Michael Sikorsky’s lecture “Buying Money” can be watched as an embedded YouTube video.
So, I want to talk about buying money today. Everyone’s talking about "the sky is falling, " so what’s kind of changed, and what hasn’t changed in raising financing? And the reason I call it buying money is because…it’s like a weird play on words, but you’re actually selling your shares because no-one else will take them.
Your team doesn’t want your stock, your landlord doesn’t want your stock, Safeway doesn’t want your stock, but they like cash. So what you’re actually trying to do is trade your stock to get cash, because once you’ve got cash, employees take cash.
So, with what’s happening right now in the world, everyone’s been pinched. I’ve got, I think, 13 or 14 companies right now that I’m one of the early seed investors or one of the majority share holders, and I can tell you that just over Christmas I got two Christmas presents, huge dough-nuts in some of the companies I’ve been invested in for greater than five years.
So, one of my portfolio companies went down from seven figures to six figures over Christmas. That automatically makes you look at the world, differently.
So, I can talk to myself as an investor… how I felt over Christmas, and I’m not even, like, a big investor compared to some other people, so, you can imagine how everyone’s portfolio is feeling, whether they’re in private equity or in the public markets.
These articles are both from Monday: "Angels Flee from Tech Start-ups, " "Venture Capital Returns Dip below Zero." So, officially, in the last quarter, VCs returned negative returns to their portfolio and, turns out, a lot of angels are just, in a sense, getting out of the market.
It’s not like they don’t have their cash and stuff anymore, but they’re not sure what’s going to happen.
I’m going to start with what hasn’t changed, and then I’ll go to what has changed. Generally, there’s always these principles of raising financing, which I don’t think changed.
Ivan was really kind where he’s saying; not everyone always agrees with me at CTI, it’s just because I’ve always said I’m the Chief Opinion Officer, and I’m not always right, but I think that you actually have to have a strong, bright line on how you approach this stuff, and that’s one of the tips that I’ll give.
It’s because if you actually have a gray line on how you approach… how you’re going to finance, it turns out that no-one can get excited by you. You’re basically vanilla ice-cream. Everyone’s kind of excited. Sure, they’ll have it, but it’s not… no-one’s getting jazzed up enough to write a check.
There’s a lot of truth to this quote, right? You can replace men with women. It’s the same thing. At the end of the day, when you’re actually raising financing, you’re getting someone absolutely seduced in the love of what you are doing.
There’s all these techniques on how you can get them in love with you, and I know you can learn that stuff from financing your vision, but at the end of the day this is actually what’s happening.
What I also want to talk about was that it’s very hard. If you sit and you read the newspaper, every single thing seems like everyone’s getting their financing done, all this stuff is just so easy, another VC Ram goes in, maybe angels do a deal, because that’s the stuff people talk about, right?
Just like, if you have a friend that makes it into the NHL, automatically they’re going to be talked about. If you have a friend that’s hit by lightening, automatically they’re going to be talked about. They’re a very, very, rare event.
Raising financing, especially if you’re talking about VCs versus angels… There’s an old quote, "Raising venture capital is like standing on a sunny day in an empty pool and getting hit by lightening, " and some people think that might be too optimistic.
It’s hard. The one thing that I’ve always been about is just more…you have to say, "Hey, I’m going to go raise this financing, no matter what happens." So, that’s the bright line test that I use for myself, but at the end of the day it’s very, very hard to get people to get excited to write checks. It gets easier, though, when you’re in certain quadrants of what’s going on.
This first axis here is your capital efficiency, and that means that you’re all the way to market for less than 25 million dollars. So think about that. You’re all the way in the market with less than 25 million.
That’s the definition of capital efficient from VCs, and then you’ve got how fast your business can scale. So, you can imagine the not-sweet spot is that your business doesn’t scale very fast at all, and you’re very, very capital intensive.
Compare that to down in this quadrant; you’re very capital efficient, and you scale very fast. Take an example, and I hate using examples like this, but take a social networking example, like Facebook, or something. Obviously it can scale very, very fast.
If you think about a social network, it’s basically a magazine. It’s a magazine, but the nice part about the magazine is I don’t have to hire writers to actually have great story pieces and then sell ads on the side. The people inside the social network, basically generating all their own local news amongst their own friends.
You look inside any social network that takes off, you’re like, "Oh wow! You’re a magazine that can serve a billion page views a day." Now you’re getting a billion eyeballs looking at your content, and you didn’t even have to write the content.
You’re selling ads that are on the side. Very, very fast the scale, and you know how fast the Facebook scale is an example, right? And still very capital efficient. They’ve raised lots of money, they’re going after stuff, but comparatively, still very capital efficient.
Imagine something that scales pretty fast capital intense-take Intel. Lots of people weren’t buying processors, like crazy, but you first have to lay out a couple billion dollars for your manufacturing plant. You compare Facebook’s… all their big raises, like their 240 million dollar raised at a 15 billion dollar evaluation. That’s an amazing evaluation for a firm.
And yes, it’s 240 million dollars that they put in kind of post… already winning that for success, imagine Intel deciding to back up a micro-processing company, like, "Well, to get into this game we first have to put in one billion dollars to make the manufacturing plant before we have any sign if anyone’s going to buy processors."
Still, Intel can raise money on this side of the fence… as soon as your business can scale faster, like there’s high demand, it’s way easier to raise money. When your business doesn’t scale fast it’s almost impossible to raise money.
You can always get your friends, sometimes, to back you, do tricks like that, but actually getting kind of serious investors is very hard.
So, imagine something that’s very capital efficient that scales very slow: me as an independent consultant. Great little business motto, "I sell my time." Maybe I’m lucky; sometimes I get 100 bucks an hour. That does not scale at all. I got 2, 000 billable hours in a year. I’m super capital efficient. I need what, a laptop and business cards.
No-one’s going to fund me to sell my time, ever, right? Other than, like, my mom. If you can’t get yourself to scaling fast, you’re not even in the land of raising capital aside from basically, friends, family and fools, as they say. If you’re actually capital intensive and slow, that’s a really bad business to be in.
So take one of the companies I’m looking at investing in right now. They’re alive, got a really great, low burn rate, but I’m not sure there’s an efficient way of getting customers. So because I’m not sure, that’s my hesitation, right?
It doesn’t mean that they can’t get those customers. When they get those customers they’re in there, but I don’t want to spend $1,000 a customer. We have to get it down to like two dollars to get anybody, maybe 50 dollars to get a new customer into their business.
At the end of the day, it really only comes down to one thing-you. People will rationalize why they’re going to make an investment or rationalize why they’re not going to make an investment. It’s your job to seduce that person to basically invest in you. All the stuff around the sides: tips, techniques, tricks, or whatever, by the end of the day they’re coming down to looking at you.
What I’m interested in is investing in people. One of the fathers of venture capital in the west coast… seed investor in Apple, seed investor in Intel. Why do you care about me so much as a person? Because that’s the only thing that doesn’t change.
Four to five companies that are successful aren’t successful with what they started with. Flickr was a massive multi-on-line player game. Now it’s photo share. YouTube was a webcam dating site, now it’s obviously a platform for sharing video. In fact, out of the successful companies, 80 percent of them aren’t successful with what they started on.
So anyone that’s ever looked at the stats goes, "OK, so the one thing I know that won’t change is the person that I’m investing in." They’re the actual constant through the business. That… a horse, quote unquote, that you actually want to bet on.
Probably, your business is going to change, your market’s going to change, your product’s going to change. All of those things are probably going to change-you can actually say that quite truthfully.
From a financing standpoint there’s something called the Animal Test. Can you actually say the person you ‘re going to invest in’s name and then add, "… is an animal." And if it makes you laugh when you say that person’s name through the Animal Test, you probably shouldn’t invest in them. I mean, whatever you can gauge that by.
Myself, I always give guys I’m going to invest in homework-I see how fast they get it done. If they’re slow on their homework, I’m like, "I don’t know if they can pass my own personal Animal Test."
If you’re having a hard time saying it about yourself, it means you’ve got to gear it up, because that’s how an investor is actually going to look at you. This is something that hasn’t changed.
You have to live on scraps. You want to be the strongest species that will live through anything, to eat the worst food. That’s basically the greatest sin, is running out of cash. You’re always alive until you’re out of money. Be a cockroach and get your burn rate down to absolute lowest possible, do all those things, then you’re actually going to live the longest.
How frugal can you run your business? There’s a early seed investor called Y Combinator out of the valley, and they’ve got…here’s a classic story: Two guys start a site called TicketStumbler. They’ve figured out a way, on $15, 000 in seed capital to get to a profitable business. You have to ask, "What does it mean to be a profitable business?"
Two guys, I think they’re in one apartment, Ramen noodle diet, but now they’re sustainable. They’re not trying to go raise big rounds of financing. They’re totally making sure that they can get through with almost nothing. So, 15 grand initial investment, now they’re cash flow positive.
It’s not a huge cash flow positive, but it doesn’t matter. Now [snaps] they’re sustainable, which is the trick, right? This, again, hasn’t changed. It’s that, at the end of the day it’s way easier to invest in people that are doing versus talking.
Paul Bucheit was the guy who created FriendFeed and also the guy who created Gmail, which most people know. Most people don’t know about FriendFeed. His concept is communicating with Coke.
He would rather talk to an investor through their product, because if you’re really good at Power Point, you can get people all sucked-in by your idea and maybe even raise financing if you’ve got something like Gmail on your resume that you’ve created, but the doing side is far more important.
So you can communicate through your product, then for sure an investor can see what you’re capable of doing, hence, you’re going to win.
This, again, has always been true. It’s even taken me a long time to really understand this. There’s, basically two models for your start-up. There’s a customer development model and the product development model.
So many people, especially if they have a large chunk of financing, default into the product development model, which is why there are so many sins created when people get too much financing.
You do things like this: well, we’ve got a great idea, we’ve got it funded, we’ll do the product, we’ll get people to test it, and then we’ll ship it and start selling it. This left-to-right path makes the absolute most sense, and especially when you’ve got financing, you can actually hire.
If you’re a marketing person, you start looking at this and you’re going, "OK, if I’m marketing, product development… Over here I probably need to do Marcom PR activities. We’re getting ready to ship." If you’re a sales person, over here you’re now figuring out, "Who’s going to be my VP of sales?"
The thing is, if you go back to all the stats, this is almost never true. If four out of five successful companies didn’t start with the right product, how does this ever work? Generally, it doesn’t. This is from a book called "Four Steps to Epiphany."
How I just sum it up quick is there’s company discovery. What are we actually going to do? And then there’s company building. When you’re doing company discovery, the entire team needs to fit in a phone booth. If it can’t, something’s wrong, already. I’ve done this wrong myself.
What you need to have while you’re doing, basically, discovery, validation, and creation. Obviously between discovery and validation, you keep looping. See there’s a big stop symbol on all that stuff? Most companies start with a hypothesis for their market, especially when you have a new product to a new market, and you’re segmenting it in a new way.
There’s no more risk that you can take as an investor. So you as an entrepreneur needs to articulate, "OK, we have a function of a new product. We’re going to function it to a new market. We’re going to segment it in a new way. That means we have risk multiplied by risk, multiplied by risk, so that’s why we’re for sure going to follow this."
The reason why so many people fall into this trap is that if you’ve ever worked for a large company, lots of times you’ll be releasing not a new product, not to a new market. You’ll be releasing features on an existing product, perhaps a new product to an existing market, your existing customer base, a completely different way of operating those projects.
What you’re selling is no longer hypothesis. Most startups, it’s a hypothesis of what you’re trying to do. You’ve thought about it. You’ve written a business plan. You seem unbelievably brilliant, but at the end of the day it’s going to be hypothesis, especially if it’s a new product to a new market. It is for sure.
Right now, obviously, financing is going to be extra tight. The nice part about that is almost no one’s going to be able to screw this up -"planning in the fourth quarter of ’09, we need to hire a Marcom person" – because you haven’t actually proven that you can actually consistently create customers yet.
The nice part about what is going to go on is no one’s going to accidentally screw up and drop into the product development methodology right now because capital is so tight. Most people are going to be forced to be up here.
Whether they realize they’re following this model or not, you are if you’re a successful startup. My first interesting startup was through Vidium. Because we had no idea what we were doing, we had no idea how to raise financing. I was absolutely terrified of it, because I’m not a business guy. I’m a software guy.
We actually were in this model. We call it a bootstrapping model. You can call it whatever you want, but you’re basically in this model, small and nimble, figuring out what your customers are going to be.
You can’t drop down to this model and say, "I have two million dollars in my seed round. So now I’ll just go hiring people and just tick this through. Tick, tick, tick, tick, tick."
You can’t even do that when you’re in bootstrapping mode. So there’s benefits to that. There’s actually a great benefit of what’s happening right now, is that the number of people that are going to drop down here and screw up, like I did, will be less.
You eventually drop down here and do this and you go, "Whoa, I’m wrong." Then you have to go back up anyways. They give you less constraints so you actually work your way back up to the customer development model because you’ll run out of cash when you do it wrong.
Winning and what hasn’t changed, there’s still a function of so many things, the function of your product and the function of a market, and how you’re entering that market: all those things are there.
Even from an investor, I really, really care about talking about your exit strategy, but if you want to blow me away, talk about your entrance strategy. You have an entrance strategy into a marketplace and you actually can articulate it?
And you actually have numbers like, "I know that I can write any marketing campaign if it’s two dollars or less per user and that’s why I’m using radio." I start to get really impressed.
You’re still going to get it wrong in problem if you’re not using customer development methodology, but if you’re focusing on the entrance, then guess what you’ve got? You’re right back to customer discovery, validation, and creation. You’re basically doing that whole thing. How am I entering this market versus how I’m exiting it?
Because one thing I can tell you is that I had no idea how to sell to somebody when I sold my first company. How would I? I’m not an MBA guy, never went to business school, software guy, total software geek. That’s what happens.
You have a business that has value that’s doing stuff that’s interesting? You automatically are going to get acquisition offers.
Even Cambry House, we got our first acquisition offers in the first five months, because people were afraid of what we were going to do. They were like, "We should buy you early." So we didn’t take it, obviously, but that’s the whole point.
If you actually have something of value, people will buy it. It’s not weird for me to say, go to Kijiji or eBay and sell my "24" series of DVDs, because the show’s popular. I’m not worried.
It’s not like it’s a magical event that I’m so lucky that someone’s going to come to my house to buy my "24" TV series, because there’s already a market for it, right? The same thing with your business. An acquisition event is actually nothing special.
The special part is that you actually have something of value. That’s why I don’t worry so much about exits. I worry more about, if you imagine that analogy if you’re in an elevator going up to the penthouse, where you get really screwed up is when you’re between two floors.
No one’s really going to pay for what you think you could do if you could on to the next floor solidly and get out of the elevator, because you’re stuck. There’s some type of emergency crew that needs to get in to either push you down or lift you up. So your value is always wrong, and if you’re stuck too low in the building, of course, you’re not going to acquire it. You haven’t figured it out enough.
You have to basically get to a high enough level in the penthouse, because otherwise it’s not interesting to buy you. Obviously, all this stuff is cyclical, right? when I, for example, raised money for Cambry House, it was a perfect time from a cycle standpoint, again, to be raising to be raising money for tech.
Dot-com had blown up in 2000. There were still guys who were super passionate, great companies. All of a sudden the cycles start turning around then you hear the exits, the exits of 2003, exits of 2004.
Oh yeah, big companies are buying tech again. Oh, it’s hot. You can go raise money. So we raised a lot of money because we were on the right side of the cycle. That actually led us towards a private development methodology, which hurt. We were spending more money than we needed to, because we had to work our way back up to customer development. But at the end it was all cyclical.
So right now, if anyone who’s going to be in a startup in tech, it’s not going to be easy money. Everyone’s going to be talking about the sky is falling. All the media is going to be about layoffs and all that stuff. You can actually be a cockroach and get through it.
You can actually, now be the early exits on the next wave. You will be the early exits to get out. It’s not like it’s not going to come back, all right?
So Bill Gates thinks it’s going to come back in 2011, 2012. So it’s going to take a couple years, but that’s what it takes to build up a company anyway. It’s an interesting point. These things, you could consider them both true.
So let’s talk about what has changed. I wouldn’t start a restaurant right now. I think it’s scary right now, it’s scary economic times, but people are pinched. Going out to eat and stuff? I wouldn’t start a restaurant.
Technology is independent. Microsoft and Apple both started in the ’70s with a huge recession going on. It doesn’t really matter. Microsoft built BASIC for the Altairs for their first product. There’s Altair computers. Someone needed to write a programming language for that. That’s literally independent of the economy.
So people are headed more towards technology. It’s actually an OK time for us. It’s scary. I’m not going to say it’s not scary, it’s not hard. But it’s an OK time, because generally the technology it’s not at these whims.
In fact, sometimes companies can be so pinched that this is the time you can say move them to software as a service. It’s cheaper. We don’t want to pay those SQL server licenses. We don’t want to pay those Oracle licenses. Move them to software as a service.
For the same reason, you can be really scared right now and companies can be really scared, they’ll actually even be motivated to now buy your new product. Especially on tech, biotech, and all that stuff.
Evaluations are your business are down. When Facebook says, "I reached 240 million at 15 billion." That’s incredible. That’s their pre-money number.
When anyone’s ever raising financing, there’s their pre-money and a post-money. When you’re talking to an investor, you can quote your pre-money and your post-money.
They will automatically go, "I like dealing with you, because not only will they know how much you’re valuing yourself at and how much you’re raising, I can subtract those two numbers and now I know the percent that I’m buying." It’s just a fast way of communicating that.
Evaluations are down. You’re just not going to raise as much money. Evaluations and startups are always black art. But there’s one simple trick for it.
If it’s less than 10%, you’re not going to be able to raise money, and if it’s more than 40 you’re hurting yourself, and any good investor won’t let you do it to yourself anyways. So most deals end up wiring between 20% to 40% of the company, anyway.
If I’m raising a million bucks, that tells me what my pre-money evaluation is. So what’s happened with the evaluations being crammed down right now. They’re so crammed down, because there’s less capital. If there’s less capital, if I could only reach 300 grand, well, it still has to be at least 10% of my company. It still has to be maybe 20% of my company.
So automatically, the dollar signs that are being injected into the business start dictating this, not the other way around. It’s a fact that the dollars are pinched when you drop the evaluations down.
The other part I want to mention here is about taking your cookies. It’s an old saying, but it’s so true. When the plate of cookies comes by, you should take one. The same thing with your company. If someone’s willing to invest in you whenever you should be leaning on the side of yes, not no, and fighting about this number.
Because if you need the cash, you should be thinking about it. If you’re asking to raise money, if you think you need the money, you’re hungry. Take your cookie right now. Don’t wait for that plate to come by.
That’s especially, true right now. There’ll be less and less people that are going to do that with you. Most people should be market cap investors. I should be looking at what your pre-money evaluation is before I put my cash in. I add that dollar to get your post-money. But people still care about share price.
It’s like showing a piece of software that’s got this amazing user interface, and nothing’s hooked up on the server side. Every single person who’s an investor feels completely confused by what you just built. They’re like, "The whole thing looks done, why do you need my money for it here? It’s beautiful?"
Now start explaining that there’s magic behind the scenes, all this magical plumbing that has to go on. You’re actually better off to show a napkin, with a scratched-up user interface in the beginning, because you’re not misleading people. Same advice I generally do with my stock price. Even though it really shouldn’t matter, I’ve actually found that it does.
So it’s just like a tip, if your company’s new, your stock price should be low. People love to go, and they can’t help but imagine your stock being worth ten dollars. They can’t help.
If you’re selling a stock at $1, 000 a share, I can’t get as excited by it being worth $10, 000. You’ve robbed me of it being worth $10, 000. Now I’ve got to imagine having a $10, 000 stock. People’s brains don’t work that way, even though it makes no sense.
Looking at a ticker price in the stock market makes no sense. It’s the market cap of the company, but by the time people are investing, by the time you’re actually aware enough to understand that you should be a market cap investor, you’ve had too many years of being conditioned for prices.
So from a psychological standpoint, I always make sure my share price matches the state of my company, like my user interface matches the faith in the project. Because if you get them out of whack, people get confused and they don’t know why. Even they don’t know how to articulate it.
I’m talking to a guy [laughter] in Germany about this one gem I’m considering investing in. He sold two of his companies – really big exits in the US. His key line to me on the phone was: "Do we both agree that we have the tremendous courage it’s going to take now to do this investment, because it’s a little early?"
Because almost everyone else is taking their money out to the sidelines. This is a guy that’s spun so many deals. I’ve done enough deals. And when we’re floating around our friends to see if they want to come in with us on another one, all of a sudden, everyone’s saying no. They are out. They’re out of the market.
You have to imagine now, if you are in any position of raising finance and getting financing, that whoever you talk to… that quote about seducing all their people, all their men… you have to make them feel comfortable. You have to make them believe that they should actually be… and take the courage to make this investment.
Because on the investor side, they don’t have to write the check. They can just wait. Why not just wait six months and see if you’re still here? Maybe you’ll be cheaper. Maybe you will have hit milestones. People like VCs and stuff almost will never say "no" to you. It makes no economic sense for them too.
Imagine that I want to invest in Greg’s company. Would I ever say, "no, Greg, I hate you, I hate the way you think, I hate your business plan, I hate all this stuff…" Why? I would be like, "you’re a little too early. Come back and visit me in six months."
So if he’s actually worked his kinks out, I have been there for him, and maybe answered one or two questions, maybe done an intro for him… he’s got his kinks worked out, now I’m in before he goes to talk to someone else.
There no economic reason for me to actually tell someone "no." Because if he’s passionate, he’s passed the animal test, and that’s… let him go off and discover what’s going to happen. Because then I can be there and invest alongside him when the risk is lower.
This courage point right now is super, super sure. And I can tell you, even as an investor myself, I am personally feeling it. I am actually feeling myself have less courage. And, I am probably one of the more optimistic investors that’s out there. I am a bit looser with my investments than I probably, should be.
The big valuations and stuff… a lot of that money gets wasted because you are stuck in that product development methodology and you don’t even realize that you are in that methodology. This gets investors, helps pump their courage up when they find out you don’t have an office. Awesome.
That they have to phone you or talk to you on Skype. I’m like, "Awesome." It’s like $2.95 a month for unlimited calls. Love those guys. Love finding all those little things inside of a business. So I’m like, "these guys are cockroaches. They can totally make it through this period."
This guy, Paul – he’s the guy who created Gmail and Friendfeed – he has the best quote on advice. "Limited life experiences plus over-generalization equals advice." So take it for what you will, but it’s just stuff from one person, who’s basically been doing this for about twelve years now.
I would actually consider other ways of doing financing that you maybe wouldn’t have considered five years ago, like a participating preferred share. So what is a participating preferred share? It’s just another one of those equity tools. It gives you equity. But, it basically gives investors a preference.
A lot of guys do deals like this all the time. But right now, you’re probably going to have to be more closer to this deal. I couldn’t imagine myself, investing without a participating preferred stock.
Guys that I’m interested in investing in, they didn’t have that structure, and I was able to tell them, with a nice bright line, "no worries, and if you don’t have participating prefs, I am out already." And so what does that actually mean? It just means it’s a liquidation preference and a coupon rate.
For example, in a deal right now I would be in, I wouldn’t do anything less than a 1X participating preferred. Meaning that if I gave them $100, 000, you owe me back always, off the top, $100, 000 plus 6% interest every year. I wouldn’t even put my cash in common stock right now.
Some investors are in participating prefs at 1.5X. So if I gave them $100, 000 and you sell the company for $150, 000, I get all of the money, and you as entrepreneurs get nothing. And so somehow entrepreneurs think that they are double dipping, because they participate.
So once the preference has been paid off, all your participating preferred stock converts to common, and now you also get the other side of the pool. It’s really not a double dip. What it means is that if you don’t execute against your plan and build up accreted value, it will hurt you. If you actually build up a great business, and you build up great value, it’s a rounding error.
Yes, if I invest in your company tomorrow, and you say you are worth $3, 000, 000 and I give you $300, 000 in participating prefs structure, you can’t go sell it for $3, 000, 000. You are going to have to make less. I get my money out first. That’s something awesome.
There is something called "venture debt, " which is not really that popular in Canada, especially for the younger firms. It’s just something to be aware of. It’s guys that are willing to do debt. But if you are super-early, they are not going to invest in you anyways.
Because how can you pay off the debt? So, basically, you’re really nice loans. I think government programs are amazing. I love the new Alberta Voucher program. I love IRAT. We’ve been so grateful we’ve gotten IRAT loans to do some of our research stuff. SHED credits. All these programs from the government are honestly amazing.
They are totally worth all of the work that goes in there, because they are not just money. They actually get smart people who are in the industry talking to all these other people on the way.
Obviously, that’s always been true. But right now, this can actually be some of the only people that have the remaining courage to invest alongside you. Some of the other angels have fled, right?
There is an old story about some Swiss Army guys lost in the Alps for three days, and they get out. And they go see their general and they’re like, "oh, we are so happy you guys are alive, we couldn’t find you."
It’s like, "no worries, we had this map." And the general looks at the map, and it’s a map of the Pyrenees. "That’s not the Alps, that’s the Pyrenees!" They’re all, "I know, but we had a map!"
Having a playbook and giving people confidence in you… in some way, any map is better than none. Because you could just look at the map and say, "OK, this is not the Alps, this the Pyrenees. But maybe there’s something we can learn from this. Maybe there is one piece of data." Sometimes people just having a tool that’s not even useful is enough to make them feel confident.
For example, sometimes investors just like to see you have a business plan. I can tell you that the way that we always distribute business plans, financial plans, this is like a web portal, so I can see what people read. And I can tell you that 99% of the time, nobody reads anything.
They don’t even click on the link. I don’t even have to say, "oh, they clicked it once, printed it out, and read it at home." I mean, they don’t even click on the link. It’s a map. It means that you’ve gone and done some homework. It’s maybe a false tool of confidence for them. That’s how you have to be thinking about anyone that’s going to invest in you.
What are you giving them? Are you giving them a playbook? Are you giving them a map? What’s going to happen here? How are you boosting their confidence in you? And then what I call "selling to the old brain."
There’s this whole concept of a "new brain" and an "old brain." The "old brain" has evolved for 500 million years, and at the end of the day the way people mostly make decisions is with their old brain.
The "new brain" is the stuff in the front, and this is where it’s all logical and rational, and down here, this is the stuff in the back… and this stuff’s not logical and rational.
For example, in the business plan, the business plan is going to go one of two ways for you. Find the exact reason that you can’t invest, or exactly find a reason why you can dismiss it. If you love me and I’ve already seduced you and I give you my business plan and it’s full of horribleness, you basically go, "I’m so glad I’m here to help this kid, because this is so bad."
"I’ve got to invest in this kid, " right? But if for some reason you can’t figure out why not to invest in me, I haven’t seduced you and I hand you my business plan, you’ll go, "I’m out, page 18, chart four, that’s not the type of curve I like to invest in." Nice. I didn’t have to say, "I just don’t like you." Right? This is generally what happens.
It’s the art of seduction that’s happening anyways. Humans are even more loss-averse and more irrational than monkeys. A monkey, on an experiment with losing on a gambling bet, is totally irrational about 2X. They’ll over-believe that their perceived loss hurts them 2X than it really does. We hate loss. It’s what mammals do. Humans are like 2.2X…
I was talking to some guys I was working with. They’re talking about buying a laptop, and they’re so afraid someone else is going to buy it they’re not going to negotiate on it. The savings of $100 on negotiating down… the pain of the loss is 2.2 times any type of savings. It starts to hurt more.
Once you start realizing that the way people are really going to make these decisions is based on their old brain, you have to have all these techniques… realizing that if you have a business plan, it’s because you’re just giving confidence, not because anyone is going to read it. It’s just a false map anyway, right?
I kind of super fan of bootstrapping, even though I have raised a lot of capital in my life, but I’ve actually found that when I raise the capital, that’s when I got sucked in the product development side and wasted more.
It’s on the bootstrapping side, even if you don’t have any idea of customer development methodology versus product development methodology, you are forced to be in the right side.
Because creativity loves constraints, you will work your way out. You can’t use capital to over-hire and believe you can just go left to right on a business.
My advice is basically angel five. VCs are obviously there, and they get the most quotes, they get the most paper because they have the biggest files. But the guys who are going to make the biggest impact and win it are generally the angels. Because they are there in the beginning.
You need to get yourself into that "Series A lap" generally before most VCs will get interested in you. And if they are interested in you earlier than that, it’s because maybe they’ve got a matching program from the government, and they need to make an investment in western Canada before it goes away. I’m not saying you can’t get those deals, but they’re not the right guys.
And one side tip: Series A doesn’t mean anything. Series A, it’s just a label that I’ve given. It basically, means that by the time I’m at series A, remember there’s that chart customer development methodology, there’s basically discovery, and then there’s company building. Series A means you know how to build your company. That’s what you’re supposed to say.
When you’re Series A, it means you’re beyond discovery. You know how to build. Hence, VCs come in and give you cash. Take Crispy Creme Donuts. You have one donut store, you don’t know how to open up a second: too early for a VC.
Maybe you’ve got ten stores, you want to roll up ten thousand stores? That’s VC. You understand how your customers work, how to segment, how to target them, how to do ads in local papers, how to keep your costs down, all those things today are company building. I actually have always had more appreciation on the angel side then on the VC side.
Because if you see guys… some call them "vulture capitalists" and terms like that. It’s just that… they’re just harder to seduce. Because it’s their full-time job.
It’s not some guy who’s maybe made some money in a business, he’s kind of bored, semi-retired, he sees some young kids, he sees a lot of attributes in this kid that he loves and wants to invest in him, now he has something exciting to talk about at the dinner table.
The VC guys they are just so much more methodical about what they’re doing. In the beginning of your business it would be way harder to answer any of their questions. The VC guys get all the stage because they have the biggest funds.
It doesn’t mean that angel guys don’t have just as great quotes but they are harder to find because they are busy making investments and building companies versus talking about it.
But what I love about Arthur Rock is that he’s always been one my favorite VCs. At a presentation, I gave recently, the audience questions were all along the same lines. "How do I get in touch with VCs? What percentage of the equity do I have to give them?" None of them asked how to build a business.
That’s actually what you’re trying to do. If you talk to entrepreneurs they are all worried about – "if I take money – I’ve lost control" or something.
And they don’t even realize that once you’re raising money, you have to move away from a founder-centered business to an investor-centered model, automatically. It won’t work.
Founder-centered company: all of a sudden my wife and I are going on a cruise to Hawaii, because there was a course there for two hours that I wanted to take and I’m expensing it through the business. It doesn’t happen when you take other people’s money.
These are almost all irrelevant questions. You should be talking to someone who knows how to help build your business. So whether they’re an angel or a VC, what you guys should be talking about is how do I build a business, not how expensive is your money to my equity.
Because as an investor, I still can’t really screw around with you. If I have any smarts, if I do you’re gone. All of a sudden in the nightmares that occur in businesses, if you don’t earn enough if it, you’re not going to be there.
And most VCs and most angel investors are actually not looking to become the CEO of your firm, in general. Of course, there are always horror stories of stuff that has happened. You know, people will steal your ideas, people will steal your money, people will give you bad investments. Of course that is all true.
Some people when they are driving to work get murdered. It’s horrible, it’s gross, I don’t mean to talk about it in a glib way, but it doesn’t happen very often. You can’t live your life on those parameters. You have to get up, drive, and go to work.
So when you’re trying to secure capital, these are the questions you should be talking to whoever is going to invest in you. Not these questions: "How are we going to do this together? Do you like any of my ideas?"
And one of the biggest sins that, I see, entrepreneurs make is that they are all like they’re smart enough to know this quote and they’re smart enough to say that they don’t want just me and they’re looking for "smart money" and you hear all this stuff, but then you just go and you test it. What of my ideas have you implemented and why do you need me? So you have a bit of homework.
Now that your ideas are implemented you should be up. They’re just basically telling you this quote because they are looking for your cash.
You don’t want to even be invested in that company, especially if you are an angel because you have a smaller portfolio that you have to win on, right? Whenever you are dealing with these guys just do your homework on the language right?
I went to the Vancouver angel forum. It was an awesome show, I love the Vancouver angel forum. I was there raising financing. We raised financing of $700, 000. So from landing $700, 000 Tuesday, on Friday the checks were given to us. But I walked around the room, because I am also still an investor and I’m asking every single person, "what is your pre-money – what is your share price?"
The reason I didn’t get to post-money is that zero people can answer my pre-money question. Which I take to mean zero can answer the post-money question which means that zero can answer the share price. Zero.
So now as an investor, I have to go educate you on all your deals. "Ohh, give me $25, 000 as a bet." "I’ll bet on you, here’s $25, 000". I think it’s way more rare right now, I think we have to wait a couple of years to get that.
But by not being able to answer those questions and know the language, automatically when I walked around that room. Let’s say I had 25 grand and I’m willing to give five guys grand because I don’t care. I don’t want to give you advice, I don’t care. Here’s five grand each. It’s the cheapest money you ever get.
Fifteen minutes, a check, a subscription and you move on. Great. As an investor, love those deals. For fifteen minutes of work, that’s a great hourly rate.
But if you can’t answer that question now I have to get married to you. And guess what? Most of the guys in there, they don’t want to get married that fast. No one does. Now I have to come and I have to fly to Vancouver and I have to figure that stuff out. So it’s just something to think about as an entrepreneur. I put huge error bars on this, because I think it’s so scary.
I did my first angel investment when I was 24. Because I figured I love this space so much, it’s going to take me a long time to get experience so I better get into it early. It’s really scary, because, generally when you’re young you have to lie.
You can’t even be an angel investor, you have to actually commit a lie. "Yes, I have $1, 000, 000 in liquid assets" because you have to have the pass national 4105. Otherwise you can’t invest because it’s so risky.
But, you actually start learning a lot as soon as you are on the opposite side. As soon as you are on the other side saying "hey I have a $100, 000 to start my company". Here’s 50 for an investment, here’s 50 for me.
Imagine now giving half of your money to another person you are investing in, how all of a sudden everything changes, it totally changes. Your whole outlook on investing changes and you get way smarter right?
So I’m not saying anyone else should do that, I’m just saying that I know for example for me that I learned a lot. If this is true for you, that your product or your business must come out of you regardless, then for sure it doesn’t matter what is going on with the economy.
Beethoven did not care if piano music was commercially viable or not at the time, he just composed. If this is true, from an advice standpoint, then for sure you should do, for sure, always right? And then I just want to have any questions.
So you talk about the pre-money and the post-money. You also have to propose your story – to justify the pre-money and post-money. What are the strategies…?
Like how am I going to get excited about what you are doing? Like earlier on it’s more about what you’re doing with your capital. I don’t really care what you’re asking. I’m just going to be like, whoa that’s a lot of money, or that’s not a lot of money.
When it’s not a lot of money you stop asking questions about what they’re doing with it because oh, well there’s two guys raising a 100 grand OK, so I’m just going to pay you to develop the product that’s all you’re going to get. You don’t even have to ask any questions.
Well, there are a couple of guys raising a million bucks. What are you doing with that? The most important part of that story is your "use of funds" and I’m putting that in quotes because I’m trying to get my head around how you’re getting yourself through the terrain. The amount of money that you are raising- I can’t let it be more than 40% of your company and it’s not going to be less than 10.
We can fight in between those two ranges as much as we want but I know I’m not going to go over 40, because you’re the one who has to carry the heavy bag, not me. And if go under 10, why am I in? I don’t own enough.
Automatically, we’re only fighting in the middle of there. And the better answers that you get, the more that you get towards 10 and 20s. The worse answers that you get the more I push you toward 40.
That’s all I do as an investor myself. You can’t value the stock, there’s no like business with discounted cash flow. It’s all made up, especially early on. As businesses get old and mature all of this stuff makes sense.
How do you do that on – there’s a couple of guys, there’s a product, no sales. Actually the amount that you’re raising, and what you’re doing with it tells me the valuation. That’s where I get the number from.
At least you want to be honest.
[laughs] That is honest! There is no technique to valuing your business. If your business is doing so well that I can actually do discounted cash flow on you – then you are at a different level.
You’re probably doing $10, 000, 000 a month. At $10, 000, 000 a month I don’t even know why you’re talking about this. Go get a book from McKinsey. It’s the greatest book ever written it’s literally called "Valuation" by McKinsey. That’s the book.
Unfortunately, for probably every single person in this room, it does not apply. If I was a McKinsey consultant, how do I walk into a multi-million dollar company and decide to buy another multi-million dollar company?
There is a lot of known art and known science there. I’m an angel investor, I have made a little bit of money, you have a product idea. You have no idea how you’re going to get it to market. How do we value the company?
Actually show me how you’re going to use the funds. If I think your use of the funds is amazing and I’m excited, then I can help put more money in. If I think you’re use of funds is really scary or really dangerous, I’ll be like you only get 50 grand. It’s not about lying or trick or technique. There is no methodology, there is none.
If I’m asking you questions as you go up the elevator and I just can’t buy them, and there’s no testing of hypotheses and how you are going to back down to the floor if you get it wrong, I’m already not going to get it. A map’s important like that guy in the Swiss Army that was lost. Any map is better than no map.
But unfortunately, I’m going to put huge error bars in your path. If someone comes to me as we’re going up to the diagram and there’s all these hypotheses. They actually put hypothesis, assumption, tests that must be proven before we can go up to the next floor I would be like OK I love this person. That’s actually what we’re doing.
We’re actually not being confident. I can’t come up to you and say OK, this is how you start a company. You do this, you do this, in the 4th quarter you do this. I can’t say that.
I can say these are the things that I hope are true but I’m not sure, I’m testing them in the market. I can acquire it for no more than $0.50. Is that true? I don’t know, go test it. Oh crap, it’s $2.75. Should we be in business? Yes/no.
What you’re looking for and what most angel-type investors are looking for is somebody who has that…?
How do we office the stuff? It’s all fate. One guy that I invested in was working full-time when he started his company. So some investors were saying – anyone who doesn’t believe in themselves, how can I believe in that guy? So watch this, you say that’s me. He quits his job, how fast does he get his check?
So I think, how can I negotiate between the entrepreneur and the new investor. So I say, I’m in, so you’re not in because he’s working full-time yet he’s built up an awesome business. So he’s going to quit sometime, but he’s a cockroach so he’s not going to waste any money. So you’re telling me, you promise you’re going to give him a check for a 100 grand if he quits his job.
It’s not true. You can always negotiate through those things. You always can set up one-line simple sentences with one piece of paper that would remove all those problems. You’ll find out that no one’s going to invest anyways.
If I’m not investing in you because you figured out how to keep a job and build up a company, I’m not investing in you because there’s something else going on that even I don’t know how to articulate. Sorry, I give long answers.
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