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I’ll Have the Ramen, Please: Founder Compensation Deflation

May 25, 2011

Brad Svrluga

I’m observing an interesting and encouraging dynamic amongst the seed and early stage deals I’ve been looking at in this environment (an environment for which, despite last week’s LinkedIn IPO madness and massive EventBrite preemptive financing, we shall NOT use the B word). It’s a bit of a frenzied world out there, with valuations going up up up, supply of early stage capital at historic highs, raw startups raising multi-million dollar “seed” rounds (some in our portfolio) and founders taking money off the table via secondaries in even Series A  & B rounds.

But despite all the apparent madness, the entrepreneurs I’m talking to seem to be consistently, and refreshingly, resisting taking advantage of it to line their pockets with big salaries.

I take my hat off to all of you guys and gals, and point to this as a not sufficiently acknowledged difference between today’s environment and the capital B Bubble of the late 90s. I celebrate it not because I think these founders don’t deserve to get paid, but because I think they are collectively making a very powerful statement about their commitment to and optimism about the companies they are building, and showing great leadership in the process. (Maybe it’s that these guys are getting enough satisfaction out of their inflated titles, a phenomenon Brad Feld wrote about the other day.)

This vintage of entrepreneur seems to really understand the value of equity, and appears genuinely interested in aligning her interests with her investors. It’s a remarkably refreshing thing to see, and very different from the profligate days of ’98-’00. It bodes well for all of us.

Counterintuitively, this downward pressure on founder comp is even stronger today than it was a few years ago, when cash was considerably harder to come by. I haven’t seen a credible early stage founder expecting to pay herself real market-rate compensation in well over a year. Whereas today I most commonly see founders working for 50% of market comp ($75-125K for a CEO, vs. the $150-250 base you’d need to recruit an early stage CEO), 3-4 years ago my non-scientific survey suggests the standard was more like founders getting 80-90% of hired gun comp.

In fact, I walked away from one very attractive deal a few years ago in no small part because the founding CEO said he simply had to make $325K/year after raising a $2MM Series A. That’s what he had been paid at the job he left to start his company, and he couldn’t cut his personal operating budget any lower. Not very entrepreneurial behavior, we didn’t think, and I was deeply worried about what else that behavior might be signaling. (NOTE: Turns out he was worth the dough – he’s more or less knocked the ball out of the park since then. Damn. . .)

Remarkably, today’s founder comp phenomenon is happening concurrently with an incredibly competitive environment, and corresponding boost in compensation, for technical talent and VP level hires across the board. But as other compensation grows steadily, one of the best CEOs in our portfolio still pays himself $60K/year despite the fact that he lives in Manhattan, has raised several million dollars of venture capital, and has a company that is doing fantastically well. And this is not a guy with a trust fund or a massive exit from a prior company to feed off of. He’s eating ramen, drinking Budweiser, and focusing on driving hard to make the very large piece of equity that he owns worth as much as possible. He recently made a key hire who will likely make 4x the CEOs cash comp this year. Did he ask the board for a raise for himself? Nope. He could get a $100K raise in a heartbeat if he wanted to push on it, I’m sure. But he knows that $100K is one more month of burn, and thus another $100K of dilution he would have to take. Effectively, he’s doubling down on his investment in the company every month by living as lean as he can. Think that generates goodwill with his investors? Hell, yeah.  Sends a signal to employees? You bet.

Admittedly it’s a bit of an odd dynamic, and this guy is certainly an extreme case. After all, I do think it is very important for the CEOs we back to be not just super-motivated, but also happy and sufficiently comfortable in their daily lives. A CEO who is hyper-stressed about balancing his checkbook at home is not going to be as effective at the office as he might otherwise be. But within reason, all shareholders, founding CEO included, are better off if compensation is kept under control across the board.

Perhaps it’s that today, with the environment frothy and the exit market stronger than it’s been in at least 4 years, real entrepreneurs are able to focus much more on the brass ring than the W-2. They’re confident in what they’re building towards, they can see a path to a lucrative exit, so they take the long view on wealth creation. That smells like a terrific leading indicator to me.

I’m going to keep a close eye on this dynamic. If entrepreneurs start betraying their deflated optimism with demands for heftier W-2’s, I’ll know the party must be coming to an end. In the meantime, I’ll enjoy the alignment that comes from this incredible crop of entrepreneurs and their parsimonious ways.

Show & Tell: The Value of Neverending Diligence

May 19, 2011

Brad Svrluga

I was in Los Angeles yesterday for a board meeting at WhoSay, an incredibly exciting company that I introduced here last week. These guys are doing great things, and have a terrific amount of momentum. It’s one of the most fun companies I’ve had the pleasure of being around.

After the board meeting, CEO Steve Ellis invited me to stick around and sit in on a pitch he was giving to a prospective client. I enthusiastically took him up on the offer, and boy am I glad I did.

The board had been sitting in a conference room for three hours prior, talking in great detail about the business, but there is absolutely no question that I learned more in the 40 minutes of that sales pitch than I did in the board meeting. I saw a live product demo, heard in living color how the company’s value proposition had evolved and how it was tuned for presentation to a specific type of client, and had the opportunity to watch a real live prospect react and respond to the pitch (fortunately quite positively!).

There is an odd dynamic that emerges in venture deals, where we do an enormous amount of due diligence prior to investing, getting to understand a company and its marketplace in excruciating detail. In fact, it’s not unheard of at the end of a diligence process for the investors to better understand certain elements of a company’s marketplace than the company does, at least for a brief period. But then, consistently, we take our eye off the ball, shifting to a simple reliance on management’s reporting to us.

With so many of our companies changing course along the way, sometimes dramatically, we lose touch. We no doubt had a deep understanding of the company’s value proposition on the day the deal closed, but unless we work at it, we simply cannot effectively maintain that understanding over time. I know I frequently do not.

If our visceral understanding of what a company does and how it does it wanes over time, how can we expect to be great board members? We pay attention to the metrics and the financials, sure, but if we lose our feel for product and market, we’ll be cursed with blind spots that might come back to bite us, and which will almost certainly be annoying to our CEO.

Preventing those blind spots takes more than just sitting in on a sales pitch, of course (constant reading, attending industry conferences, etc. are all important), but that’s not a bad place to start, and it offers an experience for which there is no substitute. If you’re an investor board member, I encourage you to ask your portfolio company CEOs to find an opportunity for you to sit as a silent observer in a sales pitch once in awhile.  And if you’re a CEO, make it a requirement that your board members join you for a pitch once a year, at least.

The mutual understanding of how a company is evolving and telling its story will provide a better context for the shared decision-making of the board. And hearing the pitch made directly by the company’s best salesman (the CEO should always be the best salesman at an early stage company) will help board members become more effective evangelists for the company.

It will take a little planning and effort, but if your experience is anything like the one I had yesterday, both CEO and board member will find it enormously valuable.

Say What? Introducing WhoSay

May 13, 2011

Brad Svrluga

I am very excited to celebrate the unveiling of one of the most exciting companies we’ve ever had the pleasure to be involved with. WhoSay is a company that for over a year we’ve been desperate to talk about, but which has been operating in strict stealth mode until this week.

WhoSay is a social media distribution and rights management platform for celebrities, brands, corporations and other entities concerned with controlling their social media presence. The company launched privately last summer, and emerged publicly through this New York Times piece from earlier this week. You can expect to hear a lot more from these guys in the month’s ahead.

WhoSay was founded in early 2010 by Steve Ellis, whom I had the pleasure of backing once before when he founded and ran Pump Audio, which was successfully sold to Getty Images back in 2007. Steve is such a good entrepreneur that I probably would’ve backed him opening a laundromat if that’s what he wanted to do. Fortunately for all of us, he had a much bigger and better idea this time around.

WhoSay’s core premise rests on three foundational truths:

(1) active participation in social media is an essential activity for any celebrity or brand,

(2) controlled effectively, social platforms create an unprecedented opportunity for celebrities to take control of their media assets, and

(3) an effectively aggregated collection of celebrity talent and assets will create powerful monetization opportunities for the aggregator and, importantly, the talent.

We live in a nation that has a $3 billion/year advertising-supported media industry that feeds off of celebrity content (People, US Weekly, E! Network). A substantial portion of this content is gathered against the wishes of the celebrities, and the content that is collaboratively produced (interviews, etc.) rarely offers the talent direct financial participation.

WhoSay provides the first social media solution that is effectively focused on this unique set of customers – offering control of distribution, protection of digital rights, and administrative tools that allow mangers and agents to participate in the creation or approval of posts before they are released to the world. But the management platform is just the thin end of the wedge. By working with hundreds of popular personalities, WhoSay creates a unique ability to serve as an aggregator and digital agent for talent.

Imagine United Airlines sponsoring a Home for the Holidays photo contest. WhoSay can package a sponsored content opportunity for United and then put the call out to its talent base. Celebrities submit their in-home family pictures from the holidays, and WhoSay syndicates that packaged content to the highest bidders, or sells advertising around it on an owned and operated website. The talent will then share the sponsorship revenue 50/50 with WhoSay. People Magazine won’t have access to pictures like that.

If the talent shared those pictures directly via Twitter, they would lose control of the rights.  But post to Twitter, Facebook, or elsewhere through WhoSay and you share directly in the upside that your content creates.

Ecommerce opportunities? Why wouldn’t Eva Longoria want the ability to use her social media presence to promote the fashions that she wears and the causes she supports?

So this is a great idea, sure, but how can a tiny startup make it happen? Critically, Steve co-founded the business in partnership with Creative Artists Agency (CAA), the biggest talent agency in the world, with massive market share in each of TV, film, sports, and comedy talent. With CAA’s phenomenal support and endorsement, the company has been able to sign top talent at a remarkably rapid rate. Without that support, it would have been impossible to get going. With the help of that kick start the company now boasts over 200 top personalities using its platform – talent from CAA and every other major agency.

The list of celebrities using WhoSay today includes A-list talent like Tom Hanks, Steve Martin, Katie Couric, Magic Johnson, and hundreds of others. In aggregate, this talent base has over 300 million social media followers. On the strength of that user base the company is already racking up tens of millions of page views per month. And they’ve only just begun.

We’re thrilled to be involved with Steve again and to have the chance to watch WhoSay grow. The business model opportunities are myriad, and coming fast and furious now.

By building quietly for a year and listening to the needs and desires of the talent along the way, WhoSay has earned the invaluable trust and confidence of its partners. And of course, it doesn’t hurt that no would-be competitors knew what they heck they were doing until now, when the talent base has reached a scale that would be all but impossible to replicate.

Now, it’s time to take the covers off and get to work turning this into a real business. We’re excited to see where it leads.

Entrepreneurs Around Every Corner – What I Learned from a Haircut

May 5, 2011

Brad Svrluga

I get a unique thrill from stumbling across the amazing entrepreneurs whom I could never invest in, but who are building great small businesses around every corner. It occasionally drives my wife crazy, but I love talking to small business owners – be they restaurateurs, shopkeepers, or auto mechanics – when I see them doing innovative things in their product and service offerings. I get excited by digging in and understanding where their ideas come from and how they think about and analyze their operations. Not infrequently, I’ll learn lessons about customer service or clever marketing programs that can be applied to my tech businesses.

I just had a great example of this yesterday afternoon. I was overdue for a haircut, and had an open hour between meetings. I used Lifebooker, a cool web service that helps connect consumers with perishable inventory at salons, spas, and other high end services, to find a discounted haircut at a place nearby. With just a couple of clicks I found a place a 5 minute walk away where for $28 I could get a haircut that was normally $45 (still way above the $15 barbershop cut I’m used to, but I was jammed for time and also curious to test out the Lifebooker service). I booked it.

I ended up at Onyx & Jade, on 38th St, and it quickly became clear that I was in an establishment run by en entrepreneur who cared about service, and who understood the value of a delighted customer. The moment I sat down in the chair, a woman came over and asked if wanted anything to drink – coffee, tea, soda, beer, cocktails – it’s all included with the haircut. As was a shoeshine. So here I was, getting a 40% discount on a haircut, and it included a shoeshine and a cocktail. This was a top notch service experience!

As Alyssa, the proprietress, began to cut my hair, I started peppering her with questions about the business. Turns out she’s an entrepreneur who set out on her own and opened this shop 6 months ago. A bold move in a tough economy – more points for Onyx & Jade.

Then Alyssa asked if I wanted a manicure. “I’ve never had a manicure in my life,” I tell her, “so no, thanks.” She tells me I’ll love it. I resist. She says “have one on me – Arlene will do it while I’m cutting your hair.” She had me trapped – it was going to be free and not take any incremental time. I relented.

20 minutes later I had an excellent haircut, a drink, a shoeshine, and my first ever manicure, all for $28. And then Alyssa showed her real entrepreneurial marketing brilliance – “So I’ve got a membership program. For $500/year, you can have unlimited haircuts, shoeshines, manicures, and drinks to go with them. Care to join?”

Wow. A customer retention program Amazon or Netflix could be proud of. For a little less than the price of one haircut/month, she’ll give you unlimited cuts and trims, throw in all the manicures you want for free, and offer you a shoe shine and a cocktail any time you want to pop in.

It’s brilliant – she gets paid up front, helping her with cash flow, and takes no risk of losing hard money, as her COGS is almost exclusively her labor. Meanwhile, she locks in a very dedicated base of customers who suddenly have (a) negative incentive to go anywhere else and (b) very strong motivation to tell their friends and colleagues about this terrific service. All this at a business that’s smart enough to use the idle labor sitting in her shop to dial up a free shoeshine and manicure to create a truly delighted customer. Surely there’s something in there that one of my portfolio companies can apply to their customer acquisition and retention programs.

I didn’t take her up on the membership – I’m not ready to desert Roger, my trusty barber of 15 years, and I don’t think I’m going to become a manicure guy, period. But I’ll go back and see Alyssa once in awhile for a haircut, for sure (probably when my shoes are dirty and it’s after 6pm, so I can have a beer with a clear conscience). She does a great job, and she’s clearly a fantastic entrepreneur with a nuanced understanding of her business model and the long term value of creating a delighted customer. Given my DNA, I can’t help but be compelled to reward that.

Eat When Served

May 2, 2011

Brad Svrluga

There has been no shortage of Bubble Talk of late. Investors and entrepreneurs alike are running around trying to figure out if the world has fundamentally changed, if the sky is about to fall, or somewhere in between.  Every venture industry blogger worth his salt chimed in over the past two weeks, so I’ll skip that party.

Given the state of the markets, though, I think it’s important that every company consider how you are reacting to this environment. There is a ton of capital out there, and for good companies, the process of raising money has never been easier. If you’re a company that’s due to raise money now, you lucked out. Congratulations.

But what if you don’t need to raise money now? Are you just unlucky to have missed the cycle? Not at all. I think we’re all lucky to be operating in this market. Every company needs to think hard about its balance sheet and be thoughtfully opportunistic, while resisting the temptation to get greedy.

As we talk about the impact of this market environment on decisions we make within our portfolio at High Peaks, I am guided by a simple but powerful three word mantra I heard from a fellow VC about ten years ago, not long after I first got into the business:

EAT WHEN SERVED.

In short, if the market wants to give you money on good terms, you should think hard about taking it, whether or not you need it.  If we somehow had perfect information about where we were in the greed part of the fear/greed cycle, it would be easy to optimize financing strategy around market swings. Given that we don’t, I’m here to tell you to go get the money now.

The point is, we don’t know when this party is going to end, we just know that it will end. I’ve seen capital markets seize up before a couple of times, and I’ve been caught flat-footed each time. I’m not in the mood to let that happen again.

So our companies are going to start eating. My partners and I are actively counseling all of our companies that have a good story to tell and anything less than 24 months of cash on their balance sheet to start talking to investors about raising more money.

But wouldn’t companies that can afford to be better off waiting another 9-12 months, making a bunch more progress, and then raising money at a much higher valuation? Some simple analysis makes my answer – NO! – quite clear.

Consider the possible outcomes of a company raising money in today’s environment; perhaps a year before its cash flow forecast suggests it needs to. Let’s evaluate likely outcomes as determined by (pardon the oversimplification) the two variables that drive financing success – (1) conditions in the macro-level financing environment and (2) the micro-level performance of the company. In the 2×2 below, the four outcomes compare raising that money now vs. waiting 12 months, when the company will have less money on its balance sheet but more data about its performance.

Comparitive Outcome of Raising Money Now vs. Waiting 12 Months

Company Performance in 12 Mos.

Weak

Strong

Financing Environment in 12 Months

Strong

Better

Somewhat Worse

Weak

Much Better

Neutral-to-Better

There is one possible outcome where the company is worse off for raising money today vs. waiting 12 months.  If the financing environment stays strong and the company performs well, the company probably would’ve been able to raise money on better terms in 2012 than it will in the next few months.  So you took more dilution by raising now. However, if either company performance or the financing environment get weaker, you are perhaps substantially better off for raising money today, and not worse than neutral.

Of course, every company situation is different, and the scientific approach would be to assign probabilities to each of the four variables in the 2×2, come up with expected outcomes in each cell and, whammo, you’d have a clear answer what to do. Problem is, while we may be able to make some quasi-intelligent predictions about company performance, we simply cannot know what will happen in the broader financing environment. Looking simply, then, at the four outcomes, in three of them we’re neutral to much better off for having raised the money now, and in one we’re likely somewhat worse off.

Based on that simple analysis, the prudent move is clearly to raise money now. And while we could perhaps do some analysis that would estimate the probability of each of the four outcomes, it’s not worth the effort. First off, you’d need some remarkable circumstances to leave that “Somewhat Worse” outcome box to be >50% likely (probably including near 100% certainty that company performance will be strong). Even more importantly, just remember that not raising capital now and guessing wrong on future performance could lead to fatal balance sheet challenges down the road.

So as we work with our portfolio, we’re getting to work trying to beef up our balance sheets wherever we can. We have little to lose, and a whole lot to gain. As we start those processes, we retain the option of feeling them out and stopping. We don’t need the money, after all, so if we don’t like the signals we’re getting from the market, we can always pass and come back when our story is even stronger.

There’s nothing like raising money when you don’t need it to swing the negotiating leverage in your favor. And even moreso, there’s nothing like a macro financing market that’s in the mood to serve up big helpings of capital. Put those two together and we should see some good outcomes.

If you’ve got a company with good momentum in an interesting sector, the capital markets are probably eager to feed you right now.

Please, take my advice, and eat when served.

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