John Greathouse http://johngreathouse.com Hands-on startup advice for emerging entrepreneurs Mon, 03 Aug 2015 12:00:26 +0000 en-US hourly 1 http://wordpress.org/?v=4.2.2 When In Doubt, Let People Think You’re A Fool http://johngreathouse.com/when-in-doubt-let-people-think-youre-a-fool/ http://johngreathouse.com/when-in-doubt-let-people-think-youre-a-fool/#comments Mon, 03 Aug 2015 12:00:26 +0000 http://johngreathouse.com/?p=5731 A version of this article previously appeared in Forbes. The Beatles’ Manager, Brian Epstein, was a 30-yr old, former furniture salesman when Beatlemania hit America […]

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A version of this article previously appeared in Forbes.

The Beatles’ Manager, Brian Epstein, was a 30-yr old, former furniture salesman when Beatlemania hit America in 1964. When he was approached by savvy Nicky Byrne to license the Beatles’ name and likeness for various novelty products and toys, he firmly stated that he would not accept a penny less than 10%.

Nicky had a difficult time hiding his surprise, as the typical range for such licenses was between 30% to 50% of the product’s price. Mr. Byrne quickly signed dozens agreements with merchandisers that subsequently cost the Beatles approximately $100,000,000 in lost royalties. Mr. Epstein later re-negotiated the Beatles’ share to 45%, but by then, Beatlemania was on the wane and the financial damage had been done.

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Get Out Of The Zone

As shown below, every negotiation entails a buyer and seller comfort zone. In order for a deal to be consummated, an intersection of these zones must exist. In the example below, agreement is achievable between $145 million and $185 million. In general, an agreement cannot occur outside of this range, unless new data, coupled with a persuasive argument, are introduced in order to drive the buyer or seller outside of their initial comfort zone.

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Brian Epstein Had No Clue, Let Alone A BATNA

“It is better to keep your mouth closed and let people think you are a fool than to open it and remove all doubt.” Mark Twain

In the case of the Beatles merchandizing, the sophisticated Mr. Byrne would have been extremely happy with any percentage below thirty and likely would have accepted any rate below fifty percent.

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Yet, because he was afraid to appear unknowledgeable, Mr. Epstein blurted out a percentage that effectively moved the negotiations outside of the expected shared comfort zone, costing the Beatles tens of millions of dollars in the process.

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While ignorance may be bliss, it is an awful foundation upon which to negotiate. When in doubt, keep your mouth shut and allow the other party to establish one of the boundaries of the shared comfort zone. If you are unsure of the fairness of their initial proposal, you can then seek additional information to determine where it falls within the expected range.

If a seller names a price at the outset of a negotiation, they effectively establish the upper bound of the negotiations. Once a sale price is communicated, the buyer is then incentivized to negotiate your initial proposal downward.

If you name an outrageously high price, you may scare away the would-be buyer, as they may feel that you do not have a realistic opinion of your venture’s value. If you set an initial price that is too low, you effectively shift the comfort zone in an unfavorable manner.

Without Whom…

Despite his frequent business blunders, the Beatles would have remained an obscure bar band if it had not been for Mr. Epstein’s career guidance and tireless promotion, which led to their recording deal with Decca. This reality was recognized by the Beatles, who appreciated Brian’s contribution to their success and excused his inadequacies. As Paul McCartney once said, “British people didn’t know that stuff at that time. I think he looked to his dad for business advice, and his dad really knew how to run a furniture store in Liverpool.”

You can follow John on Twitter: @johngreathouse.

Image credit: Associated Press

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Maximize Your Exit By Not Selling Your Company http://johngreathouse.com/maximize-your-exit-by-not-selling-your-company/ http://johngreathouse.com/maximize-your-exit-by-not-selling-your-company/#comments Tue, 28 Jul 2015 12:00:21 +0000 http://johngreathouse.com/?p=5725 A version of this article previously appeared in Forbes. In 1987, a representative of Michael Jackson approached the modest Sycamore Valley ranch house and knocked on […]

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A version of this article previously appeared in Forbes.

In 1987, a representative of Michael Jackson approached the modest Sycamore Valley ranch house and knocked on the door. The owner of the ranch was shocked by the visitor’s message. He told the homeowner that he represented someone who wanted to purchase the ranch at a substantial premium over its current fair market value. He also indicated that the offer was non-negotiable and the home owner had to respond either “Yes” or “No” in a matter of hours.

Although this is a somewhat unusual real estate transaction, it reflects a surprisingly common scenario in the business world of mergers and acquisitions, with one important distinction.

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My House Is Not For Sale

When someone knocks on your door and tells you they want to buy your house, despite the fact that it’s not on the market, you would not expect the potential buyer to then ask, “So how much do you want for it?” Even the eccentric King of Pop communicated the price he was willing to pay for Neverland.

However, in many cases, acquiring companies behave less rationally than Mr. Jackson. When we sold Expertcity (creator of GoToMeeting) to Citrix, we experienced this awkward, yet common situation. Citrix politely approached us, told us they had an interest in acquiring our company and then asked us, “How much?”

Our response was that there was no “price” as our company was not for sale. We were not rude nor indignant. We simply stated the truth. At the same time, we made it clear that we were flattered and happy to further explore if a reasonable deal could be crafted. We then turned Citrix’s question around, saying, “You knocked on our door with an intent to buy so you obviously have some idea of the price you are willing to pay. What is your price?”

As our negotiations became serious, I realized that we needed to define our Best Alternative to a Negotiated Agreement (BATNA). We boiled our alternatives down to the following:

IPO – To bolster our negotiating position, I engaged an investment bank to explore the public capital markets. This option was not attractive to the management team because the SEC’s onerous regulations would have severely constrained our liquidity. Most importantly, management’s ability to autonomously run our business would have been significantly compromised, as we would have been forced to answer to Wall Street on a quarterly basis.

Run A Sales Process – Establishing an auction was the least attractive option, even though this approach might have driven up the purchase price. We were more concerned with ensuring a cultural fit with our acquirer, rather than squeezing the last dollar out of the deal. Citrix promised to operate Expertcity as a separate division and maintain its offices in Santa Barbara and it was unclear if other potential acquirers would have been willing to make, and keep, similar commitments.

Additionally, we were concerned with our deal becoming shopworn by not initiating a bidding process. There is a well-worn adage in the world of mergers and acquisitions that, “companies are not sold, they are bought.” In other words, the most attractive companies generate unsolicited buyers which can often lead to premium purchase prices. Companies that seek buyers are often viewed as damaged goods which cannot otherwise succeed as self-sustaining entities. Such companies, if they are able to complete a transaction, usually sell at a discount.

Do Nothing – Taking no action was the potent competition faced by Citrix. Due to our revenue growth rate, Expertcity was quickly becoming too expensive for Citrix. Thus, doing nothing became our BATNA, as it encouraged Citrix to expeditiously prosecute the transaction.

We eventually sold Expertcity to Citrix for $236M. I am proud to say that Citrix lived up to all of its commitments and Expertcity, renamed Citrix Online, went on to become one of the largest employers in Santa Barbara county and one of the world’s largest SaaS businesses.

VC Funding Alternative

During late 2006 I helped the CEO of RedMojo sell his company to Novell. Our BATNA to a sale was to accept funding from venture capitalists. Taking fresh capital would have pushed out an acquisition by several years, as the institutional investors would have encouraged management to substantially grow the institutional value of the business before considering a sale.

Our approach was a bluff, as RedMojo’s management was not inclined to accept venture funding, as it would have required the team to work several additional years to generate a return sufficient to warrant the dilution caused by an institutional investment.

Fortunately, there were multiple companies interested in acquiring the company. This competition, coupled with the legitimate BATNA of venture funding, allowed us to sell the company for nearly $10 million, despite the fact that the company’s revenues were negligible and the team was comprised of a handful of people.

Who’s There?

It is impossible for you to fully understand the potential strategic value of your venture, once it is part of an acquiring company’s organization. Thus, a fair response to the question, “How much do you want for your company?” is, “What would our assets be worth as part of your organization?”

Once the potential buyer states the expected value of your assets within their organization, you can then focus your arguments on the combined value the two organizations can jointly create, rather than allowing the acquirer to drive down the standalone value of your company via comparisons with other companies or by assigning a multiple to either your revenue or net income. Attempting to determine the combined value of the entities is a worthwhile exercise because it forces both parties to think through the acquisition and contemplate how the combined company would work together.

When someone knocks on your door and asks how much you want for your company, your response should be, “Thank you, I am very flattered. However, there is no For Sale sign in front of our building. I know what my company is worth to me, but the important question is ‘What is it worth to you?’”

If the potential buyer wants your company as much as Michael Jackson desired the Sycamore Valley ranch, they may be willing to pay you a very, pretty penny indeed.

You can follow John on Twitter: @johngreathouse.

Image credit: Associated Press

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Success, Santa Barbara Style: Patagonian Sexwax With A Side Order of UGGS http://johngreathouse.com/success-santa-barbara-style-patagonian-sexwax-with-a-side-order-of-uggs/ http://johngreathouse.com/success-santa-barbara-style-patagonian-sexwax-with-a-side-order-of-uggs/#comments Mon, 20 Jul 2015 12:00:23 +0000 http://johngreathouse.com/?p=5716   A version of this article previously appeared in Forbes. When you can live where you want to live and make money doing what you […]

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A version of this article previously appeared in Forbes.

When you can live where you want to live and make money doing what you love to do, you are, by my definition, a screaming success.

Six outstanding entrepreneurs have created this sweet flavor of success in one of the most beautiful places on earth – Santa Barbara, California.

Santa Barbara has become a high-tech startup mecca, rivaling cities many times its size. The latest evidence of the city’s dynamic startup ecosystem is the recent announcement by Citrix to investment significant resources in the Santa Barbara Innovator’s Program.

The community is blessed with a temperate climate (average high temperatures between the mid-60's and mid-70's °F), which motivates accomplished people, who can afford to live anywhere, to make Santa Barbara their home. Many of these individuals become restless in their youthful “retirement” and begin investing and advising young companies.

Combine this significant pool of sophisticated Angel capital and expertise with UC Santa Barbara’s world-class entrepreneurial program and throw in a critical mass of entrepreneurs bold enough to build businesses around their passions, it’s understandable how a modest-sized community has produced so many successful tech startups. From Lynda.com’s recent $1.5 billion dollar acquisition by LinkedIn to Bessemer’s substantial investment in ProCore, AppFolio’s recent IPO filing and Sonos’ $130 million secondary, the Santa Barbara tech scene is unquestionably on fire.

However, less obvious is Santa Barbara’s rich history as a hotbed of lifestyle startups, a number of which have generated billions in revenue and garnered worldwide recognition.

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Lifestyle businesses are typically looked upon with derision by investors, as they generally do not have economic metrics that lead to large exits. However, a number of Santa Barbara’s “lifestyle businesses” are anything but small.

As Emmy Award winning comedian Bill Grundfest aptly points out in this video, entrepreneurs should seek the intersection of the things they enjoy doing and the tasks which will make them money. Starving artists pursue vocations which no one will support financially while workaholics labor at jobs which are often lucrative but offer no intrinsic rewards.

6 Entrepreneurs Who Conquered The Magical Intersection Of Money & Fun

image002Flip Flop Millionaire – Most fashion entrepreneurs are happy to have one huge hit. UCSB alum Doug Otto had two. In 1974, he began making flip flops in his Goleta garage and drove up and down the California coast, selling them out of his van for $10 each. According to Doug, “productivity fell dramatically whenever the surf was up.”

The following year, Doug traveled to Hawaii to surf. When not hitting the waves, he sold his flip flops to several surf stores, which locals called “deckas.” Doug morphed this Hawaiian slang and christened his company “Deckers.”

In the mid-1980’s, while on a rafting trip in Colorado, Doug noticed that the guide had modified his sandals with a velcro watchband strap to keep them on his feet when he stepped in and out of the river. This humble innovation resulted an entirely new line of footwear, the Teva sports sandal. Three decades later, it has matured into a multi-hundred million dollar product category.

During the early 1990’s, Doug came across his second huge hit. While surfing in Australia, he noticed that the local surfers wore sheepskin boots to keep their feet warm. In 1995, Deckers purchased the UGGS brand for $16 million. During its 2014 fiscal year, UGGS sales are estimated to have exceeded $500 million, while Deckers’ overall revenue was in excess of $1.5 billion.

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Hot Wax - Dr. Zog, aka Fredrick Herzog, just wanted to surf after he graduated from UCSB. To fund his passion, he began shaping and selling surfboards in 1968 from a small shop. Not satisfied with the quality of surf wax currently on the market, he decided to make his own.

In 1970, Zog closed his surf shop and focused his efforts on formulating a better wax. By 1972, he had refined his product, which he mixed in his garage, packaged by hand and sold to surf shops up and down the California coast, from Santa Cruz to San Diego.

He selected the name “Sex Wax” as an irreverent homage to Madison Avenue’s obsessive use of sex to sell even the most mundane products. His cheeky marketing (“The Best For Your Stick,” “Quick Humps,” and “Dream Cream”) fueled sales and caused High Schools to ban T-shirts sporting the Sex Wax logo. Like all attempts to limit young people’s access to a product, the moratorium had the reverse effect, causing sales of Sex Wax merchandise to explode.

Today, Zog’s wax product line is used by surfers, snowboarders, musicians and hockey players. By following his passion, Zog created a globally recognized brand, in which apparel sales account for over 10% of the company’s total revenue. This is especially impressive, considering that the Sex Wax logo has never been licensed to a third-party.

image004What's SUP? – In the 1970’s, Wardog was an avid surfer and skateboarding. By the 1980’s he added windsurfer to his list of water-based passions. Shortly thereafter, he met a fellow windsurfer, Deb, who became both his business partner and his wife.

Throughout the 1990’s, Wardog and Deb financed their water sport activities by testing surfing products and selling their unique Wardog surf fins. In 2003, they discovered paddle surfing and two years later, they founded Standup Paddle Sports, opening the first retail store in the US dedicated solely to standup paddling. According to Wardog, “We registered the domain www.standuppaddlesurfing.com on October 21, 2005, before the sport was even referred to as ‘standup paddle surfing.’” A decade later, Standup Paddle Sports has become a leading SUP brand, serving customers globally.

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Bones Brigade – George Powell didn't realize he was going to change the skateboarding industry when he began experimenting with polyurethane skateboard wheels, he was just trying to create a better skateboard for his son. From those early tests in his kitchen, Mr. Powell launched the Bones wheels brand in 1977.

The following year he partnered with 19-year old Stacy Peralta. Together they formed the Bones Brigade, which included future skateboarding icons: Tony Hawk, Lance Mountain, Rodney Mullen and Guy Mariano. According to George, “…Stacy (Peralta)… handpicked all the skaters, determining who was going to be the best of the young, just emerging amateurs, and bonded them together into a team we called the Bones Brigade. The key for him was to NOT steal well known skaters from other companies, but to start over completely with a new crew of unknown skaters, to make it fresh and inspiring.”

By 1980, Powell•Peralta Skateboards was the biggest player in the industry. Despite the ups and downs of the skateboarding market in the intervening years, Powell•Peralta remains the world’s largest skateboard manufacturers.

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A Climbing Passion – In 1953, 14-year old Yvon Chouinard fell in love with rock climbing. At 18, he purchased a junked coal-fired forge and taught himself rudimentary blacksmithing so he could make metal piton climbing stakes.

He eventually became proficient enough to produce two stakes per hour, which he sold to his friends and fellow climbers for $1.50 each. He made enough pitons during the winter months to pay his bills during the April – November climbing season. Yvon slowly expanded his craftsman product line to include other climbing gear, but by 1970, pitons still accounted for about 70% of his sales.

A few years later, while in Scotland, Yvon purchased several rugby shirts, in the hopes that their tough construction would be ideal for the rigors of climbing. The reaction from his friends was immediate. He ordered a few more and found that he couldn’t keep them in stock. The rugby shirt soon became a national fashion craze and launched the company’s now extensive clothing line.

Even though 2014 sales have been estimated to exceed $700 million, Patagonia remains a private B corporation, which allows management the freedom to pursue its dual pursuits of profit and philanthropy. (Note: Patagonia’s headquarters are located just down the road from Santa Barbara, in Ventura, California).

Fielding Their Passion – After Co-founding and helping build the leading call intelligence company (Invoca: backed by Rincon Venture Partners, Accel and UpFront), Rob Duva was ready for something that would allow him to spend more time outdoors.

His latest venture, Fin and Field, combines his experience of building great SaaS solutions for big markets with his co-founder’s passion for fishing and hunting adventures. According to Rob, "The thing about creating a lifestyle business in Santa Barbara, is that the lifestyle here isn't cheap. Fin & Field is built to support other lifestyle businesses. It's nice knowing that we're making it easier for small business owners in the fishing and hunting industry to effectively run their lifestyle businesses, while living the life of sportsmen."

Although it’s still early days, Fin & Field is hoping to join the ranks of Santa Barbara’s lifestyle legends, as they tackle a market comprised of over 37 million sportsmen and 25,000+ small businesses.

If you follow me on Twitter (@johngreathouse) I promise I’ll never tweet you about Santa Barbara surf conditions or tell you about that killer burrito I just ate.

Images courtesy of each respective company, all rights reserved.

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Hold On, Congress Is About To Handcuff Online Sellers http://johngreathouse.com/hold-on-congress-is-about-to-handcuff-online-sellers/ http://johngreathouse.com/hold-on-congress-is-about-to-handcuff-online-sellers/#comments Tue, 14 Jul 2015 12:00:03 +0000 http://johngreathouse.com/?p=5710 A version of this article previously appeared in Forbes. Congress' latest attempt to impose an "Internet sales tax" is just another misguided tax grab that […]

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A version of this article previously appeared in Forbes.

Congress' latest attempt to impose an "Internet sales tax" is just another misguided tax grab that will do more harm than good to American small businesses.

The Remote Transaction Parity Act (RTPA), introduced by Representative Jason Chaffetz (R-UT), purports to simplify sales tax collections while also leveling the playing field between brick and mortar businesses and online sellers.

Noble goals, no doubt. Unfortunately, it accomplishes neither.

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Does Congress Think Nexus Is A Shampoo?

As it currently stands, online sellers must collect sales tax in the states where they have, "sales tax nexus." While every state has a slightly different definition of nexus, it is generally defined as, "a physical presence, employee, or products stored in the state." In the state's eyes, merchants with nexus uses state resources like roads, which justifies collecting sales tax from buyers within their state. Sounds reasonable, right?

In theory, the concept of nexus makes sense. However, in the hands of government bureaucrats, the definition of "physical presence" can become farcical, encompassing an independent affiliate which links to your site or a company's participation at a trade show.

Sales tax nexus requires sellers to register for a sales tax permit with every state in which one of their customers resides, which can amount to 12 sales tax payments per year, per state. Successful online sellers, those who are doing well and helping to drive what little growth the US economy has seen over the past six years, have to learn the vagaries of each nexus state's sales tax laws, including those of individual counties and municipalities which levy separate taxes. Online sellers are already awash in sales tax complexity.

If the RTPA passes, the current level of complexity will explode, as e-tailers will be required to collect sales tax from buyers in all 45 states (plus D.C.) which have a sales tax. The complexity of simply knowing what rate to charge each online customer will increase exponentially, as there are over 10,000 taxing jurisdictions within the United States. The RTPA will require online sellers to collect sales taxes, based on the rate applicable tied to the buyer's shipping destination.

Not only would the proposed law require vendors to determine a customized sales tax rate for every sale, it will create a reporting nightmare. Many states require online sellers to break down the taxes they've collected in each taxing district. Imagine doing hundreds or thousands of sales per month and then having to decipher where each sale was made, in order to comply with the new law. This onerous, time consuming burden hardly "levels the playing field."

Congress was clearly influenced by the well-funded retail lobby, which characterizes online sellers as "tax evaders," while describing brick and mortar stores as "mom and pop operations just trying to survive." Nothing could be further from the truth.

While in the past a clothing designer may have opened up a brick and mortar store on Main Street, she now opens her store online and reaches a wider audience. Why punish her for making a good business decision? In addition, most savvy brick and mortar operations also leverage the Internet to broaden their geographic reach and expand their customer base - the world is no longer comprised of exclusively online and offline sellers.

You may be thinking, "Certainly Congress contemplated thresholds that will absolve small companies from such overheated intensive tax calculations." Sadly, this is not the case. The threshold is $1 million per year in gross receipts. That may sound like a lot, until you consider that the metric is gross revenue, not profit. Most online sellers of physical good have low profit margins - due to the cost of sourcing products and transporting and warehousing them. A seller could readily gross $1mm per year and still barely make a living.

Yet, you may still think, "A million bucks is a lot, this won't hurt my definition of a small business." Think again. The RTPA explicitly states that all online sellers, irrespective of their size, which use electronic marketplaces (e.g., eBay, Amazon or Etsy) will be required to collect and remit sales tax in all 45 states. Will small sellers who resell thrift store goods to make extra money be motivated to deal with this regulatory burden? Even online sellers who make their living selling items full time on eBay or Amazon may shut down their operations, once their taxes become 45-times more complex.

The Government To The Rescue

The bill promises an unspecified "electronic solution" for small businesses. As an investor (through my VC firm Rincon Venture Partners) in TaxJar, a company in the sales tax space, I know firsthand how difficult it is to implement an on-the-fly calculation of taxes when 10,000 taxing jurisdictions must be considered. The determination of taxes owed must be made instantly, once the customer finalizes their online cart and is ready to check out. Given the government's stellar record of creating web services (anyone remember the $1 billion spent on the flawed Obamacare website?), it is doubtful small businesses will ever be offered a workable solution, as promised by the RTPA.

The RTPA's intended consequences will be significant, ultimately burying thousands of emerging eCommerce "mom and pop" entrepreneurs under a mountain of expensive and impractical regulations. The unintended consequences will be even more dramatic - equivalent to suddenly slamming the brakes on our sputtering economy.

Follow John on Twitter here: @johngreathouse. I promise I will never tweet about that killer burrito I just ate.

Image: Cynthia Stine

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Oh Yeah, That Powerful Computer In My Pocket Is Also A Phone http://johngreathouse.com/oh-yeah-that-powerful-computer-in-my-pocket-is-also-a-phone/ http://johngreathouse.com/oh-yeah-that-powerful-computer-in-my-pocket-is-also-a-phone/#comments Mon, 22 Jun 2015 12:00:55 +0000 http://johngreathouse.com/?p=5697 A version of this article previously appeared in Forbes. Facebook recently joined Google and Twitter by offering a click-to-call functionality in its ads, giving consumers an option to call businesses directly, versus […]

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A version of this article previously appeared in Forbes.

Facebook recently joined Google and Twitter by offering a click-to-call functionality in its ads, giving consumers an option to call businesses directly, versus emailing them or completing an online form - effectively making the plain old phone one of the most powerful on/offline marketing tools of the coming decade.

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140 Years Old And Still Kicking

Why are the world’s biggest Internet companies investing in a technology created in the late 1800’s? Despite the fact that phone calls have been around for over 140-years, they represent the next tsunami of marketing dollars. People continue to surf the web to gather information when making a considered purchase. However, when they are ready to buy, they now stay on their handheld supercomputer and place their order by initiating a call. This approach of guiding consumers online and then offline (on/offline) through the purchasing process represents the future of commerce, whether it is online to a call or online to an in-store visit.

It’s undeniable that consumers are digesting more online content on the mobile supercomputer in their pockets than via any other modality. So much so that Google recently reported that mobile search has finally overtaken desktop search, and Facebook rolled out a new app called Hello that connects the dots between people’s social and phone contacts.
To shed light on the future of online calling, one of Rincon Venture Partners’ portfolio companies, Invoca, analyzed 32 million phone calls, across 40 verticals. The results were recently published in the 2015 Call Intelligence Index.

Some of the key points I took away from this research include:

  • 54% of all calls stem from engagement on a mobile device; mobile search marketing is the top driver, responsible for initiating 45% of calls
  • 75% of all calls to businesses originate on a mobile phone
  • Non-mobile, online channels, such as desktop search, display ads and review sites drive 30% of calls
  • Offline channels drive just 16% of calls; the phonebook, accounts for just 2% of calls to businesses

The average call duration is 16 times longer than a website interaction, at 4 minutes, 7 seconds

To better understand how this trend is impacting marketers, I reached out to Matt Miller, SVP, Analytics & Technology at the global marketing agency Performics. Matt shared with me a number of interesting insights, including that his firm has, “... gotten pretty good at implementing call intelligence platforms which economically connect brands with their omni-channel marketing strategies. Call analytics are helping (our) clients prioritize (phone) conversations with customers who are more likely to buy, which makes marketing strategies more profitable. The ROI from tools like Invoca are so clear that our clients are asking to extend this across more areas of their organization.”

Though the lines are blurring between online and offline interactions, it is now more important (and challenging) than ever for marketers to clearly understand the return generated by all their customer channels, including phone calls. Companies like Invoca and IfByPhone are uniquely positioned to help online advertisers monetize old-fashioned phone calls.

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Entrepreneurs Who Relish Being Wrong Usually Win http://johngreathouse.com/entrepreneurs-who-relish-being-wrong-usually-win/ http://johngreathouse.com/entrepreneurs-who-relish-being-wrong-usually-win/#comments Mon, 15 Jun 2015 12:00:38 +0000 http://johngreathouse.com/?p=5679 A version of this article previously appeared in Forbes. During my 15-years as a startup executive, I relished being proven wrong. Knowing that I was […]

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image001A version of this article previously appeared in Forbes.

During my 15-years as a startup executive, I relished being proven wrong. Knowing that I was had made a mistake empowered me to make the correct decision. Being wrong is much preferred to erroneously thinking you are right and relentlessly executing a losing strategy. Effective entrepreneurs reject dogmatism and embrace doubt.

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Human Nature Sucks

How can two otherwise intelligent and well-meaning people watch the same political debate and adamantly believe that their candidate won? Confirmation Bias.

Psychologists define confirmation bias as: “A tendency to search for or interpret information in a way that confirms one's preconceptions, leading to errors.” Not only does this proclivity cause us to seek affirming information, once we find it, we tend to value it more highly than data that refutes our beliefs and we can recall confirmatory facts long after conflicting information has been forgotten.

For instance, when the United States Postal Service recently issued a stamp of poet Maya Angelou with a quote from another woman, it reinforced my belief that the federal government is primarily comprised of incompetent, unmotivated workers. Stories which refute my belief careen by me undetected, but the Maya Angelou debacle will live on in my heart for decades to come.

Like most mental shortcuts, our tendency to seek out and believe data consistent with our beliefs fulfills an important role in our psychological makeup. If you questioned your core beliefs every time you came across a countervailing fact, your life would be rather dismal and anxiety ridden.

While this aspect of human nature can lead to mildly amusing behaviors in our friends (and ourselves), when assessing decisions at your startup, such close-minded prejudices can result in fatal mistakes.

Be Tacky

Startups survive by constantly making small mistakes and correcting them quickly. In this regard, CEOs are akin to sailboat captains. Both operate exposed to the elements, and surrounded by a handful of dedicated people who all impact on the company’s / boat’s direction.

Rather than establish an extensive strategic plan detailing how they will reach their destination, the startup crew simply aligns their sailboat with a distant point on the horizon. The startup CEO must then propel the ship forward by tacking the ship’s bow into the wind. This process results in a zigzag pattern as the Captain makes slight adjustments to address the vagaries of the breeze, waves and currents. However, as shown below, the ship’s general direction remains relatively unwavering.

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Confirmation bias is particularly dangerous at startups, as it slows down these vital course corrections. Rather than zigzagging in a relatively straight line, a startup stricken by confirmation bias ignores valid market signals and risks driving toward an errant point on the horizon.

For instance, if the team assumes that a higher price will result in a lower number of customers, it will have a tendency to recall those instances when a customer cancels due to price. At the same time, the team may unconsciously discount data that shows an uptick in sales beyond what could be attributable to a higher price.

I experienced this situation when we raised the price of GoToMyPC from $9.95 per month to $14.95 per month. Despite the 50% price increase, our sales exploded. When we asked our customers what motivated them to purchase GoToMyPC, many of them indicated that the higher price gave them greater comfort that our solution was a business, and not a consumer, product. This price change generated tens of millions of incremental revenue and allowed up to properly position GoToMyPC as trusted SMB solution.

Breakdowns Lead To Breakthroughs

Steven Johnson, author of Where Good Ideas Come From notes that, “Being right keeps you in place, being wrong forces you to explore.” He cites several examples of this phenomenon, including: (i) Alexander Fleming’s discovery of penicillin from a contaminated petri dish, (ii) Louis Daguerre divining analog photography after he stored some silver plates with random chemicals and images ‘magically appeared,” and (iii) Charles Goodyear noticing that sulfur and heat were the missing ingredients of vulcanization after he inadvertently warmed a sulfur-covered piece of rubber on his kitchen stove.

In all of these instances, the potential breakthroughs could have easily been overlooked as unfortunate mishaps. Fortunately, these innovators maintained an open-minded when the interpreted their counterintuitive observations. Unfortunately, most of us are not prone to such clear thinking, which leads one to ponder how many monumental breakthroughs have been thwarted by confirmation bias.

By definition, confirmation bias creates perceptual blind spots, as we only see what we expect (and often want) to see. Wily entrepreneurs proactively mitigate this perilous tendency in a variety of ways, including:

Embrace Your Bias – As with any recovery program, the first step is to admit you have a problem. Confirmation bias is not a sin, just a sign that you are human. By acknowledging its existence, you increase your odds of countering its potentially negative effects.

Seek The Truth (Ignore Who Is Right) – Strive to prove your assumptions wrong, just as a scientist tests the veracity of a hypothesis by trying to disprove it.

Separate Personalities From AnalysisPsychological studies consistently confirm that the loudest, most repeated opinions have the greatest influence on group behavior. This effect can be tempered by de-personalizing discussions so that aggressive members of your team feel less obligated to prove themselves right.

Make Cross-Disciplinary Decisions – Small teams of believers and dissenters often result in intellectually honest outcomes. It is also an effective way to mitigate the outsized influence of a forceful personality.

Discard Beliefs, Cultivate Assumptions – People tend to fight for beliefs, while assumptions are rarely personalized.

Encourage Diversity Of Thought – A heterogeneous team’s divergent backgrounds and experiences enhance its creativity and ad hoc problem-solving abilities. Such varied perspectives also reduce the overall impact of cognitive bias, as it is less likely teammates will share common preconceptions.

Cultivate (Thoughtful) Devil’s Advocates – Bad decisions are often the result of group members respecting each other. Yes, you read that correctly. Mutual respect reduces authentic dissent and increases the propensity for flawed decisions. If you have a natural cynic in your group, ensure that his or her voice is heard (to the extent it doesn’t become disruptive). If you lack a healthy dose of dissention, assign one or more people to aggressively challenge a proposed course of action.

Follow my startup-oriented Twitter feed here: @johngreathouse. I promise I will never tweet you about cupcakes or that killer burrito I just ate.

Image: Takao Umehara from the Noun Project

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Attention Startup Accelerators: Your Job Is Not Over After Demo Day http://johngreathouse.com/attention-startup-accelerators-your-job-is-not-over-after-demo-day/ http://johngreathouse.com/attention-startup-accelerators-your-job-is-not-over-after-demo-day/#comments Tue, 09 Jun 2015 12:00:24 +0000 http://johngreathouse.com/?p=5688 A version of this article previously appeared in Forbes. With top-ranked accelerators Lauchpad LA closing its doors and Y Combinator rebranding itself as a seed […]

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A version of this article previously appeared in Forbes.

With top-ranked accelerators Lauchpad LA closing its doors and Y Combinator rebranding itself as a seed fund, it seems fair to ask the question, “Are Accelerators Dead?”

Good news: a quick review of TechCrunch’s March 2015 List of Top 20 U.S. Accelerators, which includes two LA-based accelerators in the Top Ten (Mucker Lab and Amplify LA), proves that the overall health of the Accelerator landscape is sound.

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The TechCrunch team was judicious in its determination of qualifiers, insisting that the accelerators be, “fixed-term, cohort-based, with educational and mentorship components, culminating in a public pitch or demo day.” In addition, quantitative measurements included participants’ valuations, fundraising success, exit valuations and survival rates. Note: for purposes of this article, I am using the term “accelerator” to include incubators, startup labs and all other organizations geared to facilitating a startup’s early maturation.

Yet to be a truly effective accelerator, the work must continue the momentum beyond Demo Day. Obtaining funding is a key milestone, but equally important is helping fledgling companies build institutional mass once they leave the relatively safe confines of an accelerator.

To better understand how the accelerator world has matured beyond Demo Da, I sought out Jason Denenberg, former partner at Angel Capital Group, and current Director of Entrepreneurship at Launch Tennessee (LaunchTN). I previously wrote about LaunchTN’s second-phase master accelerator class called The TENN, which has a proven track record of helping startups thrive after graduation from an accelerator.

One member of the LaunchTN network of nine regional accelerators, ZeroTo510, in the Greater Memphis Accelerator Consortium, was listed in TechCrunch’s accelerator ranking. In addition, something interesting in happening in Tennessee, with the advent of hands-on venture firms like the Lamp Post Group and innovative ventures, such as PriceWaiter. My Forbes co-contributor Geri Stengel concurs that something is happening in the Volunteer State, writing last month about that state’s emerging women entrepreneurs.

In advance of LaunchTN’s flagship conference, 36|86, June 8-10 in Nashville, Jason shared with me the following three ways an accelerator should add value beyond demo day. Savvy entrepreneurs - seek out programs which incorporate these post-graduation activities.

  1. Convert Graduate-Founders Into Mentors

According to Jason, “Every experience is also a learning experience. Bringing an accelerators’ graduates back as mentors provides value to the next class, certainly. But to the graduates, it provides an opportunity to grow as leaders. It also provides a way for graduates to learn about ideas, opportunities and technologies about which they might not have been aware while focusing on building and scaling their own startup. This builds a strong alumni base; an element of significant importance to an accelerator’s value as well. If a mentorship seems like too large of a commitment, bring them back as a judge in the next cohort’s finale or demo day.

  1. Provide High Impact Exposure Beyond Your Hometown Press

One unique aspect of LaunchTN is that each master accelerator class is taken on investor and media tours of Silicon Valley and New York. Per Jason, “In some cases, media meetings and introductions don’t generate immediate results. However, by providing a simple note to a journalist, or sending an e-mail to the graduate with a writer’s contact information, the graduate’s funding announcement often garners exposure without much effort.”

Such was the case with Chattanooga-based Feetz, the self-described “digital cobbler” and graduate of The TENN. Feetz earned coverage in the Wall Street Journal following The TENN’s 2015 West Coast trip for their innovative 3D printed shoes.

  1. Adopt A “Whatever It Takes” Mentality

Accelerators should demonstrate (with actions, not just words) a “Whatever It Takes” mentality when it comes to helping graduates hit their post-demo day milestones. To this end, Jason noted that, “If a graduate needs a curated list of 55 development targets in a particular geographic area in order to get from a $1M revenue run rate to a $3M revenue run rate, we’ll provide it. If one of our TENN team companies needs legal advice to support negotiations with a large global brand, we’ll leverage our relationships, call in a favor or two and get it done.”

Although post-graduation support is key, Jason also made it clear that the ultimate responsibility for success lies with the startup team. In his words, “Following the demo day, startups must continue sell like there is no tomorrow to generate revenue and show traction in the marketplace. No program can work miracles. If the sales aren’t there, it might be time for the entrepreneurs to either pivot or seek out a new venture.” Even in the world of accelerators and post-demo day programs, some things never change. Just like in the “old days,” sales still solve all problems.

If you follow me on Twitter (@johngreathouse) I promise I’ll never tweet you about Santa Barbara surf conditions or tell you about that killer burrito I just ate.

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Your Startup Team Should Have Unlimited Vacation http://johngreathouse.com/your-startup-team-should-have-unlimited-vacation/ http://johngreathouse.com/your-startup-team-should-have-unlimited-vacation/#comments Mon, 01 Jun 2015 12:00:06 +0000 http://johngreathouse.com/?p=5674 A version of this article previously appeared in Forbes. It sounds crazy to offer unlimited vacation time to your startup employees. Something to the left […]

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A version of this article previously appeared in Forbes.

It sounds crazy to offer unlimited vacation time to your startup employees. Something to the left of socialism. Yet that is exactly what Richard Branson announced this past Fall. According to Branson, “We should focus on what people get done, not on how many hours or days worked. Just as we don’t have a nine-to-five policy, we don’t need a vacation policy.”

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They Wouldn’t Do That At RCA

It’s one thing when a wild-eyed billionaire like Richard Branson sings the praises of unlimited time off. It’s quite another when a pragmatic industry veteran like Jim Zarley echoes similar sentiments.

Jim spent nearly two decades at RCA before embarking on a serially successful Internet career, culminating in his long-time role as CEO and Chairman of ValueClick. He surprised me during a recent Local Market Launch Board meeting by suggesting that the company stop accruing vacation and allow employees to take as much time off as they need.

I was a bit shocked to learn that ValueClick implemented this seemingly radical policy during 2014. Yet Jim’s wise and reasoned support of the policy opened my mind to its advantages. In Jim’s words, “Our approach with our employees was, ‘If you get your job done, everything else takes care of itself.’” This enhancement of ValueClick’s benefits seems to have been well received by its employees, as evidenced by several positive references to the change on Glassdoor.

Eager to learn more, I had a sidebar conversation with Jim, in which he shared with me several advantages of not capping employees’ vacations, along with some cautionary advice for companies rolling out a similar policy.

Better, Not Worse – Employees are naturally skeptical whenever a major change is made to their benefits. ValueClick was proactive in assuring its team that this change was not intended to reduce their vacation, but to provide them with more flexibility and less stress should they unexpectedly need to take time away from work.

Historical Status Quo – All vacation which had accrued prior to the policy change remained in place and was paid whenever an employee left the organization, just as it would have been before the policy shift. The treatment of legacy vacation was a challenge for ValueClick to communicate properly, which prompted Mr. Zarley to note that, “The most challenging aspect of the change was the implementation. Thus, the earlier in the company's growth cycle unlimited vacation is granted is, the better.”

Company Benefit – Organizations which allow employees to take “as needed” time off, are not required to accrue the associated payroll liability, which increases the health of both their balance sheet and income statement. In addition, no lump sum payments need be made to employees because they have no “banked” vacation time due them upon their departure. Although this is certainly not the primary reason to implement an unlimited vacation policy, it is a real corporate benefit to be considered when evaluating a more liberal vacation policy.

Heads Up Required – Unlike Netflix, which does not force employees to obtain approval prior to taking time off, ValueClick asks employees to obtain such authorization. However, Jim noted that this approval requirement is not used to limit time off, but rather to ensure proper communication between employees and their managers which reduces potential disruptions during an employee’s absence.

Universally Applicable?

Most startups offer unlimited vacation time by default, as they lack the infrastructure, time and personnel to properly track employees’ vacation. More importantly, it is a moot point, as six-day work weeks are seldom conducive to taking extended Holidays.

For instance, when I joined Expertcity (creator or GoToMeeting, sold to Citrix) as one of its first business executives, the European Founder granted me three weeks’ vacation, citing the deplorable few holidays that most Americans take. The extra week of vacation proved to be nothing more than a nice gesture, as our team consisted of less than 10-people and we worked 6-days a week, including most major holidays, for nearly 18-months.

The irony was that we touted the extra week of vacation when recruiting talent, but none of the core team members took time off for a major hiatus, let alone an extended vacation. When we grew to about 50-employees, we began to make an effort to track vacation time, but our “policy” (though unwritten) was essentially the same as ValueClick’s – “If you need time off, take time off. If there is a risk you won’t meet your goals, shout and we’ll find the resources to help you.”

As Mr. Zarley noted, “If you hire the right people with a results-oriented work ethic, the amount of vacation time they take is irrelevant.”

Will Virgin Go All The Way?

It’s interesting to note that despite the broad attention Richard Branson’s comments received on the subject of unlimited vacations, only applying the policy a relatively small number of its employees (about 150).

In September of 2014, the infinite vacation policy for Virgin’s “parent company” was announced on its blog, along with the following promise: “Assuming it goes as well as expected, we will encourage all our subsidiaries to follow suit, which will be incredibly exciting to watch.” It will be interesting to see if Virgin goes all the way and tells all of its 50,000 employees, “take as much leave as you need.”

Follow my startup-oriented Twitter feed here: @johngreathouse. I promise I will never tweet you about my lack of vacation time or tell you about that killer burrito I just ate.

Image: Jonathan Daniel/Getty Images

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This Remote Working Experiment Failed And Succeeded – At The Same Time http://johngreathouse.com/this-remote-working-experiment-failed-and-succeeded-at-the-same-time/ http://johngreathouse.com/this-remote-working-experiment-failed-and-succeeded-at-the-same-time/#comments Tue, 26 May 2015 12:00:09 +0000 http://johngreathouse.com/?p=5669 A version of this article previously appeared in Forbes. Self-aware startups often learn more from their failures than from their success. Timehop, the photo album for […]

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A version of this article previously appeared in Forbes.

Self-aware startups often learn more from their failures than from their success. Timehop, the photo album for the digital age, is no exception. Created by Jonathan Wegener and his Co-Founder Benny Wong, the company has over 16M+ users. To put this in proper perspective, more than twice as many people access Timehop each day than read the New York Times.

And Then The CEO Said, “Go Home”

Timehop recently executed a radical experiment. With winter raging outside, it closed its NYC office for two weeks and made all of its employees work remotely, preferably not from their homes. Many of the employees took off for exotic, sun-drenched locales.

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Even though the experiment did not yield the results the management team expected, many of Timehop’s employees enjoyed the experience. For instance, Software Developer Kevin Steuer noted that, “Working remotely gives me more control over a concentrated blocks of time each day to code. This has been awesome for productivity.” Co-Founder Benny Wong echoed a similarly positive sentiment, saying, “No commute reduced a lot of the anxiety of running late, especially if I want to exercise in the morning.”

The experience was decidedly mixed, as an number of employees felt distracted and disconnected by the hiatus. According to iOS Developer Evan Coleman, “I’ve been struggling with separating work from relaxation. Since I’m already home, I can’t justify getting up from my laptop and relaxing. My logic is that I’m working from home, so when I’m home, I should be working.”

Developer Rajesh Shenoy felt that the great flexibility did not adequately offset the value of the casual social interactions experienced in an office setting. Per Rajesh, “I missed talking to everyone. Social interactions help take your mind off work for a bit and I believe helps prevent burnout.”

To dig deeper, I reached out to the company’s CEO, Jonathan Wegener. What follows is an excerpt of our conversation.

John Greathouse: You’ve just raised $10 million in funding, basically tripled your company headcount in a matter of months and you decide to kick everyone out of the office. What the heck?

Jonathan Wegener: Hah, yea, it sounds crazy. Back in December, I flew to Wisconsin to visit one of our remote employees. I worked out of his home for a few days and the experience was eye-opening. I was so much more productive and focused than I was in our noisy NYC office! But I also found it really hard to communicate and collaborate with the team back in NYC, even with the latest video and remote tools.

As a company, we always strive for better. The remote experiment was about capturing the best parts of remote -- focus and concentration, while improving the worst parts -- communication and collaboration. We saw a chance to improve the working habits of everyone, not just our remote folks.

We also knew that if we could improve things for our remote employees, we’d be able to hire folks from places like Wisconsin and everywhere else that talented folks live around the world. So we’d be widening the talent pool. And we could also potentially make "work from anywhere" an official job perk for everybody and build a truly flexible workplace. Plus, February in NYC is just terrible. <laughs>

Greathouse: How’d the team react to the idea?

Wegener: Most people were excited to book flights to warm places... but others were concerned about productivity or that we were turning into a company where everyone is just a head on a laptop. Our team is close knit and the idea of not seeing each other for two weeks made some folks sad.

Folks went to Orlando, Dallas, Denmark, Puerto Rico, the Dominican Republic, and someone even got a small studio in Venice Beach with views of the Pacific Ocean (and yes, I admit, that was me).

Greathouse: Was it a total free-for-all or did you had some ground rules? If so, what were they and what was your reasoning behind them?

Wegener: We established “Core Hours” of 1-5pm EST. Everyone needed to be online and available during those four hours. All meetings were scheduled during those hours which opened up the rest of the day, creating long stretches of uninterrupted work.

Outside of those core hours, when you worked was up to you. Work longer in the morning, work longer in the evening. Whatever you need to get the job done and be at your most productive. We also moved our weekly All Hands meeting to 1pm EST on Mondays and everyone conferenced in. It was kinda surreal to see all these faces from all around the world on your screen.

Greathouse: What were the immediate things you learned? I imagine such a shift exposed quite a bit very quickly.

Wegener: Within a couple days, we all noticed that our focus and concentration improved. But collaborative tasks became much more difficult. Meetings had more overhead to setup and were less productive. The team missed being around each other, and lack of facial and body language sometimes led to misunderstandings...

People who had fled to warmer places also found it distracting to rebuild their lives elsewhere -- finding a new place to buy groceries and toiletries, eat lunch, mail a package. Even finding reliable high-speed internet was difficult, especially for people who traveled internationally.

The people who stayed in NYC and worked from home really enjoyed it for a few days. Working from PJs without a commute freed up more time to work. But eventually folks got tired of it and wanted more work/life separation.

Greathouse: Let’s talk about some of those remote technologies. What were the tools your team uses to stay in sync?

Wegener: Slack is our office chat, and it works great. We used BlueJeans and Google Hangouts for video chat. Dropbox for design assets. Github for our engineers. We tried a few other more cutting edge tools like Sqwiggle and Screenhero but they didn’t stick.

We also setup ground rules for communication channels. For example, don’t @channel the team chat room in Slack unless there’s an important time-sensitive announcement -- it creates an obtrusive popup that interrupts 20 people across multiple time zones. That’s terribly distracting, and not something we had previously thought much about.

Greathouse: And besides the ‘product’ problems of technology still not being 100 percent ready for replacing day-to-day interactions, you mentioned some people problems that came out pretty early. Can you talk more about those?

Wegener: Remote work is skill that takes practice and requires a certain level of patience. Simple things like talking over a design sketch are much harder to do without a whiteboard. We also found that chat and text messaging leaves more room for misinterpretation which sometimes caused tension -- especially between employees who didn’t know each other very well. Apple has a mantra of “assume positive intent,” which means to assume people are always acting in the interest of the company or to improve something. We love this, and made it part of our value system as well.

Note: This concern was shared by Lead Architect Kevin Cantwell, who told me, “The longer I spend without in-person interaction my perception of individual signals like tone and body language dull. I'm less aware of the team's mood. Not having those small social queues make remote communication a bigger effort.”

Greathouse: So, knowing that remote working is a skill that must be developed, what were the lessons learned? Did you guys implement any changes?

Wegener: Ultimately, we decided we’re not setup to be a fully distributed team and we won’t be offering that as a perk.

Instead we’re doubling down on NYC as our home. If we find extremely talented remote employees who can’t relocate to NYC, we’ll consider that on a case-by-case basis, especially for people can get things done and are OK with occasional trips to our NYC office to bond with the team. We’ll also be buying some new equipment to improve audio and video for existing remote employees.

We’ve embraced occasional working from home which is great. It's interruption-free, productive, commute-less, and a welcome change once in a while. We've decided to create a silent library in our next office space for interruption-free work.

Overall, it didn’t have the outcome we anticipated, but we learned a ton and at the end of the day it’s made us a better place to work.

Follow my startup-oriented Twitter feed here: @johngreathouse. I promise I will never tweet about killer burritos or cuddly kittens.

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What The Heck Are My Startup Options Worth? http://johngreathouse.com/what-the-heck-are-my-startup-options-worth/ http://johngreathouse.com/what-the-heck-are-my-startup-options-worth/#comments Mon, 18 May 2015 12:00:09 +0000 http://johngreathouse.com/?p=5657 A version of this article previously appeared in Forbes. When joining a startup, there are seven important questions you should ask in order to answer […]

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A version of this article previously appeared in Forbes.

When joining a startup, there are seven important questions you should ask in order to answer the question: “What the heck are my stock options worth?”

You just received a job offer from a startup which includes 50,000 stock options. That is wonderful…or is it?

I reviewed and approved hundreds of employment offer letters at my various startups, all of which included stock option grants. The number of otherwise intelligent prospective employees who never ask relevant questions about their stock options was frankly shocking.

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Questions To Answers

I am sorry to disappoint the MBA crowd, but estimating the value of your startup stock options is not something you can do using the Black-Sholes option pricing model. In contrast, estimating the potential ultimate value of your startup options requires you to intimately understand the venture’s business model, the execution capabilities of the core team and the veracity of the company’s financial projections.

To this end, politely and persistently ask the following questions until you obtain enough information to estimate each of the variables in the formulas shown below. Answering these questions will allow you to reasonably estimate what your options may ultimately be worth.

1.     How many shares will I be granted?

The size of your initial option grant should be articulated in your Offer Letter, as well as in a separate Stock Option Agreement. In most cases, your shares will vest over a four-year period, with a one-year cliff. Under such an arrangement, if you leave your company within the first twelve months, for any reason, you will not vest any shares. Once you have completed your first anniversary of employment, vesting usually occurs on a monthly basis. Any vesting terms that do not conform to these standards should be challenged.

2.     What is the company’s total capitalization?

To help the CFO understand your request, indicate that you are seeking a “fully diluted” view of the company’s capitalization. Also, be sure that all “authorized” options are included, which will ensure that the capitalization figure includes granted and ungranted options.

3.     How many additional options will be authorized?

Authorized options include those which have not yet been granted. In order to calculate your potential future dilution, estimate the number of additional options that will be authorized and added to the option pool.

The size of a startup’s option pool will vary, depending on its maturation. However, the pool’s size, as a percentage of a company’s Total Capitalization, is generally between 15% and 20% at a company’s maturity. If an option pool is significantly below this range, it may be an indication of either; (i) a company that is stingy with its options, or (ii) significant future dilution may occur, once the option pool is increased to accommodate future option grants.

It is very common for companies to increase their option pool over time and a well-run company will manage a capital budget as a means of estimating its future option grants. As such, it is very reasonable to ask for an estimate of additional options to be authorized before the company’s exit.

4.     How many additional shares will be issued to investors?

As is the case with future options, a well-managed company can reasonably estimate the amount of investor capital it intends to raise in the future, along with an estimation of the valuation(s) at which such investment(s) will be made.

Future capital requirements are based on a variety of unknowable factors. However, it is imperative to understand the company’s underlying assumptions with respect to its future capital needs. A response of, “We have no idea,” is indicative of a company that is either: (i) poorly managed, or (ii) does not respect its prospective employees enough to provide them with a thoughtful response. Do not settle for a non-answer to this important question.

5.     How many options will I be granted in the future?

Clearly, the number of any additional options you will receive will be dependent on your tenure and performance. Some companies provide their employees with small options grants annually, usually in conjunction with either year-end or the employee’s anniversary hire date, while others seldom make such “refresh” grants.

6.     What is Management’s best estimate of the Company’s valuation upon an exit?

This variable is obviously an educated guess, at best. Even so, your prospective employer should be able to provide you with a valuation range that would be acceptable to the management team.

7.     What is the Exercise Price of my initial options?

This should also appear in your Offer Letter and Stock Option Agreement. Do not be satisfied with a response such as, “The exercise price will be defined by the Board of Directors, based on the Company’s Fair Market Value.” Ensure that your exercise price is defined in writing before you accept the position, even if it is subject to subsequent Board approval. Also, be sure you know the company’s latest 409A valuation.

Options Are Just That

Once you obtain the answers to the above question, you will have enough information solve the following four equations. At first glance, these formulas may appear complicated, however; the math is actually simple. To minimize potential confusion, the variables used multiple times are color-coded.

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I have been fortunate to work with great teams who were able to create enough value that our options were worth a significant amount of money. However, the reality is that many startups’ options are never worth anything. As such, consider any compensation derived from your options as an unexpected windfall. Working with kind, motivated and smart people who you will learn a great deal from is a far more important consideration than the potential value of your option grant.

Follow my startup-oriented Twitter feed here: @johngreathouse. I promise I will never tweet about killer burritos or pettable puppies.

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