What drives early stage valuation multiples of tech #startups?

Almost every company I have talked to in the last 2 weeks ( total of about 12 startups) has a question around valuation multiples they should expect for their company. While many are concerned about dilution and loss of control, I think the bigger worry should be the high bar of flawless execution priced into valuations.

Basically the way it works is that the higher the valuation multiple (to your revenue, forward-looking growth or execution to date), the less room you have for errors. The higher the valuation, the more flawless your execution needs to be. Else you will be either replaced as the founding CEO, or face a lower valuation in your next round (called down round, and cause cramming).

I had a chance to talk to about 20 founders who recently raised money in the last 5 weeks. All of them, except 3 have raised money in the US, and of the remaining 18-19, 7 have raised money outside the Silicon Valley.

Most investors (seed or institutional) are always looking for a “low” valuation. Few may be looking for a “fair” valuation at the early stage. Often, it is impossible to determine what the valuation of a company is or how much the multiple on their metrics should be.

The “easier” (relatively speaking) valuation multiples are determined on your revenue, if you have any, profit (still rare) or other metrics that you can sell your investors on (e.g. user growth in the case of social networks for example, when you are not yet making money).

The tougher “nice to have” valuation multiples are on the management team, market size, etc. These negotiations are always harder than those on metrics.

So what metrics matter? According to the 20 folks I spoke with, they all fell into – revenue, expected growth (what the investors believed they would be in 12, 18 or 24 months) and growth to date (execution).

Step 1: The range of the valuation multiple would be determined for most of these by an arbitrary “market size” number and many quoted “angel list” averages as a good starting point.

Step 2: Then the investors would dive into their current revenues (12 of the companies are making some money). The range for multiple of revenue ranged from 5 X (in India) to 30X (at the high end, Silicon Valley, YC company). Interesting that non of my surveyed companies had more than 30X multiple on their valuation, even though, I have heard via anecdotal evidence again, that there companies getting more.

Step 3: The startup then goes through an exercise of growth projections, and obviously, the higher the growth, the more the valuation multiple. The best way to think about this is via a rule of thumb – for every 10 additional percentage points in growth month-on-month, folks are asking for a 1.1X increase in valuation multiple. So someone growing at 20% M-o-M is asking for 2.2X increase in their multiple, above and beyond their revenue multiple.]

Step 4: Looking at past revenue growth, over the last 6-12 months (if applicable). Many founders are pointing to the past growth purely as a sign of good execution, but not an indicator of future growth numbers. Most founders I talked to believe they will grow faster with the money than without, which the investors discount, since they believe they are providing that fuel.

Step 5: Finally, most cited the use of a well rounded management team and recent competitive “whisper numbers” around startups in the same “space” as benchmark metrics for valuation multiples.

I must caution that most of this is anecdotal and not very scientific, but a good rule of thumb.

What I am telling the entrepreneurs at our accelerators is to make sure they factor in “average” valuation multiples for their projections, but execute so they can get the best.

I’d love your input if you have recently raised money. Let me know in your comments if you’d like to have a discussion (via email or on Slack is preferred).

How to A/B test your startup’s positioning statement

I had a chance to talk to 2 of our startups at the accelerator yesterday and we discussed positioning. One of the first things that we focus on is to ensure you position your company and product well. That may seem like “fluff” and “soft” to many folks, but we find that to be critical to ensure that people who you interact with – customers, partners, potential recruits, investors, etc., get it quickly and accurately.

What I have found is that depending on the background of the entrepreneur, the positioning statements tend to be very long, mostly filled with buzzwords – (no, really 99% of the people in this world dont know ARM, resin-conductors or DevOps, and most likely 90% of your target audience does not either) or overly complicated.

The positioning statement should at its simplest help explain who you are at your core.

Most folks will try to explain their positioning by using the framework below.

For (specific customer description):

Who (has the following problem):

Our product (describe the solution):

That provides (the following difference):

Unlike (your competition):

Now, for most parts this was 15 years ago. This is still a valid exercise for you to come up with your positioning, but most of this may be not as effective in our Twitter driven world.

There are 3 more manifestations I have seen for this statement:

1. Position your company / product in less than 8 worlds so that someone coming to your website can get it in less than 5 seconds

2. Positioning by successful similarity – We are XYX (an awesome product, e.g. Uber) for ABC (a very large market, e.g. school kids needing rides)

3. Retweet ready positioning – A positioning statement that is retweet worthy, so it should be less than 100 characters – so you can still provide a link to your website

The important thing to note is that your website should reflect positioning for your biggest audience – target users or customers, not potential investors or employees.

I am also not a fan of using multiple positioning statements by audience – so you should avoid telling investors you are a disruptive solution for ABC market, and tell potential employees you are X for Y.

It never adds up and wont scale.

Instead, I’d recommend you start with first making a list of segments of your customers. Preferably you are able to segment a small niche customer segment to start.

Then write down the list of problems your customers have. For example. a) the existing products are too hard to use b) the existing solution is too expensive c) the existing solution is to do something manual d) potential customers are unable to be successful since no solution exists to help them with this pain, etc.

Then you have to document the features of your product that correspond to solving the problems you listed above in the problem statement. For example: a) Our export to excel feature allows customers to get the data via API’s b) our API based mechanism lowers cost of delivery. etc. This is also sometimes the “how you do it”.

Then you have to record the differentiation associated with the features. How do you do something different to enable that feature(s). For example: our algorithm for ranking generates a proprietary score for each customer segment.

The next step (which you may not need for the positioning, but will later on) is to document the benefits of the feature / differentiation. Benefits are fairly easy to document based on cost savings, revenue generation, etc. and are based on the feature list. For example, if you have X feature and Y differentiation, that results in a reduced cost compared to existing competitive solutions for customers,.

This should suffice for you to start A/B testing. Now, use these in your web copy, presentations and when you are describing your company to others at events, meetups, etc.

Keep a log of the first 100 people (or some good enough sample size) of people you to talk to, and get a sense for which statements resonate.

Test different positioning statements until you get to the minimal set that gets people exited enough to ask you to tell them more.

Until that point, keep testing.

Predicting news: The top 25 headlines after the launch of the Apple watch #AppleWatchPossibleHeadlines

Predicting the news is rather hard.  There are many things you dont even know about or can anticipate, but not with all news related to Apple. Given the over 12,000 blog posts devoted to Apple over the last year from The Verge, Mac Rumors, 9to5 Mac, EnGadget, Business Insider and many others, it is easy to put together a list of potential headlines that you can anticipate with  some level of confidence.

For every angle of the news of the Apple watch there are 2 possible outcomes, the good outcome, the bad outcome. It is more likely that the average outcome is what happens, but with Apple fans it is not at all hard to be confident that every average outcome is re purposed as a feature and not a bug. Case in point: The iPhone 4 dropped calls and users were blamed for “holding it wrong“.

So lets do a thought experiment and put the various possible headlines.

  1. Apple confirms over 1 million watches sold as pre-orders exceed expectations (MacRumors)
  2. Here are the only 5 Apple stores still left where you can get appointments for your Apple Watch (Business Insider)
  3. Apple analyst says his checks indicate that demand for the Apple Watch is off the charts (VentureBeat)
  4. Hands on with 15 different Apple watches and straps (Video) – The Verge
  5. Which Apple watch should you buy (we have tried them all) – Mashable
  6. Apple watch tear down reveals 78% margins and $102 is the BOM cost – iFixit
  7. Apple watch reservations are being auctioned on eBay for $25 to $50 – Tech Crunch
  8. The genius move by Apple to force reservations and create artificial demand – Jon Gurber
  9. Apple has sold more watches in 1 week than Android Wear for the entire year – enGadget
  10. Apple has significant supply chain problems, which is creating artificial demand for reservations – ReCode
  11. Here is the list of top 100 celebrities who have bought the Apple Watch (with photos) – Business Insider
  12. What happens when I strapped my Apple watch on my cat and left it for a day – Apple insider
  13. Apple watch straps cause rashes on your wrist – Mac forums are full of people complaining about it – Mashable
  14. The 50 unintended uses of Apple watch that I never expected – Apple fanboy
  15. How we jailbroke the Apple watch to work with Android KitKat – Android Central
  16. The expected lift from Apple watch to Q3 revenues for the company- Benedict Evans
  17. Apple watch disrupts the iPad and Telecom carriers voice plans – Asymco
  18. Apple watch gets poor reviews from early users causing oversupply – Business Journals
  19. Apple watch oversold and the reviews pouring in are overwhelmingly positive – San Jose Mercury News
  20. New blog showing celebrities sporting their Apple Watch goes viral – Huffington post
  21. Watch demand in China over strips supply as Apple reroutes orders from Europe – ZdNet
  22. Notifications are overdone say users as many turn off apps on the watch – ComputerWorld
  23. How many people bought the $10K Apple watch on Wall Street – We have the answer – Business Insider
  24. 10 things you never knew you could do with your Apple watch – MacRumors
  25. Apple stock hits an all time high as watch users drive sales – CNBC

For each and every one of these headlines the opposite can also be true. Which means we don’t quite know if it will do well or not, but if you are a editor at one of these publications, I’d totally steal these headlines and start writing copy to beat the others.

#AppleWatchPossibleHeadline

Who should you raise money for your #startup from if you had a choice?

I got a question from a friend Abhinav Sahai, as a follow up to my post “Does who you raise money from limit or grow the size of your ambition?”

What are the parameters that one should look at when choosing ‘who’ to raise money from? 

I am going to give you the easy answer first to the question. This is based on my observation that most entrepreneurs find it extremely hard to raise money for any number of reasons – positioning, not being in the network, not having sufficient traction, etc.

The answer is “Whoever is willing to give it to you”.

For over 80% of entrepreneurs that answer should be sufficient, unfortunately.

Lets assume though that you are in a position to receive interest from multiple investors and you have to make a choice. Or you are going about your fund raise in a strategic fashion and are looking to target specific investors who you’d like to bring on board at your startup.

The overarching theme to address this question is to bring folks who provide “Smart Capital“.

Most investors will give you money. That’s why they are an investor.

What you need in addition to the capital is what you should be looking to get from investors if you have the choice.

1. In some cases that might be connections and networks - to other investors, to potential customers, partners or future employees.

2. In other cases it might be expertise and insights - how to address questions that you will face while you scale and grow your startup.

3. In still other cases it  might be credibility and advice - being associated with top folks in your industry gives you a leg up over others.

4. In still other cases you might just want someone you can trust and sound ideas off. Knowing that your startup journey is going to be long and lonely means you need folks to help keep your morale up or to help you gain perspective.

They may be more things you might need in addition to capital, but most will fall into these 3-4 buckets.

Typically most folks will tell you that they can bring their expertise and connections. 

If you can be strategic about your fund raising (meaning you have good runway, or have great traction), then I’d highly recommend you look at your fundraising as a project that the CEO undertakes herself.

It will take about 3-6 months (elapsed time) from start to finish, so you should be willing to be patient, and consistently follow up as with any strategic project.

So the question then becomes how do you gauge if someone has expertise or connections?

The simple test is to ask them questions you face daily and look for depth of the answers, the breadth of their knowledge and the ability for them to customize their learning to your needs. That will give you a sense for their expertise.

The depth and breadth of their network is also easy to test – ask them to introduce you to 2-3 people you have been trying to meet to help validate your plan.

Above all I’d highly recommend you reference check. Talk to others in their network who they have invested with or other entrepreneurs they have invested in to get a sense for the investor.

The most critical question you can ask is how they respond to tough situations. 

100% of all startups go to hell and back before they are a success or a failure. When you have supportive investors to help you along the hard journey, it will be a lot less stressful.

Facebook more than Google is the new Microsoft #fastfollower

I was catching up with all the F8 news over this weekend and something struck me as odd. Facebook is the new “fast follower“. They are pursuing the multiple app strategy, not the single app strategy.

It is almost as if they dont have new ideas, but keep picking up the best ideas from every other team and executing it better because of their inherent strengths.

They borrowed the hashtags from Twitter.

They stole stickers from folks like Line and Kakaotalk.

They picked up the send money via messenger from Google wallet.

They also picked up sending messages to small businesses directly from users from the Square app.

I can see their acquisition strategy being similar as well – buying the new age “consumer suite” instead of the Microsoft “office suite” – with WhatsApp for messaging, Instagram for Photos and likely buy Meerkat sometime soon, when they hit mainstream. I still believe they will buy SnapChat sometime in the near future.

The other part of the strategy that makes it interesting is how Microsoft and Facebook realize that they are both competing with Google (Android) and Apple (ioS) in terms of real estate on the mobile phone.

Android just recently announced Work and Home profiles which will allow the user to have 24 – 30 apps which occupy the “home screen”.

Microsoft with the acquisitions of Accompli, Sunrise and LiveLoop now owns email, calendar, productivity and is only missing work productivity – which it did own – via Skype and Skype for Business, by others.

Facebook, with Instagram, Whatsapp and its own apps dominates the “home” fun and communication screen. What it is missing is private sharing (Snapchat etc.) and possibly video (Meerkat).

I can also see Facebook partnering with someone or buying a Music app and a dating app as well.

That’s primarily because most Smartphone users (over 65%) dont download any apps and use the ones that are default on their phone.

The ones that Microsoft and Facebook are missing on iOS and Android are maps (most people use Apple or Google maps) and browser (most folks use Chrome or Safari).

I wont be surprised at all if Facebook partners with ESPN and Weather channel to create “Social Sports” and “Social Weather” apps as well.

Does who you raise money from limit or grow the size of your ambition?

I was speaking to a prominent angel investors in the Seattle ecosystem yesterday. He has been pretty prolific, doing over 20 deals in the last 5 years. He does mostly syndicates and has a band of investors he works with. Having been a successful technology executive before, he understands the market and the landscape fairly well.

We got talking about accelerators and their place in the startup food chain.

Most VC’s and angels will tell you that in the last 2-3 years, accelerator backed companies have gone from 0 to about 5-10% of their portfolio. Many seed (angel, individual) investors still believe that proprietary deal flow is critical to their success in building a strong portfolio.

The thing that struck me was how he mentioned that in the last year he has changed his position from “angel investor education” to “entrepreneur education”.

The reason was that he felt entrepreneurs were not clear on the market landscape for exits and how angel investors need to make money as well. I can understand and empathize. If angel investors don’t make money, they wont be able to convince other new investors to come along.

He was talking about the example where most of his companies (of the ones that exited) have been acquired for between $25 and $100 Million. He has 4 exits, so there’s clearly insufficient data to form a trend.

Nonetheless, he felt it was important to ensure that entrepreneurs understand that the series A VC round was getting bigger and getting harder, so he was pushing for his entrepreneurs to be capital efficient and raise as little as possible, expecting to raise < $3 million ($500K – $1Mill, first seed, followed by a < $2M post seed). That way he felt, that a < $10 Million valuation in your post seed will still get you a 2 – 5X multiple return.

Normally I would have filed this under “investor that cares about returns only so don’t bother”, but this investor is really smart and has been helping his entrepreneurs successfully raise their follow-on’s. Of the 20+ companies, he has helped 80% of them raise follow on funding within 18 months. Pretty impressive.

Then it struck me as I was speaking to a valley VC later in the evening, who mentioned there was “frothiness” in the valley and that companies were raising money because everything is just so much more expensive. He was advocating the “Go big or Go home” strategy.

Turns out there are multiple options indeed for entrepreneurs – if you can get to the valley, and plug into the network, you tend to raise a lot more money, grow big and scale fast.

If you are not in the valley, you grow slower.

I have a few questions though:

1. Do you know what drives you – making good money or making a difference? – Saying both is an easy cop out. What would you prioritize?

2. Does the size of your ambition affect who you raise money from and where?

3. Does who you raise money from (not the amount) affect the size of your outcome as well?

I suspect the answer to all these questions is a qualified yes. I’d love your 1-2 sentence answer (or 140 character tweet) to these questions.

The analogies and words people use in your startup meetings define your culture

As a founder, it is important to define and constantly manage / prune your company culture. Why? It defines your growth, who you hire and how you respond to situations.

Most founders don’t understand, though, what the company’s culture really is. When you have more than a few dozen people, things change dramatically if you are not constantly pruning and hiring the right folks. Even the best leaders have a little more than 50% batting average when it comes to hiring stars, so it is no surprise that culture changes at a startup quickly if it is not nurtured.

What is then the best way to understand what your company’s culture is and how it manifests itself in your interactions?

The best way I have found you can understand your company’s culture is attend a critical kickoff meeting for a key project for every team, every so often.

Not as a contributor or a participant, but as an observer.

Sometimes folks in the room will be cautious about having the founder attend their meetings and be likely guarded in that meeting, so I’d recommend you ask to be on the conference call, not in person. Most people tend to forget folks on the conference call, and tend to be their natural self.

Then look for key words that people use to describe actions, situations, responses and milestones.

For example, at Microsoft teams use the words rhythm, cadence, muscle memory and “landing things” a lot on the sales side of the house. On the engineering side it tends to be “shipping bits”, agile, “landing things” and cadence a lot.

It is very useful to understand where those words come from and what people believe in when they are confronted with situations. They also though, define the culture of the organization.

As instrumental as these words are in understanding what people value, it is also indicative of what gets ignored.

The best way to have an understanding of the culture is to ask questions about quality, deadlines and budget.

These items will give you the best response into the psyche of the organization.

Another thing to look for is the analogies that people use to describe situations.

Most sales teams will use sports analogies (for example you will hear at Microsoft about “hail Mary” effort to secure a difficult customer effort by end of the quarter). Engineering teams tend to (at Microsoft at least) use science analogies – (for example you will hear frequency and amplitude of releases, and the signal to noise ratio of feature requests).

Some of these analogies are truly regional and defined by background, but once in a while, when you have a new leader who wants to redefine the culture they start to use different and new analogies, which stay for much longer than their tenure.

As a founder the best way to have these “grapevine” stories stick is to use analogies that folks will adopt because it creates a sense of “insider knowledge” or “tribal power”. It is also the best way to ensure that your culture has a cult following.