financing

To finance or not to finance, that is a constant question in the startup world. Many would advise to take the money if it is there, but it's a multi-faceted decision that will have you creating spreadsheet after spreadsheet in order to run what-if scenarios.

Some of the things to be considered are:

• Capitalization Risk - how long will current capital last with projected sales? Can you get to cash flow neutral before the current cash runs out? How close will you have to cut it? What if you do a lower revenue number than projected? When do you run out of cash in the worst case scenario? Will you need to lay people off? How will that affect morale?
  
• Dillution - What will your likely pre-money be (you'll need to do some comparisons by talking to other local entrepeneurs as well as banks and attorneys to get some idea of what the market will bear). Does the dillution to the current shareholders seem to be a reasonable trade-off for reducing capitalization risk?
• Opportunity Cost - Are forces mounting that require you to accelerate some portion of your business: product development, business development, sales? Perhaps you don't have time to grow organically. Is competition increasing or the market heating up to the point you need to hire up personnel to capture more market share and support the onslaught of new customers? If so, you might want to take in more cash. New investors will also bring new networks with them that should be able to accelerate some aspect of the business.
  
• Terms of Financing - You may find that current financing terms are too oppressive. In addition to the dillution, this might include: liquidation preferences, loss of control of the board, management changes required, or reverse vesting of founder shares.

Think carefully b4 you jump, but once you do, go aggressively down your chosen path. It always takes longer than you think to raise money.

sorry for the long delay

I've been quite busy lately growing the business, raising money, and growing the family (new child on the way). For those interested in the technology side, we have started a new company blog that will describe our journey with Ruby and Ruby on Rails. Check it out here.

We have finished raising our series A financing with a mix of Angels and VC money. It was a fairly easy and straight forward financing, as financings go :) I'll write a bit about some of the issues in the near future.

Threat Assessment

I was watching the most recent hair raising hour of 24 this monday and it provided a lesson that is very translatable to business. Terrorists have obtained canisters of military grade chemical weapons and plan to use them very soon. The only lead is a phone call that was picked up between the terrorists and an expert in these sort of weapons. Jack rushes to the residence of this man and captures him, only to find a 15 year old girl being held as a sort of sex slave by the increasingly despicable terrorist helper. Jack talks to the girl and tells her everything will be fine now, but the man requires a full pardon, transportation to another country, and given the girl back to comply. Now I've seen Jack break other prisoners in shorter order than he has available in this situation, even ignoring orders to do so, but that's another blog entry. Anyway, the girl, left free to roam around the apartment, and very lucidly grasping her dire probability of being handed back over to this man, finds a gun and shoots him.

Jack did not assess the threat in this situation properly endangering the mission. The girl acted fairly predictably and while she wasn't a direct threat, she became one by pursuing her best interests which were put at cross purposes with Jack and his mission.

The lesson here is to not ignore indirect threats even from sources that would almost never pose a threat. Always recognize the interests of every party you will encounter on the journey to your goal and act accordingly.

Term Sheet Terms: repurchase rights == reverse vesting

When a company is incorporated the founders set up the ownership structure. This structure may include a vesting schedule for founder's shares. The reason for the vesting schedule is to assure future investors in the company that the founders are in it for the long haul. A typical vesting schedule that isn't too aggressive and the one I used in the case of my current company is to vest 25% up front and the remainder in 1/60 increments per month over the next four years.

When taking in institutional money, the new nvestors will assess the percentage of vested shares the founders have and may ask for a reset on some percentage of these shares. One way this happens is that they will add a "repurchase right" term to the term sheet which enables the company to repurchase a certain amount of the founders shares at a nominal price for a period. This number of shares will diminish over time, essentially creating a new vesting schedule for founders.

My advice is that if you know you will be taking in money, find a happy middle ground between something aggressive that will undoubtedly be reversed and a vanilla four year vesting schedule. Starting the company is certainly worth a chunk of up front vesting.

walk the line

I just saw Walk the Line, last night. Joaquim Phoenix and Reese Witherspoon both post stellar performances in this well written drama about the life of Johnny Cash. The story describes a complex emotional tragedy that builds steam as layer by layer of events compound leading to Cash's eventual addiction to pain killers and then salvation by June Carter who is fighting her own demons of relationship/commitment.

It is well put together, has good cinematography, great acting, and absolutely dead-on soundtrack by T Bone Burnett.

Go see it! (I wish I could make the song play as you're reading this ... I keep my eyes wide open all the time, because your mine, I walk the line...)

Term Sheet Terms: anti-dilution clauses

These provisions are commonly required by sophisticated investors to protect themselves in the case of a down round. A down round occurs when new money comes in at a lower pre-money valuation (or price per share) than the previous round post-money valuation. For example, if you close an angel round of $1M and agree upon a pre-money valuation of $4M, the post-money valuation will be $5M (pre-money valuation + money in). This means the investors will have purchased 20% of the company.

If you raise a subsequent round of $3M but can only negotiate a pre-money valuation of $4M the initial investors have essentially lost 20% ($5M-$4M = $1M, $1M/$5M = 20%) on their original investment.

Two types of anti-dilution are commonly used: Full Ratchet and Weighted Average.

If the original investors negotiated for a full ratchet anti-dilution then the common shareholders will have to dilute further in order to make the series A preferred shareholders whole. In the example above if the common shareholders held 1 million shares, this would be equivalent to giving up 200,000 shares to the series A preferred shareholders as a result of the additional dilution hit of the down round in order to maintain the original stake at the level they invested in the A round. This is a fairly simple explanation of the effects. For a more in depth analysis take a look here.

In the case of a weighted average anti-dillution, the series A investor is not made whole but are compensated. Their share price is reduced to the new price and the anti-dilution redistribution of shares is based upon the number of shares they currently have vs the total number shares in the company. Weighted Average Anti-dilution is, I believe, the most common form of anti-dilution provision and certainly the least onerous to founders.

In short: common shareholders are dilluted twice when a down round closes: first to make up for the down round dillution that occured to series A shareholders and second for the normal dillution that occurs when you take in new money.

Lesson: always involve your attorney when negotiating these terms and never accept full ratchet anti-dilution unless your back is completely against the wall. Obviously everyone hopes for subsequent rounds to increase the valuation of the company. Post bubble this has frequently not been the case. I believe the terms pendulum is currently swinging back in favor of the entrepeneur but it is always best to negotiate from a position of knowledge.

In the future I will cover liquidation preferences, reverse vesting, dividends, class voting rights and any other terms that have bitten me on the ass before. :)

RDoc Widget

My latest favorite widget is the RDoc widget by Precision Information Services out of Australia. Sure you can pull it up in your favorite browser but the ease of pulling up the dashboard and scrolling through the ruby class docs is soooo much simpler and cooler (I have a desktop corner set to bring up the dashboard, so all I have to do is scroll to the upper right and voila, RDoc). This widget was brought to my attention by master coder Louis De La Rosa, author of the Happy bookmarking app. Thanks for the tip Luis.

RSS readers

In the dog eat dog world of RSS reader competitors the one I've settled on for now is Wizz RSS. It fits neatly in the sidebar of firefox as a plug-in. Wizz also adheres to one of the mantras the 37 signals guys always talk about: simplicity. Make the software simpler so that it does a few things really well and then gets out of your way.

mac conversion #3

Wow, got all the development environment up and running, sans a cvs gui client. I tried Mac CVS but never got it working. But aside from that hiccup (am able to use the cvs command line interface without a problem), everything is humming along. I had a brief foray into using Eclipse as a development IDE instead of Textmate but it would occasionally crash. After the Eclipse problems and figuring out a portion of the Textmate Ruby bundle, made this the obvious IDE choice.

Now for the rest of the story.

First there's Microsoft Office. I do a lot of work in Excel and Powerpoint, and am *much* more comfortable with Word and Outlook than the corresponding Apple editor and email/calendar (even though I like the look and feel of iCal much more than Outlook's calendar). So, the obvious choice was to purchase Office for the Mac. This is an expensive package, but worth it based upon the amount of time I spend with these tools (about $400). After installing I needed to get my contacts, calendar schedule, and saved email folders over to the Mac. As a side note I also purchased the excellent book Switching to the Mac by David Pogue. This book covers all the basics of switching and getting comfortable inside apple's skin. One of the recommendations it made for this very task was to look at Little Machines.

Little Machines offers a $10 product that will export your Outlook information into a format that can be imported by a variety of Mac applications. There were other suggestions on how to do this for free but suggested they might take much longer and add to the frustration. I opted to go the recommended route and after configuring which calendars, which contacts, and which email folders to export had a set of export folders ready to push to the Mac in about 15 minutes. I followed the directions but probably due to some mis-step ended up importing into the native Mac apps instead of Entourage (the Mac version of Outlook). This was easily corrected by just dragging the necessary events/folders into Entourage from those apps.

I have not been that impressed by Entourage and may end up reverting back to the Mac apps. I get dup copies of some of my incoming mail messages and attachments from certain people come across as winmail.dat instead of what they should be (some weird MIME problem). Some of my outgoing email messages get random characters cut out. I also get some attachements as The calendar app is not nearly as appealing as iCal and I like Outlook's contact management better than Entourage. I'll give it a few more weeks.

Powerpoint, Excel, and Word all seem to be very good and I like the Mac "Formatting Palette" much better than its counterpart toolbars in MS.

I'm using Adium for instant messaging. It has the Mac aesthetic down and is much cooler than other open source programs (like gaim) that I've used on Windows.

I've transferred all my iTunes stuff over with a brief hiccup in recognizing a couple of music videos I purchased off the iTunes site (need to import, then try to open in iTunes at which point it will give you a dialog that tells you that the file can be used on up to 5 computers and whether this is one of them). I also forgot to set my podcasts to automatically update so after not getting them to transfer after 2 synchronizations, finally figured that one out.

The dashboard widgets are one of the coolest aspects. By setting a hot corner in the dashboard setup I can very quickly pull up the dashboard. I've installed the calendar, sticky notes, stock ticker, dictionary, Monkey Business organizer, itunes, clock, and yes, a lava lamp!

I started a couple of weeks ago a fish out of water but am now Mac functional. I'm sure there are many new adventures out there in Mac land ... and I'm looking forward to them.

viva le mac!

mac conversion #2

Checklist to get my Ruby and Rails apps up and running on the new mac:

• Need Ruby 1.8.2. Done. ruby comes pre-installed on Mac OSX 10.4. There are some who recommend reloading from source, but for now I'm going with the installed version.
• Install Rails. There is an installation package out there for Mac called Locomotive. This installs Rails, lighttpd with fastCGI, and SQLite. Locomotive is definitely a quickstart approach to getting rails going. Check out this blog entry for a broader explanation.
  
• Install mysql and create local database. Load with initial data set.
  
• Install the Mac Developer xcode package. This includes gcc, make, cvs, and a bunch of other stuff.
  
• Need an editor environment. I have been using Arachno's Ruby IDE in windows (does better syntax hightlighting among other things than Eclipse) but doesn't currently have a Mac port. So after some research I decided to use TextMate . This has been highly recommended for developing in ruby for the Mac and is the defacto editor for the Locomotive env, so will try it out.
• set up the VPN. To create a VPN connection go to applications - Internet Connect
• Download existing code from cvs or subversion server
• go to work!