So the big question is this… if you grew up poor or middle class, how do you rewire your brain to attract massive amounts of money into your business?
My Uncle Jerry grew up in a poor middle class family in Hawaii. His first marriage ended in dismal failure and it seemed like Uncle Jerry lost his way. He went from meaningless job to meaningless job and ended up in Colorado Springs. In his mid 40s, a light bulb seemed to go off in Uncle Jerry. He started to read books and attend seminars like Tony Robbins. Uncle Jerry changed careers into sales. He remarried Nancy who thinks like a successful woman and he surrounded himself with successful people. Today, Uncle Jerry is considered rich. He worked his way up the corporate ladder to become VP in Sales at a major pharmaceutical company and lives on a mansion on the beach in Kailua, Hawaii.
From my observations in history, money seems to always go to those in power. The history of mankind has been a power struggle that includes wars (military build up and intelligence) and fierce competition to control monopolies. Somehow, Uncle Jerry went from being a man with no power to a man with power.
Schmid Mast defines power as “an individual who exerts or can exert control or influence over another person.” French and Raven explain “six bases of power” including coercive power (aka power by force), reward-based power (such as the ability to pay employment wages), structural legitimate power (like a government body), referral and influencer power, expert power and knowledge power (control over highly desired information). Uncle Jerry gained power by building his referral and influencer power, expert power and knowledge power.
Power attracts money.
However, studies have shown that power comes with negative effects as well. According to Deborah Gruenfeld at Stanford University, the feeling of power in ordinary people tends to reduce their empathy and leads to behavior where they objectify other people. These studies seem to validate the cliché that “power tends to corrupt.” Such is the sad state of our world where those in power more than anyone need more empathy. Yet power seems to reduce empathy in the brain.
Neuroscientists discovered that empathy and the social instinct derive from mirror neurons and spindle neurons in the brain. Darach Keltner found that power alters the neurotransmitter dopamine and noradrenalin.
One of the ironies of power is that the skills that gain power such as empathy and critical thinking diminish as a result of power.
In Barbara Tversky’s “Mind In Motion: How Action Shapes Thoughts,” the author shows that empathy and awareness of your environment like the non-verbal gestures of other people not only make you better communicators but also better critical thinkers. Thinking does not just occur in the brain, but rather in both the brain and the body. Tversky refutes the idea that thinking derives from language. She focuses on a variety of communication systems that transcend language, such as gestures, signs, maps, accounting, and music. For example, gestures from the body actually help us think. Abstract thought happens because of our ability to imagine the layout of objects in space. In other words, spatial thinking enables abstract thinking.
I’ll discuss more about the relationship between power and money on this blog. So this would be the first of many discussions on the topic to come. If you want to be a successful founder, you’ll have to master the art of gaining power. And hopefully, you won’t lose your empathy along the way. The world needs more powerful people who also have empathy. Regarding Uncle Jerry, I still can’t decide whether he lost empathy as a result of gaining money and power.
Investing in an early tech company seed round costs our fund an average of $40 K to $50 K. As a result, making a $100,000 investment simply does not make sense for most VC funds. Angel investors fill the much needed “gap” in pre-Seed startup financing
Convertible notes allow angel investors to minimize their legal expenses and to defer valuation negotiations until a subsequent round of financing. This allows the startup flexibility for the timeline to develop metrics which can be used to determine a fair pre-money valuation in subsequent rounds of funding.
Here is seven things you need to know is about convertible notes.
1) Uncapped Convertible Notes. Usually means that the valuation for the note conversion will be the same as the Series A valuation.
2) Capped Convertible Notes. The note conversion caps the valuation during the Series A conversion. For example, if the term sheet has a $6 million conversion cap, even if the Series A valuation jumps up to $20 million the note will convert at a $6 million valuation. The convertible note seemed ideal to defer the valuation question till the company has metrics to determined valuations, but with caps the valuation question remains in play.
3) Conversion Rate Discounts. For example, the note holder gets a discount (ie a 15%) of or when the note converts.
4) Aggregate Proceeds. Usually required by the VC to convert all convertible debt to equity in this round. VCs usually want this so that no debt is senior to their investment.
5) A common mistake made by founders is to raise too much convertible debt without understanding precisely how much dilution that occurs when the note converts to equity. This is easy to do because of the rolling nature of convertible notes versus a “one time event” of a Seed or Series A financing. In addition, many founders forget to calculate the dilution that will occur from the convertible debt conversion to equity and how it also diluted the option pool.
6) Convertible debt is usually simpler and less costly than Seed and Series A rounds. Nevertheless, it’s still most likely considered a “security” as defined by the SEC. So be sure to always have an experienced attorney draft these documents. This is not something you want to “do-it-yourself.”
7) The VC Valuation on the term sheet is post money. Post money equals the VC investment plus the amount of the VC investment. Convertible notes are usually included in the money valuation.
For example, the term sheet post money valuation is $20 million and the VC invests $5 million for 25% equity. Let’s say that $3 million in convertible debts after caps and convertible note discounts are factored in. Here is where the cap and conversion rate discounts can have a major impact on founder dilution. Also, the employee option pool is agreed to be $2 million. Keep in mind that typically convertible notes and employee option pools dilute only the founders and not the VCs. Assuming no other variables, the founders in my example might be getting a much lower percentage of equity than they were expecting. Founders must know that the devil is in the details.
Blockchain seems to be that hot topic that everyone talks about but no one seems to understand. It feels like the pet-Internet days when new platforms are coming out every six months and they get better and better.
As I am going through this old town of Virginia City, I am reminded that I can virtually live entirely off of bitcoin. Uber to work. Eat at restaurants. Buy groceries at Whole Foods. Shop for clothes. Watch a movie. Take a trip. Pay employees and get them computers. Renovate my home. Buy a book. Get a concert ticket.
The easiest way to use bitcoin is to use BitPay to keep loading up your Amazon Gift Card and almost everything can be bought on Amazon. Here is a list of what I can spend bitcoins on.
(1) Travel including hotels, flights, cruises and rental cars. Check out Expedia and Cheap Air.
(2) Furniture. Check out Overstock.
(3) Computers, Software and Electronics. Check out Newegg, Dell, Intuit, Microsoft and Tiger Direct.
(4) Payroll. Check out BitWage.
(5) Use Gift Cards Any Retailer Through BitPay. Use bitcoin to refill Gift Cards to Amazon, AMC Theaters, Home Depot or Lowes, Amtrak, AutoZone, Bath and Body, Barnes and Nobles, Bed Bath & Beyond, World Market, tons of restaurants, Uber, Whole Foods, StubHub, etc.
(6) E-commerce. Check out Shopify.
(7) Buy ads to promote my business.
In March 2000, Barrons predicted massive tech failures in an article titled “Burning Up; Warning: Internet companies are running out of cash—fast.” The Federal Reserve raised interest rates which lead to an inverted yield curve. March 10, 2000 is the day the Dot.com bubble popped. In April 2000, the Nassau crashed by 34.2% and hundreds of tech companies nose dived more than 80% in valuation. $8 trillion in wealth vanished overnight.
Back in 1999, everyone seemed to know that a market crash was coming. Stock advisors told their clients that tech stocks were overvalued. 1999 reminds me a lot of 2019.
The major cause of the Dot.Com Bubble was the Taxpayers Relief Act Of 1997 which lowered the maximum tax rate on capital gains for individual investors from 28% to 20% for equity held for more than 18 months. This law incentivized average investors to speculate on the super hot tech stocks.
In addition, bubbles are always caused by easy capital, speculation and innovation. Today’s innovation buzzwords include the “internet of things,” blockchain, artificial intelligence, virtual reality, machine learning and the Gig economy.
In 1999, tech stocks rose as fast as 300% to 1900% as opposed to 350% increases in 2019. In 1999, 550 tech companies went IPO, cashing out billions for venture capital funds. Venture capitalist made over $43 billion between September 1999 and July 2000. The losers were average people; the average 401k lost 25%-35% of it’s value.
In 1999, the cyclically adjusted price-to-earnings (CAPE) ratio of the S&P averaged 45 compared to long term averages for the traditional 12-month rolling PE (price-to-earning) ratio of 16. When earnings are low, the traditional P/E jumps up and makes shares look overpriced. When profits are high, they make the traditional P/E look like a great buy. Cyclically adjusted P/E (CAPE) ratio corrects the “illusion” caused by fluctuating earnings.
The problem with the stock market today is that profits are being driven by unsustainably low-interest rates and over $8.8 trillion in corporate debt. For example, the corporate growth rates have been outpacing GDP growth.
It is alarming that the cyclically adjusted P/E (CAPE) ratio today hovering around 30 is almost exactly the same as the eve of the 1929 crash. In fact, the greatest economist in the world reknown Yale economist Irving Fisher resolutely predicted that if a correction came it would look like a harmless slump because the tradition P/E (price to earning) ratio was along historical averages.
On October 15, 1929 (just days before the Great Crash), Fisher predicted that stocks prices were in alignment to corporate earnings and “what looks like a permanently high plateau… I expect to see the stock market a good deal higher within a few months.“ Fisher lost his reputation by making the same mistake as economists today who are overlooking the cyclically adjusted P/E (CAPE).
The tech bubble will pop. It’s impossible to know when precisely but it will happen in the near future.
If the Dot.com serves as a predictor, over 200,000 tech workers will lose their jobs after the crash, the stock market may lose 30%-40% of it’s value and venture capital funding will dry up.
As a founder, how do you increase your chances for financial success? After all, a lot of self-development content out there is a bunch of bullshit… rah rah garbage getting hyped up by a charismatic speaker. In fact, modern paradigms in law, politics, medicine, science, economic and psychology are so flawed that I’ve learned to be agnostic about everything.
Since Plato, most people have viewed our “humanness” as logical thinking that must suppress our “animalistic” emotions. Scientists from the 1950s explained that our logical thinking occurs in the neocortex, our emotional reactions occurs in our limbic system (which includes the amygdala), and our subconscious habits occurs in our “reptilian” brainstem. These are dangerous ideas because they are completely false.
Thinking, subconscious habits and emotions actually are pretty similar. They are all simply our brain’s prediction machine. External sensory data including our visual cortex getting processed in the occipital lobe, our olfactory (smell) cortex, our motor cortex, our auditory cortex, and our somatosensory cortex (taste and touch) combine to form an auto-correction machine. We don’t learn, experience or simulate the world from our external sensory inputs. The brain’s prediction machine is like a scientist who makes billions of hypthosis; our external sensory input is like the research data that tests the hypothesis.
When the sensory cortexes fire together in different regions, they wire together. This is called neuroplasticity and it is mostly predetermined by our epigenics. Our epigenetics is the combination of our genetic predispositions plus the culture, concepts, values, self-identity and beliefs of our parents. Humans are the only species capable of goal-derived concept learning. Language adds even more richness to our concepts.
Modern neuroscience provides us with the scientific research that emotions are constructed. Animals don’t have emotions; they have survival circuits based on body budget management. In humans and only in humans, goal-derived concepts always proceed emotional experiences.
As an example, let’s take a red apple. So you grab an apple out of the basket and take a juicy bite. Clearly, the 🍎 is real, right? The truth is that your brain tricks you. In milliseconds, a human adult has the concept of an “apple” and of “red.” Based on our past neuro associations, our brain makes predictions about what our experience with the red apple will be. If your past neuro associations is that red apples always have worms, your brain will predict a “worm taste” 🐛 when you bite.
Ladies and gentlemen… we live in the Matrix. The red apple is simply a virtual reality simulation created by our brain. All emotions are constructed based on predictions upon past neuroassociations and auto-corrected by external sensory data.
Humans have a natural tendency towards hallucinations. The schizophrenic person hearing voices has an unbalanced body budget featuring underperforming external sensory data auto-corrections. The hallucinations are the brain’s prediction machine at work but the system fails without external sensory autocorrections. Other mental illnesses like anxiety and depression works exactly the same derived from unbalanced body budgets. On the other end of the unbalanced body budget spectrum, mental illnesses such as autism work exactly the opposite. In autism, the brain’s prediction machine fails and so a non-functioning autistic child only experiences external sensory data without prediction concepts.
Emotions, logical thinking and subconscious habits are all the brain’s prediction machines. When someone cuts you off on the freeway, your amygdala is not reacting with road rage. Your brain comes loaded with a pre-mapped instruction manual (it’s concept) of how your body should respond if your “boundaries” get crossed. The amygdala did not create this emotional reaction. The brain’s prediction machine created the emotion based on your concept and the amygdala executed it’s signals to the rest of the body.
What does all this jargon-laden neuroscience have to do with succeeding as a tech start-up? Well, I believe it has everything to do with your success. Successful startups come from successful cultures. Culture predetermines how we build our prediction machine concepts. It is not a coincidence that 85% of the US-based “unicorns” (aka the $1 billion companies) come from the San Francisco/Silicon Valley Area. Who we hang around and surround ourself with matters.
Our epigenetics matter. If you’re like me and grew up in a poor and emotional abusive environment, you’ll likely struggle and fail a lot more than a “tech bro” from Atherton who was walked into Stanford. In fact, I’ve come to the conclusion that Bay Area tech startups don’t have more talent than non-Bay Area companies. They simply have better connections to the right mentors and access to way more capital.
For those that don’t have the access to the “tech bro” epigenetics, I’ve devoted my life to researching and developing resources to help you rewire your neuro associations. Unless you learn how to rewire your wealth self-identity (spindle neurons), emotion constructions, thinking, beliefs, values, subconscious habits and all other neuro associations, you will likely fail as a tech founder.
Venture capitalist are in the business of making predictions about your success. If they make wrong predictions, they lose other people’s money.
I’m writing from the old mining town of Virginia City which is near to Lake Tahoe. So why not discuss the modern version of mining… the blockchain.
Bitcoin is backed by millions of computers around the world called “nodes.” Today, the Federal Reserve, VISA and MasterCard back the current currency system but only THEY have access to the data. THEY also control the system. Bitcoin is open source to everyone and NO ONE controls it. Bitcoin mining is highly uncertain like mining for gold. Miners solve complex math problems to verify transactions in a block performed by high-powered computers.
Blockchain seems to be that hot topic that everyone talks about but no one seems to understand.
The luck and work required by a computer to solve one of these problems is the equivalent of a miner striking gold in the ground. So the miners insure both privacy and security. For example, the miners make sure that bitcoin transactions are not being duplicated (aka “double spending”). So if you have $100 in your crypto wallet, the miners verify that you didn’t spend the $100 on a music festival ticket for $100 AND on buying a $100 skateboard online. If the miner solves the complex math problem, then a new block is added to the blockchain and the miner is rewarded a block reward in bitcoin. This is the only way that new bitcoins get issued.
The block reward is halved every 210,000 blocks, or roughly every 4 years. In 2009, it was 50. In 2013, it was 25, in 2018 it was 12.5, and sometime in the middle of 2020 it will halve to 6.25. At this rate of halving, the total number of bitcoins in circulation will approach a limit of 21 million, making the currency more scarce and valuable over time but also more costly for miners to produce.
(1) A party requests a transaction.
(2) The transaction is broadcast to all on the entire network.
(3) The transaction is validated using validation rules set up by the blockchain network.
(4) Validated transactions are kept in a block and sealed with a hash algorithm.
(5) The block approaches the blockchain for authentication and specifically the hash is authenticated.
(6) This process is very secure because if a hacker tries to change the hash algorithm, the block will be rejected by the blockchain. Only after every computer on the blockchain network validates the block via a hash authentication, then the block becomes a part of the blockchain.
Prior to the 2000 Dot.com collapse, startups were racing with time to go IPO (Initial Public Offerings) to gain huge exits for their investors. During that time as a 23-year-old tech entrepreneur and world traveler, I remember getting my Aussie ex-girlfriend’s mom Bernie all excited about buying Cisco, Microsoft, and Amazon stocks. Bernie ended up buying a ton of tech stocks in the frenzy, but she like many other amateur investors ended up selling it in the “tech bloodbath” that was to follow.
I lived in Geelong, Australia for two years while working diligently on my first software startup. If the tech market kept it’s franactic pace, I never would have jumped ship into real estate. After 9-11 and the tech bubble collapse, the herd of investors looked for safer places to park their money… namely real estate.
During the Dot.com era, companies raised massive amounts of capital from their IPOs and used it to try to buy traffic to jumpstart a network effect. Today, I see the same exact phenomenon occuring with two notable exceptions. The first difference is that the source capital is not coming from IPOs but rather from institutional investors and sovereign wealth funds. The source of the capital is 20:1 leverage with low interest rates. In fact, corporate leverage alone now exceeds $8.8 trillion usd. The second difference is a valuable lesson that VCs learned during the Dot.com debacle… the importance of getting to product-market fit quickly.
Silicon Valley has also formulated it’s “winner-take-all” strategy. Dot.com startup Amazon exemplified the “winner-take-all” approach of that era. Jeff Bezos believed that losing money could be the ultimate competitive advantage if you can raise enough capital to sustain it, as it prevents others from entering the space or gaining market share. When competitors are wiped out, then you can raise prices back up to profitability.
Examples of no-revenue companies are Uber valued at $120 billion usd and Lyft valued at $15 billion usd. It doesn’t matter to Uber that it lost $4 billion usd in 2018 and $4.5 billion usd in 2017. First, Uber raised over $22 billion usd. Uber has made a ton of money for it’s early stage investors in it’s recent IPO. Second, Uber’s traction is such that it will be “bailed out” by an acquisition. It’s possible that Uber will survive the market collapse that I forecast will be coming soon.
But here is the problem with a company like Uber… it lacks sustainable differentiation.
Network effects have no value if they don’t create monopolies. Uber will never make a profit in the rideshare business because it has no sustainable differentiation over competitors like Lyft. Raise rideshare prices and customers migrate over to Lyft. To win, Uber must beat Lyft and this doesn’t seem feasible or realistic. Alternatively, Uber needs to use it’s capital to create secondary models in markets such as supply-side logistics (aka Uber trucking). As a side note, I think Uber is trying to scare riders with “sexual assault” stories with the goal of allowing Uber to record driver / passenger conversations (obviously valuable data and a major violation of consumer privacy rights). If I were Uber, I would use Uber’s higher market valuation to buy Lyft. All the drivers who drive for both Lyft and Uber will then be working for the same company!
Uber is an example of a unicorn… defined by venture capitalist Aileen Lee as a startup who exceeds a $1 billion market cap. The number of unicorns has been on the decline since 2014. So here are the numbers… 42 unicorns in 2014, 43 in 2015, 16 in 2016, 33 in 2017, and 35 in 2018. In addition, a recent study by the National Bureau of Economic Research argues that the average unicorn is 50 percent overvalued.
Silicon Valley’s “winner-takes-all” approach works great in bull markets. However, I believe that the “winner-takes-all” fails miserably in bear markets. In a bear market, startups with free cash flow will survive. Ironically, free cash flow during bear markets may win the “winner-take-all” as no-revenue companies fight for their survival.
I think the groupthink in the Bay Area is missing another major blind spot. Prior to the Dot.com bubble, IPOs for tech companies took an average of 4 years. Today in our current “app bubble,” it’s taking 11 years for tech startups to IPO. Ladies and gentleman, this is a math problem. If you visit the history of American financial markets, bull markets tend to last either 5-7 years or 11-14 years. If IPOs for tech companies take an average of 11 years, this is like playing Russian Roulette. Better to look for 5-7 exits and being mindful of the economic credit boom and bust cycles.
So I am sharing my insights as to why VC tech investing is super risky in 2019. However, I don’t see the makings of a real estate collapse. Keep in mind that after the Dot.com Recession, tech workers lost their jobs and it temporarily effected the real estate market. But from my perspective, real estate “megacrashes” like 2007 have economic indicators such as subprime lending, mortgage fraud and over-construction. In a nutshell… I am expecting a 2000 Dot.com crash and not a 2007 real estate crash (well unless the currency collapses).
In 2001 with my first software startup on the ropes and hanging on for dear life, I shifted my focus to real estate investing. After the “app bubble collapse,” I’d bet that people go back to speculating on “hard assets” such as homes. In others words, I am expecting a two year bear market proceeded by a 5-6 year record breaking bull market.
From this discussion, it’s pretty clear how risky venture capital investing can be. Even if you pick the right founders in the right market, you’re still rolling the dice on market timing and competitor risks.
If you’re tech investing in 2019, find experienced founders who can quickly get to product-market fit, change your paradigm from “winner-take-all” to free cash flow as a near term survival strategy, and do your best to time the markets (which can be nearly impossible to do). Beware!
When living in a brand new apartment complex in Tacoma (WA) over fifteen years ago, I frequently visited their state-of-the art movie room with surround sound and theater seating. In this cinematic setting, I could really feel, hear, see and experience the movie “The Secret.” In fact, according to “The Secret,” you unlock the Law Of Attraction by feeling a desired outcome as if it already existed. For the last 27 years of my life, I’ve also been a huge disciple of SMART (Specific Measurable Actionable Relevent and Time Sensitive) written goals.
But here’s the problem. Have you tried written SMART goals and/or invoking the Law Of Attraction but have NOT gotten results? In today’s post, I will share with you a better approach based on neuroscience that works better than written SMART goals and/or invoking the Law Of Attraction.
In the last ten years, widely held old paradigms in neuroscience have been disproven with scientific research. For example, it was previously believed that we had a subconscious mind in our brainstem (aka the Reptilian brain). This is the bottom of the brain area. Neuroscience has now discovered that conscious corticals and subconscious corticals occur in the same regions of the brain. In other words, there is no such thing as a subconscious area of the brain.
Let me explain how the brain actually works. As humans, the auditory cortex, the somatosensory correx, the visual cortex and the smell cortex all wire together as they fire together. The brain through neuroplasticity gets shaped and reshaped through sensory experience AND imagination. As a side note, modern fMRIs show that the various cortexes fire from just visualization and imagination. During subconscious dreaming, whatever we focus on gets the reinforcement attention. We tend to give attention to stimuli that match our self-identity. For rewiring your “self-identity” spindle neurons, the best system is to review your Habit Goals (to be explained below) right before sleeping and right after waking.
In addition, neuroscience now shows that feelings don’t come from the limbic system. It turns out that there is no limbic system. For example, it used to be believed that fear and the “fight or flight” reaction derived from the amygdala in the limbic system. Neuroscience now understands that the amygdala executes the signals coming from the cognitive areas of the brain. In other words, the emotion of fear is a cognitive activity. Interestingly, we don’t even know that the emotions experienced by other animals resemble the human emotions because animals and humans process cognitive functions differently.
Finally, neuroscience has discovered spindle neurons that form our self-identity ego. Humans are born with spindle neurons and the 200,000 to 400,000 spindle neurons fully develop by the age of 8. The spindle neurons function like a symphony conductor. The sensory input is like the brass, the emotional inputs is like the percussion, the thinking inputs is like the woodwinds, and the subconscious cortical inputs are like the strings. The self-identity spindle neurons are the sum total of the combination of emotions, thinking, subconscious habits and sensory data collected by the age of 8.
The problem with invoking the Law Of Attraction and/or SMART goals is that it insufficiently rewires the spindle neurons that have been hardwired by the age of 8. Written SMART goals won’t rewire your “self-identity” spindle neurons. Feeling like you’ve manifested your desired outcome (by invoking the Law of Attraction) is not enough to rewire your “self-identity” spindle neurons.
I’ve developed a goal-setting process called Habit Goals that might help you rewire your spindle neurons and allow you to put your attention during subconscious reinforcement memory and learning in alignment with your desired outcomes.
Liz Demarco used my Habit Goal method to lose 35 lbs. Robin Lee described a transformation in her relationship with money. Bobbi Schwartz says that Habit Goals allow her to sleep better and make her happier and more joyful. Heather Perdelwitz says the Habit Goals helped her to replace victimization with 100% radical responsibility.
Why do you have a business? Perhaps, your “why” relates to having more money to travel or funding a cause that you’re deeply passionate about.
Watch this step-by-step video on how to develop your Habit Goals to master the art of rewiring your spindle neurons.
What would it cost you if you continue to fail to achieve your goals? Are you frustrated of falling short? Who are you hurting by your inability to attain results?
You cannot afford to skip the link that I posted above. The Habit Goal system could be the missing master key to transform your money, relationships and health.
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.