1. Given the plethora of accelerators out there, the scheduling of the Demo Day is challenging because you don't want to hold a Demo Day to close to another one. This is because you don't want to overload investors in their time and attention to give the best chance for the startups to raise money - there is enough competition amongst the numbers in the class; you don't want to add to the competition across accelerators!

However, they still do tend to clump together because the classes are generally held corresponding to the seasons or months in the calendar year.

The thing to note is that post-Demo Day, you really need to work as fast as possible to close funding because if you don't, you could end up running up against another Demo Day which could take investors' attention away from you.

For example, looking at the winter 2013 classes from earlier this year:

500startups Demo Day Winter 2013: February 6, 2013
Ycombinator Demo Day Winter 2013: March 26, 2013

A startup coming out of 500startups has effectively from February 6 to March 25, only about 2 months, before attention shifts to Ycombinator.

So work your magic on investors as fast, efficiently, and effectively as possible before the next Demo Day comes around!

2. This thought is related to Demo Days, but it more broadly has to do with optimizing Demo Day through which class you apply for.

In my previous post, Investment Pacing and The Timing of Fund Raising for Startups, I talked about the fact that the first half of the year is better for fund raising than the second. If this is true, then there are batches of accelerator classes that place you in the marketplace at the most optimal time for fund raising.

This means that the winter classes whose Demo Days end up in the early part of the calendar year have a longer period of time uninterrupted by investor seasonality than those who occur in the second half of the year. It means that the probability of you raising money is also greater if you have no interruptions due to other factors. So it may be worthwhile to work to get into winter classes than for a class in another part of the year.

Timing is everything - competition between accelerator classes and startups for limited investor time, attention, and money is fierce so optimize it wisely through timing.

Over the years after I wrote that post, I have mentored many startups, most recently at 500startups and ImagineK12. It seems that each startup, even at the beginning of the accelerator class, worries about their performance at Demo Day!

The previous post was more about the days closely surrounding Demo Day. However, I think there are more things to consider now that begins through the entire time in an accelerator program. To perform well at Demo Day, you should start thinking about Demo Day from Day One the moment you get there....

Day One to 1-2 Weeks Before Demo Day

In past accelerator classes, I always knew that there was friendly competition between the startups to give the best presentation possible on stage, over that of the others. However, startups sometimes don't realize this at the outset.

It is important to know that intelligence gathering on your fellow startups in the class should begin as soon as possible. What should you look for?

1. Who has the most traction and revenue. These will be ones that investors will keep their eye on the most.

2. Who has the coolest product, regardless of traction. These will be stars of the show from an "ooh-aah" standpoint. They will be memorable simply for their coolness.

3. Who has raised a round already. Somehow they wooed investors and may not need Demo Day to do so, or they may be announcing a bigger round then. But it is impressive when someone can get up on stage and say "we've already raised our round".

These will be your biggest competition on stage come Demo Day. You should watch out for these startups and figure out the best way to top them on stage. Rank them all from 1 to X and see where you stand in that list. The ones ahead of you are the ones you need to top - you only have from the beginning of the program to the end so work fast and smart!

Having said the above, and while I think they are your competition for Demo Day results, I also do believe that you will all more likely succeed if you all support each other and work together. So save your high priced service for those outside the accelerator; give your fellow startups a break so that you can all get the best chance to execute well by Demo Day. Support each other through the highs and lows; give advice freely and don't undermine anyone.

What are the categories to excel at? The basic categories are:

1. Traction, exponentially rising metrics
2. Revenue
3. Product awesomeness
4. Technology - unique? awesome? defensible?
4. Design excellence
5. Customer acquisition strategy, marketing excellence
6. Market size is huge
7. Founders are awesome
8. Previously committed investors, especially well known ones - social proof in action
9. Vision

In general, you should maximize your showing in as many categories as possible, and then better than anyone else in the class. (A good read: Brian Witlin's 10 Topics To Know Cold for Your Perfect VC Investor Pitch).

At one accelerator, a few startups told me that some had given them some basic numbers in traction and revenue they should hit in order to give them the best chance at getting investment. To me, if this is what someone told you, then you should treat this as the average and fight/execute to exceed these metrics! Everyone else may be attempting to hit this average, but you should try to go beyond it to look better!

Up to 1-2 Weeks Before Demo Day

OK so you've spent the last few weeks or months working your butt off to try to be the best of the class. If you're executing strongly, then you're off to the races.

But if you've tried your best and you're still lagging, what do you do? DON'T DESPAIR. Work on things that are under your control, like product awesomeness, design and technology excellence, market size is huge, and vision.

While the more traditional way of getting funded is excelling at those previously mentioned categories, I've seen startups get funding on much less progress so hope is not all lost. The idea is to NEVER GIVE UP (essential quality of any great entrepreneur).

Peacocking

If you've read The Game by Neil Strauss, you'll know that "peacocking" is what you do if you walk into a bar and try to pick up women. You need to look bigger/better/different/more flamboyant/more whatever than everyone else in there. In doing so, pickup artists have learned that they can pick up anyone!

I believe Demo Day has become about peacocking not for women, but for investors. Demo Day itself has become the pickup bar for startups. It's full of investors and you want to get their attention. Otherwise, someone else is going to get the attention and you'll be left at the bar alone with your drink. That sucks! Don't be that guy and see someone else walk off with the hottest investors in the place!

How might you peacock?

It may be as simple as all of you wearing brightly colored T-shirts, or some gimmick like a sweepstakes, or give away some cool gift (like T-shirts; one startup made Dr. Dre clone headphones to give away to investors who talked to them!).

It may be something amazing in your pitch. This something could be one of the typical previously mentioned categories, or something else entirely different. One startup I know put up a demo so amazing on stage that he generated a murmur of "ooohs" and "aaahs" through the audience, which resulted in a whole bunch of people coming up to him later asking him how he did that!

The Beauty Pageant

Another way to look at Demo Day, since it's on stage, is that it's a beauty pageant. All of you are clamoring to be Miss Universe so you better have a great showing across all categories. You're all competing, trying to look the best against the other contestants. Actual awesome performance in the previously mentioned categories helps a great deal and may be enough; peacocking adds icing on the cake (especially if there is, unfortunately, little cake, if you get my meaning).

The big prize is your two goals - the first is to get investors to come up and talk to you. The close second is to get them to invest in you. But you can't get the second without the first happening!

Keep that in mind as you're prepping for your stage debut. Whether it's through actual excellence in execution, or peacocking, or some awesome demo, or other thing, your overwhelming goal is to get investors to walk to you. You don't want to be standing around waiting for people to come up to you; find a way to make them all want to talk to you - be Miss Universe with the biggest/brightest feathers!

1-2 Weeks Before Demo Day

Prep as in my post Tips on Demo Day and Afterwards for YCombinator Startups. Make business cards and T-shirts, etc. Get the list of investor attendees and research potential investors who are your number one targets.

Practice your pitch OVER and OVER again until you are reciting it in your sleep and can do it without slides or help. Deliver it live multiple times to friends, mentors, and others until it is fine tuned to nth degree.

At 500startups, there are big blocks of hours dedicated each day and evening to let startups pitch practice. We mentors and others sit in on this pitch prep and give feedback. You should go to each one, get feedback, edit the pitch and then go back to the next session to pitch again and again and again until it is perfect.

Note that it can be a frustrating experience getting pitch feedback from different individuals because each person may tell you completely different things to change. Just gather it all, make changes that work for you, and make it flow the way you want to deliver it - remember that you're the one pitching and you'll have a particular style or personality, so you should make it your own. Try our suggestions; see if some fit and if they don't, toss them. It just needs to be cohesive and flow coherently and there are a thousand ways that can happen. We're here to help you with our feedback (and maybe confuse you), but YOU own this pitch, not us.

Also, remember that sometimes there is more than one Demo Day depending on the accelerator. If you have more than one pitch to give, think of it as a performance where you have to perform the exact same show every night. That means you'll need to have perfected the emphasis, the jokes, the words, the dramatic pauses and deliver it exactly the same way each time.

Demo Day

The day of the beauty pageant is here. Enjoy the day, relax, and deliver the pitch in the best way possible. Then get out in the crowd and network (peacock) like crazy! Read my previous post for tips on the day of Demo Day.

After Demo Day

It ain't over! Now comes the follow ups and communications to get investors on board. Get organized and track your progress. Set up meetings with investors. Read my previous post for tips on post-Demo Day.

Being in an accelerator class is one of the best things you can do to help you make progress and get funding. Make the most of your time, optimize it from day one to Demo Day.

In my Lack of Due Diligence is Appalling and Foolish post, I give a short list of documents I ask from the startup before investing. I have expanded that list slightly, adding debt obligations, business contracts, and then I modify it based on the situation and startup in question, but it has essentially been the same over the years. Most of the time I collect all this into a Dropbox folder and send it to my lawyer for review. It has always amazed me that it takes him only 1-2 hours to go through this- I guess when you look at a lot of this stuff, you get used to reading it and picking out specific stuff to look for. Every now and then, I get the opportunity to do corporate due diligence myself and yes I can definitely say it can take you only an hour to do this!

Generally, the corporate due diligence step I leave for the last step, after doing customer calls, reference calls, and research on the market. I don't want to ask for corporate documents unless everything has checked out up to this point, since those documents are confidential to the company and I want to respect that.

Note that I am ONLY talking about early stage startups: companies that have been only in existence for less than a year and have not had many business operations. Corporate due diligence can grow exponentially when the company has been in operation for years and then there are tons of documents and contracts, which can take teams of lawyers weeks to review. So feel lucky that at early stage, you don't have much company history to go through! But sadly, there could be a lot still to worry about....

So yes it can take only an hour! Just a few months back I did just this with a startup and zinged a bunch of questions back to them for inconsistencies and missing items. How does one do this? Some tips:

1. Do this often. Get used to reading legalese and understanding it quickly.

2. Learn to recognize standard legalese in corporate documents and when they diverge.

3. Learn to read and scan text quickly.

4. Take notes in a separate notepad or document while reviewing, so you can come back to important points or questions.

OK those are the preliminaries; now what to look for? Some common things I've learned to look for are:

1. Which items in the list are missing and why?

2. How many shares are authorized in the Articles? It is better to see 5M or 10M authorized. I would raise a flag if only 10K or similar shares were authorized. Lower numbers authorized also can indicate that someone incorporated by themselves at some online easy incorporation website - not the best option.

3. Scan through the board meeting minutes, assuming they exist. Identify any inconsistencies in personnel, consultants hired, stock granted to individuals and why, business dealings, operating directions, and information in the minutes and the other documents.

4. In the stock purchase plans, are people vesting or do they own stock?

5. If there have been previous financings, what do the terms of those financings look like? Do any have any effect on your money coming in at this time?

6. If there are any contracts, are there any problems with those contracts relating to future business?

7. If there is any debt, are there any liabiltiies to be aware of? Any liens on the assets of the company? Who gets paid back first and when?

8. Who is the lawyer? Be wary of lawyers who are not familiar with early stage startup work. Their lack of experience can cause all sorts of unwanted trouble - doesn't mean they aren't good lawyers, just means that lack of experience on what is acceptable and what is not can be a barrier to getting things done.

9. How much is owned by founders, employees, and, if any, previous investors? Is this acceptable to you?

10. Go to the site of the state in which they are incorporated and search for them in the incorporation database. Make sure they really exist there!

11. Write down all people and companies you encounter in the documents. Did they get money or stock? Or were there contracts that were entered into? Are they accounted for in other documents? Check the cap table - is anyone missing? Check on why anyone would receive money from the company.

There are many more that come up, but those are ones that I've encountered in previous deals. I also asked my lawyer for a broader set of Top 10 things to look out for, from his perspective, listed here:

1. No Organizational Resolutions (after Articles, to set up the company, appoint officers, etc.), or they are incomplete.

2. No qualification filed in state of domicile (e.g., DE company located in CA, no filing made in CA).

3. Docs are provided, but they are unsigned.

4. Company is set up by an Incorporator, but there is no Action by Incorporator adopting the Bylaws and appointing the initial Board.

5. Stock Options granted, but a Stock Option Plan was not adopted by the Company.

6. More stock issued than is authorized by the Company's Articles/Certificate of incorporation.

7. No Board Consent or Minutes approving the current financing.

8. Notice of Stock Transaction (in CA, a 25102(f) Notice) not filed with the State for the sale of stock.

9. No Cap Table.

10. Founders acquired stock but did not sign a Stock Purchase Agreement.

My list and my lawyer's list provide a great starting point. These lists are not, by any means, exhaustive. My best recommendation is always to collect the information and then send it to your lawyer for review and spend the money for it to be done by a professional. In lieu of that, it is always educational and interesting to go through these documents by yourself and try to spot potential problems. I always scan the documents, even when I send them to my lawyer, for practice, and also to double check his work because sometimes I may find something that he may miss, or I may care about something due to the nature of the company and situation but he won't know it's important since he isn't as close to the deal as I am.

The next step is to then decide whether you're OK with what you found or not. At early stage, it is common to find lots of corners have been cut to get to where they are now. Many early stage rounds are completed with big discrepancies in the corporate documents unfixed. If an institutional investor comes in, they will most likely demand clean up. I have often asked to clean up, even at low levels of investment. Rarely do I find that an entrepreneur won't clean it up; most of the time he/she knows it has to be done anyways, so why not now?

Other red flags:

1. I have asked for corporate due diligence documents and the entrepreneur has refused to provide them.

2. The entrepreneur doesn't want to clean up the documents, or constantly backpedals when you ask.

I have walked away from deals, after doing all sorts of other due diligence and then got to corporate due diligence and either one of those red flags pops up or I find something that I cannot live with. Do not skip this step!

Doing corporate due diligence is a necessary step no matter what the level of investment. It is best done by spending a little bit of money getting a professional eye to look them over. And it can be done on the cheap by doing it yourself.

Thanks to Mark Edwards of Edwards Law Group for contributing to this post.

Design/Prototyping

Previously CAD software required prohibitively expensive specialty computers and an engineering degree to operate. Now through Google Sketchup and Autodesk, the process of designing a product is significantly easier and accessible. The current open sourced environment of CAD designs, also allows for the leveraging of existing designs. The process of turning digital designs into physical prototype is now seamless as well, through 3D printers and other personal fabrication tools.

Another major hurdle that previously encumbered small hardware producers was the inability to produce and acquire critical hardware tech.

Now that a lot of hardware technology has been commoditized, individuals can acquire prefabricated kits and chipsets cheaply, not to mention custom chips can now be manufactured inexpensively as well.

Production

The go to market strategy has radically changed for hardware startups.  Kickstarter and Etsy have democratized the means of reaching consumers, and Kickstarter in particular has been an excellent channel for market validation and early customer acquisition.

Added to the ease for startups, Foreign manufacturing is becoming increasingly accessible to smaller firms. Small Firms can also pursue domestic contract manufacturing, an opportunity previously not available. 3D printing and other fabricating tools are also laying the foundation for truly scale free manufacturing.

Community

The DIY hardware community, called the Maker subculture, is a major driver of the larger hardware movement.  The increased availability of common platforms, easy-to-use tools, Web-based collaboration, and low cost technology has facilitated participation in the maker movement. Many contend that the current state of maker movement is reminiscent of the early personal computing movement that consisted mainly of hobbyists and tech enthusiasts. Whether one agrees with that comparison or not, the potential hardware innovation that can occur in garages all across the world is an incredibly exciting prospect.

Paul Graham, in his blog post on the Hardware Renaissance, perfectly explains the appeal of hardware from a consumer standpoint: “physical things are great”. Tangible tech is just plain cool. Hardware companies on Kickstarter have surged in popularity, to the point where Kickstarter had to change its policy to require physical prototypes in order to curtail some of the irrational exuberance of consumers.

What’s Next

We have already seen the rise of hardware startups through companies that we have screened, seen on Kickstarter or watched graduate from the most recent Y-Combinator class.  Most of these companies are still in their infancy, so questions of sustainability still remain, but their initial success is a positive indicator.

The underlying question for hardware startups is scalability. Could the next Kickstarter project eventually compete with a major hardware producer? Some on Wall Street seem to think so, as 3D printing startup Form Labs was flooded with calls from Wall Street Analysts asking about the future of the company, during their Kickstarter campaign. Some even contended that drops in 3D Systems (DDD) stock price were attributable to Form Labs Kickstarter campaign. 3D Systems seemed to take notice as well, they recently filed a lawsuit against the fledging startup. As 3D Systems demonstrated, large corporations will staunchly defend their market share, which could be dangerous for future hardware startups.

Another issue facing hardware startups is the ubiquity of the mobile device. The perverseness of the mobile device is leading a lot of new hardware to become focused on its interaction with the mobile device rather than it own platform. While mobile accessories are an exciting field, focusing on mobile as a platform rather than a channel is limiting for future hardware innovation.

Its not all bad news though, startups have the benefit of building hardware for niche markets, or other markets that larger companies would deem too small or too risky.  Apple demonstrated  both with the personal computer and the iPhone, that products can define the scalability of the market rather scalability determining the viability of the product.

Lawsuits aside, it is an exciting time to be a hardware startup.

Evidence of this trend is widespread. Dramatic population shifts are occurring back to urban centers, as people want to be closer to the action. Young people are more likely to spend their money on travel instead of purchasing durable goods. Individuals are shifting their focus from consuming mass produced products to a more customized experience. It would make sense that Apple, the fastest growing company over the last few years, is obsessed with user experience and the design of their products. Social media has become a major catalyst for the Experience Economy. Not only do we share our experiences with the people around us, but also with our closest 1000 friends!

Rise of the Humblebrag

Bragging is an innate behavior. According to Harvard psychological studies, researchers estimate that we spend 30-40% of what we say in life to telling others about our own experiences. In what shouldn’t come as a surprise, they found self-disclosure “activates parts of the brain that form the mesolimbic dopamine system, widely associated with our desire and reward mechanisms”. The amplification of social media has given people the megaphone to shout these experiences to a much larger audience. In fact, 91% of people that use photo-sharing sites have posted photos of their vacations.

So how is all of this connected? Where buying luxury brands once conveyed a message of wealth and allowed you to show off to the people that you came in contact with, social media has allowed you to show off your experiences to a much larger audience, in real-time. But shouldn’t that just mean that people would continue to show off their luxury goods to others via social media? Experiences offer a much higher utility for consumers, meaning those experiences are much more memorable and offer more satisfaction than goods purchases.

Luxury Experiences Trump Goods

Speaking of luxury goods, according to the Boston Consulting Group, the Global Luxury Market is a $1.4T industry. The experiential luxury category made up grew to 55% of the total market last year. This segment is not only made up of traditional luxury experiences like exotic African safaris, but also includes experiences like deluxe hospital rooms with specialty chefs or high-rise luxury apartment buildings offering virtual golf-facilities.  Experiential luxury is actually growing 50% faster than the luxury goods segment.  According to a study by Unity Marketing, consumers were three times more satisfied with purchasing luxury experiences than goods. The report chalks this up to a number of factors including an aging, affluent population that have reached an age where experiences are much more valuable than goods, a younger generation who define themselves by what they’ve done and not what they have, backlash from the recession, and consumers seeking a greater sense of purpose and satisfaction.

Flight to Cities

Another phenomenon is the flight to cities and urban areas back from the suburbs. In the nine months between July 1^st, 2011 and April 1^st, 2012, 27 of the nation’s 51 largest metropolitan areas exceeded their suburbs in population growth, according to census data. This is the first time this has happened since the 1920s! Many factors have contributed to this shift, which is largely perpetuated by young adults. Sustained high unemployment the continued search for jobs has certainly attributed to the flock to cities and an affinity for renting apartments over buying homes, but there are a number of other factors including the downtown revitalization efforts, reduced crime rates, reliable public transportation, and the growth of cultural amenities. Young adults are also delaying marriage and having children later, another impetus for a flight to the suburbs. Work locations also shifting back to more urban areas away from corporate campuses, drawing adults back to cities.

The revitalization on former industrial areas has also attributed to this shift. The Wall Street Journal notes:

“… A decades-long migration of factories to the suburbs and rural America has rid cities of the heavy industry that used to make them smoky, loud, and smelly. Take New York: In the 1940s, freight traffic ran on an elevated rail line on the city’s west side. Today, that line is now the High Line, an elevated public park.”

Participating in the Story: Mass Customization and Crowdfunding

Two major consumption shifts are fueled by the experience economy: Mass Customization and Crowdfunding. Mass customization gives people more tailored options. Consumers are demanding products that fit their own needs and are willing to pay more for a customized experience. Starbucks is probably the best example of this, turning the standard $1 coffee into $4-5 personalized coffee drinks. Other companies like Nike and Coca-Cola are investing millions in mass customization. Nike ID allows customers to customize their shoe choices (and is now a ~$100m portion of their business) and Coca-Cola has invested over $100m in their new Freestyle vending machines that offer literally thousands of potential soda combinations of their beverage portfolio. Startups like Cafepress and Zazzle have jumped on the opportunity to offer customized products for their customers.

Crowdfunding is also a phenomenon related to the experience economy. People are willing to fund projects with no guarantee that it will ever get manufactured! It’s the ability to participate in the story of the product and the experience of bringing a cool consumer product to life. According to Kickstarter, over $336m has been pledged to over 33k projects in 2012.

The Asset-Light Generation

In her most recent Internet trends presentation, Mary Meeker identifies the Asset-Light generation as digitalization and technology's affect on all the “stuff” that people own. Think about how much space all the VHS tapes, video games, CDs, DVDs, filing cabinets, and books took up in your house. All of these things have been digitalized, allowing people to live in smaller apartments/houses in urban areas. Why own an “asset-heavy” vehicle that sits 90% of the time in a garage when car-sharing sites like Zipcar allow “on-demand” options? Why own expensive textbooks when book rental sites like Chegg offer cheaper options to rent? New startups and enabling technology has allowed people to downsize their assets to save space, money, and inefficiency.

Conclusion

Many different trends have affected consumer patterns. From the impact of social media shifting our focus to “brag” about experiences to technology enabling the downsizing of our lives, consumers are much more focused experience than physical goods. The Experience Economy will affect how companies target and market consumers, manufacturing goods, and raise money for new projects. No longer does one size fits all. Consumers are their own individual market. Consumers are demanding unique and personalized items that may challenge traditional supply chains. Both major companies and startups will have to tailor their experience individual users. Because good or bad, you know they will be Tweeting about it!

Launch Capital portfolio companies benefitting from the “Experience Economy”:

• Zozi – Literally a marketplace for experiences!
• Fashion Playtes – Lets young girls customize their clothing.
• Custom Made – Marketplace for local furniture artisans for those who are sick of IKEA
• Daily Grommet – New product discovery, “experience” eCommerce.
• Quincy – Tailored fit for women’s business attire with an online shopping experience.

Usually what happens is, after the pitch I go back to our research team and after their digging, we find a mass of competitors. How could that be?

In thinking about competitors, I find there is generally a difference of opinion between me and the entrepreneur that is driven by the different types of competition, and whether the type of competitors that exist matter to us investing or not. Then add to that how market forces shape competition and this all gets pretty complex.

The Different Types of Competition

What are the different types of competitors? Looking out on the Net, I found these categories of competition:

Direct/Existing Competitors - usually the easiest to find, these are companies with products who are the same are very similar to yours, and attempt to serve the same need.

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Entrenched direct/existing competitors are those who have been around for a while and have grabbed a lot of market share before you showed up.

Indirect or Mindshare/Category Competitors - these are companies who provide alternatives to the need your product solves or the resources that your using your product would occupy, but it may not be obvious that they are taking away share from you.

"Just because your offering is unique, doesn’t mean it is unique in the mind of your prospects. To a prospective customer a marketing strategist, web designer, direct mail specialist, graphic designer, video producers, and print shops may all provide “marketing”."

[sources: 4 Types of Competitors, Different Types of Competitors by Peter Halim]

Potential Competitors - these are companies who have the capability and the will to enter into the marketplace with a product and become a direct or indirect competitor to you.

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Replacement Competitors -

"A replacement competitor is something someone could do instead of choose your product, but they’re using the same resources they could have committed to your product."

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Budget Competitors -

"Even if your products and services are truly unique, you still have to compete for the same budget dollars that other service providers are vying for."

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This also applies to the regular consumers. How hard is it to get customers to part with their money, if there are other choices possible? How many subscription services can a consumer have on their credit card before they say enough is enough? Advertising agencies have set budgets per year; if it all gets spoken for, you may not get access to valuable ad dollars simply because it's been all committed.

Doing Nothing - In the face of certain situations, it may result in a potential customer doing nothing as a way of deciding. This may result from having too many choices, or too difficult choices, or somehow being prevented from making a decision comfortable to the customer. It is worthwhile to ask, how can you eliminate this type of competition?

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What Matters to Us in Investing

You're probably thinking - Wow, Dave, that's a big list! Isn't that being a bit unfair to a fledging startup? Wouldn't the world be our competitor if we lay this kind of analysis on my startup?

You're partially right - as investors we like to look at your project from all angles and weigh the odds. What's the probability that a competitor, or competitors, will emerge and make life difficult or impossible for a startup we're looking at?

So taking those categories of competition above, we try to see who is there and who is not.

Direct/existing competitors are the worst. You have to come up against them and fight head to head for market share. Some of them are entrenched and thus you could have a tough time grabbing share from them. On the other hand, if they are traditional, slow moving big corporations, you may have an advantage in being a quick moving startup entering with a significantly better product. Competing against other startups - that's sometimes much harder.

The other categories are much harder to judge. We have to make a personal call as to whether or not we think the risk is too high or low enough to give the startup a fighting chance.

Market Forces Confound the Competition Analysis

The only problem is...there are too many internet startups now. There has been an explosion of entrepreneurism which complicates the competition problem.

Previously, we talked about Mindshare/Category Competitors. This was when your competitors could come from a broader category and those could become your competitors inadvertantly. However, with the enormous number of startups out there, the Category becomes so broad to emcompass all internet, meaning the fight for customers becomes the battle for attention where everyone is your competitor.

The Last Category: Everyone is Your Competitor

While this is probably true to some degree at any time, it jumps to the forefront in times like today. That's what is happening now; there are too many startups for both consumers and B2B customers to process quickly. If they cannot choose you fast enough, then your growth is stalled, causing you to burn through your cash before you can get to breakeven. Time is the enemy of startups - you cannot wait for people to process too many choices; you need them to use you quickly and they simply won't. This is why we see startups needing 24-30 months to get to someplace of stability, or to get to their next funding event.

This makes the investment decision much harder to process. What's an investor to do?

We could wait for times to change. The world moves so fast now - it is possible that within a year or two, the battle for attention may abate. Or it could get worse.

What it does mean is that for now, as we evaluate startups, the best we can do is to acknowledge the battle for attention is very real but we are being very picky now.

At this point, we try only to pick startups that have really no direct competitors, or have only old, traditional entrenched competitors. The world of internet startups has reached to almost every corner of every major industry; however, we are still finding some unturned stones, businesses and markets that have not been touched by internet startups yet. This is where we are finding the last remaining internet startup opportunities that literally have no direct competitors, or at best, competitors that are old, traditional companies which we are betting cannot move as fast, nor have the expertise or innnovative spirit of a startup.

In the old days, investors picked startups who had no competitors. The internet wasn't around back then and competition was different in other industries. With the internet, competition pops up with great ease and speed. We now look for those rare, few startups that have still no direct competitors and advise them to stay stealth, just like in the old days, to avoid other internet entrepreneurs from creating competitors literally out of thin air.

I can sympathize with that VC. Since 2006 when I started investing in startups, I've gotten caught by a lot of unexpected traps and rookie mistakes. These have definitely driven my current thinking on how I like to pick startups and their teams, finance them, and what terms are important to me. I would definitely admit that this was the most expensive education in any subject I've ever learned. Where else can you piss away 10s, if not 100s of thousands of dollars on situations that you may have avoided through better experience or forethought? Or maybe lady luck just decided to slap you down this time out of nowhere?

It was one of the reasons why I wrote this post a few years back: More Reasons Not to Invest in Notes. In the notes that I've done, I've seen many unexpected things happen. And this is why my boilerplate note has grown to include many things beyond the vanilla convertible note that someone might use.

But then, there are investors I've met out there who have never had anything bad or weird happen to them. This fact still amazes me that there are those out there like this. Still, it is my belief that the more you invest, the more likely something bad will eventually happen. You can't avoid everything bad that can happen to you; you can only do so much to protect yourself.

In our attempts to protect ourselves, the entrepreneurs we meet often suffer from our past. We argue for certain agreements and terms, some of which seem downright strange and we can be pretty adamant about those terms. We may even get emotional about them and refuse to back down on them as negotiable items.

Sorry about that. The more we invest, the more we are scarred. The best thing you can do is to be like a good therapist; sit and listen to us rant and rave. Nod with sympathy in your eyes. Let us know you understand. Pat us on the back. And when we calm down, we may actually give...or not. Like traditional therapy, some things can be cured and others...well...probably never...

In addition to all the news about the fiscal cliff and chaos in Europe, earnings per share growth (or lack thereof) is another data point we should be paying attention to. As of September 30, S&P 500 estimates that Q3 2012 EPS growth will be -3.1% [UPDATE: As more companies have reported earnings this quarter, EPS growth has been revised to -0.1%.] This is significant because a negative turn in EPS growth typically indicates a recession. Of the last four times EPS went negative, three (1989, 2001, and 2007) pointed toward massive economic slowdowns and one in 1998 was a single quarter blip.

So is Q3 an outlier or the start of a slowdown? While analysts don’t believe we’ll see back-to-back negative EPS, they’ve begun revising their estimates downward. Since the end of the third quarter (September 30), analysts have reduced earnings growth expectations for Q4 2012 (to 5.6% from 9.3%), Q1 2013 (to 3.4% from 5.3%), and Q2 2013 (to 8.0% from 9.3%). A few trends might point to a more negative outlook.

From 2008 to 2011 corporate profits soared $578B, growing from a low point of $1.2T in 2008 to $1.8T in 2011. This was widely regarded as a jobless recovery as companies cut jobs and compensation, experienced low unit labor costs and significantly increased productivity per worker. Corporations also experienced relatively low commodity and material costs over this time period as shown in the graphs below:

But as you can see those trends have changed and corporations are experiencing increased material and labor costs, which provides one explanation a decrease in EPS. It makes sense that corporate earnings growth would slow during a recovery as companies spend excess cash (hiring new people, investing in R&D, etc.) to meet increased demand. But where will the demand come from this time around?

The consensus is that U.S. GDP growth will be relatively flat over the next few years, hovering around 2% to 3% growth for 2013 and 2014. For the rest of the world, the Eurozone is in turmoil and growth in China has slowed significantly. From 2008 to 2011, China’s GDP was growing at a double-digit rate, creating the demand necessary to offset recessions in the U.S. and Europe:

But with the U.S. economy stuck in a rut and demand in China and Europe waning, who will create the demand necessary to continue to fuel record earnings? If you look a little further back to earnings data from 2006, it paints a clearer picture of how important foreign demand has been to the earnings increase:

“Looking from 2006 - 2011 corporate profits grew by about $219 Billion. However, most of this growth came from outside of the U.S., around $182 Billion. U.S. domestic industries grew by only $36.6 Billion … While the U.S. growth figure is positive, the figure of $36.6 Billion includes a positive contribution of 42.1 Billion from "Federal Reserve banks”. This was over 17.5% annualized growth. All other domestic U.S. industries when aggregated together had a slight negative growth in profits from 2006 to 2011.”

This means over the time period from 2006 to 2011, corporate earnings derived from the U.S. were actually negative if not for the federal stimulus! It looks more apparent that the U.S. cannot drive corporate profits alone.

There is evidence that the slowdown around the world has started to hurt topline revenue for S&P 500 companies. While 70% of companies reported EPS above the mean estimate in Q3, 60% are reporting a revenue miss. Guidance doesn’t look good either.  For Q4 2012, 72% of companies in the S&P 500 are reporting negative guidance, well above the long-term average of 61%. According to a survey by CEB, a membership based advisory firm, a little over half of managers expect production levels to increase in the next 12 months, down from 63% a year ago. Only 34% expect to hire in the coming year.

With all of the current risks in the market, you would think that the market would be cheap. There should be a correlation between negative guidance and stock prices (as there was until 2010), but the actual results have been the exact opposite:

It should be pointed out that sectors that are heavily tied to commodity prices (energy, materials, utilities, and industrials) make up the laggards of the group and commodity prices could be the culprit. There also might be some short-term fallout from insurance companies due to Hurricane Sandy, but this could be offset by increased production and investment in the rebuilding effort.

So is this past quarter a blip in the radar or the bearer of bad news? Is there a fundamental issue with the U.S. economy or a few sectors hurting earnings? Will there be a harsh correction in the market?

Uncertainty is most certainly driving corporate decisions and we’ve reached what Clayton Christiansen calls “The Capitalist Dilemma”. Christiansen explains this dilemma as the notion that executives and investors will fund three types of innovations: empowering, sustaining, and efficiency. Empowering innovations “transform complicated and costly products available to few, into cheaper products available to many”. By empowering innovations, companies spend money by creating jobs, increasing capacity to meet demand for new products (i.e. Model T, personal computers, etc). Sustaining innovations that simply replace old models with new ones (new HDTV to replace your old TV). This has a neutral effect on the economy because you’re eliminating your old product with a new one. Lastly, the efficiency innovations “reduce the cost of making and distributing existing goods and services”.  Replacing 100 workers with machines in an auto plant would fall into the efficiency innovation category.

According to Christiansen:

“Ideally, the three innovations operate in a recurring circle. Empowering innovations are essential for growth because they create new consumption. As long as empowering innovations create more jobs than efficiency innovations eliminate, and as long as the capital that efficiency innovations liberate is invested back into empowering innovations, we keep recessions at bay. The dials on these three innovations are sensitive. But when they are set correctly, the economy is a magnificent machine.”

In the current state of the U.S. economy the balance is off. Investments in efficiency have liberated capital, but have only lead to investments in more efficiency thus decreasing the number of jobs. Executives running Fortune 500 companies have been taught to do (and are doing) what’s right for their own companies and shareholders. Investing in efficiency innovations are what lead to record corporate profits and sky-high stock prices over the last few years. And there in lies the paradox. Uncertainty in the market has disrupted the balance between empowering innovation and investing in efficiency. We currently have a glut of cash and a lack of qualified workers, yet companies are refusing to spend money on training new employees (companies also blame the education system and want reform, i.e. the Government to pay for it, but that's a whole different blog post). Until the fiscal cliff is resolved and there’s stability in Europe, companies are going to continue to do what’s right for them and that means keeping balance sheets flush with cash. Until companies have the incentives to invest in innovation, the U.S. economy will continue to be stagnate and unemployment will remain high.

Cutting costs and investing in efficiency can only go so far. Without an uptick in demand from the U.S. and slowing growth abroad, we may see earnings take a hit in the near future. All of this coupled with Congress’ “stellar” track record on determining economic policy, I would tend be a bit more pessimistic in 2013.

Then the startup funding environment came roaring back, we had our Instagram moment, and investing on momentum was in vogue again.

But times have shifted again. What has changed?

1. Tracking M&A values, they hang slightly above $20M [source 1="Berkery" 2="Noyes" 3="2012" 4="3rd" 5="Qtr" 6="Trends" 7="Report" 8="Online" 9="&" 10="Mobile" 11="Industry" language=":"][/source]. This is pretty low in general, and pretty unattractive from an investors' standpoint when...

2. ...Valuations for startups still hang around $6-10M cap or pre-money at early stage for the hotter deals, sometimes even higher. Remember that if you are to exit at the median, you must be doing pretty darn good and be above average. If you are not gaining traction, acquihires are happening at much, much lower values, definitely well below $10M.

Now to be perfectly clear, there are those out there investing on strategies that take into account 2-5X return on money. But our economics don't allow us to do that - we need much more return.

3. Customers, whether consumers or B2B, are deluged by the exponential growth of startups and growth is harder to come by. In the near past, we used to tell startups that they needed 12-18 months to get to decent traction metrics; that quickly moved to 18-24 months, and now we think it's 24-30 months. Wow! 24-30 months - this is a direct result of our observations on how startups are growing in the competitive marketplace, the battle for customers' attention. When we saw them funded with runways of ~18 months or so, many needed more runway and so went to look for bridges, if they could not get series A - so we're now at 24-30 months!

However, practically NO startup I know raises for 24-30 months at the seed stage - well, practically none. If you go to Techcrunch and other online publications that follow startups, you'll see a ton of early stage raises at $1.5M-2.0M - what happened? This is smart. These founders, and their investors, have realized that they need more runway and have funded them for that. Startups who raise less than 24 months runway have a higher probabiility, now more than ever, that they will need additional runway to extend them to 24-30 months within a year.

But if you aren't one of the startup darlings to get $1.5-2.0M at seed, what then?

4. Last, we've been in contact with some prominent financial guys who follow the economy like hawks. They process every bit of information that is out there, stuff we all can get and a ton of stuff that we can't. (If there is anything I've learned about the financial industry, it's this - there are those with the information and those without - those without basically include everybody else including you and me - and yes, the world will continue to have unfair information advantage no matter what we do with regulations). They are fearful that another 2008 is coming. We've been digging into this and have found evidence in a potential earnings cliff, and we are concerned as well.

All this means that we think the importance of revenue at early stage is back - one could argue that it never left, but what I mean is that it has risen to the top of the stack.

The world isn't looking optimal for internet startup investing. That doesn't mean there aren't opportunities out there that can fit within the world we see right now - generating revenue is one of those key characteristics that can ensure some longevity even when the world is so uncertain. Once again, we look for that to bolster a startup's chance for survival and give them maximal runway to achieve their next funding event.

This is awesome but in today's world, you can't raise money on achieving an MVP. Investors demand more than that.

As Steve Blank likes to say:

A Startup Is a Temporary Organization Designed to Search
for A Repeatable and Scalable Business Model

[source 1="<a" 2="href="http://ds.ly/PFh1gM">Nail" 3="the" 4="Customer" 5="Development" 6="Manifesto" 7="to" 8="the" 9="Wall" 10="-" 11="Steve" 12="Blank</a>" language=":"][/source]

The unfortunate reality is - an MVP is not the above! Yet most of the newly minted entrepreneurs I've met think their job is nearly done when they've found MVP - they think they can go build a pitch off their early MVP and raise money!

A startup does require MVP but it is much more than just MVP. The problem is that MVP means early adoption of product and its features, maybe even some who will pay. But it doesn't tell you how many people will do it in the long term and whether this can support the company (the people and operations within) that is behind it.

So startups are much more than MVP and requires thinking beyond just the product. This is where I'd like to coin a new acronym, which is Minimum Viable Company or MVC.

What is a MVC?

First, I would say MVCs only apply to early stage startups - you can't really talk about achieving MVC status for a company that's been around for a longer period of time. To be minimally viable as a company, I would say:

1. It has achieved breakeven or profitability, or has a believable and achievable plan to get there.

OR

2. It has achieved enough metrics to reach its next funding event. This includes the first funding event.

Or ideally both.

The Fundable MVC

An MVC must have achieved some sort of MVP, but having MVP doesn't mean you have achieved MVC automatically. Nor does it mean you've achieved the next level of MVC which is a FMVC or Fundable MVC.

Remember that many MVCs can generate cash, but how much exactly? If you reach small or medium business status, that is great; it takes no little effort to make $500K, $1M, or several tens of millions of dollars per year. It is a notable achievement to employ a building full of workers, insuring them pay and livelihood, and providing or shipping product and services to customers. This is a win by many measures.

However, many companies like these, while there is every reason in the world for them to exist, unfortunately are not attractive to investors. This is because while they are doing great work, the likelihood of investors getting their money back and then some is very low or zero. This is the difference between an MVC and a FMVC.

We have not, as an startup/investor community, figured out how to invest in those companies whose trajectory is heading towards small or medium business status. Right now, all startups are being funded as if they are going to exit like any high growth startup. Anybody on a lesser trajectory simply won't attract the funding it needs unless more effort is done with other funding sources or structures.

Therefore, it is the FMVC that every startup needs to achieve. What are the characteristics of a FMVC? Everything that a seasoned, high growth investor looks for: big market, big vision, lots of revenue potential, world domination plan, etc. This is what will increase the likelihood of funding, not presenting your MVP at a demo day, or even a plan for a MVC, but your plan for a FMVC.

How do you turn your MVP into a FMVC?

First, you must realize that not all MVPs yield a FMVC. MVPs could yield a MVC but not FMVC. Many MVPs have potential to attract some customers, but not enough to create a company and an opportunity large and tasty enough for investors to want to put money in. This is also dependent on the market in general, meaning that 5+ years ago when there weren't so many startups sprouting up all over the place, you could have achieved an FMVC with your project; however, in today's crowded startup world, you cannot.

While every project is different, I point you to some suggestions on examining what you are doing now in hopes of turning it into a FMVC:

1. Iterating on MVCs is a good thing to do; keep trying out business models and plans until a FMVC shows up. It may mean giving up on your current MVP and looking for another one. Do not be afraid of going back to the drawing board if you find your MVP does not yield a satisfactory FMVC!

However, your time limit is your bank account. Never forget that. So working rapidly and lean is key.

2. Do you have a World Domination Plan? Is it believable? If you can envision a world where your MVP dominates whatever market and customers it is pursuing, is that big enough?

3. Are you too focused on the solution and not on the problem? Becoming too myopic about their product and forgetting about how this turns into a big company is something that I find happens with many entrepreneurs. They get caught up in the success of finding a MVP, but don't realize that they not only need a MVP but need to achieve MVC and hopefully FMVC.

4. Following on 3., it would probably be a good idea to pick up some MBA skills and start running models and scenarios to see where a given MVP can become a MVC, or potentially a FMVC.

5. A good measuring stick I use with startups is to ask what the $100M/year revenue scenario looks like. Generating $100M in business per year is no small feat - you get there and you're well on your way to becoming a big business. So can we imagine a world where your startup is making that much and believe it?

6. The weird thing about some startups is, that some break into such new territory that it is very hard to model or you can't model anything. New industries, new markets, or products and services that customers cannot imagine having or using are like that. So the FMVC you could create is purely via pitch, arrogance, confidence, etc. - whatever it takes to woo an investor to write a big enough check on what you plan whether you have product or not. In order to accomplish this kind of FMVC, your credentials must be unique: you must be well-known to the investor, you must be trusted. Ideally, you would have had an exit or more for that investor. You must show "extreme" entrepreneurial traits: be able to employ persuasive language, compelling/grand planning, superb salesmanship skills and technical skills, among others. These are the people who can get funding on a powerpoint when others flounder even with revenue.

This can be enough to win you funding and survivability.

In short:

1. An MVP is great but not enough in today's market to win funding.

2. An MVC generally means you have MVP, but an MVP does not guarantee MVC.

3. An MVC can yield a small to medium business, or a big world dominating one. There is nothing wrong with building any of those types of businesses and the world is big enough for all kinds.

4. However, we do not know how to properly invest in small to medium businesses. Our money may not be returnable from such businesses using the current equity structure of our investing. Thus, we want to invest in FMVCs.

5. As someone who is trying to build a real high-growth startup, therefore, MVPs or MVCs are not enough. You must search for a FMVC.