Internet User Defined

In their press call last week, Google obfuscated the various definitions of a user in online terms.  The WSJ takes a small swing at the debate.

Billions of dollars swirl around these definitions. Here is a deeper look at the various definitions of an Internet user.

Visitor

• Definition — visitors are users who visit your site but do not register or make any effort to provide credentials on your website.
• Usage – Many VC’s love this metric because it defines the maximum size of your funnel. Apps like Twitter have thrived on visitors, who can view twitter feeds of others without having to use Twitter themselves. Visiting is a necessary first step before using.
• Value – The only info you can know about a visitor is related to their IP address or cookies on their computer. They are a great audience to remarket to because they can be tracked across the web and see ads from you on any other site that they visit and runs display ads for revenue.

For Google, a visitor is a search visitor who is not logged into gmail or any other google service. If my grandmother went on a computer and searched for “Greek Wine” using Google’s search toolbar at Google.com, she would be a visitor.

Registered User

This is a very badly used metric that should be stricken from the roles of userdom.

• Definition — a visitor who registers their identity with your website through your own registration process or through an Facebook or Open ID interface.
• Usage — Registered users are not necessarily active. In fact, the vast majority of users are not on almost all websites. The ratio of active user to registered user is a very good indication of the user’s interest in your product. The closer the ratio is to 1.00, the more engaged your users are with your app, even if their return rates drawn out across months.

Unless Google specifies the app, it is super likely that they are bundling all of their google users into this number. It is no indication of Google Plus usage.

Active User

• Definition — There is no one set definition but there is a general consensus — An active user is a registered user who uses your application at least once in a 30 day period.
• Usage — The more frequent an active user uses your product, the more engaging your website or application.
• Derivatives — Return rate is a derivative of your active user calculation. If an active user comes back on average every 10 days, then that is also your average return rate. Facebook has one of the highest active user pools in the world.
• Derivatives – Churn Rate is defined as how quickly do active users stop being active. Churn is usually measured in terms of cohorts and averages.
• Confusion — This number is worthless if the time period (daily, monthly, yearly, etc.) is not specified.

Monthly Active User (MAU)

• Definition – Social gaming companies use this number to understand their active users in much more granular detail. It is the count of the number of unique active users in any given month. Facebook publishes this number on a monthly basis.
• Usage — It is used to track the active nature of the gaming app. 1 million monthly active users versus 1 million active users can mean two wildy different numbers.

Daily Active User (DAU)

• Definition – Social gaming companies use this number to understand their active users in much more granular detail. It is the count of the number of active users on any given day. Facebook publishes this number on a daily basis.
• Usage — It is used to track the active nature of the gaming app. 1 million daily active users versus 1 million monthly or active users are very different numbers and indicate very different success rates for the games. DAU’s are used to calculate your revenue trajectory as a game company because it captures the smallest calibration of spending activity. For many social games, if a unique user does not spend money in their first day playing the game, they will likely never spend money.
• Stickiness factor — is understood in terms of the ratio of DAU/MAU. It is an indication of how often a unique users come back. The lower the stickiness factor, the higher the churn and the less successful the game.
• Facebook — No one is quite sure how to read Facebook’s statement that 1/2 of all their active users log in every day. That would seem to suggest that they have a stickiness factor of .5 or 50%. This assumes that their definition of an active user is an MAU.

Daily Active Application User

• Definition: – a daily active user (DAU) for a given application.
• Usage: – this distinction is critical when evaluating publisher pipelines and their ability to deliver the next hit. Too often a publisher will talk in terms of daily active users, instead of by application when the user numbers are highly imbalanced.

Google has made in nearly impossible to decode the number of daily active application users on Google + much like a publisher would in terms of hiding a poorly performing title in light of the overall size of their audience.

Paying User

• Definition: — where the rubber meets the road for usage. There is no ambiguity with this definition.  The Penny Gap post by Josh Koppelman makes this super clear — getting a user to pay anything is like getting a user to pay alot. The threshold to payment is enormous.
• Its the bellweather definition for the freemium and gaming markets. Companies like Dropbox and Evernote pride themselves on understanding the conversion vectors for subscribers. Companies like Zynga and their public market investors care deeply about those same vectors as episodic virtual goods buyers not subscribers. the
• Usage: — Paying audiences in social games are often 1% or less of the total monthly active user population. Zynga claims 3% of their MAU’s are payers and also claims that they think they can double that % in the near future. Freemium companies see anywhere between 1-4% conversion rates to paid accounts.

The definitions above are worth billions. Getting your terms wrong either inflates or deflates the economics of the internet property you are engaged with. Google knows these definitions as well as anyone. Their glossing over these variances makes us ask, “What else are they hidng?”

Rather than help switch me to a more efficient and better user experience online, catalog companies like Chefs want to using negative reinforcement systems to make me respond.

Why Would I Want This Offer?

We received this catalog over Christmas and it is typical of how disconnected catalog companies are from a changing customer base.  It’s as if Chefs has forgotten that the digital world is upon us.  They are trying to use negative reinforcement to get me to keep getting a their catalog, as if it were a magazine. I am not an active customer. If I don’t buy something, they will stop sending me a catalog. How are they missing the mark?

Threatening Me is Not An Inducement

We obviously have not purchased from Chefs in a while. And they are reminding me that. Ok. So what is the inducement for me to become an active customer? The threat of not getting their catalog.

Catalogs Hurt The Environment — Appeal to My Eco Sensivities

Chefs clearly does not understand my eco sensibilities. Catalogs consume tons of paper, which consume trees which we all know are key to a healthy environment. So why would I want a catalog sent to me knowing it has wiped out trees in the process? Clearly, Chefs does not understand that I want to eliminate catalogs.

Anyway, Digital is a Better User Experience Than Catalogs

I have better search options, better content descriptions, better comparison shopping.  I can see what my friends have purchased online. Why would I want to browse through content that is not curated especially for me, that does not display user reviews or to learn more about the product and context for its use.

Digital is better, better, better.

Induce Me, Don’t Threaten Me to Become an Active Customer

We are living in an information intense, transparent economy. No one has an exclusive lock on products. Customer loyalties are easily lost and very hard to win. Induce me to become a customer. Don’t threaten me. And don’t threaten me about something I don’t care about.

By the way — free shipping does not count as an inducement. Its an expectation not a reward.

Amazon Price Check App and Showrooming

The furor over the Amazon price check app is palpable and speaks to the growing trend of showrooming consumer behavior. No sooner did I download the app but I bought 3 products from Amazon through the app because the product costs were 30% less than the big box store I was in.

The app and likely responses reminds me of the discussion in Modern European class surrounding the various political positions taken in response to German and Japanese aggression during World War II. Similarly, retailers have been bombed/attacked. How will they respond?

Response #1 – Isolationism — Ban Wifi In the Stores

The harder you make it to surf the web, the less surfing will take place. In reality, the furor that would arise from this act would dwarf the potential lost sales by customers leveraging the Amazon offer. Our past geo=political attempts at isolationism have never worked. Neither will it at retail.

Response #2 – Isolationism — Make UPC Codes Not U

If you make the codes all different, price comparisons won’t work, or so goes the theory. In reality, Amazon will simply release a version of the app that allows you to scan the product tag and all of its content (name, price, etc) and then comparison shop. Its a technology war that retailers cannot win.

Response #3 – Chamberlain’s Appeasement Policy – Become Affiliates of Amazon

In a great ironic short post, by Hunter Walk, he deftly suggests that retailers should become Amazon affiliates. Better to switch than fight the inevitable onslaught of Amazon.

And for some retailers, this might think makes sense if they can get storefront cheap enough since Amazon’s affiliate dollars are so relatively thin. Perhaps the retailer could also be compensated by the product companies, much like in grocery. Between the product subsidies and the affiliate dollars, the small retailer might net enough to stay in business assuming very low rent and staffing costs. Now that I think more about this, this would be tough to make work economically.

Response #4 – Internationalism — Fight Back with a Highly Differentiated Set of Products/Services

The US entered the WWII with a highly motivated and energized effort that turned the tide of the war (overly simplistic, I know).  Here are three ways retailers can and should fight back:

1. Deliver differentiated products
1. Build something that Amazon can’t sell. This is a well-known strategy being accelerated.
2. Differentiate by crowdsourcing design (ala threadless.com, or cafepress.com or quirky.com).  Short of full product design, you can at least get ideas, much like the GE Ecomagination Challenge where ideas are vetted to figure out what to build.
2. Leverage a high-touch offline and online customer experience with an optimized supply chain back-end, neither of which retailers offer today. Everyone knows of a store in their locale that has survived the big box onslaught by knowing their customers, tailoring their products via collections to a highly targeted and segmented audience. Instead of one size fits all, its a one-to-one, curated experience. Retailers can and should better leverage their store data to deliver targeted, curated products one to one.
3. Embrace Online as Your Best Friend, not a Distant Cousin
   Retailers treat online too often as a remote relative. In part, this is due to lack of digital experience found in most retail management teams, who naturally play to their strength. Two simple ways to start leveraging the power of online:
1. Build a loyal community online
   Amazon is a super shopping center, not an online community. Invest in building community because loyalty is a great offense that serves as a perfect defense.
2. Make Online Your Petrie Dish
   Use online to test merchandising concepts before you commit resources. Use  interactive polling and surveys that engage the existing and potential community. As if often the case today,  online must follow the direction of the stores. How stupid is that? Its like fighting with one arm tied behind your back. Of course, online will fail.

No matter what, a retailer’s best and only defense to this front assault is a strong offense.  Embrace online and the customer and perhaps retailers have a chance. If they retreat, retrench and irritate the customer,  they will be guaranteed to end up in bankruptcy court.

The Future of Daily Deal Sites: IPO and Bust?

The IPO of Groupon has raised serious questions about the future of daily deal sites. The doomsayers say the model does not work. The optimists say that there is lots of headroom left — lots of businesses yet to try the model.

But in reality both are right — the model is broken but there is lots of opportunity in current and future customers.

Why? Simple — Small business remained untouched by technology companies.

Sure we have great companies directly hitting this market like Constant Contact run by the very smart Gail Goodman, and Hubspot, founded and run by two super sharp entrepreneurs, Brian Halligan and Darmesh Shah, as well as numerous local plays, including the fast growing Yodle, again run by a very good friend, Court Cunningham.

Lots of Headroom

But none of these companies have anywhere near a dominant position in the space. Constant Contact, the largest of the technology SMB plays will grow to about 512,000 customers according to some recent analysis against a total population of nearly 4.6 million companies with between 1-9 employees according to the 2008 Census.

Broken Model

No one seriously believes that Groupon can sustain the high churn while taking 50% of the revenue from the SMB. And their stock price of $22 well below their high of $31 and their opening of $26 reflects that sentiment. With a cost of acquisition for a registered user of $5.00 and a buying user of $26 with no loyalty or recurring subscription model, their breakeven point is both much higher with much higher churn potential than a Netflix, who can rely on customer laziness to at least stay with the program for a while.

And with competition from Living Social and every publisher under the sun, it is easy to see how their margins will not be sustainable, only raising their breakeven point even higher.

Its About Stickiness — Radiate After You Penetrate

But there are some very smart folks at Groupon, including guys like Brett Keintz, who understand that their sheer scale will not suffice. 30 million customers means nothing in the digital space. See Myspace for how quickly 250 million people flee a digital property.

Having penetrated the SMB market, Groupon’s big challenge is to radiate through that business and add more value that makes them sticky to the SMB.

One obvious step that they have taken is to help business owners get control of their business calendar. The small business calendar is the SMB’s revenue. Every hour is revenue to service-based SMB’s which seem to make up a significant component of Groupon deals.

Enter Groupon Scheduler

Its no surprise to those of us who have looked at or spent any time in the SMB space. Appointment scheduling is an SMB’s worst nightmare. Some try using Google Calendar. Others try to buy third party solutions. But the ROI on these products is often intangible.

Until someone like Groupon ties their calendar directly to their revenue. Groupon’s announcement earlier this month makes it clear how they are trying to radiate and create stickiness for the SMB.

“Both consumers and merchants get immediate email confirmation of each booking, as well as automated email reminders 24 hours before scheduled appointments. Merchants can also add a “Book Now” button to their own website and use Groupon Scheduler to manage online bookings for all their services – not just those offered through Groupon”.

I predict that this application will do more to endear SMB’s to Groupon than just about anything else, short of substantially dropping their revenue cut. There are lots of extensions that can come from this core product but adding value to the SMB is a big step in the right direction.

I was surprised to see the following tweet from Fred Wilson

“Replace the words “job offer” with “term sheet” in @spolsky’s post and the advice is still spot on http://t.co/2MNZUIKZ”

Out of curiosity, I took a look at the Spolsky post and I was surprised by the advice he gave regarding exploding offers.

For those who don’t know what they are, recruiters will often use a deadline to force a candidate to make a decision. Spolskly’s made the two first points, helping candidates navigate this process. But his third point, made my blood boil:

“3. In the rare case that they don’t accept that, accept the exploding offer at the last minute, but go to the other interviews anyway.”

Wow. Fight the unethical recruiter with unethical behavior.  Accept the offer verbally, but be willing to go back on your word if you find a better offer.

And Fred seconded that for term sheets!!

How do Fred and Joel justify this behavior? If our word is not our bond, how do we interact with employees, board members and friends? Do we decide when our word is our bond based on who we are speaking with? Perhaps if our life is threatened would we lie or change our verbal commitments, but in every day business.

Having been on the receiving side of a candidate who verbally committed and then backed out, I would not wish that on anyone else.

There are risks in life. Risks in saying yes too soon, and risks in waiting too long. That’s life.

But there is no risk worth taking that damages your reputation. You only have 1. You can always get another job.

Many have suggested that the Rep Weiner scandal points to the famous Lord Acton saying  – “power corrupts and absolute power corrupts absolutely” — Lord Acton.

But there is another lesson to be drawn from his embarrassments.

Technology has brought the Town Square back in a virtual, but very real way.
In the days of Yore, everyone in a town knew the business of everyone else. Bad behavior was kept in check because everyone knew the business of everyone else. Your entire network was well defined and ubiquitous. You could not hide.

But the the 20th century enabled anonymity. We were more mobile — and could run from our troubles.

We were more nuclear and withdrawn from our larger family and community. Housing went from generations living together to only direct families living together.

We had new media in our homes – to keep us entertained alone. Telephones and newspapers replaced gossip as the prime communications tool. Why bother trying to learn what your neighbor was doing when you could learn what a country half way around the world was doing.

But the 21st century and social media is bringing the Town Square future from the past. The interconnectedness of the web and social media applications make it nearly impossible to hide, unless of course you opt out of all such interaction. Weiner’s naivete (or his cyring out for help) suggests that the Town Square of social media can and will bring down anyone in power who abuses that it, even when that abuse does not actually violate laws, but accepted behaviors.

Will this interconnectedness bring with it an improvement in our social interactions?  Will social media continue to erode  the anonymity of your actions?

As Rep Weiner has learned you can lie, but you cannot hide.

I have had this post ready for months, but never sent it off.

I am bummed to have to admit that I am shutting down Hangout – the first 3D experience on Facebook. The original vision of Hangout started in 2006 around the notion of media sharing with your friends and leveraging api’s on Facebook that were not even public yet. I raised capital quickly from world-class VC’s, built a team, became a Techcrunch 50 finalist, pivoted, raised more capital from those same, patient investors, hired a new team, re-launched  - and yet nearly 4 years after coming up with the idea — I am shutting it down.

This was not my first company, but it was my first failure. What went wrong?

1. Its as expensive to be too early as it is to be too late to a market
   Do you know the saying, “Don’t go shopping on an empty stomach?”. Well my vision was much bigger and more optimistic in terms of timing than has occurred. I was convinced that teens in virtual worlds and on Facebook would prefer full 3D with all of its higher quality animations and immersive behavior over flat flash games. Although no one had yet demonstrated success leveraging 3D in a browser, I was convinced we could.We were a very early adopter of Unity — a browser-based 3D game engine, which eliminated the need for a big download, which in turn should have improved our conversions compared to heavyweight downloads like Second Life.

   And we could prototype the experience very quickly, which only got our investors even more excited (see below raising too much money too quickly).Little did I fully realize that any sort of download increased the user dropoff dramatically and put even more pressure on building a successful user experience (virtual world or game).  The economics of increased dropoff gave me and my teams no room for error. We had to thread a needle. No margin for error. Every user who got through the download process had to be far more engaged than a typical flash game player — and as I describe below — that was not the case.So what do I take away from being too early? Well, the lesson is actually more sublime. In fact, earliness is a symptom of a more fundamental challenge with startups.Add to the dropoff challenge, Facebook changed their virality algorithm, effectively tripling the cost of acquiring new users to the game.  Whereas a decent viral game could acquire 1 or more users for each player that entered the game, the new Facebook logic reduced the virality to 1/2 to 1/3 of a user for each new user, dramatically increasing the cost of growing your userbase.

   LESSON #1– If you are early, do not differentiate on too many variables at the same time. If you look at some of the great successes, the variation on their first product was on one, not two or 3 axes. Maybe the differentiation is on technology or maybe on function, but rarely both at the same time.For Google, it was better search than Lycos or Yahoo – the base function was the same — searching the internet —  it was the technology that was different. They did not come out with Adwords, etc., until they had proven that their core product was better and audiences wanted it. For Facebook, it was a friend-driven social experience than MySpace. There was no technology risk to Facebook — just feature risk. For Mint, it was about making a web 2.0 version of Quicken. The functional concepts were well understood — it was the technology risk of getting users to trust a web service with their financial data that was the risk.

   I am sure all of these analogies break down at some point, but I believe that the underlying differentiation of each of these examples was on 1 not multiple axes.If you are going to differentiate on both technology and product, you better have a pile of cash and lots of time because you will need it to isolate the variables that are causing success or failure and focus on those. The more variables in play, the longer it will take to isolate the key variables and find product/market fit.

2. In gaming, the location of your team makes a huge difference
   Team and Location — Building Facebook games, the team needs to be near the ecosystem – SF/Palo Alto. Be as close as you can to the epicenter of the business, especially if you are leveraging a platform that changes frequently, such as Facebook where exploitation of the rules was an art form and begging for forgiveness was easier than asking for permission. For some platforms, location itself near the platform is irrelevant.  For platforms like Apple where the rules are well established and seem to be consistently applied, location is less critical. Everyone is at the same disadvantage regardless of location.

   Sure some have thrived outside it, (Wooga comes to mind), but the inside knowledge and the whirl of activity of the last 3 years in this space has meant that if you were not out there, you were at least 1-2 months behind your competition in deploying the latest tactics and learnings.

   LESSON #2 Don’t underestimate the power of location when building your next company.

3. In gaming, your team’s domain experience matters alot –
   Despite warnings by one VC to the contrary, I was supported by many who said that I could build the team here in Boston to build the first version of Hangout — a media sharing platform and virtual world. Boy was I wrong. I don’t mean to beat on Boston, but the virtual world and gaming market, and especially Facebook gaming, is not an obvious strength.I hired a smart web team because I believed that the experience was about web first and gaming second. But I was wrong. To attract and retain customers, we needed increasingly good game designs and game designers.  Beyond poking or throwing sheep, Facebook games have increasingly required good game designers. I just never got that memo.And even when I pivoted and moved the company to LA to work under a well-known general manager out of Disney and his team, I still did not understand the difference between a top game designer and a GM or a Chief Creative Officer or whatever other title you want to make up.
   
   LESSON #3 — Make sure you have team strength in the domain you are going after. If its gaming, make sure you have a top quality, experienced game designer. If its a consumer app, make sure you have good UX strength. If you insist on learning on the fly, expect everything to take much longer and consumer more capital than you planned. And that is on top of already doubling the time and capital of your original forecast because you will always be wrong in your first forecast.
4. The more money you raise, the higher the expectations and the shorter the time frame to hit those expectations.
   VC’s need to make a return on their capital. They have Limited Partners that they have to answer to. The more capital they give you, the more they expect you to put it to work. You raising it and banking it is not what they want. The capital should be put to work.There is an old saying raising capital that says you basically can never raise too much money. That is not always the case. I raised too much in my Series A on the expectation from my investors that I would use it. Short of an economic downturn (which also happened), VC’s expect you to execute on the plan they invested in.If  you change direction,  they are usually willing to go along with change (see Pivot lesson below), but you need to know how to pivot.

   But I had a more basic problem — I was not ready to spend the money because the product was not ready to be scaled. It had not achieved product/market fit when I got the capital.  So instead of using the money to begin scaling, I was using it to build the product. That is not what a Series A investment is for and I think most investors would agree after the 2007 investing bubble burst in 2008.There still remains the question of whether you should raise seed money from VC’s. Again I would come back to the expectation cycle of the VC’s. Unlike most Angels, most VC’s must answer to their LP’s. Thus, I have a hard time believing that VC seed investing is a pattern for the future. The pressure to grow a seed is as great as growing a Series A company with a lot more product risk and insufficient amounts of capital to make their returns to their LP’s (Fred Wilson has a great blog post on the outsized returns needed on large funds).LESSON #4: — Raise money from VC’s when you have Product/Market Fit.

5. If and when you pivot, pivot hard and fast.
   Back in early 2008, I had the idea to build a Facebook game that would showcase our differentiation — 3D, physics, etc. I built a prototype basketball game and showed it to a bunch of WC entrepreneurs who were in the Facebook ecosystem. They were blown away and said I should do everything I could to put this game on Facebook. I had also showed it to the NBA and they wanted to sponsor it — they offered to spend $250K to drive traffic to it. They offered all of their licensable content –uniforms, logos, etc. — for free!!I thought I had hit a goldmine. So I brought it up to the board and caught a bunch of questions about moving into the gaming market when my plan was to build a media-sharing platform.Now at this point, entrepreneurs who read this post might shake their fist and say, “See another company micromanaged by a VC.”THAT is not the case here. I made the critical mistake of pivoting too softly.I built the game and released it, but I did not have the cojones to completely pivot in this direction. I allowed perfectly reasonable questions to feel like commands, which was not the intent of the VC’s.

   Their job was and is to ask questions and to test my certaintude around the pivot.In fact, I was not yet convinced that Facebook gaming was where we should be. Was it a shiny new object, or a real, up and coming market? So when I explained to our team that we were going to build a Facebook game for the next 4 weeks instead of focus on our media sharing platform, I couched the work as an exercise, or prototype instead of as a full pivot.As a consequence, the game was built, but not with the complete devotion and energy that a startup needs to have when building for a market. It was a half-assed attempt to experiment. And after the game was built around March Madness, we abandoned the game as soon as the NCAA playoffs were over and went back to building the virtual world/media sharing platform. A big opportunity was missed because I did not act out my instinct. I allowed a few questions to build uncertainty into my head and avoid the hard decision of changing direction.

   LESSON #5 — When you pivot, pivot hard and quickly and don’t look back.

I had excellent VC partners and great team members — all of whom I would work with again, in the right circumstances, building the right product at the right time. Nevertheless, there are reasons that so few startups make it.  Even though you have ridden the horse successfully a few times, there is no guarantee that you will not fall off on the next ride.

There is an interesting piece in the Times today (http://nyti.ms/h8mNVf) regarding personal decoupling from the digital world. Its pretty well understood that too much of any one thing can be bad for you or your relationships, etc., and the immersive and all-consuming influence of technology in our lives is no different.

Not to sound religious, but this detachment from every day behavior points to the same impetus behind the Jewish Sabbath in the Old Testament. The notion of the sabbath was to change our rhythms which in turn would cause us to become more aware of ourselves, our relationships with each other and God and our surroundings.

The practical implications in our current society is that detaching from technology on a periodic and consistent basis allows us to focus on other tangible elements of our lives — family, friends,  those less fortunate than us — as well as intangible components such as our purpose in life and faith in higher powers, etc.

Lots of folks I know are beginning to implement either a formal sabbath (e.g. no work at all on Saturday or Sunday or mini-sabbaths (like the detachment from technology around certain activities).

I am trying hard not to do any work related tasks on Sunday’s. No email, phone calls, etc. from sundown Saturday to sundown Sunday. Will I suffer for it? I don’t think so. Will I and my family benefit from it? Absolutely.

Take a moment and evaluate whether a formal or mini technology sabbath is in order.

Old favorites die hard. The stink around Apple’s change to the Itunes logo is typical of the “what was wrong with the old one” attitude that can be so pervasive even amongst the earliest of adopters — technology junkies.

We are seeing this already in a number of web design layouts (see www.weather.com) and written here quite prophetically here prior to the Itunes 10 release.

Change is inevitable and while there are often change clunkers like “New Coke” (1985), the reality is change in design is usually a good thing.

Whether we like the design or not, expect to see much more flat coming out in the next year.  Steve Jobs continues to influence our design paradigms, whether we like it or not.

I really enjoyed the Boston Angel Boot Camp on June 1. A shout out to Jon Pierce for a job well done.

Among the many great discussions, the most critical one in my mind centered on the impact that the source of money can have on an early, seed startup. The discussion covered two main sources of seed funding: Vc and true angel.

What’s different? Isn’t seed money just seed money?

Absolutely not. There are hugely different expectations around returns and time depending on the source.

• Return Expectations — VC Moonshots
  • Vc’s have much bigger war chests than angels and are paid to deploy and return that warchest and more to their limited partners (investors to VC’s).  They need to deploy large amounts of capital with strong returns in order to be a great performing fund. Typically they need to return 3x their fund size in order to give their investors and themselves a decent return (See Fred Wilson for a clear concise explanation of this). Therefore, they look for 10x returns of the capital they invest, understanding that few of their investments really hit that number. But they shoot for the moon knowing that one or two moon shots make their entire fund’s return. Those moonshots can cover a multitude of sideways performers.
  • Ok you say. 10x is very cool. Yeah, but not to the VC or the LP’s of a VC. 10x on $ 1 million barely moves the needle on a $400 million fund that is supposed to return $1.2B. VC’s can’t afford the time to spend only $1 million for a 10x return. They can only handle so many companies (usually 7-10, max at a time). For a company to have an impact on their return report card to their LP’s they want/need a $4-10 million investment returning a $40-100 million return on exit or IPO in order to even begin to move their investment needle with their investors.

• Time expectations
  • If the investment size isn’t enough of an impediment, the time horizon for most funds adds a second blow to the chest.  Typically a VC looks at an investment within a 5 year window in order to return capital plus a return to their limited partners. If the portfolio company is not on the road to IPO or exit in 5 years, the investment falls into the “sideways” category. The situation can be fixed and result in success (as in Pandora) or end up in trouble and either a sale of assets or simply closing the doors.
  • Most seed investments, however, are just that — seeds. Not sprouts or full grown plants, just seeds. Depending on the trajectory, the seed can grow quickly, but as we all saw and conjecture with CRV and Twitter, the first year or so of operations, I suspect, was relatively unconvincing and caused CRV to drop out of the subsequent funding process.  While hindsight questions that decision, its more easily understood when time expectations of the VC are accounted for.  My guess is that CRV did not see a trajectory that would get them to a strong exit in a 5 year window.

Where does that leave entrepreneurs looking for seed capital (< $1 million)?

• Look for seed money from angels.
  Most seed investments are not best done by VC’s. Their timelines are too short and money requirements too large. Most seed companies have not proven anything yet. Certainly not anywhere near enough to show a trajectory to exit in 5 years consuming millions of $ in capital with great valuations along each stage. Think of a seed as sparks of a fire with a few kindling type pieces of wood — barely heating or lighting anything.
• Look for seed money from a few highly experienced angels in your sector
  Money is not money in the angel world. Find angels who understand your business and/or demonstrated success operating, managing or investing in similarly inclined businesses.  Whereas a VC can straddle many widely varying disciplines, angels have a hard time usually because their angel business is not a full-time job.

  The impact, positive or negative, that an angel can have in the early stage of the company’s life is enormous. I liken it to the rocket ship analogy. On launch a change in 1 degree of the rocket’s trajectory can be the difference between landing on the moon or the ocean. A small change in trajectory has a huge impact the earlier the rocket’s launch trajectory. Same holds true for startups.

• VC’s are best in post-seed investments (Series A and beyond gigs) where the amount of invested capital is significant and the timeline to exit is predictably shorter. The product is built and customers like it and are paying real money for it. Dilution is usually more manageable, since the product is in the market and generating traction.Another apt analogy here is fuel and fire. A series A company looking for venture capital  should be like the fire that has shown its promise, but needs more wood/fuel to expand its impact. The size of the fire and the amount of wood needs to be proportionate so that the fire does not get choked out with too much fuel or starved to death with too little.

So there is a difference in the kind of money you raise for your seed startup. Find angels who have experience in your business sector and make sure that they have the time to help you. Avoid “spray and pray” angels. They do not have the time to help. Talk to VC’s when you have viable product so that the negotiations and onward growth are more on your terms than theirs. VC’s add great value, but you must know when to apply them to your company’s growth trajectory.