It seems a little unfair that founders may only get 1-2 experiences in term sheet negotiations whereas the VC has a wealth of experience. From a VC perspective, we’re looking to mitigate our risk through preferred shares.
If I invest $1 million into your company for 25% equity, what happens if the company exits for $2 million? Without liquidation preferences, I’d only get back $500,000 back (25% of the equity). With 1x liquidation preferences, I get my $1 million back.
Liquidation preference allows the VC investor who owns preferred shares to be paid “in full” prior to any of the common share investors (founders and employees) getting paid off. With a 2x liquidation preference, the VC gets the first $2 million and the common shareholders get $0.
I came from a real estate hedge fund background and we focused primarily on hard money lending. Higher levels of liquidation preference reminds me of a hard money loan. With a 2x liquidation preference, I have something like “the collateral of a house.” If we fire sale the startup for $2 million, I can still double my money.
It’s important to note that liquidation preferences typically apply to M&A exits or bankruptcy proceedings, but not to IPO exits. On most term sheets, the preferred shares convert to common shares in the event of an IPO.
Here are some tips on a few things to check on your term sheet.
Review your term sheet to double check that your conversion from preferred shares to common shares is on a 1-to-1 basis.
It’s uncommon to have participating liquidation preferences, which means that the VC preferred shareholder still owns a part of the company even after getting paid-out their liquidation preferences. This is like eating your cake and having it too. The typical term sheet has non-participating liquidation preference which means that the investor has to choose between exercising their liquidation preference or converting their preferred shares to common shares.
Seniority of liquidation preferences. It’s common for later round investments to have seniority in liquidation preferences over earlier rounds. You’ll want to understand exactly how the waterfall of payouts is constructed. Seniority alternatively could be Pari Passu.
I’ve also been involved with Hollywood feature film funding. Liquidation preferences for a VC remind me a lot of the film waterfall. Typically, the P&A (Print and Advertising.. the cost to market the movie) gains seniority in liquidation preferences. The seniority may not even be equal amongst the P&A investors. Something like 40% to 50% of the P&A goes to media buy spends (like tv commercials). If I were investing in a film, I would want to be like Disney or Fox and own the media buy company. I’d want the profits from the media buy, merchandising and distribution fees to exceed whatever money I have invested in the movie.
If you’re a start-up founder, you’ll want to master the financial structure of your term sheets. Don’t end up like the average movie producer who made more than $100 million in box office sales but ended up making nothing after all the liquidation preferences were paid out.
At Ryco Capital, we primarily focus on investing in software in Media, Ad Tech, Real Estate and Blockchain. Software for influencers specifically lies near and dear to my heart.
In my last blog post, I shared some concerning indicators in the economy that lead me to surmise that a Stock Market crash is coming in 2020 or 2021. Because capital vanishes as well as big tech exists in a bear market, it’s more difficult to find 100x opportunities. So here is how I see the world.
Imagine a world where the Dow Jones drops 40%. Wall Street panics… a big name investment bank goes down. Crypto and Cannabis take major dives as well as emerging technologies such as AR/VR and 3-D Printing. The FED vows to make historical cuts to interest rates to recessitate and pump up the economy.
How do you invest in a world like this?
Post stock market crashes are typically the best time to buy stocks at a discount. In my working thesis, we’ll invest in distressed manufacturing companies at huge discounts. During times prior to anticipated market uncertainty, I’d prefer to focus on free cash flow. As explained in a prior blog post, it make sense why VCs don’t focus on free cash flow and rather why they take a “winner-take-all” approach in big markets.
Influencers use a tool called a “product launch” (first created by Jeff Walker at Product Launch Formula) to sell their digital products during event-driven launches. An influencer may have different types of opt-in funnels such as a “Waiting List” funnel. For example, you may sign up for the lead magnet on my website, but only the opt-ins for my product launch can be considered for the “launch list.” The calculation of Earnings Per Lead is Launch List / Total Marketing Spend.
Free cash flow is not enough. In addition to free cash flow, you want the Earnings Per Lead to be greater than the Cost Per Lead. Furthermore, you want the Earnings Per Lead to be continually increasing by using an Ascension Model to push up the Customer Lifetime Value (CLTV).
Let’s say you sell a software subscription. Your first ascension model campaign maybe a free content strategy such as a blog and podcast. Next you’ll want a DIY Software Saas. To increase CLTV, you’ll want to add Monthly Workshops to support Certified Ambassadors. Then you’ll want to create an annual Dreamforce type of conference. In addition to free cash flow, you also want an Earnings Per Lead that is ever increasing it’s CLTV. Whatever company has the greatest Earnings Per Lead can pay the highest Cost Per Lead and win the Game Of Thrones (winner-take-all).
In my working thesis, when investor’s panic and the economy collapses into a recession, companies will downsize and cut their marketing budgets. According to INC, influencer marketing has a return on investment of about 11x compared to other forms of paid digital media. During a market correction, I expect distressed companies to increase their influencer-based direct response marketing where their Earnings Per Lead exceeds their Cost Per Lead.
How does influencer marketing work? An example may be helpful if you’re not familiar with this space. Revolve runs an influencer campaign called #revolvearoundtheworld for their millennial customers. It’s been a huge success. For companies targeting millennials, influencer marketing is almost an absolute necessity as 84% of millennials don’t trust traditional advertising according to an article by Brookings. This article also points out that 1 in 3 adults are millennials and that 75% of the workforce will be millennials by 2025.
BI Intellgience predicts that influencer marketing ad spend will reach between $5 billion and $10 billion in 2022, a five-year compound annual growth rate (CAGR) of 38 percent. Companies are already converging their influencer marketing along with their video and social media marketing strategies. The trend is moving towards long term relationships with influencers who share similar values to their company. Interestingly, celebrity marketing is being eaten way by influencer marketing.
Software is making influencer marketing more accessible to smaller companies and individual brands. Influencer marketing differs from Google AdWords or Facebook ads in that they require managing the relationships with influencers (who are people after all lol). Nevertheless, let me dive into some of the predominant influencer software platforms emerging today.
Everflow. Everflow is an affiliate management Saas with more features than Cake, HasOffers, Linktrust and Hitpath but at an extremely low cost of only $200/month (as well as a great interface although some disagree). Everflow’s targeting and blocks allow you to eliminate irrelevant traffic sources and focus on the sources getting your target measurements.
Brand24. This is a social monitoring platform for small and medium size businesses to track “social conversations” about your brand. It’s used to prevent PR crisis, find brand ambassadors, gain consumer insights, and maintain a good online reputation.
BuzzSumo. This is a powerful tool that allows you to research your target audience, get ideas from other content creators and find other influencers to help promote your ideas. By the way, I use BuzzSumo for this blog.
Upfluence. Upfluence is all-in-one influencer marketing platform that allows you to market through influencers including keywords, geolocation, engagement rates, audience demographics & more – influencer outreach through bulk emails – multiple campaign management – analytics & mentions monitoring.
Rocketium. A simple and effective way to create video marketing for influencers.
Investors remain anxious about the trade war between the US and China as well as Brexit. Deutsche Bank’s chief economist, Torsten Slok, predicts slow growth for China and Japan which projects to appreciate the US dollar. If the UK Labour Party wins with promises to nationalize utilities, this could send trembles throughout the global economy.
DISCLOSURE: Nothing on this blog is meant as investing advice… just mere educational pontification on my part. Oh ya… and all the photos on this blog are taken by my iPhone.
According to the International Monetary Fund (IMF), the global economy has been downgraded to a “synchronized slowdown.” Housing price crashes are occuring in Australia, Sweden and Canada.
Corporate valuations are not yet overinflated like we normally see in most market corrections with a price-to-earnings (PE) ratio of 15 and 4.5% dividend yield on the FTSE 100. However, the PE ratios can increase if corporate earnings decrease and reduce share buybacks. Corporate earnings forecasts are projected to be lower in 2020.
Because of worries about the US/China trade wars and Brexit, corporations are returning earnings to shareholders through dividends, buying back shares to reduce the PE ratios, and focusing on cost-cutting versus future reinvestment. This five year pattern could possibly affect earnings growth in 2020.
Historically, a signal of a coming recession is the inverted yield curve which occurs when the two-year Treasury yields more than the 10-year Treasury. When the bond market is in trouble due to inflationary concerns, the party may soon be over.
“We are dealing with a fiscally unstable long-term outlook in which inflation will take hold,” says another former FED chair Alan Greenspan. “There are two bubbles: a stock market bubble and a bond market bubble.”
Inflation would trigger massive defaults in the record $8.8 trillion corporate debt markets.
Low inflation driving interest rates and unprecedented levels of debt combined with Trump tax cut stimulus has created one of the greatest bull runs over the last 10-years. Many of the catalysts mentioned above could bring down the house of cards.
It all reminds me of the 2000 tech bubble. Some experts like chief investment Officer Scott Minerd at Guggenheim Partners expect a 40% hit in S&P 500. That’s comparable to the loses in the 2007-2009 Great Crash. After the stock market tanks and people lose their life long savings, expect a return to “real assets” like real estate.
When the market crashes, I’m expecting the Fed to overreact, lower rates and flood the markets with “bail-out liquidity” which will lead to a housing bubble pop an estimated 5-7 years after the recovery. All the signs of a real estate bubble will re-emerge… subprime lending, mortgage fraud, and overbuilding in construction. In my opinion, the next real estate market crash will be the biggest crash in the history of America.
In addition, expect massive overregulation in cryptocurrency and hemp/cannabis after the next crash. Many of the scammy ICO (Initial Coin Offerings) will go under and the SEC will look to “save the day” by instituting regulations. Cannabis/hemp markets are currently valued incorrectly. Investors pour money into cannabis and hemp mistakenly thinking that these are scalable tech companies, whereas cannabis and hemp are commodities. It will be common knowledge after the next crash that 145 PE ratios in Canadian cannabis companies are insanely speculative. When it comes to cannabis and hemp, the only metric that matters is free cash flow.
Based on my personal pontification about the market, I am being way way more careful in deciding what to invest in. Media Tech, Ad tech, tv and film content, and the entertainment sector content historically are less affected by recessions although leverage and acquirers could vanish. I’d expect influencer marketing platforms to increase during tough times, as companies want more “bang for their buck” in customer acquisitions. I’m interested in real estate services software solutions in anticipation of a housing bubble albeit it being short-lived. Interestingly, I am more interested in real estate software than real estate itself.
Sometimes the best thing to do when anticipate a market crash is to sit on the sidelines and wait it out. Another view point is to focus more on companies with the potential for free cash flow that can “ride out” the storm.
I was born into poverty and surrounded by a lot of emotional abuse as a child. My hometown in Waianae (Hawaii) has more than 70% of the population on welfare. Less than 10% of the high school graduates go to college, and more than 65% of the teenage girls become single moms before graduating high school. In fact, working at McDonalds in my hometown is considered a career path.
Entrepreneurship is the ultimate challenge in personal self-development. In the start-up world, whatever you don’t know will cause you to fail. I want to share with you eight hard-learned lessons from failing over and over on my journey from poverty to financial abundance.
Money Sabotage #1: Lacking The Neuro Self-Identity Of Wealth. Humans are born with spindle neurons and develop 200,000 to 400,000 spindle neurons by the age of 8. These spindle neurons work like a symphony conductor orchestrating over the sensory cortexes (the woodwinds), the self-state stories (the strings), the frontal lobe consciousness (the brass), and the emotions (the percussions). The spindle neurons formulate your ego and self-identity based on the collective data signals in your brain accumulated by the age of 8.
By the age of 8 when your spindle neurons become fully developed, your brain has already created a self-identity that will predetermine whether you’ll be rich or poor throughout your life. But following this blog will teach you how to neuro rewire your brain!
Money Sabotage #2: Hard Work. Perhaps, your parents taught you that money only comes via hard work. Many people so firmly believe in hard work that it may be very upsetting and controversial for many people to point out that money does not come from hard work. Money is an energy that comes from your self-identity (which is hard-wired in your spindle neurons by the age of 8).
If you want to become wealthy, start by dressing for success. Next, buy the kind of car that successful people drive. Finally, buy a home in an area where successful people live.
In addition, view hard work in terms of work hour units. If you work really hard, you’ll be able to maybe to crank out 100 work hour units per week. Unfortunately, if you’re competing with another company with 40 employees working 40 hours per week. This competing company will be crushing you with 1600 work hour units per week. Making money is about recruiting, hiring and keeping a high performing team who aligns with your core mission.
Money Sabotage #3: Not Surrounding Yourself With “Sapphires.” People may have even more resistance to this money sabotage than the last one. Sapphires are people who make you feel energized, inspired, fulfilled and happy. Because money is made from total working hour units, your business will fail if you don’t hire Sapphires.
To attract Sapphires, you first need to become a Sapphire. If your spouse, friends, or family are not Sapphires, this may cause your company to fail. This maybe controversial but it’s completely true.
Money Sabotage #4: Not Solving A Drowning Point. Successful companies target a niche audience who is drowning in some pain points. If you don’t target and segment a niche audience, it’s nearly impossible to solve a drowning point. Is your company’s product a vitamin (a “nice to have” product) or a pain-killer (a “must have” product)? Successful companies always have pain-killer products.
Money Sabotage #5: Lacking Mission And Purpose. I’ll guarantee one thing in business… you will have set-backs. Without a clear visionary mission and purpose, you will quit your business when times get hard. Successful founders are driven by a mission that they are so entirely passionate about that they’d rather die than quit.
In addition, since successful companies have higher outputs of work hour units, success requires recruiting, hiring and keeping a team of missionaries. A team of mercenaries will quit when times get hard (which is inevitable). Stake your mission and attract missionaries to your evangelical purpose.
Money Sabotage #6: Lacking Both Visionary And Integrator. A visionary sees 5-10 years ahead and sets a clear vision of the company’s product, expansion strategy, and product-market fit. The visionary is the ultimate charismatic sales person and evangelists who recruit clients, strategic partners and employees. The visionary is a rainmaker. On the Meyers-Briggs, the visionaries are often the personality archetypes of INTJ, ENTJ and ENTP.
As a visionary, if you cannot sell then you don’t have a company. Learning how to sell is required before you start your company.
A visionary in most cases becomes their own worst enemy as the company grows. Visionaries tend to do an inadequate job in running the day-to-day operators. Visionaries need to hire an integrator to manage and oversee the execution of the day-to-day operations of the business including operational systems, accounting systems, HR systems, and legal systems. The visionary creates the grand roadmap and the integrator coordinates and oversees the people parts of the business to execute the details of the roadmap. On the Meyers-Briggs, the integrators are often the personality archetypes of ISTJ and ESTJ.
Almost in all cases, the visionary and the integrator are not the same person.
Money Sabotage #7: Lacking A Culture Of Self-Integrity. High performing teams have a culture of self-integrity. People do what they say they will do. The opposite of a culture of self-integrity is a culture of victimization where people blame everyone (or everything) else but themselves. Victims have no control over the world around them. The most important skill for a founder is to develop their self-integrity muscles. If the leader does not have self-integrity, how can there be a culture of self-integrity?
Money Sabotage #8: Lacking Leadership And Emotional Intelligence. Money comes from organizing people. People follow leaders. Some leaders may gain power and control through manipulation, brute force, being cut throat and controlling behavior, but you can’t retain the best of the best teams with this type of leadership. A founder of a company is in the business of people (clients, strategic partners and employees). Emotional intelligence and leadership are both absolutely required in making money.
Even if you grew up in poverty and/or in an emotionally abusive environment, you can still be successful if you eliminate these 8 Money Sabotages. If you don’t eliminate these money sabotages, your company will fail.
I have posts scheduled on this blog every Monday at 9:30 am PST. On the first Monday of each month, I will coach you on Success Habits. On the second Monday of each month, I will share my research and insights about the economy. On the third Monday of each month, I will share my thoughts about software technology with a lot of emphasis on blockchain and product development. On the fourth Monday of each month, I’ll take you behind-the-scenes at negotiations with startups from a VC perspective