Talk I

Mark J. Macenka, Goodwin Procter LLP: “The Great Value of Avoided Mistakes”
mmacenka@goodwinprocter.com

Mark is a partner at Goodwin Procter who specializes in corporate law.

• Study and analyze the market – do not underestimate the competition

• Stay focused
• Bad breath is better than asphyxiation
o Don’t worry about dilution of ownership
o Don’t fear having an independent board of directors
• Develop a network to solicit strategic and tactical advice on business/legal issues

Capital Structure
• Keep the structure as simple as possible
• Think about your choice of entity (LLC vs. partnership vs. S/C corporation) as
early as possible and seek counsel re: consequences
• Keep your documentation in good order

Ownership of IP
• Ensure others (including former employers, universities) don’t own any of the IP
essential to your business
• Ensure consultants assign or license rights in IP they develop to you
• Avoid joint ownership agreements whenever possible
• Ensure third party code contributions are used within the confines of their
applicable licenses
• Keep confidential information confidential, else you may lose trade secret
protection

Founders Issues
• Ownership
• Board membership
• Noncompetition agreements
• Stock limitations
o Vesting
o Transfer restrictions
 Right of first refusal
 Other rights of repurchase
o Internal Revenue Code § 83(b)
 Talk II

Paul Buchheit is the creator of Gmail. He no longer works at Google.

• Advice = limited life experience + overgeneralization

• “That’s impossible” = “According to my very limited experience and narrow
understanding of reality, that’s very unlikely.”
• The secret to success may well be to redefine it!
o Old definition: “I made a pile of money”
o New definition: “I learned a lot”
o Seek opportunities to learn, especially things that no one really knows.
• Useful startups
o Ensure that the suffix “that actually works” is true
 Search … that actually works
 Email … that actually works
o Try making order of magnitude changes
o Being useless in new ways does not make you fundamentally different
from other startups
• Building a product that is perfect for everyone is impossible! Your two choices
are:
o Build a product that is tolerable for everyone
o Build a product that is perfect for a subset, and then let others come
around
 Talk III

Chris Anderson, thelongtail.com - “Long Tail Companies”

Chris is the founder of Wired Magazine.

To take advantage of the long tail, consider Joe Kraus, founder of JotSpot: Instead of
focusing on dozens of markets of millions, consider millions of markets of dozens.
 Talk III

Paul Graham is the founder of YCombinator.

Why people don’t start startups?

• Too young
o Chronological age is irrelevant – maturity is important
o Useful litmus tests
 “Kid-flake reflex” – “I’m just a kid; forgive me/do it for me/etc.”
 How responds to adult challenge
• Dominance or submission is a bad sign
• “Why is x a dumb idea?” is a good sign
• Too inexperienced
o Start one anyway. You’ll get the experience. You can never know what
it’s like until you found your own.
• I’m not determined enough
o This is a showstopper.
• I’m not smart enough
o If you’re smart enough to worry about how smart you are, you’re smart
enough! Few people underestimate their intelligence.
o Write enterprise software
 This is a sales-driven business, which depends more on sales than
effort
• I don’t understand business
o Don’t worry about it. This is not the hard part anyway
• I have no cofounder
o This is a real problem. Every investor prefers to fund a business that is
championed by a team.
• I have no idea
o No problem!
o 80% of startup ideas aren’t new; therefore it’s probably OK if 100% aren’t
new
• There’s no room for more startups
o This is a fallacy.
• I have a family to support
o This is a real problem.
• I already have money
o This is a legitimate excuse.
• I don’t want to make a commitment
o Fine. See ya.
• I need structure
o Don’t start a startup.
o Don’t even work for startup.
• I fear uncertainty
o You’ll fail! There. Now you’re certain.
• I don’t realize what I’m avoiding
o Get real, and quickly. Jobs involve hard work that you don’t always like.
• My parents want me to be a doctor/lawyer/whatever
o (This is particularly endemic to Asian families.)
o Treat this as a feature request.
o Risk is proportionate to reward!
• A traditional job is the default position.
o So was serfdom, once upon a time. Adherence to tradition is not
necessarily a good thing.
 Talk IV

Michael Mandel, Michael_Mandel@businessweek.com

Chief Economist, BusinessWeek

• Innovation is unpredictable and chaotic => frightening! Hence, few economists

treat startups seriously or in depth.
• Economists treat R&D as consumption, or do not report it at all
• Other countries have savers – we have innovators
o We encourage risk taking
o We reward success
o We allow businesses that are not succeeding to fail
• Productivity growth is the driver of our economy. A falloff or slowdown in
productivity growth is the speaker’s #1 worry.
o Support politicians who support innovation
 Talk V

Max Levchin, “A Crash Course in Product Management”

Founder, PayPal

Product management is about:

• Channeling the user
• Developing a fantastic interface

The best product managers are people who understand computers.

Why do most startups fail?

• Most engineers fail to work out the details!

When you design a product, you need to think about whom you’re designing the product
for!
• Try to achieve an out-of-body experience as close you can, while you are using
the product.
• Observe the user closely!
• The best product can be used effectively while the user is distracted.

How do you find out what works? Metrics, metrics, metrics

• Measure everything
• Generate statistics
• There is no ready made package that will analyze the data appropriately – develop
your own

Practical web design

• Design your sites to use blue; red and green are problematic for the color blind
(8% of men)
• Scrolling is OK now that mice have scroll wheels – “keep it above the fold” is
less relevant now
 Talk VI

Startups
Ali & Hadi Partovi, iLike

Is my idea a winner?
• Can I easily explain the customer need in one or two sentences?
o This is not identical to, and is probably more important than, explaining
the business in one or two sentences.
• Does the business scale?
o This is not necessary, just helpful
• Am I creating added value?
o See Coopetition for a helpful definition. It’s the size of the pie when
you’re in the game minus the size of the pie when you’re out of the game.
• Will users naturally recruit new users? (AKA “viral”)
• Will the value delivered to customers increase as the number of customers
increases? AKA the network effect
o If so, you have the trappings of a natural monopoly. This is the best
possible position to be in.
• Am I passionate about it?

“Dos”
• Listen to customers
o Useful technique: force everyone in the company, from the CEO down, to
answer support calls periodically
• Know their top 5 complaints and to 5 favorite features
• Read discussion boards and email lists
• Foster communication among your own customers
• Stack rank the top problems core to your success, and get your top people
operationally focused there
• Make frugality and profitability part of your culture. Spend wisely; avoid luxury.
• Move fast. Make decisions quickly. Avoid committees. Avoid 12-month
development projects.
• Have a strong CEO.
• FOCUS. Ideas are abundant. Small companies cannot spread themselves thin.
• Hire great people. Put hiring and recruiting at the top of your priority list.

“Don’ts”
• Getting press (good or otherwise) is not an end in itself. Press is most valuable
for recruiting and making strategic partnerships. Otherwise, don’t be distracted
by the press.
• Don’t take your company culture for granted. Organizations have a natural
tendency to become political as they grow. Work to maintain a cooperative
startup culture for as long as you can.
• Don’t be greedy. Let the other party have a bigger piece of the pie up front if it
means you get more speed/maneuverability as a result.
• NEVER ignore your gut feeling about an employee or candidate. The cost of
excess baggage (in terms of cash and peer morale) is too high.
• Don’t forget to have fun!
 Talk VII

Rahoul Seth, “Financing for Startups”

Rahoul Seth is the CFO of Adteractive.

Why raise professional funding?

• May need more than one round; professional funding can help you acquire
additional rounds when necessary
• Professional funding brings you more than just funding
o Business partners
o Professional advice

Financing stages

Customer Plan Team

Seed round (angels, Customer problem Strategic Founders (you +
friends, family) you are solving Marketing others you plan to
Cash requirements hire as
necessary until consultants/partners)
income > expenses
“A” round (VC) Strong expression of Beta product Initial team
interest
“Go-to-market” plan
“B” round (VC) Successful client Road map to growth Complete team
deployments & profits
Subsequent rounds Expansion of business; significant business risk eliminated
Mezzanine round Working capital needed for equity event

Types of investment
• Debt
o Banks and/or other
o Must be repaid with interest
• Equity
o Selling ownership interest in company
o Return comes from liquidity and/or dividends

Equity financing
• Common stock
o Founders (stock)
o Employees (incentive stock options)
• Preferred stock
o Investors (stock + warrants)
o Preferences over common shareholders at liquidity event
o Prospective provisions
 • “Participating preferred”
• AVOID at all costs
• Smart money will not ask for this provision early on,
because every subsequent investor will ask for it too
• Cap level (1x, 2x)
o Board representation
o Dividends
o Redemptions
o Anti-dilution provisions

Equity: Dilution
• Goal for founders: Retain at least 5-10% of shares at liquidity

Equity: Valuation
• Founders: Purchase stock before $ received
o Cheap stock ($0.001/share)
• Investors pay FMV
o Angels: Preferred/common stock
o VCs: Preferred stock
• Employees pay FMV of common stock

Equity: Liquidity events

• Acquisition
o Most likely outcome
o Frequently, prior strategic partnership in place with acquirer
o Deal structure
 Stock swap
• Tax-free exchange
• Large potential upside with stock
 Stock for cash
• IPO
o Another financing round that also provides liquidity
o Market conditions affect it
o Sarbanes-Oxley impact
 Estimated $2.5-$3.5M/year cost
 Senior executives bear high risk
 Makes it more difficult to achieve liquidity

Debt financing
• Fixed assets (hardware, software)
• Security deposits for facilities/letters of credit
• Accounts receivable
• Working capital (only after company is profitable)
Getting help
• Legal
o Corporate
o IP
o Employment
o Licensing/customer (consider part time in house counsel)
• Accounting
o Big 4 firm (best avoided; attorneys are great sources for personal
introductions to reputable accountants)
o Growing pool of “Rent-A-CFO”s

Smart money will not try to take advantage of you – they want you to succeed, and want
to succeed because of you.
 Talk VIII

Mitch Kapor is the founder of Lotus and currently heads the Open Source Applications
Foundation (OSAF); his new project is Chandler.

Technology adoption curve

• Ahead of the average

o Small number of early adopters
o Large number of pragmatists
• Behind the average
o Large number of conservatives
o Small number of laggards

People culture
• Tech startups see themselves as more inviting workplace cultures than big
business
• Not true across all dimensions
• Survey data says startups have more bullying, public humiliation

Common dynamics in startups

• Valuing face time > productivity
• People having trouble getting facts/info needed to do job
• Reliance on rumor mill as best source of information

Meritocracy or Mirrortocracy?
• Tech startups see themselves as meritocracies: “We got funded because we’re the
best”
• This confuses talent with “people who are just like us”
• Research shows diverse teams are in fact more innovative

What you can do

• Take culture seriously
o Every action and inaction sends a message
• Walk the gap yourself
o Don’t be a hypocrite
o Don’t establish false expectations
o Example: “We care about people”
 If you say this, don’t put an at-will clause in your employment
offer. There is rarely any need for one because you can always fire
people for cause, and you can establish a correction plan for corner
cases.
• Hold people accountable
 o Don’t tolerate abusive behavior by star performers. It will severely harm
employee morale.

Entrepreneurs and Investors

Information asymmetry
• Experienced investors know a lot more than young entrepreneurs
• How might an investor take advantage of this?
• What is the investor’s responsibility to the entrepreneur?
• DO NOT RUN OUT OF MONEY. You will be at the mercy of investors
(common stock will become worthless) if you do before seeking additional
financing.

Alignment of interests
• Investors can be great partners
• But interests can and do diverge
o Ultimately, VCs must keep their limited partners happy
• Difficult issues
o Who is the CEO?
o Unanticipated events
 Investors may conclude their interests are different than yours
o Stay private, sell, merge, or go public?
• TRUST MATTERS. FOLLOW YOUR INSTINCTS.

Venture fund economics

• Very asymmetric distribution of returns
• 1 or 2 big winners provide substantially all the return in a 30-company portfolio
• Incentive is to push companies to be big winners
o Better to strike out trying to hit a home run than hit a single or double
 Talk IX

“The Skinny”
Greg McAdoo, Sequoia Capital (mcadoo@sequoiacapital.com, pg@ycombinator.com)

Elements of a sustainable company

• Clarity of purpose
• Spectacular market
• Alleviate customer pain
• Team DNA
• Incredible product focus
• Real operating margins
• Frugality
• Can start an inferno with a single match

Areas of analysis
• Founders’ DNA
• Competition
• Clarity
• Problem
• Solution

Things VCs look at

• How succinctly – and how convincingly – can founders communicate?
o “Cisco Systems builds routers” (the truth)
 Public/VCs: “WTF is a router?”
o “Cisco Systems networks networks” (the marketing)
 Public/VCs: “Oh, okay! Networks are sexy! $$$$$$$”
• Founders who understand audience
• Founders who can get out early and iterate
• Founders who are intellectually honest
o Don’t delude yourself or VCs about your competition

Understand the market

• Small companies ride large waves; they do not make them
o YouTube did not create the Web, video compression, or broadband. They
just made uploading video easy.
• Trends
• Dynamics
• Ecosystem
• Size of market
o TAM: Total addressable market
o SAM: Served available market
 o SOM: Share of market

Know yourself
• Functional contributor?
• Interim executive?
• Go the distance?

Objective: Find customers whose hair is on fire, and sell them a fire hose
• It’s OK if the hose isn’t painted the right color
• It’s OK if the hose is leaky
• It’s OK to cut other corners if necessary

On the legal razor’s edge

• Young companies can operate in legal gray areas, provided there is a colorable
argument that the winds are blowing towards legality

For an IPO
• Markets like companies that have “marquee customers”
• For this reason, your competitors will do just about anything to prevent you from
signing them
 Talk X

Mark Zuckerberg is the founder of Facebook.

 Talk XI

“Dos and Don’ts of Patents for Micro Startups”

Joel Lehrer, Goodwin Procter LLP (jlehrer@goodwinprocter.com; 617-570-1057)
Joel is an attorney specializing in intellectual property.

Trends
• Number of patent applications filed with USPTO has been increasing since 1998
and is projected to increase linearly. The allowance of business method patents is
widely credited with this increase. (The projection of linear increase is probably
an intentional maneuver by the USPTO to keep Congress happy, since the USPTO
is a profit center for the Government.)
• The ratio of granted (allowed) patents has declined
o 60-70% until 2002
o 50% now
o Business method patents: 11% or less

Meat and potatoes

• Must be inventive (novel + nonobvious) (high bar) + useful (low bar)
• Must not have been publicly disclosed prior to 1 year before application (US
patents)
• You should be the inventor
• Will take a long time (4 years), and a lot of money ($15k +)
• Does not guarantee you can actually practice the invention
o In 2000, A is granted a patent on windshield wipers
o In 2002, B is granted a patent on intermittent windshield wipers
• B cannot practice his patent without a license from A
• Solution: cross licensing

Why does anyone care?

• Wall out competitors
• Defense
• Potential income from licensing
• Value on exit
• Credibility to investors
• Articulated description of market differentiation

Joel on patents
• Work on your own time and equipment
• Understand your current obligations re: IP
• Document contributions from others
• Document code provenance
• Get assignments of IP from others
 • File provisional patents before you launch
• Do some (but not too much) searching
• Focus on the product, not the patents
• Don’t worry about the big boys (for infringement, that is)

Patents on $500/year
• Monitor blogs and bulletin boards ($0)
• Monitor newly issued patents and publications ($0)
o WARNING: Any patent application you send to the USPTO will be
published for the whole world to see after 180 days. DO NOT USE
PATENTS WHERE TRADE SECRET PROTECTION IS BETTER.
• Hire a search firm (NERAC, INREA) ($500 or less)
o NERAC will often give new clients a few initial searches for free.
• Learn how to write a provisional patent ($0)
• Draft and file your own provisional patent ($0)