Joe Merrill

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 http://www.econtrepreneur.com 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.

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.
The note converts at a maximum valuation (cap) of $3mm. 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.
We have an option to invest an additional $250,000 under the SAFE note as long as we do so while you are still in the program. We discovered this was useful when a company in our first cohort, Pei Technology, was growing so fast they needed additional capital at reasonable terms. So if you do the same, we have your back.

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 $3mm when you start the accelerator program, or you’re not willing to do a down round when you apply. Note: we’ve had a few companies enter the program as a down round and they still left happy. We add a lot more value than the SAFE note reflects.

The hard truth is that many people won’t apply to the accelerator because of the 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!

(Note: this article was updated to reflect new terms of the SAFE note for the Summer 2019 cohort)

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.

How to Engage #VCs – A Primer for #Entrepreneurs

I’m very surprised at how many founders think that we’re jerks when they, in fact, are acting like wild animals.

Successful entrepreneurs know how to engage VCs. We’re not some elusive species. We’re human just like everyone else, and yet I’m very surprised at how many founders think that we’re jerks when they, in fact, are acting like wild animals. This primer is designed to help entrepreneurs understand VCs a little better in the hopes that we can have more meaningful interactions and avoid some of the blunders that cost entrepreneurs a funding opportunity. Quite frankly, these aren’t just things that drive VCs nuts, they are basic rules for being a good person.

Don’t talk to VC’s when you’re drunk. OK, this seems obvious; however, you’d be surprised how many times drunk founders approach VCs at mixers. For some reason, there is a lot of booze at start-up and VC events that some people enjoy just a little too much. I’m not sure who thought it was a good idea to mix these two things, but I strongly suggest you avoid the bar if you want to impress anyone. I once had a drunk guy come up to me at SWSW and declare, “so you’re one of those {expletive] VCs I’m supposed to be networking with so I can get my company funded, so lets talk.” Needless to say, I moved on.
If you want funding, ask for my advice, don’t ask me for money. It is surprising how often people lead with the money question, and that is just poor manners not to mention bad communication strategy. If you want me to be interested in what you’re doing, ask me for my advice and let’s both find out if I can help you. Look for smart money that will be able to assist your company to grow, and if I see you doing that, I’m more likely to be interested in you also.
If I don’t answer the phone, don’t keep calling over and over (same for texting). Seems like a simple thing, right? And yet, on one deal we were pretty much ready to sign one day when the founder kept calling and calling until my partner and I were just begging for him to stop. He was pestering us to sign the funding agreement, and we were very preoccupied with a credit facility emergency with a different portfolio company that had to be addressed. Our investment in the other company was very significantly greater, and had to be the higher priority. We realized after many back-to-back calls from him that he didn’t respect our time, that things would only get worse if we did the deal and so we decided to walk away from the deal. If founders are jerky up front, things usually don’t get better after we give them money. So just show some good phone manners and respect my time in the same way you would expect.
Don’t monopolize the conversation. Another no-brainer, but one that is repeatedly violated, most often at events where a VC is in conversation with a group of founders from different companies. Typically, we will try to get to know everyone by asking questions to each person about their company and what they’re doing to change the world. Invariably, one or two people in the group think that this is a competition to see who can one-up, interrupt and dominate the conversation. Instead, introduce what you do and ask others the same. VCs will notice that you prefer to learn than lecture, a good attribute in a founder.
Get value from the “no”. If I turn you down, don’t be a jerk. It is OK to ask why I’m not interested, and even to ask if I know a VC that might be interested, but it is not cool to just roast me. VCs say no 95% of the time or more. It is just a simple matter of supply and demand, nothing personal. However; I’m impressed when someone is thoughtful enough to thank me for my time and consideration, then asks if I can share feedback or suggest another VC that might be interested in the investment. That is smart. If I take the time to listen to fully evaluate your company, I started with the idea that this might work. If it doesn’t end that way, ask me why. I may not always feel like I can share, indeed there may be a confidential reason I can not provide, but it doesn’t hurt to ask me why. If you do, you may get valuable feedback to improve your business model or help you realize how your company is perceived. Furthermore, asking if I know anyone who might be interested in your company may result in a referral to a good funding source. So please resist the urge to assume we’re jerks for not giving you money, and get some value from the “no”.
Avoid superlatives, balderdash and hyperbole. Wild claims and broad statements are usually a sign that the entrepreneur is either overconfident, foolish or dishonest . I went to a pitch once where the founder stated that they were the first company to do something when I knew, for a fact, they were not. I knew because I founded a company based upon that same business plan almost ten years before, and sold it to a strategic seven years later. There were, in fact, a lot of competitors, and by stating they were the first, the best, etc., they just showed that they were ignorant of the real market and totally unprepared for funding. Please know the limits of your technology as well as your competitive marketplace, and be prepared to discuss them with honesty and integrity, avoiding the breathless reporting of meaningless, management jargon.
Don’t turn the one minute elevator pitch into five minutes. If a VC gives you a time limit for your pitch, please observe it strictly, unless the VC invites you to go into overtime. This happens a lot on pitch days when companies exceed their allotted time. Look, I know you have a lot to say, but the ability to concisely deliver a compelling message is one of the best indicators that a founder will be successful. Doing so shows that you know how to sell, and respect the time of the person you’re talking to. If you don’t respect other’s time, it also speaks to a lack of empathy and possibly integrity.
Don’t bring up valuation unless I ask first. I previously stated that you shouldn’t lead with money, but let’s be frank: don’t bring it up unless asked first. Talking about your company valuation is kind of like bragging about how much you paid for your pants. No one wants to hear about it, unless they intend to buy some for themselves. So, don’t waste valuable time talking price, until you’ve sold me on the value of the pants themselves. Once I’m convinced that you have a company worth exploring further, I’ll ask and you’ll know that I’m really interested. That is a good signal for entrepreneurs that my interest is piqued, so make the most of it.
Don’t trash talk other VCs or angel investors. Investing is a team sport. Funds don’t go it alone, and we prefer cooperation more than most industries because it reduces risk and improves returns for everyone. We know that it is in the interest of all to get as many smart people as we prudently can to advise and help a portfolio company. VCs invest in teams, with each round of funding bringing in other VC firms who have value and experience that is relevant to the asset. That means that most VCs are frequently friends and serial business partners. I respect them a lot, and value them highly. If you think I’ll be impressed when you trash talk the last office that said “no” to you, well I’m not impressed. That kind of behavior shows that you may have trouble working with other people, and reading a market, both are very bad traits in founders that we seek to avoid.
Don’t show up at anything personal hoping to connect with me, like my kids athletic event, or heaven help you if you knock at my home. Nobody likes a stalker. I’m more likely to call the cops on you than even consider funding your company. Another no brainer, and yet I have more than one example where people tried to pitch to me while I was trying to watch my kids play sports at school. It is nice if you realize that your kids team and my kids team are in the same league, but please, let’s just enjoy the game. Use this time to show me that you can set appropriate boundaries and allow me to enjoy some precious time with my family. Don’t be a stalker.
Google me, find out what I’m interested in, and engage me in a conversation beyond your company. Some might find this creepy cyber-stalking, but I just consider it good recon. If you know the people you want to meet, you’re more likely to be able to build a foundation of trust. Find a genuine area of common interest and build upon it. I’m impressed with someone who tells me that they googled me and discovered an area of common interest and we can chat about that for a while. An important caveat: don’t try to fake it. Disingenuous interest is easily seen through if you only have a quick, Wikipedia education of something I’ve enjoyed my whole life.
Don’t go on and on about where you attended college. I don’t care if you went to Harvard, please show me what you can do. Your education is nice, but there are a lot of people who emphasize it too much, as if education is some kind of guarantee that they are smart. And let’s face it, Harvard is a nice school, a good fall back if you can’t get into the University of Chicago, but where you go to school is not as important as what you are doing with that education. Remember, a lot of smart people don’t go to top tier schools, and will work you under the table. Hungry, resourceful, hardworking brilliance is something VCs look for in founders. Think smart, gritty and determined, not educationally stunted by virtue of lofty expectations with little substance to back it up.
Smile. Yep, I said it. Smile. It is amazing how by just being happy, and feeling good, you subtly influence others to do the same. Smiling is free, and appreciated by all. Launching a start-up company is a full-contact, extreme sport. So, please show that you enjoy the challenge, and help your founding team to stay positive in the face of their challenges. Changing the world is hard but rewarding, so make sure you enjoy the ride.

The Multi-Trillion Dollar Opportunity

Want to be wealthier? Stop being a jerk-face to #women.

America has a multi-trillion dollar problem that just hit home for me. My daughter was sexually harassed by another student at school, and worse, the school didn’t protect her when they knew it was going on.

When examining why some economic agents like companies, churches and schools continue to protect sexual predators, I’ve come to realize that this problem is probably the single largest drag on the global economy (at least the largest I’ve ever seen) and that our legal system provides warped, perverse incentives that perpetuate this perversion. The cost to our society of this broken system is staggering. And yet society continues to look the other way to a situation that reminds me of the old story about the gardener and the rabbit. It goes something like this:

Once there was a gardener who woke up every morning to discover that a rabbit ate much of his crop the night before. He tried everything to get rid of it, but the clever rabbit eluded him night after night. Finally, in desperation, the gardener built a strong fence around his garden, even digging a portion underground, to keep the rabbit out. Supremely confident in his fine fence, he slept well that night, only to awake and discover that the rabbit ravaged his beautiful garden once again. He had fenced in the rabbit the day before.

Like the farmer, our tort laws regarding sexual harassment are fencing in the rabbit, and providing incentives to churches, schools and workplaces to protect harassers.

So, let’s look closer at the perverted incentives for schools, churches and companies (which I will call social agents). If a person commits sexual harassment, and if anyone at a social agent had any inkling that that person was a perv, then the social agent bears some liability for the perv’s actions since it was foreseeable that harassment would take place. However, social agents and individuals tend to want to see the best in people, so when perv’s do something pervy, we try to explain it as “we must have just misunderstood what he/she meant”. That is because we are nice.

Predators depend upon our kindness to do their dirty deeds. I’m not suggesting that we stop being nice, but I think how we respond to inappropriate behavior must change.

First, we need to speak up when boundaries are crossed and not care if we offend. If a man or woman in your office puts their hand on your back or shoulder, that is crossing the line. You don’t need to touch people to do most jobs, and should only do so when it is required as a part of your job description and, even then, minimize this as much as possible. There is no such thing as an OK sexual joke at the office (or at home for that matter). Grooming people by talking around the edges on mature subject matter is not subtle, it is blunt and we don’t like it. Stop doing it now. It’s time to grow up and start respecting people appropriately.

Second, in today’s Donald Trump school of management, tort laws provide cover to economic agents who pride themselves by saying that they are protecting innocent men from the wild accusations of an accuser when really, they are just protecting their bottom line. This encourages the victim blaming and cover-ups that we see in the news every freakin’ day. Current tort law “fences in the rabbit”, by providing companies legal incentives to align with predators to fight off harassment claims to avoid paying damages. Instead, we need to look at the REAL damages.

Social agents incorrectly assume that the biggest harassment cost they need to avoid is financial damage from lawsuits. This false belief encourages them to deny harassment claims and fend off harassment accusations with no thought to the emotional and personal cost to the victims. In fact, the far bigger expense is the economic loss of productivity and the broken lives of their employees, investors and customers due to their policies that fence in rabbits.

At the macroeconomic level, ranges of the GDP cost due to gender discrimination and harassment vary between 10% and 25%. Given that global GDP is around 78 trillion dollars, we’re talking about 8 to 20 trillion dollars in lost global income creation each year due to harassment and discrimination. In contrast, we fret about the billions of dollars we spend defending lawsuits from harassment. Our priorities are wrong.

Social agents only hedge these defensive costs with defensive expenditure: insurance coverage, harassment training for employees, lawsuit settlements and, if they’re super progressive, on-site counselors to help those affected by sexual harassment. However, I believe that the best defense is a good offense. Let’s do something to get the 20 trillion dollars, please.

I would like to call upon our elected officials to pass new tort laws to permit and encourage persons sexually harassed to work with social agents to pursue justice against sexual predators together. This can be done by permitting and encouraging churches, schools, and companies to sue their students and employees who harass, and recover damages commensurate with the social cost, the total social cost -not just the defensive expenses. It is time for pervs to pay up or smart up. In this way, social agents have an economic incentive to identify and root out sexual harassment because they will share the benefit of legal actions against those who harass. Harassers have an incentive to change their behavior, and the homes that foster future harassers have economic losses to incentivize them to change their ways.

What I hope you now understand is that sexual harassment is an economically expensive epidemic, and the emotional and psychological cost to our wives, daughters, and girlfriends is incalculably higher. So, let’s shift that expense to those who create it, and make it possible for our churches, schools and companies to recover damages from those who create the problems.

When groping results in the loss of your parents 401(k), maybe parents, clergy and managers will stop saying, “boys will be boys”, excusing Trumpian “locker room banter” and begin teaching proper respect for women. Furthermore, suing predators will become an effective way for social agents to capture the expenses they bear to treat harassment victims who often require special accommodation to cope with school and the PTSD or other problems harassment creates in their lives. Better yet, maybe my daughters will be able to live in a world where their contributions are valued by society and they can live without fear.

Furthermore, when we replace faux corporate hand-wringing and cringing with “ka-ching” whenever a crude joke is told in the office, and the offenders lose real money to their employers, people will stop telling crude jokes, putting inappropriate hands on backs, grooming victims and doing other macro-aggressions. No one is trying to stop appropriately asking out a coworker on a date, it just needs to be done the right way, don’t be a perv.

In short, it is time we make harassment the problem of the perpetrators, and enable our social institutions to go after them to the economic and emotional benefit of all. Enough is enough.

Is Your Start Up Idea Gold or Goop?

Is your business idea an undiscovered gem, or a flaming dumpster fire leading you to your doom. Here’s a quick rule to help.

A lot of entrepreneurs ask me to look at their business ideas since they know what I do for a living. Some are gold, some are meh, most are flaming dumpster fires. It stinks to tell people when their ideas are smoldering rubbish, so most VCs don’t and just politely decline or ignore bad business pitches. Although the full content of our upcoming accelerator/incubator, Sputnik ATX, is still in stealth mode, I’d like to share a quick rule you should apply to any business idea that you want to pursue. It is specific to answering the question: will anyone buy this? A question that is obviously important to everyone except the tunnel-visioned entrepreneur who doesn’t value his equity.

So, would be entrepreneurs, let’s take off our blinders and have an honest conversation about your product and service, and more specifically, the benefit it provides.

I’m hoping you already read my post about consumer surplus. If not, read this first. I’m going to use a lot of those terms here. Because if you’re going to get someone to buy your stuff, you had better generate a ton of consumer surplus first. Assuming that your idea and business plan can generate value (consumer surplus), you still may have a lot of trouble finding people who want to buy it because the switching cost still exceeds the marginal benefit. Say what?

Switching costs are what economists call any expense related to stopping the use of one product and service, and beginning to use another. Switching costs may include disposal fees for the old junk, training for new stuff, hardware upgrades, software patches, the time it takes to buy/train/learn the new item, and pretty much anything else associated with the new thing to consume or use. Sometimes these can be quite high.

For example, why do we all keep using Facebook when there are surely other social platforms out there? Because the switching cost includes getting all our friends to switch to the new platform (good luck with that) and also includes information loss when we miss out on posts from our friends still on Facebook or they miss out on ours since we now use some loser platform they’ve never heard of. That switching cost is sufficiently high enough that we don’t switch to Loserbook.

But what if switching has a lot of advantages? The advantages of switching are called the marginal benefit. This is the increase in value we get from switching to a different product or service. For example, if you stop eating at Chipotle and start eating at Qdoba, you get the marginal benefit of free guac at Qdoba (yes, you read that correctly). You also get the added option of queso at Qdoba, and hey, who doesn’t like queso! While this is a good place to add another marginal benefit, not playing the intestinal fortitude lottery at Chipotle, I’m going to restrain myself. Suffice to say that there are some serious marginal benefits of eating at Qdoba versus Chipotle.

Now, if you want to create a new company and provide a new service, you need to provide your consumers a product where the marginal benefits exceed the switching costs in a manner that is obvious and as big as possible. The larger the cap between benefit and cost here, will greatly influence how quickly people will make decisions to consume your new product/service.

One of the worst products to do this, of all time in my opinion, was the Apple Newton. I can pick on Apple, because they’ve made a lot of smart product launches where marginal benefit kicked the life out of the switching cost, but not on this one (thank you John Scully, I couldn’t have written this without you). Newton was a stinker. For those unfamiliar with it, Newton was a hand-held device that kept digital notes for you. That’s it. You wrote on it, it recognized the handwriting if you used its funky letter system and it converted your writing to digital text. It was also expensive. It cost $699 when launched back in 1993. That is roughly several gazillion dollars today (in Zimbabwe).

You don’t have to be a rocket scientist to know that $700 is a lot to pay for a notepad that only recognizes its own weird version of shorthand. The Newton made you pay an awful switching cost for something that you already had in a simpler, easy to use format and could buy for fifty cents at Walmart. So what happened? People kept buying notebooks that worked great, and the Newton died.

Remember how the Segway was going to revolutionize foot traffic? Yep, switching cost exceeding marginal benefit. There are more. Microsoft Bob? You betcha! Google Glass? Check! The idea graveyard is littered with expensive examples of how brilliant people created incredibly complex and expensive solutions to problems with little benefit beyond what the market currently provided.

Now, Steve Jobs returned to Apple (hurrah) and we got the iPad. It could still be used to jot stuff down, but it also pretty much ran the whole universe. The increased benefit of zillions of apps, made the switching cost paltry compared to the massive benefit provided and, viola! People buy them up the wazoo.

So, if you want to avoid betting your life savings, and that of your investors (me) on something that will never catch on, please do some product soul-searching to see if the benefit your start-up provides is sufficient to cover the cost to customers when they switch. Remember, marginal benefit must massively exceed the switching cost -iPad, not Newton. Of course, you still have to do a lot of other things right to succeed, but this is a biggie so get it right.

The Grim Economics of Death

40% of Medicare spending is in the last month of life. There is a better way.

Economics is called the dismal science because it is precisely the right tool to answer some of society’s most depressing problems. In today’s post, we’re going to look at the economics of dying, have an honest conversation about where we spend our health care dollars when addressing terminal illness, and look at the opportunity cost of end-of-life decisions. If you read far enough, you might just learn how you can change the world.

For starters, let’s address a few truths about health care spending at end-of-life.

First, and foremost, we are all going to die regardless of the quality of care we get. Death is a heartbreaking reality of life that cannot be avoided.

According to the Department of Health and Human Services, 40% of Medicare dollars are spent in the last month of life. Most of this spending is dedicated to curative therapies, in an attempt to “fix” the health problem that, ultimately, causes death. However, there is another option.

Palliative care, sometimes called hospice, means easing symptoms of illness as opposed to attempt to cure it. Palliative therapies typically provide people comfort rather than aggressive therapies when faced with end of life illness. There are, literally hundreds of studies that demonstrate that this kind of care not only improves the quality of life when facing terminal disease, but it actually extends the life of persons who receive when compared to those who receive aggressive therapies. Furthermore, palliative care costs about 50% less than curative therapies for end of life illnesses, according to just about every blind study of the subject that was conducted in the past 8-10 years. In short, Americans spend a massive amount of money when diagnosed with terminal illnesses in what will, ultimately, be a futile attempt to live longer, and often in more painful circumstances, because we choose expensive and aggressive curative therapies instead of palliative care.

Please, don’t get me wrong here. I’m not looking to unplug anyone’s loved one from the respirator. All I’m saying is that there comes a time in everyone’s life when out of heartbreak and desperation we make the choice to suffer more, cut our lives short, and leave our families buried in medical debt when there is a better option available to most of us -but it isn’t necessarily the obvious one.

Perhaps it is time that we consider our end of life choices more carefully. Do we really want to continue spending large sums of money so that we can have, on average, shorter, more miserable lives? Why don’t doctors inform us about the reality of these choices?

I think part of the problem is that we, as a society, tend to believe that the more aggressive the health care, the better are our chances for survival. Furthermore, hospitals profit more from providing aggressive care, and doctors are positively recognized for their ability to perform more of these aggressive procedures, and not necessarily measured by the quality of life of their patents. The perceived leaders of the health care system have public reputation and profit incentives to try and cure you, even if statistically that is not very likely to happen and your suffering actually increases.

For this reason, Freakonomics author Stephen Dubner has proposed that we change the incentives when terminal illness is diagnosed, suggesting that insurance companies offer these patients a financial offer: to split the difference between their curative therapy cost and palliative care, opting to pay them a share of monies saved so that they could take a final vacation with the family, or in some other way enjoy their last days with additional financial resources to spend as they see fit, rather then undergo expensive curative treatment that statistically will fail and cut their already precious life short. This would appear to be a good way to extend life, on average, and enjoy that life more before it is gone.

I would like to suggest another option, one that may not be for everyone facing a terminal diagnosis: rather than pursue curative therapies or split the difference with your insurer, why not do something extraordinary for society, something dangerous but effective for social good. For example, why not volunteer to drive an ambulance in Syria to rescue children and women injured in the fighting? Or, perhaps volunteer to do violence intervention and training on the south side of Chicago? Anyone care to volunteer to de-mine former conflict zones? You’ll likely save some lives and do tremendous good. These are certainly worthwhile pursuits, often not pursued by those who expect and desire to live for a long time. However, if you knew you had precious little time left, then what do you have to lose?

Risky and valuable behavior sometimes go hand in hand, and if humanitarian in nature, you can use what little time you have left to leave behind a world much better than you found it. You also leave behind a legacy of selfless service, right up to the end. It may sound crazy, but why not leave behind an amazing legacy of love, choosing to spend your final days saving those that the world forgets?

Of course, there is no judgement or easy answers here. Like most humanitarian questions, there is no clear calculus to make these decisions. However, with a better understanding of what really happens at the end of life, and better options for how we can spend those precious days, we can be better prepared to make the right choices for our families.