How do VCs value young companies and is a higher valuation always better

So as I am catching up today from a weeks vacation just of the coast of North Africa, I thought I would post an article from a friend who works for Scottish Equity Parteners...to let me get my thoughts straight before I launch into a new series..

How do VCs value young companies and is a higher valuation always better?
By Stuart Paterson

Contrary to popular wisdom, VCs consider it vital for entrepreneurs to be comfortable with the valuation of their company so that they are highly motivated to succeed.

Critical factors affecting valuation are the prospects for returns and the inherent risks associated with getting there. VCs focus on the prospect of a significant capital gain so potential exit value is key. Factors influencing this include the size of your market, your likely share and revenues, and above all, the likelihood of attracting a trade buyer or achieving IPO.
VCs need at least a 3x return on their investments overall to make the economics work. Situations differ, but since some companies inevitably fail, a high risk start-up requires the potential to achieve at least a 5x return. A prospect of 10x can lead to a higher initial valuation, providing that is a credible outcome.

The earlier the development of both company and market, the higher the risk. Valuations take this into account. VCs also factor in how strong and sustainable your competitive advantage is and the experience of the management team. They consider whether the product can be easily copied and how you will take it to market and achieve revenues?

Securing the participation of a syndicate of high calibre VCs at the start of the funding process can help attract other VCs to subsequent rounds. You should focus on attracting investors with a real knowledge of your sector and realistic expectations and time horizons to avoid being pushed into a premature exit.

You may need very large amounts of capital to succeed. For example fabless semiconductor businesses face high costs in designing, developing and marketing their technologies while information and communications technology companies have to offer complete solutions including software and subsystems. VCs will not usually commit total funding requirements up front and will more likely invest in stages once certain milestones have been met, so companies should aim to see an increase in valuations in successive rounds, as well as at IPO or exit.

A very high initial valuation isn’t necessarily the best thing and it is better to take a long term view on building value. Many VCs won’t invest in A rounds because their value hardly increases in the B Round, resulting in limited reward for taking a high risk in investing early.

If initial valuations are excessive, investors may think the next round is too expensive. Worse still, if your initial aggressive assumptions aren’t sustainable, a round with a lower valuation means giving away a lot more equity. Take a realistic view and remember that it is in the interests of the VCs for you to be incentivised to deliver long term value.

Consider carefully the milestones you need to hit to demonstrate that you are making solid progress at each round and remember that it usually takes longer to achieve them than you think. You should prepare for fundraising nine months before you need the cash as being forced into unplanned financing results in greater dilution . Raise enough at each stage to achieve the milestones which will trigger more funds in subsequent rounds and take more than you need if it is on the table.

First round valuation is less important than attracting the best VCs who can add real value as well as capital. It is important to consider whether you can be open and honest with them, whether they have realistic expectations concerning the development of your company and whether they will provide the follow on investments you need. That is the way to maximize your valuation when it really counts – at exit.

Marketing with not much of a budget

Ten Questions With Jackie Huba and Ben McConnell

By Guy Kawasaki

Jackie Huba and Ben McConnell are the co-authors of Citizen Marketers: When People Are the Message. Their first book was called Creating Customer Evangelists: How Loyal Customers Become a Volunteer Sales Force. As a business advisors and speakers, McConnell and Huba have worked with Starbucks, Microsoft, Whirlpool, Discovery Education, PBS, and the Corporation for Public Broadcasting. They are also the authors of the award-winning Church of the Customer blog.
Question: What inspires people to create digital content?
Answer: We think there are three reasons: The first is that the people who helped build sites like Wikipedia, TiVo Community, or Mini2 aren’t part of mainstream culture. They’re what we call the “1 Percenters,” the people who live at the edges and are different than from 99 percent of the world. Our research for the book led us to create the 1% Rule, which states that about 1 percent of a site’s total number of visitors will create content for it. The 1 Percenters flout cultural conventions. Americans love rebels, therefore the 1 Percenters often become the influencers of American culture.
The second reason: Their work is a hobby. Hobbies are fun, certainly, but hobbies can be viewed at a deeper level as an extension and reflection of one’s identity. Hobbyism grants one the permission to consider their work as recreation while subconsciously it works as ideological re-creation. It replicates the skills of the workplace and adds value that may often be lacking from it. Their content is their production.
The third reason is the sense of community. We’re not talking cities but more like extremely large families that scale. It’s easy for other hobbyists to find one another. The human need to bond with something is strong, even if it’s with a commercial entity.
Question: What should companies like Coca Cola and Mentos do in reaction to the videos their products are in?
Answer: There are three different ways to respond to amateur grassroots efforts like that:
Say nothing and let the citizen marketers have their time in the spotlight. It’s a safe and conservative approach.
Use your company website or blog to point to the citizen marketers in the spirit of “what people are saying about us.” This opens the door to ceding control, and that’s a good step. Just remember that citizen marketers don’t follow instructions. This approach requires company spokespeople to have a sense of humor. That wasn’t the case with the Coke, whose spokesperson was quoted in the Wall Street Journal as scolding people for not drinking their precious beverage!
Quickly build a program around what’s happening. It can beneficial but also tricky because it can taint the grassroots nature of what’s happening. Keep it simple. The “firecracker” nature of something like Diet Coke and Mentos has a short half-life. Better to openly solicit ideas from the people or community involved and keep it simple. Follow the lead of the community. And keep the company lawyers locked in a cage.
Question: Why did YouTube succeed over Google Video?
Answer: We suspect the primary reason is something you’re pretty familiar with: entrepreneurial focus. YouTube’s mission was itself. Combine that with a bucket of venture capital to pay bandwidth bills, and YouTube had tremendous advantage. The Google Video product team probably had to navigate the political minefields of a big company with multiple products.
Second, YouTube won because of a vitally important theme: It democratized data. YouTube made user data transparent while Google Video did not. YouTube exposed data like numbers of views, comments, referrers, as well as most popular referrers, most popular videos, most popular channels, etc. That data helps YouTubers gauge their own popularity and allows the larger community to measure relative popularity, too. Google did none of that out the gate. It democratized data using a piecemeal approach, and it didn’t set any standards along the way. YouTube set all of the standards.
The third reason was a great user interface. Simple, intuitive and elegant. With apologies to Google, the UI for its video product was clunky, confusing, and inelegant.
Question: What’s more important: appearing frequently on the front page of Digg or achieving a spot in the Technorati 100?
Answer: Neither. The total number of subscribers to your blog is the most important measure. RSS is the paperboy to an opt-in mindset. Great subscription numbers means someone is creating valuable, important or entertaining content—or all three).
To use a hockey analogy, trying to get on the front page of Digg is like taking a slap shot from behind the red line [I think she means blue line, but I digress...] and hoping to score. It’s highly unlikely unless you’re damn good and very lucky. The “Digg Effect” is great, but it’s short-lived. A few days at best. Subscriber numbers is a better indication of how well you’re connecting with the larger community over the long term.
Question: How long do you think MySpace will remain hot?
Answer: It may already be cooling. Use Alexa to compare the growth of MySpace and Wikipedia since 2005 and you’ll find nearly identical reach until the summer of 2006, when Wikipedia kept growing while MySpace flattened. It’s not over for MySpace, though; members who have invested significant time into decorating their spaces and building a network of friends won’t easily abandon the service. Like any hot business, it’s bound to cool off. As long as it doesn’t pull an AOL, it will remain a cultural influence.
Question: Why do citizen marketers proselytize the companies that they love?
Answer: Some people innately like to help. They want others to know about a brand, product or company and share what they’ve experienced. For others, it’s about status. They like being an expert about a brand or company and therefore demonstrate their knowledge by talking about what they know. Finally, others just like to connect with others who are as crazy about a brand or company as they are.
Question: Who owns what they do?
Answer: So far, most companies have been smart to keep the trademark lawyers in their cages when citizen marketers create fan sites. And for the most part, most citizen marketers have been smart to unequivocally declare their independence from the companies they cover. But who owns what has yet to be resolved. Lawrence Lessig proposes a joint ownership agreement, similar to a Creative Commons license, and that makes a lot of sense. We imagine some form of a template agreement will arrive sometime in 2007 as the number of user-generated and citizen-created sites reaches critical mass.
Question: How do you plan to get citizen marketers for your book?
Answer: We’ve followed two principles in thinking about this: First, word of mouth is most efficient when it’s designed it into the product, service or brand at inception, not just at launch. Second, ideas grow in value the more they spread.
When we coined the term “citizen marketers” in February 2005, we did so on our blog, almost two years before the book arrived. That spread to a number of bloggers, who’ve adopted it as a content category. Some point toward our posts on the subject when talking about the content category. When we started writing the manuscript about a year ago, we invited readers of our blog to join a peer-review group. People from around the world signed up, and their feedback was truly invaluable.
A number of them have since become early promoters of the book because we gave them a stake in its formation and ultimately, its outcome as a guidebook to what’s happening culturally and its effect on customer relationships. Finally, we are outsourcing our book tour to our evangelistic blog readers. Called “40 Talks in 40 Days,” we will go anywhere in North America during 40 specific days in 2007 to deliver a one-hour presentation in exchange for 200 books and travel expenses. Evangelists for social media have been the first ones signing up for the book tour. So far, about more than half of the dates are taken.
Question: Do you think that because something like “Dell Hell” occurred, other companies will work to prevent the same thing happening to them?
Answer: “Dell Hell” was the Great Chicago Fire of online customer commentary. Jeff Jarvis’s posts about his laptop lemon spread so fast and ignited kindling of discontent in so many disparate quarters that its lessons are a textbook case for companies on the importance of customer communications. At the time, Dell did not have a corporate blog and no way to respond to the online conversations. The number of companies starting corporate blogs continues to grow, and that will help them get out in front of future crises.
Question: Are citizen marketers more effective at calling out bad things or promoting good things?
Answer: It depends on your definition of “effective.” Citizen marketer “firecrackers” like Brian Finkelstein, who shot the video of a Comcast technician sleeping on his couch, fomented a lot of negative Comcast buzz but beyond that, not much happened. On the other hand, the Kryptonite bicycle lock-picking video cost that company millions of dollars in revenue. Kryptonite survived and moved on. The nature of “firecrackers” is that they create a lot of noise and commotion but typically for a short time. Therefore, we’d say positive citizen marketers are more effective – they’re in it for the long term, helping snowball word of mouth and building momentum for a product, brand, company, or person.
Question: Is there a way to identify citizen marketers before they become citizen marketers?
Answer: On a regular basis, companies should be asking customers, “Do you recommend us?” That helps quantify evangelism. Those conversations should also include discovering how many customers have their own blog, podcast, or community site. The heavy users of social media are the most likely to create content, and the top 1 percentile of evangelists is the most likely to become citizen marketers.
Question: Last but not least: How could you write a book about citizen marketers and not cite me or my books even once?
Answer: But you were such a superhero in our first book! No matter what, you’ll always be the godfather.
Nice try, guys...do you own a horse?

Slainte

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