We’re very happy to announce that the Kauffman Foundation has made a significant contribution to support Venture Hacks. If you don’t know them, Kauffman is a $2B non-profit foundation devoted to entrepreneurship.
How it happened
Update: See Bo’s comment about why they decided to support Venture Hacks.
Earlier this year I got an cold email from Bo Fishback at the Kauffman Foundation:
Hey Nivi –
I’ve been following Venture Hacks for a while and have sent many many people there.
I’m interested in talking to you about sponsorship or support. Can we get on the phone for a super short call sometime in the next couple of weeks? Not this week.
After a phone call, I flew to Kansas city to meet Bo and the Kauffman team. I pitched them without a deck. Instead, I built a 1-page outline, Wufoo-style, and “did it live”. If I wanted to show them our analytics, I pulled up Google Analytics. If I wanted to show them our products, I went to our products page. If I wanted to show them testimonials, I went to our Twitter favorites.
When I got home, I got some advice from Steve Blank: when you’re making an enterprise sale, do your sponsor’s work for him. If your sponsor needs a pitch for other people in the organization, build it for him. So I called Solvate and they helped me build a deck which Bo used to make the sale to their grant committee. Here are a few random slides from the deck:
Kauffman is a $2B non-profit foundation devoted to entrepreneurship — they fund Nobel prize winners. And now they want to reach you — the future founders of high-growth companies.
We’re very happy to bring them on board as a supporter and to welcome them to Silicon Valley.
In the second part of my interview with Eric Ries, we discuss (1) acquiring customers without launching and (2) opening up board meetings to the entire company.
At IMVU, Eric and the management opened up board meetings to the entire company. Why?
To give people the information they need to do their jobs.
To teach everyone in the company to think like the CEO.
To prevent employees from gossiping about board meetings.
I’ve synchronized the audio with some simple slides below. That’s my favorite way to consume the audio. You can also find a transcript and stand-alone audio below. Please let me know if you find the transcript useful.
Read on to learn what kind of employee Eric used to “show the door” at IMVU…
How do people find out about our product if we haven’t launched?
Nivi: And this gets to a second topic, which is you guys weren’t doing any of this really in public, because you had not launched a product, right?
Nivi: Nobody knew who you were, but people were, at the same time, were using the product, so how did you do that?
Eric: I got a question today which was something like, “I’d love to follow your advice about not having a public launch, but we need to get early beta users for our product launch. How can we do that if we are not willing to talk to bloggers? Nobody really knows who we are.”
I think a lot of people have that attitude, that without PR, you just can’t get any early customers. Again, we have got to start with, “What is the goal of early customers? Why do you want them?”
If you are charging from day one, one of the reasons you want them is you actually want to make money. You want to show that your business is viable. But even if you are not charging money, you have a need to find out whether your business is viable, whether you have that minimum viable product, whether the business model, at the end of the day, is going to work.
For that, you do need customers, and you do need to be putting customers through a product experience that will give you that information. But you don’t need a lot of customers. I think that is where people get confused.
For a big fancy launch you can get hundreds of thousands of customers to show up for one day. But for metrics analysis, generally a cohort of 100 people or 1,000 people are plenty to learn from.
If you change your goal from, “How do we get the maximum number of customers,” to, “How do we get the minimally sufficient number of customers to learn what we need to learn,” new possibilities get opened up to you.
Acquiring customers on $5 a day
Eric: For example, at IMVU, we practice the $5 a day AdWords campaign. I was the VP of marketing in those days. If I actually knew anything about marketing, I would have known not to try this. By traditional marketing standards it is considered crazy to spend only $5 a day, but we had a pretty low budget and we really were pretty frugal.
I discovered that in those days you could buy clicks for five cents a click. But to me, $5 a day meant every single day 100 human beings are coming to try my product.
If you think about that from a beta testing point of view, especially if you look back at the old days of software shipped by CD, getting 100 people to try your product is actually a lot and you can learn a lot from that. And at 100 people a day, you are in good shape, just at that tiny, tiny level.
The risks of doing that are really quite low. I think a lot of engineers have this idea that once you put your product out there in public, the investigative journalists are going to find out about it and write about it and we are going to lose control of the story. Let me tell you. You should be so lucky.
IMVU was a top 1,000 website in the whole world before it got any press whatsoever. We were making millions of dollars a year. The press was writing about newly funded, venture backed competitors that had no traction whatsoever; because those were the guys sending them press releases.
It was frustrating, and psychologically you want to have that cover story on WIRED that you can send home to mom, but you know what? We did not start this company to have good vanity covers printed about you in the press. We were there to serve customers and serve them well.
Running experiments under a different brand name
Nivi: How do I run experiments, if I already accidentally got that TechCrunch article and I…?
Eric: Yeah, I am sorry. You are not doomed, but you are going to have to go waste energy later cleaning up the positioning that you put in that article, which is undoubtedly wrong.
Nivi: Right. There is that aspect of it, but do you think you should, just basically pretend that article never existed, or do you run tests under a different brand name?
Eric: That is not a bad idea. Especially on the iPhone, I see this because of Apple’s stringent release process where there is this huge delay before you can actually bring things to market.
And also because people want to get into the top 25. That is where all the action is in the Apps store. There is a lot of competition to make sure that on the day you launch your app you get all the right coverage lined up and all the stuff happening.
People feel like they don’t want to do a bad launch under their real brand name, because that will harm their ability to do the proper launch later and get to the top 25.
But there is no law that says you can only bring out products under one brand name. I strongly, recommend that to people if you are very concerned about your precious brand. I think most startups are way too concerned about the power of their brand. They should be so lucky to get some kind of brand going.
Even still, bring it out under a terrible name. I specifically recommend people bringing products out under brand names that they hate so that they won’t ever be tempted to make that into their real official brand name and then become afraid to experiment with it.
You have got to be bringing products out under a brand that you feel comfortable experimenting in. Then once you find the right formula, there are two possibilities.
Either you will be able to port that product over to your new brand name and it will be great, or the product concept you brought up under that bad brand name will be so powerful, you just can’t get people away from it.
It is too sticky and you are stuck with it. But congratulations! You are successful! Is it really so bad that you personally don’t like the brand if customers do like it? I think it is not so bad.
Running pricing experiments in public
Nivi: A friend of ours has a popular subscription based product that they don’t charge for and now they want to start charging for parts of it for the premium model, and they want to find the optimal pricing strategy. How can they run those experiments in public and in secret? What would you suggest to them?
Eric: I would actually not be afraid to run them in public. It is hard for people who are afraid of what the worst possible thing that could happen is, to do this. But I think it is good to just try it and get over it.
What happens is, it is true that customers don’t generally like the idea that one customer got charged one price for something that somebody else got charged a different price for the same item. So there is some risk when you do different pricing offers in a split test.
But in my experience, there are two mitigating factors that make it not so bad. The first is it is actually incredibly difficult for most customers to figure out that is happening, especially if you only do it in a limited time window.
For example, I am going to tell you a story that may not seem related, but bear with me. When we were at there.com, the virtual world company, we would do a lot of QA. That was a heavy QA company.
For hours every day we had QA testers sitting in a lab together running the virtual world software and testing to make sure that it worked. I remember one day getting called in to see about…
There was one tester. They were around a physical corner from each other. So you couldn’t see each other, but they were not more than 20 feet away. They were both engaged in this activity.
The guy called me down and he said, “I am in this dune buggy riding around with somebody in the virtual world and we are seeing this glitch. We are not seeing the same thing. Something is not right.” They were calling back and forth, trying to pin down what it was.
I remember sitting there really confused about what the problem was, because it looked like the two of them were sitting there in the dune buggy and everything was fine.
I walk around the corner to the other guy. I talk to him about what the problem is. I look at his screen. On his screen, he and the other guy are engaged in a paintball match. They are not in a dune buggy at all.
He was almost a mile physically distant in the virtual world from where the other guy was, yet their conversation was perfectly consistent to them and it never occurred to anybody to ask, “Wait. What planet are you on in this time that we are comparing notes?”
They had no clue that this was happening. I think, we totally tend to underestimate just how powerful the pull of what you see is to most people. They basically can’t imagine the world, any other way than the way that it is.
Entrepreneurs don’t have that problem, so a lot of times they don’t grasp what is true for customers. It is actually very unusual for the customers to go onto a forum and post, “Here are all the offers that I am being offered and exactly what I see. Does anybody else see the same thing?” Our natural assumption is that everybody else sees the same thing.
So you are not totally likely to get caught. That is a mitigating factor. It is actually not as bad as you think when you do get caught, because don’t forget; you have the power of the apology, especially as a startup.
If you screw up… You are going to screw up all the time. If you are a customer of a startup, your general experience is, “These guys are constantly screwing up.” What customers care more about than whether you screw up or not, is how you treat them when you do screw up.
They care that you listen to them and take them seriously more than if you always get it right. If they want to work with a company that always gets it right, they will go work with some premium giant company that really has a very carefully constructed customer experience.
If you get caught doing this thing, you can always say, “We are so sorry. We were experimenting with this pricing. We didn’t mean for this to treat anyone unfairly. And if anyone was treated unfairly, we have gone back in the records and we are going to give them all double the money back for the thing that happened,” or whatever you have to do to make it right.
That is OK! It is really not that bad. What happens then is people say, “Wow. These guys are serious about making sure that we get treated fairly.” Meanwhile, you get to keep experimenting.
Opening board meetings to the entire company
Nivi: Yeah. You have talked a couple times on your blog about how you opened the board meetings up to the entire company and the positive benefits of that, and people’s perceptions of negative benefits.
Eric: Yeah. Well this is not something that a lot of companies adopt. This is considered pretty crazy.
I don’t know if it’s that most people are actually afraid of giving the whole company information they need to do their job, because it might lead them to judge the top management harshly, but people judge you harshly whether you give them the information or not, from my point of view.
Just give them the information! Your pathetic attempts to hide what’s happening don’t fool anybody.
Having been on both sides of that divide, I can tell you I never felt like I was being successfully fooled. And if you do manage to fool me for a limited time, I’m awfully pissed. My point of view is: you want people to have the maximum information possible.
You need to do it in a trust-building way. You’ve got to make sure the people you’re giving it to understand what they can and can’t do with that information, and they understand that they need to keep company secrets confidential.
If you don’t trust your employees to keep company secrets confidential, you’ve got bigger problems and you should go address those problems first.
There is some board business that has to be done in secret for legal reasons, so it’s not true that absolutely every meeting that any time ever happened at the board level is open to the public.
Employees have critical things to say in board meetings
Eric: But the interesting part about board meetings is the strategy conversation where you present progress, show data, and you make discussions about what should happen next. And that’s the part of the meeting I strongly recommend people open up to their employees.
What we did is we actually had a board of advisors and then a board of directors that was a subset of those advisors. We would convene the full set, advisors and board, at nine o’clock in the morning and we would have a maybe two-hour strategy conversation followed by maybe a half-hour or one-hour private board meeting.
For the strategy conversation the rule was: every employee can attend. We did this up until we were a 50- or 60-person company. We actually, physically crammed everybody into one room, and we had the employees sit around in as much seating as we could fit and the board members would sit at the big table.
It wasn’t a free-for-all, most of the employees were encouraged to listen, not to speak. But every once in a while the rule was that if someone had something they really needed to say, they could be recognized by the CEO and say their piece.
It was amazing. We would, occasionally have a board meeting where we would have a moment, where there would be data we were presenting to the board, and it would indicate that on a certain day, a certain metric went up and that was due to us launching that feature that day, or whatever our interpretation of what that data meant.
And not an insignificant number of times we would have an employee raise their hand and say, “Excuse me, but do you also realize that something else happened on that day?” Yada, yada, yada.
And occasionally, I’d be the one presenting! On the one hand, I’m really embarrassed. So I’m like, “No, I didn’t realize that.” This is a critical thing about running my own business I didn’t know.
But once I got over my personal embarrassment, what you would find is the board loved it! They’re like, “Thank God that guy was sitting in the room and could enlighten us about that. That changes our interpretation of what this means.”
And quite a few times I think we saved ourselves months of work by coming to a realization of something way earlier than we would have, because the right guy happened to be sitting in the room.
And yeah, occasionally you had an employee who’d make an off-color comment or say something that really shouldn’t have been said in front of the board, but people learn from those experiences. Most of the time most people had really substantive conversations.
Nivi: Did you ever get in a situation where some of the employees were like, “I don’t even care about these board meetings. I don’t even want to go?”
Eric: Yes, yes! We eventually had people who on occasion would beg me not to have to go to the meeting. And we eventually made them voluntary. For a while I was really rigorous, I said, “No, everyone has to be there. If I have to be at the meeting, you have to be at the meeting. Why do you think I’m any more privileged or unprivileged than you?”
Yeah, because board meetings are actually pretty boring. But when people are outside the room looking in — and you know most conference rooms have some form of glass — people can see what’s going on. They’ll come up with an excuse to walk by, kind of peek in. They will make up whatever crazy conspiracy theories are consistent with the data if they’re not there.
An, in my point of view, that’s such a source of waste: people gossip and there’s rumors and people don’t know. Let them be in the room, let them see how boring and mundane most board meetings are. So that for the occasional one where something actually interesting gets decided, let them be there to hear it themselves.
Everybody in the company has the ability to understand what everybody else in the company has to understand
Eric: There are some costs, definitely some down sides to doing it. One which took us by surprise was that, people can occasionally get confused about who’s in charge, we did occasionally have people — some board member would say, “You guys should really build feature X.”
Board members occasionally would just spout off about what’s randomly on their mind, and occasionally you’d have an employee get confused that that means the company is now going to go do feature X because board member so-and-so said so.
And that was actually good practice for us, to be a constant reminder that no matter who you are, no matter what it says on your business card, nobody gets to decide randomly that the company’s going to do feature X. Right? I don’t care if you’re the CEO or the lowliest person, we’re going to have a reasoned and considered process for deciding what to do.
Nivi: And it’s a learning opportunity.
Eric: It’s always a learning opportunity. The other thing that was hard for me personally was it’s hard to have your people who work for you see you be criticized in public. That was not fun.
Nivi: Hard for whom?
Eric: Well, it’s hard for me. My emotional reaction was like, “Wait a minute! I’m doing the best I can and now you’ve got to watch me get smacked around because I screwed something up.” But once I got over my personal emotional response to it, it was wonderful.
Because it humanized me to the people who worked for me — they got to see, “Oh, I see the pressure that he’s under” — but more importantly, when I needed something from somebody for the purposes of presenting to the board I could go to them and say, “Do you remember what happened the last time I didn’t have the right answers to these questions or I had shoddy this? You’re really going to send me in there with this? Come on, you’ve got to help me out!”
So it made us collaborators in creating solutions for the board rather than I’m constantly asking them for stuff and they don’t know why.
And I think, get over your own infallibility. We all make mistakes and it’s better for people to see what the real stuff is.
Nivi: I think you wrote about this on your site, basically the assumption is that everybody in the company has the ability to understand what everybody else in the company has to understand.
Eric: That’s right.
Nivi: The assumption is I have the ability to understand what the CEO has to understand.
Eric: That’s right. And that makes people uncomfortable, because sometimes we would say, “You have the obligation to understand what the CEO’s going through right now, because it’s going to impact the way you do your job.”
Some people would say, “I just want to sit in my narrow corner, do my little thing, and I don’t want to worry about what the company strategy is.” And we would show those people the door. We were really serious about that.
You really needed to have people who were… they didn’t have to be good at it! We weren’t asking them to be good at the CEO’s job, but we are asking them to understand why is the CEO making the decisions that he’s making. Because they’re going to have to make CEO-level decisions sometimes.
Sometimes the actions that have the biggest impact on the company’s performance are taken by people at the line employee level. They may not realize it’s going to have that big impact, but they are going to make those decisions. By the time the CEO finds out about it, sometimes it’s way too late to do anything about it.
We sure hope that the guy at the line level understands what the company strategy is and how his decisions impact, at least the best that he can.
Nivi: Yeah, I think maybe their decisions impact the company more than the CEO in the sense that if the CEO doesn’t come in to work, who cares? The company proceeds, but if the team doesn’t come in to work nothing happens.
Eric: OK, let me tell you: when the community manager takes a day off, you can have serious, serious meltdowns in the community if it happens to be the wrong day. That can have major impacts on the company.
Should we share bad news with employees?
Eric: I’ll say one more thing because this is a real effect that people are afraid of, which is that if you give people information about how a company’s doing, it can impact morale negatively. Sometime the company’s not doing well.
It makes some people have this idea that part of your job as a manager is to shield people from bad news or shield them from chaos. Because it’s not fair to them to have them have to do their job and also be confused about how the company’s doing. I just think that’s a really paternalistic attitude that we just need to let go as an industry.
If you want people to believe you when you tell them the good news, you have to sometimes tell them bad news. Otherwise, you have no credibility. And when there’s bad news to be shared, yes, it negatively impacts morale. But for a good reason, because things aren’t going well and we now need to rally the company around the fact that we need to change what we’re doing.
And there’s nothing like actually seeing the board say, “You guys have a major crisis on your hands that you have not yet understood,” to get everyone in the company saying, “We’re alarmed. We need to do something about it.”
That can cause some chaos, and that can be disruptive, but if you build trust and rapport with your employees then what you could do is you can sit everybody down for an analysis meeting after the board, which we would always do, and say, “OK, let’s talk about what we heard and what does it mean for the company,” and let people share their perspectives.
Let people say stuff like, “This says to me we need to cancel all our projects and completely retool.”
You need to get that idea out in the open because when somebody thinks that, you don’t want them to just unilaterally go execute on that plan! You want the opportunity to tell them and everybody else who didn’t have the courage to say the same thing: “No, we’re not retooling, but we are going to make some adjustments and here’s how we think about it, here’s what we’re going to do about it and here’s what’s going to happen.” That was pretty powerful.
Before you continue, read Eric Ries’ excellent Don’t launch, where he questions the assumptions behind most marketing launches.
If you ask most entrepreneurs why they want to launch, you’ll get an answer like, “So people find out about my product — are you stupid?” But a thoughtful founder who read Eric’s article recently asked me,
The New York Times wants to write about my company. It will take me no time or money to get this press. What should I do?
You should still consider the downsides of launching:
Launching a product that doesn’t solve a real customer problem establishes the wrong positioning in the minds of customers.
You can only launch once. If you launch the wrong product or you have an un-optimized funnel when you launch, you just wasted a one-time opportunity to harvest and generate demand.
Launching isn’t the only way to harvest demand. You can reach customers through customer development: AdWords, search engine marketing, online ads, contacting prospective customers through LinkedIn, et cetera — get creative. Don’t launch just because everybody else is doing it — be thoughtful.
Generally, you don’t want to launch until,
You’ve verified a customer’s problem by taking money out of her pocket.
You’ve optimized your funnel so the money you spend on the launch yields the highest possible return on investment.
But doesn’t the traffic we get from customer development have the same problem as the traffic we get from a launch?
Yes. In both cases, (1) you’re going to mis-position our product, (2) you’re going to sell a product that probably doesn’t solve a problem, and (3) you’re going to have a funnel that’s sub-optimal.
The leads you get from customer development and the leads you get from a launch are going to have the same problem. But when you launch, there’s a difference in what you do to the customers who don’t become leads.
When you harvest demand through customer development, every consumer you contact is engaged with your product — for example, they visit your landing page. So you can learn from them. If you observe these customers and execute a feedback loop, you can improve your product, positioning, and funnel. It’s okay to expose these customers to the wrong product, positioning, and funnel as long as you learn from them. In fact, that’s the only way to test your hypotheses.
But when you harvest demand through a launch, you position your product in the minds of many customers who don’t engage in your product. They’re not interested in your product yet; perhaps they’re later adopters. But they still read your New York Times article and remember that “Technorati tracks blogs.” They don’t come to your website or call you, so you can’t learn from these customers. You’re imprinting the wrong positioning in the minds of these customers, but you’re not learning anything from them.
You can learn from the leads you get from the press and you can learn from the leads you get from customer development. But when you launch, there’s a difference in what you do to the customers who don’t become leads.
And by the time you do want to launch, you may be the business that “collects, organizes, and distributes the global online conversation.” But everyone who read your article in the Times still thinks you’re in the blog tracking business. It’s tough to change your positioning in their minds and the Times won’t be interested in helping you fix your positioning because they already “launched” you. Do you have a clear idea what Technorati does anymore?
How did people come up with the idea of a launch in the first place?
Before the Web, it was a lot harder to harvest demand for products. Distribution channels like the shelves at K-Mart were locked up by big companies. Television commercials were expensive. Large newspaper ads were expensive. It was hard to set up and track small ads in newspapers and the Yellow Pages.
So I think young companies routed around these channels by going to the press, which consisted of a small number of influential newspapers. Startups harvested demand for their products by getting the press to write about them.
These days, we can harvest demand through customer development — we don’t need to launch. So we usually reserve a launch for (1) generating demand from people who have a problem but don’t know they have the problem and (2) harvesting demand from people who know they have a problem but aren’t actively looking for a solution.
How do I deal with a reporter who wants to write about our company?
First, the press will often approach you for a comment. Second, we’re no experts on working with the press, but here are some untested hypotheses.
Try saying, “We’re not ready for press yet. We would prefer if you didn’t write a story about our product right now. In exchange, let me tell you about what we’re ready to have you print right now. And we’ll put you on the very short list of people we contact when we launch.”
If that doesn’t work, try giving them a teaser, “In exchange, we’ll give you exclusive information about the company that you can write about…” The exclusive shouldn’t imprint your positioning in the minds of readers. Try something like, “we just hired Bill Gates.” The exclusive might generate too much hype but, at this point, you’re controlling the situation as well as you can.
If that doesn’t work, try showing them something that no one outside the company has seen, “This is off-the-record, but I want to show you this cool demo, and we will give you an exclusive when we launch it.”
Where can I learn more?
Read Sean Ellis’ blog on Startup Marketing. He has launched two companies that have filed for IPOs and he now works with Dropbox, Xobni, and other startups. Sean says, “I am insane enough to believe that I can change the way most VC backed startups are launched.”
Here’s a presentation from Sean to get you started:
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Thanks to the beta testers who paid to give us amazing feedback (check your inbox for a revised copy!). They made the book much better. Here are some of their (unsolicited) testimonials:
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Summary: The most common question we hear from entrepreneurs is, “Can you introduce me to investors?” Yes we can. We’re going to recommend startups on Venture Hacks. Investors are invited to subscribe to our recommendations. And everyone is welcome to recommend startups here. Request an invite if you want to help test the Recommended feature before we open it up—it’s also open for browsing in the meantime.
On April 1st, we started publishing the best damn term sheet hacks we could find. Why? Because a lot of entrepreneurs ask the same question:
“Can you help me understand term sheets?”
We’re trying to make everything we’ve learned—from other entrepreneurs, investors, and lawyers—readily available. We have a lot more work to do, but entrepreneurs seem to like the hacks so far.
Now the most common question we hear from entrepreneurs is,
“Can you introduce me to investors?”
Yes we can.
We like recommending startups to investors. And if you’re reading this, you might too. We want to help more entrepreneurs get introductions—so we’re going to recommend startups on Venture Hacks.
Here’s how the Recommended feature works for entrepreneurs, investors, and middlemen:
If you’re an entrepreneur, we’ll recommend you to investors. The best way to convince us—or anyone—to make a recommendation is by presenting a good pitch and a good team. For example:
If you’re an investor, you can subscribe to our recommendations:
Or subscribe to anyone’s recommendations:
And if you’re a middleman—like us—who digs introducing entrepreneurs to investors, we can’t wait to see what you recommend:
We’re building and testing Recommended now. Request an invite if you want to help us test it before we open it up. Or just browse it in the meantime. Here are a few interesting places to get started:
We get lots of email from people asking for advice. We’re going to start answering the most interesting questions here, so everyone can participate in the discussion.
Got a question? Send it to email@example.com. We read every question. Names will be changed to protect the innocent.
In the meantime, catch up on past editions of Ask Venture Hacks, where we tackled VCs vs. angels, build vs. sell, doom, the world’s biggest fund-raising mistake, and the wonderful world of supra pro rata rights.
We will be holding our first Office Hours this Thursday!
The “office” is a teleconference that anyone can join via Skype or phone. The dial-in information is below.
Bring your questions about raising capital to office hours—we will do our best to give you answers. You can also submit questions in the comments below.
We will record the call and put it online for those who can’t join the teleconference.
Unless you announce your name, you will be anonymous to everybody on the call. Naval and I will see your Skype username or phone number through an administrative panel—no one else will see this information.
“Having information that the other side doesn’t have gives [VCs] an advantage… they take advantage of entrepreneurs who haven’t been through this before… they were totally willing to take advantage of us.”
In this series of articles, we’re going to explain how to negotiate a great deal with your Series A investors. We’re calling this series Term Sheet Hacks.
The VCs know more than you do.
You, the entrepreneur, negotiate a term sheet once every few years. You negotiate your most important term sheet (the Series A) when you have the least experience. You negotiate against a VC firm that issues two to three term sheets per month. You negotiate against a “standard” term sheet that encapsulates decades of combined knowledge from hundreds of venture firms.
Like a good chess player, your prospective investors know what the game looks like many moves from now:
Their term sheet foresees the Series B, possibly terminating you, selling the company, and more.
Their term sheet anticipates those events and includes terms like ‘protective provisions’ and ‘election of directors’ that create the best future outcome for their firm.
They employ a full-time CFO or general counsel who ensures their firm is cutting good deals. And his shelf is filled with books on the hilarious topic of term sheets.
On the other hand, you probably have a basic understanding of a few simple terms like ‘valuation’ and ‘vesting schedules’. You barely know what the game looks like right now, let alone at the Series C.
Your investors can take their time – they have years to invest their money – but you’re under pressure from your employees and co-founders to deliver the money that will keep your company alive. The clock is ticking…
Good companies get bad deals all the time.
Many of the successful companies that we all read about in the news didn’t negotiate good deals simply because they didn’t get good advice. Consider Jim Clark‘s (founder of SGI and Netscape) account in The New New Thing:
“At [SGI] board meetings… Jim’s face would get red and he’d start shouting that [an investor and board member] had cheated him and his engineers.”
Or ask a friend who has taken money from investors.
Whether these stories are true is irrelevant. Like any negotiator, your prospective investors are not in the business of giving you a good deal. They are in the business of making money for themselves and their investors (their limited partners).
Isn’t this what my lawyers are for?
In principle: yes. In practice: no.
With few exceptions, most law firms advise their clients to accept “standard” terms.
Most law firms do a lot more business with VCs than they are likely to do with you. VCs refer new clients to the law firms, hire the law firms regularly, and know the attorneys socially. Where do you think the law firms’ loyalty lies?
The basic incentives between you, your law firm, and your prospective investors are not in your favor. Your lawyers make money by executing transactions and your investors simply bring more transactions to your lawyers than you do.
You can’t hack a term sheet without leverage.
Don’t bother trying to apply any of these term sheet hacks if you don’t have leverage. You can’t negotiate at all without leverage. Roughly speaking, leverage is power.
Alternatives are the most basic type of leverage in any negotiation. Fancy negotiators call their best alternative a BATNA (Best Alternative To a Negotiated Agreement). If you’re negotiating a term sheet with the famous Blue Shirt Capital, your BATNA may be an independent term sheet from the renegade Herd Mentality Management.
A BATNA is just one type of leverage and it is possible to negotiate effectively without a good BATNA. Hostage negotiators do it all the time. But if you’re not in the mood for a hostage negotiation, get multiple offers before you apply any of these hacks. Don’t let anyone tell you that creating competition to invest in your business is a bad thing.
Let’s get this party started.
Our goal here is to give you the knowledge to effectively negotiate against the experts. We don’t have all the answers but we’ve negotiated enough term sheets, started enough companies, and learned from enough entrepreneurs, lawyers, and VCs to understand how this game can play out. Term Sheet Hacks is a work in progress and we’re looking forward to learning more from your comments and emails.
These articles assume that you either have a term sheet in-hand or are anticipating one. If you need a basic understanding of term sheets, read Brad Feld’s term sheet series and hire a lawyer.