10 Reasons Why Early-Stage Companies Fail November 6, 2008 From Invention to Start-Up – Seminar Series for UW Faculty Geoff Entress

2 Former Venture Partner at Madrona Venture Group Board member of drugstore.com (NASDAQ NM DSCM), Sandlot Games, Judy’s Book and BuddyTV Former board member of Madrona portfolio companies Seadragon Software (acquired by Microsoft) and Redfin Angel investor in over thirty Pacific Northwest businesses, including Isilon Systems (NASDAQ GM ISLN), World Wide Packets (acquired by Ciena), Coffee Equipment Company (acquired by Starbucks), BuddyTV, Shelfari (acquired by Amazon), I Can Has Cheezburger and Sandlot Games Member of Executive and Screening Committees of Seattle’s Alliance of Angels Former co-founder of UrbanEarth.com, a hip hop music web site Former securities lawyer with Perkins Coie, worked on several IPOs and venture financings Former hedge fund co-founder and ran analysis and pricing groups at Salomon Brothers and a unit of Prudential

3 Geoff’s Angel Investments

4 The Main Reason that Start-ups Fail: They Run Out of Money* * Well, sometimes they are just shut down and investor money is returned (but not the norm)

5 10 Reasons Why Early-Stage Companies Run out of Money (and Fail) Spend too much, too fast Don’t generate enough revenue Can’t raise money when it is needed

6 #1: They Spend the Money they Raise Too Fast Conserve your cash – very difficult to raise

7 #2: They Hire too Fast (Ahead of Their Product Development) Common mistake is hiring sales staff before product is ready to sell

8 #3: They Fire too Slow Better to do one deep painful cut than to endure multiple smaller cuts Demoralizing to the team

9 #4: They React too Slowly to Changes in the Market They don’t change the overall cost structure quickly They don’t layoff soon enough or cut deeply enough They don’t adjust the business model The US Economy Totally Looks Like a train wreck

10 #5: They Don’t Hire the Right Team as the Business Grows Founders often don’t scale to large public company CEOs The early team may not be right once Company grows A players hire A players

11 #6: They Don’t Listen to their Customers Customers can be “sold” but… Customers usually know better than you what they want

12 #7: They Don’t Change their Business Model when it Becomes Obvious that it is Flawed Be decisive Be flexible, learn what works and do more of it Throwing stuff at the wall to see what sticks Ecommerce example

13 #8: They Don’t Raise Enough Money Focus on milestones required for next financing Structure the financing appropriately –Preferred Stock –Convertible Debt –Common Stock or LLC interests

14 #9: They Raise Money from the Wrong Investors All money is green, but it is not all the same Different types of investors have different return and timing expectations (venture, angel, other financial and strategic)

15 #9 cont’d: Expected Returns at Different Stages Seed stage – developing product 250K-$1mm IRR 70+%Need 10x in 5 years Venture Series A – Revenue - paying Customers $1- $3mmIRR 50%Need 5x in 3-4 years Venture Series B – Sales Expansion $3- 10mmIRR 40%Need 3x in 2-3 years Late stage – mature business$15-50mmIRR 25%Need 1.25x in 12 mos 10% IRR = double your money in 7 Years 20% IRR = double your money in 4 Years 40% IRR = double your money in 2 Years 100% IRR = double your money in 1 Year

16 #9 cont’d: An Aside: Determining Valuation Discounted Cash Flow (DCF) analysis – but often hard to do Compare to comps – also can be hard to do Compare to other angel financings – Series A’ s of $2-5 million Back-into from assumed VC Series A – if assume Series B of $5-8 million at $8- 12 million pre-money, better price A at a post of $4-5 million to generate return Do a convertible debt offering – don’t have to price it today – but still have to price voluntary conversion on acquisition or maturity (also known as “punting”)

17 #10: They Don’t Leverage Their Board and Investors Communication is key – monthly updates at a minimum Board and Investors will have contacts and insights that you won’t You will need investors to agree on key strategic decisions like raising money or selling the Company Existing investors are your back-up source of financing

18 #10+: They Don’t Sell When the Opportunity is Right In a period of high growth Demand in the market When they are a strategic “absolutely must have” Great return

19 #11: They Have Bad Luck No matter what you do, and how many precautions you take, and how good your product is, sometimes bad things will happen, you will run out of money, and you will fail Sequoia Capital PowerPoint Deck