Month: November 2007
Today’s guest blogger is Matt McCall of DFJ Portage. Matt was a co-investor with us in FeedBurner and sat on the board with me. He writes a great blog called VC Confidential. When the following question appeared, we did the super efficient thing and forwarded it to Matt to answer. Following is his response which is cross-posted on his blog at AsktheVC: Ad Revenue Models.
Question: (1) How do Web 2.0 companies like Feedburner make money? (2) What makes a blogger or content provider select one network or blog community over another (i.e., are the bloggers themselves being paid or are they essentially working for free)? (3) How is online media advertising different now than during the internet boom?
The most popular Web 2.0 revenue model is based on advertising. Publishers (blogs, media sites, etc) get paid by advertisers who advertise on their site. FeedBurner is an ad network and while it made some money off of licensing its platform to large publishers, most revenue came from the ads inserted into the feeds. This ad inventory comes from either the company’s own direct ad sales force or from ad networks. Some of the ads are CPM based (impressions viewed) while others are CPC ($ per click…a la Google). The publisher generally keeps 60-70% of the ad dollars and the ad network gets 30-40%. So, if Motorola runs an ad campaign through an ad network like FeedBurner, they might pay $5-10/CPM (cost per thousand impressions). The ad network then takes that ad and serves it up on the various websites it has deals with. If the ads are viewed 1,000,000 times, Motorola would pay the network $5-10,000. The network would keep $2-4,000 and the publishers would get the rest. In the case of bloggers, they first pick which ad networks to go with (usually based on which drive the most revenue for the space given) and then approve different ad campaigns. They get a cut of those ad dollars.
More advertisers understand the benefit of online advertising and so, there are more ad dollars flowing into this space than during the Bubble. More importantly, Google has created an entire ecosystem based upon its CPC model where advertisers only pay when ads are clicked on. They feel there is more accountability since they only pay when an action is taken. Also, there is very little cost associated with running many of these publisher sites, so it doesn’t take much to get to break even.
That said, the economy is likely sliding into recession and ad budgets will get slashed. CPC and CPA (cost per action) based revenue should hold up better than CPM based ones since there is a clearer ROI. In 2000, Yahoo saw its revenue plunge 40% in one year. When the cycle corrects, there will be quite a lot of carnage in the ad supported publisher world. Smart operators will get their costs inline and focus on driving the best possible results for advertisers.
Dick Costolo (aka Mr. Ask the Wizard) – the founder/CEO of FeedBurner (now a Googler) has another outstanding post up titled Early Stage Board of Directors. In his delicious way, Dick talks through how he thinks about the potential composition of a Series A board and gives entrepreneurs some ammunition for their potential investors when they say “let’s have a board with five Series A investors and no founders.”
One of the issues that we debate internally is regarding the value of patents. We’ve written a lot about the subject over the years and those of you who are regular readers know that Brad hates all software patents, and I’m fairly close to that line as well. Last night, our friend Rob Shurtleff sent us an email asking the question “what is the value to startups in filing patents? Do VCs really care?”
Rob’s take (and he is a VC) is that:
“1: Software patents have in our experience not added significant value to early stage companies when they are acquired;
2: Early stage companies can’t afford to use granted patents as an offensive weapon (this is equivalent to the rules of Mutually Assured Destruction), a few nukes isn’t going to cut it when fighting a super power;
3: It costs a huge amount of time and money to do a high quality patent filing, there are a lot better things to spend your time and money on; and
4: The rules are changing and making this whole area less predictable.”
I think Rob is pretty dead-on accurate. In fact, I think patents are probably the most overvalued “asset” that startups promote when raising funds.
Now, let me caution everyone on a couple of things:
1. There are some business plans that absolutely require patents: anything in the biotech / medical space, new hardware technologies, semi-conductor, new computing or interfacing languages, etc. In other words, much of this post assumes that you are an early stage software company, or a business based on business methods; and
2. These opinions are mine alone (although I’m betting that at least Brad and Rob won’t put up much of a fight) and some VCs may care very differently about this. Whether they SHOULD is another issue, but I know of VCs that do exhaustive patent reviews of all of their deals. If you are seeking funding from them, you better have your turkeys in a row. (Happy Thanksgiving, everyone).
I’m going to get a lot of hate mail from patent attorneys. Sorry guys, but I have to agree with Rob’s first point, above and to me that is the deciding factor.
Also, don’t underestimate Rob’s fourth point about the changing of the rules. “Patent Reform” is becoming a sexier topic in the legislature. “Something” will change soon. If Google, Microsoft and others get their wish, they’ll trumpet around that they’ve fixed much of what is wrong in the system – just be prepared for the “first to file” standard that they are proposing the effects this may have on the ecosystem. If anything, it will just further reinforce my opinions above.
Q: I have read the your article on typical compensation for senior management of venture backed companies. There was no mention of severance and length of contract terms. Can you opine?
A: (Jason) Most everyone in the startup world is an at-will employee and does not have an employment contract. For those of you unfamiliar, “at-will” means “can be fired at any time for any reason.” Most employees have offer letters which outline basic terms of their employment, but are silent with regard to severance benefits. Basic terms include provisions on confidentiality, assignments of inventions and the like.
I’d estimate that less than 10% of folks working for startups have employment contracts. The contracts are usually one year in nature. The ones that I have seen still make it clear that the employee is at-will, but provide some sort of severance benefits, whether this is accelerated vesting or some small cash payout. Sometimes for high level executives you’ll see 3-6 months of vesting and / or cash comp, but it is not the norm.
Remember, startups are normally resource constrained – they don’t have extra cash or equity to pass out to people, so don’t expect any types of severance benefits that you would see at a large company.
One company that draws a lot of questions is Google. Specifically, folks have questions regarding the fact pattern of their initial public offering. We weren’t investors in the company, so we generally don’t get involved answering these, but today my friends Mike Sullivan and Julia Vax from Howard Rice sent me this nugget:
“Google’s IPO in 2004 shed some light on a little-known federal securities law – the one that requires that companies with more than 500 securityholders (including holders of stock options) to “go public”. The SEC has long required companies with 500+ securityholders and at least $10 million in assets to publicly file detailed information that is the equivalent of an IPO prospectus. That’s what forced Google to do its IPO – they realized they could no longer shield their confidential financial information as a private company.
On November 15, the SEC announced a rule change to create an exception for stock options – so that companies will be able to have an unlimited number of optionholders without having to register as a public company. Some have speculated that Facebook might soon be facing the same 500+ optionholder issue that Google faced – but now Facebook (and other rapidly growing companies with lots of optionees) will be able to remain a private company without compulsion from SEC rules.”
All in all, the SEC has their head on straight here. Thanks Mike and Julia for imparting some knowledge.
I came across Furqan while reading Found+Read’s article titled A few more things no one tells you about VC… Furqan had a post recently titled Topics Covered On This Blog (So Far) that helps us navigate. It includes the following on raising capital:
Also included is a bunch of stuff on startups. Good stuff – worth adding to your reading list. Furqan – nice blogging – keep it up!
Q: What should my compensation be? I’m going to be the first full-time employee of a new startup. As it is so early stage, it is hard to say what the title is, but the role is certainly similar to a CMO or VP BizDev type person. The company just raised around $500k in an angel round that is convertible debt to be converted at the valuation of the first VC round but better terms. I’m more interested in equity than a market salary, but I do have a mortgage, wife, 1 child and another on the way.
A: (Brad): The good news is the company has a little money in the bank. That gives you (and them) the ability to have a rational discussion about the trade between cash and equity. If you recognize this is a trade (e.g. the less cash comp you take, the more equity you get), you can have an intelligent conversation.
The mistake I see most often is that the early employee doesn’t recognize this trade. The conversation goes something like "I’ll take a 20% discount to market salary but I was 5x the normal equity I’d get if I was getting a full salary." This irrational. While you can make the argument that cash is worth a premium to equity, it’s not worth this kind of a premium.
The normal dynamics tend to end up between the two end cases – full salary and no equity at one end and 50% salary and 2x normal equity at the other end. My recommendation when people ask me this question is to say "figure out the least amount of cash comp you can afford – ask for that – and then ask for roughly 2x the equity package you would normally get. Oh – and expect that the equity will have normal vesting terms on it – you shouldn’t get better vesting because you are taking a salary cut."
Dave Naffzinger’s post – Startup Stock Options: Should you Exercise your Options? is a must read post for anyone that has been granted a stock options. I’ve worked with Dave in two companies and he’s a star. This post is dynamite and while it doesn’t tell you a specific answer (there never is a "correct answer") it gives you the details you need to make an informed decision.
Today’s post of the day is from VentureHacks and is titled What should I send investors? Part 3: Business Plans, NDAs, and Traction. The whole post is worth a read even though the summary says it all:
"Summary: Don’t send long business plans to investors. Don’t ask for NDAs. Don’t share information that must remain confidential. Understand that investors care about traction over everything else."
Jason and I welcome Matt McCall from DFJ Portage as today’s guest VC blogger. We sent Matt one of our backlog questions – his response is below. Matt also posted it on his excellent blog under the title How VC’s Determine % Ownership Thresholds.
Question: What’s a completely generic range of equity a VC typically wants for a round 1 or round 2 investment?
Most VC’s will generally say they target 20-30% ownership in a company to “make it worth their time”. This means that if they invest $3m early on, they expect the post-money to be around $10-15m and if, in later rounds, they are investing $10m, they expect to have a $30-$50m post-$.
Often, however, VC’s will use the “percentage” threshold as a means by which to increase money into a round or to get the valuation down. I have seen a given VC say they need 25% ownership for deal (to get valuation down) and do a more competitively sought deal at 15% two weeks later. In the end, two things drive all of this. First, there are legitimate minimum investment amounts a firm needs to have per deal. A $500 million fund will never get its capital deployed by doing $2m and $3m deals. They need to put $7-10m to play early and $20m+ over the life of the investment. Second, the valuation (and hence % ownership) will be driven by attractiveness and competitiveness of the deal. In the end, it is really about valuation (assuming their investment appetite remains in a set range).