Monthly Archives: September 2011


To understand Amazon as a business/stock, it is important to understand it is at least two almost completely different businesses.  

-Media, which accounts for ~45% of revenue and is growing ~10% y/y, and is going through a massive transition to digital goods where the main competition is going to be Apple, Google, Netflix, cable companies, etc.
– Everything else (known as “EGM” – “Electronics and General Merchandise”) which accounts for ~52% of revenue, is growing ~24% y/y, and where Amazon is mainly competing with specialty e-commerce sites and (primarily) offline retailers like Walmart.
The stat I find surprising is how much room there is to grow.  Amazon’s share of (global) e-commerce is ~8.3%.  E-commerce is only ~6% of global retail.  Hence Amazon’s share of total global retail is ~0.5%.



Notes from a Skillshare class on “Defensive Finance”

Tonight I taught a Skillshare class called “Defensive Finance”.  My colleague Eric Stromberg was kind enough to take notes.  These notes are a bit dry because I didn’t want to publish the real-world anecdotes I used to illustrate them. But perhaps they will be somewhat useful.

Defensive Finance

Vesting vs. Exercising 

  • Most companies have 4-year vesting
  • Vesting – occurs while working for a company
  • Exercising – If you leave and have vested a portion of equity, you have the right to exercise.
    • There is generally a 90 day exercise period before losing options. 
    • Standard advice law firms give is to not inform employees. So have to pay the strike price to own the common stock.
  • Founders get actual common stock. Use lawyers from one of big 4 startup firms (Gunderson, Fenwick, Cooley, Wilson Sonsini)
    • Founders buy shares at a nominal price, like $100
      • So, they never have to spend money on strike.
      • Get long term capital gains treatment
  • Single biggest mistakes is to omit founder vesting.
    • Many cases in venture capital where investors would look at cap table, and a big owner of the company would be someone who did not work there anymore, because he/she was a founder that left early. But founders vested immediately, so the long-gone founder owns a large chunk of the company
    • The argument for immediate vesting is that some worry is that if investors push you out its good to have stock vested, but this is rare.

Acceleration on Change of Control

  • Single Trigger- Vesting acceleration on acquisition
  • Double Trigger- Refers to getting acquired and fired. Have to have full acceleration in case of double trigger.
  • These are both things that founders should try work into the term sheet. Also good to get them for employees (especially double trigger).

Founders Contributing Capital

  • If some of the founders are contributing capital, separate labor component from their monetary component. If under ~$200,000, make it a convertible note. 
  • Have the note convert at next round of financing, or some discount to it. 
  • Cash equity should vest immediately at next financing, whereas sweat equity should not should not.
    • The document usually says something to the effect of “I give $50,000 at 5% interest rate to be converted to equity at the next financing.”

Liquidity Preferences

  • Need to know what % of company you own – total number of shares is a meaningless number.
  • Founder, Employee and Investor Shares
    • Founders have common shares
    • Employees have options on common shares
    • Investors have preferred shares
  • Let’s say a company raised $500 million on a $3 billion post valuation and investors were given 1X straight preferred. This means in the event of a sale, the investor gets the max of $500 million or the percentage ownership they bought 
    • So if  the company then goes down in value and sells for $1 billion, if you are the investor, which are you going to take? The $500 million.
    • If you are a founder and you thought you had 10%, instead of getting 100 million get 50 million because you get 10% of the remaining $500 million.
  • In last down market, companies took higher valuation in return for 2-4x preferences. This can be troublesome, especially for employees who think they have a certain percentage, but may not get anything after the liquidation preferences play out.
  • 1x is standard in this market, particularly in seed deals

Misaligned incentives

  • If have investors with different class of stock, can have misaligned incentives
    • One thing popular in entrepreneur friendly environment is uncapped convertible note.
    • Problem is that if I am an investor, my incentive is to get you a low valuation in the next round
    • You have investors who are (in theory, economically) trying to make the company worth less
  • A company had two acquisition offers. One was for $20 million in cash. The other $20 at hot private company at hot private company (for example, Twitter or FB)
    • Investors want the hot private company stock, because higher variance bet
    • Said to the founder: “if you sold the company for cash, would you take every dollar you made and invest it in the hot company?”
    • In some cases, may see founder get cash and investors stock

Board Issues

  • There is part of the term sheet is clause called “Board of Directors”
  • Control and ownership are generally negotiated separately. Control has to do with board seats.
  • Seed Structure
    • Most common structure is either just founders or something like 2 founders and 1 investors
    • Means that the founders control the board
  • Post-Series A Structure
    • Investors want more control
    • 1 founder, 1 investor , 1 mutually agreed upon independent
    • Or 2 founders, 2 investors, and 1 mutually agreed upon independent

Protective Provisions

  • These are additional rights that investors have that can override a board vote
  • Sometimes, in addition to board control rights, the investor has additional blocking rights, for example a the right to block a sale or financing
    • Some are reasonable, like founders can’t distribute more than $100,000
    • Others may include blocking rights on sale below, say, 3x of the valuation at which the investment was made
  • Bad investors will use things like blocking rights to not just block the sale, but to get more of the company
    • For example, saying the need 30% of a $100 million sale instead of 20%, because that’s the number they have to hit to have the deal make sense. 
  • Series B investor preferences are sometimes senior to Series A preferences
  • So, If a Series B investor puts in $5 million, and A puts in $2 million and the company sells for 5 million, the series B investor gets 5 million while the series A investor gets nothing.
    • It’s very common for series A investors to have blocking rights to a senior security. So that, for example, a series B investor can’t put a 1000X preference on top of the series A investor.
    • Try to avoid giving investors blocking rights on non-senior (parri passu) investments.

Additional Notes

  • Shares to advisors generally vest over, say, 2 or so years, and it is nice to give vesting at change of control
  • Every venture backed company is a C corp. LLC’s are very difficult for venture investors because of tax write-off
  • If there is a 50/50 split between you and your cofounder, you probably haven’t thought about equity split enough
  • 83B election is something you want to get immediately when you for a company
    • If don’t get it don’t get long term capital gains, and the clock starts ticking 12 months from when you file 83b
  • If someone else was helping you out during the early stages of a company, make sure they are in or they are out. And if out, make sure they sign a release.
  • Investors want to see founders that have enough remaining vesting that it can get you to the next milestone. At least a couple of years. 
    • Generally, start vesting founder equity at a reasonable milestone like when you left your job, not when you first came up with the idea.
  • Typically A round post option pool for employees is 10-20% (more often 10% lately)
    • Size of option pool has significant impact on founder ownership, and is something founders often under weight when they raise money, instead simply focusing on the dilution they will see from the investor.

bitcasa and convergent encryption

People have speculated how the new startup bitcasa can both encrypt files client side and dedupe files server side.  The CEO says they use a method called “convergent encryption.”  This encryption method uses the file being encrypted to generate the encryption key. That way only people with the unencrypted file can generate the key but the same files unencrypted will be identical encrypted (and therefore de-dupable).  It is believed by the security community to work as advertised, with two possible vulnerabilities:

1) “confirmation-of-a-file attack” – someone who gains access to your files can confirm whether you have a certain file.  For example, someone could verify you have a certain movie/music file or leaked document.

2) “learn-partial-information attack” – in certain cases (from what I’ve read those cases haven’t been strictly defined) an attacker could learn some information from a file if the attacker already knew other information in the file. Examples might be a government form where a lot of the text is known but some sensitive text (e.g. your social security number) isn’t.

I’m a fan of client-side encryption, and even with these “vulnerabilities” it seems to me what bitcasa is doing is a good idea and should be adopted at least as an option by other storage companies.

One big limitation that comes with encryption is the inability to do operations like searching text on the server side. This can potentially be addressed through a method called “homomorphic encryption.”

B2B, B2C, B2B2C, and B2S

In the startup world, “B2B” and “B2C” are familiar terms that were coined in the 90s:

B2B = startups whose customers/users are businesses
B2C = startups whose customers/users are consumers

Lately I’ve been hearing “B2B2C” which although a bit clumsy sounding is useful:

B2B2C = businesses who partner with other businesses to reach customers/users who are consumers

Finally, I propose the term “B2S” to refer to an especially risky type of startup that usually emerges in markets where VC money is plentiful:

B2S = businesses who sell only or primarily to other startups