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Spectatular failure from red-hot startup Fab that raised $330 million and then went bust

I read / skim roughly 10 startup related articles going back 2+ years now. After a while things do get repetitive however today I came across a article about Fab which I found particularly interesting for 3 reasons.

1 – The dollar figures involved in investments received, sales generated, units shipped and acquisitions made is quite astounding especially considering the short time frame.

2 – Incredibly few companies reach product market fit. “Fab had product market fit, but Fab didn’t understand its product market fit,” a former Fab employee said.

3 – It had a CEO with an interesting personality and background who wrote an impressive memo to his stakeholders about the mistakes made.

I won’t attempt to summarize or try to add interesting anecdotes to the article as its superbly written and very insightful. I recommend you take a look. There are a lot golden nuggets in their which many founders can learn something from.

http://www.businessinsider.com/how-billion-dollar-startup-fab-died-2015-2

In early 2011, Bradford Shellhammer and Jason Goldberg shut down Fabulis and started Fab.

In early 2011, Bradford Shellhammer and Jason Goldberg shut down Fabulis and started Fab.

Spectatular failure from red-hot startup Fab that raised $330 million and then went bust

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Don’t overpay for advice and connections: our encounter with Silicon Valley Investor

I have for a long time wanted to write my experience of how we nearly got screwed by a Silicon Valley based angel but was worried about repercussions of doing so. Still I will censor the name of the investor involved to not create unnecessary reputation loss  for him. My only goal is to educate and warn 1st time entrepreneurs especially those new the fundraising game of the big bad wolves out there and the games they play.

The Meeting

This Feb we were in Silicon Valley for a 5 week road show and acceleration program with our incubator IncubaUC.

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It was the most intensive learning experience of my life. We pitched angels, VCs and serial entrepreneurs daily sometimes even twice daily. At the polished corporate offices of Palo Alto based law firm Greenberg and Traurig we pitched members of prestigious Silicon Valley Band of Angels and the Sandhill Angels. That is where we met Wolf (his name censored) our first interested professional investor.

Pitching the dragos

It was a time when Fundacity was still young, without a ready MVP, clients or a solid business model. We were still searching for product market fit. Silicon Valley was not impressed and we realized how far we still had to go to get any serious investment interest in a place like the Valley. However to our surprise WLF took interest and the talks began. It was like a dream come true.

As first time entrepreneurs, we were totally inexperienced in investment negotiation. We had no idea what to watch out for and what fair terms were. Worst of all we were enchanted by the buzz of what we saw in the Valley. We wanted to be here…badly…and we thought Wolf was our golden ticket.

We tried hard to push for a term sheet before our flight back. I remember pressing Wolf hard for a soft commitment when we took a car ride in his Mercedes the day before my flight back to Santiago. We needed this deal as we had less than $5k in the bank. With Wolf deal we could get a few months of breathing space and qualify for CORFO’s next $100k of grant funding. CORFO wanted a to see serious investor interest from the Valley. In addition, we  thought this deal could get us market  entrance to the number one market for seed investors. The USA. A lot was at stake. We were needy and our counter party sensed it.

We fought hard to play the game and keep the deal hot over the ensuing 3 months from Chile. Long distance relationships are hard and its no different for business deals. Regular Skype’s and emails gong back and forth. We hustled to keep the intrigue going and show progress.

The Deal

At long last, on 5 June 2013, we received a term sheet. Based on my research the deal seemed fair at the time. $1m pre-money that asked for a liquidation preference. Moreover, the investment would be small enough, $20k, not to dilute us too much at this early stage. If things went well, Wolf would help us close a series A. Awesome right? Well not quite. Separately, the deal came with the ‘offer’ of Wolf’s advice and connections. He asked for 10%…upfront!

Even with our little experience we sensed this was completely unreasonable. 10% upfront…jeez…for what exactly? We tried to convince ourselves that this was acceptable because we wanted the deal to materialize. We needed the money. Diego was flat broke living with his mom and I was in LatAm, far from home, couch surfing at a our first employees studio flat. I could hardly think straight under all the pressure.  We were paying a developer $2.2k/month and were running out of money fast. I drew no salary and lived from savings which were dwindling fast.

The Heroes

Fortunately we had some great mentors. Sam Zebarjadi from 500 startups and Hiroshi Wald the MP of Austral Capital.

Hiroshi at mentoring session

Hiroshi at mentoring session

Hiroshi is probably the sharpest investor I had the privilege of meeting. His advice was bang to the point. Sam Zebarjadi knows the industry from both sides of the table and is a seasoned entrepreneur. He knows hows things work. Both our mentors unanimously told us to walk away and that the deal was ‘crazy’, but there was a lot at stake and things were getting emotional. It was indeed a lemon deal looking to exploit our inexperiences. Wolf made us wait long and hard for this deal and had us completely beta trapped. Our view of him was distorted as day by day we overestimated his importance and potential in making Fundacity great. We were complete suckers to made the deal work.

Wolf’s offer for the 10% upfront equity, I quote:

1. Help design the website functionality
2. Detail the deal flow process from an angel point of view
3. Promote the website to angel and accelerator groups ( marketing function ?)
4. Contribute ideas to make the site superior to competition and popular. Examples are a better due diligence process
5. Design a crowdsourced screening and due diligence process
6. Coach the team on all financing and management issues and help secure future financings

The Questions / thoughts from our advisors

Hiroshi and Sam helped us regain rationality in 3 ways:

  1. Advised us to scrutinize each point in isolation and ask question that evaluate the true value it represents.
  2. Gave us benchmarks to industry norms. i.e. what is the usual equity advisors get.
  3. Differentiate between what an investor is expected to do by default and what is additional advisory service.

1. Help design the website functionality does he have relevant design expertise?

  • Extremely vague
  • This is usually something you would have as part of the internal team vs. advisory
  • Do you need this? i.e. is there an issue with design and functionality at this point?

We concluded that this point had no value to us as we had no needs/issues on this front. Diego, my co-founder is a unicorn and design master whilst Wolf had no verifiable credentials on this front. He was 60+ and we had to teach him how to navigate around Skype and at times his browser.

2. Detail the deal flow process from an angel point of view

  • Do you already have access to this information?
  • This information is readily available online and via several programs, including the incubation one you’re probably involved in
  • Seems like you can get this by picking up the phone and speaking with 5 to 10 angel investors

Indeed whilst the promise of access to investors sounded amazing to us. In reality, all we had to do was get out of the building to find this information. In fact, if we were unable to contact our target customers we really had no business to be creating a tool for this user base. Looking back, between May and July I interviewed roughly 50+ investor groups from 10+ countries to gain feedback. I didn’t spend a cent to do this. Imagine I paid 10% of our company…

3. Promote the website to angel and accelerator groups ( marketing function ?)

  • Could be interesting but what does it entail? Sharing a URL with colleagues may not help…
  • As an investor with a 2% stake, would hope that he would be encouraged to promote the site.
  • Sharing a link on Twitter, Facebook and LinkedIn won’t garner interest.
  • Is he willing to actively do business development i.e. make calls, do meetings, drive sales?

I find that this could be interesting but we needed milestones. Working at PricewaterhouseCoopers I learned that goals had to be SMART (specific, measurable, attainable, relevant, time-bound).  A lot of advisory documents have milestones or other deliverables in them.  This is needed to ensure that advisors don’t come, sit back and vest stock.  You must make them work for it, and this guy needed to do the same. I asked Wolf to suggest KPIs along these lines, but he made it clear that he wanted the equity upfront and not vesting subject to time or KPIs.

4. Contribute ideas to make the site superior to competition and popular. Examples are a better due diligence process.

  • Vague

Whilst it was a desirable outcome, Wolf had no specific ideas to offer. It lacked substance thus had no value.

5. Design a crowdsourced screening and due diligence process

  • Cool idea
  • What are the details?
  • Does he have the right qualifications and knowledge to do this?
  • Do you need this?

Wolf had no concrete ideas here. He did not have an verifiable qualifications or experience developing anything digital based. Also. I was not keen on developing this feature at all. In fact, he required us in his term sheet to develop something around this. It is something he wanted. Therefore, he was asking us to develop something vague and was unable to bring anything to the table in developing or even defining it. Valuable?

6. Coach the team on all financing and management issues and help secure future financings.

  • Traditional role of advisor @ 1% or so.
  • An investors with a 2% stake should be motivated to do this without additional equity.

Conclusion

In general, when looking under the hood we found there was no substance or value to be gained in return for an upfront 10%. Sam shared with us a advisory contract from the Founders Institute that help us benchmark what was  a fair price. I have shared it countless times since with fellow entrepreneurs. You can view here. If the above analysis still left me with doubts then this document made things absolutely clear. An investor is expected to give us mentorship and make introductions as its in their interest to maximize the value of their investment. However, if more is on the offer then equity can be offered but that should rarely if ever be more than 2%. In fact looking at the Founders Institute contract the most involved and active advisory contract grants 1% equity!

Lastly, such a deal, i.e. giving high equity upfront, may be a deal breaker for later deals. Investors in later rounds during their DD will see that you gave lot’s of equity up without a good reason. They may break off the deal as they think less of the team or ask for equity for ‘advice and connections’. Before you know it you have lots of great advice and connections but no company.

I consider myself very lucky to have had mentorship during this challenging time. Had we signed and only realized consequences later it would be too late. We would have overpaid for advice and connections that may have brought us little more than Wolf reviewing our designs and giving some standard client type feedback and calling in some favors for investors to have meetings with us. Sure, getting meetings with top dogs is valuable, but there is a huge gap between a meeting them and a sale/investment. To close we would still need to cover the basics ourselves. A great product was needed and with or without him that would still be left to us.

The Decision

Thus, fortunately, despite our dire need for cash and lack of a BATNA (best alternative to a negotiated deal), the team and I unanimously agreed to turn down the deal if the terms could not be negotiated. But how do we do that? It took me lots of mental practice and preparation to lift myself out of the beta position I felt swallowed in and rise to the role of equal…role of potential partner where entrepreneur and investor should always be. After all, both sides should be bringing something to the table. No one is doing anyone a favor so we had to stop thinking like he was.

Then we realized he was a big bad wolf

Hiroshi gave great advice. He advised us to be upfront and honest and talk over our thoughts. We had our call to tall things over. The response from Wolf was that it was a

Take it or leave it deal.

Moreover, he threatened by:

I will hire indian contractors to do the project without you if you don’t agree. I already have a great team lined up! It will cost me much less…

big-bad-wolf

If we weren’t sure of partnering with him before well now we definitely felt he was not the right guy now. After re-asking whether it was a take it or leave deal and him coldly confirming it was. We saidL

…well in that case we’ll have to just leave, Wolf.

I sounded cool and confident but inside I was very upset and looking at Diego it was clear he was as well. We said bye to Wolf and I actually thought Diego would burst into tears when i heard his crackling voice say ‘bye’. My advice is you must never be afraid to walk away.If the deal isn’t a win-win from the get go then will forever regret the union later. Worse still is we would have lost all our authority in front of Wolf by confirming to him that he calls all the shots.

Following that meeting Wolf actually wrote an email to our incubator to say he was shocked that we walked and that he wanted answers. He said felt advisor did not understand what he had to offer. I responded with the email below hoping to open the doors for reason and reflection but still reaffirm our position:

Dear Wolf,

I am frustrated that we did not find our middle ground yet. As said, we are really excited to have you as an investor. We are ok with the pre-money valuation you offer, which is not high, but we accept and welcome it.
 
Also, we are interested in your mentorship, advice, contacts and ideas. 
 
To formalize your involvement that is outside what an investor would do we propose using the Founder Institue expert advisory agreement. Which specifically asks the advisor for:

–  Twice monthly meetings to provide feedback on Company’s strategy for at least two hours each.
– Contacts: Advisor agrees to make introductions to and assist in the acquisition of marquee customers, strategic partners and key industry contacts and attend meetings with such potential customers, partners and key contacts.
– Projects: Advisor agrees to assist the Company on at least one strategic project as requested by the Company during the term of this Agreement.

You will notice this is exactly what our current relationship is like and how we imagine it to be. For this, as per the Founder Institute, we can offer you 0.8% and very happily do so because we really want you on board Wolf.

The 10% without offering something else/more is not justifiable and is a killer for future fundraising rounds and for our existing investor Donatas. The 10% was originally discussed in return for a patented idea(s) you conveyed you were working on. We are still interested in offering it but only in return for a valuable idea which for us means a patented idea that is tested, validated and integratable with Fundacity.

Equally, the terms were in February, where Fundacity was at very early stages. Today we have an even stronger development team and almost version 1 ready and that should be reflected in current terms.

We sincerely hope we can find a workable agreement. I believe collaboration between us will be fruitful and can be structured to be a truly win-win for both sides.

We look forward to receiving your thoughts.

Best wishes,

He ignored it. He was clearly not going to get 12% of Fundacity for a flimsy $20k. Good riddance I say. My advice is

Be honest. Be transparent. Get advice. Remember you are the prize and the money is the commodity.

Don’t be afraid to walk away

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Happy hacking and innovating fellow hustlers.


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Making Sense of AngelList #1 : Investors @nivi @joshuaxls

This is an amazing analysis done using the API of Angel List. The result: Silicon Valley is the epicentre of startup fundraising activity or Angel List focus on SV and many users list their primary locations as SV to be part of the community even if they live elsewhere….or a mix of both!

 

Making Sense of AngelList #1 : Investors.

 

I don’t know whether AngelList data is skewed toward Silicon Valley investors or many investors list SV as a primary location even if they don’t live there but SV investors take large majority and they are very central. They are well-connected to pretty much every group and co-mingled with the second largest group, NYC/Boston investors(teal color).

 

Check out Making Sense of AngelList #1 : Investors.

 

via Making Sense of AngelList #1 : Investors @nivi @joshuaxls.


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Fundraising in the Valley – What I’ve learnt

The startup ecosystem  in Silicon Valley is exceptional. Talented entrepreneurs, top class lawyers, experienced mentors and savvy investors all within a stone throw coexisting in a tight-knit ecosystem.

Fundraising here is amazing and there is definitely lots of tricks to the trade. Whilst I am no expert on the subject I would like to share with you a couple of broad learning points you should definitely do when fundraising in the Valley.

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1. Talk to people

The Valley is a unique place not just because of the startup talent and experience here but also the willingness of people to give advice. Experienced entrepreneurs and lawyers are great sources for free advice. Veteran entrepreneurs mentor other startups to stay plugged into trending developments of rising startups and to seek advisory roles .Lawyers hold free initial consultations to win clients. Use social networks to find people and ask to meet them. Do your homework and go with specific question to make the most of these meetings.

Today for instance I had a great meeting with Wilmer Hale, a law firm I am likely to engage with, where I received great insights on where the market is pricing startups at various stages of developments. This greatly increased my ability to sense where the market is at right now and what valuation I should be seeking here. They also gave me specific valuation advice about Fundacity. Remember lawyers see deals all the time and have a great sense of where the market is at.

2. Get  a plan B

This can never be overemphasize. “The best Plan A has a great Plan B standing behind it. The more potential investors you have interested in your company, the better your negotiating position is. Spend as much time on your best alternative to a negotiated agreement (BATNA) as possible”(1). Also, I strongly suggest you clearly decide what the price point is at which you will walk away from a deal. Never begin a negotiation without that. When walking away also be transparent and communicative about that point to help the other party understand. In this way, if possible and meant to be, the other party will understand your stance and can still make it work. Don’t rush the process. Enjoy the thrill of the brewing deal. Never forget to consider the option of falling back on sweat equity and bootstrapping a little longer until the time and the price is right.

3. Value value value

The deal terms are driven by many factors but fundamentally it is the value your product/service is hoping to create. Focus on creating real benefits to your target users. Benefits not features. Understand your user and get the value proposition straight. In the end of the day this is what earns the prize.

Some useful books I can recommend for some background reading are:

1-Venture Deals by Brad Feld and Jason Mendelson (great read with some good fundamentals. I particularly like the “entrepreneurs perspective” at the end of each section. You can flip through this over a weekend)

2. Term Sheets & Valuations: A line by Look at the Intricacies of Term Sheets & Valuations by Bigwig Briefs (Very technical book. More dry  than Venture Deals but definitely gives you lots of answers)

3. The Business of Venture Capital by Wiley Finance (more about VC than about a startup raising funds. However understanding how VCs function is a great way to understand your negotiation partner)


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Mentoring with Andrew Lee

We are currently pitching in front of Andrew Lee. The general format of these meetings is each of us (7 startups) pitch to the mentor in a conference room of SupHQ (startup office space) and each pitch is followed by Q&A.

Interesting lessons learnt from listening to the feedback he gave to us.

“What is the one thing that makes that product really great? For instance when adobe came out the one thing they did really great was that you could send things in a really small format.”

“How do you scale that so that 15 million people can use that. how does your product differ from an agency model.”

(the idea is that investors seek tech startups where manual input is minimised  so it can be easily scaled)

“How are you really revoluntionsing the market? What features are you cutting out and what are you keeping and making better? How does this better deliver the core benefit the target user is seeking?”
This is an interesting concept I read in Blue Ocean Strategy. Image below is from the book and speak to the strategy
Strategy Canvas from book "Blue Ocean Strategy"
“I hate the word ramification all it actually means is if you click a button and you get something out of it” 
Thanks Andrew


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San Francisco day 3

It is pretty late and the day started bright and early at 730 with Insanity training with Diego. We are sitting in our second pitch and mentoring workshop of the day. I am scheduled to pitch soon. I must admit I am somewhat on edge as the pitch has changed enormously. Overnight we did a business model pivot. The story has changed…a lot… whilst the underlying platform is still the same. This is causing a bit of unease in my brain. Old and new ideas are fighting for dominance. The story needs to be clear and articulated with confidence. I need to present as if we have been doing this for years…I cannot show that ideas are still forming in my brain. The pitch depends on it.

The mentors with us now are Humberto Matsuda partner at Perfoma Investimentos, a Venture Capital firm from Sao Paolo, and best selling author and serial entrepreneur Cristian Barbosa. Humberto is a cool guy. I met him in October at Geek Fantasy Camp where he was a mentor. We have been in touch ever since then. His knowledge of the Brazilian startup scene is amazing and I think one day when Fundacity goes to Brazil he will play a pivotal role.

Humberto shared with us many insights about the VC world including the 7 risks that they look to understanding in any business namely:

Market, people, product, financial projection, regulations,  intellectual property, competition.

………

1 hour later. Pitch delivered. in the middle I had a moment of freezing and funnily everyone thought I was just creating suspense. In reality I lost track of my thoughts….nervousness was taking over. fuk…Luckily I remembered to not take myself and the situation too seriously so I just started smiling and thought to myself how ridiculous the situation was. After all I know my story and I know my business like no one in the room. Soon enough I regained thoughts and resumed the pitch. Feedback was good. Day wrapped up at around 2130. Marcelo and Hiroshi took Diego and I aside and told us they were impressed by the pivot that happened over 20 hours, the quick change to the slides and said they now believe that we have identified our business model. Connecting LatAm talent to the world is a valid value proposition. Fundacity is a business with a future. Diego and I feel euphoric. The hard work and endless discussions about Fundacity and what it is are bearing fruit. We are ready for day 4.

Humberto Matsuda

Humberto Matsuda

Diego

Diego

Marcelo and his Geeks :)

Marcelo Diaz and his Geeks 🙂