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science, art or sorcery?
clues to .com valuations

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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 and K-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.

Mr. Raben: I'm Jesse Raben from 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.


Audience Member: 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.


Audience Member: 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.

Mr. Frederick: 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.


Audience Member: 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?

Mr. Frederick: 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 anxiously.


Mr. Almeddine: My name is Sam Almeddine with 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?

Mr. Frederick: 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 next venture.


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.

Mr. Frederick: 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 pretty similar.

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.


Mr. Monroe: I'm Hunter Monroe with ValueSpeed, Inc. 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?

Mr. Frederick: 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 risk.


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.


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