Sangat Pedas

Venture Capital & Internet startups


2010 was the year that the big venture capitalist finally discovered Indonesia which now has become the land of unlimited opportunities. Some investments have already happened but much more will follow in 2011. I’m not an expert but I’ve worked with several VC’s in different startups and would like to share some experiences and hopefully give some good advice.

This post is based on my personal experience and “knowledge” so any comments are welcome.

Any similarities to actual people, situations or VC’s are pure coincidence. A salut to our own VC, guys all negative things I might say about VC definitely doesn’t apply to you guys, you’re the best! To all other VC’s in the world: I LOVE YOUR MONEY YOU!

Passion versus money.

With investments pouring into Indonesia I’ve noticed some animosity developing against the corporate VC culture and some regard corporate as a foul word. Others wonder how they even stand a change against International companies who plan to conquer the Indonesian markets with huge investments. Well, let me first start with reassuring the Startup Lokal community by giving a few examples on why I think you guys definitely stand a chance, hell, I would go even further by saying that you guys are the epic center.

In 1996 Larry Page, later joined by Sergey Brin, started a project that would revolutionize the world and result in the most successful Internet company of all time. Google started as a research project at Stanford in 1996 and by the end of 1998, though still in beta, their database contained 75.2306 Million indexed URL’s and Google had a growing amount of users. The search market was already there and big with companies like Excite, Yahoo, Hotbot and Lycos all well to extremely well funded. The first funding for Google as a company was secured on August 1998 in the form of a $100,000 contribution from Andy Bechtolsheim, co-founder of Sun Microsystems, given to a corporation which did not yet exist. It wasn’t until june 1999 that the first real investment took place in the form of a $ 26 mln. equity funding and the rest is history. My point here is that amidst all the financial power of companies like Yahoo two young guys with limited means managed to create a startup that would revolutionize the Internet. The same can be said from Mark Zuckerberg and his with his college roommates and fellow computer science students who started Facebook.

On the other hand we see giant Microsoft struggling to get a piece of the pie resulting in a staggering $2 billion (!!) loss in the last year. The problem here in my opinion is not the astronomical amount but the fact that they just can’t seem to manage to turn the downward trend around. I’m sure Microsoft’s online division has lots of really capable people and I’m certainly not claiming to know the Microsoft organization, but in my opinion startups need startup people. Startup people are most of the time the exact opposite of corporate people, their chaotic, unorganized, stubborn and are dreamers, but they have a huge passion, vision and are very capable in adjusting to their changing surroundings. In Microsoft’s defense, in an organization that has over 135.000 employees worldwide there’s no room for chaotic, unorganized, stubborn dreamers. My point here is that all the money in the world is no guarantee for succes.

What’s a VC like?

Basically a VC wants to get rich of other peoples ideas, capacities and success. Further they have some really annoying characteristics like (but not limited to):

a. They don’t know your business;
b. They have an opinion (huh? yeah!);
c. They think they know better than you  (Come on!! are u serious?);
d. They need corporate reporting, quarterly presentations, budgets, consolidated figures etc etc (BORING!);
e. They’re a general pain in the ass;
f. They have money, yes sir, way much more than you (probably will ever) have (YAHOOOOOOO!!!);

In defense of the VC, think what you would be like if you trust f.i. $10 mln. to often complete strangers?

Who needs VC anyway?
Well, I dare to say almost every Internet startup need them at some point in time, the right question should be WHEN do you need them. Well first rule of thumb should be wait as long as possible but not too long. If you run an Internet startup which has nice traction you want to wait as long as possible because everyday you wait you’ll get a better deal. On the other hand there could be numerous of reasons why you shouldn’t or can’t wait any longer and you don’t want to be in a position where you’re with your back against the wall and have to accept any deal they offer you. Of course there can be numerous other reasons such as competition that’s heating up, investments needed for expansion etc etc.

Choose your VC wisely!
Huh? Can I choose my VC? Yes you can! Chances are that if you’re contacted by one VC others will follow so hold your horses and don’t automatically bet on the first one. Personally I think that negotiations between the average startup entrepreneur and a VC is a really unfair event. The investment manager of a VC probably already did dozens of negotiations like this, has a huge knowledge of the legal side and knows every trick in the book giving them an unfair advantage. So, when you had such a nice talk with your potential VC and really felt a “click”, bear in mind that their mission is to make money, as much as possible and their NOT YOUR FRIEND NOR WILL THEY EVER BE! Though let me add some nuance before I get misunderstood: of course people within a VC can become friends but a VC itself just doesn’t have any friends, it’s not part of their business plan. So my first advice would be to get help since this will probably be your first investment round and you probably have no idea, so try to find someone that has done this (successfully) before or find a consultant and make sure that who ever helps you has a direct interest in getting you the best deal. The cost of a consultant can be perceived as high but is nothing compared to the money he can save/make you in the long run. And ask yourself, what do you know about share lockups, convertible loans, tag along and drag along clauses and IP laws?

Criteria for selecting a VC
Well, for sure there’s no “one-size fits all” advice here but let me just give some points I think are really important:

a. Make sure they know your business.
Nothing more annoying and destructive than having a VC that knows squad about your business, that will lead to lots of awkward discussions and destruction unless they give you carte blanche which is in most cases only give for entrepreneurs with a proven track record; So if you run an e-commerce site try to find an investor with successful e-commerce companies in his portfolio.

b. Make sure your goals are the same.
If you want to build a sustainable company and have no interest in an exit than find a VC with the same strategy. Also discuss other short and long term goals and make sure you’re on the same page.

c. Look at long term financing.
Most funded companies need more than one investment round before they are mature. Think big, think worst case scenario and make sure this second round won’t dilute your shares up to a point where you’re role is diminished to a managerial one.

Determining the current value of your company
Most startup investments will involve the issuing of new shares which are bought by the investor which will result in the founders now owning part of the shares. This is not a bad thing as long as the total value of the founders shares stay at least the same. So this will involve valuation of your company and the VC will have tons of arguments why your company isn’t worth all that much and most of the time all these arguments are reasonable. However, what they like to leave out of the picture is that with determining the value of a startup part of the value lies in the “expected value”. So, purely based on the financial position of your company your share will probably be worth next to nothing since it’s hardly making any money, but the potential as well as the traction of your startup should significantly add to the value of your company. The problem is that this involves expectations which are always arguable from both sides and could be an extremely complex process. You could try some highly complex number crunching (let me know how that worked for you) or apply my method. My method would be by starting my personal goals like:

- Do I want an exit? (which for me is always yes so I can begin my next startup)
- How much money do I want from such an exit?
- When do I want an exit?

Second, if you don’t already have them, make business plans. Yes, more than one and this is where it becomes a little bit mathematical. Here I apply probability theories  that can be applied to just about everything you have to predict. It’s a system in which you analyze each or the most likely scenarios and give each scenario a probability % accumulating in 100%. In this case what you do is make 4 business plans for the 4 most likely scenarios, best-case, worst case and two others in between. Try to be really objective, set aside your optimism and discuss with fellow entrepreneurs who have more experience than you. So now you have 4 business plans predicting your EBITDA which is a leading factor in determining the future value of the company. Next determine the probability for each scenario, so chances for the Best Case Scenario are for instance 10%, Worst Case Scenario 25% and the other two make up for the rest of the 100%. Now use this formula:

E-EBITDA= (EBITDA-1 x Probability-1) + (EBITDA-2 x Probability-2) + (EBITDA-3 x Probability-3) + (EBITDA-4 x Probability-4)

Where E-EBITDA is Expected EBITDA.

One easy way of determining the companies future value is multiplying it by x, where x depends on the business you’re in and for Internet companies could be as much as 10 to 20.

This will take maybe 1 or 2 weeks work and first of all will impress the hell out of the VC, often startup entrepreneurs don’t bother to make business plans let alone come up with 4 each with their own probability. Another important aspect is that you’ve forced yourself to really think about the future and the value of your company. Now let the VC come up with calculations why you’re wrong.

Making the deal

First off, put yourself in greedy and selfish mode to the extreme but without becoming unreasonable. Up to a certain point a VC will wring you and make you believe that their proposal is the best deal possible and that you all have the same interest…. Yeah sure, guys this is about money, most of the time loads of money and there’s no such thing as a free lunch. VC’s want to make the most money as possible from a deal and limit their risk as much as possible. After all, not every investment a VC makes will make them money so this deal will also have to earn them the money they’ve lost on other deals.

At one point you got to think about every aspect of the deal: money, governance, contracts etc. Bare in mind again, the guys you’re talking to have done this so many times so again get the right support. This it where it becomes legal and don’t think for a minute that this will be a swift and easy period which will result in multiple contracts accumulating into hundreds of pages legal stuff. READ THEM ALL THOROUGHLY!

If your VC wants a majority share and you can live with that then governance would be a point of extra attention, you probably don’t want to become the puppet of the puppet master.

Life after VC
So there you have it, money in the bank! Finally you can upgrade your servers, hire staff and start some serious marketing. Now you will need to change, adapt to having a VC in your company and believe me I know. I could be characterized as extremely stubborn and running on steroids when things don’t go my way and often you’ll find the same people in VC’s. But actually things turned out pretty good for me. It took me some time but I’ve learned it’s better to work together than to fight. Also having VC has added knowledge and experience to the company (and former companies) and myself, it made me more a team player and I’ve definitely improved my political skills. In retrospect I’m pretty sure every time I could have gotten a better deal but as long as the deal I did get will allow me to reach my goals I’m satisfied. One other upside is that being backed by VC opens so much doors which usually are closed for startup entrepreneurs.