“I’m raising ‘X’ at a ‘Y’ valuation”

X: How much should I raise?

How expensive are your experiments?

In any startup, there are huge risks in your future. Your job as a seed-stage company is to identify the biggest risks and tackle them first. Money doesn’t buy you a ticket around these risks. Instead, fundraising allows your team to build experiments that attempt to solve these challenges.

At LabDoor, the most expensive part of our early operations were literally experiments – analytical chemistry assays that we used to reverse-engineer dietary supplements and energy drinks. In our pre-seed stage, we raised $250,000 from local angels, friends & family, and me. That had allowed us to build out our proof of concept – 100 simple LabDoor reports viewable on a web application.

At this point, we had seen 20K+ people use our product, were preparing to launch our first mobile application out of beta, and had clear customer metrics to guide our short-term product roadmap. We just didn’t have the cash or manpower to analyze new products or build applications faster, let alone spare a dollar for a marketing campaign.

The biggest risk for startups like ours is proving that consumers would actually use our products to successfully manage their health and safety. Our hypothesis was that if our applications could cover over 80% of product sales in the supplement market and actively engage users at scale to add their products to a ‘LabDoor Cabinet’, then we could quantitatively prove consumer demand for LabDoor.

We worked backwards from there. I calculated the expected cost of the analytical testing, weighed the value of potential hires, and worked with my team to estimate our annual marketing spend. Then I added the cost of one additional startup experiment in each category (never go all-in on the first shot), and settled at a $750K seed round.

Y: How much is my company worth?

Wrong question. Seed-stage valuation has very little to do with the actual liquid value of your company.

It has everything to do with the market value of the convertible note or equity document that you’re selling. Can you demonstrate scarcity in the market, led by respected investors? Who is begging for participation in the round, you or your investors? And what are market conditions in your startup community?

I would suggest finding a valuation that efficiently clears the market for your target raise. If you’re raising $1,000,000, review recent successful fundraises on sites like AngelList, and honestly assess your startup relative to these companies. Startups with built-in networks, like recent YCombinator graduates, will likely raise at a higher valuation. If you have no clear path to a lead investor, consider dropping valuation below the expected average. Remember, your number one objective here is simply to put money in the bank, so don’t stress too much over 0.5%.

If forced to pin down absolute values for 2013 Silicon Valley pre-money prices, I’d label $2-3MM valuations for weak seed rounds, $4-5MM for average seed rounds, $6-7MM for ‘hot’ seed rounds, $8-10MM+ for all-star seed rounds, $20MM for Jack Dorsey (Twitter edition), and $40MM for Jack Dorsey (Square edition). And expect 50%-100% discounts for any round raised outside the SF Bay Area.

Note: One of the biggest mistakes entrepreneurs ever make is to raise a round of funding at a valuation where they would be comfortable selling the company. At this point, your incentives will be horribly mis-aligned with your early investors, who are counting on you to bring them a 10x-20x return on their investment. If you’re trying to make a $5-10MM company, don’t choose investors who are looking for $100MM+ companies. In many cases, you’ll be better off bootstrapping to profitability with a simple product or service, and building out the company on revenues. (There is absolutely no shame in this – an exit at this range will instantly put you in the top 10% of entrepreneurs.)

Take as many entrepreneur meetings as possible

If there’s one idea from this blog series that I hope sticks with the most startup folks, it’s that entrepreneurs should go out of their way during the fundraising process to meet as many fellow entrepreneurs as possible.

This may seem counter-intuitive. Fundraising is supposed to be a ‘full-time job’. No time for ‘having coffee’ with a ‘random entrepreneur’; just “put money in the bank”. That’s the advice I always got.

However, fundraising is a very exhausting process. We pour endless energy into an investor and hope that something sparks in their minds.

Conversely, in meetings with entrepreneurs, energy flows back and forth, as each party fills with excitement while discussing their vision and goals. Worst-case, a meeting with a fellow entrepreneur turns into an impromptu counseling/commiseration session, with both sides bitching about a disrespectful investor or sharing the constant fear of missing payroll.

I’ve found that these meetings are a great way to recharge along the fundraising path. They are also often great sources for investor introductions and references, which can actually make the journey significantly shorter.

For me, this was one of the most important features of joining a startup accelerator. Having thirteen other CEOs available for support and feedback was incredible.

Remember: Never startup alone!

Investor: “I’m interested but I don’t want to lead”

Whenever a potential investor tells me that they are ‘waiting on a lead’, this indicates that they are not capable/confident enough to make an investment right now.

Here’s the dilemma – once you have a lead investor, it will be way way easier to get investors to follow. So these ‘follow-only’ investors who hang around you early in the process are actually not that valuable.

Even though it’s tempting to keep around people that seem like they may want to give you money, I would be extremely wary of these folks. At best, they’re time-wasters. And at worst, they’re trying to earn an ‘option’ to buy your stock at a future date when someone else has taken the first (and biggest) risk on you.

Split them into two groups:

  1. Investors that are money-only: I would play hard-ball with these folks. Their value is limited anyways, so try to pressure them to commit money early, with the implicit (or explicit) understanding that it’s now or never for them to get into this round. Worst-case, you lose a weak investor. Best-case, you close easy money.
  2. Investors that are money + value: If they are truly interested and valuable, keep them on your list at an early part of your investor ‘funnel’. These are people that should get update emails when you convert investor commitments, sign pilots, or get positive press, but not people who you need to spend time meeting and pitching. Prepare to close them quickly once your lead investor signs.

‘Sprint and Follow’ Leadership

“Lead by example.”

This cliché, constantly provided to new entrepreneurs and first-time CEOs, is often terrible advice for the heads of large organizations (or founders of startups that aspire to be large). What entrepreneurs usually gather from this recommendation is that they simply need to work their asses off, and their team will follow them.

This kind of ‘sprint and follow’ leadership works great for short-term objectives and small companies, where the passion and charisma of a leader can will a team to a win. The original ‘sprint and follow’ leaders were Braveheart-style warriors, where the objective was victory in a single battle and the alternative was near-certain death. But on a scale of leadership, these people would be categorized as Level 3 or Level 4 leaders.They achieve significant performance standards from their teams, but find their gains unscalable to larger projects or longer durations.

One of the hardest parts of being a product-oriented CEO is learning to lead the team from the sidelines, instead of trying to make every play themselves. Mark Zuckerberg once famously operated in the latter fashion, continuing to work in the bullpen and driving Facebook’s heads-down, developer-centric culture from the front.

In this structure, motivation is often extrinsic and reinforcement is often negative. Bill Gates, the top product CEO of his generation, spent much of the first five years of his Microsoft career directly leading the technical development, often jumping into action to redo work when his employees did not perform up to his standards (and then openly berating them for the errors).

“At various stages of the company I’ve had to learn new things. In the first five years I didn’t let any line of code get out of the company that I hadn’t reviewed, and most people’s code I didn’t like as well as mine, so I’d mostly just rewrite it.” — Bill Gates, October 13, 2005

Confession time: I am not a Level 5 leader. But I come to work at LabDoor every day focusing on the skills and will necessary to earn that title.

In my early days at LabDoor, and at Avomeen before it, I was a ‘Sprint and Follow’ leader. My key metrics were hours worked and tasks completed. I reviewed every report and sat in every meeting. It was truly painful for me to watch a project get delegated and then completed less-than-perfectly. At Avomeen, if the output on a Scanning Electron Microscope reading looked a little blurry, I’d jump into the seat and spend thirty minutes developing a better image myself. During LabDoor’s time at Rock Health, it was a matter of pride for me to be the last person out the door each night, not just from our company, but amongst the entire accelerator class.

After about 30 straight months of this between the two startups, things started fraying at the seams. I found myself constantly exhausted, permanent bags under my eyes and increasingly losing my battle with the snooze button each morning. My team, which had loyally sprinted with me every step of the way, began to show signs of slowing down as well. We were a powerful force at the edge of our limits. I was building a lean startup in all the wrong ways.

LabDoor has since done a ton of things right. Starting at the top, I’ve trained myself to recognize and highlight my own shortcomings, especially to my own team. It’s given me the courage to ‘quit’ on projects and tasks that weren’t positively impacting our company. My two co-founders owned their departments, and led without being told to lead.

We had fewer team meetings. The press stopped hearing from us. Our perpetual ‘seed round’ quietly closed. And through it all, we had the most productive four months of our company’s existence.

Now, we’re lining up a series of huge milestones ready to launch in rapid fire over the next few months. We’re all working towards the same key metric — the amount of actionable scientific data delivered to our users.

I’m not delegating more or working harder. The real lesson is much, much simpler. I simply acknowledged my numerous weaknesses, eliminated them from my ‘job description’, and focused my one true strength — intense, unbridled passion — towards the stuff that was left. I’m still not a Level 5 leader, but I’m getting closer.

Launching a $1M+ startup for under $10K

Case Study: 10 Storks

The fastest and most effective way to build a business is to start selling. Customer development must precede product development. It doesn’t matter if all of your business processes are manual. And lack of experience is no barrier.

In June 2013, my partner Shoua had just graduated from college and was looking for a ‘real job’. My entrepreneurial sales pitch to her was simple – start a company instead. Worst-case scenario, she earns a ‘real-world MBA’ and increases her job prospects. Best-case, she builds a real business and gets hooked on startup life.

Together, we came up with the idea for 10 Storks, a subscription service that provides a mix of essentials and luxury items for pregnant women. Shoua’s years of nursing and women’s studies education fit perfectly, and after a little startup coaching, she was off talking to potential customers and designing products.

Key objectives:

  1. Go from idea to launch in under two months: You’re not a real startup until you ship product(s). One of the reasons why startup incubators are so successful at launching strong startups is that they have the built-in time pressure of Demo Day focusing founders on building and shipping.
  2. Positive unit economics on launch date: This is basically Business 101, but so many startups, especially those with VC money, completely ignore it. Our initial responsibility was to maximize the customer experience while (barely) breaking even on the product.
  3. Go from launch to a profitable business with $1MM+/year revenues: In all honesty, 10 Storks has the chance to be more small business, not startup. And that’s perfectly fine. Our goal here is to build a real company, one that pays real salaries and makes real profits.

Key limitations:

  1. No real development or design experience: For startups like 10 Storks, distribution is king. And subscription commerce distribution is 90%+ web-based. At a minimum, we needed a professional website with payment processing and the ability to launch and track SEM ads. We had to hack together a low-skill solution.
  2. A CEO with no real entrepreneurial history: Shoua is the kind of person who worked 30+ hours on nights and weekends while managing a full college work-load and making thousands of dollars selling stuff on eBay and Amazon on the side. Her mission is to prove that actions are more important than experience.
  3. Only one FTE: I work 80+ hours/week at my own awesome startup. My time commitment for 10 Storks was limited to ad-hoc ideation, nightly strategy sessions, and a few Sundays worth of amateur ‘web development’. 10 Storks was and will always be Shoua’s baby (no pun intended).

Getting started:

Here’s a very counter-intuitive, but extremely valuable, startup exercise. Sit down with a notebook and start writing down every reason why your new company will fail. Don’t be shy here. No investor or reporter will ever see this piece of paper, so if you sugarcoat anything here, you’re only lying to yourself. Try to hit at least 30 potential risks.

Now, rank-order these challenges, with #1 being the most likely to kill your business. Things like “Bank Account = $0” and “New Customers/Week = 0” should be at the top and “Someone steals my idea” and “Someone sues me” should be near the bottom.

Your job as a startup founder is now to orient your company and product decisions in a way that attacks these biggest risks first. This maximizes your velocity towards building a real business. It will also help you eliminate early monetary sink-holes. Ignore the big investments in scale, like inventory and infrastructure. Variable costs are your friend – money now is worth so much more than money later. And avoid anything that requires lawyers or accountants.

Five lean startup lessons from 10 Storks:

  1. Start saving early. When I launched my first startup in 2010, losing $10,000 would have put me seriously into the red. Now, we’ve built up enough of a personal runway to make a big bet on ourselves. It’s still a relatively large risk on my part, but we’re privileged enough to not have to live on the street if this all goes to zero.
  2. Earn supplemental income. In these calculations, the $10,000 is all for the business. You’ve also got to keep paying for rent and groceries. To help pay our bills during the early days of 10 Storks, we implemented an unusual income source – dog sitting. We have two dogs of our own, so it seemed like a small incremental effort to add a couple more for $30-40/dog/night. One weekend, we took care of a total of six dogs, all male, ranging from 20-80lbs, in our 700 sq. ft. apartment. Our apartment was half startup hub, half dog kennel.
  3. Choose one decision maker. At this early stage, many of the decisions you make will end up being wrong, whether you take 5 minutes, 5 days, or 5 months to make your move.  It’s fine to debate key strategic moves, but an efficient single trigger is essential. In 10 Storks, I deferred all final authority to Shoua.
  4. Favor instant gratification. Put off as many long-term investments as possible. Skip bulk purchasing – the lessons from your first five customers will inevitably change your product offering. A professional ‘Terms Of Service’ and ‘Privacy Policy’? Definitely not part of your minimal viable product.
  5. Do things that don’t scale.  Use your diminutive size to your advantage. Perfectly personalize the customer experience. One day, you’ll tell your salespeople to treat every customer like the most important person in the world. It’s time to live up to that ideal right now, especially since your first customers will truly feel that special.

Results:

10 Storks launched, on schedule, on August 1st, 2013. In June and July, we spent $260 on web development tools and templates1, $400 on operating expenses, $620 on prototype boxes for mom bloggers, and $3,450 for the contents of the initial run of 10 Storks boxes2. We still have over of the money left over to fulfill upcoming orders and start testing our initial marketing strategies.

Between pre-release beta testers and launch-day customers, we sold out our initial boxes by 4:30PM Pacific on August 1st, and tripled our order for box contents that evening. We barely managed to keep up with demand through the traffic, and are back accepting orders now. 10 Storks is on pace to have over 50 paying customers in month one, and we’re targeting 500 new customers over the next 3-6 months.

Past performance is no indicator of future success, but 10 Storks has exceeded every goal and milestone we’ve set for it so far. As for that $1M+ valuation, I have no doubt that Shoua could have investors lining up to blow that number out of the water. For now, she’s continuing to build the company the old-fashioned way, through customer orders.

This post was initially published at Medium.com. Also, buy a 10 Storks box.

Notes:

[1] Some of these costs can obviously be minimized or eliminated based on the capabilities of your team. Our team’s limitations, especially as they relate to my skills and available time commitment, drove a few of these purchases.

[2] There are whole categories purposely missing from our expenses list. For starters, total marketing costs equaled $0. All initial distribution was performed through social media, content, and reviews by mom bloggers. We also spent $0 on rent, salaries, lawyers, etc.

Traction?


“You’re too early for me.”

This classic investor line is a staple on the fundraising trail for early-stage startups. It deserves a place alongside “it’s not you, it’s me” on the pantheon of rejection lines. However, it seems like no investor ever has a straight answer for how much traction they really want to see. Instead, you’ll usually get a long, rambling response including the phrases ‘it’s not an exact science’, ‘we know it when we see it’, and ‘product-market fit’.

Who has the real data? According to AngelList, these are the traction numbers you need to hit to raise a $1MM seed round on their platform (Source):

  1. Enterprise: 1000 seats @ $10/seat/month
  2. Big Enterprise: 2 pilot contracts, some revenue
  3. Social: 100,000+ downloads/signups
  4. Marketplace: $50K revenue/month
  5. E-Commerce: $50K revenue/month

Nowhere close to these metrics? There are two directions to go:

  1. Investors will forgive certain entrepreneurs for lack of early traction. These include founders that previously executed successful exits (especially for the investor herself), founders with unique industry-specific experience, and founders they like.
  2. If you don’t fit into one of the categories above, it’s time to seriously consider downgrading to a smaller round led by friends & family or bootstrap the company until its next big milestone.

Many investors wrote off LabDoor immediately. Real science is super expensive, and there’s no obvious business model. We weren’t the hottest company on TechCrunch, and we didn’t have millions of users. But we stayed extremely focused on our strengths – team, product, and story. The best investors pick for extreme positives, not the lack of negatives. Find those people, and do whatever it takes to add them to your round.

And those investors who labeled you “too early”? Remember their names, and don’t be afraid to tell them that they’re too late when they show up at your Series A.

3X Startup Founder. Love Science & Startups.

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