Unicorns, Decacorns … What next?
In April of 1991, five of my friends and I co-founded our very first company, Nimbus Technology. We had all worked for Elxsi, a Mini-Supercomputer company, where we designed and manufactured state of the art multiprocessor computer systems that could scale linearly from one to 20 processors!
It was a time for rapid innovation in semiconductors. New and more powerful Chipsets were being introduced to the market every six months. Workstations and Desktops that incorporated these Chipsets were driving companies like Elxsi out of business.
We thought, as entrepreneurs we could control our own destinies! However, as a team we had little to no experience in starting or running a business. We were just skilled in designing complex systems using state of the art design automation tools. Sheer confidence in our skills convinced us to take the ‘big leap of faith’. The intrigue and the promise of entrepreneurship were too strong for us to resist; it blinded us from the risks we had to overcome as a business!
Since then I’ve co-founded five companies from scratch and funded over 20 start-ups as an Angel investor. After all these years in this industry, I’m still mystified by the process of company valuation!
The Magic of Company Valuation
Funding a startup was a real challenge in those days especially for immigrants like us. We had very little ‘trust equity’ to trade for the seed capital. So, Nimbus was bootstrapped with less than $25,000. Fortunately, in six months, we were able to bring in a million dollars, mostly as licensing fees for our system design, from a couple of Corporations; one of them was Cypress Semiconductors.
Soon, we were able to attract someone with a proven track record as the Chairman to enhance our trust equity. A short time thereafter, a leading venture capitalist in the valley presented us with a term sheet.
As newbies to entrepreneurship, we had so many questions. The most important one was : What the hell was Pre Money Valuation? After hours of head-breaking sessions, we reluctantly accepted that the process was more an art than science! It’s interesting to note that even today, famous venture capitalists struggle to rationalize the valuations for AirBnB and Uber without using fluffy and vague language only to strengthen the notion that Company valuations are Magical!
Despite the ambiguity surrounding valuations, I learned a few important lessons. The company valuation, the funds raised and the equity traded for those funds were all connected.
The key question was “How much money was required to grow the company to the next level, say in about 24 months, such that the valuation for the next round could be multiples of the current round?” Having a good understanding about the expenses for the following 24 months and the equity we were willing to trade for it would put us in a better position to negotiate a reasonable value for the company.
Raising excess capital just because of inflated valuation may look and feel good initially but will put undue pressure on the company to grow at an abnormal pace! It would be like excessively watering your garden only to spend more time thinning the weeds, later! So when the investors’ sentiments and focus changes from growth to profitability, the founders would be left holding the WeedWacker. Remember, as a founder, your fiduciary lies with the company and no one else.
The rest of the terms were so complicated that the deal didn’t consummate. Shortly thereafter, Nimbus was acquired by Alliance Semiconductor just before its IPO. It was at Alliance Semiconductor, that I met the co-founders for Lara Technology.
Take the Deal, Dummy!
Lara Technology was founded in June 1997 with the singular goal of creating a device that could accelerate packet processing in routers and switches. After a couple of rounds of funding, in 2000, the Board split Lara Technology into two companies, Lara Networks and Empowertel Networks, to maximize the share holder value. Lara Networks would serve the data routing market while Empowertel Networks would serve the CLEC (Competitive Local Exchange Carriers) market. Splitting the company was easier said than done. It strained both the management and the employees which by then had grown to over 450 employees spread across 4 locations around the world.
Early in 2001, Cypress Semiconductor approached Lara Networks with an acquisition offer. We started our negotiations at $500 Million and after six months of intense due diligence, the deal consummated at an acceptable $300 Million, most of it paid in cash. That was when Dot-com bubble had burst and Nasdaq had shaved off 78% of its peak value wiping out nearly $8 Trillion of wealth.
Later in 2002, we were presented with multiple offers from large multinationals to acquire Empowertel Networks . The offers were as high as $750 Million. However, one of the executives convinced the Board not to accept any of them because he felt they were all low. A few months later, the CLEC market crashed and we had to pivot in a hurry. Although we had discovered a lucrative new market, raising additional funds was hard in a toxic market; prompting an anxious Board member to engineer a merger at a much lower valuation!
Had we taken the offer at $ 750 Million for Empowertel Networks , the aggregate valuation of both the entities would have been over a Billion dollars. In today’s terms, we would have achieved the Unicorn status in less than five years after seeding an idea with $150,000 of our own capital. Unfortunately the Management and the Board were not on the same page regarding market conditions and expectations.
Remember, valuation is dynamic. It can come down as dramatically and as fast as it went up!It is therefore vital for both the Board and the Management to be pragmatic in order to maximize the shareholder value.
Fundraising — keep it simple, stupid
In 2003, I founded YuMe Networks with a vision to build an online video distribution platform, a sort of “Netflix on Net”. A year later, after broad market research and several versions of PoCs, I brought on board two co-founders.
Around March 2006, then newly incorporated, Khosla Ventures (KV) presented us with a term sheet after three months of intense due diligence. On signing the term sheet, KV expressed their excitement to be working with YuMe which was destined to become a “Billion Dollar Company”. Within a week Accel Partners reached out. This prompted KV to introduce BV Capital to the party.
In the end, Accel Partners had made the cleanest and the best offer. As founders, we naively justified that bringing all three investors could accelerate the growth of YuMe. Instead, it incubated a lot of back room politics spurred on by the co-founders’ greed and the only thing it accelerated was my unexpected exit from YuMe!
Seven years later, in 2013, YuMe went public valued at $300 Million but is currently languishing at a $100 Million valuation; nowhere near a Billion Dollar Company as KV had prophesied. The rapid erosion in the shareholder value has been associated with an extremely Weak Board. For the institutions, YuMe was just one of many investments in their portfolio and could be simply marked down as long as they made good on the others.
In retrospect, I should have simply taken only the Clean Offer from Accel Partners and worked diligently towards building a great company; bringing one member at a time to build a strong board.
Remember, in the entrepreneurial arena, you will encounter many alphas. Picking the right ones to work with will make the difference between a success and a failure. But in that rushed moment, I had also ignored the much touted saying “Too many cooks spoil the broth.” Additionally, if someone is already convinced that you were destined for success, they really are underselling the blood, sweat, and tears it takes to get there. Also, it sets up unrealistic and hostile situations down the road that could lead to poor or unethical decision making.
Whole New World of Mythical Creatures
With my unplanned exit from YuMe and the financial debacle of 2008, I decided to take a break. Last year, after an 8 year hiatus, my son convinced me to join him in his new venture, IdeaLyst Inc. Walking into the new entrepreneurial world, I felt like Rip Van Winkle. I was dumbfounded that private companies are now valued over a Billion dollars! Unlike the mythical creatures, these Unicorns are everywhere and some are even valued in tens of Billions of dollars while still being private.
My advice to my son was not to get caught up with new terminologies and its propaganda. Instead of getting fixated on the valuation, I told him to be passionate about his mission. Everything else could evaporate. Focus on building a great team, product and a company.
Based on my experience, I made a list of Ten things he could focus on to make his journey as an entrepreneur a whole lot interesting and less mythical.
- Pick co-founders who are trust worthy and have impeccable integrity.
- If you can, invest your share of skin in the game.
- Raise just enough capital until you find the product-market fit. (Corporations also invest)
- Until that time, be stingy with the cash but be generous in soliciting Customer Feedback.
- Be Fair.
- Take The Clean Offer when it comes to Institution deals.
- Strong Boards build Great companies.
- Walk the Talk (Plan and Execute without all the fuss).
- Don’t cheat (It can only get ugly).
- Be patient; things take time to mature. (Unicorns were not born in a year!)
Finally : What do you call a Unicorn that’s been downgraded?