By Inflection points in startup life technically happen every day, but in my experience, there’s a difference between the once-a-week variety and the truly BIG decisions – to sell the company, to raise funding, to pivot on business models, to expand into a new location or new product. Sometimes these happen organically as a result of turning the flywheel, but on occasion, outside events force your hand.
The toughest part for me is knowing when/whether a big decision is exciting and brave or simply foolish. And usually, the answer won’t be apparent for months or years.
In my experience, inflection points have a weirdly powerful capacity to remove confidence from even the most experienced and strong-willed entrepreneurs. Thus, you can imagine how a first-timer like me feels…
These big decisions almost always have two serious options (or perhaps it’s just in our human nature to narrow things down to a bimodal choice). The graphic below helps illustrate:
In startup mythology, entrepreneurs are a risk-hungry breed, willing to put it all on the line every day for something bigger and bolder. In reality, though, lots of anecdotes and evidence suggest that these folks may, in fact, be somewhere between average and more risk-averse than normal when faced with an inflection point like a funding event, acquisition, new executive leadership, a new product, a market or company focus “pivot,” etc.
When faced with these inflection points, I find myself following a very familiar path:
• Share the problem with lots of other entrepreneurs and professional friends
• Talk to my executive team at Moz individually and as a group
• Talk to my investors
• Talk to my wife & my grandfather
• Write about it publicly if possible (e.g. in 2006, 2007, and 2010)
An irony exists here – despite these many conversations and different points of input, the decision I usually come to is a very personal one, and most often the input and advice of others has more of a re-assuring effect than an influence on which way I go. It could be that it’s merely the act of having the conversation many times over that helps me get to a decision or, at least, feel comfortable that there aren’t any angles/options I’m missing.
My latest inflection point is one around outside investment. I blogged on this topic previously and noted that I was leaning against a second round of capital. Thanks to a number of internal and external factors, I’m re-considering that alignment, and it’s an arduous, nerve-wracking process.
Of course, there’s the confirmation bias to fight against – once I publicly stated my opinion that taking capital wouldn’t be wise, I have all the reason in the world to reach for and/or invent reasons to justify that position. Confirmation bias is a powerful motivator, but hopefully, being aware of it can help to mitigate some of its influence.
On the flip side, there’s the natural attraction of entrepreneurs to take capital in good climates for a variety of illogical reasons – Everyone else is doing it! It’s the “right time” to raise! It will get me coverage on TechCrunch! It’s what all the exciting companies do! It’s so much money and such a good VC brand; I better take this seriously! – these insubstantial and misleading justifications have poisoned plenty of entrepreneurs before; woe be to the unwary.
Avoiding these irrationalities and sticking to the right questions and hard facts isn’t easy, but it is required. My personal consideration set includes lots of questions and only a few solid answers. It looks something like this:
Is the business’ growth currently impaired by capital?
A little bit. We had a lot of success with our engineering hiring promotion to the point where we’re being a bit more passive with CSEs, even knowing that bringing more great folks on board could have a positive effect in the medium and long-term.
We’re also somewhat more cautious on the pricing of our product, investment in marketing channels and growth of product/marketing/content team members than we’d like. The same is true on some facilities, benefits and promotional costs. We will always want to stay disciplined in these areas, but today we’re a little more thrifty than even we’d like.
Finally, there’s some bigger, longer-term investment opportunities we want to consider including acquisitions, technology (running more aggressive, less constrained tests to grow our web indices in size + freshness, for example) and data (e.g. access to social data via GNIP, Twitter, etc).
What would be the right amount of money to raise?
Given our inputs: ~$12.5mm in revenue this year (2.2X last year’s revenue), likely going to $20mm+ next year (without any investment), 82%+ gross margins, net profit of ~$1.5mm this year (with the rest going to growth); the right number would seem to be at least $8-$10mm to add enough safety buffer to invest aggressively without taking on massive risk. If we want to also try some acquisitions, pushing that number to $12-14mm makes sense.
What’s the right pre-money valuation?
Here, it’s likely best to use public market comparables and relevant startup fundraising events from the past 12 months. Both point to numbers that value B2B SaaS companies (e.g. Ancestry, Hubspot, LogMeIn, Dropbox, Braintree, LinkedIn, Carbonite, etc) between 6-8X of their current revenue run rate. Given that we’re doing ~$10.8mm in June, that sets a value of between $65-$90mm as reasonable targets. That said, if the market takes a downturn, we could be looking at 3-5X valuation instead – it’s hard to know if Mark Suster’s advice (raise money now so when the party’s over, you’re sitting pretty) on this point is right and raising money in a good climate is the right thing, or if Warren Buffet’s contrarian viewpoint better applies (be fearful when others are greedy; be greedy when others are fearful).
How would we use capital?
There’s the obvious investments:
• Restart aggressive hiring of engineers
• Invest more in potential marketing channels
• Add team members ahead of revenue in marketing, product, customer service and operations
• Put money toward greater bandwidth for our web crawls (both fresh web and the wider link graph) and to our entry in social metrics data.
And the higher risk, but potential ones:
• Build up new departments like API sales, hands-on retention, content/media and research
• Attempt some technology & talent acquisitions (as transparent as I am, sharing this list would probably not be wise)
• Experiment with some weird and offbeat marketing, branding and awareness channels (maybe even.. gasp… something offline?!)
• Develop some products outside the core focus of the product and run tests to see how they might perform/integrate/overlap with existing customers’ needs
• Invest more heavily in events (maybe even some sort of certification) and find smart ways to track ROI and optimize the value of our own meetups/conferences/training/etc.
And probably some “unknown unknowns” in the idea department – those we’ve not yet identified but may arise organically after taking funding and starting to invest.
The risk is twofold. We might A) Invest unwisely in projects/channels that don’t produce the right ROI, forcing us to move slower and more cautiously (which means we probably should have stuck to organic growth) and/or B) Succeed with our investments to such a degree that we stay profitable/breakeven (proving that if we’d had the courage to invest in these without outside funding, we’d be in an even better place).
Should founders take money “off the table?”
I’ve never been a big believer in either competing philosophy around founder liquidity, which include A) Founders who take money out are less hungry and won’t work as hard to succeed vs. B) Founders who have liquidity have better alignment with investors to shoot for a home run vs. taking a smaller exit.
It’s my opinion that this bias is in your DNA (i.e you’re the kind of entrepreneur who’s looking for something big or the type who’s looking for a right deal at the right time) and it’s tempered by market conditions, company performance and belief in the future. The only caveat is when things in one’s personal or family life take a rough turn and immediate finances become critical. I do know of stories like this that pushed founders to cash out/sell, when prior funding events with money “off the table” might have avoided this scenario.
Assuming my behavior or focus wouldn’t change in going from my current wealth status (~$25K in a checking account, no car and a rented apartment in walking distance to my office) to something bigger, does that mean I should hold onto an extra 8-10% of ownership? And what about my co-founder, Gillian? The consensus from investors and entrepreneurs we’ve talked to seems to be yes – cash out some shares. I think my biggest ongoing concern about this issue is whether the thought of having some personal wealth biases my decision the wrong way.
What should we optimize for in a funding partner?
Honestly, this one is hardest for me. I’ve drawn the following diagram for 6-7 founder friends now, and everyone orders priorities differently:
The only one I know I want to prioritize at the top is the quality of the partner. There’s plenty of entrepreneurs who can deal with assholes or hardasses on their board and never lose an ounce of sleep, but I’m a softy. I need board members who are willing to live up to our TAGFEE core values the same way any employee or independent board member must.
Are we foolishly ignoring exciting exit opportunities?
The world of social media, the network we’ve amassed and the transparency with which we operate the business has made it relatively easy to engage in conversations with potential investors. In fact, nearly all of them came to us.
But, there may be great potential buyers would take the company and give us even more fuel and opportunity to accomplish our mission. We’ve certainly not put a substantial investment into cultivating these types of relationships, and I, personally, know less about that world that I do about fundraising (something I’ve failed at 50% of the two times I’ve tried it).
Am I properly thinking this through for everyone, not just me?
In the last few years, I’ve built up a reserve of self-confidence that I lacked for a long time. It could be that I’ve simply gotten lucky, or it might be that I really am a tick or two above complete startup newbie, but either way, a sizeable modicum of self-doubt still exists.
I never want to be one of those CEOs who optimizes for his own personal gain at the expense of others in the company, particularly employees. And it’s truly hard to know whether taking a substantive funding round is a smart way to protect against a bumpy road while giving us the freedom to invest or a canister of rocket fuel that’s either going to get us to the moon or crash trying.
My risk tolerance might be X (where X=high enough to support taking investment), while the 39 other Mozzers could be at X-1 or even X/2.
Is there a danger to Moz’s culture and team inherent in taking additional capital?
This is almost certainly the biggest concern I have, and the one most discussed internally by our executive team. We’ve all seen companies take capital, grow, and lose the culture and team that made them great. That, to me, is an unacceptable option.
But we can’t know how high that risk is, or even whether investment makes it more likely that we’d face that situation. There’s varying degrees of opinion about this on our team, and today, I’m of the belief that by prioritizing culture and core values above all else, we could avoid this threat. Yet, this fear’s got a hold on me…
Is taking investment brave? Is rejecting a great offer foolish?… It’s easy to spin it either way, and almost impossible to know what’s right until the call is made (at which point we’ll need to build a time machine, go back, and try the alternative).