Founders Friendly VCs

It would be expected that Venture Capitals (VCs) when they are defining the terms and conditions of their investments would greatly favor their interests vis-a-vis the Founders.

However, one of the guiding principles of VCs everywhere is to be Founders Friendly. This attitude can be seen for instance in Term Sheets and Investment Agreements. There is a generic disposition for issues that may arise between Founders and Investors to be resolved through consensus. In many instances there is no rule inscribed in the contracts on how to overcome a deadlock. Another example is the absence, in many instances, of a penalty clause in case of breach of contract. In some legal systems such as the Portuguese, the absence of such a clause makes it a great deal more lengthy the legal procedures if the need arises.

In part, this approach stems from the economic environment. In the last years, it has been a sellers market and VCs have adapt accordingly. Additionally, the profusion of successful Founders turned Investors, has helped VCs gain a different perspective towards Founders/Investors relationships.

In the end of the day, however, I believe the major reason for this approach resides in the realization that a VC investment to be successful has to be based in a truly cooperative relationship between Founders and Investors.

Don’t get me wrong, Investors will insist in including protective provisions against down rounds (Anti-dilution clauses) and poor Exits scenarios (liquidation preference clauses). They will also demand a Board position and approval rights in major decisions for the company. In all likelihood there will also be a Good Leaver/Bad Leaver clause to protect against Founders who leave a Startup in the middle of its journey.

Nevertheless, the Investor is also aware that the Founders are the persons better placed to make the Startup a success. Key people may be brought to help complement the Management Team, but to do these recruitments or going a step further and replace the Founders against their will is to condemn the project to failure. Therefore, Investors have to truly partner with Founders in order to keep the different interests aligned and everyone focused in growing the Startup.

In this sense, it doesn’t really make much sense for Investors to overprotect the Investment Agreement. Founders will be managing the company in its day to day operations and in all but a handful of issues, Investors will be just supporting and advising the Founders.

If a stalemate is reached, chances are that forcing the Investors will on the Founders will result poorly, and unless it’s one of those few issues that are vital for the Investor, he will give precedence to the Founders.

Nowadays with the crunch in valuations, the Founders Friendly thesis is being questioned as the market power shifts towards Investors. Although some Investors will be tempted to follow this path, I believe that in the end of the day, Investors and Founders should have a balanced relationship. Founders are not employees of the Investors, but equals in a high risk venture.

And if the project is not a success there is always the Liquidation preference provision to safeguard that whatever money can be salvaged, Investors will be the first to be compensated for their investment.

 

 

Startups need a Plan B

“The winter is coming.” In Venture Capital circles, it has become a common place to hear this phrase.

CB Insights has even created The Downround Tracker: a list of Startups that have had since 2015 a funding round or an exit with a valuation lower than the previous round of financing. At the time this post was being written there were 56 companies in this situation.

For the Shareholders of a Startup a Downround can be a traumatic experience, as it will trigger Anti-dilution provisions penalizing Founders, force Investors to acknowledge a devaluation of their shareholdings and downplay employees expectations regarding their stock options.

However, it is still a much better scenario than not being able to get funding at all. Therefore it’s very important for Founders to have a backup plan if their current funding efforts don’t succeed. Here are 5 examples of backup plans:

1. Consider other kind of Investors: if your preferred Investors don’t show an interest in your Startup, consider other options both in a geographic point of view, as well as in the type of Investor. Crowdfunding, Business Angels or Corporate VCs are just some other options to traditional VCs;
2. Work your current Investors: current Investors would rather participate in the new funding round only in the pro rata of their current shareholding. However, if new investors are nowhere to be found, they may consider doing a bridge round and make an advancement on the pro rata investment of the new funding round;
3. Reduce your burn rate and if possible break-even: to reduce a Startup’s burn rate and risk lose momentum is a complete anathema to many. In normal circunstances I agree with this assessment, however if there is no more funding to be had, Founders should follow this course of action to avoid having to liquidate their Startup;
4. Sell the Startup: look into the close relationships you were able to build with large players (suppliers, customers, distributors) in which they validated for their own use the Startups value proposition and see if they have interest in an investment or in an acquisition. Aside from these already established relationships, the market where the Startup operates should be mapped to see who else might be interested and has the funds to do it. There are several possibilities ranging from selling the company as whole, to specific assets, to an equihire in which what is being bought is basically the dev team;
5. Liquidate the Startup: when everything else fails, an orderly liquidation of the Startup is the best course of action. Please bear in mind that the failure of a Startup is the most likely outcome of such a venture and should not be seen as the Founders falling in disgrace. Nevertheless, things should be done properly in order to avoid an insolvency process and the consequences arising from debts namely to the Tax Authorities and Social Security.

In conclusion, I strongly believe that Founders should have at all times a backup plan in case they aren’t able to raise the funding round they wish for. In the current economic climate this Plan B is even more important. The last thing a Founder should do is spend the last cent waiting for a miraculous turn of events and then be saddled with debts that he will have to pay from his own pocket.

Conservative Venture Capital Investors

It’s understandable that with the current trends in Venture Capital, many investors become more conservative in their valuations and in the cash-burn values that they are willing to finance in a Startup.

Some talk about the easy money that has flooded the Venture Capital market, with the quantitative easing programs that many Central Banks have engaged, others question the founders friendly philosophy that has been prevalent in many investors.

I have struggled myself with some of these issues, but at the end of the day one has to be pragmatic.

Although every investor claims that he brings a great deal value added to the Startup beyond the money that he invests, the truth is that Portuguese investors will be for the foreseeable future at a disadvantage when competing with their foreign colleagues. Much is being done to build and reinforce networks abroad, but when your competitor calls home to the most important market the Startup wants to address or is already addressing, he will bring more value to it. The same can be said about the expertise  in a specific area. Portuguese investors lack, by and large, a critical mass to be able to specialize in a given area.

Portuguese investors should therefore focus on their competitive advantages, and invest in earlier stages. Pre-Seed, Seed and Pre-Series A Bridge rounds are in my opinion the stages where today, foreign investors aren’t yet very keen in investing and where being Portuguese gives an investor some advantages, namely:

• Proximity with the Founders: being able to meet face to face, at a moments notice and establish a close relationship in stages where the project is evolving at lighting speed and everyone, Founders and Investors alike, need to be in constant realignment, is a huge benefit to the success of the project;
• Understanding of the environment: especially for first time Founders in Pre-Seed and Seed stages, it’s very important to be able to talk to someone who knows the legal, fiscal, regulatory, recrutiment and accounting idiosyncrasies of the country where the company is located and has plenty of experience in navigating these issues;
• Experience in bringing Portugues startups in to the world stage: Portuguese Founders and Startups have their strong points, but also plenty of room to improve when addressing foreign markets. Some of these quirks come from being used to work in the Portuguese market which has its own specificities. Foreign markets have their own requirements and being able to count with the experience of investors in bridging those gaps saves time and money;

Some Portuguese investors however don’t seem to realize that they compete in a globalized world where foreign investors are increasingly aware and interested in investing in Portuguese Startups.

They think that Seed investments are beneath them, Pre-Series A bridge funding is done almost as a special favor, because their standards are really in Series A companies. At the same time, however, they don’t realize that when competing with foreign investors for Series A rounds, they will have to offer better terms to be even considered as an alternative.

Nevertheless, what happens in many instances is that they offer lower valuations, smaller amounts of money and more complex financing structures.

The lower valuations and the more complex financing structures, are somewhat understandable in the light of trying to buy a shareholding the cheapest way possible, and it might have worked in the past when competition was scarce, but today with pan european investors and even some american ones scouting for good investment opportunities everywhere, Portuguese investors have to become more competitive.

The smaller amounts of funding are even more troublesome as they impose a slower growth and therefore a lower selling price of the company in the future. It might be argued that it’s a question of being more conservative. In my opinion it’s a question of ambition. If a Startup offers a truly innovative solution that addresses a real pain in a sizable market, Founders should not be content with small and peripheric markets, they should aim to be category leaders in the largest core markets.

In conclusion, I believe that Portuguese Investors which specialize in Series A rounds and beyond should be more competitive in the terms they offer, and should consider investing in earlier stages. At the same time, they should be open to more ambitious growth strategies that can produce world champions.

Startup Valuations Are Falling

There have been in the past months plenty of news and blog posts about a compression in Startup valuations.

The first signs appeared as companies such as Zendesk, New Relic or Box priced their IPOs below their last funding rounds.

In the case of Box, for instance, these concerns were quickly forgotten as its shares closed the first trading day at $23.23, well above the IPO price of $14. At the time Box was touted as the proof that Unicorns are real. Last Friday, Box closed at a share price of $9.9. This is but an example of a Startup share price that has been dropping from its post-IPO peak in many cases even below its IPO price.

In private markets, there have been also plenty of news about down rounds, with Unicorns such as Jawbone having seen its valuation halved from $3B to $1.5B.

Steadily, this reduction in valuations has trickled down to earlier stage rounds, with increasingly more Series A and Series B investors also compressing the revenues multiples implied in the funding rounds valuations. A few months back, a monthly recurring revenue of 50 thousand dollars was deemed as the minimum threshold for a 5M dollars Series A round, implying a 20X annual recurring revenues (ARR). Nowadays, that threshold is increasingly being set at around 100 thousand dollars, implying a 10X ARR.

Down rounds are therefore increasing across the board, but the real news is that they shouldn’t be taken for granted. Given the resentment they generate by diluting Founders, downplaying employees expectations and reducing value for existing investors, some outside investors would rather fund new projects that don’t present them with such problems.

Portuguese Startups have in general been funded with conservative valuations and are run with very modest cash-burns. This means that they can survive with smaller rounds of funding and in some cases will be able to break-even, if need be.

My biggest concern is for those startups that need a bigger funding round, not to survive, but to change speeds in addressing foreign markets. Those ones, sadly won’t be able to increase their execution speed in sales & marketing and run the risk of missing the window of opportunity in the largest markets.

 

 

 

Don’t Give Up!

No matter how proficient a Founder is in technical matters or how good his sales&marketing skills are, the challenges that he will have to face will at some moments seem so insurmountably, that only a truly perseverant person will be able to overcome them.

Fundraising is undoubtedly one of those challenges. To contact 100+ investors and receive an overwhelmingly majority of NOs is enough to dismay the most enthusiastic person. Neverthless, a Founder will have to keep at it until he gets through to that 2 or 3 investors that will present a Term Sheet.

Another area where this quality is very needed is in the contact with users/customers. Achieving product/market fit, growing the user base and monetizing it demands a great deal of perseverance.

In all this areas, a common comparison of a Founder state of mind is of a roller coast ride, with lots of downcast moments in which everything seems hopeless and a few (hopefully increasingly more frequent with time) successful moments.

Last week, as the news about Outsystems 55 million dollars funding round spread through the news outlets, I remembered the tenacity with which Outsystems’ Management Team growed the company until it reached this stage.

Outsystems was my first tech investment back in 2005. The company had a  reasonable footing in the Portuguese market and the whole world to conquer.

In spite of its innovative approach to rapid application development and delivery, the company struggled through the next years to replicate abroad the success it was able to achieve in Portugal.

It wouldn’t have been possible to become world leader in its market, if Outsystems Management Team hadn’t persevere through many failed attempts, constantly adapting its go to market strategy and always knowing that it needed to surround itself with the best resources possible.

In human resources for instance, Outsystems soon realized that in some key areas it would have to recruit abroad and it was truly remarkable the difference in execution that these persons allowed. Again, it wasn’t always a success at first try, but the Management Team never loosed faith and kept taking advantage of every opportunity to reinforce the human resources.

Likewise, to build its network of 130 partners across 33 countries and 22 industries, Outsystems had to overcome several difficulties. However, once its Management Team realized that it had to build such a network to better reach and serve its customers, they never let go of it. They tried several approaches and models and relentlessly built the present network, which I’m sure will keep on expanding.

In conclusion, I would like to leave a word of encouragement to all the Founders out there that struggle in their daily efforts to build an awesome startup. Every single successful startup faced its own share of difficulties so don’t loose faith in yourselves and in your project. Persevere, but also be flexible. If things aren’t working as they should, adapt your strategy, understand what’s wrong and keep improving!

 

 

 

Monetization vs User Base Growth

In B2C projects there is an added tension between monetization and user base growth. Consumers have grown used to having web and mobile content, as well as apps for free. Additionally, content and apps production have increased much faster than demand. Statista.com estimated that in June 2015 Android users could choose between 1.5 million apps in Google Play App Store, while Apple App Store had 1.4 million apps. At the same time and according to Forrester Research,  consumers in the US, spend 85% of time on Smartphones in Apps, but 84% of this time is spent using only 5 apps.

Faced with such a daunting challenge in the user growth front, it’s understandable that Founders would like to opt, at least in the early stages of their projects, for offering their product for free.

However, sooner or later, a monetization strategy will have to be found, and the transition from free to pay has its own challenges:

1. Are users willing to pay for it? With so much competition for users, the value proposition may not be strong enough for users to pay for it. They may simply choose a free competitor instead of paying for your product;
2. Which users? The product was developed based on the feedback of an enlarged base of free users. Paying users will be a subset of that base and product development will have to be adjusted in order to cater to the needs of that subset;
3. Which monetization strategy? As always with anything related with a Startup, chances are the right monetization strategy will not be achieved at the first try, and the backlash of such a trial and error process can easily kill the momentum a startup needs to preserve in order to achieve success;
4. Won’t users feel betrayed? This is one of the reasons why some Founders rather offer a free trial, even if an extended one, than an outright free use. In the former, there is from the start the acknowledgment that the user will have eventually to pay for it, while in the latter an expectation is created that the use will always be free;

Another concern that Founders should bear in mind when deciding between a free or paid strategy is fundraising. Startups that with a small investment from Founders and/or their Family and Friends are able to generate millions of active users are increasingly scarce. Investors usually want to see a working revenue model and minimum monthly revenues (both in absolute value and in its growth trajectory) before funding the company.

In conclusion, I would advise against purely free offers. If the product fulfills a real need, users will be willing to pay for it and should not grow accustomed to get it for free. Alternatives such a free trial or a free pricing tier offer a balanced way to let users see for themselves the added value of the product, while at the same time allowing Founders to fine-tune from the beginning the monetization strategy.

 

 

 

Full-time Founders!

Kind of a redundant headline, right? If you have a tech based startup and you believe it has the potential to become a unicorn, why on earth would you treat it as a hobby and work on it as a part-time job?

Well, the number one reason is when Founders need to earn money in another job to pay for their personal expenses, as well as to pay for the costs of the startup. That is also one reason why there is so many tech entrepreneurs coming out directly of universities. They don’t have a house to pay or a family to support. Therefore and with low personal “fixed” costs and some financial help from family, it’s easier for them to bootstrap the Startup to the point where Business Angels and/or Venture Capital firms take an interest on the project and invest in it.

Older Founders usually have higher personal expenses, as well as higher opportunity costs (such as a high salary and a corporate career). As a plus, they may have enough money reserves to bootstrap for themselves the Startup. Even if there is an investment from a VC and in the early stages of a Startup, the Founders’ salaries will never be as high as it could be if they worked for a big corporation. This investment that Founders make in the Startup will come to fruition at the moment of an IPO or Trade-Sale, when they sell their sizable chunk of the Startups’ share capital.

Sometimes, however, Founders want to do it all. They manage the Startup and on the side they do other work (consultancy, freelance work, teaching), with various degrees of time devoted to the Startup. Before a BA or a VC investment, such a situation might be understandable, given that Founders may not have enough money to sustain themselves or/and the Startup. With BA or VC funding, the norm is for Founders to spend 100% of their time working in the Startup, as the funds raised should have taken into consideration the need to pay a salary to the Founders. Some Founders, however, find these salaries not to be enough and insist in maintaining other professional endeavors.

In my opinion, part-time Founders are not compatible with the challenges and the need for speed in growing a Startup. Competition is high in virtually all markets and no matter the competitive advantage, if the Founders are sharing their time between various activities, the execution won’t be good enough to succeed in top tier markets. Being a Founder is a 24 hours, 7 days a week, work and even so, chances are that the Startup will not succeed. If Founders aren’t able to devote themselves 100% to the Startup, the probability of success will decrease even further into the realm of an unlikely event.

 

 

 

Don’t waste a Board Meeting!

Building a successful Startup is an incredibly tough job. Therefore, Founders should leverage all the resources they have access to.

When a Venture Capital firm invests in a Startup, a special focus is given in building a good Board of Directors. In a Seed and Series A stage, the Board of Directors is usually composed of 3 to 5 members, with 1 to 2 Founders, an equal number of Investors and finally an Independent Board Member.

Founders usually adopt two different attitudes regarding Board meetings:

1. Necessary Evil: Board meetings are thought of as a burden that must be endured. With this mindset, Board meetings become reporting sessions without much time being given by the Founders to strategic issues and to try and involve everyone in finding solutions to the challenges that the Startup faces. If the company evolves well, Investors will tolerate this approach and focus their energies in the portfolio companies that demand more attention. When problems arise, the frustration of not being able to help will lead to increasingly tenser meetings, with Investors pinning the blame squarely in the shoulders of the executive team.
2. Embrace the Board: Founders are humble enough to realize that if they have resources that can be used for the good of the company, it’s their duty to extract the most value possible from them. Investors and the Independent Board Member are in an unique position to offer different perspectives of the challenges as well as possible solutions that in their experience have worked in other situations.

For Board Meetings to run smoothly, Founders should prepare in advance the meetings, namely:

• Compile the slide deck with care so as to present not only the status of the company, but also to share the main challenges the Startup is facing and the remedies the Founders have envisioned. In this kind of situations, it’s important also for Founders to include enough data points about the challenges for the other Board members to be able to help;
• Share the slide deck in advance with the other Board members so that they have time to read it and to ask for additional information or clarification if need be;
• Important decisions as well as issues that the Founders anticipate that will be controversial warrant a pre-board meeting conversation with the other Board members so as to align positions and avoid stalemates in the Board meeting;
• From time to time special Board sessions should be schedule to brainstorm/discuss in depth specific issues. Investors and Founders alike are always very busy, and regular Board meetings have a lot of ground to cover. Therefore it’s more productive to have special meetings to go through specific matters.

Investors from their side, should also avoid some pitfalls, such as:

• Trying to run the company themselves: Investors are non-executive Board members who’s main role is to support and advise the Executive team. It’s very easy for Investors, specially when there is a bump in the road, to try to micro manage the CEO. It never ends well. If the Board thinks that the CEO is not up to the job, then it’s the Board duty to have him replaced;
• Transforming Board meetings into accountability sessions where most energies are spent looking at the past and pining blame for what went wrong. Don’t get me wrong, it’s important to review the past evolution, but even more relevant is to help  the Executive team overcome the challenges it’s facing. Founders for their part have the duty to present to the Board the hurdles the company is facing, as well as the steps they propose to do, to overcame them;
• Not preparing for the meeting: Investors have very tight schedules, but they have to set aside some time to at the very least read the slide deck before the meeting and adequately prepare for it. However, if Founders don’t send the information a few days in advance, they can’t expect Investors to be able to go through them thoroughly;
• Not attending the entire meeting: arriving late, interrupting constantly to answer the phone or departing before the end of the meeting doesn’t help to establish the right connection with the other Board members.

In conclusion, Board members should work together in order to maximize the chances of success of a Startup. It’s very easy for egos to hinder this cooperation. When that happens and problems arise (and they always will, even in the most successful Startup) everyone will be more focused in pinning blame, instead of working together to build a solution.

Aptoide raises $4M Series A round!

As it was widely publicized last week, Aptoide a Portuguese startup  secured a $4M Series A funding round from european and asian investors.

In 2013 Aptoide was one of the first investments made by Portugal Ventures in its Call For Entrepreneurship initiative. With the support provided with this initial investment, the Management Team grew Aptoide to become the world’s largest independent Android App Store with over 500 thousand apps available for download, 100 million annual active users and 2 billion downloads.

It has been a pleasure to be involved in this journey and to have taken part in Aptoide’s series A funding round effort.

In order to possibly help other Startups in similar stages, I would like to share some of the key factors that in my opinion contributed to this success:

1. Awesome Founders that tirelessly built a great project in a very competitive market and against very big players;
2. Amazing supporting team that leveraged the efforts of the Founders and has been able to sustain an impressive growth both in terms of users and in revenues;
3. Great hire to assist the Founders in the fund raising process, which encompassed several continents and allowed for a mix of new investors that are a good fit to the geographical target markets of the company;
4. Experienced Independent Board Member,  instrumental in supporting the Founders in preparing for the funding round, in introducing them to investors and in navigating through the different offers and subsequent contractualization phase;
5. Flexibility between all parties involved in reaching a compromise that took into consideration each other’s concerns and interests.

I would also like to share some insights from this funding round:

1. Time: from the very beginning with the preparation of the information to the money in the bank, Founders should be prepared for a 9 to 12 months waiting period;
2. Structure: because this will be a long and demanding time for Founders, the Startup has to be structured in order to continue its growth even if the Founders are not able to dedicate as much time as before;
3. Capacity to adapt: Founders enter the fund raising with a clear picture of how things should work out. Reality, introduces unexpected challenges that test Founders ability to adapt and to think outside the box to overcome these difficulties;
4. Headquarters: much is said about the demands that foreign investors make about changing the Headquarters and the place of incorporation of a company to their geography. Aptoide’s fund raising shows that what is truly relevant is whether a Startup can demonstrate that its current growth plans are good enough not to warrant a relocation.

For a startup coming from a Seed Round, raising a Series A round with foreign investors is the ultimate test that it’s on the right track. Therefore I would like to extend my heartfelt congratulations to Aptoide’s Founders as well as to all its employees and everyone else that made it possible!

Don’t delay the Approval of the Annual Accounts!

Building a startup is a 24 hours, 7 days a week affair. Achieving product/market fit, improving traction metrics and keeping the startup funded are the top priorities.

Understandably, the closing and approval of the annual accounts comes as a red tape kind of task that most Founders see as being of little value. If the Founders don’t have any sort of training in accounting some of the concepts involved are difficult to understand and this task will slide even further down the priorities scale.

Accountants and Statutory Auditors for their part, are in this time of the year fully booked, and if the startup doesn’t pressure them to do the year-end closing, they will prioritize other customers who are more demanding.

In Portugal the annual accounts comprise the following documents:

1. Balance Sheet;
2. Profit and Loss account;
3. Cash Flow statement;
4. Statement of changes in equity;
5. Notes to the financial statements;
6. Management report;
7. Statutory Audit Report (if the company is required by law to have a Statutory Auditor);
8. Report from the Audit Committee or from the Single Auditor (if the company is required to have an Audit Committee or a Single Auditor);

Usually, the annual accounts follow the civil year, although this can be different if the company’s activity calls for it, as for instance can happen in the agriculture sector.

For Tech Startups, the norm is for annual accounts to follow the civil year. Therefore and according to the Portuguese law the annual accounts have to be approved in a shareholders meeting until the end of March. If the company has subsidiaries there are two additional months for the accounts to be approved, so they must be approved until the end of May. This extra time is given so that the subsidiaries approve their accounts until the end of March and the mother company can then approve its own accounts which should take into consideration the accounts of its subsidiaries.

Although these deadlines are set in the law, there aren’t any penalties for companies who break it. The penalties arise only when the company doesn’t meet the deadline to fill the annual return to the Tax Authorities, which must include the annual accounts. This filling must be done until the 15th of July.

For a Startup it doesn’t make much sense to adopt an easy going approach and approve the annual accounts only in July, for the following reasons:

1. There is no need for it: Startups are small companies with few assets and liabilities, therefore their accountants and statutory auditors should have no trouble at all to do the year-end closing by the end of January, with plenty of time to schedule a shareholders meeting in the first quarter to approve the annual accounts;
2. Fundraising: Investors will ask for the annual accounts and for a Startup to not have them will look bad. It will show disorganization or even worse that there is something trying to be hidden;
3. Accountability: the approval of the annual accounts is an important moment in the life of any company, in which the Management Team presents to the shareholders the accounting record of what happened in the past year and submits itself to their judgement;

In conclusion, there is no need for a startup to delay until the second half of each year the approval of the accounts of the previous year. The accountant and the statutory auditor should be more than able to do the year-end closing by January. As the Startup grows accounts will become much more complex and the reporting needs for instance to Investors will be much more challenging, therefore it’s important to establish early on a good accounting discipline. It shouldn’t also be dismissed lightly the potential negative impact of having to justify to a potential Investor why the annual accounts aren’t still closed. Investors will always assume the worse.