art or sorcery?
clues to .com valuations
page four of four | previous page
If you analogize to the invention of
the telephone, back then people didn't speak of telecommunications
companies. If you were a stock broker and you used the telephone, you
weren't suddenly a telecommunications company that garnered a higher
multiple. I think we are getting caught up in the question of whether
or not a company is an Internet business. E-Trade
trades at something like $10,000 per account, meaning their market cap
is worth $10,000 per account. E-Trade has fundamentally changed the
brokerage business, but they have not changed the way they get paid.
Brokerage firms still get a commission on every dollar of stock that
is bought or sold. In the end, you do have to return to some
sort of fundamental analysis.
You asked for a time period. It's going
to be as companies start to have earnings or as these mergers start to
take place. You are hearing a lot about Yahoo!
or AOL doing deals
with the likes of Wal-Mart
That puts analysts in a quandary because they have two different sets
of multiple and they are not sure what to do.
Mr. Hooke: In
other words, ask the question five years from now.
Ms. Kim: I think
that the phenomenon you were describing of using proxies is continuing
to "devolve," if you will. Before it was earnings, profits,
then down to revenues. For pre-revenue companies it's customers. I
find myself in the peculiar position of not having any customers
except for the pilot customers and we are hearing that the new measure
is number of skews, especially for bargain-makers, which is what we
are. I think this will devolve, and, ultimately, we will all have to
prove our value. Another interesting thing I have heard is that in
both the private and public markets, apparently the biggest driver of
a huge jump in valuation of companies is when you have a set of
customers, a product line and then a second product line launched.
That's when you get the biggest jump. That's how you prove to the
market that your customer is much more valuable than the earnings and
the revenue streams that were being put up on your first product line.
I'm Jesse Raben from allthingsjewish.com.
Two questions. One is a quick follow-up. Jeffrey, are you saying
that after you get an angel round of investment you go back and
revalue your company when you walk into the VC? The other question
is, what is your opinion about hiring a strategic marketing
company to help you finish your business plan, do the marketing
and take you to a VC? What is the basic percentage that these
people charge for this service?
Mr. Anderson: I'll
take the first question. Yes, that's what I was suggesting. You get a
little bit of a track record behind you in terms of building the
business and hopefully moving up towards customers and revenues so
that the valuation of the company could possibly be justified at a
higher rate. You must be careful and make sure that you understand the
minimum amount of dollars that you need and have to be able to get to
that level. As Scott said earlier, you may be better off if you take a
lot of money up front and make a big push, but if you are worried
about dilution, that is one strategy that is used.
Mr. Hooke: Angie,
what about the second question? Did you consider that option?
Ms. Kim: We had a
marketing agency early on that we continued to use for a lot of our
creative work and such. They actually offered those services, but we
thought, who better to talk about the vision of the business than the
founders? We certainly did dry runs with them, more as a complementary
business relationship building service than any sort of fee. As far as
the business plan, the overviews, the actual pitches and things like
that, we did them ourselves and we really didn't consider using the
agency. It just seemed like a marketing agency would be too focused on
the marketing area.
Is there an optimal scenario that you would like to see from
building the management team pre-money? Obviously, if you have
some of the team in place it demonstrates value, but without the
money it's difficult to attract top players.
Ms. Kim: Our key
hires, CIO and CFO did not come through pre-money. It was pre-closing
but post-signing of the term sheet. I think that it was important for
some of those key hires that we knew which VC firm we were going with.
They did a lot of talking to our board members from the VC firms to
get an idea. A lot of the employees we hired prior to that time were
based on relationships we already had. I think we would have had a
pretty tough time trying to sell the company on just the three of us
alone with no funding. At least a couple of good angels were behind
us, so the pre-term sheet was definitely all people that we knew and
trusted, with generous options. After the signing came the really,
really key hires. We tried beforehand, but we couldn't pull it off.
Mr. Frederick: A
lot of entrepreneurs have a misconception in thinking that they have
to come to us with a full-blown management team. That's really not the
case at all. I think in Angie's case, we would have bid on just the
three of them. They were that impressive. We would have been excited
if they had three or 30 employees. One of the things we can help with
is recruiting people. Once you have VC money, it's a lot easier to get
A-list talent, and we get tons of resumes.
You mentioned the VC exit strategy. Is it something I need to
articulate in the business plan? Does it always have to be an IPO,
or are their other options that you might use for the exit plan
for the VC?
Mr. Hooke: I think
the VCs are open to any option—IPO, merger, sale to another company.
I suppose it depends on the breadth of the product line whether it can
be an IPO.
Absolutely. We are completely open to either of the two common exits,
IPO or acquisition. We generally go into an investment with no
preconceived ideas. The most important thing is that we are looking
for scalability. Can you scale to the point that you can afford an
institutional exit, which generally means, can you get over $100
million in market value? If you can't, you might not be a VC play
because we are not going to get the returns that we need.
What's a potential management buy-back of stock with VC valuation?
Mr. Hooke: I have
never seen anything like that in business plans. Scott, have you?
Very, very rarely. We have done some management buy-backs of stock,
but never early on or in the first stages of the investment. To us,
that's a very bad signal. We want that entrepreneur pretty much
strapped to the mast.
Mr. Hooke: An
appropriate term. He is a very nice guy for a VC.
Mr. Frederick: We
are honest about it. We do see it later, when the company nears the
public markets or has acquisition offers coming in to buy the company
at $100 million when we think it has billions of dollars worth of
potential. It's not fair to let a CEO drift in his poverty, so what we
have done in the past is to allow some entrepreneurs to pull some cash
off the table. We do that by buying some stock from them, and that way
they can enjoy some of the riches earlier without awaiting the IPO so
Mr. Almeddine: My
name is Sam Almeddine with OfficeDiscounters.com.
Can you give us more specific ideas about the range of valuations
for companies that come to you, let's say "two people and a
business plan" and companies that have seven or eight
employees and a prototype?
Wow, it's tough to say in generalities. I can tell you, generally, two
people and an idea will fall in the first bucket which is a $2-$5
million valuation. Really, do we see $2 million anymore? No, not at
the level that we play. We now write bigger checks, so valuations are
drifting up toward $5 million pre-money. There are things that can
distinguish you. Minimize the risk. If you have something very
proprietary or if the management team is very compelling, you can hop
up to that $5-$10 million or even $10-$20 million bucket. On the West
Coast, it's not unheard of. My law school roommate got a term sheet
from a Silicon Valley VC at $20 million pre-money sight unseen for his
Mr. Giasson: I
have two questions. One is, how much time should you plan on to
get the first round of VC funding? Second, I have heard stories
and read an article by David Gladstone that says the shotgun
approach is very effective for soliciting money from VCs, which
means handing out plans all over.
Ms. Kim: You have
to devote so much time to fundraising. I can't say how much we
underestimated it. Of the three founders, Aaron spent most of his time
doing supplier business development, and Jim and I spent maybe 70% of
our time fundraising, 30% hiring and pretty much no time doing
anything else, sadly. We dragged it out a bit by doing a lot of our
comparisons between the two coasts, but it was a huge time sink.
Mr. Hooke: How
many VCs did you approach?
Ms. Kim: A lot.
Much of it came from our angels and advisory board. They would say,
"You have to go meet with blah, blah." That would lead to a
VC firm which would then say, "Wow, I really like you, but we
can't do quite as much money as you are looking for, so you should go
see these three other VC firms." We probably ended up meeting
with 20 VCs.
There are two great lessons in what Angie just said that relate to
your shotgun issue. David Gladstone is a great guy and very smart, but
I'm not sure that's the message he is trying to send. I'm warning
against "scatter shot" because, as Angie said, you can waste
a lot of time trekking across the country to talk to a VC where you
just don't fit. Do research. There are a lot of resources, such as TECHCapital's
and Digital South's
grids. Fran does an amazing job putting together sources at Fran's
Funding Resources. Get to know what a VC is like. Your accountants
and lawyers can also help you. We rely on them for deal flow, so it
helps you two ways. First, it can help you focus and, more
importantly, it will get your plan read first.
Mr. Anderson: From
a valuation standpoint, there is a method called the Venture Capital
Method of Valuation that gives you a sense of what VCs are willing to
put into your company. You survey the market and it's probably not as
subjective as you might think. I imagine the funding alternatives are
Mr. Hooke: They
also invest in syndicates. There might be four or five in a deal with
a so-called lead buyer. You have to find the lead first, then others
will follow after that.
I'm Hunter Monroe with ValueSpeed,
I'm one of these people "strapped to the mast" trying to
get into your first bucket. How do we do that? We have a prototype
and a signed deal with a partner. What is it exactly that's going
to minimize risk to you, Scott?
What's going to minimize risk for us? The quality of the management
team and the extent to which they make us believe their understanding
of the competitive landscape. We are not afraid of competitors; we
just want to make sure that you guys know who they are and how to
compete against them. Proprietary technology is fantastic. It
certainly helps. I also think that a lot of entrepreneurs fail to get
into the details about sales and marketing or distribution channels.
How are you going to reach your audience and do so in a cost-effective
way? You should say, "It costs us X to get there and they buy for
Y, and Y is bigger than X." If you can do that, it minimizes our
Mr. Witzel: I want
to thank all of our speakers today. I thought they were terrific.
Thanks to everyone for coming. Happy holidays and we look forward to
seeing you next year.
previous page | End, page four