TBJ Investments, LLC

Pitching a VC: Why Financials Matter

I was once being pitched by a very smart entrepreneur who, when he got to the slide about his companies financials, said "I made all of this up, but here you have it." On the one hand, it was an pretty flippant approach to a relatively crucial aspect of his business. On the other hand, he was saying what ever other early stage entrepreneur was thinking when describing to me the financial outlook for his or her extraordinarily risky and unpredictable business. So why bother with a slide on your financials when pitching a VC? It is well understood by entrepreneurs and VCs alike that the specific numbers an entrepreneur pitches when describing her early stage business are completely made up. Most early stage CEOs are lucky to have visibility into the next 6 months, let alone the next 3 year that are reflected in their financials (and the 5 year forecast is mere fortune telling). Nonetheless, there is a huge amount of information about a business, and about an entrepreneur, that is reflected in those financials. The key is not to focus on the numbers themselves but, rather, to focus on the assumptions in those projections and the points of leverage for that business. It is almost assuredly the case that a early stage company's projections are wrong. In the last decade I have only seen one company actually hit the numbers they pitched me on. The rest of the companies have missed by varying degrees of big time. But the real question when listening to a pitch isn't whether the company will actually hit the numbers they are projecting, but rather what those projections say about the entrepreneur and the business? Is the entrepreneur focusing on the right things? Do the financials make reasonable assumptions? If the assumptions are anywhere close to right, is there a big interesting business to be built? Smart investors will dig into your financials to get a better sense of how you are thinking about your business. Company financials are rife with assumptions. Entrepreneurs can easily gain or lose credibility based upon the assumptions that are embedded in their financials, their understanding of those assumptions, and their ability to justify them. How long will it take to hire the people you need? How much will you pay them? How much will it cost to acquire a customer? How many engineers will it take to build your product? What is your margin (are you selling software, hardware, a cloud service)? What is the length of your typical sales cycle? How long will it take for you to collect earned revenue? How much are you spending on marketing? What is the expected return by channel? If you are pursuing a freemium business model, what percent of your user base do you expect to pay? How much will it cost you to support the free members? How much money will your company make, if any, and when? How much more money will it realistically take before you get the Company cash-flow positive? What will you achieve with the money you are raising now? These are all incredibly important questions for any startup and how you are thinking about them will have a huge impact on the success or failure of your business. No one will have perfect answers but an entrepreneur's ability to be directionally right will often be the difference between success and failure. Not only will it be important to understand the assumptions built into your financial plan, it will also be crucial to appreciate the sensitivities of your model. There are often single variables that make the difference between a good business and a great business (or, more likely, between a viable business and a failed business). If the cost of acquisition is off by 50%, do you still have a viable business? If free customers only convert at 1%, can you support the 99% who will always be free? If the viral co-efficient of your service is 1.2 instead of 1.5, what does that do to growth? What if it takes 90 days to collect on billings rather than 30 days? These "what if" questions are critical to the understanding of your business. You should appreciate the places your business has leverage, and the places that your business has potential vulnerabilities, and be ready to engage in an honest conversation about those pivot points. I will be the first person to acknowledge that early stage financials are a work of fiction. But some fiction has the ring of truth, while other fiction is so outlandish that it is impossible to suspend disbelief. It is an entrepreneur's job when pitching her business to convince an investor to suspend disbelief. The better you understand the underlying assumptions in your plan, the more effectively you'll be able to do just that. So embrace the opportunity to build credibility. As an investor, I'm happy to buy into your fiction, I just want to avoid unbridled fantasy.

via www.ventureblog.com

I totally agree with testing and uncovering the assumptions in the financials. The challenge is doing it if you actually have a real company up and running,and the metrics are incomplete. In this scenario, the entrepreneur who has NOTHING is actually better off than the entrepreneur who has actually gone off and generated revenue, albeit inconsistent.

Zuckerberg in Boston, or "Yet another one that got away"

The last week, Boston has been abuzz with the news that Mark Zuckerberg was coming back to "visit". In one of his various interviews, the founder of Facebook remarked that "if he could do it all over again, he'd have stayed in Boston".

Almost immediately, select members of the Boston technology community seized on that statement as proof of Boston's equivalent status to Silicon Valley. There was just one little problem that those people conveniently overlooked...

Rather, there were 2.3B problems those boosters overlooked. $2.3B worth of funding that Facebook has raised since leaving Boston; none of that from Boston angels, investors, hedge fund side pockets, asset managers, private equity or venture firms.

Instead of crowing about Zuckerberg's comments as some sort of self-serving justification of their own existence, I think that Zuck's visit should be viewed more in collective shame.

Shame on Boston for letting him get away. Shame on the local angel investor community for not getting into the deal. Shame on the VC community for not only missing the early stage rounds, but with the exception of Greylock's west coast office, not being a part of ANY successive round. Shame on the Hedge Fund and PE communities for not getting into the deal via side pocket funds in later rounds.

Download Who-owns-facebook.jpg (JPEG Image, 600x446 pixels)

For a city that is one of the major money centers in the US, this is a major failure. This was never a matter of lack of capital. This was all about lack of will, lack of vision.

As it turns out, Zuck's trip to Boston wasn't just a simple visit, but a recruiting trip. Hundreds of the best and brightest students of MIT and Harvard were pre-selected for interviews with Facebook. I look at this as the biggest talent suck in Boston seen in recent years. Some of the best talent coming out of Boston universities was just drained away to the west coast.

I would hope that this visit, and the fact that Facebook is now valued at ~$50B would serve as a teaching moment, and an opportunity for reflection. I fear that lesson will be lost in the rush to claim some hollow victory in Zuck's initial comments.

How to avoid the next one? How to keep the next Zuck from leaving? Here are my thoughts:

1. Enable VC associates to originate deals up to $100K on their own, investments in technical members of their peer group.
2. Support a standard Boston Seed Deal termsheet, pre-vetted with local law firms and VC's. This termsheet should be similar to the Series Seed terms, but adjusted for East Coast investors. One page, easily executed.
3. Boston LP's should scorecard Boston VC's on their ability not just to generate returns, but invest in companies that create jobs in the Boston metro. Given that most VC's haven't generated returns aboove the S&P the last decade, this extra requirement shouldn't cause undue alarm.

Last, no one gets fired in VC for missing a deal. In the operational world of high tech, a sales rep missing the big deal in their territory would be fired. Not in VC. Somehow that lack of accountability needs to change.

 

Race In Silicon Valley

In the furor over race in Silicon Valley, I had a few ideas on how to improve the situation:

- Expand recruiting beyond Stanford, Cal, CMU, MIT. Georgia Tech is the #4 engineering school and one of the most diverse engineering student bodies around. One of the things that's always pissed me off is SV hiring managers not taking the 4 hour flight to recruit in the US from a major public school, vs. bitching about not being able to find diverse candidates.

- Be transparent about your workforce diversity. Mike Swift of the SJ Mercury news tried to cover the hiring practices of a number of major Valley companies (who shall go nameless) and they slapped an injunction on him, stating this was competitive information. My understanding is that the data showed that these "select" companies were far more likely to hire overseas nationals than US minorities, even when the overseas nationals didn't go to the sacred 4-5 schools.

- Also look at the better ranked HBCU's, Tribal Colleges, etc, several of which have joint degree programs with the top schools. For example, one can attend Morehouse and get a joint MS in Engineering, Physics, etc. from Georgia Tech. Wellesley has a joint deal with MIT as well. The NSF is a great resource for other schools for recruitment.

- Kill the STEM education in high schools, etc. canard. It's always used to justify the lack of brown faces in SV companies. There are plenty of minorities in engineering fields, though from my perspective clearly not enough. The issue is that SV companies/VC's have to stop being so lazy and recruiting at the same 4-5 schools. I also wonder how many SV companies even bother to check the NSBE/SWE/SHPE memberships on the top 4-5 campuses?

- Not everyone needs to be a BS/MS/PHD in Engineering/Computer Science to work in High Tech..How many Sales/Marketing people are PHD's in Electrical Engineering from Stanford? As a point of comparison, look at the relative diversity of Pharma sales forces; most of those people don't have life sciences masters or PHD's. Same thing with big Telco. Far more diverse in sales/marketing than High Tech w/o the necessity for advanced degrees from a select group of schools.

- Increase diversity of the VC GP pool. I think there are less than 50 GPs of color in VC firms nationwide. I'm a strong advocate of bringing back the SBIC program for Equity Investment firms, and creating a new generation of more diverse VC firms, by composition, strategy, etc. That will also create more competition with the incumbents.

- Public retirement LP's of venture firms have to start scorecards for VC's. Little known secret is that VC's only need to put in 1% of the Fund from their own pockets as per NVCA rules. That means the other 99% is OPM (Other People's Money). Much of that is from public LP's(Calpers, Calstrs, Utimco, etc). So, retirement fund money from a diverse population(50%+ in California) goes to VC funds who then overwhelmingly invest in startups led by white men (87% according to CB Insights http://bit.ly/aiQ50C ). Over a 10 year basis, most VC firms have barely tracked the S&P, so you can't say that this strategy is yielding higher performance. I think this is one of the roots of the problem; change the funding behavior and the trickle down effect of having a more diverse leadership group in funded companies will naturally create a more diverse pool of employees.

That's all I got. Now, gotta get back to running my company and being a statistical anomaly...;o)