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October 9
By Alyssa Royse
Okay, I’ll say it. Something stinks here, and it’s not just the smell of cooked books at Entellium. The incredibly simple scandal over there is sending shockwaves through the Seattle startup community. How did this happen? What does this mean for the rest of us?
Here’s how it happened: 1) People lied. 2) Nobody checked up on them. Easy as pie.
Now, I’m new to this startup thing, I have always admitted that. So I was shocked that this could have happened. I mean, this scam was not a complicated one – as far as I can tell from the charging documents, there were no complicated offshore accounts, no elaborate shell companies to hide funds, nothing like that. There was stated revenue that was GROSSLY out of line with actual revenue. That’s all. Just simple lies.
Simple lies should be fairly simple to uncover. So I asked what I thought was a simple question on the STS list. Didn’t anyone check?
Bill Bryant was quick with an answer: “A Board would never "check bank statements"; they rely instead on management reporting. Investors have information rights but these generally only extend to "financial statements" (which is management's representation of the underlying contracts, bills, bank statements and the like) and not to the source documents themselves.
I've been in several hundred board meetings over the past nearly 20 years and not once has a Board ever had access to, or reviewed, bank statements or similar source documents. At the end of the day, an investment in a firm is predicated on trust & integrity.”
I’m sorry, that’s kind of silly. As I told Bill, I’d love to live in the world of “trust & integrity” when it comes to business and financial practices, but, I dunno, I’ve been watching the news lately, and that doesn’t seem to be working out very well for any of us.
In response to Bill’s comment, Pascal Stolz pointed out: “I would offer that a Board has a general common sense approach to the situation in a business and there are things that flat out would come out as an outlier:
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Why a company with a “reported” revenue of $5M needs to raise money? The answer is simple, there is a shortfall of $4.5M…
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As reported to the Board (to justify the short fall) the cash burn reported is such that user/customer acquisition costs would be completely out of whack.
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Hence, someone would ask the question: how do we reduce that cost.
It should not take 4 years to figure out…”
Apparently Brian Myers agrees with Pascal: “With the claimed revenues being so far above actual, simply checking the bank statements would raise huge red flags. (2006: $580k actual vs claimed $4 million) It wouldn’t take a full audit to discover this; even an internal controls review would reveal the red flags.”
Needless to say, conversation quickly turned to independent oversights & audits. That is a scary thought to many, mostly just because of the cost. A thorough audit can be expensive – 10’s of thousands of dollars.
But popular opinion seems to be that such an audit wouldn’t be required unless a company had revenues of $1M or so and was raising cash for growth. (Had to laugh when Bill Bryant said that until that point, the only thing to look at on the books are expenses. Truer words were never spoken.)
Typically, the cost of such an audit would fall on the company seeking funding, and that can sound like a lot of cash. But let’s put it in perspective. Entellium raised over $50 Million, an audit was likely to cost about $40 thousand. Audit costs relative to capital – seems like a good investment to me. Especially if it keeps you out of jail.
Or, you could look at the cost of the audit relative to the cost of YOUR investment as a VC. Is the audit cost worth it? I dunno. There were millions of dollars lost, that buys a lot of accounting services. It doesn't seem like a lot of money to spend in order to avoid losing a whole lot more money. It really just kind of irks me, on a lot of levels.
First of all, lying just plain mean and stupid. I know that isn’t exactly profound, but the truth is exactly that simple. Don’t do it, it’s wrong.
It’s easy to say, “hey, what’s the big deal, they got what’s coming to them.” Well, here’s the big deal. I can name at least a dozen really good startups in Seattle right now, with ethical partners, solid business plans, honest (if not impressive) books, who could really use investment to grow successful companies the slow, steady and honest way. That $50M that was swindled out of investors could have been invested in good companies.
Whatever, the honest amongst us will keep being honest. (And there are FAR MORE of us out there who are honest, we just don’t make the news.)
Brian Myers has some great advice about what we, as entrepreneurs, can all be doing: “Executives already know the need to build trust by providing transparency and verification. The lesson, or opportunity, for startup executives is to take that to heart.
I’ll use an example other than financial. In every investment the VC asks whether the company has non-disclosure agreements and invention assignment agreements with all the employees and contractors. Every exec team should know the question is coming. The best answer is, 'absolutely, here is a three-ring binder with copies of every one of them.' Contrast the confidence that answer instills with 'well, we think so, but maybe not all. We gotta check and get back to you next week.' Excellence = confidence and trust = higher valuation and higher exec team compensation.”
Good call, Brian. There is just no excuse here. Not on behalf of the liars, and not on behalf of the investors. This shouldn’t have happened.
And on that note, I’ll give David Gellar the last word: “No excuse on the accounting mess there. Clearly people in accounting would have known. And, again, a firm as small as Entellium simply wasn't sophisticated enough from a breadth of products and sales model perspective to be overly complex.
The Ignition partners should be very embarrassed and probably fired.”
October 9
By danielle morrill
In networking, as in life, I can’t stand people who just go through the motions. At a recent tech event I saw a ritual which I thought was unique to the brick-and-mortar business world. I found myself standing among a circle of people who pulled out a stack of business cards and passed them around, spoke little (if at all) of their businesses, and then parted ways. As one woman informed me, they’re measured by how many cards they collect. They’re just trying to “make the numbers”.
Can I get those ten minutes of my life back?
For many entrepreneurs, networking is a significant time commitment. Finding talented people to create, fund, grow or sell a business is challenging enough. Staying motivated in the face of insincerity just might have you hiding in your office with a case of serious social burnout. Instead of dropping off the grid, why not attend a networking event and leave your business cards at home?
3 Reasons to Leave Your Business Cards at Home
Ditch that social crutch. Ever notice who conversation lags and becomes awkward. "Can I have your card?" becomes the que that a party in the conversation has lost interest and wants to politely (or passive aggressively) end it.
Find out how memorable you are. An email address scrawled on a napkin doesn't have the context a card full of information provides. To get me to send that follow-up email the conversation has to wow me, and stick in my brain, or I’ll draw a blank looking at your email address on the back of my moleskine.
Don’t get pigeon-holed anymore. You hand over your business card, and upon reading it the recipient immediately asks, “How do you like being a [title on card] for [company on card]?” Personal branding is more about your soul than your specific role within an organization. Get rid of the idea that you have to talk solely about what you’re being paid to work on, share your passions.
Around Town Tonight
Not sure where to go sans previously mentioned business cards?
Tonight there's a hops & chops happy hour at Linda's, on Capitol Hill. The group is organized by Dave Chappell, founder and CEO of Teach Street, and rumor has it that the inaugural meetup two weeks ago 30-40 people range. I attended last week, as an alternative to the vice-presidential debate, and discovered that Linda's does a killer burger.
Where you'll find me?
I'll be over in Bellevue, checking out the Eastside Entrepreneurs Connecting party. The event is invite only, but I've included Joe's email on the events page so all you need to do is drop him a line if you'd like to go. This is a new group forming, and I'm looking forward to meeting some new people (I will have business cards). As always, you can read about my adventures in real time on Twitter.
Seattle 2.0 is your resource for events in the Seattle tech community.
8Comments »
October 9
By Kevin Leneway
I like a blog with ambition. When I decided to start my first blog last year, I wanted it to be big. So I came up with the boldest, most audacious, and in hindsight, most spectacularly stupid name I could think of - A Startup A Day. Do you have any idea how hard it is to come up with good startup ideas every once in a while, let alone on a consistent, daily basis? Trust me, it's hard.
There were two things that I did have going for me. First, at least I didn't call it "A Good Startup A Day", which gave me the wiggle room I needed on those many muse-less evenings. And believe me, there were some real bombs. One of my personal least favorites was
Startup #31: Things That Look Like Stuff
. The premise was, and I swear I am not making this up, a site where you can post pictures of grilled cheese that look like the Virgin Mary.
Of course, it really didn't matter if the ideas were good or not because no one was reading it. At first I chalked it up to the fact that I was just starting out and it would take a while for my future fan base to find me. After a few months of single-digit daily readers, I decided to buy my way to fame. In honor of my 50th idea, I posted several domain names and offered up $50 for the person who came up with the best startup for any of these names. I posted details of the contest to all the big social news sites and waited for the readers to start pouring in. A few days later, to my extreme embarrassment, not one single person had entered the contest. I mean, come on! $50, no strings attached, for maybe 60 seconds worth of work.
But I kept at it, if not posting every day then pretty darn close to it. I embraced my position as the ultimate Z-list blogger. Who cares if no one outside of my gene pool knew that I was spending an hour or two each day carefully crafting each post? The challenge kept me going, and even though I've managed to post 152 ideas in the past year, I still feel a little pang of guilt each night that I fall asleep without living up to my promise of posting a new idea each day.
When Marcelo asked me to join the team here at the Seattle 2.0 blog, I decided that instead of just doing a few random posts about some of the new and interesting startups in Seattle, I wanted to, once again, go big. And just like I did on the first day of my personal blog, I wanted to get it down in writing from day one, so that every time I put out a new post I have to live up to the huge challenge I laid out for myself from the beginning.
So here it is - my goal is to ensure that every single person on the planet knows that Seattle is hands-down the best place in the world to start a startup. They will know what I know, that the Seattle startup community is full of some of the most ridiculously talented, ambitious, world-altering people you will ever meet. It is the place where great ideas are brought to life, magical applications that
allow the musically-illiterate compose a song
,
force the lazy to get back to work
, and
let my mom build a website
as easily as she can get an Email address. It is a community that shares the
wisdom
of those who
have been there before
with the energy of
next generation
of
amazing entrepreneurs
.
We've got some work to do, but come on Seattle - it's about time. Forget The Valley, it's time for
The Square
to take it's rightful place in the international spotlight. I'll be posting about some of the startups and people that I know and admire, but if we don't yet know each other, please take a minute to introduce yourself and tell me what you're working on. You can Email me at
kleneway@hotmail.com
or shoot me a tweet over on Twitter (
astartupaday
). Thanks for reading, and looking forward to working with you to turn all these bold claims into reality.
2Comments »
October 8
By Rebecca Lovell
Approaching an angel group is like a first date. It’s a two-way street, and it can lead to a relationship. At the MIT Enterprise Forum’s October 2 “Meet the Angels” event, the moderator turned the tables on spokespeople from seven area groups (full disclosure: including yours truly), and asked us to deliver 5-minute pitches to a standing-room only crowd of entrepreneurs. This inspired me to dust off and update our Top 10 list for entrepreneurs. In Dave Letterman- meets- Fight Club style, these questions are first-date appropriate:
10. What are your fees to entrepreneurs? Your time is money, but money is money too...make sure the fee structure is transparent, as there are both for-profit and not-for-profit forums in town. The range of fees is significant, from under $100 to over $6000. 9. No, seriously, what are your fees? This is the part where you ask about application fees, presentation fees, cut of proceeds, or any additional obligations or hidden fees throughout the process. For an overview of the Seattle-area angel group's, check out Susan Schreter's article on the topic in the P-I. 8. How long does it take to close the deal? From submitting an application through due diligence, getting funding from an angel group may take longer than you expect (or like). Turn-around times range greatly from group to group, and expectations should be set for how much time will be required, and over what period of time. 7. How much money did your forum invest last year? Not how much investment did your network "facilitate," not "how much did your members invest in start-ups in general", but "what was the dollar figure of investment made only by y our members in deals that you screened?” 6. In what stage of company does your forum invest? What is your profile of investments by industry? If you make the tough decision to seek equity funding, one of the perks is that professional, active angels want to invest not just their money, but their time…and can be a much-needed shot in the arm to your advisory board. Find out the group’s experience with high-tech, consumer, retail, or real estate industries…and seed, early stage, post-product, post-revenue, or growth stage companies. Does the group have members who both understand and have an appetite for your deal? 5. What is your track record? This can be a tricky one, as angels invest individually, at different times, but beware fuzzy math. Investors (and entrepreneurs) get returns upon exit, not with a VC up-round. 4. Of the companies that presented, how many received funding from your members? Don't be shy about asking for the average and range of investment either. 3. If I present to your group, how many investors will be in the room? This is an opportunity to ask not just about attendance but about their membership base....accredited investors? Active and experienced angels? Or service providers and hangers-on? 2. What's your deal flow? How many companies do you meet with every month? How many companies presented to your organization last year? Since your organization's inception?
And as much as results matter, so does the experience.....so: 1. Can I contact any companies who have recently participated in your process?
For some best practice recommendations, check out this link on the Angel Capital Association web site. But don't just read about it-- ask! What they answer-- and whether they answer-- will speak volumes. On a personal note, for a first date I recommend coffee or happy hour, never dinner. If you like the date, you can always have dinner afterwards…but if you start with dinner, you could be in for 90 minutes of sheer misery.
October 8
By Marcelo Calbucci
We are happy (and very excited) to announce the launch of the new Seattle 2.0. We took it to a whole new technology direction, but keep our vision of a place for, by and about tech startups in Seattle.
The first part of this announcement is the new team that you'll be connecting to every time you read a blog post here. Each one of those persons were hand-picked based on their knowledge, energy, good writing skills and by the fact they are knee-deep involved on the Seattle tech scene. Please, welcome to the Seattle 2.0 team:
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Alyssa Royse (from Just Cause It) who'll be our Editor-in-Chief, keeping us honest, focused and bringing new writers/guest bloggers.
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Matt Hulett (from mPire/WidgetBucks) will be our Entrepreneur-in-Residence, talking from entrepreneur to entrepreneur.
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Rebecca Lovell (from Alliance of Angels) writing about the Angel angle.
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Danielle Morrill (from Pelago/Whrrl) who'll be our Events Editor, not only maintaining the events list, but also writing reviews and a few cool ideas that we're backing.
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Kevin Leneway (from Microsoft) who describes himself as someone that loves beta products, loves startups and loves technology and he'll be writing about the great products coming out of Seattle.
Now for the technology part... First, go check out the new homepage ( www.seattle20.com). You'll notice that it doesn't look like a blog. It kind of looks like TechMeme, but it also has our own blog in there. And if you look at the menus, you'll see you can read many b posts or navigate through many Seattle blogs directly from the Seattle 2.0.
Better than that, if you want to be featured on our homepage you just have to write a relevant blog post on your own blog and our crawler will pick it up and bring our readers to your post.
Well, we can't be categorized in a standard way. We are just creating something new, but the fact is that you'll be able to get your daily digest of Seattle tech startup scene by visiting www.seattle20.com, subscribing to our RSS, or signing up to get daily emails.
I really hope you enjoy it!
0Comments »
October 7
By Matt Hulett
Most certainly you’ve heard about the IRS Regulation 409A. Here is some "light" reading on the subject from the IRS in case you are interested. It became effective on January 1, 2005 by the IRS and came out of all of the nasty Enron mess. What is it? It has to do with the treatment of non-qualified deferred compensation. Many of your investors are typically concerned about this issue. In a nutshell, this is a broad regulation for private companies and it redefines the way companies determine fair market value in granting stock options. In the past, what would typically happen is that your Board would make what is a called a good faith determination of fair market value and grant options. Now, companies must formally value their common stock options or risk the penalties should they be wrong with their option pricing. I would also like to not that I am not a financial professional (but, only play one on the blogosphere).
So why do you care? Well, the main reason is that if you are not valuing your options appropriately, penalty for undervaluing options is that the option holder gets taxed at normal income rates on the “spread” (difference between the grant strike price and what the IRS deems the “correct” value) as if it was income given to him by the company PLUS an additional 20% tax on top of this in further penalties. Furthermore, the company gets penalized on withholdings it should have made on this additional “compensation” it provided to the employee. According to the IRS, under 409A, there are three choices to value stock options as a private equity stage company:
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The Board determines in good faith the FMV, but if an option holder gets audited and the IRS thinks the strike price is not truly FMV, then the option holder has burden of proof to show otherwise;
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Have a person, internal to the company who has “significant knowledge and experience or training in performing similar valuations”; create a written valuation report detailing the accurate pricing of the common stock. The IRS does not provide an explanation of the parameters for “significant knowledge and experience or training in performing similar valuations. The big issue is no one really knows who qualifies to do the valuation and what the report should look like.
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Hire an independent, qualified, experienced valuation firm to create a written valuation report. This is still not clear, as outside of the traditional valuation firms, it’s unclear who is qualified to perform the valuation.
There is a lot more around this subject. When the regulation was first issued, every early stage company ran around to get outside valuations in order to protect themselves. C’mon, who would want a nasty 20% tax penalty. As a rule of thumb, almost all companies are going through an outside appraisal for stock option pricing 12-18 months prior to an IPO (although, IPOs are harder to come by these days). You are more than likely ok to do an internal valuation if there is not an exit or IPO in your future (future being the next 18 months). Costs have come way down over the years and you can expect to pay between $5k-$15k. You or your CFO should consult the appropriate consultants in this field.
1Comment »
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