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what’s the real deal?

financing ideas to IPO

Jeff Osborn formed Osborn Capital after years as a serial entrepreneur and successful executive at UUNET.  With more than 40 seed investments in startup companies, including his own manufacturer of racing boats, Osborn is a straight talker who’s not afraid to give his personal take on the “real deal” of getting funding.  At this Netpreneur.org Coffee & DoughNets meeting held September 20, 2000, He covered topics ranging from an explanation of pre- versus post-money, to who makes the best (and worst) investors, to the future of the economy.  

Statements made at Netpreneur events and recorded here reflect solely the views of the speakers and have not been reviewed or researched for accuracy or truthfulness. These statements in no way reflect the opinions or beliefs of the Morino Institute, Netpreneur.org or any of their affiliates, agents, officers or directors. The archive pages are provided "as is" and your use is at your own risk.

Copyright 2000, Morino Institute. All rights reserved. Edited for length and clarity.

fran witzel: welcome

Good evening.  I'm Fran Witzel, Vice President of Morino Institute's Netpreneur.org¾the dot.org learning community for new economy startups.  On behalf of the Netpreneur.org team and tonight's sponsor, UUNET's Head Start program, it's my pleasure to welcome you to the first of our fall lineup of events.

          Our featured speaker tonight is Jeff Osborn of Osborn Capital, an early stage angel investment fund.  Tonight we'll hear Jeff’s thoughts on “The Real Deal: Financing Ideas to IPO.”  Jeff was an entrepreneur, a UUNET executive and, most recently, he has been investing in and mentoring startups.  Jeff and his team have invested in Aptis, which was sold to Nortel Networks; Compatible Systems, which was told to Cisco for $567 million; and ArrowPoint Communications, which was also sold to Cisco for $5.7¾as Carl Sagan would say¾BILLION dollars.  In addition to Osborn Boats, Osborn Capital has invested in eHarbor, EyeCast, Netwhistle.com, altaVoz and several other companies.

          After Jeff shares his insights, we will follow up with a Q&A session moderated by Shannon Henry, Staff Writer and Columnist at The Washington Post, who has been recognized as one of the most influential people in Greater Washington's tech community.  I believe that The Post and Shannon have done an incredible job of informing the world about the incredible entrepreneurial stories in our region.  Many of those stories are being created by people in this room.  Be sure to log on to washingtonpost.com for Shannon's Download chat, a virtual continuation of tonight's event where she will interview Jeff and takes even more of your questions.

          The “real deal” for financing startups has changed since this spring.  Many of the rules are the same, some have changed, but the odds of getting seed funding have definitely changed.  PricewaterhouseCoopers MoneyTree recently reported that while the overall amount of VC money invested for the second quarter of this year increased, the number of seed and early stage investments dropped by 25%.  What does this mean for entrepreneurs and what do you need to know to succeed?  Judging from Jeff's experience, one company that knows about success is UUNET, and we are very pleased that UUNET's Head Start program is sponsoring tonight's event.  Having quickly grown to be the largest ISP, UUNET has not forgotten its entrepreneurial roots.  Through its Head Start program, the company now offers full service support and access to startups while they are still young and have the potential of becoming the next generation of large UUNET customers.  Brad Wise is one of the key people at UUNET who has rekindled the entrepreneurial spirit with the Head Start program and other initiatives to address the needs of ASPs and emerging high-growth companies.  He was one of UUNET’s original sales team of 10 under Jeff Osborn, and now he is Vice President of Channel Sales & Development responsible for leading channel sales, security product sales and UUNET's small business marketplace strategy.  Please help me welcome Brad Wise, who will introduce tonight's speaker.

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brad wise: introduction

Thank you all for coming tonight.  I certainly do not want to spend a lot of time talking because we definitely want to get Jeff Osborn up here.  I do want to say thanks to Fran and all the team at Netpreneur.org for continuing to put on events like this so that we can all benefit from them, and for allowing us to be a part of this event tonight.

          When I was asked to introduce Jeff, I immediately started reminiscing about the several years we spent together at UUNET.  In fact, it's kind of ironic that we are doing this event in late September because it was in late September six years ago that I got the opportunity to interview with Jeff¾the shortest interview I’ve ever had.  It was over the telephone, and he said one thing to me, “Impress me.”  I got 60 seconds to impress him, and, fortunately enough, I guess I said the right things because I'm here today.  It has been an absolutely wild ride at UUNET, and Jeff was a real visionary leader, both on the sales side and overall leadership of the company.  I sat down with some folks, yesterday, who were part of that original 10-person team to get some stories.  I have about 50 stories here, but I won't tell them.  I know that Jeff, in his entertaining way, will share a number of stories with you tonight, so, without further ado, it is my honor to welcome Jeff Osborn.

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jeff osborn: straight talk on a grinding proposition

That was really gracious of Brad, but I hate getting an intro like that because there is pretty much nowhere to go but downhill, so I'd like to thank you all for coming out tonight . . .

          Where should I start?  Oh! I wrote some notes.

          My name is Jeff Osborn.  I'm currently with Osborn Capital.  I had to go to work, and that company had the same name as me.  Actually, I started it.

          For four years, we have been investing in small companies, primarily in Northern Virginia and New England.  In 1996, the idea was that it seemed like Northern Virginia was becoming a real technology center, but nobody really knew it yet.  The number of VCs here was one¾was there anybody other than FBR?¾and the number of lawyers who understood how to spell “IPO,” even if you spotted them the vowels, was zero.  It seemed like there was a lot of potential and, from the UUNET experience, we were fortunate enough to be able to fund some companies.  The total number of deals we have done is 43, and we have sold or taken public a number of them, although a lot of IPOs have been on hold since April.  I mention that just in case you have been asleep or in an ice cave, because it's gotten a little ugly lately.  I was also with UUNET from 1993 until early 1997 as the first VP of Sales & Marketing, and one of my first employees is here, Sara, who now works for me.

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once upon a time on the Internet

          People sometimes forget how fast this whole Internet thing has moved along.  I think it's going to catch on; what do you think?

          A lot of people don't believe me when I remind them that in April of 1994 there was a rule change making it legal to do commercial business over the Internet.  Before that, in order to get somebody online you had to sign a paper pledging that you would do nothing related to business over the Internet.  Think about it.  There I was trying to get a thousand bucks a month out of somebody for this thing that they are not allowed to use for what they want to use it for; now it's just about ubiquitous.

          I spent the last two weeks with some people on a raft in the bottom of the Grand Canyon.  We decided that we wanted to share each other's pictures, so somebody started writing down email addresses.  I remember asking, “What are you doing that for?  There's 16 of us.  Everybody's not going to have an email address.”  What are the odds?  Everybody had an email address.  In 1993, however, I would speak to large groups of technology business people and ask, “Who has an email address with an @ in the middle?”  I’d get 10-15% positive responses, so this thing has been pretty amazing.

          I have been chasing this high-tech thing since the early 1980s.  I was a programmer first, then I realized that with a haircut and a suit you made four times as much money.  It was a revelation.  I wasted a year and a half in which I would go into a roomful of programmers and realize I was in about the middle percentile of intelligence of people in the room.  The first time I walked into a room full of salespeople and did that same check, I was the smartest guy there . . . even asleep.  It was an interesting and, eventually, really wise move.  In 1983, I was with a company in California that was doing something called “TCP/IP routing” which turned out really big.  We actually canceled our first IP product because nobody was going to use it except researchers and universities.  Who knew?  Well, it caught on.  I did a series of startups, mostly in telephony, in the 1980s.  Then, in 1991, full of youthful vim and vigor at age 32¾which was a young age to start a company, then, believe it or not¾I went off and started a thing called Wilder Systems.  We developed the software, went out to try to raise money and didn't.  I went through bankruptcy, and it was very ugly.  The remaining guy sold the company for a few million bucks.

          That's what used to be a successful startup.  We ran up $5,000 or $10,000 bucks on credit cards, did some tricks and stuff, got some money together, sold things for cash, paid for things on 90-day terms and we put a company together.  When I was a boy, that's how you started it. Unfortunately, over the last two years, the method has become: first somebody gives you $20 million, then you hire 1,000 people, then you lease a building and in some decade you think about becoming profitable.  I'll get into it in a little more detail tonight, but I think the good old days are back.  Anyone who has not yet figured that out is going to have a very, very difficult time of it.  In April, our team started making phone calls and telling people in the portfolio companies, “You better have a plan somewhere that shows how this thing succeeds without raising another nickel.”  We got a lot of push back, but just kept repeating it until they said, “Yes, sir.”  If you don't have a plan to end up making money without raising another nickel, you really, really need to think about just what it is you are doing, the livelihood of the people working for you, the security of your marriage and all those other pieces.

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no guts, no glory . . . and no entitlements

          Here is the Horatio Alger portion of my little story.  When I started Wilder Systems, we sold networking software, and I did a lot of tricks¾I maxed out all my credit cards, stopped paying the mortgage (it came back to bite me in the butt) and we used a clever trick that I haven't seen anybody use in years.  It’s an interesting one, one based on the fact that you shouldn't be doing this if you don't know your industry pretty well.  If you have been a librarian for 20 years and you now want to do optical networking switches with forward-looking routing, that's probably a bad idea, but, if you know your business, then you can use that to some advantage.  I had been doing international distribution software for a few years, so I sent out offer letters to all the international distributors I knew.  I offered them the one-year exclusive on the software we hadn't written yet for an early cash order of different amounts based on the country they were in.  It was, maybe, $10,000 for the U.K., Western Europe or Japan; $5,000 for some of the smaller countries; and a grand for New Zealand, Ghana and countries of that size.  Literally, before we started the company, we had $26,000 in actual firm orders in the bank.  That was the last money we ever raised by trickier means than stiffing suppliers and demanding cash.

          I believe that these techniques will be coming back in vogue, so you might want to be the first entrepreneur on your block to try it.  It's easier when everybody isn't doing it.  Just a thought.

          There’s something that's happened that I'm worried about.  Ten years ago, networking was a bunch of folks with soldering irons in our pockets.  We were ham radio geeks boosting the power of our Cobra cordless phones.  It was people who were really into it.  If it never became anything more than a good job, we still would have done it.  In the last five years, a lot of those people have had their companies hit it big, made a bunch of money and all the rest of it . . . by the way, I'm not saying that making a bunch of money and hanging out is a bad thing.  It's been a real blast and I highly recommend wealth at a young age.  You might want to write that down, it's one of the more important things to take away from this evening.  But a lot of people are getting into it now just because some guy they read about in Newsweek made millions of dollars.  They say, “I can do that, too.” If you are doing it right, starting a company is a really grinding proposition.  It's hard, so I thought I would turn you on to the “Four Easy Secrets To Internet Startup Success.”  They are: one, be smart; two, work hard; three, know your stuff really, really well; and four, get lucky.  Then there is the part that people forget, which is: Repeat as needed.

          On my . . . fifth? . . . I don't know which . . . my fifth startup, I'll walk you through a scene.  I stiffed the mortgage because that was my clever funding method.  We were selling things in cash, but it wasn't coming in fast enough, so when they seized the car I kind of figured that I needed to get serious.  We tried to do a big licensing deal that would get us a single check for $40,000.  I would get to keep the house and the marriage and all those other things.  The day that deal definitely fell through I was pretty crushed.  I went home early because I had really built it up to my wife that it was going to happen.

          I walked into the yard and there was the sheriff.  They were taping a foreclosure notice on the front door of the house.  My car had been seized by two big thugs in black tee-shirts a couple of weeks before.  We had pretty much come home and taken the phone off the hook because you knew that anyone on the other end was going to yell at you.  Anyway, I walked into the house that day and my wife was standing there with a perfect thousand-yard stare, utterly devoid of hope.  She asked me one of those questions that a guy just never wants to hear: “Is this what you wanted?”

          It was one of those defining moments, and I would have given my left leg to be anywhere else but there at that moment.  I decided, cleverly, to go with the truth.  I thought about it, and said, “Yes,” and kind of cringed.  She gave me a big hug and a kiss and said, “I guess this is what I wanted, too.”  Needless to stay, I'm still married to this woman, the saint.

          The good news is, that was in May of 1992. Three years later, to the day, I made about $10 million in one day.  Yes, because this is America.

          What I'm trying to say is, if you really want to do the “hey I want to make $10 million” thing, make sure you have the guts and the resolve to also do the “lose the house, lose the car, threaten the marriage” thing.  If you are doing it right, that's a more likely outcome on the first try than the other.  Okay?

          There really is, however, this “entitlement/birthright” thing going on that just really creeps me out.  Twenty-two-year old kids are saying, “I went to college for four semesters and I'm not rich yet!  Whose fault is it?  I'm looking for somebody to blame.”  It's weird.  This audience tonight is actually older than a lot of the entrepreneur groups, which I'm thrilled to see.  If you haven't done anything, how are you going to be the best at doing it unless you are really lucky or something.  Marc Andreessen, I think, turned out to be a bad role model for a lot of people because not every 22-year-old is Marc Andreessen.

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shares don’t mean squat

          Anybody want to see my picture of how to raise money and how it all works?  Is that worthwhile?  Okay.

          This process has changed, as Fran alluded.  It's a lot harder now than it was back in the spring.  It was a little crazy for a while there.  Things have quieted down, so I'm going to go through this as if the last six months hadn't happened because I'm not sure what the heck is happening right now.

          By the way, this is the coolest toy in the world.  [Osborn is writing on a standard whiteboard that is configured with a device that digitizes whatever he writes or draws and projects it on a large monitor.]  You are going to love this.  You write on the board here, and it shows up there.  Is that the coolest thing you ever saw?  I want one of these. This is just way hip.

          What's the best way to do this?  How many of you have raised millions of dollars from a traditional venture capitalist?  [A smattering of hands are raised.]  How many have only gotten “family and friends” money or your own credit card advances?  [Most of the audience members raise their hands.]   A bigger number.  How many are in-between; say angel money but not big VC money?  [Again, a smattering of hands.]  Okay, so most of you are in the category of “Oh gosh! I have a car payment and I don't have any money.”

          Let me map something out here.  [He begins creating the chart shown in Figure 1 below, starting with the first column of numbers labeled “Startup.”]  Since you are a Washington, DC, crowd, note that the word “capital” here ends in “t - a - l,” not “t - o - l.”  Nowhere else in the country do they make that mistake.  It's really funny.  It's not the Washington Capitals, as in money.

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Figure 1: An Example For Calculating Valuation

(click here for an expanded version in PDF format)

  Startup   Angel Round 1st VC Round

Add’l Rounds -->

Pre-Money Valuation $0   $1,000,000   $10,000,000 -->
Amount To Raise   $10,000 $300,000 $5,000,000 -->
# Shares Allocated    1,000,000  300,000 1,000,000  -->
Post-Money Valuation  $1,000,000 $1,300,000 $11,500,000  -->
Start Price Per Share $0.01  $1.00   $5.00 -->
Founders’ Cumulative Share  100%  77%  43%  -->
Cumulative Shares 1,000,000 1,300,000 2,300,000 -->

          OK.  You start out with some number of shares in your company.  It's worth some amount of money that you pull out of your shoe box, for lack of a better orifice.  Over time, people will pay you larger amounts per share and your holdings are diluted.  Did I lose anybody on that?  Is it worth stepping through how that process actually works?  I find this is like talking to a 13-year-old boy about sex.  If you ask people whether they understand shares and dilution, they nod their heads and say yes, but they get a “deer in the headlights” look on their face.  You ask, “How big is your option pool?” and they say, “Um . . . uh . . . Olympic.”  So, sometimes I have a hard time figuring out whether people really know or not.  I’ll go through it, but if it becomes really boring just throw stuff at me and I'll stop.

          Generally speaking, first is the startup phase¾watch this; this thing even catches spelling mistakes and it has an eraser.  That's so cool.¾At the inception round, you have a pre-money valuation.  Can anybody tell me the difference between pre-money and post-money? . . . Did you not raise your hands because you are shy or because you didn't know?  Nobody is admitting it.  It’s the 13-year-olds.

         Let me demonstrate.  Basically, there is a pre-money valuation at what we'll call inception or startup.  Nobody admits it, but this is really a number you just pull out of your ear.  It really is.  Does anybody have a better way to value three guys with a good idea?

[continued]

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