Sunday, April 20, 2014

Top Accelerator Generates 50X Return - How Can Investors Participate?

Accelerators and incubators have claimed prominent roles in the earliest stages of startup formation. These programs have seeded thousands of new companies and created significant value.

Y Combinator is the program with the longest track record and the largest amount of publicly available information. As of February 2014, Y Combinator has seeded an astounding number of more than 630 startups. At a per company funding of $15,000 to $20,000, Y Combinator has invested $10 million since its launch in 2005.  Y Combinator receives 6% of equity, effectively valuing the startup at approximately $250 thousand. Kawasaki's law of pre-money valuation assigns a value of $500,000 for every full-time engineer and subtracts $250,00 for an M.B.A. For a team composed of two technical co-founders, Y Combinator's investments constitutes a 75% discount compared to this rule of thumb.

Recently, Y combinator announced that its portfolio companies are worth more than $20 billion. AirBnb and Dropbox account for around 75% of that valuation. Assuming, pro forma,  five successive rounds of funding and a 15% dilution per round, the original 6% stake now is down to 2.7%, equal to a value of more than $500 million. In other words, Y Combinator has achieved a 50X total return on the $10 million invested so far. While almost all of these investments are still illiquid, the likelihood of realizing these returns is high. And since Dropbox and AirBnB were members of the classes of 2007 and 2009, respectively, there may be more hits to emerge still.

Until 2009, Y Combinator only invested its founder’s money. In 2009, Y Combinator raised a $2 million fund from Sequoia Capital and a number of angel investors, followed by a $8.25 million fund in 2010. Y Combinator raised and manages these funds to increase the number of startups it invests in.

Since 2011, startups in the program are offered additional funding after the initial Y Combinator equity investment. Yuri Milner and SV Angel launched the YC managed Start Fund to provide $150,000 in convertible debt to every startup in the program. In 2012, YC VC replaced Start Fund with a reduced amount of $80,000 instead of $150,000. Y Combinator was looking for each of the fund investors to provide the startups with advice, and consequently Khosla Ventures replaced Yuri Milner in 2013. In times when capital is cheap, advice is at a premium.

As the Y Combinator case shows, accelerators may prefer having prominent angel investors and venture capital firms as partners in their own earliest stage funds. Other early stage investors can create their own next stage index fund by spreading their investments over a wide range of accelerator startups. The returns can still be above average, but will require significant capital and effort.

How To Run A Hyper Growth Company - Free Advice From The Coach

Successful startups undergo significant changes as they approach an IPO. Lately, ever increasing late stage funding rounds have put management teams under even more pressure to grow even faster. However, these expectations often overwhelm the capabilities of the founders and their teams. While the preferred startup narrative is one of a rocket like ascent, the road to success is filled with many bumps.

The Coach is an almost mythical authority in Silicon Valley when it comes to dealing with those situations. Bill Campbell was on the boards of both  Loudcloud/Opsware, and Netscape and is frequently mentioned in Ben Horowitz’s book The Hard Thing About Hard Things. He is a self professed operator and has been a CEO at Claris/Apple, Go, and Intuit. He has been a long serving board member at Apple, and Kleiner Perkins Caufield & Byers has brought him in to advise the CEOs of Google, Zynga, Twitter on how to improve company operations.

There is no substitute for working with the Coach. While there is no particular methodology, there are four valuable lenses he has repeatedly and successfully applied, and which form a logical combination - staff alignment, business plan, team meetings, and operating reviews. Here are some of his insights as told by others.

The Staff Alignment

It was Bill Campbell’s idea to gather a few key Googlers together and hammer out a set of the young company’s corporate values.

Rather than simply focusing on whether a manager has achieved his financial goals - which can lead to short-term thinking - Campbell gives equal weight to four areas. The first is traditional: performing against expectations. But then he looks at management skills, working with peers, and innovating. If you aren't good at all those things, you aren't good.

I push hard on innovation and best practices. In the absence of true innovation, there’s no excuse for not knowing where the best practices are. And a lot of best practices can come as tweaks that will make a practice more innovative. I give high grades to anybody who knows exactly what’s going on in the industry and can adapt to this quickly.

The Business Plan

Campbell next initiated a strategic planning process for [Intuit]. Intuit’s VMOVA (vision, mission, operating values) effort had set the cornerstone for strategic planning by identifying the company’s values and missions. Campbell built on these to codify and energize strategic operational thinking.

In the middle of each quarter, Campbell held an off site at which each manager submitted a business plan with numerical goals and reviews performance against these goals. Business leaders presented quarter-to-date results and objectives for the next quarter; at each meeting leaders had six weeks’ performance data for the current quarter and six weeks to plan for the next one. Each manager could change key variables - staffing, expenses, direct-marketing spending, tech support, and so on - before the quarter began. ...Over a period of time, Campbell’s meetings generated a perpetual quarterly plan.

The Team Meetings

My contention today is that that if a months is 20 working days, you’ve got to spend a day doing nothing but reviewing projects. A whole day, with the whole management team, so that we can clean up those projects, clean out the ones that aren’t going to be good, and take the bodies that are recovered and put them on the projects that look like they have the best prospects.

These management planning offsites [...]  unified the company. ...Campbell valued the social as much as the strategic elements of the meetings because he knew that stronger relationships would improve teamwork and business results. After a few quarters, he had a management team working effectively together, both formally and informally.

The key skill is not in convincing people of your point of view with rational arguments, but, when circumstances require, in build a feeling of consensus in the face of uncertainty or adversity. Bill’s strength was his ability of select a straight course through the swirling darkness, then create a deep emotional reserves in his team that drives them to victory, even when defeat seems inevitable. he metered out sufficient time for open discussion, then closed debate with a fatherly decision that all were expected to accept as their own, in the service of the greater good.

One of Bill’s first acts as CEO was to establish a kind of corporate rhythm, a weekly sequence of meetings by which the company shared information and made decisions. This organizational pulse started on Monday morning at nine-thirty with ‘estaff’ - a meeting of the executive staff, where large issues and strategic initiatives were discussed - and ended on Friday at four-thirty with the ‘comm’ meeting, where the entire company gathered to communicate new, make announcements and give demos and awards. estaff started as late as nine-thirty because Bill, who usually arrived at the office around six, liked to spend the early morning talking to the East Coast, before people there went to lunch, and meeting privately with any employee who had a problem that couldn’t be solved through normal channels. Following the comm meeting was a ‘beer bust’, with drinks and munchies, a Silicon Valley tradition that Bill had followed since his Apple days.

The Operating Reviews

He instituted monthly operations reviews, in which senior managers provided updates so that Campbell could help set goals and track revenues and expenses. Cook welcomed the discipline in these monthly reviews, which harkened back to the quantitative analysis and metrics he’d introduced to marketing.

I care about the ones that care a lot about operating values, that care about durability and lasting value. I’m not interested in ‘quick in and out’.