Valuations

Who needs a board when you've got a whiteboard!

Your board (and VCs by extension) are not the only accountable 3rd-parties... I'd argue that they're not even the best accountable 3rd-parties because they're interests are not necessarily aligned with yours - VCs have limited partners to worry about.

Look no further than your customers for great 3rd-party accountability. If they love and use your product, they will pay you more money and recommend you to others. They should be the only thing that matters. In fact, by not having a board you have the luxury of only being accountable to them.

>How could you hack a replacement for a board meeting?

Mastermind groups.

We just did a late-seed round from a VC firm and didn't set up a board.

Something that has worked for us is doing a bi-weekly Google Hangout that has no agenda. The rule is no one prepares for it, but we just talk about stuff at a high level. So far it's been really helpful. We don't feel unnecessary pressure to prepare decks with stats and metrics on things that aren't important or will be changing quickly (plus I have the key ones memorized anyways), yet we communicate frequently enough that issues can be tracked closely and fixed.

It also works that we had only one firm in the round so coordinating it is easy. Might not work if you have lots of angels or other investors.

The fundamental questions seems to be (1)"what is the purpose of a BOD"; and (2) are the "good things" the primary purpose of the BOD or the emergent phenomena that happen as a result of (#1). In other words, will (#2) type events happen outside the context of (#1). And this includes changing (#2) type things to be (#1) at a formal level.

Wouldn't Buffer-like transparency be just as effective, honestly?

The thing implied seems to be "The process to generate the presentation to the board == Value due to focus on key metrics."

If you know what your key metrics are, if you have to provide them to outsiders once a month, does it matter if the outsiders provide feedback or not?

It seems not as long as the only goal is focus on the key metrics.

Only flaw would be if you picked the wrong metrics, but if you picked the wrong metrics...would you really have succeeded anyway?

My father-in-law works really well as someone I am scared to report key metrics to.

We can always find someone we respect and fear (just a little) and yet has enough business background to make intelligent judgements.

It is really up to us if we want to have the judgement, and put ourselves in thrall to that judgement.

That's exactly what happened during the 2000 crash -- much of the "revenue" being booked by internet companies was imaginary (in the form of contract swaps), and much of that was driven by intra-industry advertising. Everyone was paying everyone else to advertise, and it all fell apart more quickly than you'd expect given top-line revenue numbers.

I suspect something similar will happen this time around -- there will be a slowdown in the real economy for some unpredictable reason, and the imaginary, startup-servicing-startups economy will implode.

This is an important observation. There are absolutely angel and venture-backed startups with "real" revenue (fewer with actual earnings), but if you look closely, it appears that a non-negligible percentage of them derive a not insignificant portion of their revenues from sales to other angel and venture-backed startups.

More broadly, an even larger number of startups are also indirectly dependent on the current landscape, as they operate in regional markets where consumption is being driven in large part by the influx of capital into tech.

There's nothing wrong with building a business that takes advantage of these types of situations, but my sense is that a lot of the entrepreneurs running these types of companies aren't consciously aware that they're the beneficiaries of an environment that will eventually change. As such, they're not at all focused on trying to diversify their revenue base and to be frank, it many cases there really isn't an opportunity for them to do so anyway.

To YC's credit, it's incredibly hard to sell anything to the YC ecosystem from outside of it, because they already have chosen options from inside of it. Yet another reason to give radical differentiation a shot if you can stomach it.

Comps and competition. Three lines of enquiry to get started:

1. Compare between buyers (i.e. engage with multiple buyers so you can hopefully choose between competing offers)

2. Comparables

2a. look for recent sales of companies with similar size/trajectory)

2b. look at exit valuation ratios for companies in a similar industry ($ per engineer, price/earnings ration, $ per $revenue)

3. DCF (this is the first method of valuation taught to MBAs, but may not be much useful if your future cash flows are highly uncertain)

Comparables are good, but you may also want to check out Aswath Damodaran's work. The simplistic version is to do a discounted cash flow analysis and use comparables to get an idea on the discount and other variables.

It depends.

Generally speaking valuation is speculative. Think of it this way - a gallon of milk is priced at $3 because that's the price people are willing to pay for it. If it was $10, no one would buy it and if it was $0.01, they'd run out of supply. Same thing goes for business. The valuation is whatever people are willing to pay for it. If I buy milk for $3 it's because I know if I consume foods right now it will give me energy so I can do more things later in the day. Some people create a story speculating that a particular gallon of milk has the ability to give you twice the energy, so they'd price it at $6. These stories turn out to be true sometimes and sometimes not. Hence, why today valuations are considered crazy because everyone is painting a unicorn story.

A few factors go into valuing a company, which potentially aid the craze:

1. There is extremely low liquidity in non-public markets for investing. In other words, you don't have a millions of people in the US investing in startups every day. In a perfectly elastic market, valuations are 100% correct. Due to the high liquidity and number of actors, public markets are much better at reaching perfect elasticity whereas private markets are not. In other words, less actors dictating how much they are willing to pay for something means higher deviations from the true price.

2. Many tech companies are irregularly (irregular in relation to existing companies) evaluated today because they do not follow traditional investment metrics. This is largely set by precedence. When Facebook and Google IPO'd, the investing community was fairly clueless as to how to evaluate these companies. The metric they've chose is DAU/MAU because it translates into how much attention "land" they can acquire to resell to advertisers and hence increase revenues and profits. Now that these are "the metrics" it means every other "tech startup" is in a land grab to attain those numbers quicker anf faster than before. This is why Instagram and WhatsApp had such high valuations...their DAU/MAU's were crazy high and growing at faster rates than Facebook itself.

Generally, the larger investing community values companies based on earnings. EBITDA is usually a popular metric to do this, but one metric can't dictate everything about the valuation. Valuations are based on a series of metrics, a multiplier, all based on the speculative return of buying the business. So for example, a company a one-year $1.1m budgeted forecast might be speculate to be worth $5mil simply because the revenue growth trajectory means they can return. Now add in a multiplier of 2.2x because your team is a group of badasses and your contracts last 3 years, and bam your company is worth $11mil.

Because tech markets have high growth potential (Uber is quoting to having had doubled their growth every 6 months) it means the valuations are abnormally higher than many other businesses. How many hair salons do you know that are doubling revenue every 6 months and have relative businesses who have shown similarly consistent growth in that market?

All things being equal, the question ultimately becomes "what part of the hockey stick am I on?".

the most sound way, imho, is discounted cash flow.

http://en.wikipedia.org/wiki/Discounted_cash_flow

if you are a saas company, check this out

http://a16z.com/2014/05/13/understanding-saas-valuation-prim...

Meritt, ignore DCF's - they are utterly useless in the tech / venture world, especially at the stage you're at. Look at it more as "what value are you providing to the firm" - everyone and their grandmother will claim that its strategic (ergo, justifying high valuations with non basis in financial reality), but very few can pull that off. Failing that is if you can show how valuable you can be to that firm - ie, to use a simple example, if using your approach can provide them with a 5% uplift on their typical sale). Otherwise, its an opportunity cost thing for you - what is your logical upside at a more mature stage, and what is your self-perceived probability of getting there? You don't have to sell, which makes it very powerful.

What have comparable businesses raised capital at? Think about it as a calculation like V = P x M (Valuation = Profit x Multiple; sometimes you'll use Revenue instead of Profit). The Multiple is the magic number.

I'm helping a seed round at present, and we managed to find several 'competitors' who raised several rounds each at a fairly consistent Multiple. We have subsequently used that to explain the discount valuation we're using.

Crunchbase is a good place to start, and in a big enough market with good google-fu you'll be able to gather the data to support a Valuation.

compare your revenue growth rates, earnings growth rates, gross margin and other metrics to similar public companies. Then looks for a price/sales figure (or forward price/sales figure). Based on the info you've given, your company is probably worth around $20 million at the moment.

Here's one way to figure out the valuation of your bootstrapped company.

If you continue running the business and pursue your current operating plan, how much cash will you have in the bank in year 5 and year 10? (Broad estimates are fine)

Generally speaking, your year 5 and year 10 estimate is going to represent a reasonable approximation of your company's valuation range.

For example, let's say you believe you will have $5.5m in the bank in year 5 and $12m in the bank in year 10. Your valuation will approximately be $5.5m to $12m.

Financial buyers will generally offer $5.5m. Strategic buyers will generally be willing to pay $12m or more depending on the prospective synergies/option value of the assets.

That said, you'll need to ask yourself how much money are you willing to accept today to walk away from $12m over 10 years. Are you willing to accept $5.5m in exchange for more freedom/time to devote to other things that may add more personal/financial value over those 10 years.

(Many startups are optimizing for high option value and this approach might not be appropriate for those companies)

It may also be related to the fact that the get-big-quick scheme is inherently risky in order to return the necessary rewards. If you're raising a ton of money you have to be a home run, and that means you may pass on moderately profitable opportunities in order to keep looking for insanely profitable ones.

Your point about fail louder is probably right. We dug into data after Sam made this statement and the data suggests there is not much of a relationship b/w initial funding and successful outcomes.

Data here -- http://www.cbinsights.com/blog/funding-round-exit-valuation-...

> stop worrying about unemployment and just start paying everyone a basic income?

What I've never understood about BI is how it works for the middle class. Consider: a cohabiting couple each work entry-level tech jobs and bring in a combined $100k. They buy a condo together, maybe a couple of halfway decent cars. They're being responsible. Then, economy tanks/tech bubble bursts/etc and they have to live off their BI which if I understand correctly should fall somewhere in the $15k/year range each, so $30k total. How do they pay their bills?

In other words, what good is $15k/year when you've been living on $15k/month? Or $7k or $5k/month? It's better than a poke in the butt with a sharp stick, but it's just delaying the inevitable, isn't it?

If then BI is instead mainly for the low-income portion of society, well, we already have that -- it's called welfare/social security/disability. I'm missing something.

A lowering of the real rate of interest, either by a voluntary decrease in spending and a corresponding increase in savings, or by an artificial rate set by central bank policy, will indeed lead to more investment into earlier stage production areas such as farming, mining and startups.

Taxes discourage investment, however, so they can change time preference again towards less savings and more later stage consumption. Then again, also here we see a political preference for the early stage production areas, e.g. farming subsidies.

You should check out some Karl Marx sometime. This isn't exactly what he says, but it is a part of it. The concepts you refer to in your post are called "fixed capital" and "variable capital" and their ratios, as well as the "reserve army of labor," amongst other things.

>And then those companies invent things that make more jobs obsolete, causing unemployment to remain high.

I would say this one is incorrect. It isn't so simple as that. Inventing new tech often creates new jobs. As an example look at the different medical imaging technologies created over the years: x-ray, ultrasound, CAT scan, MRI, etc. Each added to the number of medical imaging jobs it didn't obsolete anyone.

Partially correct. Technology companies fall into three main categories:

1.) Companies that let their customers do what they were already doing, but more efficiently, such that they need less manpower. Eg. self-checkout machines, manufacturing robotics, enterprise IT, backend logistics, data warehousing.

2.) Companies that let previously unskilled groups perform the jobs of skilled workers. Eg. EBay (disrupts auction-houses and collectibles), blogging (disrupts the publishing industry), AirBnB (disrupts hotels & hostels), Uber (disrupts taxicabs), StackOverflow (disrupts IT consultants).

3.) Companies that let people perform entirely new things that they couldn't do before. Eg. Google (researching topics that would've been prohibitively expensive to learn about), Kickstarter (funding creative projects), PayPal/Square (accepting payment as a small independent vendor).

The uses of a transformative technology tend to progress from 1 to 2 to 3, because that is the rough order of obviousness and risk to the entrepreneur. When a new technology comes out, all you need is familiarity with the technology and with existing processes to understand where a manual process could be automated outright. This is the domain of enterprise startups founded by people with deep knowledge of an industry and a keen interest in new technology.

Once those opportunities have been picked clean, entrepreneurs look for cases where they could use technology to let a disenfranchised group do the work of an enfranchised group. They take the people who have been rendered out of work in stage 1, and then give them the tools to put higher-skilled workers out of work in stage 2. Doing this requires a strong understanding of both the processes of the industry that will be cannibalized, and an understanding of the capabilities of the workers that will take their job, and an understanding of the technology that lets you bridge the former and the latter. So entrepreneurs here need to do a lot of synthesis and need a bit of "in the right place at the right time" as well.

Once those opportunities are picked clean, then entrepreneurs start looking for things that people want to do but currently can't because they lack the means. This is where the great consumer companies of the next age are formed. It's very risky business for the entrepreneur, though, because there is essentially zero data available on what things people would like to do if they could but can't currently. Usually entrepreneurs that succeed here do so via vision, creativity, and a good sense of what they themselves want to do.

We're currently just starting stage 2 in the Internet/mobile/cloud revolution, so I would expect more job destruction and more short-term social pain in the near term. But it stops when all the easy opportunities of stage 1 and stage 2 have been picked clean, and people are forced to hunt for consumer business models that employ all the people put out of work by the earlier stages. Stage 1 and 2 destroy jobs, but stage 3 creates them.

BTW, for the last major economic transition (the Gilded Age and Industrial Revolution), the stages looked like this:

1. Sailors => Steamboats. Weavers => power looms. Blacksmiths => Steelmaking. Coachmen => Railroads. Miners => bulldozers, excavators, and heavy equipment. Domestic servants => home appliances.

2. Railroads => Automobiles. Whalers => Oil. Coal miners => Oil. Messengers => telegraphs. Farmers => Meatpacking/agribusiness.

3. Electricity. Home appliances (part of this industry replaced domestic servants, but part let consumers do genuinely new things, like microwaves and blenders). Penicillin. Air conditioning. Airliners. Elevators. Refrigerators. Computers (kicking off the next revolution).

Note that there's a large overlap between the stages. The last stage 1 business, replacing domestic servants with vacuum cleaners and washing machines, didn't happen until after WW2, while the first stage 3 business, electricity, happened in the late 19th century. I think we've seen the same thing with the Internet age, where Google and PayPal were among the first Stage 3 businesses, but Stage 2 hadn't even happened yet.

The general pattern is based on who're the substitutes for each industry. Stage 1 substitutes machines for labor. Stage 2 substitutes labor for labor with the help of machines to do things more efficiently. Stage 3 uses machines (built by labor) to solve unfulfilled human desires.

What breaks the cycle is that eventually someone uses all this capital to found a business making use of all these unemployed people. They're an untapped resource.

You're basically describing technological progress, but there's no reason to assume that tech will always replace expensive laborers with relatively smaller amounts of automation. All that productivity created by new technology represents increased demand, and having workers go idle is just as much an inefficiency as using an older process. An inefficiency that can be (profitably) corrected with the right business model.

Tech can, for instance,replace expensive components with cheaper labor (think usability inventions), or help scale up existing production to meet greater demand (think bigger factories). Both of these require more workers in the aggregate, not less.

> Are my assumptions correct? What breaks the cycle?

Long-term people

* invent some other occupations that were not possible a generation ago (social media consultant, AWS architect)

* have fewer children

I'd say it's more like 20x revenue actually (assuming the stage is series A/B)

> And just like salespeople should 'always be closing', business owners should 'always be exiting'.

That's interesting, could you expand on that a bit? Do you mean you should always have a few good exit scenarios prepared (e.g. keep a few potential acquirers interested) in case you need one?

Well, the Yo case is really eye-opening.

It seems 1Mi dollars is pocket change to some people.

1Mi dollars is a lot of money in the real world.

  > Are the consumer markets so much better in America that
  > it's worth paying 4x valuation and competing with lots of
  > other VCs for deals? The answer may be "yes", but it 
  > doesn't seem obvious to me

Don't forget that there are known quantities of legal/tax vehicles for VC investment in certain countries. If those things are not present, I imagine it would increase the risk for the VC, and impact valuation and capital availability.

The consumer markets and VC climates in other markets can be much worse. Take china for example...the VCs are only interested in funding shanzhai rip-off copies of ideas of ideas already proven in western markers.

Probably not all that different from the last one. Economy starts heating up, and the Fed begins to tighten interest rates to damp down inflation. It takes time for interest rate hikes to make their way through the economy, so they keep tightening. Eventually, everybody realizes that money isn't cheap anymore, and moreover, they realize that everybody else has realized that money isn't cheap anymore. That causes a mass stampede for the exits as people fly away from risk.

In the last crash, the economy started heating up in 2004, the Fed started tightening in 2005 and continued through 2006, the market hit a top in August of 2007, there was a slow-motion recession through late 2007 and early 2008, and then everybody ran for the exits in the summer of 2008.

This time, I think the economy started heating up in 2013, the Fed is planning to tighten starting early 2015, it'll take about 18 months for the rate hikes to make their way through the economy, and so I'd expect a crash around 2017.