Pricing our small angel round… and hubris vs. humility

…and we’re back.  I hope to get back to regular blogging after the disruptions this last few months.  Getting a product out.  Family.  I have a nice backlog of posts for the coming few weeks which should ease me back into it better than my last attempt to start blogging again.  But before I get to those I felt compelled to start with an issue that’s been bugging me.  I also want to explain why I think we’re making the right decision to close a small, low-priced funding round against a lot of input to the contrary.

What sparked my line of thought was @shervin’s tweet yesterday:  Delusional hubris not connected to reality creeping up in Silicon Valley. #behumble

I was kinda shocked at the Open Angel Forum.  The OAF fantastic initiative by @jason to build alternatives to the pay-to-play nonsense or the angel groups that are little more than coffee-mornings and sewing circles (we all know which ones I am talking about).  The companies were serious and the angels were genuine angels.  Personally we got to finally connect with an angel we’d talked with oh the phone for a while.  I enjoyed the event.  But I found the valuation expectations of most of the participants eye-popping.

Since OAF I have run into this worrying trend in attitudes among fellow startup founders.  It’s almost like they’re reading all these articles about the supposed flood of angel investment and act like they already have it.  The conversations are all about how to maximize this first valuation, minimize dilution.  A lot of young founders out there seem to have forgotten that the point of the angel round is to build the foundation of the business that they’re going to be working on for the next several years.  Forgotten that the value of angels is as much in their nudges, advice, thoughts and input as it is in the dollars they invest.

I think it’s not just hubristic to think this way, I think it’s disrespectful of the whole process and the individuals involved.  It’s sometimes worth reminding yourself of the cycle:  an investor earns money, pays taxes on that money, takes some of it and trusts you to try your best to make a return on it.  That in itself deserves your respect.  But I digress…

I want to highlight our thinking, as we’re about to do a small funding round.  

AppWhirl - which will become App.Co on the 20th of this month - has been bootsrapped, unpaid, by myself and my co-founders over the course of the last twelve months through a careful iterative process of hypothesis testing, learning & pivoting known to many as Lean Startup.  Our vision is to be the blogger.com of apps.  A tool so simple that anyone can and will make an app.  We’re focused on a future where there are tens of millions of apps, on all sorts of converged devices (phones, tablets, tvs).  It’s a huge market.  There are a ton of pay services to do this, or tools for more skilled folks requiring more time and effort - even Google has one now.  But we think our target market segment is by far the biggest, and we think we have a unique insight into what an app is, and where the trendlines are going.

Sounds great right?  Well, sort of.  

Problem is since we opened up the beta we’ve been absolutely snowed by demand.  So much so we’re having to slow down the invite process.  We are also seeing conversion rates through the roof.  People get their invites, become registered users, build apps and submit them at rates far higher than we anticipated given the current early stage of the product.  People really want what we’re offering, and they want it now.  We’re at the limits of what we can do on our own with no resources so time to go out and start to raise some money.  

We recognized that we’re too early for VC money.  Tested the waters, found some great VCs we’re keeping up with, but at this stage we’re unlikely to justify the valuations necessary and, to be honest, the time it would take to work that process properly is not time we have right now.  So we took a step back and asked what milestones do we need to hit to be either a) VC ready or b) self-sustaining in a ramen-noodle profitability sense (preferably both at the same time), and what is the minimum amount of money we need to get there.  

I see a lot of fellow founders worried at this stage about dilution.  I get that - but it’s often dumb, coming from founders who’ve already diluted themselves too much through a poor initial equity distribution.  What we want is simple:  

  • Fast close - make it a quick easy decision for an angel in/out; 
  • valuation that doesn’t make our next round a mountain to climb; 
  • top notch angels who can add smart input that’s way more valuable than their $$.  

That way we have people far more experienced than ourselves, in terms of negotiating rounds and valuations, on board by the time we hit the VCs.  Aligned Interests.  This will help mitigate any extra early dilution.  Plus we’re just more likely to win this way.  

Don’t optimize for dilution before you’ve even got a company which you know is going to survive.  Optimize for smarts and speed.  That’s the only way you’re going to win?  I’ve done a startup where we optimized for valuation in the first round.  We ended up with bad money (yes there is such a thing) and an adversarial relationship with investors.  It was a disaster.  Don’t do it.

What did we decide at AppWhirl?  

A lot of people like to keep such info confidential but we’re not worried about it: we are pitching for $100k at $1million post.  Even wealthy super-angels like a deal!  Valuation is not an issue now.  It’s about believing in the team, the progress, the plan and the vision.  We want to open and close the process in a two week span with simple standard terms.  Then we want to move on and build a great company with the help of the angels we bring on.  We’re lucky in having a great, successful angel helping us with all of this, and hopefully a couple of others will follow.

So why are valuations sky high, yet we’re looking at a deal like this?  Hubris.  @shervin is dead right.  Seed round valuations are partly a reflection of the ego of the founder.  If you say you value the input of angels but don’t price accordingly you’re sending a signal that you don’t really believe that, and it’s the money that’s most important.  If you hold out for that bigger valuation now you rob yourself of execution time and make the next round harder.  And, of course, too high-a-valuation now makes your next round a much bigger hurdle. 

We’re hoping a little humility goes a long way.