antonybrydon

Due diligence on demand

There's a very good post on venture hacks today on how to close a term sheet quickly. I agree with two-and-a-half of the three hacks¹ and want to add a fourth that I think deserves a spot on the summary list:

      4. Have all due diligence ready to go on demand

Due diligence on demand means that the company's due diligence is always current, up-to-date, and ready to be delivered to a potential partner, investor or acquiror at a moment's notice.

Given that financing and acquisitions are rare (once a year), this may seem like overkill. But it actually demands that the company keep its books current and in perfect order, which has a number of other associated and equally important benefits.

At Visible Path, we documented our business operations from day one around a typical due diligence checklist that a public company might use when acquiring another public company. The index has 14 sections and 100+ subsections that include corporate governance, stockholder information, securities agreements, material contracts, product and mfg information, government regulations, litigation and audit information, employee information, employee benefit information, financial information, marketing information, property, employee benefit plan matters, facilities. With thanks to Peter Astiz of DLA Piper (who helped me create the original document) and Neal Williams of Carr & Ferrell (who used it to manage our financings and transactions), I've appended the actual document below:

 

The week we incorporated, we only had a handful of documents in these binders: our Certificate of Incorporation, our Bylaws, our founders Employment Agreements, and a cap table describing the ownership of the company. A few documents and about 100 empty tabs. These empty binders seemed a bit silly when we started but as we ran the business - hired employees, filed trademarks, signed up partners, each relevant document was filed in the appropriate section as it occurred, and the binders quickly filled out.

The implication of Jott's discontinued free service for your freemium service

Jott announced that they are discontinuing their free service effective February 2, citing a terrible ad market that is insufficient to support the free paid product. Customers will need to upgrade to paid plans at $3.95 per month or $12.95 per month to keep using the free service.

It's a surprising move, because the company says 30% of free users ultimately upgrade to paid versions. It's a high upgrade percentage, and seems at first blush like a great example of the freemium model at work.

It's an unsurprising move, because the cost of supporting these free users with a service that uses human transcription has to be very expensive, even if some speech to text automation is used for preprocessing. If the cost to support a user is even a dollars a month, it's easy to see to company going further into the red as the model (and free base) scales. The profits off the paid base are outweighed by the costs of supporting the free base.

It seems less likely that the struggling ad market affected the decision, because the most that advertising could contribute per user per month is a fraction of a dollar. Hit a user once per day at a $10 CPM and you're making only $0.30 per user per month. The ability to offset the human transcription costs with advertising seems challenging in good and bad ad markets alike.

Let's suppose that the entire ad market evaporated and Jott lost all advertising revenue. Since roughly 30% of the base is paid, Jott could offset that loss by increasing the profit on an average paid subscriber by $1 per month. They could do this by introducing new features, introducing a new subscription level, or optimizing price for profit - and maintain a free service and a freemium model that seems to be working well.

Since they didn't choose this path, and chose instead to sacrifice the freemium model, I suspect the costs of the free service are more significant than the reference to the ad model suggests and the profits on the paid service aren't near what's needed to offset the marketing expense. [Note: I've got zero insight into the actual economics of Jott's model - if my calculus is bad, I'd be grateful for a correction.]

Timing is everything > Raising capital from friends and family, angels and venture firms

Raising capital is an important part of starting a business. As an entrepreneur, you may be able to minimize or delay the need to raise capital if your service is relatively inexpensive to bring to market and you minimize expenses or find a quick path to revenue, but its more than likely that you'll need capital at some point - either to simply bring the product to market or to capitalize on the opportunity by growing as faster than you would be able to otherwise.

The approach to raising capital is important, but it's also very simple and straightforward. That's not to say it's easy. It's a little like the Appalachian Trail - it's a clearly marked hike, it's difficult to complete, it takes many months, and it's only confusing when you wander off the track or try to find shortcuts. The steps are simple: (1) founders (2) friends and family (3) angels (4) venture, but...

...but the optimal time to approach each audience is anything but simple. Each of these audiences has different requirements and should be approached at the appropriate time. If you spend time approaching these audiences prematurely, you waste your time and ruin your chance to make a strong first impression. Both of these can be catastrophic mistakes for a young company.