Entrepreneur Myths (20 page)

You still have to deal with the tiny little issues of launching and marketing the product or service. I don’t care what anyone says — besides raising capital, selling and marketing the product or service (especially if you have no marketing budget) is difficult because of all the noise and ad clutter in the marketplace. To breakthrough the noise, seek inspiration from nature.

Markets are like Mother Nature

You have millions of species (ventures in this case) working to survive and prosper in the ecosystem, and then you have to deal with sub-ecosystems, and sub-ecosystems of sub-ecosystems, and so on. There were times, as an entrepreneur, that I felt more like a little ant. Breaking into markets with new products or services is a tedious, laborious process where patience, intellectual capital and money are critical to survival in the existing ecosystem.

Technologies enable entrepreneurs to provide disruption in the marketplace. Let’s look at the film business, for example. I am a co-founder of Madman Pictures. We have written over 20 scripts in the action, adventure, animation, comedy and drama genres. Most of the scripts require budgets of $50 million to $100 million per film. Our films appeal to mass market, global audiences. But you need big money to make money.

So what the fuck do you do if you don’t have 50 million big ones in your pocket to produce a film? You can spend all your time raising capital on the large budget films. The odds of raising capital in the film business are very much against you, especially if you never produced a big budget film or any budget film. Experience counts when you’re raising capital in the film business. Even though my partner has sold more than 10 scripts to other production companies, neither one of us has directed or produced a film. So we chose another route.

In order to get big, you have to think small

You have to start somewhere. Instead of whining about it or wasting precious fucking time raising capital, we took the only low-budget script we owned and decided to produce our first movie. We wrote, directed and produced it with the help of friends. This is not any different than a programmer developing an app, application or platform. Fuck, I think it’s easier to program than develop a film.

The name of our film is
Bicycle Bobby
. Going through the entire exercise of making that film increased our odds of getting other films funded, should we decide to go the external financing route. I can look someone straight in the eye and ask them to hand over $100 million to produce the next film because we are confident we can do it. Whether you produce a small budget or big budget film, you go through the same process of filmmaking.

Don’t bullshit the investor

If you’re a software developer, and you’re pitching me for money, you’d better have a damn good demo, beta or an actual product, or I’ll throw you out my fucking door. If you have an idea that is more than what I call “half digital,” you’d better come to me with a solid prototype. And it had better work. I’m not looking for smoke and mirror products.

I funded one young entrepreneur who needed a couple of hundred grand to build a sold prototype of an entertainment hardware product. He rigged up a crappy mockup of a prototype, but at least I could see his vision. Usually I don’t fund non-working prototypes but, being in the technology business, I didn’t listen to my own advice and funded him anyway. What a mistake. After I funded him, he made a working prototype, but the market shifted and bigger companies had introduced a similar product. He was fucked and so was I for investing into the venture. I learned my lesson. Funding a non-working prototype, no matter how great the product, increases the investor’s risk, due to the added time needed to make the product workable and launch it into the marketplace.

I see entrepreneurs building great prototypes, but scaling them into manufactured products can sometimes become difficult. If you build a prototype, make sure it not only works, but is also scalable — if you want your investor to fund the next evolution of the prototype.

Sweat money works

If you have an idea for a new product or service, don’t ask me to invest my money when you can build the prototype on your own dime, intellectual capital and sweat money. I did it myself through sweat equity, or very little money — more than once. Why would I treat you any different? Now go out there and become a revolutionpreneur.

Brain Candy: questions to consider and ponder

(Q1)
If you have an idea for a product or service, can you build your prototype, beta or actual product on your own dime or with sweat money?

(Q2)
If you need money, can you barter somehow, or get suppliers to give you parts cheaply or for free to develop the product?

(Q3)
Is your product digital? If so, then there is no fucking excuse why you can’t build it cheaply, but you do have to find someone with digital knowledge.

(Q4)
Can you build your product or service through sweat equity with your partners or friends?

(Q5)
What is the quickest you’ve built a working product? How about a prototype? Were you able to turn a prototype into a real product that customers bought?

Entrepreneur
Myth 30
| Money grows on trees

When I was a kid my parents told me, “Money doesn’t grow on trees.” Entrepreneurs should know this, but that doesn’t seem to be the case. I have a friend who says, “Money makes money.” It does — if you know what you’re doing. Money makes money, but it doesn’t grow on trees.

Entrepreneurs pitch me for money with that “money grows in trees” attitude. Their company valuations are so high I almost have vertigo. Bubblepreneurs’ high company valuations make it difficult for investors to make money. Company valuation is one of the trickiest and touchiest discussions in the investment process. Entrepreneurs have given me $10 million to $20 million valuations for nothing but an idea and a dream. Dreams are worthless, unless you have a track record of making money for investors.

When it comes to valuations, simple math applies. If you’re a startup, and you value your company at $10 million when it has no revenue, product or solid management team, and you want the capital — well, good fucking luck. You just might get away with it if you achieve substantial growth in customers through a freemium strategy or the current hype in Silicon Valley.

As an entrepreneur and investor, I’ve been on both sides of the table. I promise and assure you that money does not grow on trees. You might read articles in Tech Crunch or Business Insider about companies in Silicon Valley and Silicon Alley with billion dollar valuations, but it didn’t happen overnight. These companies had major traction. It was not based on just an idea.

Professional investors demand high returns because they know the reality of a startup’s success. Most will fail or have mediocre results, from an investment perspective. According to Washington Technology Partners, 60% of high-tech companies that are funded by VCs go bankrupt.
⁵

If you value your company at $10 million and the investors expect a 10X return on their investment (ROI) — that means you have to build the company to where it’s sold at $100 million for the investor to get his ROI. Can you, as an entrepreneur, really fucking do that? Do you have the confidence to build the business to a value of $100 million in three to five years? I’m talking about non-diluted equity, with no additional money invested.

The ROI is worsened by diluted equity. That happens when new investors are included in additional investment rounds, causing your share of ownership, along with that of your investors, to become less valuable. In this case, more money invested by others also warrants a higher exit ROI for everyone through Googlio or IPO. How many entrepreneurs have ever built a business from scratch and sold it for $100 million? I bet you $50 million dollars it’s a lot fewer than you think. If you plan on going public, what is your quarterly sales and growth over the last three to six quarters? Even companies like Groupon, despite operating at a loss, had substantial revenues to show before going public. Becoming acquired or going public is not easy. Only one in six million high-tech companies wind-up going IPO. And most them took three to five years to get on the IPO train.

The odds of exiting for > $100 million are against you

Fred Wilson, a very smart venture capitalist, wrote an article, ‘Why It’s Hard Being an Early Stage Investor Right Now,
⁶
which included a graph showing how many companies had exits of over $100 million in the past four years. It shows there were only 85 in 2007, 46 in 2008, 39 in 2009 and 74 in 2010. I rest my case. For detailed graph, see Myth 57: A power law works in your favor.

When you offer equity in your company at high or astronomical valuations, you set high expectations for all shareholders — including yourself. You put yourself under great pressure to perform at those high valuations. You may not feel it at first but I assure you that you will feel it sooner than later.

I know an entrepreneur, with an incredibly successful track record, who built a billion dollar company, took it public and made a lot of people some serious money. On his next venture, he raised money at the astronomical valuation of more than $200 million, while his revenues were less than $8 million. He didn’t think he was under pressure but as the company grew, the pressure to perform and sustain the high valuation increased daily.

The multiples didn’t add up. He used the currency of the overpriced stock to purchase other companies and build his empire faster. He tried to purchase one of my portfolio companies, but the mathematics of the transaction didn’t add up. His company didn’t warrant the current value, while my portfolio company needed more money at a higher valuation to continue its growth. Neither party wanted to be diluted heavily. The deal didn’t work out because both companies were overpriced for each other. This was in the early 2000s and during his acquisition binge, the market changed and his company value went down. My portfolio company, after I left the fund, pursued the private investment route, and then later sold out to him at a lower valuation. Ironically, his company was acquired later by another company. Looking back on the deal, everyone believed money grew on trees because of the high valuations.

I see it all the time. High valuations create hype, momentum and buzz, increasing valuations even higher to the point where entrepreneurs and investors start believing in the money tree. Facebook, Groupon and Zynga, on the other hand, are in a different market position. Because of their ability to generate revenues, their valuations are high, and they haven’t been shy about acquiring other startups — and some of the capital used to purchase companies is in the form of stock. In many instances they’ve also acquired software developers and their intellectual capital.

When raising money, don’t overprice your venture or you could add tremendous pressure on yourself and your management team. The rules of thumb apply even in the bubble-ish atmosphere in Silicon Valley today. If you’re a startup, see the valuation table in Myth 45: Valuation is based on numbers. It includes the rules of thumb I use for valuating ventures. Keep in mind they are rules of thumb and not set in stone.

My advice: If you don’t have money invested in your venture, sales or customers acquired through the freemium business model, or business experience, then a $6 million post valuation might be stretching it. I’m being kind giving this high-end number because I’m a nice guy.

Because money doesn’t grow on trees for you or your investors, the best route is to stage your financing in phases. Take the least amount of money possible, and make your valuations realistic for yourself, plus current and future investors. There’s a fine line when it comes to making everyone happy. Of course, everyone wants to make the most money they can, but there’s a point in valuations where I think stupidity comes into play. On the other hand, you could go the Silicon Valley route and raise larger amounts at the higher valuations. You have to be careful. When you raise larger amounts, try not to blow threw it quickly, thinking you can raise more money. If the markets change, you’re fucked. I‘ve seen this happen more than 20 times.