One thing I’ve noticed since I started blogging is that starting a blog entry is a lot easier than finishing it. There are plenty of things to write about and I find it pretty easy to start a new blog (I usually do this in my head first and try to think it through before committing it to paper). It’s a lot harder to finish them, however. My blog draft file is full of ½ completed blogs that are waiting for me to finish up. I’ve been thinking about this a bunch recently and trying to figure out if this is specific to blogging (or any forming of putting thoughts to paper) or if it is just a part of the human condition – something that we generally don’t notice since we’re not often presenting our ideas in an organized format (or without getting immediate feedback).  After considering this for a while and thinking about it as I sat through meetings and talked with people in the past weeks, I think that the answer is that this is not something that is specific to blogging at all.  Humans as a general rule are pretty good about coming up with ideas, but pretty poor at thinking them all the way through.  This isn’t necessarily a bad  thing– feedback from others on partial ideas often helps us think them all the way through.  That said, I think I’m going to try to effort to better think through (from start to finish) what I say before I jumpin with an idea.

I’m intending this blog to be a mixture of my personal thoughts on being a venture capitalist (and my travels through the maze of the VC world); thoughts on life more generally; and what I’ll call VC 101 tips and pointers. One of the things I’ve noticed (and this is something that I’m happy to say the TypePad statistics really do a nice job of, my rant about them last week aside . . .) is that my VC 101 posts get a lot of traffic (and cross-posting/track-backs that drive this traffic). The impetus for my starting this blog was to capture my personal thoughts on being a VC, however I want to be sure I mix up my content to attract a broader array of readers. So, I’m going to keep up with the VC 101 posts, since it seems like there’s a segment of people who read my blog that sincerely appreciate an insiders view on the mechanics of venture capital. Today’s post is on deal algebra. Basically it’s a run-down of deal valuation terms. When you live in the VC world and use these concepts regularly, you sometimes forget that they are not necessarily obvious in their meaning (which can lead to confusion down the road; not good when you are embarking on a new venture with an entrepreneur). We noticed this a few years back, and as part of a larger effort to gather information that would be helpful to our portfolio companies Dave Jilk created this summary of key VC deal terminology that we sent around to a bunch of our CEOs and other people we work with (note: I’ve made some edits to Dave’s original work mostly for length). VC Deal Terms: In a venture capital investment, the terminology and mathematics can seem confusing at first, particularly given that investors are able to calculate the relevant numbers in their heads. The concepts are actually not complicated, and with a few simple algebraic tips you will be able to do the math in your head as well. The essence of a venture capital transaction is that the investor puts cash in a company in return for newly-issued shares in the company. The state of affairs immediately prior to theinvestment is referred to as “pre-money,” and immediately after the transaction “post-money.” The value of the whole company before the transaction, called the “pre-money valuation” (and is similar to a market capitalization). This is just the share price times the number of shares outstanding before the transaction: Pre-money Valuation = Share Price * Pre-money Shares The total amount invested is just the share price times the number of shares purchased: Investment = Share Price * Shares Issued Unlike when you buy publicly traded shares, however, the shares purchased in a venture capital investment are new shares, leading to a change in the number of shares outstanding: Post-money Shares = Pre-money Shares + Shares Issued And because the only immediate effect of the transaction on the value of the company is to increase the amount of cash it has, the valuation after the transaction is just increased by the amount of that cash: Post-money Valuation = Pre-money Valuation + Investment The portion of the company owned by the investors after the deal will just be the number of shares they purchased divided by the total shares outstanding: Fraction Owned = Shares Issued /Post-money Shares Using some simple algebra (substitute from the earlier equations), we find out that there is another way to view this:Fraction Owned = Investment / Post-money Valuation= Investment / (Pre-money Valuation + Investment) So when an investor proposes an investment of $2 million at $3 million “pre” (short for pre-money valuation), this means that the investors will own 40% of the company after the transaction:

$2m / ($3m + $2m) = 2/5 = 40%

And if you have 1.5 million shares outstanding prior to the investment, you can calculate the price per share: Share Price = Pre-money Valuation / Pre-money Shares = $3m / 1.5m = $2.00 As well as the number of shares issued: Shares Issued = Investment /Share Price = $2m / $2.00 = 1m calculate with post-money numbers; you switch back and forth by adding orThe key trick to remember is that share price is easier to calculate with pre-money numbers, and fraction of ownership is easier to subtracting the amount of the investment. It is also important to note that the share price is the same before and after the deal, which can also be shown with some simple algebraic manipulations.

A few other points to note:

• Investors will almost always require that the company set aside additional shares for a stock option plan for employees. Investors will assume and require that these shares are set aside prior to the investment.
• If there are multiple investors, they must be treated as one in the calculations above. To determine an individual ownership fraction, divide the individual investment by the post-money valuation for the entire deal. For a subsequent financing, to keep the share price flat the pre-money valuation of the new investment must be the same as the post-money valuation of the prior investment.

Venture capitalists generally participate in boards in one of two fashions – either as actual board members or as board observers (see Brad and Jason’s post on Term Sheets – Board of Directors — for more information on how we take positions on boards). As an associate at Mobius I was not able to take actual board seats, so I took the board observer position in the companies I worked with (note that generally this isn’t an official designation – although I have seen board agreements that require the venture firms to specifically designate the board observer; more commonly its just a seat at the board table reserved for someone from the venture firm other than the board member). As an observer I am an active participant in board meetings, but I don’t vote on any board matters and in some cases need to step out of meetings (typically to protect attorney/client privilege, which covers board members but not board observers). The boards I am involved with have all welcomed me into all of the regular and executive sessions of their meetings. Different firms treat the distinction between board observers and board members differently. At Mobius I am encouraged to be an active participant in the businesses I work with and I have never been shy about voicing my opinions at meetings. Other firms have a similar philosophy, but some feel that observers are just that – people who can attend meetings but should not participate. I’m planning a series of posts with some of the CEOs that I work with, so you can get a sense of how the relationship dynamic plays out. Stay tuned for that.

One of the big changes from my recent promotion to principal is that I’m now able to take actual board seats. I’m going to take this leap very soon and am interested to see what the differences really are sitting on the other side of the table. I won’t attend my first meeting as a board member until February, so we’ll all have to wait until then for the answer, but I plan to write about it here as it strikes me as a very important step (and milestone) in my progress as a venture capitalist. More on the company that I’m stepping up my involvement with in a future post as well, but I wanted to clarify thedistinction in roles before I get to that.

I was thinking today (as I’m sure many people are) about the life and legacy of Dr. Martin Luther King Jr. One of my favorite quotes is from Dr. King (although I’m afraid to say that I couldn’t find it quoted directly on-line – apologies for not giving a direct link).  To paraphrase is goes something like this:  Those who have succeeded have yet to find something great enough at which to fail Like the story of throwing your hat over the wall, this quote inspires us to reach for great things.  True in business and in life.

Ross and Dave sent this link over to me today.

Parody –  a strong sign of flattery.  Clearly Apple has marketing down – we could all take a lesson. . .

https://www.gizmodo.com/gadgets/images/iProduct.gif

I just set up FeedBurner on my site to start tracking readers.  I should have done this a long time ago (where long time = 7 days ago when I started my blog).  I’m pretty bummed with the stats that are available on TypePad.  By pretty bummed, I mean that the stats are essentially useless.  They don’t have any information on click-through nor do they tell me either what aggregators are  hitting my site (although I can see a little of this in the referrers section, which is pretty much the only part of their statistics that I find useful) and they definitely don’t tell me how many underlying readers there are for my site because they can’t surface information on how many customers each aggregator is pulling for.    I’m going to write a future
post on the vanity of blogging, but suffice it to say for the moment that I (and most bloggers that I know) check my stats pretty regularly.  Its not that I’m specifically trying to vie for a large audience (although it’s nice to know that the work I put into my site is being seen by others), but I’m still interested in how many people are reading what I’m putting out there.

So FeedBurner will help this problem, but the way its works is to essentially alias my site through their system.  That’s fine, but anyone who has already pulled my site into their aggregator won’t show up in these stats since they aren’t pulling from the aliased site (they don’t exist as far as FeedBurner is concerned).  I could solve this, I suppose, by hosting my own domain, using MovableType (or some other software) instead of Typepad and redirecting all of my site traffic through FeedBurner.  Then again, the reason I’m using Typepad in the first place is so I don’t have to do that.

I’m just venting. Brad told me the very first day I started blogging to set up FeedBurner and, as I sometimes do, I basically pushed off his advice until it became very clear that he was completely right and now I blame him for not locking me in my office until I set it up a week ago.  Seriously, though – setting up FeedBurner right away would have allowed me to capture the information I want.  By waiting a week, I basically lost information on several hundred readers that I can’t recapture until I either create my own site or until TypePad improves their stats.

So if anyone from SixApart is out there listening – sharpen your statistics and make them into something that’sactually useful for your users.

[end of rant]

One of the things I’ve been thinking about as I’ve been sitting down to write is the balance I’d like in my blog. My intention was to write a professional blog, but with a personal twist –not a blog just about the mechanics
of being a VC, but my personal observations of the VC world and my growth as a venture capitalist. A few people have written in and reminded me not to forget about writing some posts about me with the idea that my VC observations will be more meaningful if I occasionally write posts that have nothing to do with being a VC, but give some background about how I got here and what else is important to me.

A high school friend of mine wrote to me the other day. He’s been reading my blog but was disappointed that I hadn’t posted on some important topics from our childhood:

“you gonna write anything about the red sox or patriots or just how to write financial models?” He asks.

Well, here you go, Dan. . .

I grew up just outside of Boston, so the events of the past few months have been pretty amazing to me. I always figured that the Red Sox would win the World Series sometime in my lifetime – I just wasn’t sure when. I was 14 in 1986 when the Sox came within a strike of winning it all. I actually didn’t see the famous Buckner gaff live. I had been babysitting down the street. The parents of the kids I was sitting for came home and we watched a little bit of the game together. When it was clear to me that the Sox were about to win I ran home (about 5 houses away) to enjoy the moment with my dad. When I got home my da locked solemn and told me that the Sox had blown it. I, of course, thought he was pulling my leg, so I called his bluff and ran into the family room to celebrate the victory. Long story short, that evening is one of the most vivid memories of my childhood (being a Red Sox fan is truly a scarring experience).

I’m going to give credit for the Rex Sox win this year to my 1 year old daughter (at least partial credit). In late summer my wife and I were in Boston for a wedding about an hour south of town. We spent a couple of days in the city to visit some friends and enjoy some time near where I grew up. My other best friend from high school (actually the twin brother of the author of the jab quoted above) is the sports director for one of the local Boston TV stations. He arranged one morning for me and my daughter to get access to the ballfield. I can assure you that it was absolutely a highlight of this life-long Red Sox fan’s life to walk into an empty Fenway Park with my daughter on my back (decked out in her infant sized Rex Sox ball-cap), walk down to the first row of seats and then onto the field. I had a camera to document the moment – picture of Sacha on the infield grass; me holding her in front of the green monster; her sitting on the visiting team bench (presumably putting a curse on them). Pretty amazing.

I’m, of course, convinced that her visit to the field brought good luck in the post season. At least that’s what I’m going to tell her . . .

At Mobius Venture Capital, as in many venture firms, we don’t have analysts (people whose primary responsibility is to run models, cap tables and the like). As a result, each of us does most of our own financial modeling. I actually like this set-up, because it makes sure that I’m both directly responsible for my work and am up to speed on the financials of each of the companies I work with. Reviewing financial models is not the largest part of my job, but is an important part of what I do – for screening new investments; tracking portfolio company performance as well as analyzing follow-on investments into companies in which we already have a financial interest. In the course of reviewing many many many such models, something rather counter-intuitive has struck me: most financial models are too detailed. That’s right – most models have too much information in them; too many assumptions; too many inputs; and are too hard to follow. Now, don’t get me wrong – there is definitely a place and time for a detailed line item budget (say for a rolling 12 month operating plan). That said, trying to detail out line item projections over a 5 year period I think makes models less rather than more useful. When I was in college I really enjoyed theoretical economics. One of the classes that I liked the most was Econometrics. As a relatively green econ student, I remember that my inclination (and that of my classmates) when building econometric models was to put in as much data as possible – the theory being that more data wouldn’t harm the model and would potentially help it. Our professor, Gary Krueger, pounded into us that this was in fact not the case – weak data hurt your model and taking out mediocre variables actually strengthened the veracity of the output (the garbage in/garbage out theory – although he had more colorful way of describing it at the time). I think a lot of modelers fall into a similar trap as me and my classmates first did – instead of simplifying their business to a reasonable and manageable number of inputs and variables, they attempt to put every complexity of their company into the model.

In mathematical terms here’s what I’m referring to: Take one variable V that you have 80% confidence in.

Break that variable into 3 sub-variables – A, B, C – each of which you have 90% confidence in.

Since your confidence in your original variable (V = 80%) is greater than the product of the three sub variables (A*B*C = 73%) you are actually better off sticking to the simpler variable even though you have less confidence in it than in the sub variables individually.

There’s a balance here that is important to strive for because financial models need to be sufficiently detailed as to accurately reflect the business, be able to run realistic sensitivity analysis on, etc. However if you end up with a 10MB model for your start-up (and I’ve seen these), you’ve probably gone too far.

Here are a couple of specific thoughts:

– Before you start modeling list out the key drivers of your business – really distill what the key assumptions are and make sure you call these out in your model

– Add detail where it really helps – a lag from bookings to revenue reflect what is really going
on in your business – that’s good; deciding on an employee by employee basis what various raises are to be in year 4 doesn’t add much (simplify this assumption)

– Break out your assumptions – be explicit about the drivers of the business and group them together (perhaps at the top of each page) so that a reviewer can easily see what each of the drivers are

– Don’t hide assumptions within formulas – formulas should be driven off of numbers that are exposed,
not contained within the formula cell

– Be clear (by color coding or some other mechanism) what cells are assumptions (i.e., you
input a specific number) vs. derived from other cells

– Don’t be afraid to make general assumptions where the detail doesn’t really add value to your
model – for instance on T&E load for employees (I’ve seen many models with 3 tabs to try to calculate things such as year 6 cell phone use per employee)

I could keep going, but I think you get the picture. Perhaps more important than anything else, don’t forget to step back from the model when you’re done and look at the macro trends that you are predicting. Does the revenue ramp make sense? Do the revenue and expense totals per employee seem reasonable and do they grow (or shrink) logically? Are variables such as your days receivables and payables in the ball-park? Are your working capital assumptions generally reasonable?

More variables and assumptions are perhaps not the key to better modeling – smarter and more well thought out ones are.

sjl

A number of people have written in and correctly identified the Adventure reference of my blog title. Here’s the full reference and why I chose it as the title for my ramblings.   When I was a kid I used to love playing “Adventure” (written by Will Crowther and Don Woods back in the late 70’s). My dad worked for Digital Equipment Corporation, so I was rarely without a computer of some sort (terminals in those days; first with a 300 baud modem and eventually a super speedy 2400 baud model that didn’t even require you to insert your phone receiver into two plastic cup things to make the connection – you could actually plug your phone line directly into the modem!). I also had basically unlimited VAX time since I could log into an account my dad set up for me pretty much any time from home. I liked computers and spent a lot of time trying to write up rudimentary BASIC code and, of course, playing Adventure. I eventually mapped out the entire adventure world (I still have the pencil written map in a box of memorabilia from my childhood).

I remember that one of the hardest things to map was the “twisty maze of passageways, all alike” (also knows as the Pirate’s Maze). The first few times I ended up in this maze I just gave up and quit the game. It was a place that basically took you around in circles and didn’t let  you out. After a few tries, I realized that the way to map the maze was to take a bunch of things into it and start dropping them in rooms (you could pick up tools and implements along the way in Adventure). Eventually you’d get back to a room that you had dropped something in and in this way you could actually map out the maze (despite each room’s description being exactly the same). From there you could figure out how to get out from any entry point (reversing your direction when you went in didn’t work).

To a large extent this process encompasses a lot of what I still do today. A good part of the leverage VCs bring to their portfolio companies comes from having seen many companies go through lots of situations and leveraging learning from the past on current situations. This sounds pretty basic – don’t make the same mistake twice; do the stuff that worked again, etc. The trick, of course, is figuring out when you are in the same room again since a lot of the rooms sound the same, but are in a totally different part of the maze. This is one of the keys to successful stewardship of companies (for VCs as well as entrepreneurs). Since the business world is dynamic, you are never really in the exact same room again, but one needs to learn to recognize similarities across situations and apply past experience to the present. This is why I think it takes real time to become a successful venture capitalist. You need to have those experiences behind you in order to build upon them. I think it is also one of the reasons that many successful venture capitalists have spent some time in the operating world – it’s easier to recognize situations from the outside if you’ve been in them before on the inside. While I think others would not emphasize this latter point (and certainly there have been successful venture capitalists who do not have an operating stint in their background), this is clearly a theme at Mobius where all of the investment staff has operations experience in their past.

On a personal note, I know that this is one of the ways that I’ve grown the most as a venture capitalist over the past three years – I needed to both understand how my operating experiences relate to the current situations portfolio companies find themselves in and I needed to build (and continue to build) a base of experience as a VC that both helpes me to recognize what room of the maze I’m in and, importantly, where to go from there.

sjl

This isn’t a post on venture capital or anything else related to business but rather something much closer to home . . .    If you have a window well, please make sure it is covered. My wife and I have two dogs, one of whom is a 12 year old yellow lab named Beau. Beau is quite possibly the sweetest dog ever born (I’m of the belief that every person gets to have one truly exceptional dog in their lifetimes – Beau is this dog for us).  Beau wandered away the other night. We couldn’t find him for several hours. I finally started checking the window wells in some of the adjacent houses and found him in an uncovered well at a house down the block that is under construction. It was dark and the window well was flush with the ground – I almost fell in myself. Beau was pretty seriously hurt. Friday we thought things were over for him (he couldn’t walk at all), but now things are looking a little better as he’s regained use of his front legs and some use of his back legs. He’s taking steroids and we’re hoping that his back/spinal chord was bruised (in which case he’ll regain much of his abilities) and not broken (which would be very very bad news). While the accident was clearly my fault (he wandered off and should not have been in a position to fall into the well), I have a couple of observations:

1) I can’t believe how many window wells are uncovered. There were more uncovered wells around us than covered ones (and these are wide, deep wells). Most had little or no lip on them. Many were very close to a walkway or alley. One is our own well, which is probably 7 feet deep and has only about a 6 inch lip. We ordered a cover for it when we moved in,  but it isn’t ready yet.

2) I’m amazed at the local codes. I know that they codes are weak, because when we bought our house we asked for one of the window wells to be covered and were told no, citing that it wasn’t code. As I understand it, in my county the only wells that are required to be covered are those within 3 feet of a curb/walkway or within 15 feet of a door. The one in question at our house was about 3 ½ feet from the sidewalk.

I think it irresponsible of builders and homeowners not to do something about exposed wells. I also think the codes need to be changed. We called the guy that we hired to make our well cover this morning to try to hurry things up. In the meantime we’re going to see what we can do to make things safer at our house. We’re also going to ask our neighbors to do the same. As sad as we our about what happened to our dog, things could have been much worse if it had been a child who had wandered off. While I don’t even want to think about that situation, I found out from some of our neighbors that several children have fallen into wells in our community (resulting in a few lawsuits).  This is a scary situation. My wife and I are going to petition the local zoning board to try to get the rules changed.  I’ll let you know how it goes.

In the meantime,  if you have a window well please cover it!