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Valuation Sanity in Brazil, part two

Filed under Brazilian Venture Capital by


Yesterday, Anna Heim wrote a compelling, thorough article on the Next Web about valuations in Brazil.  I appreciate the fact that she accurately reflected my thoughts, despite the fact that I was in a crowded restaurant using a bad Skype connection when we spoke.

Her article inspired me to follow up on my original post on Valuation Sanity and to re-emphasize some points:
 
1.  Investors are to blame for inflated valuations, not entrepreneurs.
 
Bubbles don't happen because entrepreneurs ask for high valuations.  They happen because investors invest at high valuations.  As Anna mentioned, I don't think valuations are a real problem with Brazilian startups — yet.  If valuations become a problem, however, it will happen because investors become irrational.
 
2.  There are costs to asking for inflated valuations.
 
Entrepreneurs can hurt themselves by asking for inflated valuations.  For one thing, investors don't like to be treated like fools.  For another, many VCs (me included) pass on deals just because of the entrepreneur's initial ask on valuation: if the entrepreneur is starting at 10x what I believe is a reasonable valuation, what's the point of negotiating?  We won't get to an agreement, at least not without wasting a lot of time haggling like carpet salesman.  Lastly, a crazy ask on valuation shows a disconnect between the entrepreneur and reality that feels unsettling to an investor.
 
3.  Don't base valuations on the US market.
 
Important differences exist between markets.  The US, Brazil, Europe, China, etc. all have different sizes, growth rates, interest rates, maturity, broadband penetration, mobile usage, etc.  Most startups in Brazil are addressing the Brazilian market, so basing valuations on a different ecosystem, like the US, creates distortions.
In addition, the US market is still in a huge bubble, in my opinion, that will result in a massive die-off of VC funds and startups over the next 5-10 years and provide sub-par returns in all but the top 10% of companies.  So let's not base our valuations on the US.
 
4.  Returns take time.
 
There is a saying in Brazil, "Make money quickly."  This makes sense in the context of past economic shocks and killer inflation: make money now because it's not clear what tomorrow will bring.
This connects to the mentality of asking for an extreme valuation now (and cashing out as quickly as possible) because the market could go away quickly.
 
But the days of economic shocks in Brazil are gone (hopefully) and, anyway, this mentality doesn't fit with venture capital.  The average holding period — the time between an investment and a liquidity event — during the dot-com boom was 3-5 years.  As of two years ago, it had expanded to 8-10 years.  The historical average is something like 7 years. 
 
Thus the opposite, cynical, proverb about VC, "Venture capital is a good way to get rich slowly."  Actually, I'm not sure it's a good way to get rich at all but, if it happens, it happens over a long time period, both for investors and entrepreneurs.
 
My point is that, while valuations matter, we should always keep the primary focus on building great companies for the long-term.  Silicon Valley wasn't built by entrepreneurs and investors growing features masquerading as companies, then cashing out at inflated valuations.  It was built by entrepreneurs and investors with a long-term vision to build world-changing, sustainable companies like HP, Intel, Apple, Cisco and Google. 
 
We can and should build the same kind of companies in Brazil.

September 26, 2011 at 08:55 Comments (3)

Why Incorporate in Delaware?

Filed under Brazilian Venture Capital, US Venture Capital by

 
Yesterday's post addressed whether Brazilian startups should incorporate in the US.
I believe they should if
1.              They plan to have operations (customers, offices, employees) in the US in the next 6-12 months.
             2.              They plan to seek investment from non-Brazilian investors.
3.              They believe that their exit will likely derive from a source in the US (an American acquirer or IPO).
The most compelling reasons are #1 and #2 — #3 is a distant consideration.
 
Today's post addresses where startups should incorporate.  The answer is Delaware. 
 
At first glance, Delaware seems an unlikely base for corporations.  It is a tiny state, the second-smallest in the US (Rhode Island is the smallest) and is notable to me mainly for the fact that Bob Marley lived in Wilmington and that my best memories as a child came from summers at Rehoboth Beach.
 
So, why are 60% of Fortune 500 Companies, 50% of publicly traded US companies as well as 50% of all American corporations based in Delaware?
 
1.              The Court System (most important, see #6 below)
2.              Cost
Delaware charges $89 to form a corporation. That’s cheap. (Keep in mind that you will incur other costs, such as paying someone to act as your registered agent in the state.)
3.              Efficiency
You can form a company in one hour, just by sending a fax. That’s efficient. (But you have to have the fax in by 9am, right? Wrong. You can send it any time before 9pm at night and they will form the company that day.)
4.              Flexibility
You do not need to have offices in Delaware in order to base your business there. (Delaware also provides structural efficiencies, such as allowing companies to have just one executive and one board member.)
5.              Taxes
Your company will not pay any income taxes in Delaware if it does not conduct business in the state. You will only pay a small franchise tax.
 
Other US states have some combination of the attributes listed above but none have this one:
6.              The Court System
Corporate law encompasses a huge amount of complex issues – taxes, shareholders rights, executive conflicts of interest, fiduciary duties, mergers and acquisitions, employment law, etc.
It takes subject matter experts to adjudicate corporate law cases intelligently and consistently, and Delaware judges ("chancellors") are the ultimate subject-matter experts. They are black belts in corporate issues and they, not juries, decide corporate legal cases in Delaware.   
As such, a virtuous cycle has arisen: Delaware courts have become the best venue for adjudicating corporate legal cases, which results in more companies forming in that state, which in turn creates more case law.
Over time, this virtuous cycle has made Delaware the gold standard for corporate law, such that even lawyers in other states must study and understand Delaware law. (When I went to law school, the vast majority of corporate law cases we studied were from Delaware.)
A nice by-product of Delaware’s legal dominance is that, by incorporating in Delaware, companies can be certain of the legal standards they must obey and certain of the way those standards will be enforced.
 
In sum, I am not offering legal advice – always use a lawyer when analyzing these issues. I am suggesting, however, that you use a lawyer that will recommend that you form your company in Delaware…:)
 
 
September 23, 2011 at 06:27 Comments (0)

Should Brazilian Startups Incorporate in the United States?

Filed under Brazilian Venture Capital by

 
 
Before addressing this question, remember that this is a complex issue, each company’s situation is different and every startup should consult a good attorney before making a decision.
 
In my opinion, you should strongly consider forming a company in the US if:
 
1.              You plan to have operations (customers, offices, employees) in the US in the next 6-12 months.
2.        You plan to seek investment from non-Brazilian investors.
3.              You believe that your exit will likely derive from a source in the US (an American acquirer or IPO).
 
Regarding #1: if you realistically expect, and the business realistically demands, operations in the US, then having an entity there makes sense. 
 
I would strongly consider whether it is realistic to get sales in the US, however, before making this decision. Specifically, are there competitive companies already succeeding in the US market? If so, it will be hard for a new foreign competitor to have success. Not as hard as it used to be but still difficult.
 
Of course, this analysis greatly depends on the type of business involved. A Brazilian games company can just as easily reach US customers as a US company – there are few barriers to entry in the games market. On the other hand, most B2B businesses have a much higher hurdle.
 
Regarding #2: another reason to form an entity in the US is if you expect to receive investment from a US or, more generally, a non-Brazilian investor. This point can outweigh point #1; in other words, even if 100% of your operations are in Brazil and will remain there, if you realistically expect to receive investment from a US investor, you may want to form a US entity. 
 
Why?  Because for most venture funds, the ability to invest in a US entity makes a deal much more attractive.  
 
First of all, many funds have restrictions against investing in non-US companies. Their Limited Partners (investors in their fund) signed up for a fund that has a certain geographic focus (US) and a certain risk profile (e.g., a fund that is not making investments in markets with separate tax, legal and governance systems). 
 
Secondly, the ability to use standard US legal documents – Term Sheet, Share Purchase Agreements, Shareholder Agreements, etc. – makes the investor much more comfortable, as does the knowledge that, if there is a dispute, it will be resolved in the US court system. If there is an dispute with management, the investor does not want to fight in the Brazilian legal system for the next ten years.
 
Finally, many investors just don’t want to go through the long diligence process required to invest in a new market. It’s the VCs job to understand a portfolio company’s business, regardless of where they are located but it’s too much time and expense to learn all the aspects of a foreign market, including the tax system, governance standards, legal environment, etc. Even if the fund mangers can avoid spending time on those diligence items, they will need to pay a lot of lawyers to do it.
 
In sum, when I talk about this subject with Brazilian entrepreneurs, I usually say that, if ten US investors would like to invest in your company, roughly five will drop out unless you are a US entity (or unless you agree to become a US entity before the investment).   The number of dropouts will be even higher with early-stage funds and super-angels.  
 
In addition, although it costs money to form and maintain an entity in the US, usually the valuation increase of your company vastly outweighs the cash expense. 
 
Point #3, regarding where your exit will likely take place, should not carry much weight. I hear a lot of entrepreneurs talk about IPO-ing on NASDAQ and for some it’s possible but the reality is that only the largest, most sustainable companies tend to IPO. This has been true for most of the history of the public markets, except for the period between 1996-2000, when NASDAQ became a market for “public venture capital”.
 
In addition, new regulations (Sarbanes-Oxley) in the US make it very expensive and bureaucratic to operate as a publicly traded company, so even firms that can successfully IPO often decide against it.
 
The more likely exit, acquisition, could happen more easily if you are a US entity AND the acquirer is a US entity but, obviously, it doesn’t help much if you are US entity and the acquirer is Brazilian. In sum, in most cases, I wouldn’t base the decision on whether to locate in the US based on speculation about where your exit will take place.
 
 
 
 
 
 
 
 
 
September 22, 2011 at 05:56 Comments (0)

Three Simple Time-Management Techniques

Filed under Random Posts by

 

I have always struggled with managing my time efficiently.  More than most people, I believe.

As such, I've sought help from a wide-variety time management techniques, most of which I've subsequently abandoned.  After compiling a library of half-read books, downloading twenty once-used apps and trying to emulate the systems of organized colleagues, I've selected a few simple techniques that work for me.

First, I divide my tasks into Stephen Covey's Four Quadrants.  This keeps me focused on the most important activities each day, while ensuring that I maintain sight of my long-term goals. 

Tasks in the "Important but not urgent" quadrant are the most elusive — we tend to ignore these tasks despite the fact that they have the largest impact on our effectiveness. 

The second technique is a simple age-old wisdom: plan your day the night before.  Specifically, spend the last 10-15 minutes of each work day prioritizing and scheduling your tasks for the next day.  It's amazing how much more efficient it is to start the day with a to-do list from the night before — it eliminates distractions and provides continuity from one day to another. 

The third technique comes from Tony Schwartz at Harvard: execute the most important task in the first 90 minutes of the workday.  The first 90 minutes are when people operate most productively.  I try to put items from the "important and non-urgent" quadrant in the first 90 minutes of each day.

That's it: Four Quadrants, Plan the Next Day, First 90 Minutes.

A few suggestions: first, keep your system simple.  Elaborate systems with multiple actions often work but they rarely last.  Personally, I can't sustain more than three techniques for time management (see above).  Find a system that you can sustain.

A second, related suggestion: don't expect perfection.  "Nothing's perfect" and perfectionists never stick with anything.  My system has gaps and I work my system inconsistently but it's effective and I don't abandon it. 

Third, expect to make minor tweaks to your system regularly.  I used to search for some unifying theory of time management which, once implemented, would make the universe fall blissfully and permanently into place.  Nope. 

Maintaining balance, maintaining anything, requires frequent recalibration.  Frequent minor adjustments are part of sustaining any system.

September 20, 2011 at 09:18 Comments (0)

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