August 18, 2010 by dan.

Having served on more than my share of boards, and often on the comp committee, I am often asked about the following situation:

• A company has taken quite a bit of investment, usually from institutions and angels.
• The deal that was struck has a liquidation preference (if you don’t know what this means, you should educate yourself). Good terms for companies meeting their goals are 1x participating preferred (sometimes capped); bad terms are 2x to 3x and usually granted when a company is in trouble and needs to raise money.
• Acquisition seems like the best alternative, but the offers are for less than the liquidation preference (or not much more than the preference).

In this case, the common stock and options are essentially worthless. The founders, employees, and others who bet on the upside find themselves in the position of having worked for little-to-no upside (or in the case of board members or consultants who took options – nothing!).

What is the board to do?

Here is my perspective:

• Recognize that management did not deliver the value that was promised when the money was taken. It is not fair to give management a great return, while investors lose money.
• On the other hand, it was management’s sweat that got the company to exit. This needs to be rewarded.
• The board should try, as a first priority, to ensure that management gets a good deal from the acquiring company. This is good for the acquirer and allows the proceeds to go to investors.
• If a carve out is necessary, I believe that it should be graduated (like a graduated income tax). In that way, as the investors do better, management increasingly does better. This aligns incentives. For example, if the liquidation preference is $10M and the acquisition will be in the range of $5-15M, the carve out might look like this:
  • 5% of proceeds for the first $5M (which is $250k at $5M)
  • Between 5-10M, $250k plus 7.5% of the amount over $5M, which is $375k at 10M
  • $875k plus 10% (plus the value of their stock, which is now in the money) for any amount over $10M
• This seems to give both aligned incentives and balance the reward for management with the need to get investors their money back.

Of course, all of this looks much better when the company sells for a lot more than was invested!

Posted in Company behavior, Startups, Boards, Investment Terms, Angel Investing | No Comments »

August 18, 2010 by dan.

Over the last several weeks, I have had a series of experiences where boards have not represented the interests of shareholders. Why? Kindly, you would say inexperience or lack of knowledge. Less kindly – incompetence. Or even less kindly – greed.

In one case, the board, without any form of communication about the company’s status or consultation to the vast majority of shareholders, in short order (1) forced a “pay-to-play round” led by two institutional investors; (b) granted the CEO and other senior managers a HUGE carve out (despite several years of missed targets and poor performance); and (c) negotiated a quick sale of the company where the winners were the management (who got the carve out and a bonus from the acquiring company) and the institutions that forced the pay to play. This was done by a board that was incredibly conflicted, but counted on the fact that the angel investors in the deal (there were about 30 of us) wouldn’t take any action. Payout to the angel shareowners - $0. That’s right – nothing. This is egregious, but not uncommon.

Angels need to be willing to take better actions to protect their investments.

1. We must be willing to band together. I am working with several attorneys and the Alliance of Angels to create an LLC that can be used to aggregate our investments in a company. In this way, we will in aggregate be a “major shareholder” in the startup and get rights and privileges commensurate with a VC. This will add a small expense to our investing and require some overhead, but it should be worthwhile. And the company should love this, since this will be one shareholder instead of many.
2. We need to insist on a board seat and assign one of our members with sufficient experience to take that seat.
3. We must insist that our CEOs communicate, communicate, communicate. I get frustrated with a CEO that has bad news and decides not to share it until there is good news. Often the only communication is one from the law firm representing the startup and usually that is really bad news. Funny how the CEO was quite communicative while raising money from us. Boards need to step up and make sure that their CEOs treat their investors with the respect that they have earned by investing in the company.
4. Boards must represent shareholders in holding management accountable. I’m not saying be obnoxious. But, if you hired a contractor to fix your house and they didn’t do the work they contracted for, you wouldn’t pay them the full amount. Why do boards feel it is OK for a team to miss on their execution and then reward them? Boards need to step up.
5. Carve outs need to be measured. I understand that an acquisition can only occur with a willing management team (and a willing board). If there is a large liquidation preference overhang, (as there often is) management’s stock might all be under water. There is a need to take action to make sure that rewards are balanced. Boards need to be proactive in this. I will be posting a separate blog on my assessment of best practices on this.

So.. investors need to insist that board really do represent them and not allow them to take the easy way out, create conflicts of interest, or have investors take it on the chin. Boards – step up!

Posted in Startups, Company behavior, Rip-offs, Boards, Investment Terms, Alliance of Angels, Angel Investing | No Comments »

June 28, 2010 by dan.

A number of years, I joined the board of the Humane Society for Seattle and King County (www.seattlehumane.org), a local non-profit that runs an animal shelter, adoption facility, and does veterinary services for the animals in our care. For those that believe in animal welfare as I do, you will easily understand how an organization of this type can attract experience and well meaning board members.

Shortly after joining the board, I began to try to study and make sense of our metrics – especially euthanasia numbers. I well understood that not every animal was “adoptable,” some were too sick to be saved or had behavioral problems that made them unsafe to be in a house with either other pets or small children. But the numbers just didn’t make sense to me. So, along with the support of other board members, I began to ask for more details on the metrics, drilling to the next level of numbers. What emerged was a picture of management controls and lack of consistent strategy that meshed with the desires of the board. As a result, the board changed management first on an interim and then permanent basis. And, we established a goal that “no adoptable animal in our care would ever run out of time or space.”

Over the course of a few months, we focused on a metric that matched that goal (it’s called the Asilomar Live Save Rate) and have been successful in maintaining that metric at a level that qualifies us as a so-called “no kill” shelter for several years since. And then we were able to go to important, but secondary, metrics (e.g length of stay until adoption) that improved our operations and the care we gave our animal guests. I am proud of these accomplishments, but it has caused me to reflect on the importance of goals, strategy, and leadership in a more general sense.

In both the non-profit and start-up worlds (some claim many of my startups are non-profits! J), understanding your goals is a critical element in success. Goals must be meaningful to the organization and actionable. And have corresponding metrics that match those goals.

This seems simple, but in several of my companies, this has proved exceeding difficult. Many metrics follow results by too wide a gap to be actionable. In many cases, revenue is such a metric. But in almost every case, there are a handful of “value drivers,” those metrics that truly derive the value and health of the business. For example, in a telecoms consumer services business (like one a ran earlier in my career), the key value drivers were, (1) cost of customer acquisition; (2) average revenue per customer; and (3) churn. For each business type, these will be different.

The power of setting a good goal, understanding your value drivers/metrics, and having a strategy to maximize those value drivers and fulfill the goal is the path to success.

Posted in Seattle Humane, Company behavior, Boards | No Comments »

June 10, 2010 by dan.

Since I blogged about my poor experience with Netgear, today I had a much better experience with technology. Well, sort of anyway. I was finally able to locate Windows 7 drivers for a couple of arcane devices on my desktop server, so decided to upgrade from Vista to Win 7. After cloning my drive, I put in the Windows 7 installation disk and ran it. After about 30 min, it returned an obscure error about missing files. So.. I tried it a second time telling it not to go online and get the latest update. Again it failed. That was the bad news.

It took me quite a while to find the number I could call, but eventually did. With that number in hand, I called Microsoft customer service. The first person I spoke with just took my info, gave me a case number, said that I qualified for free support, and transferred me to tech support. My call immediately dropped and I had to call back. With my case number in hand, I got right through to Jeff, who spent the next hour on the phone with me to fix the problem. First, he took the error code I had received and did some research. Within a couple of minutes, he knew exactly what caused the problem – it was my optical drive which (while working for files) would occasionally fail and not find a file. He then suggested that I copy the installation files, which my drive wouldn’t do. So, he recommended going to another computer on my network, copying the disk there and then using the network to install it. That worked! And then it installed perfectly.

Through all of this, Jeff from Microsoft in the Philippines, could not have been more knowledgeable, friendly, or helpful. Not happy that the install didn’t work on the first try, but very happy to have such a good level of support.

Posted in Company behavior, Microsoft | No Comments »

May 31, 2010 by dan.

I’ve always liked Netgear. They seem to be a company that stays ahead of the technology curve, makes reliable products and understand the balance between easy to use and advanced features. I no longer like Netgear.

My old Netgear router, which had been the paradigm of reliability, died suddenly last week. It was over two years old, so I didn’t complain too much. Instead, I made an emergency run to Fry’s and purchased the top-of-the-line WNDR3700 Range-Max dual band wireless N gigabit router. The two main features I really liked were: (1) very high speed processor that should give better performance, and (2) ability to configure 2 SSID’s, so that a visitor could gain access to the internet without getting access to either my security phrase or my local data. Very cool I thought.

Setup took me a typical time – about an hour. And after the usual of downloading the latest firmware, having to reboot all of the other switches and my modem, I was on the internet, transferring files, etc. The wifi worked with my iPad and iPhone. And for those regular readers, it also worked with my home theatre control system. All was good in the world again.

Given that it was past midnight when I finished, I waited to add the cool new features till the next day. It was then that my router stopped working. I enabled the guest SSIDs, and suddenly the wifi was dead. I went into the configuration menu, and noticed the radios were turned off, so turned them back on – only they didn’t go back on. So, I looked at the router, and the lights for the wifi were off. I manually turned them on. But they turned off on their own again as soon as I downloaded the config. Thinking I had inadvertently misconfigured the router, I reset it to factory configuration and started again. Then the problem repeated itself as soon as I turned on the guest network. I played with the various settings, but it happened every time. So.. I concluded I had a defective unit.

The next morning, I hopped in the car and drove the 15 miles to Fry’s, who were gracious about the exchange. Got the new unit home and it was exactly the same. By this point, I had invested well over 8 hours on this, not to mention the previous 4 I spent figuring out that my old modem had failed.

So, I began investigating on the web, only to learn that this has been a known problem with this unit since March. (See: http://forum1.netgear.com/showthread.php?t=49720&highlight=guest+ssid). The original bacth of routers sold prior to January, apparently do not have this problem. But the ones sold in 2010, all suffer from this issue. There has been a beta firmware upgrade available for two months that fixes the problem, but seems to have other issues. Netgear will release it, but only under NDA! So the message is, you have to suffer, call our customer service, be put on hold, sign and NDA, and then we will give you a less buggy upgrade, for a product that didn’t work to begin with. In other words, Netgear has known that they are selling a defective unit for over three months, continue to sell this unit, have not notified their retailers, and let customers know that this was a problem.

This is intolerable and unacceptable behavior, the kind that should be punished by fines, and big ones at that. My time is valuable to me, but apparently not to companies like Netgear that feel it is acceptable to have their customers to their testing, spend countless hours making a defective product work, and then have to beg for a solution that exists. They should just recall this defective product and either replace it with one that works, or refund 100% of their customers money, and also give a credit for future products.

Posted in Company behavior, Wireless, Netgear | 11 Comments »