A $7,000,000 Mistake
We were one day away from having 7 million dollars in the bank, but then the whole deal fell apart.
It was the beginning of 2006. The startup I had been working for was acquired by Hewlett-Packard and I was discovering that big company corporate life wasn’t for me. A few of my coworkers felt the same way so we decided to leave and do the startup thing again.
MySpace was hot. Facebook was becoming a thing. Instant messaging was the communication choice of the up and coming generation.
Parents didn’t understand any of it. Predators did.
We decided to rally around a real problem, protecting kids online. The NetNanny’s and CyberSitter’s of the world hadn’t amounted to very much. This was not a sexy space for a startup. The technology challenges were immense, the legality of our idea wasn’t straightforward and by all accounts, there was no money to be made.
My cofounders and I were in our late 20's. We were transitioning into legit adults with young families. We had a unique perspective on technology that kids were using and fears that parents were having. To Catch a Predator was all the rage on TV. Online predators were making news daily and children were spending more and more time on the computer using apps and visiting sites their parents didn’t understand.
We worked with law enforcement specialists who taught us how predators worked. There were patterns and lingo to look for, but every case was unique. Kids were at risk and didn’t know it. Parents were worried but didn’t know what to do about it, so we built a product.
Parents could easily install our software on the computer that their kids used and be notified in real-time when their children were having online conversations with potential predators. Previously, products provided parents with instant message and email logs, but parents reading “LOLWTF” and “ASL?” in hundreds of pages of logs wasn’t actually enabling them to protect their kids.
At the heart of our software was a language analysis engine that understood how to make sense of the language kids were using online. For example, a predator might want to know if a kid’s parents were at home. They could ask “Are your parents home?”, or “where are ur parents?”, or “ur r3ntz at the cr1b?”, or “u alone?”, or “rents out?”… you get the point. We built some software that could take any of the above permutations of this basic question and send an alert in real-time to a parent that said, “Your daughter is currently talking to someone on AOL Instant Messager who is asking if her parents are home”. From there, they could log into our site, read the part of the conversation that triggered the alert with an explanation of why the alert was triggered and make an informed parenting decision about what to do about it.
A simple example is “ASL?”. If someone your child does not know is asking them “ASL?”, as a parent, you should know about it, but you would most likely never catch those three letters in any log or transcript. Age? Sex? Location? That’s how predators started their hunt. We were hunting the predators. Our technology was amazing. Game on.
We raised a little money, launched the product, put the word out, and parents started installing our software. 18 months later we had a mature product monitoring millions of children’s accounts online. We were sending alerts every day. We received email after email from parents thanking us for saving their children’s lives, literally. We were proud, we were making a difference in the world, but we were also running out of money.
Our service was free as we were working out the business model. We actually had a genius business model but hadn’t implemented it yet. We wanted more users so we spent money on marketing. We were in newspapers, in magazines and on TV but we started running out of money, so the time came to raise more so we could afford to build our business around protecting kids.
We were in Texas, but started making the rounds to the venture capitalists in Silicon Valley. We met with all of them. Everyone loved our story, but most were hesitant to get involved in this space. How would we make a billion dollars?
The VC meetings continued as our balance in the bank dwindled. We were running on fumes so we had to stop spending money acquiring new users. By this time, we had a pretty good idea about what it costs to acquire a user and a good guess about the potential monetary value of each user. Right when we were at the end of our runway, we got a call from one of the top venture capital firms in the world, Benchmark Capital.
After learning about the very real dangers of online predators through a situation of someone close to him, one of the partners installed our software. He tested it, he used it, it worked. He got it. He called us and said he wanted to invest as soon as possible.
We were looking for 5 million dollars, but after all the interested parties got together, we had about 7 million confirmed and a term sheet in hand. We were stoked. Our idea was validated, our company was going to grow and more kids were going to be protected. The terms dictated that we move our company from The Woodlands, Texas to Silicon Valley. Some of us, including myself, had young children at the time and deep roots in Texas, but we were willing to pack up shop and head west for the money, for our company, for our product and for the children who needed us.
As our wives started making arrangements to sell houses, research schools in California, pack garages, etc., my cofounders and I piled ourselves and our servers into a minivan and drove to Palo Alto. We stopped in Vegas to celebrate our success, though I don’t remember much about the celebration… because I was so excited to get to California, obviously.
We arrived in Palo Alto and set up shop in the VC’s office, literally. They had a boardroom that they said we could use as we started to hunt for office space. So we set up our things and got back to work, in their offices, as our wives sold our houses and continued planning the multi-family migration.
We had a term sheet, we agreed on the deal, but the money had not been wired yet. We asked several times about it, and were told there was just some delays with the paperwork, with the banking system, getting everyone’s signatures, etc. We were told not to worry.
We were told the money is pretty much in the bank… except it wasn’t.
One Tuesday night after being there for a couple weeks, we were going to have our monthly board call. The money was to be wired the next morning, finally. The investor at the VC firm who led the round was going to be on the board the next day, so we invited him to the board call that Tuesday night.
Everyone was excited about the new board member. Introductions were made. Confidence was high. As usual, graphs were presented to highlight product trends. One of the reasons we needed more money is because it was costing us money to acquire users. We knew this, we had a formula, our product was non-viral by nature. Parents don’t talk about their kid chatting with strangers, it makes them look bad. Parents don’t talk about finding out their kids were behaving like predators, it makes them look even worse.
Our new user graph was not impressive. It was flattening out, but that’s because we starting reducing our spend as our balance dwindled. This is why we needed to raise money. We were excited to be able to affect this metric, starting the next day. Our new investor, soon-to-be official board member, seemed a little concerned.
We explained our strategy and our formula, but he seemed surprised that our product was’t exhibiting organic growth like Facebook and YouTube. He got spooked. He told us there might be a problem. He told us to figure out a way, in short order, to make our product viral. This is when the wheels fell off.
Our product was not viral, and it wasn’t going to be.
The next day was weird. We were told maybe it would be a good idea to head back to Texas as things got worked out. We were told they would be in touch and surely we could figure out how we could convince the other partners of the VC firm that our product had huge potential. Everything would be fine, but lets take it slow. We packed up the minivan again and drove back to Texas. We did not stop in Vegas this time.
When we got back to Texas we brainstormed about what we should do, but it became apparent that any efforts to make our product viral would not be genuine and would compromise the essence of what we built. We knew it wouldn’t work. We had a few calls with the investors and explained our position, they understood and said they would chat about it internally. Then we got the call.
The investors were out. Our company didn’t fit in their portfolio. They were no longer interested. They apologized profusely for the way things unfolded. In hindsight, I believe they genuinely felt bad about what happened, but that didn’t change the fact that they were not going to fund our company.
The call ended. There was silence, then frustration, then sadness.
We went back to other investment firms that we had also received term sheets from prior to committing to Benchmark, but after Benchmark pulled out, the news spread and we had the scarlet letter, or maybe the scarlet zero. We were hosed.
We had to find new houses in Texas. We had to undo the migration plans. We had to explain to our families that we failed. We had to try and pull off a miracle to keep the company alive and millions of kids protected.
While we were heads down trying to figure things out, our board was not happy. They felt that Benchmark had committed, on many documented levels, to fund the company and backing out at this stage was not acceptable. They wanted to sue. A lawsuit started being prepared for a whopping sum of money. I had reasonable equity in the company and would receive a very large payout if we were successful.
I never felt good about the lawsuit, but also trusted our board and advisors. It was explained by many more experienced entrepreneurs and investors that we had indeed been screwed, so a lawsuit was in order. During the talks about the suit, it came up in conversation that our current investors were protected against a countersuit, which would be inevitable, because we had provided them with directors and officers insurance (D&O) per the terms of their investment… except we hadn’t.
Truth be told, we forgot to get the D&O insurance coverage. We had to get everyone’s signature, which meant coordinating with personal assistants and constant nagging. We should have followed through, but we were heads down and excited about the product, so we didn’t. We forgot about it.
When we told our investors about the dilemma, they were outraged, and understandably so. For almost two years they had been personally liable for what me and my friends were up to. We didn’t anticipate getting sued while we were in business, but when you are dealing with kids safety, who knows what could have happened. We should have protected our investors. We didn’t, and that’s what ultimately put the nail in our coffin.
The only hope to keep the business running was to get a bridge round assembled, which would have been a little money to give us enough runway to go find more money. The investors were going to do that for us, but not after they found out about the insurance situation. I don’t blame them. We really screwed up.
We were out of money. The servers would need to be unplugged in a few days and no more paychecks would be issued. We had protected a lot kids, but we couldn’t afford to do it anymore.
We went from being one day away from having $7 million in the bank, to out of business, in a couple weeks time. We were heartbroken. We failed.
After some quick calls, we ended up selling the assets, our technology, to a company in the UK. We sold the assets for what our original investors had put in to the company, about $1.5 million, so we were able to give them their money back. More importantly, the purchasing company was now better equipped to continue their mission, which had been ours, of protecting kids.
Looking back, I’m not mad. I wish we could have continued to grow our company and protect more kids, but I’m thankful for the lessons I learned through that failure. I don’t actually buy into the “you learn more from your mistakes” mantra, but I learned a hell of a lot through this one.
Ultimately, this failure caused me to pursue my own ideas which led me to a fortuitous meeting with Evan Williams, and the rest is history. I went on to work with Ev at Twitter and now on Medium. I’m happy with the turn my story took and I’m undoubtedly better positioned to continue my journey having gone through this debacle. Funny how life works like that. Protect kids, get screwed, learn and move on… just remember to get the D&O insurance next time.