Five by Five: Considerations for Raising Capital

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In the 1986 movie Aliens, the tough female Marine pilot delivers this evocative line to her platoon commander as her shuttlecraft descends to the planet’s surface: “…I read you five by five…we’re in the pipe…”.

Five by five. Loud and clear.

My hometown of Santa Monica and the surrounding region have surged onto the national landscape in the past 12 months as a hotbed of startup activity. This is terrific news for the community.

And as might be expected, there is no shortage of advice, varying from constant blog postings to a seemingly limitless selection of events. For entrepreneurs, the volume and widely varying quality of available information can be overwhelming, not to mention difficult to sort out.

One oft-overlooked area for a startup’s consideration is the strategic decisions that underlie the capital-raising process. These decisions can be critical to the ultimate success of the effort and the company and avoiding mistakes can save you a lot of work.

Here are five areas deserving careful thought as a new company considers the process of seeking outside capital.

  • Find experienced advice: Before deciding anything, seek out those who have proven records of accomplishment over a meaningful period of time. There’s plenty of advice. Just make sure you evaluate who’s giving it as well as the information itself.
  • Weigh the capital alternatives: There are several capital categories to evaluate, including friends and family, the new burst of incubator/accelerator options, angels, venture capital and strategic capital, to name the major ones. Each has distinct characteristics.
  • Analyze carefully how much you need: Build a model for your company that includes consideration of how many people, what you can accomplish and when, conservative revenue projections and other essential numbers from the bottom up. And then double that amount.
  • Build a capitalization model: Construct an analysis showing how much you need over what period to reach self-sufficiency and then add an analysis showing returns to investors in your company. It helps to show investors you’ve thought about how they’ll make money.
  • Be realistic about valuation: Assuming your goal is a self-sustaining enterprise that eventually provides liquidity, understand how to value your company at the outset to facilitate growth.

Obviously there are dozens of other issues and decisions on people, strategy, product and related topics. But it’s the rare startup that succeeds on a high level with no external funding. Even Bill Gates took in capital from outside investors.

So think clearly, filter out the noise, and listen for clear, unattenuated signals, and you can save yourself time and boost the chances of your company’s success.

Presidential Power

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The first stories on the news feed this morning pertained to the disclosure that the US government will pay $50,000 to each of the families of the 16-17 Afghan civilians allegedly killed by an American army sergeant two weeks ago. The officer has already been identified, charged and imprisoned at Leavenworth while awaiting trial here in the US.

As of this writing, the Obama Administration hasn’t officially confirmed this amount, but the local Afghan provincial council publicly stated that they were told the payments came from President Obama. (I’d bet it was part of the terms of the payments.)

It’s worth recalling briefly the killing of 300-500 (depending on the source) civilians by US soldiers in the so-called My Lai massacre in 1968 in Viet Nam, which generated enormous publicity and political backlash once finally revealed to the public. In that case, the event was purposely concealed by the Pentagon, and not disclosed to the American public until 18 months later, and then only through the investigation of the incident by Pulitzer Prize-winning reporter Seymour Hersch of the New York Times. In spite of the admitted participation and charging of several soldiers, only one (William Calley) was eventually convicted. He served three and half years of house arrest on a US military base.

Today’s reports provoked two thoughts. First and obviously, the transparency (such as it is), speed of disclosures, events and responses subsequent to the actual act, as compared to 1968, can be largely attributed to the power of today’s communication channels. The world knew of this event within 24 hours. The soldier was identified within 72 hours. He’s charged and in prison. The US government has acted to redress the grievances of those affected.

$50,000 per casualty. The previous price for compensation to families of civilian casualties of war in Afghanistan was $2,000, so this is 25 times that amount. Quite a jump and certainly not a token increase. For context, consider that average Afghan’s annual income is around $460. That means the US has just committed to pay out about 109 years’ salary to each of the families, as compared to the prior level of about 5 years’ salary as compensation. The total payout, including payments to the families of the wounded, is around $900,000.

Consider that, on average, the US government spends this amount about every seven seconds, and this amount will cost you and me about half a cent each. I don’t think this will have much impact on the deficit.

So why bother writing about this? I submit that it’s a textbook example of the canny wielding of Presidential power leveraged by the speed that information travels globally. The administration knew it had to get ahead of the news. The alleged perpetrator has already been charged and held. It knew that there had to be compensation to the families. It had to be meaningful (to the victims’ families). We’re a (very) rich country. This amount isn’t even a rounding error on a rounding error.

The voters will like it. It’s an election year.

Bounty Hunters

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If you pay attention to professional sports, you know that it’s been recently reported that the NFL is investigating allegations that the New Orleans Saints had a formal, institutionalized and approved “bounty” program managed by its top defensive coach, Gregg Williams, by which individual players could earn extra money for hitting an opposing player hard enough to knock him out of the game (a “cart-off”).

What has pushed this to the top of the sports media heap are several factors: 1) The program was in place during the Saints’ run to the NFL championship in 2009 with all its attendant good feelings following Hurricane Katrina; 2) in Saints’ playoff victories that year, two opposing star quarterbacks, Kurt Warner and Brett Favre, were both injured seriously enough to leave the game while playing and losing to the Saints; 3) the same Gregg Williams was defensive coordinator for the Indianapolis Colts in 2006 when quarterback Peyton Manning sustained a neck injury that eventually led to his perhaps career-ending neck surgery in 2011 and 4) this program was run with full compliance and knowledge of Saints head coach Sean Payton and team General Manager Mickey Loomis after it had been ordered shut down by Saints’ ownership.

Subsequent to the story breaking, it’s been widely acknowledged that informal bounty programs exist throughout the NFL, but this is the first time (from what I’ve read) that it’s formally acknowledged that rewards are given for injuring another player. Needless to say, the sports blogosphere is apoplectic, and coming down hard on the team and the coordinator (although interestingly several players have publicly announced how much they have enjoyed playing for Williams).

A fun problem for Roger Goodell. But given the economic stakes, the nature of the game itself and the ever-increasing size, strength and speed of the players, candidly not altogether shocking or surprising. The NFL is by far the most lucrative entertainment entity in the world, and as a sports organization, winning is valued above all.

As a rough metric, consider that the NFL earns $4 billion per year for its television rights, more that twice as much as the NBA and Major League Baseball combined. That $4 billion averages out to approximately $15 million per game (including the playoffs and Super Bowl). Compare that number with the NBA, which brings in about $700,000 per game from television, and MLB, which come in at a paltry $300,000. And it’s reported every year the Super Bowl is the most widely watched television program and NFL telecasts win the ratings every week during the season.

So what will happen? My uneducated guess is that 1) the existing NFL rules prohibiting bounty programs will be greatly enhanced 2) plays resulting in injuries will be formally and scrupulously reviewed after the fact; 2) severe penalties will be imposed (analogous to how “flagrant fouls” are handled in the NBA) for injury-causing hits. Recall Andrew Bynum, Laker center, was suspended for four games at the beginning of the 2011-2012 season for a flagrant foul in the last minutes of the Lakers’ season-ending loss to the Mavericks in the prior 2010-2011 season.

The viewing public? Ratings won’t be affected one iota.

Finally, if you want more perspectives, literally as I was finishing this post, this appeared on ESPN’s website.

The Surge: Liquidity for Southern California Technology Companies 2002-2011 (Part 2)

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Our most recent analysis reviewed Southern California technology startup companies exit events from 2002 to 2008. This analysis will review the years 2009-2011, completing our review of the decade 2002-2011. This decade is instructive as it reflects the period following the 1999-2001 bubble and its immediate aftermath, and provides a reference platform for future analysis.

This analysis will also complete a comprehensive review of all exits for the period since 1995, which has been published in a series of columns also available on this site.

Details on the database and our methodology are available under the About tab.


 

 

 

 

 

 

 

The period 2009-2011 represents a sharp spike in liquidity values for southern California, culminating with $7.7 billion reported for 2011, the highest single year since 2000, according to our analysis.

2009, in comparison, reflected the macroeconomic environment and, with $725 million in liquidity values, was the lowest year in the 17 years covered by the database, narrowly beating 2002 with $737 million in liquidity.

As such the period represents the greatest percentage change of any three-year period, even including the bubble period of 1998-2000.

In 2009, Sierra Monolithics ($180 million), Networks in Motion ($170 million) and Direct Drive Systems ($120 million) were the three reported exits over $100 million, representing 65% of the total value for the year. In all, $725 million was spread over 31 reported exits for an average of $23 million, the lowest since the $14 million average of 2002.

2010 reported a 266% jump in liquidity value to $2.7 billion. At $500 million, Kelley Blue Book was the largest, and is included here since its business had migrated completely online by the time of its acquisition, even though the company had its start in 1918. Maxlinear ($321 million), General Monitors ($280 million), and five other acquisitions over $100 million combined with Kelley Blue Book to provide $1.7 billion (65%) of the total for the year. The total was spread over 79 reported exits for an average of $34 million. It’s notable that Kelley Blue Book and General Monitors were self-financed, long-standing companies, leaving Maxlinear as the top vc-backed exit for the year.

As previously reported, 2011 represented yet another sharp jump to $7.7 billion, driven by the liquidity availability afforded by the IPO’s of Green Dot ($2 billion) and RealD ($1.1 billion) which alone represented 40% of the year’s total. It is noteworthy that both companies were proven entities with records of revenue and profitability, Green Dot being founded in 1999 and RealD in 2003, reflecting the more recent trend towards IPO’s for companies with substantial revenue (if not always profits).

Look for a recap of exits for the first quarter of 2012 soon.

After the Bubble: Liquidity for Southern California Technology Companies 2002-2011 (Part 1)

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This and a subsequent post will review the 10 years of Southern California technology company exit events from 2002 to 2011. This decade is instructive as it reflects the period following the 1999-2001 bubble and its immediate aftermath, and a review provides a reference platform for future analysis.

As previously posted, Southern California venture-backed and self-financed information technology companies created approximately $7.7 billion in liquidity for their private investors in 2011, the second-highest in our database of exits since 1995.

The year 2000 was the height of the technology bubble. In that year alone $23 billion of liquidity was provided to investors, dwarfed all years before and so far afterwards. (A review of exits over the entire period covered by our database can be reviewed here.) A few companies provided liquidity to investors in 2001 (notably SeeBeyond and Cognet Microsystems) but the true liquidity nadir was reached in 2002.

The period beginning in 2002 started with a natural low following the bubble and since then has represented a relatively rational environment, reflecting macroeconomic factors, increased oversight and scrutiny for companies completing IPO’s, and with regard to specific annual totals, timing differences for significant exits that can skew year-to-year results. For this period, total liquidity was approximately $27 billion, according to our analysis, spread across 500 reported exits for an average imputed value of $47 million per exit.

2002 and 2003 were dismal years, providing $2.1 billion in total returns. Only three companies (Linksys, Citrix Online and Access360) provided liquidity at values over $100 million, and it’s worth noting that Linksys received no reported venture capital financing prior to being acquired by Cisco. The average exit value was approximately $25 million spread over 93 recorded exit events.

As the environment improved and successful companies matured, 2004-2005 saw a spike in total liquidity to $9.6 billion returned via 106 reported events for an average imputed value of $91 million per event. 31 companies (29% of all exits) provided returns to investors of $100 million or more, representing $8.2 billion (85%) of the total for all exits.

Far and away the biggest exit was Cogent (no reported venture capital financing), valued at $2.2 billion after its IPO, using our methodology. Exits at $500 million or more included MySpace ($570 million), Shopzilla ($560 million) and JAMDAT Mobile ($517 million). This group of five companies represented 39% of all liquidity provided in the two years. Another $4.3 billion was provided by 12 exits, including PriceGrabber ($485 million), ValueClick (fka Fastclick, $484 million) and Rent.com ($433 million).

2006-2008 provided an up and down period for private investors. Total liquidity provided was $4.8 billion over the three years; spread over 119 exits for an imputed average of $40 million per exit. One company (DivX; $567 million) provided returns greater than $500 million, and three others (Business.com, Internet Brands, undisclosed) provided returns between $250 million and $500 million. This group of four represented approximately 29% of the total for the period.

A subsequent post will focus on 2009-2011.

The Jaws of Victory

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Last night the Los Angeles Lakers beat the Dallas Mavericks 96-91 in a close game that was not decided until the final seconds. The Lakers did their best to snatch defeat from the jaws of victory by missing 7 consecutive free throws in the final minutes after leading by 7 points with less than 2 minutes remaining. What made this particularly interesting was that the 7 misses took place on 4 consecutive possessions, and were missed by 3 very good free-throw shooters: Matt Barnes, Pau Gasol and Kobe Bryant. Each makes about 80% (4 out of every 5) of his free throws. Therefore, using elementary probability math, the chance that each of them would miss any one free throw is 1 out of 5, or 20%. The probability of 7 consecutive misses is therefore 0.20^7, or .00128%, or for those scoring at home, 1 in approximately 78,000. Truly historic. Of course, we must remind ourselves that the probability of any particular specific sequence of events in a sports event, which by definition is a collection of random events, is always low. Nonetheless, I bet you won’t see three 80% free throw shooters miss 7 in a row on consecutive possessions. Final note: in spite of their efforts they pulled out a victory since the Mavericks couldn’t take full advantage of the Lakers’ largesse by converting opportunities on the other end. Happens all the time.

Liquidity for southern California IT startups in 2011 highest since 2000

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Southern California venture-backed and self-financed information technology companies created approximately $7.7 billion in liquidity for their private investors in 2011*, according to a new analysis of our proprietary database spanning 18 years of exits for over 800 southern California IT companies backed by approximately 1,000 different investors.

Analysis of the database, constructed by Ocean Road Partners from information provided by Dow Jones VentureSource, Socaltech.com, private data and public filings shows that the $7.7 billion total was the highest since the bubble year of 2000, when $10.8 billion in liquidity was generated, and the third-highest in the period covered since 1995. $7.7 billion compares to approximately $2.6 billion generated in 2010, a 296% increase, and the second straight year of growth after a low of $475 million in 2009.

73 companies were identified as exited at an average value of approximately $106 million. Nine companies produced exit values of $100 million or more, the most at or above that level since 2007. Eight were identified as exiting at or above $250 million, and five at or above $500 million, the highest in that category since 2000. In aggregate, 28 of the 73 companies, or 38%, disclosed a value. The remaining 49 companies were recorded as merging with or being acquired by another entity at an undisclosed value, or were identified as “out of business”.

The 10 companies identified as exiting at or above $100 million represented $5.7 billion of the total value, or 74%, demonstrating the concentration of value among the biggest winners and demonstrating the historical risk profile and performance of early-stage startup investment portfolios.

The biggest winner for 2011 was Green Dot, producing liquidity in the public markets for its significant pre-IPO investors of $2 billion, the highest of any such exit since 2000 and the 8th highest in the database. Notable pre-IPO backers of Green Dot included Sequoia Capital and Total Technology Ventures. Southern California investors included members of the Tech Coast Angels.

Private exits with disclosed values over $100 million included Riot Games ($400 million) and HauteLook ($270 million). An confidential private exit returned proceeds over $100 million to investors.

Initial Public Offerings played an unusually active role in 2011 exits. Six companies provided a liquidity opportunity to their pre-IPO investors in 2001, the largest number in this exit category since 2005.  In addition to Green Dot, RealD provided an exit value opportunity in 2011 of approximately $1.1 billion. Notable backers included southern-California based Shamrock Capital. Other IPO exit opportunities included Cornerstone OnDemand, DemandMedia, ReachLocal and InPhi.

*See “Definitions” under About This Blog for more information.

© Ocean Road Partners 2012