The New Financing Playbook for Blockchain Startups

When I first wrote Mastering the VC Game, Satoshi Nakamoto had just issued his seminal Bitcoin white paper. At the time, no one could have imagined the transformative impact the invention of Bitcoin and the blockchain would have on the venture capital industry.

With the invention of Ethereum and a Turing-complete platform that allowed for smart contracts, startups could suddenly raise money ahead of delivering products from a crowd of investors, not just a universe of a few hundred venture capitalists. Last summer, I wrote about the impact Initial Coin Offerings (ICOs) were having on the venture capital industry. This summer, I am amazed at how quickly the science of token-based fundraising has evolved and the hybrid of VC, crowdfunding and crypto token economics best practices that have emerged.

Last summer, one of my portfolio companies, Enigma, completed a $45 million ICO with only three employees and a (very well-written) white paper. Like many companies at the time, they had only raised a total of $1 million in a prior seed round and had yet to deliver any software to the market. At the time, they were not alone — startups raised more capital in ICOs than in venture capital rounds last summer. As of this writing, over $10 billion has been raised in ICOs since their invention in 2016. The money seemed to come so easily that aggressive entrepreneurs seized the moment.

Those days are gone. As William Mougayar correctly observes, “the only token that matters is the one being actually used.” The SEC has stepped in with some strong, cautious guidance and both professional and retail investors, although still enthusiastic about blockchain and crypto, are showing a bit more caution.

Today, a new playbook is emerging for startups who wish to follow best practices in fundraising in a post blockchain world. To understand the contrast to the pre-blockchain, you first have to understand what the best practices playbook looked like previously:

Financing Playbook, Pre-Blockchain

  • Seed round: $1–2m. Raise from a mix of smart, value-added angels or seed funds. Pre product-market fit. Build the team and deliver an MVP in order to run some experiments to test the customer value proposition. Run a few go to market experiments and perhaps a business model / pricing experiment. Hit some important value-creating milestones, such as early customer revenue or at least engagement.
  • Series A: $5–10m. Raise from a professional, series A firm. Complete the product, round out the team with some commercial executives (first salesperson, first marketer) and get to product-market fit. Begin developing a repeatable, scalable business model. Stand up a growth team.
  • Series B: $10–30m. Raise from a professional, series B / growth stage firm. Execute on your repeatable, scalable business model. Expand beyond the initial product to deliver multiple products in adjacent areas. Expand internationally. Build a senior executive team that includes a head of finance and a head of customer service / operations.
  • Series C: $30–60m. Raise from a professional, pre-IPO firm with a good, credible brand to assist in the IPO process. Work towards a profitable, scalable business model. Execute well across multiple products, multiple channels, multiple geographies. Complete some M&A to expand your product footprint. Build a strong, independent board and prepare for IPO.

In a post-blockchain world, the playbook has changed dramatically from the pre-blockchain world and also has evolved from the go-go days of last summer. Today, the market has become more discriminating, forcing companies to be more deliberate and professional. Here’s what the best practices playbook looks like now:

Financing Playbook, Post-Blockchain

  • Seed round. $1–2m. Raise from value-added angels and professional seed funds, particularly those with strong reputations and credibility in the crypto community. Include in the seed round terms a token conversion option, allowing equity holders to convert into tokens at their election (following a vesting schedule) if the company’s business model is more focused on token value creation (utility, security) than equity value creation (revenue model, cash flow). This option tends to be anchored on a pro rata ownership share of the equity. In other words, if an investor were to own 10% of the fully diluted shares, they would have an equity conversion option on 10% of the tokens that are held by the company in treasury post-ICO. Build the team and articulate a product roadmap in the form of a technical white paper. Focus on writing code and building out a testnet (i.e., public beta). Ideally, leverage existing platforms (e.g., Ethereum, Cardano, NEO) to minimize the amount of new code required. Link your vision to a secular trend in the space and enlist thought leaders to publicly endorse you on Twitter, Reddit, Medium and at conferences.
  • SAFT or SAFE-T or SAFTE. $3–6m with a pre-defined “launch valuation rate” (i.e., crypto valuation cap at which the dollars convert to tokens) as well as a discount. The labels the different lawyers might use are somewhat fungible, but this investment agreement is typically in the form of an option to purchase future tokens or equity with professional investors that are a mix of traditional VCs and crypto funds. This agreement looks very much like an offering document nowadays (due to recent SEC guidance), with many provisions that you might find in an IPO boilerplate, but is explicitly not a registered security but rather a carefully-worded agreement to purchase a non-registered investment security. Entrepreneurs attempt to raise enough from smart money (and ideally good brands to assist in the ICO) to go beyond the technical team and add a community executive and investor relations / business development. Issue the testnet and perhaps even release an initial component of code on the mainnet (aka the live blockchain) — not the entire product roadmap, but enough to get a community of developers something to play with and get excited about. Build out your community infrastructure (Telegram, Slack, Reddit, Twitter) and have your community manager recruit and engage with two types of members: developers (most important) and investors (secondary but still critical). Expand and publicly publish the multi-year product roadmap and vision. Prepare for ICO.
  • ICO. $20–200m. The range is wide, but most top-tier ICOs are aiming for a crypto market cap of $100–300 million which would place them in the range of 50–150 top tokens (as of this writing, #50 is trading over $300 million and #150 is trading at $70 million according to CoinMarketCap). Thus, if they are selling 50% of the tokens, they might be raising $50–100 million. At this stage, a decision needs to be made as to whether the project meets the Howey Test, and is thus aiming to be a utility token, or should be a registered security. More and more blockchain projects are leaning towards the full offering and registration requirements consistent with a security token offering (known as an STO) due to the SEC’s recent guidance. The team needs to be a more fully formed team — not quite as mature as the IPO team (e.g., no CFO required) but ready to handle developer recruitment and support, have a point of view on the business model, a full treasury and finance function (what will you do with all that money? how will you maintain security? what are your treasury policies? how much tax do we pay on the ICO proceeds and when is that tax due?) and a fledgling legal function to assist with compliance. And a real product needs to be delivered or very close to being delivered, where customers and developers can actually evaluate the quality of the code (it is all open source, after all).

These points of evolution are a good thing. They are causing startups to slow down, be more professional and responsible, and deliver real code that has some real utility — not just a well-written white paper and an active Twitter account. Some companies may skip the SAFT step and still go right from a seed round to an ICO (e.g., our portfolio company NEX is in the midst of doing that), but it takes a pretty special team to deliver a large enough number of milestones in that rapid a fashion. Most companies are going to take 2–4 years to be fully prepared to journey from inception to ICO/STO. Considering the median age of an IPO company over the last fifteen years is eleven (our company, MongoDB, just completed it in ten and it seemed breakneck!), this time compression is still an amazing development for the future of innovation.

Many open questions remain and there is much more work for entrepreneurs and investors alike to sort through. One of the trickiest, for example, is incentive compensation. We have had decades of experience with stock option grants to employees, complete with vesting schedules, acceleration provisions and various exercise price processes and mechanisms. What is the right incentive compensation structure for token-based startups? Is there going to be a vesting schedule and, if so, for how long? What are the tax implications? If the token is a registered security, how will the issuance of securities as employee compensation be handled?

It is an exciting time for both entrepreneurs and investors in the post blockchain world. I suspect that the next year will bring similarly rapid and unanticipated developments and evolution!

The Search for Product Market Fit

Each year, I join my friend Ed Zimmerman (lawyer, super angel, wine enthusiast and raconteur) at his annual Venture Crush First Growth conference (fka First Growth Venture Network) to talk about product-market fit with early-stage entrepreneurs.

Each year, I try to think anew about the topic, reflecting on some of the lessons and research related to my entrepreneurship class at Harvard Business School.

Below is this year’s version, complete with a new framework for thinking about the three kinds of experiments all pre product-market fit startups must undergo: Consumer Value Proposition experiments, Go To Market experiments and Business Model experiments.

Feedback welcome!

 

The Rocket Ship Startup List: 2018

New graduate? Jump on board one of these high flying companies

Graduating students hungry to dive into the startup community (aka StartUpLand) often struggle to select the right, specific opportunity to start their career.

Each spring, I provide a comprehensive list of exciting, growing, hiring startups–both private or recently public–that are worthy of consideration as places to start or continue a career in StartupLand. The criteria for being on the list is subjective but is a mix of fundraising (typically > $10m in the most recent round), scale (typically > 50 employees), momentum (typically growing revenue or users > 50%) and hiring (typically > 10 open reqs, including a number of entry-level positions that would be a fit for recent college or business school graduates).

Before we get into the companies themselves, I suggest checking out my posts Getting Your First Startup Job and Are You Suited For A StartUp? where I give some more detailed advice on how to select the right company for you and position yourself to secure a job.

Once you have reviewed this framework for deciding what you’re looking for, this post will give you a list of over 500 companies to research and approach.

As usual, the list is compiled and organized based on location since I believe in selecting a geography to plug in to (and contribute to) a community and ecosystem. I received fantastic input from angels, entrepreneurs, lawyers and VCs across the world, helping me pressure test and compile this list (note: Flybridge portfolio companies are in blue). I recognize that the list contains no companies from India or China. I hope to cover those geographies in the future but just didn’t feel I had good enough intelligence at this time. I’d also point folks to Stanford’s Andy Rachleff’s terrific list, which he publishes each fall with a similar theme (albeit more Silicon Valley focused).

I’m sure I made many mistakes and omissions, which are all my own. Feedback welcome!

East Coast

Boston 2018 list v3
NY 2018 list v2

West Coast

SF 2018 list v3

LA 2018 list v2

International

Other Startup Hubs

ATL: Bitpay, Ionic Security, Kabbage, MailChimp

CHI: AvantCredit, bloXroute, BucketFeet, Civis Analytics, Dough, Fooda, Groupon, Iris Mobile, Kapow, Narrative Sciences, Precognitive, Raise.com, ShopRunner, Shiftgig, SpotHero, SproutSocial, Tastyworks, Uptake

CO: FullContact, Ibotta, LogRhythm, Rally, SendGrid, Sympoz, TeamSnap, VictorOps, Webroot, Welltok

DC: 2U, Cvent, Optoro, Sonatype, Vox Media, WeddingWire

SEA: Apptio, Avalara, Avvo, Convoy, ExtraHop, Julep, Juno, Koru, OfferUp, Outreach, Peach, Porch, Pro, Redfin, Rover.com

UT: Bamboo HR, Canopy Tax, Domo, Health Catalyst, HireVue, InsideSales, Instructure, Lucid Software, Observe Point, Pluralsight, Qualtrics, Solution Reach, Workfront

That’s it! Special thanks to all those who provided me with anonymous input as well as my colleague, Caroline Constable, who did most of the heavy lifting to help me in compiling this list. Again, feedback welcome!

Dropbox S-1 Teardown

I love S-1s. I know I am weird but S-1s are loaded with great nuggets of insights about business models, company performance and have fascinating stories embedded in the sometimes turgid prose.

Dropbox has been one of my favorite startups for many years. I have taught a Stanford Business School case on Dropbox in my HBS class on Launching Technology Ventures for many years regarding their scaling their sales and marketing operation. We also teach an early stage case on Dropbox to all first year students at HBS. And a few of my former students joined the company early and became key executives over the years. So, when the Dropbox S-1 came out yesterday, I was excited to read through it and see what I could learn. To be clear, I am not an investor in the company and don’t own any shares (as far as I know!)

In short, Dropbox is a cash machine and possesses a magical business model. Anyone who concludes otherwise doesn’t understand the difference between cash flow and GAAP and the power of negative churn. Let’s jump in.

Is The Business Model Working? Yes!

Dropbox has a magical business model and the data in the S-1 proves it. The company reports that “we generate over 90% of our revenue from self-serve channels”. Think about that for a minute. The free product is so attractive that it drives massive adoption and the conversion from free to paid is so obvious and smooth (more usage leads to more storage leads to paid product) that the company has a customer acquisition engine that derives from a simply great product and a compelling value proposition. Forget sales and marketing, at Dropbox, the product itself is a massively effective and efficient customer acquisition machine.

Does it cost too much to service all these free customers? Happily, Dropbox is following a cost curve of declining storage and cloud costs. Gross margins have soared from 33% in 2015 to 54% in 2016 to 67% in 2017. If a CEO tells you she is going to increase gross margins from 33% to 67% in two years on a $1 billion revenue business, you would check her in to an insane asylum. Dropbox did it easily.

The other magical part of the Dropbox business model is that it’s so darn viral. Every time I share a Dropbox document to someone, they need a Dropbox account. Every time they set up a Dropbox account, it drives more document sharing and storage. And the cycle keeps going. 100 million new accounts in 2017 is another stunning number, proving that the viral machine continues to work well despite what some may worry is a growth saturation point.

Cohorts and Negative Churn

The other compelling part of the Dropbox business model is the power of negative churn (i.e., revenue from your existing customers, on a net basis, are growing not shrinking) and the behavior of its cohorts. We see this similar behavior in one of our enterprise storage portfolio companies, Nasuni and our database software company, MongoDB. Every year, the company starts with a customer base that grows 20–30% per year on a net basis. Thus, if you theoretically fired the entire sales force and shut down all marketing activities, these companies would still grow 20–30% per year.

Dropbox’s cohorts are behaving in a similar fashion. There is a chart buried on page 63 of the S-1 that tells the story. Cohorts of customers are growing rapidly months after signing up for the service. The January 2015 cohort grew to 2x the monthly subscription amount paid two years in. The January 2016 cohort grew to 2x the monthly subscription paid after 20 months. And the January 2017 cohort grew to 2x the monthly subscription amount paid after 10 months. In a word, wow. When cohorts are getting better over time, that dramatically, something very right is going on.

But What About the Losses?

Now I know many of you are wondering — if the business model is so magical, Jeff, what about the losses? The company reports a net operating loss of well over $100 million in 2017. How can you reconcile these incongruous data points?

Many business reporters don’t seem to understand that GAAP net income is a meaningless measurement for a subscription-based business model. Dropbox users sign up for an annual fee and pay in cash up front and then the company recognizes that revenue over the entire year. Further, there are massive non cash charges that hit the income statement, such as stock-based compensation. What you really need to examine is free cash flow.

Page 67 tells the free cash flow story. The company’s free cash flow has gone from negative $64m in 2015 to $137m in 2016 to $305m in 2017. Think about that for a minute. Here you have a company growing at over 30% year over year in top line revenue that is able to achieve a positive swing of nearly $400m in annual free cash flow over two years. And they did this while improving gross margin by 34% points. Again, wow.

Miscellaneous Tidbits

A few other things struck me as interesting. After raising so much in private capital, most founders can expect to own 5–10% of their company in aggregate. According to the S-1, CEO/founder Drew Houston owns 25% and his co-founder, Arash Ferdowsi owns 10% for a combined 35%. Drew and Arash built a company from zero to $1 billion, raised a ton of money, and still own over a third of it. If Dropbox ends up being worth over $10 billion, these guys will each become billionaires on paper while still retaining complete control over their company. Amazing.

Another fascinating thing to me is that it has taken 11 years since inception to get to this point. I’d be shocked if Drew wasn’t still CEO of the company for many years after the IPO. Thus, building real businesses takes a long time, even if your business model is magical and you hit every major platform trend just right (i.e., massive secular shifts to cloud, storage, big data and mobile in the case of Dropbox).

Final fun tidbit: the company dumped $11 million in cash and stock into the Dropbox Charitable Foundation at the end of 2017. An interesting use of free cash flow and a nod to interesting initiatives ahead.

Conclusion

When I teach the Dropbox case at HBS, I end the class with a checklist of the business model elements of the company: strong virality, strong network effects, recurring revenue model, high gross margins, negative churn, low customer acquisition costs. I guess that’s how you get from zero to $10 billion in market cap in ~ 10 years.

How To Raise Your First Round of Capital

Last week, I delivered a presentation to Harvard Business School students on how to raise your first round of capital from angels and venture capitalists. The presentation is a derivation of my book (Mastering the VC Game) and my experience as an entrepreneur and venture capitalist. Enjoy!

 

Business Leaders Get Woke

oprah golden globes

Watching the Golden Globes last night, the message hit you like a two by four. Black dresses, biting jokes, poignant acceptance speeches — all hitting on the same set of themes. At one point in the evening, my teenage sons turned to me and my wife and asked innocently, “are they going to move on at some point from this activism thing?” No, guys. America is not ready to move on. Not even close.

This zeitgeist is proving very challenging for business leaders, who by and large prefer to remain nonpartisan and disengaged from politics. As The Economist recently observed, “The Trump era has made it harder for executives to stay above the fray.”

There are two separate but powerful forces coming together at this point in time driving this phenomenon. First, a recognition that great companies and great leaders are mission-driven, not just bottom line-driven. Today’s workforce (looking at you, millennials) are seeking inspiration from their work and want to associate with companies and brands that match their progressive values. Customers are holding brands accountable for not merely the quality of their products, but also the quality of their behavior.

Second, the daily headlines and dominant news cycles focused on policies and statements coming out of Trumpland make it impossible for business leaders to be bystanders. Instead, business leaders are being forced into the sometimes uncomfortable position of becoming upstanders. When political leaders behave in a manner inconsistent with a company’s mission and values, business leaders face a workforce and a customer community that demands speaking out in an authentic, visible fashion.

The State vs. America, Inc.

A prime example of this tension business leaders face was the resignation of the president’s entire business council in the wake of Charlottesville. Think about that for a moment — normally, these business councils are a CEO’s dream: an opportunity to network with other CEOs to generate useful deals and insights while building a direct relationship with the president and other powerful government figures who could shape your company’s fate (case in point: AT&T fighting to merge with Time Warner).

Other examples include the flare-ups between CEOs and state governments. When Indiana’s legislature passed a controversial religious freedom law (soon to be heard by the Supreme Court), many CEOs declared they would stop doing business in Indiana. Salesforce CEO Marc Benioff’s actions and advocacy were particularly notable, canceling all Salesforce programs that would require customers or employees to travel to Indiana.

When North Carolina passed its restrictive bathroom law, business leaders reacted strongly, following the outrage of their employees and customers. Suddenly, the state that was a symbol for innovation and a business-friendly environment (e.g., Research Triangle Park luring biotech firms away from Massachusetts) was viewed as a pariah, costing it many billions of dollars according to an AP analysis.

Calling for a Movement

I struggle to find the right phrase to capture the essence of this movement, but the movement is undeniably growing into a more, powerful force that can’t be ignored. One that I like is Compassionate Capitalism, conveying that business leaders aren’t abandoning capitalism but rather seeking to exercise their capitalist muscles to pursue good works. Salesforce’s Benioff wrote an obscure book with this title nearly 15 years ago. Perhaps it is worth dusting off. The Pope’s surprise TED Talk last year called for a Revolution of Tenderness, particularly from the world’s tech elite:

“How wonderful would it be if the growth of scientific and technological innovation would come along with more equality and social inclusion. How wonderful would it be, while we discover faraway planets, to rediscover the needs of the brothers and sisters orbiting around us. How wonderful would it be if solidarity — this beautiful and, at times, inconvenient word — were not simply reduced to social work and became, instead, the default attitude in political, economic and scientific choices, as well as in the relationships among individuals, peoples and countries.”

Whatever we call it, the trend is clear. Business leaders are being asked to step up and lead in unfamiliar territory. Many are not well prepared for the burden.

A recent Harvard Business School alumni asked me skeptically: “Are you all teaching students how to be leaders, not just managers? Are you teaching them to solve big societal problems, not just small business problems?” I think the answer is yes but I continue to reflect on what more we can be doing to prepare business leaders to be leaders during this historic time. Our local business group, The Alliance for Business Leadership, is proving to be one effective forum in this regard, but we need many more.

Society will be much better off if we can figure it out. And if business leaders can become upstanders, Oprah’s evocation of a new day will come all the sooner.

 

Getting Your First Startup Job

EnteringStartUpLand_300dpi.jpg

When Julisa Salas told me she wanted to join a startup, I was worried. Her background was not exactly typical for StartUpLand and I was concerned her search would end in disappointment.

Julisa had been a liberal arts major (English Language and Literature) who secured her first job out of college at a large investment bank before returning to school for her MBA. Capable, smart and personable, she was also the type of candidate that most startups shy away from — no technical background, zero startup experience, and a young woman of color trying to break into an industry dominated by white men.

A few months later, Julisa emailed me with great news: she had landed a job at one of the hottest startups in the country, a fast-growing restaurant technology platform called Toast that had just raised $30 million in financing and would later go on to raise another $100 million to fuel its rapid growth.

How did she do it?

Wanted: Joiners

In my work as a venture capitalist at Flybridge and professor at Harvard Business School, I have advised thousands of professionals, young and old, seeking jobs in StartUpLand. One of my observations is that “joiners” don’t get enough credit or recognition.

Founders receive all the accolades and attention, but it’s employees number 2 through 2000 that turn a great idea into a great business.

The problem is, startups can be hard to figure out. How can you tell whether a company has the potential for success and is the right fit for you? What are the best entry points?

For the last few years, I have been interviewing joiners to determine the patterns as to how they found their way into startups, selected the right startup for them, and figured out what are the jobs to be done. I wrote Entering StartUpLand to help deconstruct startups for joiners, providing them with a playbook to navigate their way in and be effective and successful when they get there.

That’s where Julisa comes in.

The Joiner Playbook

Julisa is a textbook case of an outsider finding her way into StartUpLand. The playbook she executed is precisely what I recommend others follow. Here’s what she did:

  1. Pick the right company. My advice to picking the right company is to filter your decisions by these four factors:
  • City: Startup hubs are tight communities comprised of clusters of universities, established technology companies, entrepreneurs, angels and venture capitalists. Decide what city is right for you based on personal preferences and culture because once people choose a startup community, they tend to stay. Julisa was most comfortable in Boston. She had grown up in NYC and wanted to stay on the East Coast to be close to family but loved the vibe of the Boston tech scene.
  • Domain: Select a field you’re passionate about. Ask yourself what are your favorite brands, websites, apps or subjects to read about? For Julisa, she was excited about SaaS, mobile’s disruptive force on vertical industries, and hospitality was of particular interest to her.
  • Stage: I often use a road-building metaphor to describe the various stages of a startup — the jungle (where you are surrounded by a tangled mess and have no idea where the paths are); the dirt road (where the path is visible but bumpy and windy); and the highway (where you’re trying to speed as fast as you can down a straight and smooth road). Julisa felt that the dirt road was best for her. As someone who wasn’t technical, she wanted a company that had figured out product-market fit and was now focused on scaling sales and marketing.
  • Probability of Success: This step is the hardest to get right. How can an outsider select the likely winners in a given domain? The simple answer is to ask a handful of insiders. Julisa spoke to entrepreneurs, lawyers, headhunters, VCs and professors in the Boston startup ecosystem and pushed them to name their favorite dirt road stage, SaaS companies. A few companies kept coming up again and again, and Julisa began to target those companies.

2. Arrange a warm introduction. Startups are full of people with large, vibrant social networks. Look for mutual connections, or friends of friends, who might put you in touch with the right people. Harness your digital footprint via LinkedIn, Facebook and Twitter as well as your offline network to prompt contacts to endorse you and find an “in” to your desired startups. Warm introductions trump a cold email every time.

The startup community is generally very generous with its time and has a strong “pay it forward” culture.

Julisa was able to use her network of professors, friends, and contacts to get her a foot in the door with a few startups that fit her target criteria. Once she earned that first meeting, though, the real magic was what happened next.

3. Come bearing gifts. When Julisa found out she had a meeting secured with one of the Toast executives, she immediately developed a plan of action to learn more about their business. Since their target customer was restaurants, Julisa grabbed a clipboard and pad of paper and walked up and down the street for a week, interviewing restaurant owners about their experience with point of sales systems. After interviewing owners from 50 restaurants, she distilled her notes into a few key observations and walked into the Toast interview armed with a rich set of feedback.

When the interviewer realized what she had done, her lack of technical skills or startup experience became irrelevant.The whole conversation shifted to her market insights and how Toast should react to them.

By the end of the meeting, the interviewer had invited her back later that afternoon to meet some additional Toast members. In the interim few hours, Julisa quickly put together a slide presentation distilling her research results and used it to frame the conversation. The Toast executive team was blown away and offered her a job a few weeks later. Today, Julisa is Director of Growth at Toast and well on her way to an amazing career in StartUpLand.

Make Julisa’s strategy work for you

Julisa’s story is evidence that you don’t need to be an engineer or a startup veteran to successfully navigate your way into StartUpLand. Choose wisely and find a warm introduction to get in the door.

But most of all, come bearing gifts of insight and intelligence and you are bound to get that dream job regardless of prior experience.

This post appeared originally on ThinkGrowth.org.

To learn more about pursuing your ideal job in StartUpLand, go to www.jeffbussgang.com