How to Get Your First Sale

The customer’s own emotions and desires should drive the conversation naturally into your solution, not the other way around.

Trying to get your first paid customer can be tough, especially when you have to do more than just sign up for Google AdWords and -gasp- engage with other humans to complete a transaction of goods, services or both. So if you’re start-up model is just getting eyeballs and selling clicks, this post isn’t for you. This article is about how to get a paying customer for anyone who is doing more than just selling advertising on a site.

When you started your company, I will assume that you had an idea for some awesome thing that would generate a ton of consumer surplus. If you don’t know what this is, please read this first. Now, back to your great consumer surplus generating concept, I assume you have. This minimum viable product is untested, so you’re not sure yet if the “baby is ugly”. Truth is, it probably is ugly, and if you do the start-up sales process correctly, you’ll learn helpful product information that will not only help you sell the baby, but get some good plastic surgery to make that baby pretty.

First things first, find the people who you think will want the product/service. You should be able to network naturally into the person with the problem. If you can’t then you probably don’t know the industry well enough to understand their problems, let alone solve them, and it was a bit presumptuous for you to quit your job, mortgage the house, and risk it all on something you didn’t understand.

Networking into the sale usually means that you reach out to friends/acquaintances, or the friends/acquaintances via direct introduction (email or face to face). Just don’t spam the universe on LinkedIn, everyone hates that and it won’t help you as much as a targeted approach on people who can get references on how smart you are, how good your company is, etc. Those references and network information will help overcome the barrier to buy your future customers face.

The barrier to buy is the cost that a customer incurs to do business with you. That isn’t just money that they pay you, but the value of their time, risk to their current business operations, etc. To make a sale, you have to convince someone that the total cost of doing business with you (time, risk, money) is far less than the benefit they will get from using your product. Since most of those factors are not money (easy to often assess by pricing) your future customer will estimate time and risk costs based upon how well you present yourself, how highly your network speaks of you in reference (your reputation) and the apparent ease of doing business with you from their own assessment.
You lower the perceived risk of these factors by responding to emails quickly, dressing appropriately for any face to face meetings, showing good manners (yes, in every classical sense of this), and not interrupting potential clients/customers.

Ok, so lets go to step two, after you’ve networked into the prospective customer, how should you introduce your company? Here are some basic rules:

1. Don’t push a product on the customer, ask them to talk about their problems first. It is sometimes easier to dig a pit and allow a boulder to fall into it, than move the boulder, since gravity is a lot stronger than even the most Popeye-esqe forearms. This means that the customer’s own emotions and desires should drive the conversation naturally into your solution, not the other way around.
2. At some point, you’ll see the opportunity to share how your company can solve the problem. When the customer need discussion opens that door, show how you solve the problem in 10 seconds or less. Brevity and simplicity gives you power. You don’t need to demonstrate every minute feature of your stuff, just put out there your solution in the simplest way, and be OK with a moment of silence after you say it. If the customer responds with curiosity, find out what specifically interests them in the solution, thus getting permission to delve into the part of what you do that they are interested in.
3. Make sure that your short explanation explains the consumer surplus they should expect from your innovation. It should be obvious how the product/service is going to be something they want.
4. Be honest that you just have minimum viable product at this time, and so you would appreciate getting feedback from them on how you can improve the product. It is important that they know you’re building the plane while flying it, so you can manage expectations. Good first customers will give you a lot of feedback and recognize it is in their interest to do so. If a company sees this as a burden, they’re not a good fit for your first sale.
5. Ask at what price they could say yes today (or the soonest their internal sales system permits). For customer number one, it is not about the revenue, it is about credibility and good feedback.
6. If they say no, then ask them why they aren’t interested, and follow up with additional questions so that you can understand how your product-market fit may not be right for this customer.
7. Before you leave, ask who they know that might be interested. Even when you’re getting turned down, they may know who will say yes. Even if they say yes, they may have a friend in the business who you can call next. Referrals are like gold.

And as a final note for some services where you generate a very massive consumer surplus, you may be able to get the customer to pay upfront for a product/service down the road. That is the holy grail, and should be pursued if you can get it, but don’t be greedy. This most often happens in industries where the customer is used to prepaying part or all of the price to get a service, but this isn’t always the case.

I once saw an innovative part manufacturer get a major industrial to pay them for the inventory cost of their first shipment so that they could go into production and deliver something that generated sufficient consumer surplus to cover the cost of capital above the cost of the part. Also, first customers may want to be investors, and the money they invest helps to not only lock them in as a customer but can also provide a potential exit for the sale of the company at a later date. Treat these first customers well!

What Every #Bitcoin Investor Should Learn From a Dictator Named “Awesome”

Bitcoin investors should learn a lesson from Awesome, a dictator who lost his life introducing the one of the world’s first fiat currencies

Bitcoin investors should learn a lesson from Awesome, a dictator who lost his life introducing the one of the world’s first fiat currencies.  A fiat currency is a form of money to exchange goods and services that has no intrinsic value.  For example, a gold coin is not a fiat currency, because it is made of gold, something that has value in, and of, itself.  Paper currency, like the US Dollar, is a fiat currency because the note has no intrinsic value.

Bitcoin has a lot in common with early fiat currencies, so let’s take a second to review fiat currency and take a quick history lesson from one of its early adopters.

First off, how does fiat currency get its value?  Fiat currency has value when:
1.  It has limited supply
2.  People believe it has value
3.  It can be easily transferred to facilitate economic transactions

Right now, Bitcoin meets all three of these standards. There is limited supply due to its unique block-chain encryption standards, people believe it has value from the increasing rate of exchange to the dollar, and it can be transferred easily to facilitate economic transactions using online Bitcoin wallets.  So how did fiat currencies get started and what can we learn from these early currencies about the future of Bitcoin?

In 1294 Gaykhatu (literally, “Awesome” in Mongolian) was the leader of one Hoard of Mongols ruling over what is now Iran, Iraq and Southwest Asia.  Taking his name a little too literally, Awesome decided that he needed fiat currency like that introduced by his distant cousin Kublai in China. 

Awesome was in the middle of a crippling drought in his territory, and after several years of expending all of the royal treasury building a seriously sweet palace (still unfinished, of course), he was broke. When he heard that Kublai was just printing his own money, he saw his path to riches and summoned the Ambassador from Kublai’s court, demanding to see the new paper currency.

So smitten with this idea, Awesome copied the idea and printed his own money.  He liked the notes printed by Kublai so much, he even copied the Chinese characters on them.  He demanded that everyone accept these new notes as currency.  However; Awesome had competing currencies.  He didn’t think about confiscating all the gold and silver currency in circulation and soon discovered that no one wanted his paper money (Kublai at was smart enough to make some of his Chao out of copper to help with the perception of value).

Awesome also launched his new currency during the worst cattle plague his realm had ever encountered, and printing new money at such a tumultuous economic event was just poor form.  Needless to say, no one thought Awesome was awesome.  Riots and violence broke out around his kingdom.

Topping it off, Awesome himself emptied out his treasury of the notes he printed for himself, buying lavish materials for his palace from merchants foolish enough to accept his worthless piles of paper.  Awesome was bankrupt, his markets frozen from the lack of a credible medium of exchange.

In the end, he was pelted with all manner of foul, medieval produce without refrigeration, and openly mocked over the irony of his increasingly worthless name.  His cousin was so angry, he didn’t stop there, he killed Awesome by strangulation with a bowstring and took over his kingdom. Yeah, that ended badly.

So, what does this have to do with Bitcoin?  Bitcoin has value only from the drug dealers, money launderers, illegitimate governments, and black market moguls who see Bitcoin as a valuable exchange to conceal their dirty doings. Like Awesome, these neer-do-wells created a virtual currency that can’t be traced to support their palace building.

And like Awesome, this party will crash back down to earth.  There are two primary structural problems to Bitcoin that will undermine its ability to satisfy all three standards for a fiat currency.

First, quantum computing stands to make any encryption 100% worthless in the next ten years.  We are rapidly approaching a future where there will be no secrets stored on computers, because no computer can encrypt itself sufficiently to prevent a quantum computer from hacking any and all methods designed to protect it, end of story.  This means that the encryption protecting Bitcoin itself, Bitcoin wallets, and any and all servers that are used to process and secure its ownership rights, will all be broken and worthless.  This destroys the fundamental premise of value, to say the least.  Goodbye limited supply!

Second, governments can block people from using Bitcoin as a measure of exchange.  Why would they do this?  Because Iran, North Korea, drug cartels, tax evaders, and money launderers are using Bitcoin to evade sanctions, bank laws, taxes, and pretty much violate every lawful economic law on the books.  They are already starting to do so, in China and South Korea, and the impact of this on Bitcoin value is just beginning.

At the end of Bitcoin, no governments will allow an asset class that has a primary purpose to undermine the faith of their regulated, lawful financial system and allow untraceable and untaxable exchanges of value between two parties.  In short, all these ICOs are a threat to the established global financial system, so the governments who created this system will not permit Bitcoin to stand.  You can’t fight city hall, let alone every major world government.

When these governments begin to go to war against crypto-currencies in earnest, belief that Bitcoin has value will plummet, the ability to use it to exchange goods and services will evaporate, and its demise will be the latest chapter in fiat currency collapse.  When this happens, I hope the Winklevoss twins have good security.  I’d hate to see them go the way of Awesome.

Joe Merrill is an Austin-Texas based venture capitalist at Sputnik ATX and Linden Ventures. Follow his blog at or on Twitter @Austin_VC

Tax Facts – What Government Doesn’t Want You to Know

Warning: this blog post is about taxes. Taxes are an inherently boring topic, but useful if you want to understand something that will seriously impact your life. So, please read on if you want to learn the economics of what takes 40%-50% of your income. Otherwise, stop here and remain blissfully unaware.

There is a lot in the press these days complaining about the tax cut package passed by congress and signed by the President. Almost universally, the comments in the mainstream media have an agenda that appears to be almost perfectly tailored for the echo chamber created on each side of the aisle for the major news outlets’ political sponsors. However, a careful scrutiny of the history of US tax law (and tax rates) paints a very different picture of how these tax cuts will impact the United States insofar as its impact on the tax base and the demand-side of the economy.

While US tax law goes back to the very founding of the Republic and the tariff system created by Congress to fund it, personal income tax is a relatively new idea.  Although there was a brief period from 1861 to 1872 where a personal income tax existed to help pay for the civil war,  it wasn’t until the 16th Amendment was passed in 1913 that the government actually got the right to tax our incomes for the first time.

From 1913 until 1931 at the start of the great depression, the federal tax rate hovered at around 1.1% for the poorest families and while progressive (meaning wealthier families paid more than this), it was not punitive for rich people either, with 7% as the top bracket for people earning over $12mm a year in today’s dollars (adjusted for inflation).

However, from 1932 to 1941, Hoover and FDR had tax policies that, by any survey of the most liberal-minded economists, had disastrous results on the economy.  Tax revenue in 1931 was 834mm USD.  In June of 1932, Hoover decided that the worsening economy required government to start collecting more taxes to balance the budget.  Hoover almost tripled the top rate from 25% to 63%, and the low rate increased from 1.1% to 4%.

The amazing result was that tax revenue fell from $834mm to $427mm in 1932.  Why?  Well, when you take money from people’s pockets, they have less to spend.  Less spending results in less profits, and lower corporate tax collections (if companies are losing money, they don’t have profits to tax).  This fell further by 1933, with a mere $353mm in taxes collected as the economy continued to shrink and the government took more and more of the pie for itself (a concept economists call crowding out).  FDR raised them up to 76% when he took office (he raised the top rates to 76% by 1936) and unemployment spiked to 20%.  By 1937, FDR realized that his efforts to spend money to lower unemployment were only partially successful.  Unemployment was down to 15% but the government was spending huge amounts of money and creating large debts in the process.  

So why did this happen?  This has to do with the impact of taxes on the overall economy and the velocity of money. Since the government can only tax profits on money in circulation, the speed with which money moves around between firms in an economy have a major impact on taxes.  For example, if our economy only had four companies, and each company has $100 a year in profit on $200 in sales, then the economy would have $800 in sales, and $400 in profit to share. However, if the government taxes 50% of that profit, there is $200 less money for the companies to share with the economy, and the economy will shrink.  Now, think about how many times a single dollar is exchanged in a year between consumers and companies, and how each time the dollar is exchanged it creates a taxable event. More exchanges equals more taxes.

So if the government raises taxes very high, they reduce the number of taxable exchanges by the amount they took in taxes multiplied by the number of times those dollars would have been spent in a transaction. In short, the government is taking money so that it can’t be spent and then taxed.  While I’m not calling for the abolition of taxes so that we’ll have economic stimulus, it is a good idea to understand that when taxes go up, the economy goes down by a multiple of that tax collected.

However, at the time of these tax increases during the great depression, some Keynesian economists (those who believe that government expenditure is key to stimulating the economy) were shocked because these New Deal tax increases were increasing unemployment and New Deal spending wasn’t improving the economy to compensate.

Government spending was just helping us to limp along while incurring huge debts in the process since demand for government program spending far outstripped taxes collected.  Governments are like us, if they borrow a lot of money today, they will need more income in the future to pay off the debt and maintain their standard of living.  Sadly for us, when governments need to increase their income, they must raise taxes (taxes are the only way they get money legitimately).  So FDR decided to raise taxes again and again.  By 1940, the upper rate for wage earners was 94% for upper income earners, and 23% for anyone earning more than $500 a year.  Needless to say, the economy was so bad by this point, it took World War II to force dramatic changes in production and labor and end the depression.  At the end of WWII, Truman decided to start cutting government spending and lower taxes beginning in 1945.  Economists complained at the time that Truman was going to guarantee another depression, after all government spending is what they believed saved them from the depression getting worse, right?  Actually, Truman’s decision restored accountability in the economy and the nation grew to full employment in very short order.  Needless to say, the corporate tax rate was dropped from 90% to 38%, providing companies plenty of additional cash to grow and hire new workers.  In a recent survey, 2/3 of all economists agree that FDRs policies made the great depression worse and enabled it to stick around for a long time.

What does that mean for us today? Well, during the Obama administration taxes went up, and so did regulation (a quiet form of taxation because it raises the cost of doing business). So despite the Federal Reserve pumping unprecidented amounts of money into the economy through quantitative easing, the velocity of money (over 10 before Obama was elected) fell to just over 5 when he left office.

So, if we are to fix this, we need to have policies that would lower taxes and lower regulation to a sensible level. Both would be good ideas, if your goal is to grow the US economy. So when I hear people opposed to both of these, regardless of their intentions, we need to recognize that they are advocating policies that hurt the financial future of America’s families.

That is why it is all the more important to have sensible people in government who can not only enact policies that help working class families, but are able to explain these policies in a way that unites the American people behind them. Alas, that last part is what both parties appear to be lacking these days: leadership.


Note: some nut job out there may construe (how, I don’t know) this article as some sort of tax advice and then think about suing me. I’m not a tax adviser, this is not tax advice, so don’t make any tax decisions from my article.  And yes, this is proof positive that attorney’s can ruin our lives.

Free Money to Go International

International expansion seems spooky and very expensive for a start-up or small business.

It doesn’t have to be.

Don’t get me wrong, if you’re a start-up you should totally focus on the low-hanging fruit at home before you look abroad. However, if you have good traction and are ready to add some sizzle to your B round, a good international growth channel can dramatically expand the size of your addressable market and be easier to execute than you think.

You just need to know what FCS means.

FCS is the Foreign Commercial Service at the US Department of Commerce. Yep, you heard right, the government can help you. While this may be a shock to some people, the US government helps companies grow overseas, and even more shocking to libertarians: they really know what they’re doing.

The FCS has offices all over the world, and in major US cities, like Austin, taco metropole of the universe. These offices maintain commercial networks and cultivate business ties in the communities where they work. They permit US companies to access these networks, and they even screen and set up appointments for you in the countries where you’re looking to expand.

I’m getting ahead of myself and am clearly over excited about this, so let’s start from the beginning: how can you grow internationally?

First off, the world is quite large (I’m sure you noticed) so you can’t roam around willy-nilly and expect to find customers. You need to do a market study. This means that you survey the global market for demand for your product/services and identify areas where your product/service has the largest demand. You then overlap this with places that are import friendly to the US. Add a dash of channel research to identify the leading companies and paths to the customer in that market, and you should be able to analyze and identify the most promising place for you to export your good stuff.

So how do you do all that research? You don’t! The FCS will do this for you, and it is cheap (like a couple hundred bucks cheap). If you were to hire a consultant to do this for you there are two problems:
1. The consultant will be crazy more expensive, like tens of thousands of dollars
2. The consultant will give you bad advice, because no consultant has the breadth, information and experience of the entire US government at their disposal.

Think of it this way, do you want your intel from the government who also runs the CIA, or Barney the sales blogger who you found on the internet? Yep, no contest there. Get the FCS do to this for you.

Now that you have the research and have identified the most promising market, how do you find partners and expertise to enter the market? If you guessed, “ask the FCS”, then you have a cunning grasp for the obvious, and you may have just read about that when I got over excited earlier.

The FCS will, for a modest fee of a couple hundred bucks (see a pricing trend here?), contact companies in the international markets that you’re targeting and pitch them your company and then screen and identify those who are interested in working with you. Best of all, they have a staff of people in the local economy who speak the language and know the culture. No one will be accidentally offending the prospective partner’s family for five generations because they blew their nose at the wrong time.

Next up, setting up appointments to visit them either directly or online. You guessed it, FCS will do this for you also, for the couple hundred bucks we’re just going to mention again so you remember how this works.

Help you get a visa to travel there, yep, FCS will direct you to resources to help with that.

Add you to the local FCS trade show booth to promote your company and make more international connections?  OH YEAH! They do that too.

Give you thousands of dollars in grants to pay for the FCS fees, your travel to the international market, cover the cost of translations, etc, (and yes, this may seem like a bridge too far) but… HECK YEAH, they have block grants for this also.  Free money!

In short, the FCS will pay your company to use their services and even pay for your sales team to go visit and set up your first international sale.

I don’t know any consultant who will do that for anyone. The FCS will educate you on how to export, provide data on where to do it best, set up connections for you in the market, and pay you the money you need to do it (if you get the grant). This is the biggest sales no-brainier ever.

So, why are you still reading this blog post? Go out and contact your local FCS office and get busy exporting!

Yes, I’d like $100,000, but What the Heck is a SAFE Note?

The SAFE note allows Sputnik ATX to invest in your company today, at a price that will be determined in the future.

There are two problems with early stage investing: how much is a company worth when truthfully, it is still worthless; and how can early stage companies protect themselves from over dilution when they are, effectively, worthless.  Two sides of the same intractable coin.

To solve this, VCs and entrepreneurs need a quick and easy way to provide seed funding, without a long, drawn out negotiation, onerous debt covenants, or a crazy valuation that could hurt the investor and/or the entrepreneur. YC came up with a novel way to do this in 2013 called the SAFE note.

When Sputnik ATX funds a company in our program, we give them $100,000 through a SAFE note.  This begs the questions, what is a SAFE note, and why use it?

This article answers these two main questions, and summarizes a few of the terms of the Sputnik ATX SAFE note.

First, what is a SAFE Note?

A SAFE note is a Simple Agreement for Future Equity. This note provides that should we give you funding in the accelerator program, you agree to provide us equity in the future at terms outlined in the note. Think of it this way: Billy sees his friend Mitch enjoying a Popsicle by the ice cream truck but has no money. Mitch offers to give him the money for his ice cream today if he’ll pay him back tomorrow with ice cream of slightly greater value, hopefully Amy’s Ice Cream because that is just the kind of cool person you are.

That is how the SAFE note works, we give you money today, and you give us shares in your company tomorrow, preferably a good deal for both of us because you’re growing fast.

The SAFE notes gives us the right to trade the note for equity (shares in your company) when you raise additional funds in the future in a qualified round of funding that is priced by the future investor.

SAFE notes have some preferred qualities to convertible debt notes. Unlike debt, the SAFE note does not come with onerous restrictions and covenants that risk insolvency, induce regulations, force interest payments, complicate subordination agreements, etc. It sits on your balance sheet as a form of equity. Think of it as happy equity as opposed to angry debt.  Ben and Jerry’s, not frozen ice milk in one gallon plastic tubs.

The SAFE note allows Sputnik ATX to invest in your company today, at a price that will be determined in the future, that you can influence in your favor by channeling your inner worker bee and making honey. No need to haggle over valuation with us now, just get funded and get to work. The note will convert in the future when you raise more serious funding and the value of your company is better understood and defined by you and your future investor.

Why use a SAFE note?

SAFE notes have great economic value to both investors and start-ups. For investors, SAFE notes mean that we don’t have to negotiate valuation with all the companies we’re looking to bring into the accelerator. That is a time killer for both the companies and investors, and the resulting valuation is never better than a poor guess regardless of effort. We punt this decision down the road and agree to just convert the note when that value is clearer, and the investment large enough to justify more precise pricing.

SAFE notes also permit companies to clean up their early-stage cap tables without fear of triggering convertible debt covenants that might prevent them from making needed changes. A cap table (for all you cool rookies out there) is a list of everyone who owns shares in your company, as well as the type of shares, value of those shares, and rights of those shareholders; along with the same information for all debts and debt holders.

We don’t like convertible debt for many reasons: it can lead to sub-optimal decisions to avoid covenant defaults, but also can skew debt ratios for some companies that would benefit from SBA loans in the future. SBA loans are a great way to access cheap funding, so forcing early stage companies to take debt seems like a bad idea for equity holders that would benefit from this.

The Sputnik ATX SAFE Note has a couple of key provisions you should understand. Note: there are more, but these are just the ones we get asked about the most.

  1. The note converts at a 30% discount.  This means that for the $100,000 Sputnik ATX provides you, it will convert in your next round of priced funding as if I gave you $130,000.  That is so that we can capture a small fraction of the value we created before your next funding round.  Given the fact that most early stage companies increase value between 100% and 200% between rounds, we think this is a good deal for the entrepreneur. We’re getting you Ben and Jerry’s today, so make sure to give us some more tomorrow.
  2. The note converts at a maximum valuation (cap) of $4.5mm.  This is to protect us from getting diluted in a scam round with your cousin Vinnie where he invests a small amount of money at some crazy high valuation, just so you can cram us down.  This is, obviously, not cool. Of course, you would never do such a thing to your VCs, so I assume the cap will not bother you.

The real implications of these two provisions are that they only work if you can grow your company value faster than our discount rate (hooray for everyone) and if you’re company isn’t already worth more than $4.5mm when you start the accelerator program.

The hard truth is that many people won’t apply to the accelerator because of this second point.  They think their idea is worth a whole lot more, so we don’t see them.  That is awesome for us, because funding entrepreneurs who have over-inflated valuation bias leads to failed companies (losses) down the road, and we’d like to avoid that kind of investment also.

In this way, our SAFE note is poka-yoke designed to help us screen for entrepreneurs who are in the Sputnik ATX sweet spot: MVP and at least one customer.  These are the makers who are ready to grow, and we are here to help make that happen.

We wouldn’t have it any other way!

Public Goods: What a US #Startup can Learn From #China Sidewalks of Death

The greatest threat to modern China comes not from foreign invasion, but in the form of bicycles, millions of bicycles.

Chairman Xi Jinping take notice, the greatest threat to China is not from America, it is from the bazillion bicycles you’ve permitted to infest your sidewalks. Bicycles now cover pretty much every vacant piece of concrete and asphalt from Beijing to Urumqi. What am I talking about? The billion or so bike share start-ups that are now brilliantly exploiting what every entrepreneur should know about: public goods.

Look around anywhere in China lately and you’ll quickly see scads of bike-share bikes everywhere.  There are ten or so leading companies, each with its own distinctive paint scheme and bike design.  These bike services allow anyone to make either a large, one-time upfront payment (say $500 for life-time usage rights) or to make monthly subscription payments, like $20 a month, for unlimited use of that companies bikes. After subscribing or becoming a member, the user can take any bike from that company that they find, from any location, and ride it to wherever they want, then just leave it there. It is bikes on demand.

The bikes automatically lock themselves, and can be opened by taking a picture of the bike’s individual ID tag using the bike sharing application on their phone.  To make the service convenient, the bikes are ubiquitous and deposited along almost every street, all over town.  Their presence on sidewalks, now impassable, and other areas around the city have become a blight and a danger (tell me about it, I had to jog in the street sometimes to avoid both stationary and moving bikes that formed a dynamic death maze on the sidewalk).

However sketchy to pedestrians, this business model is proving to be very popular in the smog and traffic-choked cities of the middle kingdom.  In cities where parking is very hard to find and the sheer number of cars causes massive disruption akin to the plagues of Egypt, bike sharing solves an important human need for cheap and reliable local transportation. And in that success lies a powerful lesson for the eagle-eyed entrepreneur: leverage public goods to get a free lunch.

Public goods are things that we commonly share, like roads, sidewalks and schools.  They are typically free to use for the public. A free asset to leverage is more than just nice for start-ups that can utilize these public goods rather than invest in the same resource for themselves, often at very great expense. In the case of China’s bike menace, the public good is the sidewalks all around town where their bikes can be parked. If the bike start-ups had to build their own bike parking lots across the entire city, the whole venture would be too cost prohibitive. By leveraging a public good, they dramatically lower their cost structure and have a viable path to market.

Other start-ups can learn from this model. For example, if you’re starting a night school for adult learners, why build a school building and invest a lot in capital expenditure when you could just lease unused classrooms at night from your local school district?  Using that public good is a lot cheaper for you to get started, even if you have to pay a nominal fee for it.

Another good example of this is the interstate highway system.  This public good is a boon to car manufacturers and transportation companies that don’t have to bear the full cost of their complimentary asset. So if you can find a novel way to use public goods to solve a social problem, you could be on to the next big thing.

Start-ups that have innovative ways to discover and use public goods save capital that can be redeployed into more productive, value-creating work.

Just please remember, don’t block the sidewalks. Runners need space too.

The Economics of #Fundraising – TNSTAAFL

Raising money?  Read this first.

Dilution, overvaluation, free money, TNSTAAFL, and how to deal with VCs like a pro.

First time founders are typically the most likely to object to dilution when fundraising. They tend to overvalue their companies early, thus creating problems for fundraising later. They do this to avoid dilution, which on the surface seems like a good idea, but can prove deadly to your start up when you get to the A round.

Dilution Is Your Friend

The adage, you can have 100% of nothing, or 50% of something is very true here. Keep in mind that while each round of funding does lower your overall stake in the business, it should increase the value of the company such that the increased pro rata value of your stake grows with each round of funding. This means that an increase in overall value should normally offset the loss of additional equity paid out. So take a deep breath, and, look at the overall economics of the deal.

When properly executed in a funding transaction, dilution should increase the dollar value of founder holdings even though your overall share of the company is less.

Overvaluation Can Kill

When you first get started, figuring out how to value your company is really, really hard. Discounted cash flow models and complex valuations (e.g. monte carlo forecast simulations) are utterly, utterly useless. The fact is, your start up is worth only the value of your future work, and since no one can tell the future, you might as well stop trying.

Despite this stark truth, many entrepreneurs put high values on their companies when they first get started. As a general rule, any company that says they are worth more than $3mm from the get-go, is pretty much overvalued. Unless you have magic beans and geese that lay golden eggs, your day-zero company is not worth more than a couple million.

So, if you raise money from family and friends at a valuation of $4mm, you lose face when six months later a pro VC funds you at $3mm and you have to explain the dilution and write-down to the people you love.  Have fun with that.

How to Avoid Overvaluation

Fortunately, there are two cool methods to avoid the overvaluation trap: SAFE notes and convertible debt. Let’s start with the latter.

Convertible notes are simple debts, convertible into shares of the company at a future date. If you take early funding with a convertible note, your investor becomes your bond holder and doesn’t have to know what you’re worth today. Since the note is convertible, it will become equity in the future and typically does so at a discount due to the increased risk the investor took when giving you the note. In this way you don’t have to worry about valuation until the professional money comes in, and they expect this kind of note will be on your balance sheet already.

The SAFE note was developed by Y Combinator to avoid putting debt on a new company, or to even permit funding an idea before it becomes a company. It works like a synthetic convertible note, except it is just a promise to pay equity in the future for the same discount to the valuation for funds given to develop the idea or company. It isn’t debt, just a promise to provide shares like convertible debt in the future.

Given these options, it is far better to use them for early pre-seed funding than run the risk of over valuation or over dilution.

When to Avoid Dilution – TNSTAAFL

If you need funding, then you’re going to get diluted. TNSTAAFL is economist jargon for, “there’s no such thing as a free lunch”, which definitely holds true here. However, there are some alternative funding sources you can still tap, albeit not free, but typically superior to dilution if you can pull one of them off:

  • Get your customers to prepay for services. You can do this by being honest with them about needing development money and how they can get a deal if they provide it: maybe giving them the finished service for free for a period of similar value. This not only helps you avoid dilution, but can also get you test-beds for product, as well as your first customers. This is often done on Kickstarter also, where you can get money in exchange for product betas. Just don’t become the Coolest Cooler, ever.
  • Look for grant money. This is rare, but most commonly found when your idea benefits the US military in some way. They give out a ton of grant money to develop start-up companies that solve their problems. And they have a lot of problems outside of how to more efficiently kill the enemy, like how to provide emergency relief services, quickly and safely refuel aircraft, feed a million people, etc.
  • SBA loan. The US government may actually give you a loan to start your company. Depending on the type of company you found and your creditworthiness, this may range from a small amount to some pretty large loans. It is worth looking into.  Check out their website to learn more.

However, the easiest way to avoid dilution is by learning to be what I call “ramen lean”. This means that you live so frugally, you basically can’t afford to eat more than ramen (not suggested by any doctor or myself, but it is a good metaphor here). If a start-up can reduce expenditure, every dollar they save is dollar of dilution avoided.

How to Manage Abusive VC Sharks

Sometimes, a VC will pressure you to do a deal that stinks, destroys the economics of your company, and/or is just too greedy. If you find yourself in front of a tough-talking VC who asks for more than her/his fair share, then you need to walk. Don’t talk yourself into a bad deal. Money is commodity, find the right flavor for you. Just be sure when you do walk that the greedy person isn’t you.

Walking away from a deal when you don’t feel good about it, is the best thing you can do when someone is ripping you off. Trust your instincts. It is empowering to turn your back on an offer and walk away. Sometimes, albeit rarely, the VC will come back with better terms, but be careful here too. People tend to be on their best behavior when dating, and you don’t see their true colors until after you marry. So if you see red flags while dating a VC, just move on to the next funding source and don’t waste time.

You can’t manage an abusive VC, but you can leave the room.

This can be avoided if you’re willing to do diligence on funding sources before you approach them. For example, email or talk to the companies in a VC’s portfolio and find out about how the VC is as investors. Did they do what they said they would do? Find out if they even are looking for investments in your sector. Focus on finding good-neighbor funding sources that add value by helping your company to grow in verticals where the angel/VC has both capital and subject expertise.

The 18 Month Rule

Regardless of the amount raised, it is almost a joke among VCs that your funding will last no more than 18 months. As well as you can plan how each penny will be spent, the best laid plans tend to meet reality. Things will be good for 10-12 months, then you’ll realize you’re burning money too fast and the next round is taking too long to raise. So, you’ll start to economize, pinching pennies and perhaps laying off the least productive workers so that you can keep your company alive. This is due to how humans manage according to expectations.

Now that you know this behavioral bias going into a funding round, you need to be cognitive of this bias, adapt your expectations accordingly, and then consciously manage your money more frugally over the full term of the funding round. For example, don’t wait until your funding is almost gone before making hard HR decisions. Let employees go sooner rather than later if they don’t contribute sufficiently or are a bad cultural fit. The best time to act miserly, is as soon as you get funded. Doing so leaves some of your powder dry for when you’ll need additional marketing dollars a year down the road, and would love to have them while fundraising. You’ll have a better product in the future, and will wish you had more money to market that when you’re fundraising and need to show traction. Don’t blow it all now.

Overall, don’t let fundraising intimidate you and be sensible about your choices with equity. A good VC partner like Sputnik ATX (honk, honk) will help you fundraise also. Now, go find that awesome angel or VC, and get started with your plans to change the world.