Posts Tagged Startups

Venture Capital is Not For Everyone

Venture capital

Venture Capital Mindset by Dilbert

We are often approached by founders who believe that venture capital is a necessity to guarantee their company’s success. The VC community, to its credit, has done an excellent job of extolling the virtues of and benefits of this source of financing and one might think that the only way to build a successful tech company and exit at a great number is by tapping into venture capital. In fact, while a successful exit by a VC-backed company results in plenty of press, an equally successful exit by a bootstrapped company more often than not goes unnoticed. 

Venture capital plays a very important role in the capital markets and financing high potential growth companies but importantly, it is ONLY appropriate for certain types of companies and those that have phenomenal growth opportunities…a fact that many founders do not understand.  Matching the appropriate type of capital to the company’s opportunity is key and in light of this need to match, we thought that the following article would provide founders with food for thought.  

Eric Paley from Founder Collective wrote an interesting article detailing his thoughts on the negative aspects of rushing into a decision to bring on venture capital investment. Venture Capital is a hell of a drug strikes us as a very balanced view particularly when one considers that many founders do not understand the economics that drives VC investment decisions.  

As you read through the article put some thought into how Paley’s insights might have changed the outcome for Toronto-based Flashstock Technology.  Flashstock, founded December 2013, raised a total of $3.1 million in three rounds: $800,000 in January 2014 from a boutique New York-based VC and $2.3 million from two angels in rounds of $800,000 (June 2015) and $1.5 million (October 2006).  On June 28th, the company announced that it had been acquired by Shutterstock Inc. (NYSE: SSTK) for US$50 million

 The three main observations from Paley’s article are:

Venture capital increases risk for founders
Exit value is a vanity metric
Capital has no insights. Don’t trade a solid business for a lottery ticket

A more detailed summary and direct quotation from Paley’s excellent article follows.

Venture capital increases risk for founders in two ways:

It limits a founders exit

VC cash comes at the cost of reduced exit flexibility and the burden of an increased burn rate. Viewed probabilistically, the most likely positive exit for a start-up is an acquisition for less than $50 million. This outcome has little benefit to VCs, and they will happily trade it for an improbable shot at a higher outcome.

Entrepreneurs agonize over a percent of dilution while ignoring the fact that they are surrendering their most likely exit options for a low-probability shot at building a superstar start-up.

Founders often use the capital infusion to increase burn to dangerous levels 

Beyond signing away exit options, new venture capital typically is raised to fund higher burn rates. That increased burn rate is a great investment when it is being used to fuel a model that is working. Paley observes that more often, the increased burn is used to search for a model that works, and the company quickly learns that capital has no insights; it’s just money. Then the company cannot sustain the burn, the CEO decides to cut the burn way too late and cannot manufacture enough VC enthusiasm to keep the dream alive.

Paley puts forth his view that one rough rule of thumb is that start-ups should be able to triple their post-money valuation in two years. If founders can’t figure out how to get 3X leverage on every dollar they spend, then they are better off not spending the dollars — or raising them in the first place.

According to Paley, “founders need to think of venture capital as a power tool — a fairly dangerous one — but instead often mistake it for some magical, infinitely renewable resource. In the right hands, power tools can solve some real problems. Used incorrectly, they can chop off your hands”.

VCs need billion-dollar exits, founders don’t

Billion-dollar exits are brilliant, but they shouldn’t be how founders calibrate success. The mania for billion-dollar valuations is the result of the business model of the venture capital market — not some legitimate definition of start-up success.

Here’s a very rough illustration of billion-dollar VC fund logic:

VC raises a billion-dollar fund, needs to triple the fund to be successful
VC makes ~30 major investments
VC breaks even on 10, loses money on 10, needs remaining 10 to be worth an average of ~$300 million in proceeds to their fund

VC can only expect to own 20-30 percent of any given company (often less); anything less than $1 billion exit of your business isn’t a success in this model

This is why there is so much focus on billion-dollar exits. Not because this outcome is high frequency, but because a few massive funds need it to be so. Let’s not just point fingers at the billion-dollar funds. Similar VC math causes irrational trade-offs for founders whether their investors have billion-dollar funds or quarter-billion-dollar funds.

As a general rule of thumb, assume that your exit needs to be approximately the size of the VC fund to “matter” in its returns. Of course, this is the tail wagging the dog, as the capital gatherers are encouraging irrational behaviors of founders with a sales pitch of “go big or go home.” No one says the truth, which is “go big or ruin your life.”

When the founder’s business fails, which probability says it most likely will, that VC has 29 more shots on goal. You destroyed your single start-up, not to mention the wasted sacrifice over years of your life. In most VC deals, the investor is taking much less risk than the founder.

Exit value is a vanity metric

If one of a founder’s goal is making money, focusing on the exit price is a bad idea. It’s quite possible to sell a start-up for a billion dollars and make less than someone who sells theirs for $100 million.

Venture capital isn’t the right choice for most businesses, but when used well, it can be very powerful. Unfortunately, many VC-backed founders are using it incorrectly.

Eric Paley, Managing Partner, Founder Collective 

Posted in: Q1 Blog

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The Changing Nature of Venture Capital Investment

Once upon a time, VC investors would put money into a startup in a Series A round and the capital would be used to help build a product and prove its viability.  If successful, a Series B round would help get that product to market and the startup to the point of being able to generate revenue.

Those days are apparently over.  So says TriplePoint Capital’s Ben Narasin in an article in TechCrunch.  In today’s startup environment, Seed rounds are being used to build products and Series A rounds are used to get them to market.  This is due in part to the decreasing costs involved with getting a new technology built and off the ground.  It also means that VC investors are looking at putting money into companies when they are much further down the road to success (or failure).  This has made the bidding on Series A rounds more competitive for VCs because they are investing in technologies that are more fully baked, which could be helping to fuel the increase in startup valuations that has been observed in recent years.

Read the full article here.

Posted in: PE/VC News

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January 2014 Newsletter

Mike’s Commentary:

Is Ecobee Next?

Google’s $3.2 billion acquisition of Nest Labs is not only a monumental event for that company but could also turn out to be a game changer for Toronto-based Ecobee.  The acquisition shines a light on the “conscious home” space and validates the foresight and work of Stuart Lombard and his team to develop the Ecobee line of programmable WiFi enabled smart thermostats. Unfortunately, the acquisition also further illustrates the challenges that Canadian technology companies have in attracting the capital and attention necessary to compete in the North American and global markets, as evidenced by the amount of capital Nest Labs attracted and the stable of Tier One US VCs that stepped up to the plate.

Founded in May 2010, Palo Alto-based Nest Labs is a home automation company that designs and manufactures sensor-driven, WiFi-enabled, self-learning, programmable thermostats and smoke detectors.  The company’s founder and CEO is Tony Fadell, a former Apple executive and designer of the iPod, which of course brought the Company instant notoriety.  Nest Labs reports that it has over 25,000 certified professionals who help install Nest in the US and Canada and has more than 300 employees spread across three countries.
(continue reading…)

Getting Another “Keek” at the Can

In November, we came across news that Keek had found it challenging to attract new investors and, as a result, looked to the public markets for capital.  Given the $30.5 million that was invested since October 2011 and the haircut that those investors will now take, this is not good for anyone.  The founders and investors lose and a large amount of capital has now been erased from the Canadian capital pool.  And while we all understand that venture investing has high risks, a company that apparently had such high prospects and needed to be restructured so quickly simply leaves a bad taste in everyone’s mouth.

While we certainly sympathize with the challenges of raising a large round of private capital in Canada, we do like the fact that the Company’s current investors took action to replace management and restructure it with a team that apparently is focused on finding a revenue model that works, accessing whatever capital they could find in order to survive, cutting the Company’s burn rate, and is looking to complete a private placement quickly to get new funds.  (continue reading…)

Evan’s Commentary:

2013 Was a Great Year for Tech M&A…But Not Everywhere

January is a good time to reflect on the year that just passed and to make resolutions for the year ahead.  But instead of a list of the top news stories of 2013 or resolutions about eating better and exercising more, here are some findings from the M&A market in the past year and a resolution that those of us in the Canadian technology sector should try to stick with long after we’ve given up our diets and gym memberships.

When it comes to mergers and acquisitions in the technology sector, 2013 will mostly be remembered for the constant popping of Champaign corks.  Why?  Because according to Mergermarket, global M&A transactions in technology, media, and telecommunications (TMT) totaled US$510.3 billion, an increase of 54.1% from the $331.1 billion in transactions in 2012.  Although TMT M&A has not yet reached the pre-financial-crisis high of $603.8 billion in 2006 and much of the activity was comprised of a small number of mega-deals (the increase in TMT M&A would have been 16.6% if you exclude just a single transaction: Vodafone’s acquisition of 45% of Verizon Wireless for $124.1 billion), there was still reason to celebrate.  TMT M&A in the US amounted to $301 billion, up 70.4% from 2012, and European deals amounted to $132.2 billion, a 97% annual increase in a region that is still largely struggling economically.  (continue reading…)

Rob’s Commentary:

Entrepreneurs Hatch Ideas at U of T’s Startup Weekend Competition

This past weekend, more than 80 University of Toronto students gathered and competed for 24 hours to see who could develop and pitch a winning business idea. This included developing an idea into a business concept and outlining the customer value proposition, revenue model, marketing strategy, partners, and key activities required to get their idea to a minimal viable product.

The event focused on ideation and the team-building process, critical skills required by all successful entrepreneurs. This means the point was to build business models, not companies. While there are many incubators and accelerators that work with entrepreneurs after they have completed university, very few are focused on nurturing these skills while students are still in school. The students who competed will be those who will someday compete for spots at MaRS, the Creative Destructive Lab, or Ryerson’s Digital Media Zone.  (continue reading…)

In Other News:

Congratulations go out to Derek Smyth in his new position as Chief Revenue Officer at Vision Critical, a leading provider of insight community technologies.  During the past seven years, Derek has proven himself to be one of Canada’s most savvy venture investors with stints at OMERS Ventures (where some of the investments that he led included Hootsuite, BuildDirect, Desire2Learn, and  Vidyard), Bridgescale  Partners, and Edgestone Capital.  He is now going back to his roots as an operator, when he was the CEO of Bridgewater Systems and COO of Ironside Technologies.

Posted in: Q1 Blog

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Entrepreneurs Hatch Ideas at U of T’s Startup Weekend Competition

(Rob’s January 2014 Newsletter Commentary)

This past weekend, more than 80 University of Toronto students gathered and competed for 24 hours to see who could develop and pitch a winning business idea. This included developing an idea into a business concept and outlining the customer value proposition, revenue model, marketing strategy, partners, and key activities required to get their idea to a minimal viable product. 

The event focused on ideation and the team-building process, critical skills required by all successful entrepreneurs. This means the point was to build business models, not companies. While there are many incubators and accelerators that work with entrepreneurs after they have completed university, very few are focused on nurturing these skills while students are still in school. The students who competed will be those who will someday compete for spots at MaRS, the Creative Destructive Lab, or Ryerson’s Digital Media Zone. (more…)

Posted in: Q1 Blog

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Toronto’s Hubba Raises Seed Round

Congratulations to Ben Zifkin and the rest of the team at Hubba on raising a seed round of $1 million in funding.  Hubba is an innovative startup based in Toronto that is building a platform for retailers, manufacturers, and the ad agencies that work on their behalf to aggregate and share data from a wide variety of sources in one convenient location so that consumers will not have to scour the internet to find product information, customer feedback and reviews, social media campaigns, and other data that can help them make more informed buying decisions.  To learn more, click here.

This funding round was led byBrightspark Ventures.  To read more about this transaction and the innovative way in which the capital was sourced, click here.

Posted in: PE/VC News

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Toronto-based 500px Raises $8.8 Million in Venture Capital

Toronto’s 500px, a platform for photographers to post and sell their work online, has raised $8.8 million in venture capital investment from US firms Andreessen Horowitz and Harrison Metal with participation from Creative Artists Agency, Rugged Ventures, Dustin Plett, and ff Venture Capital.

This is fantastic news.  500px is a great local startup that attracts 2.5 million users and a billion page views every month.  It is encouraging to see it attract interest from a slew of investors, including one of the biggest names in venture capital, Andreessen Horowitz, which has backed many successful tech companies such as Twitter, Facebook, Groupon, Zynga, Foursquare, and Airbnb.  The firm has made a number of Canadian investments recently, including the Vancouver companies Convergent.io in 2012 and Tiny Speck in 2011.

For more on the transaction, click here.

 

 

Posted in: PE/VC News

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Vancouver-Based NodeFly Acquired by StrongLoop

San Francisco-based StrongLoop acquired Vancouver-based NodeFly, which will now operate as a Canadian subsidiary for the company.  The transaction takes place just months after the company was founded and seeded with $800,000 in capital by Shasta Ventures in November 2012.  The NodeFly team should be very proud of how quickly they were able to build their infrastructure monitoring application and attract an acquirer.

Click here for more information.

Posted in: M&A News

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The Unprofitable SaaS Business Model Trap

Here’s a great article by Jason Cohen about the problems with one of the most popular business models in today’s software market.

The Unprofitable SaaS Business Model Trap

Marketo filed for IPO with impressive 80% year-over-year growth in 2012, with almost $60m in revenue.

Except, they lost $35m.  WTF?

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Posted in: Articles of Interest

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Apple Buys Toronto-Based Locationary

Congratulations to the team at Locationaryand its investors Extreme Venture Partners, Trellis Capital, Plazacorp Ventures, and MaRS Investment Accelerator Fund on the company’s sale to Apple.  It is great to see another Toronto-based company being acquired for its innovative ideas and solutions by one of the biggest players in the tech sector.

Locationary was founded in 2009 and its platform allows businesses to integrate and make better use of customer-generated data in their marketing efforts.  It will be interesting to see how Apple makes use of this technology in its mapping tools.

For more information on the deal, click here.

 

Posted in: M&A News

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The Absolute #1 Start-Up Mistake…And How To Avoid It

by Jordan Dolgin, CEO of Dolgin Professional Corporation

Hands down and without a doubt the #1 Absolute Start-Up Mistake I see clients make time and time again is far from obvious and far from intuitive.

It has nothing to do with the business concept itself.

It has nothing to do with the size of the ”addressable market” for a new product or service.

It has nothing to do with the quality of key management.

It has nothing to do with raising capital, managing cash flow or the marketing strategies or techniques employed. (more…)

Posted in: Articles of Interest

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