Growth5 Blog

Thursday, May 27, 2010

Bridging the Valuation Gap: Participating Preferred

Fred Wilson of Union Square Ventures recently posted about changing his position on the "double dip" of Participating Preferred Shares (mostly against it now). Although Wilson uses the Participating Preferred in certain circumstances these days, his post was an excellent reminder of how Participating Preferred can be a great compromise when you can't agree with an entrepreneur on valuation.

What are Participating Preferred Shares? Wilson offers this simple and easy to follow explanation:
"In a preferred stock, the investor gets the option of taking their money back in a sale or taking the share of the company they bought. I believe a preferred stock is critical in venture investing. However a participating preferred goes one step further. In a participating preferred, the investor gets their money back and then gets their ownership share of what is left.

Let's do a simple example. Let's say you invest $1mm for 10% of the business. And let's say the business is sold for $25mm. In a preferred (sometimes called a "straight preferred") you get the choice of getting your $1mm back or 10% of $25mm. You'll take the $2.5mm.

But if you own a participating preferred, you get your $1mm back and then you split the $24mm that is left with the founder. So you get $2.4mm of what is left and the founder gets $21.6mm. You end up getting $3.4mm with the participating preferred vs $2.5mm in the straight preferred."
Let's say that you are willing to invest $1mm into a company for 10 percent of the firm, but the entrepreneur won't budge from that same $1mm being worth only 5 percent of the company (the entrepreneur believes the firm is worth twice of what you do). If you can get the entrepreneur to agree to a Participating Preferred deal under the 5 percent terms, you will be protected if the company doesn't do as well on a sale as think entrepreneurs think they will.

You make the deal for the Participating Preferred Shares owning 5% of the company for a $1mm investment. The company later sells for $15mm.

Had you been able to negotiate the lower valuation / higher percentage (10 percent) back when you invested, you would have walked away from the sale with $1.5mm ($15mm x 10 percent).

Had you only negotiated Straight Preferred Shares (not Participating) at 5 percent, you would have walked away from the $15mm sale with $1mm as you would have had the choice of getting your $1mm back or taking $750k ($15mm x 5 percent). You would probably take the $1mm.

However, even though you agreed to a higher valuation / lower percentage (5 percent) the Participating Preferred Shares you negotiated would pay you back your original $1mm and then you would take 5 percent of the $14mm left over, or $700k for a total of $1.7mm, which is MORE than you would have made owning 10 percent of the company with no Participating Preferred Shares ($1.5mm). And more than the Straight Preferred at 5 percent ($1mm).

Participating Preferred Shares are a great bridge when you have a valuation gap. If the sale price exceeds every one's expectations, you aren't going to care that you didn't get your originally offered lower valuation price / higher percentage of the company.

It's when things don't turn out as well as planned that you can still show a modest return on your investment by using this vehicle. These type of shares work as they are intended if the entrepreneurs aren't able to follow through on their vision that they had based their higher valuation on. The entrepreneurs are making the $15mm sale based on the last investment round of your money closing at $20mm. But since you negotiated Participating Preferred Shares, you are basically cashing out as if you had invested at a $10mm valuation (your original intention) and sold at $15mm.

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Monday, May 24, 2010

Twitter Organizer: Eddi

The Palo Alto Research Center (PARC) is developing a new Twitter client application that is intended to take the constant flow of tweets and organize them by intended meaning.

"The application, called "Eddi," automatically groups tweets for you into topics mentioned either explicitly or, unlike most Twitter clients that also provide topic browsing, implicitly. The end result is a Twitter app you can use to quickly find the popular discussions within your own personal Twitter stream, either by search, tag cloud, timeline or category list. It even suggests tweets you might be interested in reading, helping you sort the signal from the noise."

Eddi provides two tools:
1. a topic browser where the "essence of the approach is to coerce a tweet to look more like a search query and then get a search engine to tell us more," says Michael Bernstein, a researcher at the Computer Science and Artificial Intelligence Lab at MIT who is involved with the project; and

2. a recommendation engine "that ranks tweets by how interesting they are to you. To determine this, Eddi's algorithms look at your own tweets and interactions with other Twitter users."
The tool is named after eddies in a stream.

Eddi could be very helpful in elevating Twitter's effectiveness for its users. And "if only Evan Williams would step up and have the Twitter team build (private) groups, photo hosting, video hosting and support for Zynga's games, we would actually have a place to move to," said Mahalo.com CEO Jason Calacanis in this post where he explains why he is deleting his Facebook account over Facebook's actions regarding their users' privacy.

Thanks Jake for passing the article along!

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Friday, May 21, 2010

Facebook Privacy Tools

Over on the idfive blog, Andres posted this piece on Facebook's privacy policy. Bill followed up with this visual that looks at how Facebook's privacy policy has grown to over 5,800 words over the years.

You've probably been reading about the controversy. If you're unfamiliar, you can start with the San Francisco Chronicle's Unfriendly Facebook. Or any of these on Google News.

Facebook created this mess by instituting new privacy policies without explaining to users how the policies would affect them, how users could opt out, and then changing the updated options numerous times creating much confusion.

While Facebook ponders how to fix this, these tools can help you feel more comfortable that you have your privacy settings at a level you're comfortable with.

1. ReclaimPrivacy: scans your Facebook settings and let you know where you’re at risk. Simply visit the site and drag the free “Scan for Privacy” button up to your browser’s bookmarks toolbar. Log into Facebook, click the bookmark, and it instantly analyzes your privacy settings in a popup window, letting you know what’s “secure” and where you may be at risk.

2. Untangle’s SaveFace: locks down your Facebook profile completely. It installs in an identical fashion to ReclaimPrivacy – visit the SaveFace site and drag the icon to your toolbar. This time when you log in and click the bookmark, it changes all your settings to “friends only.”

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Monday, May 10, 2010

Zero to a Million Users

Drew Houston of Dropbox and Adam Smith of Xobni put together this excellent presentation on launching an online business and ramping up users. You can check out the presentation here, it is also embedded below.

Beneath the embedded presentation I have listed the major points Houston & Smith have offered. If you're an entrepreneur working on launching your first online business, you should memorize slides 24 - 63 (#11 - #15 in the major points list below).


1. Xobni & Dropbox are VC-backed startups in SF. Both reached 2 million users in 2 years.

2. Make something people want. Biggest risk: making something nobody wants.

3. Weak product-market fit cannot be fixed by good marketing. Good product will be wind at your back.

4. Xobni analytics solved a problem no one had (adjustments needed).

5. Learn early, learn often. The cost of changing your plan increases as you get further along in development. Test early, test often, make sure you're building something people want, the way they want it. You can learn on a $0 budget by simply talking to people.

6. Learn without launching: AdWords tests & Hacks: fake landing pages, screenshots, etc.

7. Create a simple landing page: capture interest / email address.

8. Go where your early adopters hang out.

9. Dropbox put together a private beta launch video; 12,000 diggs later the beta waiting list jumped from 5,000 to 75,000 in one day (March 2008).

10. Avoid ghost towns: bootstrapping to critical mass. Go with niche first, world later.

11. Building buzz:
  • tie yourself to a bigger trend;
  • meet journalists in person ALL THE TIME;
  • journalists are really busy, come up with the angle for them;
  • put a media resources page on your web site;
  • generate word of mouth with scarcity;
  • help users tell their friends; and
  • utilize inbound marketing so you can GET FOUND.
12. Getting people to use your product:
  • d0 a few things really well instead of a lot of things poorly;
  • every 10% easier you can make your product, you will get a 50% larger audience;
  • don't make your audience think – if they have no decisions to make it is less likely they will have problems with using your product;
  • don't make your audience have to read, either: design landing pages and signup flows accordingly:
    a) concise beats comprehensive
    b) call out the next steps
    c) simple converts better
  • hook the user first, educate over time (tours, tip emails, etc.);
  • you do not see the same product your users do (plan accordingly); and
  • make feedback painless – then iterate.
13. Getting your product to sell itself:
  • the best products turn users into evangelists;
  • encouraging word-of-mouth (Dropbox referral program increased signups by 60%); and
  • tricks of the trade: Facebook & Twitter feed, emails, contact list importers, etc. (Dropbox had a goal of averaging 100,000 invites per day)
14. Metrics: know thy funnel
  • Output I: know where to invest marketing $$$. Xobni finding: AdWords users don't convert to paid users BUT they refer others who do!
  • Output II: allocate engineering resources between usability, engagement, & virality.
15. Scaling without virality: "dollar in, dollar out" marketing
  • remember that some markets don't elicit virality or buzz
  • focus on what acquisition costs will be needed $X vs. the estimated lifetime revenue of that user $Y. Utilize strategies that maximize the gross margin between $X & $Y.

Thanks Sean for emailing this presentation!

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