This Week in Startups - Zoom’s revenue tops $1B, valuation falls + Startup Checklist: how to prepare for fundraising | E1333

Episode Date: November 24, 2021

First Jason covers Zoom's Q3 earnings and reflects on broader tech valuations (01:53). Then, Jason does a Startup Checklist episode on how to get your startup ready for an investment (16:10). The episode covers the basics like making sure you have the right structure (18:06), the ways you can fundraise (39:33) and more.

Okay, today we have another startup checklist episode. This is episode number eight. I'm going to cover how to get your startup ready for investment. These are 10 critical points that you can check off. You probably got three or four of them. You want to risk not having the other six or seven? Of course you don't. This is an episode you want to watch with your co-founders.

But first, I want to talk about overpriced stocks, sales to valuation ratios, and how the world now post-COVID as we move into the endemic phase. The stock market's coming back to reality. And one of the amazing companies that we saw grow during the pandemic was Zoom, a fabulous company that is printing money, and they had an amazing, amazing quarter. But their stock has been cut in half since August. And now they face reality of a stock market that is going to value them, not based on hype or memes, but based on reality.

Still a great company, but we're going to dive into their valuation and their recent quarterly report for Q3. Stick with us. This week in Startups is a lot of. brought to you by LinkedIn Marketing. To redeem a $100 LinkedIn ad credit and launch your first campaign, go to LinkedIn.com slash checklist. Odo is a fully customizable and fully integrated suite of business apps that lets you build and scale your stack as you build and scale your business. Your first app is free forever and right now Odo is offering $1,000 off your first implementation pack at Odo.com

slash twist. That's ODO.com slash twist. And Vanta, compliance and security shouldn't be a deal breaker for startups to win new business. Vanta makes it easy for companies to get a SOC2 report fast. Twist listeners can get $1,000 off for a limited time at vanta.com slash twist. Okay, and in our news story today, Zoom announced amazing earnings, but their stock is down 17%. Let's look at the numbers here. Zoom's Q3. Revenue was $1 billion, I kid you not. 35% increase year over year. Net income was $340 million. That's up 71% year over year. 2019 total revenue is $330 million. And when you look at that 2019 total revenue $330 million, you know, revenue was $1 billion in a quarter. So this is a high growth company, super high

growth, pretty amazing performance. They have over 2,500 customers paying more than 100K a year. Those are the whales in the system. That means if you were to put a hundred, if they're paying $100,000, that'd be $250,000. If they're paying $100,000, that's $250 million. In other words, the whales in their system are 25% of their revenue. Their top 2,500 customers are 25% of their revenue. Extraordinary that people are really paying a lot of money inside corporations for Zoom. And you know what? 100,000 or more is actually not that much if you were a giant company. Why wouldn't you pay that?

What were you paying Cisco previously? What would you be paying WebEx or GoToMeeting? Like, seems actually quite affordable. This is Zoom's 14th consecutive quarter with a trailing 12-month net dollar expansion rate in customers with more than 10 employees above 130%. This means their growing revenue within existing customers at an absurd rate, which makes sense. Net dollar expansion rate basically means how much money is being paid by existing customers. So how much more are your existing customers spending? If you think about Zoom or Slack or a CRM system like Salesforce,

the more people get value from it, the more the person sitting in the cubicle next to them or in another department might deploy that software. So Zoom is bottom-up SaaS, just like Slack and Yammer, which David Sachs kind of pioneered this model. people can start using Zoom. They don't need permission from anybody in their IT department in all likelihood. They just start using it. They pay for it on their corporate card. Then it gets rolled up into some giant corporate account. The corporate account then expands. Hey, if you need Zoom, just email the IT department. They'll get you a couple of licenses. The end. All of this good news still is resulting in the company coming back down to earth. This year's 35% revenue growth is way less than the three quarters of a year ago when they grew over 350% when the pandemic hit. how many Zoom calls were you doing?

I wasn't doing any before the pandemic and then 100% of our lives moved on to Zoom. So now it's like Restream is half my life, Zoom is half my life. Once in a while I get Microsoft Teams or a Google hangouts, but not too often.

And so revenue is growing, but the multiple they're trading at has come back down to Earth. If you look at this chart, if you're on the YouTube channel, what you'll see is the price to sales in mid-2020 hit 100, In other words, whatever their top line sales was, they were 120 times that in terms of the valuation of Zoom.

Now it's at a much more reasonable 20x. In other words, if they made a billion this quarter and they're on a $4 or $5 billion run rate over the next year, but they're growing faster than that, but $4 billion run rate, okay, $4 billion times 20, $80 billion market cap. So the market cap is coming back down to earth. So, if you look at meme stocks, this is one of the problems with them is that sometimes people who buy meme stocks are buying them based on momentum, they think it's going to spike, and they're just flipping the stock. When you have stock flippers who are day traders, the meme stocks then can face this compression.

So when you see people trading at this high sales to the valuation ratio, that is a huge problem. There was a group of them that were the Chinese stocks, which came back down to Earth. you had the work from home stocks, Zoom, Peloton, etc., Slack when they were. Slack really didn't go up too much. That was interesting because I think the Microsoft teams headwinds were very strong. And then, of course, you have meme stocks, AMC, Peloton to a lesser extent, maybe also in that group was GameStop. And DoorDash got caught up in that and Zoom, work from home, maybe even a little bit of meme in there. And when the actual people who hold stocks for a decade, like hedge funds,

or retirement funds. They want to hold on to a million shares of this company and hold it for a decade or two, like they hold their Apple or their Disney and they never want to sell it. They don't want to take the tax hit. Okay, those folks are not going to buy the stock when it's trading at 100X, the sales.

They'll wait for a pullback and then they'll buy in. I think that's what we're going to see. That's probably why Peloton and some of these other things will do well. Of course, there was the OG meme stock, Nikola, which remember when I was giving Nicola a hard time saying, hey, this company is not worth 40 billion. Everybody's like, oh, that's because your friend did another electric car company,

whatever bullshit. And of course, it was a giant scam. And I was right. So victory lap here. With Rivian, I saw that thing go up to 130, $140 billion. I called that one out. I've been proven right already. I'll be proven right that when that company comes down to 50, 40, 30, maybe my target $25 billion company. Nobody is going to hold these things for a long time if they're overpriced. Why would you hold an overpriced stock? You would cash it in and then buy the underpriced stocks. So this is one of the problems we have in the stock market right now is people got too excited about China, too excited about work from home. The compression happens, reality sets in, and then you have these whipsaw moments.

And what I think we'll see is a flight to revenue producing companies with great customers, which luckily Zoom is one of. Nobody's canceling their Zoom. It's just too good of a deal. It's too cheap, too affordable, and too really just too fucking good, right? It's a really great product. So I think this is going to be a huge, huge company. I don't think they're going anywhere.

I think they should be buying companies. They probably should have done secondary and bought companies at that high price. I think they did buy some. But it reminds me a little bit of the Silicon Valley famous talk, one we've had for many decades in the tech business, which is Revenue equals death. And I'll leave you with this quick 50-second clip of Russ Anaman talking about revenue versus pre-revenue companies.

A couple of F-bombs were bleep in there. See you on the other side of 50 seconds. Richard, one potential issue. Our hosting fees could become a challenge as we scale. It's a shit. But we can offset a lot of that once we get a few customers and start a subscription revenue model. What?

Revenue. No, no, no, no, no, no, no revenue. I'll call you back. What? Why would you go after revenue? Because to make money? No. If you show revenue, people will ask how much.

and it will never be enough. The company that was the 100-X or the thousand-exer becomes the 2x dog. But if you have no revenue, you can say you're pre-revenue. You're a potential pure play. It's not about how much you earn. It's about what you're worth. And who's worth the most? Companies that lose money.

Pinterest. Snapchat, no revenue. Amazon has lost money every fucking quarter for the last 20 years. And that Bezos motherfucker is the king. The king. There's no revenue. No one wants to see revenue. It's hilarious.

And then the part of the clip that's, cut out is at the end, he goes, you guys know what ROI is, right? And they're like, return on investment. He's like, no, radio on internet, which is the tip off that this character is partially based on Mark Cuban, who did broadcast.com famously and sold it to Yahoo at the peak. Is now a time to be cautious? Yeah, probably. Might want to be defensive in some positions. Sure, if you own a lot of crypto in your way up, maybe you want to pay down your debt, maybe you want to own your house, if you own a lot of stocks that are trading at 50 times, their sales, 100 times, their sales, yeah, maybe you want to sell some and buy some that are undervalued. Peloton seems

undervalued now. Maybe I might want to buy some Peloton. I believe in that company, great product. I think it's going to print money over time. I think their best days are ahead of them, not behind them. So what's happening now is the return to reality. There was just crazy enthusiasm. There were Stimmy checks. There's a mania going on, IPO mania. And now it is the time for everybody to take stock and say which of these companies actually have passionate users who are not going anywhere, great founders, great product teams, and huge TAMs, total addressable markets, like trillion-dollar Tams or hundreds of billions of dollars Tams. Well, if I look at that, Airbnb, pretty great, not going anywhere.

Coinbase in Robin Hood, I think they both won the day. I don't see either of those going anywhere. That's going to be your Coke Pepsi. Uber, Peloton, Facebook, Google, Amazon. They don't have out-of-wack PE erasures. believe. I think they're all pretty realistic. I obviously have two of those names, you know, that I own directly, Square I own directly, Robin Hood, Uber I own directly. The other ones I probably own in some of these fidelity funds, like the low cost funds I own of those mutual funds. And so

I'm really only talking my book here with Robin Hood, Uber. The other ones, I just think they have tens of millions of users in most cases, and those users love the products, and I don't see them going anywhere. So flight to quality is what we're going to see. Here's a chart. This chart came out on Sunday from Compound. The Twitter account is Charlie Bill L-L-O, B-I-L-L-O. And he's just tracking percentage below all-time closing high. And top of that list is Nicola, 85%. Also on that list, you're going to find Peloton down almost 72% Zillow, almost 72%, Stitch Fix, 73%. Beyond Meat, 67%. Robin Hood, down 58%. Although that was, again, during that meme, I think there was like a two-day period where it went up to $70 and the gang came back down.

So those temporary spikes, I think, I would discount out of these, Zoom down 56%. Alibaba and Baidu, 55% each. Redfin, 54%. So things are coming back down to earth To a lesser extent Lyft 39% Palantir 45% PayPal and Twitter both down 37% snap down 38%.

So the market is really heated and people now are going to move to more defensive positions which could indicate a buying opportunity if you believe in these companies for the long term So if you thought Zillow is going to be here 10 years from now or Stitch Fix was going to be here 10 years for now or you think Niccolo's filled with a bunch of geniuses and they're going to get their role of the legal problems.

Okay, assess each of those companies. Do we think Niccolo's going to be here? No, I think that's going to be a wash. I think it'll be a $1 share and then be delisted. That's my best guess. That would be what I would predict. I'm not saying that's a fact. Don't sue me.

Zillow and Stitchfix, will they be here? Will they be strong? And Peloton, will they be here and be strong companies 10 years from now? Yes. Will they be trading at a higher price than they are now? I think yes. I can't imagine a world where Stitchfix, Zillow and Peloton are not great companies 10 years from now. So maybe it's a buying opportunity.

Maybe not. You have to drill down. You got to double click, you got to do the work, do your own research. And I think that's what's happening in the market. A lot of people who are enthusiastic, maybe a lot of day traders. You know, they made their money, they sold. They booked the win. Don't get me into cryptocurrency, please.

Chatroom. Don't make me talk about ripple and the craziness over there. Why you would bet on a cryptocurrency that has no value in the world, doesn't provide any value, that the people control, and that the SEC thinks is a stock and is doing an investigation into it. be careful. What do I think of lime and bird? I think those are real businesses. People got very excited about them. I don't know what they're trading at versus their sales. I would look at their sales to valuation. I do think that they're either buyout targets or they could become

sustainable businesses over time. I think that people love scooters. They love micromobility. It's a thing. Is it 100x from here? I don't know. Is it a 5 to 10x from here? That seems more likely or possible. So drill down, look at their unit economics, look at their profitability. I think all these businesses get two or three years of public now, tech companies, to show growth and lose money. And then after two or three years, they're going to be expected to show profits, which Uber, Lyft, DoorDash, Instacart, they're all being kind of pushed towards, you know, show us reality, show us you can ring the register and that there's some money left at the end of the day. All right, next up, as promised, episode eight of the startup checklist. You can visit

the startup checklist at this week in startups.com slash checklist. You can follow along. And in this important, critical episode for founders, you've been waiting for it. This is an important one. What you need to do to get your startup ready to be investment grade, to be ready to take that big check from seed investors, angels, and hopefully eventually a venture fund that joins your board stick on us. Before I start the ad read, just go to LinkedIn dot com says checklist and you will get a $100 credit toward your first ad campaign on LinkedIn. Okay, let's get to the ad read here. Every startup founder and marketer has been in the situation.

You know it well. You're planning to launch your new campaign. You know your audience. The team is happy. Everything's going according to plan. You love your creative. But you got that one thought in the back of your head, don't you? How can I be sure that my acquisition campaign will drive high impact leads for my sales team?

You need those high quality leads. We all know that. And with LinkedIn ads, you don't. need to guess. Because when you advertise on LinkedIn, your message reaches the people who are ready to engage you. They're in the business mindset. You know that. LinkedIn equals business. Business equals LinkedIn. The end. Over 30 million companies are active on LinkedIn today. And over 71% of professionals use LinkedIn to make business decisions. So startup marketers don't wait to start achieving your brand and lead gen goals. No, LinkedIn is offering our listeners exclusively a $100 ad credit

to get started today, get the Hyundai, and get your first LinkedIn campaign up and running at LinkedIn.com slash checklist. Lington.com slash checklist. Terms and conditions apply because they're giving you a hundy. Okay, everybody, it's time for episode eight of the startup checklist. If you've been watching this series, it's basically 100 items on a checklist that you should ask yourself if you're starting a company. So for founders and co-founders, you could sit in a room, print this out, bring it up on your tablet, turn it in. into a notion document and cut and paste it over, make a new page out of it, and write your notes on it. And I'm sharing this with the founders out there because we really, as part of the mission

here at this week in startups, want to help founders avoid the pitfalls, become more informed, and we want to see more people participate in creating companies. Why do we want to see people do that? Well, we're investors. And the more people who try to create great companies, the more options we have as investors to place a bet. And it's my personal belief in a addition to the basic business model of an investor, which is to invest early, continue investing, and then hope for the best, you know, an IPO of your company or maybe it gets bought. And we all make 100, a thousand times our money. Putting aside that profit motive and the business model, society is better.

The human race does better when founders make products and services that are better than the ones that came before it. It really is that simple, folks. If you can make a better product or service that solves a problem and is helpful to people in the world, that's virtuous. So let's get to work. Episode 8 is about preparing for your fundraise. That's today's episode, preparing for your fundraise.

This is the eighth episode in the series. You can see all of these checklist items and all the episodes at this weekendstartups.com slash checklist. We always make it really easy. This week and startups.com slash slack to join our Slack. This week and startups.com slash basics

to see the startup basics series. this week in startups.com slash meetups to meet up with other founders in your local neighborhood, and that program is going fantastic. But for this one, it's slash checklist. Okay. So this is item 71 on the checklist. It's the first one we're going to go over today, which is you want to check this box. Are you a Delaware Seacorp? You need to be a Delaware Seacorp if you're going to raise money from investors in America. Why? Well, Delaware law is very favorable to shareholders and to companies. This means the company must do what is best for all the shareholders in the company. And this is why venture capitalists and founders and everybody involved in entrepreneurship

has really selected this as the winning type of corporation. There are other ones out there that might be better for crypto or might be better for hedge funds. There are offshore types. But for whatever reason, this type of company has become the standard here in America. And even if you're an Australian company or UK company, you can be a Delaware corporation so that people can invest in your company easily. Once you say you're a Canadian company, a European country, you know, or a company in a specific European country, tax, lawsuits, investor rights, going public, tax treatment, I already mentioned, I think, accounting practices, all of that and HR issues all will change. If you're investing and you're trying to scale an industry,

you really want to be comfortable and understand one of these jurisdictions, and that one is the Delaware Seacorp. Investors are very comfortable about it. They know it. The process is super straightforward, and there's very limited liability. There are some tax benefits. If you're an international company looking to raise some U.S. VCs, but you don't have a U.S. entity, well, you probably should just create a U.S. entity. You can talk to your attorneys about that. Some people flip it over, but it is absolutely correct to do a Delaware Seacorp. Now, some people say, hey, what about an L.C. One-time tax treatment. The problem with that is, if you're going to take investors and you start as an LLC, you're going to have to switch over to a C-Corp. And when you do switch over to a C-Corp, a Delaware C, it's going to just be like paying your legal bills over again and you'd have accounting issues. LLCs are great for venture funds or partnerships like a law partnership or an accounting partnership with a bunch of CPAs or maybe you're buying real estate assets because it has one-time taxation. And that's great. but you don't have shares in an LLC.

You have units, and it's a completely different structure. They're two different types of entities. So you can talk to your lawyer about that. You can do some Google searches. But just for the purposes of this checklist, we don't really need to debate it. You need to be a Delaware C. And you, again, when you're raising for Metro Capitalist,

you don't want to throw up red flags. Having the wrong incorporation is like walking into the room holding like five red flags in each hand, that you don't know what you're doing. Okay. item 72. Do you have a cap table and is it clean? A messy cap table is a deal killer. It is a huge red flag for investors. And it often results in people not investing in a company. When they say the cap table is broken or a messy cap table, it means that there are some people early on in the cap table

that have a very large percentage of the company and maybe they got it at a very low price. And then the founder's ownership is way below 50% before they can. get to Series A. When you're at a series A, you really want the founders to be above 50%. So, have two founders, 25% each. You have a three founders, 15 to 18% each, maybe even 20% each. Why does it need to be there? Well, we anticipate there'll be a series B and people will be diluted 15, 20%. There'll be a series C. Maybe you're diluted 10 to 15%. And then you do another round of funding and you diluted another 10%. You get the idea. You get diluted a couple times, you might be down if you're a solo founder at 20% by the time the company gets sold,

or if you're two founders, you might wind up with 7, 8, 9% of the company when it goes public. That seems fine. It seems fair. You have all this money put in. The employees got 10, 15%. A bunch of investors got the bulk of the company. They put a ton of money to work. And maybe you sold some secondary shares along the way.

But it needs to be clean at the start. And so pre-Series A, founders are going to need to own 50 to 65%. that's Series A, maybe they get cut to 40, 50%, like I was saying. Series B, 30, 30, 30, IPO exit, 10 to 20% ownership. You don't want to give a large percentage of your company to a dev shop or consulting firm. There are predatory accelerators and dev shops and consultants who will say, hey, we'll give you 10K, plus we'll build your app, which will cost $500,000. It'll take us six months, and we value your company at $2 million, so we now own for the $100K,

We own 5%. And for the 500K, we own another 25%. Now they own 30% of your company. And now you're going into an accelerator. They get 7%. Now 37% is owned by investors. And then a seed round happens. You dilute 20%.

Oh my God. You're way behind the numbers I just stated. So we see this all the time. It can be fixed. It's just painful. So one of the things that happens all the time is a company that's done too much fundraising. We'll get to a new fundraising round. And the investors say, listen,

I will give you $10 million for your Series A for 25% of the company, but the founders are only at 30%. I want to see them at 50%. So therefore, I want to do a founder refresh. And that's not coming out of my 25%. That's coming out of everybody else's. And so boom, now all your previous investors get diluted. They all feel terrible about it.

How do you mitigate against them feeling terrible about it? Well, if they can participate in the new round, well, then they can at least buy more shares and keep their percentage ownership up. K-A pro rata. And another way to do it is to just be fair with them, maybe put that additional founder grant at five years. Maybe they, you know, the founders each get 2% a year for five years, 1% a year for five years. I've seen 5% one percent each year for five years. Basically locks in the founders if they've been toiling away for three or four years and they're fully invested. You might have to do that anyway. But this can create a lot of bad feelings. And sometimes

a venture capital firm, I've seen this three or four times recently. A venture capital firm will say to win a deal, we'll give the founders a 25% founder refresh and we want these terms. And the founder says, oh, this is the best deal we could find. I couldn't get anybody else over the finish line. And now you got this inside dealing. Is it illegal? Is it unethical? Was that the best deal? Well, the fact that we have to sit here and debate it is what creates all the bad feelings. Because I've had a situation recently. I would say what company. I'll make this a little bit mysterious by blending the numbers here. But I had a company that couldn't raise around except with this one predatory jerk CEO of VC who wanted to give them a whole bunch

of equity, I got the internal folks to make another offer and they didn't take the internal offer. They still wanted to go with that one. So then it was like, okay, the founder is really just looking after themselves and we don't need to be involved with this company anymore. We're going to basically, you know, not participate as much as we would because the founders kind of screwed us, right? And that's the bad feelings that you don't want to have with your investors. So you have to be very careful about the stuff. It is a little dicey. communicating well and being reasonable is the way to avoid this. But sometimes you get predatory VCs, jerk VCs who will just put in these like take or leave it offers. Then it's up to the

existing investors to give an offer that is reasonable to the founder and then the founder has to want to take it. And none of this is easy because the founder could quit. The VC could pull its term sheet. The existing investors can sue. All kinds of bad things that happen. And that's actually kind of the great part about equity structures is because everybody's tied to that share price and the number of shares they have, this kind of debate can happen. And it's really important. Item 73 on your checklist is, do you understand dilution? What is dilution? It's the reduction in equity as new shares are issued. That simple. You issue new shares. We've got 100 shares in the company. We issue 100. Now there's 200. Each share is worth half as much, all things being equal.

Let's just say we just doubled everybody shares, like a stock split. Okay. So the share price is $10. There's 100 shares. We now make it $200. The share price is now $5. Everybody has two shares who had one. Okay, no big deal. But if somebody buys the shares, they buy those hundred shares for $100 each. Now you got $10,000 going into the company. So the company would theoretically be worth a little bit more money because more cash is being putting in for buying those shares. The more of the company you sell, obviously to investors, the less you own, the less you own, if you get too diluted, you start to lose control of the company. and shares ultimately are the proxy for voting in a company.

You do create a board that votes, and you can have super shares. So there are things on the margin that are not one for one share voting. Like in America, we have one person, one vote, hopefully. Some people might cheat from time to time, but you go to jail if you do that. So I don't recommend it. In corporate structures, yeah, you could have super shares. One person's shares could vote 10 times what another person's can. You typically don't see that early on in venture back companies.

you see that in later stage public companies, where the founder gets to negotiate that right. But again, the important thing here is to understand that you don't want to get too diluted early. You do need to understand the difference between preferred and common shares. Common shares means the founders, the employees, advisors, preferred shares are people paying money. What do preferred shares exist?

Well, generally, if you're putting money into the company, you can get screwed pretty quickly. You give $10 million to the company. The company has control because the founder's own 60, 70%, they could just vote to sell the company or they could issue more shares and you can get into all these legal battles. What the preferred does is they get a set of rights that maybe other common shareholders don't get like information, like a board seat, like the ability to have their shares, their shares sold first before the common go, if it's a short sale. In other words, if you sell for

less than the valuation you raise money at before, why is that important? Well, What if the person raises the money and just takes the money and runs off with them? That is like always the fear when people are starting out. Our industry runs on trust. And when trust gets broken, lawyers get involved. Some sabers get rattled. Hopefully things get settled. You generally don't see it going to a Delaware court.

Although, sometimes it comes close. Not that I would have any experience in this realm. I have experience like twice and 350 investments. Literally once in 350 investments, has it gotten to the level of like, Okay, this could become a court case. Pretty interesting, right? So I do think overwhelming majority of the time, everybody's a good actor. Sometimes you get a rogue founder, a rogue investor. They go crazy and things explode. Okay. You're going to need to understand your pre and post money valuations. Pre-money is the valuation before the new capital has been accounted for,

before the new monies come in. So pre-money, $8 million. Two million dollars is coming in. What's the post-money? Well, it's the $8 million, the value of the company before the money came in. Well, now the company has $2 million in cash. So it's an $8 million. million dollar value for the enterprise. That's what we value the company at. But we have to put a value on the $2 million in the bank account. So eight plus two equals $10 million post money. Here's another example. Company A raises $100 million out of $900 million dollar valuation, free money, $900, post money, $1 billion. You get the idea. And this is something you can learn online pretty easily. You can double click on it, find tons of videos and blog posts about it.

What's most important is that you have a great attorney who's by your side, who's willing to take the time to walk you through this. You can do a spreadsheet. You can use Cardi. You can use CapTable I.O. You can use CapBase. You can use Cake. Tons of different CapTable software out there you can use and try and figure it out.

And even using Google Sheets or Excel is a great way to do it. So you can actually kind of understand the formulas yourself. If you listen to this week and startups often, you've heard me talk about Odo Suite of Business Apps a lot. Well, they're going to give you your first app free forever and then a thousand dollars off your implementation pack at odoo.com slash twist odio.com slash twist and here's why odoo is so great for startups while their suite of business apps can help you run your entire company from just one platform they're going to streamline all your workflows by bringing all your information together

this eliminates all the annoying repetitive tests like entering data across multiple platforms plus if you only need two or three apps right now that's okay use those two or three apps to optimize your workflow and that's all you'll pay for you'll pay for you. for. O-Doo is not going to charge you for apps you don't use. Of course they wouldn't do that. So O-Doo offers 30 main apps and over 16,000 apps from their open-source community.

You know, the apps they have bookkeeping, sales, CRM, website builders, and more. Again, your first app is free forever and O-Doo is offering a thousand dollar credit on your first implementation pack. Go to O-D-com slash twist. For $1,000 off, that's O-D-O-O-O-O-com

slash twist. Okay, number 74, in your pre-fundraising checklist. Eliminate any other surprise red flags from diligence. This is outside the cap table now. The cap table's got to be clean, understandable, and perfect. Great. We got that done.

Item 74, surprise red flags. Here's ones that we see all the time. An outstanding lawsuit. Okay? Yeah, that's material. Or a letter or a threat. So when you go into diligence, you might see, can you please inform us of any legal letters you've gotten,

lawyer letters, threats of legal action, legal action, or any suspected potential legal action that you think, or an oral threat of legal action, and you're going to want to make sure that you've resolved them.

So let's say you had a dispute with a former consultant, and they think you owe them $5,000, you think you owe them $1,000, you're going into fundraising to raise $2 million, that's going to come up. And then a VC might look at you and say,

okay, that happens, But if there's three of them, okay, maybe the deal's off. And you might look at it and say, well, why can't you resolve that? So what I always say to folks is, hey, resolve that stuff before you go into your fundraising. They want $5,000, you want $1,000, you say to them, listen, I'm willing to go all the way to the mat, but I'm willing to do it one time just to get this over for both of us. I'll split the difference with you, $3,000 instead of you want five, I want one, I'll give you three.

If you can do that, by the end of the day, let us know. Either way, we're going to take it to the mat and we're both going to lose money on this. You can just be really super candid with that. I understand we disagree about this. can we come to some resolution? And, you know, sometimes you can't, sometimes as you can. I have always been of the nature, like when I feel wronged, that I do not settle, although I have settled once in these situations,

because it was becoming too legally costly to fight in California at a disgruntled freelancer, the exact situation I was talking about. And, you know, I was just advised, like, it's very hard in California. They almost always side with the contractor. your contractor was claiming they were owed overtime they clearly weren't they signed that they were a contractor and you know it was like okay you can either pay two or three thousand dollars in bogus overtime claims or you can spend ten thousand dollars going to court i was like let's spend the ten thousand and then everybody around me was like jaycal please pump the brakes think big picture and so

i reluctantly did that very hard for me to do when i feel wronged only one time i did it i kind of regret it in a way okay are you paying your rent out of the business instead of paying yourself a salary. This keeps coming up. People keep asking me like, hey, can I rent an apartment to use for a corporate apartment? I'm using my apartment because it's work from home. Don't ever do that. You start to look like Adam Newman at WeWork when you start using the company for personal things like an apartment. And then you're like, well, I use it for work sometimes. No. If it's your apartment, then you pay for it. And then the percentage of time, it's not your apartment, then you can expense the company for that and make sure your accountant believes it. And it's pretty tight.

don't do this kind of stuff. The fact that you have to explain it and that you're not cheating the company out of money, that means you've lost. The appearance of impropriety is impropriety. Don't put yourself in this position. I many times will forget which card I'm using, accidentally put something on a corporate card that's personal,

and I am religious about that. I always carry like two or three credit cards with me, so I have like two personal and two business. I literally carry two business cards and two personal cards because if one doesn't work, just having to remember that I did it. And if I do have that happen, I'm like, I just immediately text somebody from the company.

There's a $200 expense for dinner. My personal car didn't work. This is a personal expense. I put it on the corporate. Please make sure you charge me for it. Or vice versa, hey, my corporate card didn't work. I just picked up the hotel bill for $2,000 when I was, you know, on this trip to New York.

Please make sure that I get. It's all my expense account, right? You just want to make sure you're making that tight. Another surprise red flag we see all the time is people do cash-based account. as opposed to doing accrual-based accounting. Don't let that drag you down. Not being intellectually honest in any way about the business. You know, you put in a consulting project under your SaaS revenue. You give somebody the product for $1,000 and then discount it for $950. All this stuff winds up coming out when you're working with great investors and you want to work with great

investors. So there's no reason to bend the truth. There is no reason to break the truth. That's called securities fraud when you're selling it, when you're lying. And you are selling securities, that's security for this. I think that's kind of the most basic definition. I think we'd all agree. But bending the truth, it's just not worth it. Don't bend the truth. Don't put, you know, your pipeline and potential customers on the same slide with your existing customers. Make it three different slides. Here are paying customers. Here are potential customers on trial, free trials. Here's our pipeline of companies we hope to someday land as clients. Just be clear. Red flags. You want to roll away them. Okay. Building a data.

This is a sign of a mature company. I'm seeing it more and more at earlier stage companies because people are doing fundraising over Zoom and they're happening faster. So a lot of founders just have their data room ready to go. They send person the term sheet, they send them a docket sign, and then they give them a password to a data room. This is a place where all the most important documents for diligence are kept. Could be a Google Drive, could be Dropbox.

Very simple, but your financials, your P&L, your balance sheet, we've talked about those. Maybe the founders, their legal names, their emails, board minutes, bank statements, and corporation documents, IP transfers, all of the previous raises and those convertible notes and safes, and of course, your cap table. Other items are, you know, specific to, you know, what type of company you are, a consumer, a SaaS company. But if you're an app company, you might have your app reviews in there. You might have your app store sales with like the actual document from Apple, like their

statement. You might have cohort retention data if you're a SaaS company. You know, Sachs is going to be asking for that and his team over a craft, you know, just best in the business that SaaS. You might have an work chart in there, your number of employees, your payroll, stuff that they can verify to make sure you're a real business, how much money you've raised to date, if there are any side letters, the name of your attorneys and accountants, their contact information, all basic stuff. And you can think of it as a way to just prove your worthiness versus other companies. If this stuff comes in and dribs and drabs, what I've seen VCs think is, okay, they've been really busy building their business and it's high growth and it's growing 50% month over month.

Okay, it's been a little sloppy. We can help them with that. They just need a chief operating officer or VP of ops, no problem. But if you've been around for a little while, you raise five million bucks and it's sloppy and you're raising your Series A or a seed extension or a Series A extension, a bridge round, man, that looks lame. It looks like you're sloppy, and nobody wants to invest in a sloppy company that doesn't take this stuff seriously. Tight data room equals easy fundraising because your credibility goes up. And we're all in a race in this lifetime to be more credible, especially in the business

realm. Okay, sock two compliance is critically important. Why? If you don't have sock too tight, you're going to lose major customers. You just can't close them. It's that simple. And guess what? Vanta, B-A-N-T-A, is going to give you $1,000 off your sock.

2 compliance. Vantas compliant software makes it easy to get and to renew your SOC 2. They continually test against technical and non-technical SOC2 requirements. They partner with over two dozen audit firms who have been trained to file SOC2 reports directly within Vanta. And on average Vanta customers are SOC2 compliant in just two to four weeks, compared to three to five months without Vanta. Take it from Kitty Hawk CEO John Hegrines. He heard me read Van der Kvents. He heard me read Van Gog. Vantas ad and email me about how much he loves Vanta. I'm kidding you not. John told me that Vanta was essential in helping Kiti Hawk get Sock 2 compliant so they could target larger customers. If you haven't heard of SOC2, you will when you get to those big customers. So unlock the big

sales and give your employees time to work on more business critical assignments like your product, like sales. Vantas giving Twist listeners a $1,000 discount on their subscription at vanta.com slash twist. Once again, vanta.com slash twist for $1,000 off. B-A-N-T-A.com slash twist. Checklist item number 76, understand the startup funding documents. Safe convertible notes and price rounds are the three that you're going to do over and over again. Safes are convertible securities, and this converts at the event when investors formally buy shares. So when one million and more is raised in a price round when they actually put a price on the shares, the investment converts into equity at a predetermined valuation cap or a discount. So a safe was made by Ycombinator.

It's very founder friendly. It's not very investor friendly. There are some flaws in it around the conversion date. So this was introduced by YC back in 2013. It's not meant to be paid back. It typically has a cap and no discount. Or has a cap and a discount. Typically, the cap is this is the most I'll pay, the discount is, if it's below that number, so the most I'll pay is a $15 million valuation. If it's below that $15 million, if it's 10, I get 20% discount on that 10, so I pay eight. And it's generally, safes and convertibles are really quick and easy for doing fundraising. You can do it for 5K, 10K or less with, you know, a great law firm. And remember TopTel, they never raised another round of funding. This was something that was pointed out to a

why it combined when they came up with this safe, which is not safe for investors, and investors never got their money back, they never converted into equity, and it's just sitting out there. And this was always the criticism of the safe, was this is kind of like a made-up instrument that has some flaws in it, and at some point, somebody will abuse it because it won't have a conversion date, convert into equity, and TopTal is the canonical example of that. You can do a search for TopTal safe legal issues, and you'll find a ton of stories about it. We actually did a couple podcasts on it. A convertible note is a debt instrument.

It means it's a loan, but it's not meant to be payback. None of us in the VC land and angel investors are looking to give loans. If we were, we'd be a bank. It has an interest rate and it has a cap and a discount. The interest rate is very friendly. One, two, three, four, five percent. Typically, sometimes East Coast investors want it to be seven, eight, nine, ten percent, but nobody's in it for the interest rate.

And it tends to be a little more investor friendly because it has a conversion date on it. And that means every 24 months, or typically, it has to be either extended a year or two, which means, you know, the people who took the money, go to their investors and say, hey, it's a convertible note. Do you want your money back? Or do you want to extend the note? Or do we want to convert into equity right now? In other words, if they didn't have another price round happen, you kind of have to have a discussion about that. I find that's the most healthy thing to do. My entire life is extending these notes. Company's not doing well, can't raise another round of funding, but they're not dead. They still have 20 months of runway.

They don't want to raise. They want to prove some more things out. So they get a higher valuation. They say, hey, J-Cal. Can we extend the note 12 months? Sure. Can we extend it 24 months? Sure.

Doesn't matter to me. And then sometimes the modest interest, 3% interest on 100K is $3,000. So if it winds up being 12, 15K after four years and that buys us some shares, it's not really, maybe we got 15% more shares. That's nice, but it's, again, not why we're in the business. We're in the business of 100x as early stage investors. a thousand X, not 15%, right? So there's some caveats with convertible securities.

Founders should set a minimum investment amount, 50K, good target. And you don't want to raise that too many caps and discounts. It was this moment in time where a lot of YC companies were doing like, hey, the cap is $8 million, then it's going to go to 10 next week and 12 the week after and they did high pressure. And then they kept these going over time and it got chaotic. And then some people, it's technically not illegal, generally speaking, but it's unethical. People might do different caps for different people.

They might be like, hey, J-Cal, you're dope. We want you on the cap table. Eight million for you. Hey, dentists, we're going to give it to you for $16 million. And the dentist pays $16 million, and then they try to get me in the next month at $8. How's the dentist's going to feel when, you know, they find out that I got two-for-one shares? They might not feel great about it. I don't advise it.

Don't create bad feelings. Don't do things on the slide. and don't let these things stack up because founders, they're very difficult to calculate. You know, the attorneys and the different cap table software out there,

they can get it wrong, people can be confused, and founders all of a sudden look at seven or eight safes or six or seven convertible notes, and they don't know what they own. It's basically what happens. Priced round,

the gold standard. It's super easy. You price the shares in the company. You sell a certain amount, and it's a little more expensive. Documents can cost 20K. some top-tier firms, 40, 50K, depending on how complex it gets. And that's basically the cost to do in business in Silicon Valley.

Sometimes venture firms will ask you to pay their legal bills. I highly recommend you tell them no. And they will typically acquiesce, especially in a market like this, that's very founder-friendly. Or if they ask for 50, you can say, how about 10? And then maybe you wind up at 20. Again, sometimes venture firms will ask the companies to pay their legal bills for the deal where they're putting money in. And so good idea to always ask for that discount.

Okay, item 77. you want to have a plan that gets you to 18 to 24 months of runway. Why? Because you want to be able to work on your startup for like a year without having to think about this fundraising process because it is a full-time job. It is hard. And so if you get to 18 to 24 months of runway, that's a really great sweet spot. It means you could work for 12 months. If everything's going great, in months 9, 10, 11, 12, you could be opportunistic and send an update to a couple of investors. You've met when say, hey, things are going great. We're thinking about raising money. And you still have nine to you know, whatever number of months in the bank, 10, 11, 12 months of runway in the bank,

that puts you in a great position of power in negotiating. And that's where you want to be. If you have six weeks, you're going to have to take whatever deal comes up. And that could be, you know, just at the same valuation a year ago and you get no credit for all the work you did if you did make progress. So you've got to be very savvy about this. Some people in a hot market say only raise a year, because you're always going to be able to raise money.

Not great advice in my mind because that means you work for six months and then you have to come up for air and say, okay, I got to raise money again. And, you know, six months may not be enough for you to figure out your business and product market fit or scale to the extent you want. And, you know, raising too much, I've had too much money in the bank, it just takes the edge off of your team and you will have sold shares so far in advance that maybe you could have captured that at a higher evaluation. In other words, if you have five months, five years of runway, maybe you just want to have three and raise, money in year two or three, so you, you know, are raising it a higher valuation and it's,

you know, a higher share price. The early stage valuations are low, so you're diluting when you take in more money. So it is a little bit of an art and science, you know, in terms of this, which would make it alchemy. Best live rock album ever recorded. It happens to be the Bandar Straits. Look it up. So in this alchemy, I've asked a hundred times this question to investors. They all say 18 to 24 months. Some say 12, but 90%. say 18 to 24 months. And you're optimizing for product market fit here, right? You're not optimizing for your IPO.

You just got to get product market fit. And in point number 66 on the checklist, this week in startups.com slash checklist to go through the whole checklist. I talk about building a growth model. This is where it's going to come in handy. Your growth model and this plan is how you're going to explain to investors, how you picked how much you want to raise. We picked this to hit this goal.

We picked $3 million because it gets us to $1 million in ARR in 18 months. Boom, now you sound credible. He gives us 24 months and okay, what will the business look like in 24 months? I don't know. Better? That's not good. You want to be able to say, we'll have this many customers, we want to have this much revenue, we want to have this many employees. This is our management team after we deploy this capital.

Okay, item number 78 on our list, do you know how to value your startup? Man, if I had a nickel for every time I got this question, just as a disclaimer, valuation is a function of market. Valuation is a function of the market. The market is filled with buyers and sellers. The buyers of shares and companies are angels, syndicates, equity crowdfunding sites, venture capitalists, seed funds. The sellers are founders who own the companies and get to make the decision who they sell their shares to and who they want on their team, who they want on their cap table. If you have but one person in an auction, what price are they going to pay if the minimum starting bid is $1 million for this painting?

they're going to pay one million. If there are 10 people in the auction, and three of them really want this painting, is it going to go for a million? Or is it going to go for $5, $6, $7, $8 million? Okay, now you know everything you need to know. Fundraising is so hard that most founders will just say at some point,

I just want to get this over with. I got a term sheet. I'm closing. I love this venture capitalist. What a great founder does. And that's a good founder. It's reasonable. You found your dream investor.

It's a fair price. was the deal. But what a great founder does is they say, okay, this is a good investor, it's a fair price, let me see if I can find a great investor and an elite price and an even better price. Now that takes time. It takes Hutspa. It takes knowing how to work the market and being like that auctioneer trying to get people excited. And so that means you have to do a fundraising process where you get three, four, five term sheets in at the same time. How do you do that? Well, you do a bunch of first meetings. You do a bunch of second meetings. You say, hey, everybody, here's my process. I'm spending the first three weeks of September doing first and first meetings in the last

week of September, the first two weeks of September will be first meetings. The next two weeks will be second meetings and third meetings, if necessary, and due diligence. And I would like on September 27th, all term sheets should come in if you're interested in doing this fundraising. And then you manage people to that date. Hey, and you can tell them, hey, we have two fun, we have two term sheets in. They say, oh, who's, who's bidding? I'm not comfortable saying. that obviously for privacy reasons is what you say. And I won't tell people what your term shit is conversely. But thanks for asking. Sometimes people will ask. Then if you'd like to, we'd love to review your offer to be our partner. And you say it like that. So you don't have to say it like being a

jerk. Like the auctioneers don't say like, okay, somebody beat him because I want to make more money. No, they say, okay, you've given me seven. Well, somebody say $7.5, $7.5 million. Anyone for $7.5 million. to the gentleman your deal at 7 million going once anybody for 7.5 okay I'm going to go twice we'd like to see 7 5 New York City London 75 going once going twice Jason in the blue shirt okay final I'm going to sell it I mean if you saw that Sutherby's the other week for the Constitution they gave a lot of room and they were very gracious about getting another bid in kind of the equivalent here you want to be gracious about it you want to be a jerk about you want to be cutthroat about it about it. You can say to somebody, oh, I know you said you're going to say a term sheet in.

Friday was the deadline. We didn't get a term sheet. I looked at my spam folder. I wanted to check in with you. Were you planning on putting a term sheet in because we're going to make a decision on Monday afternoon? If you can get it into me over the weekend, we'd love to have it because we really enjoyed meeting with your team for these three or four points. So again, you're trying to be human here, just like that person's, you know, is very gracious. Okay, so now let's talk about what valuations actually are today. It used to be, you know, in the medium hot market. People would just look at your revenue, if you had revenue. They'd say, okay, you got a million of revenue. 10, 15 times that, 20 times that. Okay, 10 to 20 million dollar valuation. We're done.

Even in early stage, you're at $100,000 in revenue last quarter. That's $400,000 a year. Great. 10, 20 times that is $6, $7, $8 million. Great. Seems reasonable. People coming out of Accelerators would typically expect in the Valley, six to $12 million valuations, independent of having revenue or not. Today, we're seeing companies that haven't launched in the crypto space raising at $100 million, and they're just an idea in a white paper essentially. And, you know, it's crazy. And as we all know, that model does not work given exits.

So you cannot be a seed investor in pre-product market fit companies and expect to have a good returning fund if you're paying over $10, $20 million at the entry point. It's not even clear if you can make it work at $30, $40 million. And valuations are getting pretty hot right now. Now, there are outliers, and you don't want to put yourself and compare yourself to an outlier. These outliers tend to be explained away by some thing that happened that is very unique. Like a sovereign wealth fund or a family office or a strategic investor like Sony or Samsung or Intel, doesn't care about valuation, but they care about currying favor with the founders.

So they pay a price that makes no sense. And they throw that money in and it makes no sense to anybody. But okay, that's what happened. So, and something could be a function of everybody wants to be in the deal. If you look at Clubhouse, $100 million when they had like a couple hundred people on the platform, then a billion, then $4 billion because it was so hot. Now they've lost 90% of their downloads and 95% of their users according to a statistic I read on Twitter today or something in that range.

And now that company's probably worth like low hundreds of millions in a mercy sale. You know, it's going to be years of them rebuild. up into that valuation. And so weird things happen. You can't let weird things inform what you think, outliers inform what you think your companies were. Your company is worth what people will pay for your shares. And it's your job to get in front of enough people,

to sell the vision, to have really great traction, and to manage that process. I've seen people poorly manage the process and get disappointing term sheets or no term sheets. And I've seen people just, you know, have less traction and just be incredible at running a process and selling a vision and do well. And this is where salesmanship, this is where the theatrics, this is where the deck and your ability to percent does make a difference. Now, that doesn't mean the core business is not the most important thing. Traction, core business, team, those are the most important things.

But we're talking about valuations here. And valuations are a function of market. And markets are emotional. We see that today. Rivian worth like 130 or 40 billion at the peak. Nicola worth 40 billion at the peak now lost 90% of its value. I don't know what Rivian's lost, but a massive amount of its value. People get emotional. They do stupid things. We see it in people's private lives and we see it in buying of stock.

Why would it be any different? It's the nature of humans. Okay, 79. You want to start good governance early. I would suggest you and your founder and your first seed investor start holding board meetings. early, even the first year or two. Why not? Do it quarterly. Talk about your plan, learn how to set up an ESOP, learn how to do board minutes. It could be a half-hour board meeting, a 45-minute board meeting. We did board meeting training with a bunch of companies like Grin, lead IQ, FitBod. These were

companies that were in our accelerator, and we would have them sit in on each other's mock board meetings, basically just me and them and Ashley and Jackie. And we watched how they presented, and I just gave them feedback. Now when they actually have real boards, Steezy is included in this, and real revenue, tens of million in revenue in some cases, they're pros at it. They know how to manage a board. And so I like governance early. Why? It just gives a signal to downstream investors, the next set of investors. That you're serious about building a scale, an at-scale company, and you will be ahead of the curve. You've got your employee stock options set up. You know how to do minutes. You know how to do.

your books, man, just like that diligence room will put you in a better position in terms of how you're perceived by investors, so will this. Now, a lot of people will disagree about that. Oh, it's a waste of time, whatever. I'm not saying to a three-hour meeting, not having five board members. The two founders, one of their advisors or angels, that person can be an observer, even they don't even have to vote. There's not any consequential voting that will happen at these anyway because you're still getting product market fit. But a great way to share your plan, present your plan, and be ready for when you have Sequoia or, you know, Chimoth, or David Sacks, or Bill Gurley shows up for your board meeting. Wouldn't it be great to have done six?

I think so. Number 80, our final item, you must accept that fundraising is a full-time job if you are but one founder and you don't have a co-founder. You're going to need to have lie lieutenants who you can say, hey, listen, you've got to run the show here while I go out and do this. It's going to take you six weeks to six months. If you get lucky, an inbound term sheet can happen. It can get done in 30 days. You can be a hot startup. It can get done in five days. But I'm telling you the averages. Six weeks to six months is what a process takes. I've seen it take anywhere in between those, six to 25 weeks. And it might be full time for the bulk of those. You have to have somebody focused on your flywheel where you have a great team who are really obsessing over

customers to build the product they want. If you have two co-founders, Oh, that's great, or three, because one can go on the fundraising tour and the other two can mine the store. That's why places like YC or a lot of seed funds are looking for co-founders. And so block off six months, be delighted if you get it done in six, but be prepared to do, I would say, 150 targets resulting in 75 meetings, resulting in 25 second meetings, resulting in five term sheets. That would be a pretty interesting funnel, I think. You target 150 people with emails and you really understand who they are. Targeting each one takes you 15 minutes. You do four an hour. Okay, that's like 40 hours of work to just build that list. And that's arduous,

painful work, talking to people, asking them recommendations, looking at different databases out there, pitch book, crunch base, etc., reading stories, working backwards on Angel List to find investors. You get the idea. So, you know, just even building a target list could be a week or two. Now you start emailing folks. That could be two or three weeks. Now you start doing first meetings, two or three weeks, second meetings, two or three weeks. You get the idea. This is an arduous and painful sales process and treated as such. Okay, that wraps up episode eight. On episode nine, we're going to talk about building that investor pipeline, nailing your first meeting, and getting that term sheet. Can't wait to see you for episode nine. This is where the money hits the bank account. This week

in startups.com slash checklist, and we'll see you next time. Bye-bye.