3rd Ave, San Mateo, a beautiful May morning, as I biked into work today…
As you may know, we’re only just getting around to setting up Zolo Labs properly. We’ve been rather lax about this… even though we had established the entity way back in May of 2012, we only opened a bank account as recently as January this year.
One of the many important things you have to do for a new company is to select a law firm, and thus someone as your general counsel. This selection is important, because you don’t want to end up in situations that could have been avoided if you’d just worked with someone that knew startups and VCs and the various issues that often come up (or even those that come up not so often).
So the way things worked for us was that we got introduced to a few top law firms in the Valley. We don’t know a heck of a lot about lawyers and how to tell if one is good. Still, we decided we’d meet with a few folks, and see how things went. We felt this was important, because it’s likely we’ll work with this person for several years. In the end we ended up having multiple meetings with each firm – first with a partner, and then with the team that would be working with us.
Well.. being some of the top firms in the Valley, they all came across very well – highly professional, highly competent, and very well plugged into the eco-system. All of them offered a fee deferral, owing to the fact that Zolo Labs is pre-funded. They all try to be as helpful as they can, and they all offered to introduce us to their favorite VCs, relevant potential partners, etc. No law firm requires equity these days (for either fees or in exchange for the deferral), and many offer project billing (instead of straight up hourly fees). Most often, they also don’t charge to attend your board meetings.
Since they all offered more or less the same services, and they were all very good, it became really hard to make a selection based on any sort of objective opinion. We finally went with the partner who was most interested in our products and the vision for our company. In the end, there was no other way to choose – and we chose based on how excited they seemed to work with us. This is how we ended up with Goodwin Procter.
As things continue to progress, our plan is to continue to update our readers here. We have a certain philosophy when it comes to building our company, and we’ll share a little bit of that in the next few posts…
Our vision for Zolo Labs is an ambitious one: we see a suite of services that interoperate and solve common problems in our information overloaded lives, particularly in the enterprise. Having said that, we’re completely focused on Zolodeck just now.
This one service itself is fairly non-trivial, having not just to deal with a ton of data (multiple email inboxes, multiple social networks), but it also needs to process it quickly in a variety of ways, and then present information so that it can alleviate the communications overload problem. After all, an automated, personal relationship manager needs to be real-time, contextual and relevant, intuitive, and helpful. And fast.
The project is a ton of fun to work on, but it is also, well, a ton of work, and it’s probably going to be hard for just Siva and me to do it all for an extended length of time. Especially as we start adding other data sources to the core of our engine (things like blogs, note-taking services such as Evernote, file-sync services such as Dropbox, etc.) We know we’re going to need venture capital in the future, so we’ve been doing a bunch of research on what it’s going to take, when might be a good time to go looking, and so on.
There’s a fair bunch of literature on all this out there… here’re some examples:
On further reflection, I think our way of thinking about this could be all wrong. We seem to be focusing on milestone goals so we can go talk to angels and VCs, instead of just focusing on the business.
Shouldn’t we nail the initial product first, figure out product/market fit, ultimately provide enough value that our users will pay us for the service? See if we can grow the business in this organic way? Then, after getting some understanding of how real our market is, etc., figure out what we’d need to do, plan for it, and think about raising money?
Or perhaps this business-first thinking is what the above posts really mean. Perhaps it’s the same thinking, just distilled into pithy one-liners of wisdom. “For an enterprise focused startup, thou shalt have at least $100K in annual revenue before seeking funding”.
Anyway, so our approach now is to focus on the product. As it should be, of course. We had launched an early alpha (henceforth referred to as Alpha1) in December last year. We were working on it during nights and weekends, so the code was less than ideal. Since March, Siva and I have quit our day jobs, and have been focusing almost full-time on Zolo Labs (still need to consult a bit, so we can continue to put food on our respective tables ).
Overall, we’ve only *really* been at it for the past 6 weeks or so, of which about a month was spent cleaning up our codebase to build a more stable foundation for going forward. And for the past couple of weeks, we’ve finally been working on adding product functionality. Phew.
So the plan is to do another external release in about 3 weeks time (with the original name of Alpha2). This time, we’ll be supporting not just Facebook, but also email inboxes (only GMail or Google Apps email for now). We’ll release to around 50 or so users, in order to gather feedback on the new features.
I’m guessing our thoughts about funding will take a backseat for a few more weeks. Let’s first see if we can get some traction.
I’ve been researching early-stage financings. I know I’ll soon be talking to investors, so I figured I’d better understand what the various options are and what they mean. I also thought I’d share my research with others, and so if you’re in the same boat as I am, then perhaps this post on the evils of convertible notes will help you
Before I started researching this topic, I always thought convertible notes were a great way to raise your first round of outside money. The benefits were touted by everyone who were supposed to be in the know:
- they’re faster to get done
- they’re cheaper to get done
- they’re easier to get done (term-sheets are simpler)
- they delay the pricing question so you have time and money to build out your company a fair bit before a price is set on it. That’s obviously in your best interest, since your company probably isn’t worth very much when you just start out
- everyone is happy, and there are no real downsides to this type of financing
Here’s what I believe now:
- it isn’t fair to the very people who take the most risk and believe in you before any one else did. Why? Because, the better your company does, the higher the price they pay for their shares. That just isn’t the right way to treat your earliest backers and well-wishers.
- this situation is why most convertibles now have valuation caps on them. So if you’ve raise 2M with a 8M pre cap, you expect to give away at most 20% of your company. And you’re probably cool with that, in fact, the higher the cap, the better, eh? But a cap is not a (minimum) valuation, so what if you later find that you can only find investors at a price of 4M pre? You’d have given away 33% of your company to those initial investors. Maybe that’s OK, but you no longer have a choice in this decision
- convertible notes also have a discount associated with them, so in the above scenario, if that discount was 25%, you’d actually have to give away 40% of your company, when you were only ready for 20%. Again, if you thought this was OK to begin with, maybe you’d be OK with it, but you’d no longer have any control on this decision either
These are the reasons that, as an entrepreneur, a convertible debt round is rather bad.
More than the financial reasons, though, my problem is with the misalignment of interests. I’m a very firm believer in partnerships. You want your interests perfectly aligned with your investors. Right? With a convertible round however, even though they wish you success, your investors would rationally hope for a lower price for your company, so their investment works out better. They’d want you to succeed, but not too much. They’d want you to succeed just enough to be able to raise a series A, and then succeed a lot more later. That isn’t aligned.
The color of all money is green, but you get a lot more from your investors than money. And this misalignment screws that up.
Even if it all works out in your favor, I really hate how it isn’t fair to your early investors. These folks took the highest risk, believing in your dreams and capabilities. Punishing them with higher prices isn’t what partnership is about.
So I now think it makes more sense to raise a priced round at a decent valuation. That’s what we’ll look for when we start looking for Zolo Labs.
P. S. – I’m obviously no expert in any of this, and am just getting started on learning about it. So take everything here with several huge grains of salt. Perhaps another thing is that if you’re a super-hot startup and everyone (knowingly) wants to get in, then I imagine it changes this model of thinking…
Everyone loves viral products. Certainly, the founders of companies that make viral products do, as do the venture capitalists who fund them. Heck, we’d love Zolodeck to be viral. And a lot of people like to talk about how to make viral products. In fact, just do a search for that topic on Google, and you’ll get way too many results. And most of them will offer more or less the same platitudes. These include:
How to compute the viral coefficient for your product. The formula basically points out that you should increase the number of new users each user invites, and then you should increase the conversion rate of those invited. Duh.
Build features that broadcast things your users are doing with your app through social networks such as Facebook. These result in annoying newsfeed floods… and they turn people off (rather than on), and have become quite ineffective these days.
Continuously reach out to invited users, and remind them to sign up. Yes, spam them.
Don’t artificially limit the number of invites each user has – since only a few people invite others, and some of them invite a lot.
These are platitudes, because even if you do all these things, you couldn’t make a Content Management System (say) go viral. In other words, these tips above are useful only when products are inherently viral (that there is some kind of inherent value that increases for everyone when the user-base grows). Obvious examples of such products are Facebook today, and Hotmail from the days of yore.
So these recommendations seem to gloss over a couple of issues:
You have to provide value to the individual user first. Else, you’re in the world of “Network Effect Catch 22″. You know you’re in this world if you already need a network of users to exist for your product to be useful, and you just launched. Why would anyone invite others when there’s no value?
You have to actually be useful to both sides of the invitation. A user should get some value when their invitees join, and obviously, the invitee should get value. It’s not just a case of being the cool kids and inviting your friends to the latest hotness.
Virality is an aspect of your product and use-case. You can certainly think hard about your product and see how it might be made viral through useful features, specifically those that are useful to both sides of the invite equation. (We have a couple of ideas around this for Zolodeck). Once you’ve got that, that’s when you should look at things like your viral coefficient. Not before.