Freshwater Investor

Degree of Difficulty

Fred Russell — Fri, 27 Jan 2012 20:03:56 +0000

When recruiting for your next startup adventure, consider the job description and degree of difficulty recruiting for Shackleton’s voyage to be the first men to reach the South Pole in early 1900:

“Men wanted for hazardous journey. Bitter Cold. Long months of complete darkness. Constant danger. Safe return doubtful. Honour and recognition in case of success.” –Ernest Shackleton

2011 Private Equity Stats

Fred Russell — Wed, 25 Jan 2012 22:15:34 +0000

The Pitchbook data for 2011 is included in the PDF below. It shows total private equity deployed fell by one third to $100 billion in 2011 from $150 billion in 2010 and down precipitously from the 2007 peak of $570 billion. The amount of “dry powder” held by private equity firms was $60 billion at year end 2011. The average hold period of a portfolio company was nearly 5 years old (up from 3.5 years in 2007).

exerpt PitchBook_PE_Trends_4Q2011_Presentation_Deck

The Pitchbook data book showing private equity results since 2000 is included in the PDF below. One of the more interesting factoids is that the median private equity purchase multiple in 2010 was “only” 8.3x EBITDA (to put that number in perspective, you can purchase Johnson & Johnson today for 8.5x EBITDA, get a global franchise and collect a 3.5% dividend).

Exerpts from PitchBook_Decade_Investments_2001_2010-1-3

Startup Capital: Feast or Famine

Fred Russell — Mon, 23 Jan 2012 21:29:58 +0000

Is there too little risk capital for entrepreneurs? We hear this a lot and we generally agree that the answer is yes. Great post from here. Summarized below.

For years there has been a pervasive opinion across the entrepreneurial landscape that the US has a shortage of capital required to startup and grow new ventures. It is suggested that companies cannot find the cash necessary to start new and exciting ventures. Furthermore during this economic downturn, we’ve heard a crescendo of voices lamenting the lack of startup funding, as communities finally recognize that new companies are the key source of job creation in this country. But, what evidence do we have of this shortage of capital?

New Company Formation – According to the Kauffman Foundation, entrepreneurs start about 700,000 companies per year in the US. Dr. Carl Schramm, Kauffman CEO, recently said that startup formation is stagnant or even decreasing in the US in the second half of 2011. So, we are clearly not experiencing an upsurge in new company formation today.

Sources of Capital for Startup Entrepreneurs – The primary sources of cash for new companies are (1) self (the entrepreneurs’ resources), (2) government grants, (3) friends and family, (4) angel investors and Super Angels, (5) venture capitalists and (6) strategic investors. We have no measure of the changes in available capital resources from entrepreneurs and their friends and family, but we have no reason to believe they have changed radically over the past few years. Strategic investors tend to be later stage sources, and will not be addressed here. Let’s take a closer look at trends in government grants, angel investment and venture capital financings.

Several sources (including Startup by Elizabeth Edwards) estimate that $2-3 billion per year is awarded to very early stage companies by federal government grants (mostly SBIRs). At $100,000 or so per grant, perhaps 2-3000 pre-seed and seed/startup companies receive SBIRs and other government grants per year. Furthermore, total federal grants to very early stage companies have been increasing over the past few years.

According to the Center for Venture Research, The Angel Investor Market in 2010 was about $20 billion and funded about 60,000 companies, with about one-third of that capital committed to seed/startup stage companies. Total angel funding in 2010 was up somewhat, but has ranged from $15 to $20 billion for several years. The fraction of angel capital committed to follow-on and later stage investing has increased over the past five years. But the number of seed/startup stage companies receiving angel capital has been rather steady at 20,000 to 25,000 companies per year.

The Angel Resource Institute recently published the first definitive study, to my knowledge, of Super Angels. While the authors made no attempt to estimate the total impact of Super Angels and their Micro-VC funds, I will attempt to do so. It appears to me that there are about 100 Super Angels in the US. On average, they are investing $1 million or more per year into perhaps five companies each, most of which are seed/startup stage companies. So, we think about 500 seed/startup companies are receiving at total of $100-200 million annually from Super Angels.

According the MoneyTree© about 2% of venture capital has been invested in seed/startup stage companies (perhaps 400 companies per year) in each of the past five years, with no obvious trend towards a decreased commitment to this stage. There is anecdotal information suggesting that VC investment (perhaps outside the MoneyTree© survey) in the earliest stage companies is increasing somewhat today.

In summary, it would appear to me that 25,000 or more companies are successful in raising seed/startup capital in the US annually. Furthermore, with the recent activity of the Super Angels and trends in government grants, angel financings and VC investment, one could conclude that the total US volume of seed/startup investment is increasing.

We have an additional indication of “money chasing deals” (a lack of fundable startups, not a shortage of startup capital) as measured by the competitive environment in the more active US entrepreneurial communities. A recent informal survey of angel groups indicated that valuations are highest in Silicon Valley, New York City and Boston, which are arguably the most entrepreneurially active communities in the US. Furthermore, the survey indicated that seed/startup valuations all over the US have risen in the past year, and especially in these three markets. As we know from elementary economics, scarcity is one cause of increasing prices – in this case, lots of seed/startup capital looking for investment opportunities with too few qualified entrepreneurs.

It is pretty clear to this observer that the formation of companies is rather steady and the capital available to fund those companies is increasing. There does not appear to be a scarcity of capital for seed/startup stage companies that can qualify for funding. Could it be that shortage of capital is only being reported by those entrepreneurs whose ventures do not qualify for seed/startup financing?

State of Entrepreneurship Address

Fred Russell — Mon, 23 Jan 2012 21:27:43 +0000

The third annual State of Entrepreneurship Address, “A Roadmap for State Growth,” will be presented by Carl Schramm, president and CEO of the Kauffman Foundation, who will discuss effective, low-cost ways of promoting entrepreneurship and innovation at the state level. Lunch and a panel featuring state policy experts, including two governors, will follow. Event will be held on February 9, 2012 at The National Press Club in Washington, DC

Kauffman Economic Blogger Survey Q4 2011

Fred Russell — Mon, 23 Jan 2012 21:27:07 +0000

The Kauffman Foundation posted its Fourth Quarter 2011 survey of leading economic bloggers as a means of gaining inside perspective on the direction of the U.S. economy. You can download the report here in PDF.

Economics bloggers are pessimistic in their outlook on the U.S. economy with 96 percent believing economic conditions are mixed, facing recession, or in recession. 35 percent think the economy is worse than official statistics indicate and only 8 percent believe it is better.

Millionaire Tax Impact on Entrepreneurs?

Fred Russell — Sat, 21 Jan 2012 01:05:02 +0000

Would small business owners would be impacted by tax increases on those earning more than a million dollars? It is well know that the vast majority of U.S. millionaires have some ownership in a business of some sort. Most derive a large portion of their wealth from from a private business. A study by the Office of Tax Analysis found that there were 392,000 tax returns with adjusted gross income above $1 million and of those 273,000 returns (nearly 70%) were defined as “small business owners”. Law of unintended consequences.

Startup Tips from Walt Disney

Fred Russell — Sat, 21 Jan 2012 01:03:54 +0000

Great advice to entrepreneurs from one of the most successful startups ever.
See the full piece here.

1. Pressure Helps You Break Through Your Breakdowns. According to Disney: “Mickey Mouse popped out of my mind onto a drawing pad 20 years ago on a train ride from Manhattan to Hollywood at a time when business fortunes of my brother Roy and myself were at lowest ebb and disaster seemed right around the corner.” Singer/songwriter Jim Croce wrote several top ten songs immediately after learning that his wife was pregnant. A struggling musician and itinerate truck driver, he was concerned he would be unable to adequately provide for his wife and unborn child. Entrepreneurs constantly experience breakdowns, followed by breakthroughs. Properly channeled, stress can help generate the energy and creativity required to move you from one breakthrough to another.

2. The Four C’s You Need To Follow Your Dreams. Walt’s Four C’s of Dreaming are: “Curiosity, Confidence, Courage, and Constancy and the greatest of these is Confidence. When you believe a thing, believe it all the way, implicitly and unquestionably.”

3. Money Does Not Lead To Happiness, But Happiness Can Lead To Money. A common theme among successful entrepreneurs is that making money is not a primary motivator. Money allowed Walt to do more of what he loved to do, which was create entertaining content. As he once said,”I don’t make pictures just to make money. I make money to make more pictures.”

4. Wear A Mouth Guard. “You may not realize it when it happens, but a kick in the teeth may be the best thing in the world for you.” Friendly constituents will not sustain your startup. You must convince dispassionate, objective customers that your value proposition is worthy of their cash. Along the way, you will receive a number of elbows to the face, jabs to the jaw and kicks in the teeth. Such rejection and setbacks should motivate, not demoralize, you. A kick in the teeth only hurts if you let it.

5. Color Me Curious. “We keep moving forward, opening new doors, and doing new things, because we’re curious and curiosity keeps leading us down new paths. When you’re curious, you find lots of interesting things to do.” Great entrepreneurs are intellectually curious. To such enterprising souls, the inherent ambiguity of a startup is thrilling, rather than daunting. Accomplished entrepreneurs are curious about their customers’ desires, competitors’ future strategic directions and their industry’s technological trends. They relish learning. Entrepreneurs are life-long students…. always learning, because they are curious.

6. Entertain Yourself. “We are not trying to entertain the critics. I’ll take my chances with the public.” Startups cannot afford to mistake what has gone before for what lies ahead. If you have an adequate understanding of your customers’ needs and the direction and pace of technological change, you will skate where the puck is going.

7. Promise Brands. Walt considered every facet of his operation as an opportunity to reinforce his brand, rather than dilute it. According to Walt, “Anything that has a Disney name to it is something we feel responsible for.” Understand your brand’s promise and work diligently to deliver on it with every new sale. One of the reasons the Disney brand remains so powerful is that it fulfills a big promise. You may not provide your customers with the, “Happiest Place On Earth,” but your brand’s promise should still be bold and compelling.

8. Conventional Wisdom Is A False Constraint. “When I started on Disneyland, my wife used to say, ‘But why do you want to build an amusement park? They’re so dirty.’ I told her that was just the point — mine wouldn’t be.” Entrepreneurs are not constrained by today’s world. Rather, they envision a world the way it should be. Like many successful entrepreneurs, Walt destroyed his competition by changing the rules of the game rather than abiding by the industry incumbents’ conventional rules.

9. Just Start. “The way to get started is to quit talking and begin doing.” The best advice in Guy Kawasaki’s The Art of the Start is on page 9, “Get Going.” Start. There is little likelihood that your initial value proposition will be the one you ultimately pursue, but you will never find the intersection of your core competencies and the market’s desires if you do not get started. What are you waiting for?

Raising Angel or VC Financing

Fred Russell — Sat, 21 Jan 2012 01:02:45 +0000

Two good slide decks from Slideshare about raising money from VCs or angel investors. See here. and here.

Growth vs Profits

Fred Russell — Sat, 14 Jan 2012 17:58:51 +0000

Which is better a rapidly growing startup that loses money for many years or one that gets profitable quickly? The answer is largely one of personal preference. The investor’s risk tolerance will play a key role. The table below sets forth an example of two startup companies. The first grows rapidly but loses money for three years. The second reaches break even in year two and makes money thereafter, but doesn’t get nearly as large.

Most VC’s will, I think, invest in the first company. I prefer the second. Here’s why.

First, the top company has more risk and requires more capital — it loses money for three years and consumes $5 of capital whereas the second company loses $1 and breaks even in year 2. The top company also requires a 75% growth rate (which is astonishing); the bottom one requires a healthy growth rate of 25% which seems more achievable, all other things equal.

Second, the top company generates $19 million in total profit on $5 million of capital (roughly 4 to 1); the bottom company generates 6 to 1 in cumulative profits to capital. So the bottom company can distribute $6 for every $1 of capital compared to only $4 for every $1 for the top startup.

Third, a year five exit generates returns that are equivalent. Using a 5x exit multiple, the top company generates $75 on $5 invested or 15x. Using the same math, the smaller startup company generates 15x ($15 on $1 invested).

Startup Act du jour

Fred Russell — Sat, 14 Jan 2012 07:51:44 +0000

Practically every U.S. congressman has introduced legislation aimed at small businesses.
U.S. Senators Jim DeMint (R-South Carolina) and John Barrasso (R-Wyoming) introduced the Startup Expansion and Investment Act —legislation that would provide new and growing companies with relief from the costly regulatory burdens of the Sarbanes Oxley Act of 2002. Who could oppose less regulation on small businesses? As we previously discussed Virginia Senator Mark Warner sponsored the Startup Act. Once again this stuff should be unopposed. Even Obama is trying to get closer to small businesses. He recommended that the director of U.S. Small Business Administration become a cabinet level position. Essentially giving small businessmen a seat at the table.