloud” provider, too. That makes both of these amazing companies great channels for startups.

True that Salesforce.com in particular has made interesting moves toward open-cloud services by purchasing Heroku and also launching Database.com. It seems if anybody wants to move more toward open it will be Salesforce.

But for now when you want to build an independent, high-growth, VC-backed startup you need to build your overall company on a truly open cloud.

Enter Amazon.

They came from a different perspective. They have the mass retailer mentality of “stack ‘em high and sell ‘em cheap.” They started by offering cloud storage (S3) on a super cheap, pay-as-you consume basis. Every startup I knew in 2005 (when I started my second company) was using this. Why would we commit hundreds of thousands to EMC before we knew whether we had a big business?

They then launched processing capabilities (EC2) and we startups suddenly didn’t need to buy production servers. Then they launched a simple database, management tools and so on. Amazon will surely keep moving up the stack. My bet is that they fold A9 (their search tool) into AWS and offer search-as-a-service, too.

It sure would put pressure on Google if they had Facebook competing on one side of them for share of users’ time and Amazon flanking them on the other side by providing search to every website out there that might threaten AdSense and even Google’s core search business. Who knows?

If you want a deeper understanding of the layers of the cloud , how it is emerging and some of the exciting new players you can read it here.

Amazon changed our industry. This is mind boggling. That little online book company. Not Google. Not Microsoft. Not IBM, HP, Accenture, Cisco, Salesforce.com or anybody else. Amazon. 100% of the credit. And 9 years after they launched AWS there are still no credible competitors.

I find this strange. And maddening.

That said, Amazon – through AWS – even without strong competition is as wonderful an experience as Amazon the eCommerce retailer feels to you as an online shopper. Jeff Bezos simply deserves to be held up with Steve Jobs as two of the most important people driving innovation in computing today.

Spawning of Micro VCs
The biggest media attention in our industry went to the so-called “super angels” during the 2009/10 timeframe and while I don’t believe there is such thing as a super angel I believe that much media attention was deserved.

The earliest people that I spoke to who understood the changes in our industry were True Ventures & First Round Capital. They built industrial-scale funds dedicated to backing early-stage startups with $500k rather than $5 million. They knew the venture math that if only 50 companies / year are sold North of $100 million the entry price for their investments mattered. These funds were active back in 2006 when I was raising money for my second company. As were individuals like Jeff Clavier with SoftTech VC who was also way ahead of the market in spotting this trend.

More recently great funds like IA Ventures, Floodgate, Rincon Ventures, Founder Collective, Freestyle Capital and others have raised money to focus on early-stage investing as a strategy. And many more individuals that I respect are switching from investing as individuals to fund structures to invest in this category like Aydin Senkut (Felicis Ventures), John Frankel (ff Venture Capital), Manu Kumar (K9 Ventures), Chris Sacca (lowercase capital), Dave McClure (500 Startups) and many more.

I have called the creation of Micro VC as the most important change in our industry and I believe it. These people understand that the nature of startups have changed. They have increased the number of investments, they understand that outdated board meeting formats are too slow & unresponsive, they have designed founder-friendly term sheets that can be executed cheaply and they are allowing for a massive increase in the rate of new startup innovation. At least in the consumer & business web.

The larger ones also do more to hold CEO summits, create recruiting databases, set up email distribution lists, create pools of stock options that can be shared across companies, etc.

I still think it was Amazon that created this category not the other way around. Where open-source computing gave us a 90% reduction in our software, Amazon gave us a 90% reduction in our total operating costs. Amazon allowed 22-year-old tech developers to launch companies without even raising capital. Amazon sped up the pace of innovation because in addition to not having to raise capital to start I also didn’t need to wait for hosting to be set up, servers to arrive, software to be provisioned.

Amazon.

I know I’m going on-and-on. I’m not a shareholder. I’m just in awe of what they’ve enabled and baffled that the media doesn’t give this more focus.

In the next post I explore how the changes initiated by Amazon and then propagated by Micro VCs has led to a blurring of the lines in which stages VCs & later-stage investment firms traditionally invest and why this is driving up valuations in private companies beyond common sense.

This post originally appeared on Both Sides of the Table by Mark Suster

I have conversations with entrepreneurs and other VCs on a daily basis about fund raising, the prices of deals, how much companies should raise, etc. I’ve stopped talking about this as much publicly because it’s such a heated, emotional topic where the points-of-view are strictly subjective and for which the answers will only be revealed in the future.

I’ve decided to take all of my private points-of-view on the topic and make them public in a keynote speech at the Founder Showcase in San Francisco on June 15th.

I thought I’d post on one of the topics beforehand. It’s the one bit of advice I find myself giving to entrepreneurs most frequently these days, “raise money at the top end of normal.”

Huh?

Here’s what I mean. There is an inherent value that any company has. On a public stock market that is the value that investors place on future free cash flows of the business discounted to today’s date to account for the time value of money. The more mature the company and industry, the easier it is to predict its future. When investors are feeling confident about the future they tend to bid up the value of public companies due to an increased perception that the future cash generated by the company will appreciate. The price of public stocks change instantly in reaction to news that is perceived to affect the future value of that company.

Every day shareholders vote on the value of the company by buying or selling shares. There is no price movement without one person agreeing to sell the stock and another agreeing to buy it. Stocks that have a lot of people trading are said to have a lot of liquidity, which basically means it’s really easy to get into (buy) or get out of (sell) the stock.

Private markets for stocks are the opposite. They are pretty illiquid. If you invested in the first angel round of a startup company it is usually very hard to sell your stock—usually for many years if ever at all. So how exactly are prices determined?

There is no great science to it. The earlier you invest the higher the chances the company won’t work out and thus you pay a lower price than later-stage investors. As an investor you’re trying to pay the appropriate price for your perceived risks of the company succeeding and protect yourself in the event that it isn’t quite as valuable as you had hoped. As the risks below get eliminated the higher the valuation investors are prepared to pay.

Over time some “norms” have emerged in pricing based on investors risk / return profile.  The obvious thing that investors think about is making a financial return on the investment they made in your company. Early-stage investors in technology startups are only looking for growth-oriented companies that can achieve an “exit” someday—either via selling your company to a larger company or via an IPO. The former is much more likely than the latter. So investors have to have some general sense of what companies that are similar to yours ultimately sell for in the private marketplace via an M&A transaction and they have to have some sense of valuations on public stock markets to be able to back into what their potential returns on your investment might be in the event of an IPO.

For example: If you were to invest $41 million into a company (and one could assume that you owned between 33-50%) then the company is worth $82-123 million at funding. As an early stage investor you’re often planning around 10x your investment at the time you write your first check so in this case you’d be going into your investment expecting an exit of $800 – $1.2 billion. Then you can do a little bit of research and find out that very few companies ever achieve this valuation in a trade sale so you’re clearly gunning for an IPO. You’re unlikely to want to make this sort of investment with the product or the market not yet validated. The risk wouldn’t be appropriate.

Ah, but you say that for a normal-sized angel check or A round check one shouldn’t worry about the ultimate exit because he or she is getting in really early and at a cheap enough price so who cares whether one pays $5 million pre-money or $15 million pre-money—you just have to make sure you back really big companies. Well, obviously if you knew that in advance it would be big, of course that would be true. But the reality is that you’re faced with two problems: 1) the earlier the stage the riskier and thus more write-offs so you need to have enough ownership percentage in your winners to make up for the losers and 2) the earlier stage your check the more likely the company will need many more funding rounds behind you and thus you face dilution.

So rounds tend to be “range bound” where prices at the top end of the valuation spectrum often being done in boom markets (i.e. 2007, 2011) and for the hottest of companies test the top end of the range, and in bad markets for fund raising (2003, 2008) test the bottom end of the range.

There is no such thing as a uniform price. It is highly dependent upon many factors: experience of the team, type of opportunity (a big biotech or semi-conductor A round is likely to look different from an Internet A round), geography, etc. So the ranges you would expect can be highly imprecise. But to help with the explanation I’d like to put down some markers of typical Internet pre-money valuations done in major US markets (San Fran, NY, LA, etc.) while acknowledging that San Fran deals are often higher valuations due to increased competition amongst investors.

There is no value judgment in my putting up these numbers nor am I negotiating with anybody. I’m just pointing out my gut feel for approximate ranges of deals that I’ve seen with Silicon Valley having the highest valuations, NY / LA / Boston / Boulder / Seattle having valuations in a slightly lower range but comparable and sometimes significantly lower prices in markets that don’t have a healthy venture market. These are not scientific, just anecdotal and just trying to provide some transparency for entrepreneurs on what I’ve seen in the market. And of course there are always outliers.

Prices have definitely gone up in 2011 as depicted in the anecdotal chart below. Again, prices are expressed as pre-money valuations.

For me I think that investors have got to accept the new reality in pricing if they want to remain competitive in markets like we’re seeing now. As ever, prices are still determined by: quality of team, quality of product / market and competitiveness of the deal.

So when I advise entrepreneurs on fund raising I often say that it’s OK to try and shoot for the “top end of normal” for the market conditions. So in 2011 as a startup company if you can generate lots of demand you can definitely raise an A round of capital (say $3 million) at a $7 or 8 million pre-money valuation or slightly higher whereas just two years ago you would have struggled. That’s fine. That’s the deal you get when you’re raising in a good market for startup financing.

What I caution entrepreneurs from doing is raising money at significantly ABOVE market valuations. I’m a VC so I have an obvious bias. But that’s not where this is coming from. I’ve been preaching the “don’t get ahead of your inherent valuation” message for nearly 10 years. I raised my A round at a $31.5 million post-money valuation with no revenue. It was early 2000. That was market. I saw this kind of pricing when I first entered the VC market in 2007. We had companies pitching us that had almost no revenue at all and they were raising $10-15 million in capital at a $40-50 million pre-money valuation. I should also point out that while they had built their products they had limited market traction.

We passed on all of these deals and often tried to discuss the possibility of more modest amounts of capital raised and at more realistic prices. It’s hard to stop a train. One company which was raising at $40 million pre-money wrote a comment about me in a public forum saying something along the lines of “Mark worked really hard to understand our business and was very detail-oriented. But he and his firm were just too cheap on valuation.” Fair enough. But he sold within 3 years for not a huge price after having raised more than $20 million. Another firm we saw tried to raise $15 million at a $60 million pre-money with similar metrics. They did an inside round, spent a bunch of money and then went through a fire sale of the business less than 2 years later.

Here’s the problem. If you haven’t figured out product / market fit and therefore still have a highly risky business you run great risks for getting too far ahead of yourself on valuation. If you raise at a $40 million pre-money on what would in normal times have been a $15 million valuation you’re fawked if the market corrects and you need another round. To any prospective investor you look like you’ve failed even before your first pitch. Even if you have an interesting story to tell, most investors won’t want to go through the brain damage of doing a “down round,” which creates tension between them and early investors.

Finally, even if they could bring themselves to offer you a major down round, the more sophisticated investors know it’s fool’s gold. They get a cheaper price, they wipe out much founder stock value and they reissue you new options. You’ll take the money—what choice do you have? But 6 months later you’re not working past 10pm. 1 year in you stop catching early morning flights. Within 2 years your evenings & weekends are spent planning your next business. And the CEO they would hire to come in and run the business when you go would always be a mercenary.

So my advice: go ahead and ask for a valuation that 2 years ago wouldn’t have been likely. Use competition to make sure you get a fair price. Raise a slightly higher round than you would have previously but keep some amount as a strategic reserve. Make sure that when you need to raise your next round of funding that you are able to show an uptick in valuation that is important for new investor confidence and to maintain great relations with your early investors.

Increase price. But unless you’re already a well-known technology heavyweight be careful about raising above the range of prices that are normal for a bull market. If you’re hot, don’t raise above normal. Raise at the top end of normal.

Other topics I’m going to cover at the Founder Showcase on June 15th:

• Why I believe convertible debt with no cap is wrong for your investors
• Why convertible debt WITH a cap is wrong for you
• How much money should you raise?
• When should you start talking with investors?
• Why you shouldn’t stack too many brand names into a round
• Are we in a bubble?
• and more.

Hope to see you there.

No Entrepreneur Sets Out To Demotivate Their Team

Assuming no one would demotivate their team intentionally, then why do we see it happen so often? I believe it’s because too many entrepreneurs and leaders are so self-centered that they really don’t see what impact their actions have on others. What these leaders need to do is spend more time eliminating their own demotivating habits, rather than delivering more motivation.

Maybe it because there are plenty of tips, seminars, and books on the motivation side of the equation, starting with the basic Motivating Employees for Dummies, and so few resources on elements of demotivation. To learn about ways that your team is demotivated, most leaders would need to look no further than feedback from their own team, for comments like the following:

1. Be sure your team doesn’t know what is important to you. You do this by changing your mind on an issue several times a day. Or by making sure your answers to employee direction requests run counter to ones given previously. Keeping your team guessing may keep them alert, but it is highly demotivating.
2. Never explain your actions. Just because you are the boss, that doesn’t mean you don’t have to explain your actions. They are watching you carefully, but they can’t see what’s going on in your mind. Non-specific directions like “make it better” or “get it right next time” are not helpful or motivational.
3. Hire team members who will follow your instructions. Then you have to make sure they are punished for taking any initiative that you personally did not authorize. These people may appreciate having a job in these tough economic times, but they won’t be motivated to take any risk, or lead your company through the competitive minefield.
4. Keep people on their toes with a threat of consequences. This may be as simple as withholding opportunities and rewards, but people need to understand that you are serious about punishment for mistakes. Even implied threats are demotivating, yet most employees say their supervisors do hold threats over them on a routine basis.
5. Team meetings are for delivering the latest decisions. Bring your team members along to all the meetings, but make sure they listen carefully rather than speak or provide input. You may ask them to bring you up to date on what they’ve been emailing you, but you’ve been too busy to read.
6. Agree to milestones and then accelerate them. After you hear the latest sales projections, you can’t resist adding a “stretch” objective, just to keep people challenged. For development projects, you prefer milestones just after major holidays, so people have the option of working through the holiday for extra credit.
7. Thank your employees for the little extras. You recognize the need for positive feedback, but it’s less risky to apply it to potential problem items, like “Thank you for doing the job manually, rather than waiting for your computer to show up,” or “Thanks for coming to my house to fix my kid’s home computer.”
8. Be careful not to get too involved in your employees own goals. If you help them too much, they will just leave you for a bigger opportunity. They need to understand the commitment of meeting your goals first, so you send reminder emails to them at midnight on Saturday, marked urgent.

If you recognize yourself in any of the points above, or find this article on your desk chair one morning, it’s never too late to change. Rethink your own behavior in order to ferret out any unintentional or intentional demotivational acts.

It’s time to move to the positive side of the motivation curve, from the team’s perspective. Motivation is one of the most powerful driving forces toward entrepreneurial success. In these tough competitive times, you need all the help you can get. Don’t try it with a demotivated team.

This post originally appeared on Both Sides of the Table by Mark Suster

Quick Practical, Tactical Tips for Presentations

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In the past I’ve given some tips for handling meetings effectively, covering topics like:
- How not to let your meeting go down a rat hole;
- Dealing with the elephant in the room;
- Dealing with skeletons in your closet;
- How to make meetings discussions, not “pitches”
- A tale of two pitches (I eventually invested in the first company that pitched)

Today’s post is a subtle one about positioning yourself in a presentation. This might be a VC meeting but also might just be a sales or biz dev meeting. It’s any meeting where you are in a small room and are being called on to present on some form of overhead slides

1. Sit closest to the projection screen – Many times a week I have entrepreneurs who do presentations for me and often I’m with some or all of my colleagues. From witnessing all of these presentations I can tell you that there is a right place and a wrong place to sit.

If you look at Diagram A above you’ll see that the presenters are sitting at the opposite end of the table from where the screen is. When I lay it out this way I’m sure it would be obvious to you that this isn’t the optimal place to sit but I’d say a good portion of presenters make this mistake. The problem is that the people your presenting to are forced to choose between looking at you and looking at the screen. When they choose the latter they are totally tuned out to what you’re saying.

If you look at Diagram B you’ll see that the people you’re presenting to can look you in the eyes and glance up at the screen. You’ll hold their attention much better. Your laptop will be synchronized with the screen so resist the temptation to turn around. Your goal is to work the room, look people in the eyes, judge people’s responses to your presentation and engage. You can’t do that if you keep turning around and looking at the screen.

2. Avoid a home team & away team (unless you’re in Japan) – Another thing I often try to avoid is the “home team” and “away team” format if I can. If you show up early to set up then it’s easy to stake out the right seats (Diagram B). First, sitting across the table from your teammates puts you in the right position near the screen but also it creates an environment that is not “across the table” and therefore easier to make things informal and build rapport.

I personally wouldn’t worry about it if it the team coming to see your presentation seems a bit surprised and says, “oh, we normally all sit on the same side.” Just smile and say, “Oh, sorry. We didn’t realize.” If you can get away with it, go for it. Sitting by the screen is the best excuse.

I’ve lately been attending meetings with our shareholders (called LPs or limited partners). I’ve learned that LPs don’t expect presentations to be done on a screen so I need to travel around with paper. That’s not really me but I’ll stick to convention. I’ve found it more difficult to break out of the home team / away team this way.

One warning: I was taught that culturally in Japan there is an expectation that you sit in the home team / away team format so you need to follow this convention. The away team (that’s you) sits with their backs to the door. I’m told that this comes from ancient times when you would always want to be able to see the door to know whether an enemy was coming so if you were hosting you always chose the side across from the door.

3. Work the entire room, don’t fixate – When you’re presenting to another team make sure to spread your eye contact evenly across the team to whom you’re presenting. Often in a meeting there is one or more talkers in the group of people you’re meeting and I’ve found that some people end up giving them all of the eye contact. I’ve also seen some presenters give all of the eye contact to the most senior team members.

Both of the scenarios make me REALLY uncomfortable when I’m in the room because I always notice. I can’t stop thinking inside my head, “What is the person who’s not getting no attention thinking? Are they offended?” Honestly, this is a very common occurrence and is a mistake. Don’t make it. Show respect to everybody you’re meeting.

4. Don’t have hand outs - If you’re doing a printed presentation (as I have been lately) you have no choice. But for all other presentations don’t hand out any printed materials in the meeting. Your goal in the meeting is to build rapport and to command the complete attention of the people to whom you’re presenting. Even the best behaved of recipients can’t help themselves but to flip ahead to see what’s coming. The worst behaved will literally never be on the slide you’re presenting. Yes, it’s rude. But you enabled them. If you really want to hand out notes do so at the end of the meeting as a “take away.”

5. Never present “eye charts” – One line that I hate hearing is, “I know you can’t read what’s on this slide, but …” or “I know this is a bit of an ‘eye chart’ but …” Listen, if I can’t read it then why the eff would you bother putting it up on the screen? In slides, less is almost always more. Bigger fonts, more visuals, less text should be your guideline. For any situation that requires a complex diagram then you must do a “build.” That means that you only show one section of the screen at a time and then hit the mouse to show the rest. No fancy builds (i.e. spinning, complex fade ins) – if you must use it keep it subtle.

6. If you have detailed slides you can hand them out in real time - There are times where teams want to go through detailed information in a meeting. One example would be detailed financial statements. In this instance I recommend coming with printouts of those pages, hold them in your folder and hand out when you hit that section of the meeting. Some great CEOs I know do this for board meetings.

So, there you have it. Tactical advice for meetings. It’s not going to make a bad company, good. But trust me when I say that if you get the tactical meeting dynamics right the rest of the meeting has a better chance of going more smoothly.

Did you ever wonder how a new entrepreneur knows how to “do the right thing” for his business? Most experts believe that the essence of doing the right thing is ethics. Translating that into business value, a study by Wirthlin Worldwide concluded that 80% of customers still base a good portion of their buy decision on their perception of that firm’s ethics.

Ethics are generally defined as a set of societal standards that encompass the norms of the community. These norms are not genetic, and they have to be learned. At the base of these are moral values, but in my view most of the rest are gleaned from experience, parents, and formal education.

In the real world, the latest updates come from good business books, like the new one by David M. Shedd, “Build a Better B2B Business.” This one focuses on the generic attributes, as well as specific processes, which add up to the ethically right thing for most businesses.

The generics include integrity and honesty, as well as the above mentioned moral values. The specifics for business include providing leadership in building the business, but also in contributing to the greater good:

1. Communicate your values and business goals. Doing the right thing for the business starts with defining core values. Then create business goals to tackle the few critical issues and opportunities for the business. To be effective, communication has to be two-way and continuous, to keep the “right thing” as “top of mind” for all team members.
2. Align the organization to your values and goals. Ensure everyone is in alignment to live the values and focus on and execute the goals. Make the tough decisions to ensure the success and profitability of the business, and make the tough personnel decisions to put the right people in the right positions, giving them the training they need.
3. Manage priorities for the short-term as well as the long-term. Just as people must manage their personal and work responsibilities, so, too, must companies balance their priorities. Prioritize on the constraint in the business – that which is important, not on what is most urgent.
4. Endeavor to beat, not meet, industry standards. Doing the right thing is not just “getting by,” or squeezing within the letter of the law. It means knowing and living by the spirit of the law, as well as not waiting for new laws and regulations to fix problems. The same is true of employee standards, and social responsibilities.
5. Create winning teamwork. Leading people to do the right thing as a team is one of the most challenging things to teach and coach. Making a team work well requires constant communication, demonstrating accountability, ensuring motivation, recognition, and continual learning.
6. Look at yourself from your customer’s perspective. The right thing is for every business leader to value every customer and realize the importance of each in building the business. Your appreciation of your customers and focus on delivering value to them is a pre-requisite to customer satisfaction, growth, and success.
7. Balance work and life. We are all in business to be successful, but we are all people too. Another way to send a strong message about doing the right thing is to step up to the thorny “quality of life” issues, including balancing one’s work and personal life, work at home, and providing the right health, social, and spiritual needs.

Since ethical behavior is the base, the traits to foster this must always be sought out and nurtured. These traits include day-to-day work consciousness, enhanced discipline to foster a combined business and ethical acumen, and empathy for a high level of engagement. This insures that everyone is joined together, feeling a common imperative to do the right thing and make the right decisions.

So don’t assume that “doing the right thing” comes naturally, and doesn’t require any effort. Yet the evidence indicates that a startup which consistently does the right thing has a competitive edge, and a higher success rate. Are you ready and willing to take the high road for the ethics of your team and your company?

Ten Ways to Optimize Your Investor Pitch Time

The average length of a funding pitch to angel investors is ten minutes. Even if you have booked an hour with a VC, you should plan to talk only for the first fifteen minutes. The biggest complaint I hear from investors is that startup founders often talk way too long, and neglect to cover the most relevant points. Or they get sidetracked by a technical glitch due to poor preparation.

If you start by pitching your extended life story, that’s the wrong point. Equally bad is an extended pitch on your new disruptive technology. Investors are more interested in your solution and your business, rather than your technology. Here are some tips on the right approach and the right points to hit:

1. Match your material to the time allotted. If you have ten minutes, that means no more than ten slides. Then match your pace to cover all the material. I’ve seen several presentations that never moved past the first slide before running out of time. An obvious effort to keep talking after the time limit won’t save your day with investors.
2. Remember you are pitching to investors, not customers. Some entrepreneurs seem to think that their product pitch is also their investor pitch. I outlined what investors expect to see in an earlier article “Ten Slides Make a Killer Investor Presentation.” These are tuned to the ten-minute limit, but are just as adequate if the investor gives you an hour.
3. Check the setup and set the stage. If the projector doesn’t work, or won’t connect to your laptop, you are the one that loses. Have at least one backup plan, such as copies of your slides to hand out and discuss, in case all else fails. The first words out of your mouth should be “Can everyone hear me, and read the screen?”
4. Research your audience before presenting. The most respected presenters are the ones who have done the research before hand to know who is in the audience, and have tailored their message to these interests. If you know only a few people in the audience, acknowledge them, and convince the others that this is not a random cold call for you.
5. Dress appropriately and professionally. It’s always better to be over-dressed than under-dressed. Business casual is the standard. Remember that most investors are from a generation where faded and torn jeans were on the wrong side of success in business.
6. Let the top person do all the talking. Tag team shows don’t work in short venues. More importantly, investors want to see and hear the top guy – typically the founder or CEO. They will be judging his aptitude, his character, and his passion. Others can be present for effect, but deferrals to team members for answers are a sign of weakness.
7. First, get their attention with your elevator pitch. Start with the problem and your solution. These are your hooks, and they better be covered in the first 30 seconds. State your value proposition, and what specifically you are offering to whom. Skip the acronyms, history of the company, and the colorful autobiography.
8. Lead with facts, but skip the details. Skip the generic marketing phrases like more user friendly, massive opportunity, and paradigm shifting. “According to Gartner, the opportunity is 100 million by 2015, with 12% compounded growth.” Investors don’t need to know the implementation details of your patent or customer support plan.
9. Don’t forget to ask for the order. How much money do you need, and what percent of your company are you willing give up for that amount? If you want investor interest, the business parameters of a deal should be presented as clearly as the product parameters.
10. Close by asking for questions and promising follow-up. Acknowledging feedback and actually listening for ways to improve will always lead to a positive impression. You should answer questions with data if you have it, but avoid defensive responses in favor of a promise to follow-up after the meeting.

Most importantly, don’t forget to practice, practice, practice. Just because you have given a thousand pitches in your life, don’t assume you can finesse this one by reading the bullet points in real time from the slides that your team put together for you. You need to be totally familiar and comfortable with your pitch to give it effectively.

Forget the theory that you can “rise to the occasion” and impress everyone with your dynamic speaking ability. If you are pitching the wrong point in the wrong way, the occasion will be more the demise than the rise of your dream.

Track Your Metrics

Startups that reported tracking their metrics are 61% more likely to be successful in raising money, and increase their monthly user growth by 2x-7x. It seems that the metrics-tracking trend started by Google Analytics is now a near-requirement for a successful startup. Tools like mixpanel, chartbeat, and KISSmetrics all allow different forms of user tracking and funnel/conversion optimization. The bottom line is that if you aren’t tracking your users, you can’t learn from them.

Get a Mentor (not necessarily an investor)

Startups that reported that they had helpful, non-investor, mentors (such as an advisory board) raised 2x-3x more funding than those that didn’t. Mentors are people who have been there and done that, and probably already have a few successful investments or companies under their belt. Good mentors accelerate the learning process by sharing their experiences in building companies, and preventing mistakes before they happen. Interestingly, the Startup Genome Report found that whether or not investors were actively involved had little impact on a startup’s success or failure.

Work full-time

Founders who worked full-time were 24 times more likely to raise funding than those who only worked part-time on their idea. In addition, they also reported 4-5x the user growth rates. Working full-time lets you learn faster by having more time to iterate. In addition, most investors see full-time involvement as a sign of commitment to the business as institution (that you’ll be there when times get rough) and, realistically, will rarely fund a part-time initiative.

Get a co-founder

Founding teams with two or more partners have 3x the user growth and raise 2x the funding of single-founder startups. The necessity of a co-founder has been endlessly debated in Silicon Valley, but the Startup Genome Report comes down firmly on the side of multi-founder teams. Multi-founder teams are more likely to be honest about the performance of the product and learn faster as a result (it’s easy to lie to yourself, but not as easy to lie to your friends/mentors).