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internet startups swing for the fence:
a conversation with Tim Draper

Continued, page two of two | Previous page


Q&A: the crowd goes wild

Mr. Witzel: I received this question from our audience today. It says, "I think many people who are here today would like to know how Draper Atlantic's deal flow works. Referrals only? Cold mailing? Phone calls? In short, how do you want the 100 business plans sitting in the audience to get to you?"

Mr. Draper: Good question. The easiest way for us to get a business plan is an executive summary by fax, which is sort of unique. We get a lot of emails, but it's hard to read a lot of things on the screen. If you really want to make it easy for us, send an executive summary by fax and then mail in the whole plan. No, it doesn't have to come with a referral. Some of our best deals were not referred; they came right over the transom, so don't make any special effort to get somebody to give us the pressure.

We're trying to search for diamonds in the rough, and we are doing the best we can. We are always "understaffed," or whatever they call it. I always think that just means everybody gets to work more. I encourage you just to get them in, and don't worry about how they arrive. Once they are in, they get logged and you get your decline letter. No, I'm joking. Anyway, we have a process which we are passing on to the Draper Atlantic guys. We get 10,000 ideas a year in California, and some of those come from you folks, I imagine. We are going to ship them right back out here. We have a great office out here, and they are going to do a better job than we ever did.

 

Mr. Khera: My name is Vivek Khera from Khera Communications (http://www.kcilink.com). "Open source" software is all the rage these days, with Linux being the poster child. A lot of companies are trying to set themselves up as service companies giving away product. I don't see how that can be such a high margin business. Would a venture company really want to invest in something that's people intensive as opposed to something you ship out and you have high margins on the sales?

Mr. Draper: Yes, that's a good question. The reason we nutty venture capitalists are investing in companies who give stuff away is that, by giving it away, it spreads faster. Our whole game now is market share. If you own the market, you can then figure out how to make money. Microsoft made money in so many different ways. If they had originally given away the operating system, they might even be more successful today. Linux, yes, we are hoping. I sit here with this Windows software and think, "Why do I have to go to "Start" in order to shut it down?" I think that's kind of irrational, but that's just me.

 

Mr. Marein-Efron: I'm Daniel Marein-Efron. For those of us who have taken angel money, can you give us a hint about how we structure the arrangement for them? How do we tell the angels exactly what their piece of the company will be after we go to a VC and get a valuation? They obviously want an upside. What's the VC perspective on what we should tell them?

Mr. Draper: Part of that depends on who the angels are—how big and how important they are to your future success. I would do one of two things. I would ask them for a loan that they will convert into the first round with a VC, and, if there is no first round, then it just converts at a certain price. Otherwise, I would set a price and just say, "If this VC comes down and it's a tougher deal than this, we'll give you that deal." Then the angel is covered and happy. There are probably 100 different ways to skin a cat.

 

Mr. Sklarew: I'm Ralph Sklarew. I noticed on your list of 10 tips, getting VC money wasn't one of them. My question is, how do you value a company that comes to you with just a napkin?

Mr. Draper: That was an oversight. There will be 11 next time.

What's happened to us is that somebody comes in with a napkin and we get enamored with an idea. It didn't used to be that way. We'll spend an hour with someone trying to figure out how this idea could work, what kind of a virus we can create, how big can it get, and what happens if you do such and such. We're doing a lot of what-if stuff. Once we figure that out, and once we have thought it through a bit, we'll say to the person, "We have thought about it, you go think it through the rest of the way." They come back with what they've done, and then we fund them. Sometimes.

The valuation varies. It's all over the map. We're driven by the market, just like anybody else. We have to know that we have a big enough stake in the company for it to matter, but, on the other hand, we want to make sure the entrepreneur feels like it's his or her baby.

 

Mr. Howe: My name is Bill Howe. Going back to your first tip, about looking for big markets with very large P/E ratios, since most Internet stocks right now enjoy fantasy ratios with lots of P and no E, will Wall Street begin to hold these companies accountable for more real world P/E ratios? Is that going to happen, and, if so, will that cause your capital sources to dry up?

Mr. Draper: People talk about the swing from fear to greed. I think it has a little bit more to do with a scale where, at one end, people are looking three months out, and at the other end of the scale they are looking three years out. If you look three years out, given those P/E ratios, they are pretty reasonable. If Yahoo! grows at 8X during a year, it makes sense. If they grow at 8X three years in a row, that's a lot of growth. You could argue that those valuations are perfectly rational. If thinking swings to the three month end of the scale, then Yahoo!'s stock price would come way down. It will come way down, but then it will swing back and they will go three years out again. Then Yahoo! will be way up, so I suspect it's going to be a wild ride. I have a great tie which I didn't wear today. It's a bunch of kids on a roller coaster. That's the way I look at the Web.

 

Mr. Daswani: I'm Sharad Daswani with pleaseRSVP.com (http://www.pleaseRSVP.com). Building on the concept of viral marketing, can Web traffic or a large consumer base somehow be a factor rather than high margins?

Mr. Draper: Eventually it has to make people money. If you have traffic or content, if you are a virus or a magnet bringing people to your site and those people buy things, then you have a real site with real commerce on it.

Mr. Daswani: So, when you looked at HotMail you were looking more at the traffic that would be generated. . .

Mr. Draper: Yes. What was great was that we didn't know what was going to happen. It could have been anything, but, having been associated with Upside (http://upside.com), a publishing firm that grew to many readers in a short a time, we knew that we had something.

 

Ms. Richardson: Hi, I'm Tamara Richardson with YouthSports.com (http://youthsports.com) and I, too, want to ask you a clever question about how you value your companies. Maybe you could just tell us the average valuation of companies added to your portfolio in the last year, and what was your average equity stake?

Mr. Draper: Oh, boy. It differs by industry, and it even differs by region. I don't know. It differs by the amount of money that goes into the company, too. In some cases, we put in a lot of money and we take a small stake, but the companies were very far along in a huge market. In some cases we put in a little money for a huge piece of the equity because the company was just beginning. Typically, we take less than half, but if we don't have 20%, we don't care. That's not completely true, but it's kind of the range. Picking a valuation is tricky, but the amount of money is almost incidental because, as you put more money in, the risks are lowered. The answer is, it changes.

 

Mr. Moukheibir: I'm Dr. Nabil Moukheibir from Connectance.com (http://connectance.com). I believe a netpreneur should be as selective in choosing the investor as the investor is choosing companies. My question is, how does a netpreneur choose the investor that's good for health and health care-related investments?

Mr. Draper: Probably somebody with some experience in those areas. With the Internet, the network is very important. I'm not as familiar with health care, so it may not be me, but perhaps one of my local partners has that expertise and can handle it for you. There are certain firms that have focused on biotech. Now, they are all bailing out, but there are some that have focused on biotech for many, many years and they know about dealing with the regulators and such. I just didn't want to do that.

Mr. Moukheibir: Does that mean that I have to go and ask each one if they are presently in health care?

Mr. Draper: You don't have to ask each one. There are all sorts of data available on that. There are a bunch of different lists, such as the Western Association of Venture Capitalists (http://www.wavc.com) and the Mid-Atlantic Venture Association (http://mava.org). Just go through the list and see what they are interested in. You are right. Be picky.

 

Mr. Harvey: My name is Jamey Harvey, of Digital Addiction (http://www.digitaladdiction.com). My company is making a next generation play and socializing platform that spreads like a virus. I'm trying to model it, and I don't have any idea how. I'm curious how HotMail grew. Also, if you were looking at a plan that involved a viral component as the main pillar of the product, what would you look for in the models?

Mr. Draper: That's a good question. We have thought about this. You need a value proposition to the user. Just because it's free doesn't mean it's going to spread. Users have to feel like they are getting something. Email was perfect for that because it was something they wanted anyway and they were getting it free from Hotmail. They had heard a lot about it and this was a neat opportunity. Net Zero (http://netzero.com) is doing a free ISP, and there is a real value to that. Some people are offering free calendars and Homestead (http://homestead.com) is doing community building.

The real key is a value proposition because then people will tell their friends about it. Communities come in and go out, so you get a special virus that goes back and forth, but you have to have something worth spreading.

Mr. Harvey: My other question is, when the Hotmail guys said they were going to put up billboards. . .

Mr. Draper: They did that by the way. It was the only marketing expense they had.

Mr. Harvey: That was my question. How much paid marketing was necessary and was it useful at all?

Mr. Draper: No. Not in that case, but, in most cases, yes, you have to market in lots of different ways. You have to spread the word.

 

Mr. Owens: My name is Charles Owens, chairman of AbleMedia (http://ablemedia.com). I have been an investment banker for the last 25 years. I think that what most entrepreneurs need to know is what it costs to do a VC deal. In other words, there is more to investing than just presenting a napkin and a three-page summary. When the individuals in this room decide they would like to approach a venture capitalist, how much money should they have in their back pocket in order to get this deal done? After all, there are lawyers, there are accountants, there are other people involved, or do you expect them just to walk in and get the deal done with a napkin?

Mr. Draper: That sounds like a Catch 22. That's a rational investor. No, we don't expect them to have anything. We usually share a lawyer with them. We say, "Pick a lawyer, we'll share them with you." Then the lawyer will write it up. Usually the lawyer wants to work for the company long-term, but knows that his bread is buttered with all the new deals we are going to send him. It turns out that we will write up a term sheet and send it out, so we don't need the lawyer.

The accountant? We don't need to see numbers; we are seeing concepts. We are seeing visions and that's what we invest in. You don't need money in your pocket for that; you need money to keep yourself alive while you are talking to venture capitalists, because we take a while. I think that's the most important money to have. As long as there is money in your bank account, you are all right.

Mr. Owens: What's the cost to them of the equity interest in their company typically? Is it more than 50% with Draper?

Mr. Draper: No. As I said, we typically don't want to take control the first time we invest. It varies. 20-50% is the range. Sometimes you just think, "Here is the perfect deal." When Columbus made this deal with Queen Isabella, she said, "I'll give you three ships but I want half the profits." Columbus said, "Okay." He went to his crew and said, "I'll give you half of whatever I get." That was the deal. It was a good deal. It came up with America.

 

Mr. Sohn: My name is Doug Sohn and "The Millennial World Adventure" is our vision. I have a highly technical question for you, if you don't mind. What's the fax number for Draper Atlantic?

Mr. Draper: Okay, good. 703-757-9286.

Mr. Witzel: Another example of shameless promotion.

Mr. Draper: Way to go.

 

Mr. Ringel: Good morning. My name is Michael Ringel. I'm the founder of a company called Let's Talk Business Network (http://ltbn.com). I've been a big fan of one of the companies you invested in, Wit Capital (http://www.witcapital.com). Where do you see the future of online IPOs?

Mr. Draper: What's happened is that the mainline investment banking world is not giving Wit as much of the IPO as Wit would like, because it's carving into their market share. WIT is really changing.

Mr. Ringel: And you see the future of that type of investing continuing to grow?

Mr. Draper: Oh, it's going to be fantastic because it evens the playing field. It hasn't been even. The institutions have eaten those things up and now there is an opportunity for individuals to come in. It's good. It's a lot of fun.

Mr. Witzel: We are going to take one more question. If you have other questions, please go to http://www.draperatlantic.com, drill down to the "contact us" button and put your question through there, or you can send email to hart@draperatlantic.com.

 

Audience Member: What's the best way to get interactive feedback from multiple venture capitalists so that you can tweak your ideas before you finish a final business plan?

Mr. Draper: Yes, that's important. You want to get to a few venture capitalists, get them to be honest with you, where they're saying, "Look, you shouldn't be running your company," or "There is no market here." That's what people aren't hearing, and it's what they need to hear. It's hard for a venture capitalist. You want to encourage entrepreneurs, so we'll sort of say, "Well, you know, it sounds good," and "I'm not sure," but then you get the decline letter.

We try to list three or four reasons why we have decided to turn down the idea so that the entrepreneur can swing back a year later with a full team, or whatever it is that he seemed to have been missing the first time

It's a tough one. I would just test your idea against anybody you can, and don't ever worry about somebody stealing it. It's your vision. It's your canvas, and it's you that's going to do it.

 

Audience Member: Do you have an open door week or open door day when people can just walk in and talk to you for five minutes?

Mr. Draper: Here it is.

Mr. Witzel: Thank you very much. Everyone, let's give Tim a hand. We really appreciate it. Thanks so much for being here and participating in the Netpreneur Program community.

 

End, page two of two | Previous page

Statements made at Netpreneur events and recorded here reflect solely the views of the speakers and have not been reviewed or researched for accuracy or truthfulness. These statements in no way reflect the opinions or beliefs of the Morino Institute, Netpreneur.org or any of their affiliates, agents, officers or directors. The transcript is provided "as is" and your use is at your own risk.  

Copyright 1999,  Morino Institute. All rights reserved. Edited for length and clarity.  

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