startups swing for the fence:
conversation with Tim Draper
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the crowd goes
Mr. Witzel: I received this
question from our audience today. It says, "I think many people who are here today
would like to know how Draper Atlantic's deal flow works. Referrals only? Cold mailing?
Phone calls? In short, how do you want the 100 business plans sitting in the audience to
get to you?"
Mr. Draper: Good question. The easiest way for us to get a business plan is an
executive summary by fax, which is sort of unique. We get a lot of emails, but it's hard
to read a lot of things on the screen. If you really want to make it easy for us, send an
executive summary by fax and then mail in the whole plan. No, it doesn't have to come with
a referral. Some of our best deals were not referred; they came right over the transom, so
don't make any special effort to get somebody to give us the pressure.
We're trying to search for diamonds in the rough, and we are doing the best we can. We
are always "understaffed," or whatever they call it. I always think that just
means everybody gets to work more. I encourage you just to get them in, and don't worry
about how they arrive. Once they are in, they get logged and you get your decline letter.
No, I'm joking. Anyway, we have a process which we are passing on to the Draper Atlantic
guys. We get 10,000 ideas a year in California, and some of those come from you folks, I
imagine. We are going to ship them right back out here. We have a great office out here,
and they are going to do a better job than we ever did.
Mr. Khera: My
name is Vivek Khera from Khera Communications (http://www.kcilink.com). "Open source"
software is all the rage these days, with Linux being the poster child. A lot of companies
are trying to set themselves up as service companies giving away product. I don't see how
that can be such a high margin business. Would a venture company really want to invest in
something that's people intensive as opposed to something you ship out and you have high
margins on the sales?
Mr. Draper: Yes, that's a good
question. The reason we nutty venture capitalists are investing in companies who give
stuff away is that, by giving it away, it spreads faster. Our whole game now is market
share. If you own the market, you can then figure out how to make money. Microsoft made
money in so many different ways. If they had originally given away the operating system,
they might even be more successful today. Linux, yes, we are hoping. I sit here with this
Windows software and think, "Why do I have to go to "Start" in order to
shut it down?" I think that's kind of irrational, but that's just me.
Mr. Marein-Efron: I'm Daniel Marein-Efron. For those of us who
have taken angel money, can you give us a hint about how we structure the arrangement for
them? How do we tell the angels exactly what their piece of the company will be after we
go to a VC and get a valuation? They obviously want an upside. What's the VC perspective
on what we should tell them?
Mr. Draper: Part of that depends on who the angels arehow big and how
important they are to your future success. I would do one of two things. I would ask them
for a loan that they will convert into the first round with a VC, and, if there is no
first round, then it just converts at a certain price. Otherwise, I would set a price and
just say, "If this VC comes down and it's a tougher deal than this, we'll give you
that deal." Then the angel is covered and happy. There are probably 100 different
ways to skin a cat.
Mr. Sklarew: I'm Ralph Sklarew. I noticed on your list of 10 tips,
getting VC money wasn't one of them. My question is, how do you value a company that comes
to you with just a napkin?
Mr. Draper: That was an oversight. There will be 11 next time.
What's happened to us is that somebody comes in with a napkin and we get enamored with
an idea. It didn't used to be that way. We'll spend an hour with someone trying to figure
out how this idea could work, what kind of a virus we can create, how big can it get, and
what happens if you do such and such. We're doing a lot of what-if stuff. Once we figure
that out, and once we have thought it through a bit, we'll say to the person, "We
have thought about it, you go think it through the rest of the way." They come back
with what they've done, and then we fund them. Sometimes.
The valuation varies. It's all over the map. We're driven by the market, just like
anybody else. We have to know that we have a big enough stake in the company for it to
matter, but, on the other hand, we want to make sure the entrepreneur feels like it's his
or her baby.
Mr. Howe: My name is Bill Howe. Going back to your first tip, about
looking for big markets with very large P/E ratios, since most Internet stocks right now
enjoy fantasy ratios with lots of P and no E, will Wall Street begin to hold these
companies accountable for more real world P/E ratios? Is that going to happen, and, if so,
will that cause your capital sources to dry up?
Mr. Draper: People talk about the swing from fear to greed. I think it has a
little bit more to do with a scale where, at one end, people are looking three months out,
and at the other end of the scale they are looking three years out. If you look three
years out, given those P/E ratios, they are pretty reasonable. If Yahoo! grows at 8X
during a year, it makes sense. If they grow at 8X three years in a row, that's a lot of
growth. You could argue that those valuations are perfectly rational. If thinking swings
to the three month end of the scale, then Yahoo!'s stock price would come way down. It
will come way down, but then it will swing back and they will go three years out again.
Then Yahoo! will be way up, so I suspect it's going to be a wild ride. I have a great tie
which I didn't wear today. It's a bunch of kids on a roller coaster. That's the way I look
at the Web.
Mr. Daswani: I'm
Sharad Daswani with pleaseRSVP.com (http://www.pleaseRSVP.com). Building on the
concept of viral marketing, can Web traffic or a large consumer base somehow be a factor
rather than high margins?
Mr. Draper: Eventually it has
to make people money. If you have traffic or content, if you are a virus or a magnet
bringing people to your site and those people buy things, then you have a real site with
real commerce on it.
Mr. Daswani: So, when you looked at HotMail you were looking more at the traffic
that would be generated. . .
Mr. Draper: Yes. What was great was that we didn't know what was going to
happen. It could have been anything, but, having been associated with Upside (http://upside.com), a publishing firm that grew to many readers in a short a time, we knew that we
Hi, I'm Tamara Richardson with YouthSports.com (http://youthsports.com) and I, too, want to ask you a clever
question about how you value your companies. Maybe you could just tell us the average
valuation of companies added to your portfolio in the last year, and what was your average
Mr. Draper: Oh, boy. It differs
by industry, and it even differs by region. I don't know. It differs by the amount of
money that goes into the company, too. In some cases, we put in a lot of money and we take
a small stake, but the companies were very far along in a huge market. In some cases we
put in a little money for a huge piece of the equity because the company was just
beginning. Typically, we take less than half, but if we don't have 20%, we don't care.
That's not completely true, but it's kind of the range. Picking a valuation is tricky, but
the amount of money is almost incidental because, as you put more money in, the risks are
lowered. The answer is, it changes.
I'm Dr. Nabil Moukheibir from Connectance.com (http://connectance.com). I believe a netpreneur should be as
selective in choosing the investor as the investor is choosing companies. My question is,
how does a netpreneur choose the investor that's good for health and health care-related
Mr. Draper: Probably somebody
with some experience in those areas. With the Internet, the network is very important. I'm
not as familiar with health care, so it may not be me, but perhaps one of my local
partners has that expertise and can handle it for you. There are certain firms that have
focused on biotech. Now, they are all bailing out, but there are some that have focused on
biotech for many, many years and they know about dealing with the regulators and such. I
just didn't want to do that.
Mr. Moukheibir: Does that mean that I have to go and ask each one if they are
presently in health care?
Mr. Draper: You don't have to ask each one. There are all sorts of data
available on that. There are a bunch of different lists, such as the Western Association
of Venture Capitalists (http://www.wavc.com) and the Mid-Atlantic Venture Association (http://mava.org). Just go through the list and see what they
are interested in. You are right. Be picky.
Mr. Harvey: My
name is Jamey Harvey, of Digital Addiction (http://www.digitaladdiction.com). My company is making a next
generation play and socializing platform that spreads like a virus. I'm trying to model
it, and I don't have any idea how. I'm curious how HotMail grew. Also, if you were looking
at a plan that involved a viral component as the main pillar of the product, what would
you look for in the models?
Mr. Draper: That's a good question. We
have thought about this. You need a value proposition to the user. Just because it's free
doesn't mean it's going to spread. Users have to feel like they are getting something.
Email was perfect for that because it was something they wanted anyway and they were
getting it free from Hotmail. They had heard a lot about it and this was a neat
opportunity. Net Zero (http://netzero.com) is doing a free ISP, and there is a real
value to that. Some people are offering free calendars and Homestead (http://homestead.com) is doing community building.
The real key is a value proposition because then people will tell their friends about
it. Communities come in and go out, so you get a special virus that goes back and forth,
but you have to have something worth spreading.
Mr. Harvey: My other question is, when the Hotmail guys said they were going to
put up billboards. . .
Mr. Draper: They did that by the way. It was the only marketing expense
Mr. Harvey: That was my question. How much paid marketing was necessary and was
it useful at all?
Mr. Draper: No. Not in that case, but, in most cases, yes, you have to market in
lots of different ways. You have to spread the word.
Mr. Owens: My
name is Charles Owens, chairman of AbleMedia (http://ablemedia.com). I have been an investment banker for the
last 25 years. I think that what most entrepreneurs need to know is what it costs to do a
VC deal. In other words, there is more to investing than just presenting a napkin and a
three-page summary. When the individuals in this room decide they would like to approach a
venture capitalist, how much money should they have in their back pocket in order to get
this deal done? After all, there are lawyers, there are accountants, there are other
people involved, or do you expect them just to walk in and get the deal done with a
Mr. Draper: That sounds like a
Catch 22. That's a rational investor. No, we don't expect them to have anything. We
usually share a lawyer with them. We say, "Pick a lawyer, we'll share them with
you." Then the lawyer will write it up. Usually the lawyer wants to work for the
company long-term, but knows that his bread is buttered with all the new deals we are
going to send him. It turns out that we will write up a term sheet and send it out, so we
don't need the lawyer.
The accountant? We don't need to see numbers; we are seeing concepts. We are seeing
visions and that's what we invest in. You don't need money in your pocket for that; you
need money to keep yourself alive while you are talking to venture capitalists, because we
take a while. I think that's the most important money to have. As long as there is money
in your bank account, you are all right.
Mr. Owens: What's the cost to them of the equity interest in their company
typically? Is it more than 50% with Draper?
Mr. Draper: No. As I said, we typically don't want to take control the first
time we invest. It varies. 20-50% is the range. Sometimes you just think, "Here is
the perfect deal." When Columbus made this deal with Queen Isabella, she said,
"I'll give you three ships but I want half the profits." Columbus said,
"Okay." He went to his crew and said, "I'll give you half of whatever I
get." That was the deal. It was a good deal. It came up with America.
Mr. Sohn: My name is Doug Sohn and "The Millennial World
Adventure" is our vision. I have a highly technical question for you, if you don't
mind. What's the fax number for Draper Atlantic?
Mr. Draper: Okay, good. 703-757-9286.
Mr. Witzel: Another example of shameless promotion.
Mr. Draper: Way to go.
Mr. Ringel: Good
morning. My name is Michael Ringel. I'm the founder of a company called Let's Talk
Business Network (http://ltbn.com).
I've been a big fan of one of the companies you invested in, Wit Capital (http://www.witcapital.com). Where do you see the
future of online IPOs?
Mr. Draper: What's happened is
that the mainline investment banking world is not giving Wit as much of the IPO as Wit
would like, because it's carving into their market share. WIT is really changing.
Mr. Ringel: And you see the future of that type of investing continuing to grow?
Mr. Draper: Oh, it's going to be fantastic because it evens the playing field.
It hasn't been even. The institutions have eaten those things up and now there is an
opportunity for individuals to come in. It's good. It's a lot of fun.
Mr. Witzel: We are going to take one more question. If you have other questions,
please go to http://www.draperatlantic.com, drill down to the "contact us"
button and put your question through there, or you can send email to email@example.com.
Audience Member: What's the best way to get interactive feedback from
multiple venture capitalists so that you can tweak your ideas before you finish a final
Mr. Draper: Yes, that's important. You want to get to a few venture capitalists,
get them to be honest with you, where they're saying, "Look, you shouldn't be running
your company," or "There is no market here." That's what people aren't
hearing, and it's what they need to hear. It's hard for a venture capitalist. You want to
encourage entrepreneurs, so we'll sort of say, "Well, you know, it sounds good,"
and "I'm not sure," but then you get the decline letter.
We try to list three or four reasons why we have decided to turn down the idea so that
the entrepreneur can swing back a year later with a full team, or whatever it is that he
seemed to have been missing the first time
It's a tough one. I would just test your idea against anybody you can, and don't ever
worry about somebody stealing it. It's your vision. It's your canvas, and it's you that's
going to do it.
Audience Member: Do you have an open door week or open door day when
people can just walk in and talk to you for five minutes?
Mr. Draper: Here it is.
Mr. Witzel: Thank you very much. Everyone, let's give Tim a hand. We really
appreciate it. Thanks so much for being here and participating in the Netpreneur Program
End, page two of two
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1999, Morino Institute. All rights reserved. Edited for length and