You know what gets no airplay ? Unflattering truth.
Here's an article by Heidi Roizen, "How to Build a Unicorn From Scratch – and Walk Away with Nothing" as a fine example of the titular principle (granted, her choice of venue probably helped). I'm quoting the whole thing so as to adnotate it in my own hand. It's very basic stuff, but only if you're in this field - which I suspect makes it a pretty valuable read for most people.
This is a grim fairy tale about a mythical company and its mythicali founder. While I concocted this story, I did so by drawing upon my sixteen years of experience as a venture capitalist, plus the fourteen years I spent before that as an entrepreneur.ii I’m going to use some pretty simple math and some pretty basic terms to create a really awful situation in the hopes that entrepreneurs reading this might avoid doing the same in the real world.
As I’ve seen over many years and many deals, in all but the most glorious outcomes, terms will matter way more than valuationsiii, and way more than whatever your cap table says. And yet entrepreneurs – often with the encouragementiv of their stakeholders – optimize for the wrong things when they negotiate their financings.
This is my attempt to paint you a picture of why this is such a bad idea. The situation I present is fake, but the outcome is remarkably similar to those I’ve witnessed. Don’t let this happen to you.
Let’s start with our entrepreneur, whom we’ll call Richard. He’s founded a breakthrough company. Let’s call it Pied Piper.
Richard attracts Peter, a newly-wealthy budding angel investorv, who agrees to put in $1 million as a note with a $5 million cap and a 20% discount.vi
With his $1 millionvii, Richard builds a small team of people, rents an Eichler in Palo Alto, and gets to work. Once he is able to demonstrate his product, he heads to Sand Hill Road. He’s in a hot space in a hot market. He nails his pitch, and the term sheets roll in.
Because Richard is extremely sensitive to dilution (after all, he’s seen The Social Network) he wants the highest valuation possible. (Early in my career, another venture capitalist called valuation ‘the grade at the top of the paper’ – and I’ve never forgotten that.) The highest valuation, $40 million pre-money, comes from an emerging venture fund, let’s call them BreakThroughVest (BTV). BTV is excited about this deal, but has ‘ownership requirements’ of at least 20%viii, so they insist that to support that valuation they need to invest $10 millionix. Plus, they want a senior liquidity preference of 1x to protect their downside since they feel the valuation is rich given the stage of the company. x
Richard is thrilled with the valuation and the fresh capital for only 20% dilution.xi The prior investor, Peter, is stoked that he is getting his $1 million investment converted into roughly 20% of this super hot company, and now with the validation of an external term sheet he can mark his position up to $10 million, a 10X! This helps Peter validate his position as a savvy angel and solidify his syndicate following on AngelList.xii
Term sheet signed. Champagne popped. A few weeks later, funds wired.
With the $10 million, Richard rents space in SoMa on a seven-year lease, hires lots more people, and within a few months he is able to roll out the minimally viable product to test the market.xiii Awash in the buzz of his fundraise, a feature in Re/code, and some early user traction, Pied Piper is perceived as the emerging leader in a nascent, winner-take-all market.xiv While they are not yet monetizing their users, the adoption metrics are off the charts.xv
Pied Piper attracts the attention of a tech giant we’ll just call Hooli. Hooli’s consumer group wants access to Pied Piper’s data.xvi With Hooli dollars behind Pied Piper, Pied Piper could inundate the market with consumer facing advertising to build their user base and upend competitors given the massive network effect of the product.xvii Hooli approaches Richard with the idea of a large strategic round.xviii In the deal, Hooli would invest $200 million for equity while in return the two companies would enter into a business development agreement on the side in which Pied Piper guarantees to spend that money in a massive consumer campaign on Hooli’s ad platform.xix They float the magic “B” valuation. Richard goes to sleep dreaming of rainbows and unicorns.xx
Richard fantasizes about being named a member of the Unicorn Club by the press. His employees calculate the huge paper gains on their optionsxxi – they will all be instant millionaires – and since no one is more than ¼ vested, they are all highly motivated to stay in spite of long, long work hours. BTV is thrilled with the 20x markup on Pied Piper, since they are about to hit their LPs up for a new fund. The original investor, Peter, has achieved legendary status – his $1 million has turned into approximately $200 million on paper. He’s on the YC VIP sneak preview list, he’s been offered a spot on Shark Tank, and Ashton just called to try to get into his next deal.xxii
Of course, that $200 million for 20% stake also comes in with a senior 1x liquidation preference in order for Hooli to create sufficient downside protection and thereby justify the $1 billion valuation to their board. xxiii
Richard, Peter and BTV all agree it is worth doing. With $200 million to spend on the most massive consumer-facing ad campaign in this sector’s history, the $1 billion valuation will seem low in retrospect.xxiv
Except, it doesn’t end up happening that way.
The ads start running, but the conversion rate is low. Pied Piper shows Hooli the atrocious metrics and demands out of the advertising commitment, but Hooli won’t budge: Performance metrics were not pre-negotiated, and furthermore the ad group that recommended the investment did so in part to prop up their revenues with Pied Piper’s money ‘round-tripping’ into their coffers. The ad group is counting on that money to hit their annual numbers. xxv
Pied Piper is forced to run the whole campaign, blowing through all $200 million. The good news: They increased their user base by 10x.xxvi The bad news: The resulting business model those users end up actually supporting equates to more of a ‘market valuation’ of $200 million. In more bad news, turns out Richard incorrectly estimated the cost of supporting those users, most of whom are taking advantage of the ‘free’ part of a freemium model. Support costs skyrocket. xxvii
Word about the poor conversion leaks out.xxviii The advertising stops when the money runs out. Growth slows to a trickle when the advertising stops. New investors sniff around, but with the preference overhang of $211 millionxxix, they are concerned about employees being buried under that structure and therefore being unmotivated to continue. They ask prior investors to recap, but the investors don’t want to give up their preferences: Pied Piper is now looking like it might be worth far less than the paper valuation, which means those preferences are very valuable as downside protection. Furthermore, BTV is out raising their fund, and the last thing they want to do is write down their 10x markup on the Pied Piper investment. xxx
The board is now super unhappy about the massive miscalculation of support costsxxxi, awful user conversion, gargantuan ad overspend, the lack of growth the company is experiencing, and the departure of a few key employees who’ve seen this movie before and have done the ‘overhang math’.xxxii Richard as CEO is out of his element – the problems are huge and the company needs more money, which he is incapable of raising given his lack of experience navigating waters like these.xxxiii Unfortunately, it is the CEO’s job to fix problems and raise money, and if he can’t do it, someone else has to. So the board (which now controls the company with 60% of the stock) votes to remove Richard as CEO. They recruit an interim CEO (let’s call him George)xxxiv to quickly take the helm. George says he’ll take the job on two conditions: One, that they create a 5% carve-out for him and the go-forward employees (he’s done the overhang math too) and two, that they extend the runway so he has time to either turn this thing around – or sell it.xxxv
The company is not profitable and the current investors are tapped out. “Let’s extend the runway using debt,” says BTV. Maybe things will improve with time – or at least perhaps they can get their fund closed before they have to take the write down.xxxvi
They lean on their good friends at PierLast Venture Bank who cough up $15 million in debt, with a senior preference and a 2x guarantee. Onerous terms to be sure, but hard to get debt with a balance sheet like this. Unfortunately, Pied Piper is burning $2 million a month on office space, cloud services, customer support, and expensive employees who are needed to build the next generation of the product. Without support they’d have to shut down existing customers and revenue, yet without development of the new release that they hope will save the company, they will have nothing to sell. Since they can’t cut their way to glory, they have to simply hope they can grow into their valuation.xxxvii
Time ticks by while the company plods forward with very slow growth. Market pressures force them to lower prices, pushing profitability off. A few key developers leave. Once again, they are facing the prospect of running out of money in 90 days. Current investors are worried. Not only do they not have funds to put into the deal, but once payroll is missed they could be personally liable for the damage. Not good. xxxviii
Luckily, WhiteKnight, a public company with a complementary product and plenty of cash, offers to buy Pied Piper. The offer is $250 million.xxxix It’s not a billion – but it’s still a big, impressive number. It’s not that easy to create a company worth a quarter billion real dollars to someone else. That’s huge!xl
The venture debt provider PierLast is very nervous about Pied Piper’s balance sheet and looks to the VCs to either guarantee the loan or get the sale done.xli They want their $30 million. Hooli is likewise pushing to sell, after all they are guaranteed the first $200 million of any proceeds, after repayment of 2x debt to PierLast, while the company would have to be worth over a billion for them to see any further upside given that they only own 20%. Their calculus is that this is about as unlikely as seeing a real unicorn given the state of the company. BTV, who no longer has any capital left to invest from their original fund, has recently closed their shiny new $300 million fund, so they decide it is time to take their chips off the table. They vote to sell too, getting their $10 million back. Peter, while sad about the outcome, has developed a huge syndication following on AngelList and has recently benefitted from an early acquisition that netted him $3 million on a $250k investment.xlii Can’t win them all, but he’s at peace. Even Richard votes yes to the sale: He still has a board seat but given the company’s lack of profitability and lack of any other sources of capital, turning down this deal would mean insolvency, missed payroll - and personal liability. George (the interim CEO) and the key go-forward employees demand their $12.5 million carve-out. Tack on more money for lawyers and ibankers, and…
Oh wait, that’s more than $250 million. Oops.
Ergo, Richard ends up with nothing.xliii
So what can we learn from Richard’s grim fairy tale?
Liquidation preferences, participation, ratchets – even the very term preferred shares (they are called ‘preferred’ for a reason) are things every entrepreneur needs to understand.xliv Most terms are there because venture capitalists have created them, and they have created them because over time they have learned that terms are valuable ways to recover capital in downside outcomes and improve their share of the returns in moderate outcomes – which more than half the deals they do in normal markets will turn out to be.xlv
There is nothing inherently evil about terms, they are a negotiation and part of standard procedure for high risk investing. But, for you the entrepreneur to be surprised after the fact about what the terms entitle the venture firm to is just bad business – on your part.
Cap tables don’t tell the real story
For any private company with different classes of stock, the capitalization table is not-at-all the full picture of who gets what in an outcome. xlvi
In the above example, each of the three investors held 20% of the stock and Richard and crew held 40%, yet the outcome was vastly different because of those aforementioned pesky terms and preferences.
Before you close on any round, you should create a waterfall spreadsheet that shows what you and each other stakeholder would get in a range of exits – low, medium and high. What you will generally find is that, in high, everyone is happy. In low, no one is happy, and in medium (which is where most deals settle) you can either be penniless or “life-changingly” compensated, depending on how much money you raised and what terms you agreed to. It is simply foolish to sell part of the company you founded without understanding this fully.xlvii
This is why it is so crazy to me that many entrepreneurs today are focused on valuation – the grade at the top of the paper. They are willingly trading terms for a high number. Before you do so, run the math on the range of outcomes over multiple term and valuation scenarios, so you fully understand the tradeoffs you are making.
Venture capital is not free money. It’s debt. And then some.
People mistakenly think of an equity investment as ‘only’ equity dilution. After all, if you lose everything, your venture investor can’t come after you for your house like a bank lender could. However, most all venture transactions are done for preferred shares with a liquidation preference, which means all that venture money is guaranteed to be paid back first out of any proceeds before you get to make a dime. The more money you raise, the higher that ‘overhang’ becomes. And interestingly, the higher the valuation, the higher the delta of value you need to create before the investor would rather hold on to the end instead of getting his or her money back (or a multiple thereof, as some terms dictate) in a premature sale if things are looking iffy.xlviii And what company doesn’t go through iffy times?
Stacked preferences can create massive problems down the line.
This one is a hard to articulate in a blog post. Plus, I am a venture capitalist who on occasion puts said senior preferences in my term sheet. They exist for a reason – again often to do with the valuation and the risk/reward tradeoff the investor needs to make using the downside protection of a senior preference against the minimization of dilution the entrepreneur wants to achieve with a sky high valuation. They are not inherently bad.
But regardless of why they are there, the more diversity of value and terms in each round, the more you will create a situation where your investors (who are almost always also your voting board members) will have very different return profiles on the same offer. In the above example (and again I apologize for simplified math but it is directionally accurate) Hooli is getting their $200 million back on a $250 million acquisition. They own only 20% because of the high valuation they paid. So for them to instead double their return, the company would have to go public for $2 billion! This is a case of the bird in the hand being worth more than the two in the very distant bush.
Investors are portfolio managers: You are not.
You are betting usually 10 years of your life and all your available assets on your startup. Your investor is likely investing out of a fund where he or she will have 20-30 other positions. So in the simplest of terms, the outcome matters more to you than it does to them.xlix As I noted above, when you have stacked preferences, each person at the table may be facing a vastly different outcome. But now layer onto that their fund or partner dynamics. Ever heard the expression, “lose the battle but win the war?” I’ve seen behavior that would seem crazy, until one considers what is going on in the background. For example in the above, BTV is out raising a fund and depends on that 10X markup to validate their abilities as investors. Facing a write down, a fire sale – or an extension of runway using debt (and not incurring any accounting change) – which one do you think least impacts the most important thing they are doing right now? For our angel Peter, whose star has risen with this legendary markup, what value is there to him of taking a $1 million loss right now instead of just leaving a walking dead company out there and on his books (although this company is not technically walking dead because, since it is not profitable, it is not walking. But I digress.)
Most reputable investors do not engage in this sort of opticsl, and many of us who have been through the dot com bust are actually rather aggressive with our write downs to accurately reflect a sense of true value in our portfolios. Also, most investors who are also board members wear multiple hats and take their fiduciary responsibilities very seriously – I know I do. But, I bring up these behaviors because I’ve witnessed them more than once out there in the real world. As an entrepreneur, you should at least think through the motivations of others, both when you are structuring investments as well as when you are considering a sale. They will on occasion matter… a lot.
What to do.
Now that I’ve scared you, let me reiterate that most investors I deal with are great, ethical people.li If I didn’t think of venture capital money as good for entrepreneurs on the whole, I wouldn’t be a venture capitalist.lii But we VCs do a lot more deals than you entrepreneurs do, and you need to go into them with your eyes open to the downside consequences of the terms you agree to.
Here’s what I recommend:
Focus on terms, not just valuation: Understand how they work. Read this book. Use a lawyer that does tech venture financings for a living, not your uncle who is a divorce attorney, so you are getting the best advice. Don’t completely delegate this because you need to understand it yourself.
Build a waterfall: Once you understand the terms being offered, build a waterfall spreadsheet so you can see exactly how each stakeholder will fare across the range of potential exit values (yes by stakeholder, not by class of stock: Investors often end up owning multiple classes, and likewise different people in the same class may have very different circumstances that will influence their behavior even in the same outcome.)liii
Don’t do bad business deals just to get investment capital: I know, duh, right? But I’ve seen otherwise brilliant entrepreneurs get entranced by these big number deals with big corporates, only to deeply regret them later when they cannot be unwound. My advice, separate the business development contract from the equity contract. Negotiate them individually. If the business development deal would not stand on its own merits, don’t do it. liv
Understand the motivations of others: This can be quite trickylv, but I believe you should at least think through what might be the motivation of the others around the table. Is that junior partner going to get passed over for promotion if he writes down this deal? Is that other firm fundraising right now? If you don’t know, ask. I always aim to be transparent with the entrepreneurs I work with about what my and DFJ’s goals and constraints are, independent of my role as a director. lvi
Understand your own motivation: What are you doing this for? So you can see your face on the cover of Forbes? So you can have thousands of employees working for you? So you can be a member of the billion dollar Unicorn Club? Perhaps it is to do something you are personally excited about and in a reasonable amount of time, maybe take enough money off the table to live in a nice home, pay for your kid’s college and your retirement. I’m not saying one is more correct than the other, I’m just saying that your own goals will dictate whether you should even raise venture at all, how much to raise, and what to spend it on. If you raise $5 million and sell your company for $30 million, it will likely be a life-changing return for you. If you raise $30 million and then sell your company for $30 million, you’ll end up like Richard.
Pretty good, I thought.
- And by mythical she means fictitious. [↩]
- I undersign the story, in that it's a very good summary of one particularly common failure mode. [↩]
- "Valuation" denotes the implicit value investment places on the recipient. To understand how this works, suppose you have six daughters and I pay you ten million to pick one of them. The intuitive conclusion would be that your remaining litter is NOT worth fifty million, but less - because I already picked the only valuable one off that lot. Then again this example uses simple items such as your own daughters, and processes that are close to your own experience such as buying and selling women as cows, so you are well equipped to correctly evaluate it, and your intuition is well alligned to the actual reality of the matter. Add "entrepreneurs" and "businesses" to the mix and suddenly your memory hole takes over.
Terms, meanwhile, denotes the actual content of the agreement. For instance, if I pay you ten million to pick one of them, but the actual deal reads "will pay ten million in cash for the pick of the litter, provided the father agrees to take her back and return the money (plus interest) in one year if she turns out to be annoying, or in three years if she fails to produce two marketable children valued in excess of six million together in that interval, or in five years if she fails to bring at least six million in the open outcry auction held every year for used up women in Brunei", the deal doesn't mean you're the great father that produced ~sixty million worth of young sluts out of a slightly older slut and so all sluts out there should mail you their misty panties. The deal just means you're an idiot like no other and your mom should be ashamed. Very, very ashamed.
Makes sense ?
Good. So yes, terms are a lot more important than "valuations", in any and all contexts. Bear this in mind. [↩]
- Generally both are clueless yet enthusiastic. This never works out well. [↩]
- According to Paul Graham, the presence/absence of these is what makes or breaks the possibility of a Silicon Valley. He is broadly correct, but not for the reasons he would like to be : the presence of enthusiasm-minded, clueless people that also have money is a key factor in the success of any Ponzi scheme, and a required contributor to financial misallocation and economic instability (you know these as "growth" and "social mobility", because you're so very focused on observing parts and fragments of phenomena). [↩]
- To get the jargon out of the way, and express ourselves like people who master this language : Peter agrees to deem Richard's contribution in the shape of the pre-investment Pied Piper (PP1) as worth 4 million. Thus his contribution in cash entitles him to 20% of the post-investment Pied Piper (PP2), leaving Richard (presumably) with 80%. [↩]
- And a lot of future promises built on top of it - this is very important! [↩]
- This means they will not invest in companies if their investment would leave them with less than 1/5 ownership of the result. This is because they want a seat on the board, which is customarily 5 people, which is to say they want to have a say in how the company is managed in the future (because they sniffed out Richard as an ambitious noob, which is to say valuation-driven (because that's their entire business model, they offer high valuations to attact a particular sort of nitwit, much like deep ocean predators have a light in front of their mouth) and the way you nail these is with liquidity preferences, but let's not spoil the fun - suffice it to say every kind of cat has a way in which it's skinned, and you're the cat in this discussion). [↩]
- Which they do because it pushes everyone else out, ie, it de-facto but discreetly forces an exclusivity deal.
Noob CEOs generally are inclined to favour these anyway, because they're idiots, and they figure "hey, the fewer suits involved, the more time I have to do actual work", instead of the correct "if I don't have at least three sets of suits to play against each other I'm proper fucked". What do they know. [↩]
A liquidity preference means that while shares may entitle the holders to a % of the proceeds of the company, whatever it may be, nevertheless BTV gets 10 million right off the top no matter what.
So structured, the deal changes the meaning of the other people's shares, from actual equity to mere options. Before this deal, Peter owned shares of a company [he] valued at 5 mn, or in other words 1mn in equity. After this deal, Peter will own options of a company BVT valued at 50mn, which only vest if the company actually ever sells for more than 50mn.
There is a very large difference between "you own 1/5 of this, whatever it may be worth" and "you own 4/25 of this, provided it's worth over 50mn". The former can never be zero, no matter what. Importantly, it scales linearly with the performance of the company. The latter can be - and often is - zero, because it does not scale linearly with the performance of the company.
To understand this magic in electric engineering terms, the PP1 deal Peter had 20% of worked like a transformer : if you apply current in the primary, you get current in the secondary. Maybe more or maybe less, depending on the nature of the transformer. The PP2 deal they're moving to, Peter's 20% is now 4%, and more importantly the assemblage now works like a transistor : unless you get THIS MUCH current in the primary, you don't see anything in the secondary.
Obviously the two situations are not equivalent, and the proposition that you'd value PP1 shares like PP2 shares (10x ! wow!) is rank imbecillity, of a kind often favoured by rank imbeciles. (For the record, the term is used properly - imbecillity is the situation where changes in the primary circuit yield no changes in the secondary circuit. Such is life.) [↩]
- Richard does not understand how dilution actually works, because he's only looking at one number, like the people watching USG reported "inflation" figures. He's not perceptive enough to notice that the very meaning of the shares changed, and that change significantly dilutes him. [↩]
- Which is exactly why the bag holder's in the game to begin with. You'd think they could just give everyone badges like they did in highschool and save on electricity. [↩]
- Let's put this in easier-to-follow terms.
Rachel is a 16 yo hottie attending a local public school. She is a virgin, until the gangland borders move and the local thugs take over the school. Rachel is gang-raped in the cafeteria, and then in the locker room, for about six hours all told. Apparently she's hot stuff, because the men (no, not boys) have so much fun they leave in her spastic palm two twenny bills.
Rachel sort-of washes up, and goes to Zara to buy see-through tank tops and low cut jeans with a zipper extending from the pubis to the tailbone, for ease of access.
You don't think that's what happened ? That's exactly what fucking happened, down to the t. Guy got raped and ran off to spend the payoff in such a way as to maximally ensure he gets raped again. Oh, "it's just what's done" ? Welcome to Islam, America. [↩]
- Why ?
No, this is important. Why is it perceived thus ? What is the meaning of "emergent leader in nascent" ? Is this maybe something you say to retarded kids, because you don't want to lie, not to the young ?
Why is the market "winner-take-all" ? What sort of actual, existing markets can you think of that actually display that dynamic ? Forget markets, you don't know jack about markets, what situations at all whatsoever can you think of where the winner takes all ?
The winner takes it all in the ass, you mean, like the US got raped for being a world power a teensy little over a decade. Like Bell got raped for being the winner-takes-all telephone company. Like Myspace got wiped for being "winner-take-all" facebook. Think things through, whenever you hear things said, and especially when said at you. What does it mean ? Why would someone be saying that ?
Socialisation 101, this stuff, but apparently ESL and desocialisation go hand in hand like typhoid and dehydration. [↩]
- Right. While the donut shop gave out free donuts, it was so damned crowded actual paying customers couldn't get in. Nor did they want to, because who associates with the sort of bums that crowd a free donut shop anyway.
What is the meaning of "adoption metrics" for something that's given away ? Leaving aside the general meaninglessness of "metrics", what exactly has been adopted ? What does this mean, "adopted" ? Do you suppose you could have someone move into your basement, if you spent 10-20k to make it a sort of apartment, and then advertised "free basement apartment" ? Congrats, you've driven adoption. What now, you'll start charging rent to the bum that moved in ? How about "no you won't, and you won't be able to ever kick him out, either." Revisit the history of webservices that tried to charge after being free, it's guaranteed to amuse you. Online dogs have rights to your stuff for free and so forth dontchaknow. [↩]
Hooli's "consumer group" knows that it's been lying for years, and knows that the choices before it are very strictly two fold : either buy or bury any competitor that might be in a position to blow the lid off the layers upon layers of scam. That's it. [↩]
- Very many different nopes.
First off, advertising generally is a horrible waste of money. Among that sad field, online advertising is the absolute utter worst. In fact, advertising expense is such a bad move for a new company, you can comfortably short anyone doing it and never lose money.
Second off, even if it worked, advertising is a provably loser move in a "nascent" anything. A dollar spent by Coca-Cola today to keep the pop guzzlers guzzling pop is not terribly likely to help Pepsi. In fact, it's likely going to hurt it. But if you're advertising "cellphones" in 1995, or personal computers in 1985, you are in fact driving the market not your own product. Every dollar you spend helps your competitors too, maybe not a dollar's worth... or maybe more! It's unqualifiable, and for this reason a horrible fucking idea.
Third off, "network effect" as understood by noob "investors" is bullshit. Nothing works that way in reality. If you actually wanna do sociology, well then guess what sonny! You have to actually learn sociology. You know, the trade, a profession of sorts. At the very least study the god damned TvTropes wiki, preferably starting with hype backlash and stuff. They know a little more about "network effects" than twitter entrepreneurs do.
There's more, but really, what's the point already. [↩]
- As a useful heuristic, whosoever says "strategic" is lying to you.
The basic idea of strategy is to forego immediate gains (that's tactics) for obtaining a better overall position. This basic idea works if it's your idea. Otherwise, strategy is too damned valuable to be just given away to a schmuck like you - and the strategy salesman is just looking for a way to get you to unzip that fly all the way to the tailbone by your very own self. [↩]
- This, incidentally, is exactly the Ponzi scheme Paul Graham describes himself to have participated in, back when Yahoo was still a thing. To quote :
By 1998, Yahoo was the beneficiary of a de facto Ponzi scheme. Investors were excited about the Internet. One reason they were excited was Yahoo's revenue growth. So they invested in new Internet startups. The startups then used the money to buy ads on Yahoo to get traffic. Which caused yet more revenue growth for Yahoo, and further convinced investors the Internet was worth investing in. When I realized this one day, sitting in my cubicle, I jumped up like Archimedes in his bathtub, except instead of "Eureka!" I was shouting "Sell!"
- Let it never be said that rape victims don't sleep well. [↩]
- Discounting of course the interesting situation where their options are really options on options. [↩]
- It's not just that he's on the YC VIP sneak preview list, he’s been offered a spot on Shark Tank bla bla. More importantly, much more importantly than that : everyone, everyone,
~ everyone ~
on the YC VIP sneak preview list, and on Shark Tank, and everywhere else in that sad, sad world is a Peter.
To understand how this works, we'll have to take a detour and understand how spam works, because hot damn! Ponzi schemes and email spam go together like the horse and carriage. So, spam :
This is how spam works. Spam itself is not a business, in the sense that it does not come with a positive Expected Value. It comes with a negative EV. Sure, it is argued, but without proof and mostly by parties that are both directly interested in the argument and well known to straight out lie in similar circumstances - such as various US District Attorneys - that there exist some entities and some methods that actually allow spamming with a positive EV. I suspect even this claim is false, but obviously we won't be able to prove it.
So, if this is true, how come and where from all this spam ? Well, idiots, stupid people, Dunning-Krugerrands notice there exists spam, decide that because it exists it must be making money (because if it weren't beneficial the other sheep in the herd wouldn't be doing it, no ?) and start doing it themselves. A few months to a year and a half later, after having spent large amounts of their own worthless time as well as a few dollars here and there (for hosting, for "surefire" tools, for what have you), and after having caused untold thousands of dollars in damage (to the brands that still take affiliates, to the people trying to run the Internet, to random users, blogs, forums and whatnot) they finally give up.
But that does not matter, because during their few months to a year and a half some other idiots, some other stupid people, some other Dunning-Krugerrands in their formative years picked up the idea and are soon going to start spamming themselves. There's an SEO expert born every minute, as the old adage goes.
The same exact process populates the upper end of the conference freakshow : it's Peters all the way down, and perhaps the finest example available happens to be actually named Eric. Let's proceed with quotes :
Eric in 1999 :
A few hours ago, I learned that I am now (at least in theory) absurdly rich.
I was at my machine, hacking, when I got email congratulating me on the success of the VA Linux Systems IPO. I was working on my latest small project -- a compiler for a special-purpose language I've designed called Scriptable Network Graphics, or SNG. SNG is an editable representation of the chunk data in a PNG. What I'm writing is a compiler/decompiler pair, so you can dump PNGs in SNG, edit the SNG, then recompile to a PNG image.
"Congratulations? That's interesting," said I to myself. "I didn't think we were going out till tomorrow." And I oughtta know; I'm on VA's Board of Directors, recruited by Larry Augustin himself to be VA's official corporate conscience, and it's a matter of public record that I hold a substantial share in the company. I tooled on over to Linux Today, chased a link -- and discovered that Larry Augustin had taken the fast option we discussed during the last Board conference call. VA had indeed gone out on NASDAQ -- and I had become worth approximately forty-one million dollars while I wasn't looking.
Well, that didn't last long. In the next two hours, VA dropped from $274 a share to close at $239, leaving me with a stake of only thirty-six million dollars. Which is still a preposterously large amount of money.
You may wonder why I am talking about this in public. The first piece of advice your friends and family will give you, if it looks like you're about to become really wealthy, is: keep it quiet. It's nobody else's business -- you don't want to look like you're gloating, and you don't want to be deluged with an endless succession of charity appeals, business propositions, long-lost best friends, and plain bald-faced mooching.
Trouble with the "keep it quiet" theory is that I've made my bucks in a very public way. When you're already a media figure, and your name is on the S-1 of a hot IPO, and email from friends and journalists starts coming in like crazy as the stock breaks first-day-gainplaying it coy swiftly ceases to look like a viable option.
Besides, it wouldn't be fair to dissemble. I serve a community. I'm wealthy today because my efforts to spread the idea of open source on behalf of that community helped galvanize the business world, and earned the respect and the trust of a lot of hackers. Larry thought that respect was an asset worth shelling out 150,000 shares of VA for. Fairness to the hackers who made me bankable demands that I publicly acknowledge this result -- and publicly face the question of how it's going to affect my life and what I'll do with the money.
This is a question that a lot of us will be facing as open source sweeps the technology landscape. Money follows where value leads, and the mainstream business and finance world is seeing increasing value in our tribe of scruffy hackers. Red Hat and VA have created a precedent now, with their directed-shares programs designed to reward as many individual contributors as they can identify; future players aiming for community backing and a seat at the high table will have to follow suit. In this and other ways (including, for example, task markets) the wealth is going to be shared.
So while there aren't likely to be a lot more multimillion-dollar bonanzas like mine, lots of hackers are going to have to evolve answers to this question for smaller amounts that will nevertheless make a big difference to individuals; tens or hundreds of thousands of dollars, enough to change your life -- or wreck it.
(Gee. Remember when the big question was "How do we make money at this?")
The first part of my answer is "I'll do nothing, until next June". Because I'm a VA board member, under SEC regulations there's a six-month lockout on the shares (a regulation designed to keep people from floating bogus offerings, cashing out, and skipping to Argentina before the share price crashes). So it's not strictly true that I'm wealthy right now. I will be wealthy in six months, unless VA or the U.S. economy craters before then. I'll bet on VA; I'm not so sure about the U.S. economy :-).
Assuming the economy does not in fact crater, how is wealth going to affect my life in six months? Honestly, I think the answer is "not much". I haven't spent the last fifteen years doing the open-sourcefor the money. I'm already living pretty much exactly the way I want to, doing the work that matters to me. The biggest difference the money will make to me personally is that now I should be able to keep doing what I love for the rest of my life without worrying about money ever again.
So I expect I'll just keep on as I've been doing. Hacking code. Thinking and spreading subversive thoughts. Traveling and giving talks. Writing papers. Poking various evil empires a good one in the eye whenever I get a chance. Working for freedom.
I expect most other hackers confronted with sudden wealth will make similar choices. Reporters often ask me these days if I think the open-source community will be corrupted by the influx of big money. I tell them what I believe, which is this: commercial demand for programmers has been so intense for so long that anyone who can be seriously distracted by money is already gone. Our community has been self-selected for caring about other things -- accomplishment, pride, artistic passion, and each other.
OK, so maybe I'll break down and finally get a cell phone. And cable broadband so I can surf at smokin' speed. And a new flute. And maybe a nice hotrodded match-grade .45 semi for tactical shooting. But really, I don't want or need a lot of stuff. I'm kind of Buddhist that way; I like to minimize my material attachments. (My family gripes that this makes me hell to buy Christmas presents for.)
I'm not going to minimize my attachments by giving it all away, though, so you evangelists for a zillion worthy causes can just calm down out there and forget about hitting me up for megabucks. I am *not* going to be a soft touch, and will rudely refuse all importunities.
I'm not copping this harsh attitude to protect my money, but rather to protect the far more precious asset of my time. Because I don't want to have to become a full-time specialist in deciding whose urgent pitch to buy, I'm going to turn everybody down flat in advance. Anyone who bugs me for a handout, no matter how noble the cause and how much I agree with it, will go on my permanent shit list. If I want to give or lend or invest money, *I'll* call *you*. (Sigh...)And yes, there are causes I'll give money to. Worthy hacker projects. Free-speech activism. Firearms-rights campaigns. Tibet, maybe. I might buy a hunk of rainforest for conservation somewhere. Megabucks are power, and with power comes an obligation to use it wisely. I'll give carefully, and in my own time, and only after doing my homework -- too much charity often kills what it means to nurture. And enough about that.
Ironically enough, one result of my getting rich is that I will probably start charging for speaking appearances, now that nobody can plausibly accuse me of doing it for the money. I won't charge open-source user groups or schools, but I will cheerfully extract a per diem from all the business conferences that keep wanting me to to boost their box office. Charging a price for my time will separate the expensive conferences that attract powerful people from the marginal events where the hacker community would get less leverage from my presence.
Remember that ? Yeah, the guy was just hacking (specifically, hacking away at RMS's back with a knife shaped - coincidentally!!! - just like O'Reilly needed it to be) and suddenly...
But then, Eric in 2015 ?
I created a Patreon page just before leaving for vacation on 2 Aug. The background to this is that while I’m now getting some regular bucks for working on NTPsec, it’s not a lot. Royalties from my books have been dwindling and my wife Cathy isn’t making all that much from legal contract gigs that are all she can get since Obamacare costs killed her full-time law job. Add the fact that our eight-year-old car has developed problems that would cost more to fix than its book value, and the house needs a new roof, and it’s looking pretty broke out.
Awww. These are the "smart investors" which, to quote another washed out derp,
Do you really need the rich people? Wouldn't it work to have the government invest in the nerds? No, it would not. Startup investors are a distinct type of rich people. They tend to have a lot of experience themselves in the technology business. This (a) helps them pick the right startups, and (b) means they can supply advice and connections as well as money. And the fact that they have a personal stake in the outcome makes them really pay attention.
Tell you what, I don't know that many corrupt bureaucrats that have to beg on obscure websites in their old age. Do you ?
- Of course. By now, there's not even all that much to say. Why mend the stupid things you've done in the past, when you could just double down and not have to face (yet) the music of just how stupid you've been ?
- So let's do a short recap (excuse the pun) :
1. Guy builds thing, which is apparently useful. PP1 is born.
2. Peter comes and gives him 1mn in cash in exchange for 1/5 of all future profits whatever they may be. PP2 is born.
3. BVT comes and
trasformsdegrades previous equity into options, gives themselves 20% of all future profits + 10mn off the top no matter what, and throws 10mn into the pile. PP3 is born.
4. H comes and
transformsdegrades the notion of money. They give themselves "20% off all future profits" just for the sake of the show, to maintain in the three piggies the mistaken impression that H actually thinks there's an upside left, and - here comes the cherry - 200mn in the shape of guaranteed sales for their own selves. So the deal isn't as much that PP3 is valued by H at whatever. The deal is moreover that by transforming itself into PP4, PP3 agrees to value the product of H at 200 mn.
A deal can be anything, you see. That's the beauty of capitalism. Generally, a deal is a means for the iliterate to give away their ass. Ever saw Oklahoma Kid btw ?
Notice how at every point the one variable that was being watched was increased, at the cost of wreaking havoc on the economic substance it supposedly measured ? The fundamental problem at work here is that formalism is not a workable life philosophy. Richard is roughly in the position of the dumb blonde whose mother told her to always say "no" to boys, because that way she can't get herself knocked up, can she ? Well, it depends. If the boys aren't very stupid they'll soon enough figure out that blondy just follows a formalist approach, and will ask her something like, "Do you have anything against bending over ? Taking your panties off ?"
The formalist approach to life may seem ridiculous on examination, but I doubt you understand just how deeply it infects your thought process (or at any rate, what in your own estimation passes for thought process). For instance, you imagine that if you never say the word nigger you are not racist. That's not how racism works. You won't go to heaven by never saying fuck, you won't be enlightened by never saying nigger, and you won't get rich by never agreeing to low valuation deals. [↩]
- Because why ?
Why would they need this, except should they actually know the shit they're peddling is worthless ? Obviously they won't admit this, first of all not to themselves, but how come they have to invent soviet style "demand creation" ?
Not like online advertising is fraud throughout or anything, right ? [↩]
- How can this be good news, their cap base increases 40x. For that matter, most of that 10x, say 3-4x or so, would have happened anyway, and happened anyway because of reasons that are much deeper than the advertising campaign.
Let's think about it for a second, by looking at Jane. Jane saw PP on her friend Rhonda's phone, and thought it was cool. She was going to get it Sunday, but then she saw an ad Saturday and clicked through. The ad campaign "converted" Jane, right ? And the lifetime value of Jane as a customer is properly attributed to the ad campaign, right ? Not like all that's in question is the one day difference between Saturday and Sunday, which, being a weekend, is not even worth money.
What if Jane already had the thing installed, but the campaign overwrote her cookie like those things do and then misreported her as a new user ? An online advertiser would never do something as shady as this, would they ? [↩]
- This is very often the case because measuring small values correctly is difficult.
To explain what I mean : suppose you run an insurance company. People pay you ten dollars and you pay the families a grand should they die. First week, you collect fiddy bucks and pay out nothing. Second week, you collect ninety bucks and pay out twelve in commissions. Third week you collect two hundred and pay out thirty in commissions. Fourth week you collect five thousand, pay out seven-fifty in commissions with a big fat bonus because look what a great job marketing's doing, and the fifth week cholera strikes. You are exposed to a maximum liability of (5 + 9 + 20 + 500) * 1000 = 534k, and have a very strong balance sheet worth less than 1% that. What now ?
Learn about micromorts and shit, I guess. Check it out, the actual professionals in the field even have a word to discuss concepts which were throughout foreign to you, who knew! [↩]
- Do you know how often this was the case ?
Every time to date. No, I'm not kidding : every "most massive consumer-facing ad campaign in this sector’s history" to date, without exception, at all times, in all sectors, was a disappointment. There is not a single case when this didn't happen, in centuries.
Great companies can be built on very smart wasp buys (such is the story of Apple - the entire thing exists today because Jobs had a knack at buying ads with ROI), but no "largest spend" ever paid off. [↩]
- Yeah, that's the deals they signed : before this company can be worth anything to anyone, it needs to be worth 211 million.
That "anyone" includes the very fucking employees that are supposed to do the product. Which means that the company was already a write-off when BVT agreed to sign on the H deal. It was. They figured the best they can show for their 10 mn investment is a momentary 20x and that's it. Better than nothing, and they're in the business of doing business.
Richard, meanwhile, is in the position of taking it in the ass. Like Greenspun. [↩]
- Because nobody actually looks this deep.
That's what the entire inflatable deck of painted cards relies on : that nobody looks deep. And because "it's a business standard" and "best practices" and so forth - nobody will conceivably go to jail even if caught, which catching isn't all so easy.
And this is the deep reason the United States are doomed as a going concern. No matter how much you might love them or what part of them you might love, this acquired inability to structure finance is roughly speaking AIDS. There is no survivial rate. [↩]
- Because it's always easier to prosecute obvious idiocy than structural maladaptative behaviours. Especially if the obvious idiocy rests with not-you. [↩]
- Yeah, they have it.
If your company is in a similar situation, leave now. Now. Do not wait for anything, there's nothing to wait for. [↩]
- Nobody can raise money on this sheet.
The only way to raise money here is by personal credibility, and, to quote Buffett,
When a manager with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.
Why would you get mixed in the shit ? [↩]
- Never ever hire anyone who ever took this job. He's no good, and he knows he's no good, or else he wouldn't take this kind of job. [↩]
- "Extend the runway" is a very descriptive term, except as is typical for psychotic fields, it is not so much descriptive of the situation as it is descriptive of the participants.
You see, the way "ventures" work, the sort "venture capitalists" "invest" into, there's this much money available in the bank and this cost structure therefore the company has to "take off" before so much time. If you have 1mn in the bank and payroll stands at 100k per month (ie, you've hired yourself) you have ~eight months, of which only the first six are any good - people start spending more time sending resumes than working on your product towards the end. If you have a twenty million in the bank but twelve employees of the "San Francisco airs and pretense" crowd + a "hip office" with "amenties" eating you 50 to 100k a month, your twenty million's maybe worth a year. So knock your girlfriend up and then race her to delivery! It should be fun!
And by fun I mean stressful, but what do you care, you're young, you still have both your kidneys and all your intestinal lining. Go, break the world, shit fresh pineapple. Change the revolutionize! [↩]
- At this point the junior has the run of the company because the major already ate his full and doesn't care anymore - hey, what could PP5 ever do to make the 200mn H got pale in comparison ; whereas Richard and Peter are fucking imbeciles, and they think it's their fault and they're trying to "make it up" to the rapist by wearing better slutty outfits every day and covering the blue welts with as much corrector as they can beg / borrow / steal. Mostly from their personal friends - hey, what are personal friends for if not to pick up the pieces of the H & BVT all-night gangbang sessions. [↩]
- Ahahahahaha. [↩]
- Have more sense than this.
Seriously, if you are going to ever get into business, at the very least learn how to play defense. Fishing wouldn't be very much fun if half the fishermen ended up eaten by the fish, and who would go hunting if the wolves also carried scoped rifles ? [↩]
- Maybe in a good market. In a real market the offer is ~20 million (remember "Slashdot Media" ?). And for that matter - GigaOm doesn't even get an offer at all.
So no, no quarter billion for you I'm afraid. [↩]
- No, it's not.
Richard has managed to turn a moderately promising idea into a pile of smoldering ash, and a bunch of assholes moved around worthless paper back and forth. There is absolutely no relation between the 250mn and Richard, so no, he hasn't "created" anything. He could have, if he had enough sense to list on MPEx. But he didn't, and so... he didn't. [↩]
- This is exactly how these deals work out, in practice. "Oh, you don't want X ? So then are you making me whole ? No ? Well then better want X, or else I sue". [↩]
- Which is the worst that could possibly have happened to him. Give him twenty years. [↩]
- Well, Richard ends up getting to walk.
Think about this : after a half decade spent sucking this set of cocks, his retirement consists of... being allowed to walk away. That's what he gets : his own asshole back, stretched as it is. For now.
And you thought my 3rd note was scandalously off the mark. Tsk tsk, how naive you've been. Are you ashamed ? Will you apologize for the stupid thoughts you had in my direction ?
You should. [↩]
- Absolutely. This is not optional, not a "see also", not "extra reading". This is IT.
You don't know this, you don't belong here, at all. Stay home, doodle on your smartphone, whatever. [↩]
Terms exist because venture capitalists have created them, and they have created them because they understand founders are fucking stupid. So they built themselves pivots to unhinge the main types of idiots they encounter, of which the "valuation" fixated type is easily the most common. [↩]
- You gotta figure out what you're looking at. Reading a "cap table" on the expectation you're looking at straight equity, when in fact you're looking at options, or even options on options, or even insane CLN arrangements, is simply bad thinking. You don't look at a graph without indication of scale, do you ? [↩]
- Alternatively, if you fancy yourself a "tech entrepreneur" and wanna deal with the von Neuman machine, spend a year of your life getting a basic quant education. The proposition that you're a "CEO" but can't evaluate or even identify an option is about as ridiculous as the proposition that you're a stripper but don't know where the pasties go or what keeps them on. Get with the program. [↩]
- This is a big deal, and perhaps even more often seen in practice than the actual situation she discussed - not in the sense that it's seen more times, but in the sense that it's seen more times in good companies.
There's an old article discussing the matter, I suppose I should translate it one of these days. [↩]
- This can not be overstated enough.
Never, never have the slightest compunction to tell any investor to get fucked. Nobody cares about him, about his needs, expectations, desires. He's a schmuck sitting on other people's money for which he won't be held even minimally accountable, asking you to spend most of your life on his business! Forget "your great idea" not getting done - there's much more value in a half decade of your life than some stupid "idea" getting "done".
Ideas aren't worth jack, and part of what that means is that you don't owe them anything. Fuck 'em, let them do themselves if they're that valuable and important.
You have to put more effort into defending yourself, especially the vulnerable parts of yourself - such as your time, or your cognitive independence - than they put into defending the pile of paper. Don't be that guy. [↩]
There are no exceptions. And for that matter, "reputable" investor is not unlike "reputable scammer". TradeFortress and garr255 all the way down. [↩]
- Let's quote the source.
For example in the above, BTV is out raising a fund and depends on that 10X markup to validate their abilities as investors. Facing a write down, a fire sale – or an extension of runway using debt (and not incurring any accounting change) – which one do you think least impacts the most important thing they are doing right now?
Uhh... I dunno, I guess if she admits every.single.person.involved is a contemptible piece of shit she'll have just about as easy a time doing what she does as if she said something else. I'm sure. Because you know, those ethical people are ethical and they'd welcome the
criticismnegativity if it were accurate. Only it isn't. Honest.
Why don't you believe ? [↩]
- And if I didn't think of cocks as good for women as a whole, I wouldn't be a woman fucker. I'd... hm. I'd go out there and fuck goats, honest I would.
Because these are options I actually have, I could just up and decide to go fuck goats from now on.
Why don't you believe ? [↩]
- Generally speaking, business is war, and your investors are your enemies just as much as your customers are your enemies. Not understanding what drives the enemy is pretty ridiculous a position to find yourself in. Why are you even there if you're not going to understand what the drives the enemy ? To be nice to people and create a lot of positive value + smiles ?
Fuck you, seriously, you're too stupid to live. [↩]
- Then why do the equity deal at all ? If they're separable like this ?
She's clutching at straws, because she doesn't want to say "bad things". [↩]
- No, it's not tricky at all. If you think it's tricky, it's because you've allowed perhaps well meaning but ultimately dangerous fools to pull the wool over your eyes in key fields.
Of course you can't be a half decent CEO of a start-up if you only look at one side of the box.
"Hey Bob, I think if we made this side larger the box would have more space in it!"
"Even if they make the other sides much smaller ? "
"What other sides! I'm telling you, make this side bigger!"
It doesn't stop there tho! It goes all the way to the core of your thinking, and it uproots all the faux "values" that were pounded into you since you were about ten. You can't think of women in terms of cattle to be bought and sold on the open market, nude throughout and fucked without asking ? Beeeep! You can't understand the motivations of others.
And I don't mean "when it comes to women", and I don't mean "others in the sense of rapists". No, I mean, if you can't think in those terms, you can't think period, and that means you can not understand the motivations of anyone ever, including sweet old ladies offering you tea and deer in rut staring you down in the middle of the fucking highway.
Thinking is a fine balance of many complex things, and in order to be able to do it at all you have to be able to do it completely. So make a habit, today, of considering everything. Everything. If you can't calculate the speed at which your six year old daughter slides down on a pole on the lubrication of her own virginal six year old guts, you can't think at all. Either fix that, or go find a master and slave for him or her earnestly for the rest of your life. There's nothing wrong with employment contracts : they exist specifically so the bovine sort of people don't entirely starve.
It's true, you won't ever make much. But at least you'll never find yourself in this position where you're walking away from five years of your youth with a rectum the size of someone's fist. Don't knock it. [↩]
- Careful what you ask, I learn more from what people ask than from what they actually say. [↩]
Sunday, 20 September 2015
Jesus Christ three cheers for footnote thirteen. And fourteen. And...adnotate all the things, pls.
Sunday, 20 September 2015
Such hybris on ESR...
Sunday, 20 September 2015
@pletzalcoatl I'm here all week.
@Antitank Only took ~15 years for that frisbee to return, too.
Friday, 25 September 2015
Hehe, I wonder what BitPay's "adoption metrics" are.
Friday, 25 September 2015
Off the charts.
Saturday, 26 September 2015
A valuable read indeed.
Tuesday, 14 June 2016
Nice article. Now riddle me this: why is it that "start-ups" and faggot populations correlate?
¿ƃɐɹp uᴉ ʇno ƃuᴉoƃ oʇ pǝʇɐɔᴉpǝp ǝɯᴉʇǝɟᴉl ɐ ɥʇᴉʍ op oʇ ƃuᴉɥʇʎuɐ ǝʌɐɥ ʇᴉ plnoƆ :ʇuᴉH
Wednesday, 15 June 2016
@David FRANCOIS Cheers.
@anon Aceste cuvinte care ne doare-n fund.
Thursday, 28 July 2016
Your company is very impressive .