Today’s guest post comes from Ted Rosen, a partner at the law firm Fox Rothschild. How to write an effective company “teaser” is one of the most common topics I’m asked about by entrepreneurs and I think Ted has some excellent thoughts on how to prepare a company summary that hits the right points but isn’t so long that you’ll lose your reader’s attention (or make them abandon the summary before reading the important parts). Ted really nails it in the piece below. I’d especially call out “jargon free” and “keeping it simple” – the inverse of which are probably the two most common traits of poorly formed executive summaries. As always, I welcome comments, ideas, suggestions, etc. You can reach Ted directly at trosen@foxrothschild.com.

PREPARING AN EFFECTIVE EXECUTIVE SUMMARY — OR “TEASER” TO LAND VENTURE CAPITAL FINANCING

By: Ted D. Rosen, Esq., Partner Fox Rothschild, LLP

An effective executive summary — also known as a “teaser” — is a crucial tool that helps entrepreneurs catch the eye of venture capitalists and other sophisticated investors. Those venture capitalists and investors have the money that could make the difference between the success and failure of your fledgling business, but they tend to be bombarded with business plans to the point that they could not possibly read all the information they receive from business owners seeking financing.

A well-written business plan is also crucial, but it is generally premature at the start of the courtship — the right tool at the wrong time. A clear, concise, well-written teaser is an initial sales document and therefore the tool of choice to get a business owner from the start of the process to the point where an investor needs the more specific information that a business plan contains.

As legal counsel to many emerging companies, I have read hundreds of teasers and am all too often taken aback at how poorly they present the companies’ initial case for funding. Owners of such businesses and their advisors must package the business and present its compelling story in such a way that it increases the likelihood of success in a capital raise.

As with most communications, business owners seeking capital should focus at least as heavily on the venture capitalists’ expectations and desires as their own. A well-written teaser describes for a prospective investor the three main benefits that the business offers its customer base, in descending order of importance. From that, a prospective investor can weigh the likelihood of robust sales and revenue — crucial elements in the decision whether to fund. (An effective follow-up document, the business plan, will mirror this format with greater detail of the competitive benefits a company offers.) 

For each benefit to the marketplace, the teaser should describe what customers’ needs are met by the business’ products and services; touch on whether the business model is sustainable and how revenue will be generated; and discuss why customers will pay for what the company offers. Opine on whether the company offers must-have or nice-to-have products and services. Does the company solve some crucial problem for its target customers? Don’t exaggerate on any of these points and generally avoid unsupportable superlatives — the best, the only one of its kind, or self-serving phrases such as game-changing or life-altering — because savvy venture capitalists will see through that gambit quickly. Support your claims by providing supporting research — past performance, for example, or clients’ testimonials and studies that buttress your claims.

MUSTS, AND MUSTS-TO-AVOID

As with any pursuit, there are some rules of the road to follow. I have observed over the years what tactics work and which ones fall short. Many of these suggestions may seem obvious, but they are worth repeating because following them should result in an effective teaser that might catch the eye of your next investor.

In clear, concise, jargon-free language, write a reader-friendly summary that an executive in any industry can grasp. Besides describing the benefits of your goods to your customer base, explain clearly the revenue model and value proposition; include information about your market, its size and demographics so investors can judge the scale of opportunity; pricing issues and competition. Investors know that virtually all companies have competition, so trying to convince them that you don’t will damage your credibility from the outset. You should explain why you have or perceive a competitive advantage over your competitors and why you believe you will maintain that advantage, but avoid puffery and bluster.

Your management team will probably be of great interest to investors, so describe the people, their qualifications and their track records. Make projections, but make them realistic. State how you intend to use the proceeds of the capital raise, but keep that broad and flexible. Finally, state clearly how much you are seeking to raise and how you arrived at that figure.

Employ KISS twice: keep it simple, stupid and keep it short, stupid. Avoid highly technical writing because at this early stage, investors are trying to get a big-picture snapshot of your company, not what kind of alloy you use in your widgets. Technical writing will turn off an investor if he doesn’t understand the teaser, which should appeal to a broad base of venture capitalists, not just those intimately familiar with your industry. So too will excessive verbiage; keep the document to four pages at the most.

Write in an active voice, not the passive. Be realistic, but avoid negativity of any kind. Avoid empty adjectives that carry no substance. And avoid the spell-check land mine; triple-check spelling and formatting. Venture capitalists have so many teasers and business plans — and underlying businesses — to choose from that they are likely to discard those that appear sloppy.

Finally, avoid the temptation to use a power-point display to supplant or accompany a teaser. Power-point presentations tend to be too long and, frankly, too dull for most investors’ patience levels, particularly at the early stages of the relationship.

My partner Brad recently wrote a great post entitled “Addressing the VC Seed Investor Signaling Problem“. This, along with several larger funds reaching out to me to ask for advice about starting their own seed investing programs got me thinking about the hype surrounding the VC Seed Investor Signaling Problem. My conclustion:

THERE IS NO VC SEED INVESTING SIGNALING PROBLEM

As Mark Suster points out in two fantastic posts on the subject (here and here) signals abound in the investment world. And frankly, as signals go, this isn’t a particularly major one. I’m serious. There are a million reasons that an investor group may or may not be able to continue to support an investment, some of which relate to their view of the performance of your business and many of which have nothing to do with it.

The bigger issue with so many VCs jumping on the seed investing bandwagon – other than the obvious overy-hyped bandwagon jumping – is transparency and communication. And this is the advice I give to entrepreneurs and to the funds that have been reaching out to me. Know the goals of your investor’s seed investing program.

And live with the consequences.

At Foundry we view seed investing as we view non-seed investing. Our goal isn’t to seed a bunch of companies, pick the clear winners and abandon the rest. Instead we expect that some portion of our overall portfolio will start their lives as seed investments and, just as we do for every other company we’ve invested in, we’ll invest with our eyes wide open, have a thesis around our investment (“hope” is not a thesis, by the way) and work as hard as we can to help make these companies successful. Some won’t work out, but I suspect the ratio of seed investments not working will be similar to that of our non-seed investments. And as with any of our portfolio companies, if we feel it isn’t working out we’ll have an open and honest conversation with the company about how we’re seeing things, what we think we can do to turn things around and where we feel we need to get to in order to be excited about investing further.

And while I’m not a big fan of “spray and pray” seed investing, from an economic point of view I understand the strategy (maximize your exposure to as many positive random events as possible – Nassim Taleb would be proud!). And from an entrepreneur’s standpoint I can somewhat see why it may be attractive to participate in such a program (lower threshold to entry, more standardized deal, etc.). Like everything in life, one size doesn’t fit all and I’d be pretty pejorative to suggest that Foundry’s seed strategy is the only seed strategy worth pursuing (although it’s clearly the strategy my partners and I think is most likely to result in the best returns for our investors). My point here is that the issue isn’t one strategy vs. another it’s about transparency and respect for the entrepreneur. And by my way of thinking respect in this case means clearly communicating the goals of your seed program, the milestones you expect a company to reach to obtain follow on financing and what help an entrepreneur should expect along the way. From there everyone is free to make their own choice of who they want to work with and under what regime.

And for the record, I don’t at all like the “we’ll sell our investment back to the company” if we’re not supporting them with a future financing. If your VC requests that of you right after telling you they’re not going to continue to fund your business I’d suggest you offer them $1 for their trouble. And I’d be happy to suggest the proper finger to use when emphasizing the single dollar you had in mind…

AdExchanger just posed an interview that I did with them that touched on some of our ad-tech investments as well as our overall investment philosophy. I’ve cross posted an unedited version of that interview below.

1. Why get into the venture capital side of the business? Do you ever get the entrepreneurial "itch"?

I first got into venture capital about 10 years ago and I love my job. I was running a few business units for a small public company and while I enjoyed the operational side of my job, I was also responsible for M&A and partnerships and had a particular affinity for the transactional side of my job. While I consistently have the entrepreneurial itch, I actually think this makes me better at investing – it reminds me of why I’m in business (to support entrepreneurs who are the real stars of the show). I’ve also co-founded a few companies (including Trada which is a company in the Foundry portfolio that helps advertisers better execute paid search campaigns; I wrote about that experience recently on my blog: https://www.sethlevine.com/wp/2010/08/trada-from-the-beginning) and I’m very close to many of our portfolio companies at an operational level which helps to satisfy the entrepreneur in me.

2. What is Foundry Group’s investment philosophy?

Unlike many venture capital firms that invest in certain geographic regions or specific technologies and sectors, Foundry Group’s investing activity is largely driven by a thematic approach. The themes we pursue tend to be horizontal in nature and are often driven by underlying technology protocols and standards or emerging market trends and customer needs. Rather than looking for short-term hits, we focus on themes that have the ability to drive a cycle of innovation (and hence provide multiple investment opportunities) over a period of five to ten years or more. My partners and I have written extensively about this thematic approach on the Foundry Group blog: https://www.foundrygroup.com/wp/category/themes/

3. You’ve invested in AdMeld, Triggit, Lijit, Medialets and Trada among others in the ad space.  Foundry Group is an advertising start-up "bull" it would appear. Thoughts?

I’m extremely excited about the portfolio of companies my partners and I have put together at Foundry Group which includes some great ad tech companies which you list above. We think of these investments as part of our “Glue” theme – meaning that they’re all essentially connective technologies that help increase the velocity, accuracy, transparency and availability of online advertising. I believe that online advertising is going through an important transition with the rise of real-time bidding platforms and advertisers increasing ability to buy audience vs sites. Our investments in many of the companies above follow that idea. Additionally, mobile is becoming an increasingly important platform as devices become more powerful, more flexible and better connected. Obviously our investment in Medialets – the market leader in rich media mobile advertising – reflects our belief that mobile in general, and rich media on mobile specifically (which is really the kind of advertising that mobile was made for) is a rising area in advertising. We’ve been fortunate to be able to work with some of the companies and people that are at the leading edge of digital media and I think we’ve put together a great portfolio of companies in this area (and I’d add Mandelbrot Project to your list above, although we’re not talking much about what they’re up to yet).

4. What are some key overall, characteristics that Foundry companies share?

I’ll resist the temptation to answer with some superlative VC cliché about how great all our management teams are or disruptive the underlying technologies are becoming.  Rather, I’d say that the one truly common trait across our portfolio of companies is the obsession these businesses have with their product. This product obsession starts with the CEO and pervades the management teams and operations of our companies. They eat, sleep and breathe product.  From my perspective the results of that obsession is obvious when you look at what each of our companies is doing to change their respective markets.

5. Can you identify a couple of common errors that entrepreneurs make when raising funds?

I think there are two relatively common mistakes that entrepreneurs make when fundraising. The first is trying to do too much in the first meeting. The goal of that meeting isn’t to sell the investor on making an investment, it’s to whet the investor’s appetite and leave them wanting to learn more. Entrepreneurs should structure that first interaction to do exactly that. The second most common mistake is not asking what the process is on the investors side and as a result mistaking activity for progress. Every firm (and angel) has their own process – understanding that process and making sure you know how a firm reaches a decision (who has to be won over, in particular) is extremely important. The adjunct to this point is that while relatively few entrepreneurs methodically do it, it’s important to perform due diligence on the investors you’re talking with, just as they’ll be performing due diligence on you. Find entrepreneurs they’ve worked with before, in particular those at companies that didn’t work out as planned, and ask how the firm and the specific partners were to work with. You can also use this as a chance to understand from a third party both the partnership dynamic within the firm as well as what their perspective of the investment process looks like.

6. Given the scope and size of Foundry Group’s investments today, it would appear you’re at an inflection point.  At the very least, your current group can only manage so many investments after all and the fund itself is nearly fully-invested is it not? What’s next?

We have a very specific, and somewhat non-traditional view of the firm we’re building at Foundry. Our intention is not to create a legacy or have a business that survives the 4 founding Foundry partners. We have no associates at the firm and all do our own work. Our current fund is $225m and our intention is to raise a series of funds of the same size and then be done. As we like to say: “last one finished shuts off the lights”. To be clear about where we are as a fund and a firm, we have plenty of capacity to continue to make new investments.

7. Can you talk a little bit about the growth of the Boulder startup community and what makes it unique to other startup communities such as Silicon Valley, NYC, Boston, etc.?

I think Boulder is increasingly becoming known as one of the leading start-up cities in the United States (for example, here’s a recent BusinessWeek story naming Boulder the #1 city in the country for start-ups). And I can tell you from living here that there is a ton of great energy in this community – from TechStars (which started here) to the Boulder Open Coffee Club, to our local NewTech Meetup to Ignite Boulder. Interestingly (and somewhat different than other markets) the Boulder start-up scene is both very distributed (there are a large number of leaders in the Boulder start-up community) and collaborative. I don’t know that I’ve ever been in a city where people involved in start-ups were as willing to help each other out as they are in Boulder.

8. What are your thoughts about M&A and IPOs – and a successful exit for ad tech startups? Do you see a window developing?

We’ve all seen the global statistics – August was an unusually strong month for mergers and acquisitions. The interest rate environment as well as the relatively large cash balances of many large corporations appear to be driving somewhat of a resurgence in acquisition activity. I’m cautious that these high level data (driven by large global transactions) will be both sustainable and mean an more favorable overall environment for venture backed businesses. The time I’ve been in the venture capital business has been perhaps the worst IPO environment since the venture asset class came into being, so I’ll refrain from making any predictions about whether we’ll see any kind of sustained resurgence of the IPO market (but we can all hope together….)

9. If a startup wants to get a meeting with a VC for potential investment, any tips? Any tips on pitching Foundry Group in particular?

If you have a direct (or indirect) path to an introduction – through another entrepreneur or someone else you know – that’s always the best way in to any VC. It provides additional context which is helpful. That said, many VCs these days (Foundry included) are pretty open about what they’re interested in. I always appreciate it when people engage with me on topics that I’m writing or tweeting about. And to give this some additional context, Foundry has funded several companies that first reached out to us because of a blog post (including one company where our first communication was through Twitter).

So after much teasing by friends and in a vain attempt to solidify my geek creds, I finally took the plunge and ordered a MacBook Pro. I’m dumping my Microsoft infrastructure and am going to switch over cold turkey once I get the thing set up. I’m anticipating a difficult few weeks transitioning.

And here’s where I need your help. For readers that have made the switch, what advice do you have to make it go smoothly? For all Mac users, what programs, add-ons, short-cuts, Mac resources (particularly a directory of short-cut codes) do I need? Also, very specifically, I’m looking for something that will let me sync a network share locally so that all files are available off-line. This needs to then sync up the changes when I’m connected back up to the network. And the catch is that this needs to happen against a Windows server.

Thoughts welcome and encouraged in comments and by email.

[late breaking update – as I was writing this my new Mac showed up in the office!]

This morning we announced that TechStars is opening it’s 4th (and final) program in New York. As readers of this blog know, I’m a huge fan and supporter of TechStars (and, along with my Foundry partners, an individual investor each of the TechStars programs in Boulder, Boston, Seattle and now New York City).

For those unfamiliar with the program, TechStars is a mentor driven accelerator for start-ups. Founded in Boulder and now running programs in Boston and Seattle, New York will be the final US city to which we take the program (we feel the model of having non-overlapping terms is the best way to maximize the success of each city program). Working with TechStars companies for me has been an absolute blast. The teams bring an energy and enthusiasm that is infectious and the progress that they are able to make over a 3 month period is nothing short of amazing.

The New York program continues the tradition of bringing together promising startups with an unbelievable list of mentors (who really make the program). New York mentors include people like Alex Blum of KickApps, David Karp of Tumblr, Eric Litman of Medialets, Howard Lindzon of StockTwits, Avner Ronen of Boxee as well as investors Dave McClure, Fred Wilson, Roger Ehrenberg, Brad Burnham, Jeff Clavier and others.  The New York program will be run by David Tisch – a well known local entrepreneur and angel investor. TechStars founder David Cohen will be temporarily moving to New York to manage the program along side of Tisch. It’s the access to these mentors and the time and energy that they put into the program that really make the experience a worthwhile one for the companies involved.

Our goal with each of the TechStars programs is to have a significant portion of the funding from the local community. The people and firms that are participating with us in investing in the New York program include well known local venture firms and angel investors (FirstMark, First Round Capital, DFJ Gotham, AOL, IA, RRE, Village Ventures, Social Leverage, and more). Many will be participating as mentors as well as investors.

It’s an exciting day for TechStars and for the New York tech community. Applications for the New York program are now open – check it out!

StockTwits announced two great new features in the last week that are worth checking out.

The first is a partnership with SecondMarket to expand the StockTwits platform to include private company streams. So just as you’d tag a post with $AAPL you can now tag private companies (think $ZYNGA,$4SQ, etc). Just as it is for public equitites, tagging your posts (tweets, blogs, etc.) with private company symbols is a much more efficient way to identify the company you’re talking about and become a part of the broader conversation about a company. StockTwits has put together an impressive database of private company symbols and is adding to this list daily.

The second feature was launched with less fanfare – a WordPress plugin that takes any ticker symbol in the body of a post and links them to the realtime discussion of that company at stocktwits.com. You can see how this works in this post – check out $GOOG, $CSCO and $AAPL. Very cool stuff. From a very cool company.

Paul Graham, founder of Y-Combinator, sent out a tweet on Friday saying: “Convertible notes have won. Every investment so far in this YC batch (and there have been a lot) has been done on a convertible note.”

It’s an interesting data point on Y-Combinator companies, but is this truly a macro trend? Have convertible notes really won?  And if so is that good for start-ups? Good for investors?

I think the answer to these questions are that 1) it’s not at all clear that this trend is as definitive as Graham suggests; 2) it’s a mixed bag for entrepreneurs (more positive in the short run, potentially negative in the long term); and 3) it’s clearly not a positive trend for early-stage investors.

First a quick terminology recap (skip this paragraph if you’re already familiar with convertible debt vs. preferred equity). The most common forms of investment in early stage business are convertible debt and preferred equity. Convertible debt is exactly that – debt which is convertible into equity at some later point in time (or is paid off). Typically this conversion is at a discount to the next equity round (to compensate the debt investors for their risk) and sometimes carries warrants (same rational) or a cap on the equity price that the debt converts into. Historically convertible debt has been easier (and therefore cheaper) to put in place. Preferred equity is stock which carries with it certain rights (preferences) in terms of how and when it gets paid back and a handful of other items that relate to the control of the underlying business.

Also, before I jump into this let me state that I have the view that, like many things involving start-ups, there’s a balance between what’s good for investors and good for entrepreneurs (there’s a symbiotic relationship between the two). I believe in cutting fair deals with entrepreneurs and don’t at all subscribe to the belief that an investor should try to obtain harsh control or preference terms (almost all of our investments at Foundry have a 1-times preference multiple and are non-participating; see this post by my partners Jason and Brad for more details on what these terms mean if you’re unfamiliar with them). Paul himself said in a March 2009 article: “When you hear people talking about a successful angel investor, they’re not saying "He got a 4x liquidation preference." They’re saying "He invested in Google." And I believe that’s true, although as you’ll see below, I also believe there also has to be reasonable compensation for the risk that early stage investors are taking. We should all be so lucky as to find the next Google, but one’s investment strategy needs to be geared to finding the next Mint or del.icio.us.

Has Convertible Debt Won?

I asked this question to a number of angel investors (all with institutional angel funds or running Y-Combinator like programs) and the results were mixed. Interestingly there seems to be  a real split between the coasts. While all of this year’s Y-Combinator investments have apparently been structured as convertible debt, that’s not the case with other programs. While some are clearly seeing a heavier weighting to convertible debt than to equity, one east coast based program I talked to told me that fully 100% of their companies who had received funding had done so in the form of equity.  Of the super-angels I talked to, several reported that “all” or “almost all” of their initial investments were currently being structured as convertible debt with one (again, east coast-based) exception who reported only 5-10% of their deals were structured as debt. It’s hard to say where in the country the line shifts from equity to debt, but it’s clearly a much stronger trend out west than on the east coast (at least the northeast which was where the firms/programs that I spoke to on that side of the country are located). To be clear, any west coast trend by definition is trend, given the skew of investing to that geography (and by far the majority of the so-called super-angel investors are west coast based).

The trend that Paul is pointing out appears to be taking place, but is less than definitive (and much less so than I expected). 

Now on to by far the more important question – Is this trend a good one for entrepreneurs and investors?

Traditionally convertible debt is used for initial funding rounds that are smaller in size, where the financing isn’t substantial enough to cover the greater legal costs of a more traditional seed equity round, where the investor base lacks a “lead” to price and negotiate terms, or where the financing size is such that all parties agree that not enough money is being raised to put a stake in the ground around pricing. As I noted above the conversion terms typically contain a discount to the next financing round and – according to the super-angels I talked with – also almost always contain a cap on the price at which the equity can convert at later. Both these terms are designed to bound the risk that the convertible debt investors are taking in not pricing the round – they’re investing in an debt-like instrument with equity like risks.

Entrepreneurs like convertible debt for some obvious reasons. For starters, it can be much quicker to put together a convertible debt financing, so more of the capital being raised goes to the operations of the business, not to the lawyers (this clearly benefits both the entrepreneur and investors). Importantly it also puts off the valuation question to a later date and tends to shift at least some risk from entrepreneur to investor (I’ll talk about why this is in the next paragraph below). Interestingly however, with the increasing number of seed financings we’ve also seen a decrease in the complexity and cost of equity seed financings such that they more resemble in time and cost convertible debt structures (both Y-Combinator and TechStars have model seed docs up for those wishing to further streamline the process). As a result I believe some of the perceived difference in time and cost are disappearing and less relevant to the debt vs. equity debate.

It’s the question of terms that’s key to the investor side of the equation and where I believe the convertible debt trend starts to fall down. In the investor’s best case scenario, the convert terms reflect the current market value of the business (specifically, the cap appropriately prices the equity value of the business at the time of the debt investment). However the investor hasn’t actually purchased equity and has opened themselves up to an easier renegotiation of their terms by a later investor (who, almost by definition, wields more power at that time than the original angels, assuming the company actually needs to raise capital). More likely, however, the convert cap reflects a premium to the current fair market value of the business. One super-angel I talked to told me that while a year ago these caps “approximated what I’d pay in equity” that they’re now “33% higher than what I’d normally agree to pay now.”

I have no doubt that the convertible debt structure has the effect of raising prices for early stage investing. Within some reasonable range this isn’t a huge problem – early stage valuation ranges move up and down with the markets – but in larger increments (which we’re seeing now) and viewed in the light of angel investing economics, these changes in early stage valuation may be problematic.

Traditional venture investors average up their cost basis in a company and “protect” their ownership over time by investing in subsequent rounds. Often, angel investors don’t participate in future rounds (or if they do, they do so at a much less meaningful percentage of the round) meaning that their initial buy-in forms the basis for the majority of the shares they ultimately own in a company. Ironically, the trend of companies raising less capital actually enhances the importance of the initial round buy-in (both because that initial buy-in becomes less diluted meaning the first round price was that much more important and because even if an angel wants to buy up more in later rounds they’ll have less of a chance to do so; I also believe that along with the trend of companies raising less capital we’re also seeing earlier and somewhat smaller average exits – also enhancing the value of initial round buy-ins as fewer investors are truly swinging for the proverbial fence). I’m a big fan of the rise of the so-called super angels – I think they’ve been great for the overall entrepreneurial ecosystem and I’d like to see them continue to thrive.

So how is this trend bad for entrepreneurs?

Clearly in the short run this trend is positive for entrepreneurs because it has the effect of both deferring an often difficult conversation (around valuation) and ultimately increasing early stage company values and as a result decreasing entrepreneur dilution (by the way it’s also good for Y-Combinator, TechStars and other similar programs since the shares the program gets of each company act as founder shares in this financing equation). And I have no doubt that there will be many entrepreneurs who benefit from this trend. But it’s not clear to me that it’s sustainable (just as it wasn’t a decade ago). Ultimately investors need to be compensated for the risk they take in making their investments. With capital being relatively fluid (and the angel markets being finicky) as companies run into trouble, as valuation caps begin to be disrespected, as overall return profiles decrease because of higher early stage prices, money will flow out of the asset class. And ultimately this doesn’t benefit entrepreneurs either.

Conclusions?

If you’re a long time reader of this blog you’ll know that I don’t like superlatives and I don’t like sweeping generalizations. I don’t think convertible debt is bad and I don’t believe as famous angel investor David Rose has said that “Smart Money’ doesn’t invest in convertible debts. Period.” Different situations call for different capital and financing structures. That said, a broad market trend towards convertible debt has implications that I think are bad for the overall early stage investment ecosystem.

I look forward to a healthy discussion in the comments below!

Quick disclosure note, I’m a personal investor in TechStars and from that end actually benefit (at least short term) from this trend. As an angel investor I’ve participated (this was prior to raising the Foundry Group fun) in convertible debt structures, including several very positive outcomes.  I’m also an investor in several angel funds that are in the middle of this market. Foundry itself rarely (which is to say never to date) structures a first round as convertible debt.  

As if the world didn’t already have enough patent trolls, Paul Allen has sullied his name and jumped into the fray suing Google, Facebook, Apple and a bunch of other high profile companies alleging infringement of a number of patents held by his company, Interval Research Corp (now defunct). It’s a travesty that Allen has stooped to this level. Patent trolls are in my view the lowest of the low. And while our current – completely messed up – patent system erroneously rewards this behavior, most trolling takes place by firms and individuals you and I have never heard of (and frankly don’t want to know). Why Allen – worth an estimated $14Bn – feels the need to stoop to this level is hard to imagine.

And consider the patents at issue. One involves “technology” that suggests related products to a ecommerce site user. Another shows web news readers stories on related subjects.

Clearly very novel and protectable.

I’m considering trying to patent a “method for extorting money from legitimate companies for using obvious technology that was erroneously granted patent protection” and using it to go after these patent trolls.

Bleh.

My last post with some thoughts on product pricing has received a ton of traffic, comments and email. Clearly this topic is one that a lot of entrepreneurs care about (and struggle with). A few people pointed me to a great post by Ruben Gamez of Bidsketch on the Software by Rob blog that talks about freemium plans and why, in Ruben’s view, they aren’t always drive the results companies are looking for. It maps well to my thinking (I directly called the freemium model into question in my pricing post). There’s some great data in the post – definitely read the full thing. Here’s a few that caught my eye:

Bidsketch started out with a freemium model. Ruben carefully documents their early success with this (by early, he’s referring to a weeks, not months) and their challenge only a few months after launch of a sub 1% upgrade rate and rapidly increasing support challenges (they had a huge user-base – just not one that was paying). And then he did something “radical” – and completely got rid of the free version. This change led to an 10x increase in paid conversions.

Jason Fried from 37signals had a similar experience. “…the majority of people who are on pay started on pay…” he says. And by correlation, most people who start on free stayed on free.

CrazyEgg doubled their revenue the month they dropped their free plan.

We’ve had similar experiences with companies in our universe that struggled with freemium pricing plans. And while there are clearly companies that have made a success out of offering a free service to a large percentage of their user base and charging the few that are willing to pay (including some very successful ones in our own portfolio) I’m hoping that more companies at least consider that their best pricing plan may not need to include “free”.

I’ve been pulled into a number of product and pricing meetings recently (for reasons unknown I’ve become the Foundry pricing and productization guy). I thought it would be helpful to put some of my thoughts into a blog post and hopefully spur some conversation in the comments and over email. With any broad topic, there are always exceptions to the general rules. There are also few absolutes and much of this advice varies depending on your specific product and market. And keep in mind here that I’m dealing generally with web services of some kind in the advice below (not consumer apps and not enterprise software). With those caveats, here are some ideas on pricing models:

– Beware of too many pricing tiers. Relative simplicity is helpful in many things related to building companies and pricing models are no exception. As it relates to pricing tiers, I favor fewer pricing levels. More tiers = more complication = more confusion. It also makes you more likely to violate some of the other ideas below. I generally like 3 or 4 product tiers plus one “call us for enterprise pricing” tier.

– Have a clear delineation between product tiers. Many companies initially offer a base level that includes all of the features of their product and then offer a little more of each feature at various incremental pricing levels. For some relatively straightforward services this can make sense (think Basecamp where your sales pitch is about offering more of a relatively defined thing, that everyone pretty much understands and values, and generally will want more of as they use the product more). For most products, however, this is a bad idea. For starters, most companies vastly overestimate their prospective customers’ ability to understand the features of their product (thinking the value of each feature is self evident). It also complicates the buying process as prospective customers try to figure out how much of each of those great features you’ve developed they want, and doesn’t create clear delineations between pricing tiers. While there are some features in almost any product that need to be priced this way, I generally favor opening up some number of completely new features with each pricing increment (say an analytics layer or workflow module, etc.). This has the side benefit of giving you lots of nice ways in your product itself to promote higher tiered features (think grayed out features – “click here to upgrade!”). It also makes the upper tier value propositions relatively straightforward – want X feature? You’ll need to purchase the Silver package for that.

– How about overlay features that you charge by the drink for? Many companies have parts of their product which some advanced users may want to access at every product level (API level access being a pretty obvious example). In these cases (and to be clear, these should be product features that a subset of your customer base is looking for – if not, they should likely fall into your regular pricing tiers) I think it’s fine to have an overlay where you charge incrementally to the base price of each tier ($X for every 1000 API calls or something similar).

– Be careful what you put a tariff on. You should understand very clearly what drives your own costs as you start to matrix out your pricing so you know what user behaviors cost you money. You should also understand (by talking to early users) what drives customer adoption, usage and lock-in of your product. And with all that in mind, be careful what you chose to put a tax on. There’s no hard and fast rule here and this is a nuanced conversation that’s hard to generalize and put into writing. But remember that your pricing will effect your customer’s behavior around your product. And I’ve found that many companies make the mistake of charging for features that are the key lock-in points for customers in their early use of a product and in so doing actually limit their likelihood of getting enough value out of the product that results in their becoming a long term user. To be clear, you should try to align (but not necessarily match exactly) customer value to customer cost. But not at the expense of lock-in. To keep on the Basecamp example, note that they allow for unlimited users at even the base pricing level. They (correctly) realized that while they could have easily charged for this they’re better off getting as many people in an organization using the product as possible.

– The freemium myth. I’ve been a great beneficiary of freemium models (as both a consumer and an investor) but I think for many companies the freemium model doesn’t make sense. If your product offers value out of the gate, if your service is such that it doesn’t necessarily benefit by having a large volume of users (and back-end data aggregation is probably not that benefit, which I point out since I often hear it used to justify fremium models for companies that in my mind shouldn’t have them), if you are selling largely to enterprises (companies) – you may not be the right candidate for a freemium model. I know it’s in vogue and I know that your product is so cool if only you could get a million people using it you’d blow past the typical freemium upgrade rates of 1-3%. But in all likelihood if you’re offering a product of value that’s well thought through, well designed and well architected, you’ll make more money by simply charging for your service out of the gate. (Note that I’m really not talking about consumer oriented applications here, where freemium models tend to make more sense)

– Don’t be afraid to charge for your product. The other benefit of not going down the freemium path is that avoids another common mistake companies often make which is not charging enough for their product. When you’re jumping from “free” to “something” that something often needs to be relatively modest – after all you don’t want to scare customers off and you do need enough of them to pay something in order to stay in business. But the reality is that if you have a good product, many users who will pay “something” will pay more than you think for your product. Put another way, those that get value out of what you do get enough value to be willing to pay a meaningful amount of money for it. You may lose a few people at the low end, but many products have a lower price elasticity than their creators realize. I’ve watched many companies spend untold cycles trying to raise the price of their product after initially setting prices so low that they essentially commoditized what they do. It’s also worth noting that if you get it wrong it’s a lot easier to lower prices than to raise them. And to be perfectly clear, I’m generally not a fan of the $19.99 entry price point for a product/service sold to business users. You can charge more. And you should.

– Beware the long “trial” period. I’ve written about this before. I think most companies offer too long a trial period for their product. Just like most customers who will pay for a product will pay more for that product, most trial users who will eventually become customers at 30 days will do so at 14 days. The idea here is to give people enough time to see how awesome you are but not too much time to change their minds or to forget about you. There was a great debate about this question when I wrote about it last time and I still haven’t found any academic research to back up my hypothesis, but that’s my opinion.

Hopefully some of these ideas will be helpful to you. Maybe a few will be provocative (as always, let me know!). I do recommend that companies working on their product pricing matrix spend plenty of time with customers to understand how they are using their product. It’s also helpful to bounce pricing ideas off of not just your early customers but also some trusted advisors who are not as close to what you’re doing. Getting a fresh set of eyes on your feature set is a good way to avoid drinking too much of your own cool-aid when it comes to your view of the ease with which potential customers will understand your value and pricing matrix.