Tag: startups

Why Entrepreneurs Should Take A Look Inside Pandora’s Boombox

Why Entrepreneurs Should Take A Look Inside Pandora’s Boombox

The true tragedy at Pandora Media is not that the stock traded below its IPO price within 24 hours (though investors who bought shares in the secondary market on the first day may disagree).  Rather,  it’s that the founder (who was one of three co-founders) holds only 2.25% of the outstanding shares.  Meanwhile, two venture capitalists, both of whom are former Wall-Streeters, individually own over 20% each. Pandora is not making its founder, or the people who work there, wealthy. But it has turned out to be a very lucrative investment for the venture capitalists who took the company public.

Aren’t startups that make real products/services supposed to make their founders wealthy, not their financiers? What happened here?

Pandora launched in 2000, during the height of the tech boom, and has followed a long and circuitous path to becoming the $2 billion plus $1.75 billion company it is today. The business required a lot of outside capital, necessary to negotiate and acquire rights to music content and to build out its streaming capability. In addition, they have a large team of music analysts on staff to catalog tracks as part of the Music Genome project. Two of the co-founders (Will Glaser and Jon Kraft), left Pandora after the tech-wreck and the company required many successive rounds of financing to stay afloat. Pandora had a number of near-death experiences as the business model changed from subscription to advertising, and their focus shifted from serving music retailers to subscribers. It would have been easy to write them off about a dozen times over the years, but they managed to survive and go public in the end. It is a remarkable testament to their perseverance that they are now a business that has built a service offering a unique blend of algorithmic and curated content, combining both crowd-sourcing and expert analysis. And they have a devoted subscriber base that is growing.

How then, to explain the fact that a co-founder who has been at the company for twelve years, through numerous ups and downs, ends up with a minute share of the firm, while the financial sponsors walk away with many multiples of their investment?

As many entrepreneurs in the tech space already know, capital infusions almost always require giving up equity.  And when a company requires several capital infusions, it means that equity is spread even thinner.  But when a company is in danger of folding, lifeline capital infusions require deals that, in retrospect, may seem horribly one-sided (rarely in the founders’ favor).

There are mitigating circumstances, of course, and we’re not saying that Pandora’s founders are guilty of making horrendous deals – they likely did what they had to in order do keep the company afloat.  Nor are we saying nice guys finish last (even though we think Tim Westergren is one of the nicest founders we’ve ever had the pleasure of meeting). We also recognize that Pandora’s trajectory is not one that other startups will necessarily follow. It’s just an illustration of one particular outcome, one which was spectacularly unfavorable to the founders monetarily.

So what should founders do?

The first thing is to understand the value and cost of venture capital financing. As a startup founder, you want your idea and work to reward you. If your business is as good as you believe it is, equity capital may turn out to be very expensive. Debt, could easily make more financial sense and leave you with more control of your company. It’s also important to understand the parameters of the deal you’re offered. Learn to read term sheets and, as always, get more than one quote. For instance, aggressive deal terms can dilute founders to a surprising extent. A few years of 8% coupons on compounding cumulative preferred can quickly add up. That said, there are certain advantages to working with a good VC. Some of the best can help you develop your business by providing good advice, and if they have a large following, help launch your product or service. A good VC’s experience and timely assistance can be invaluable. For example, it’s the VCs who suggested Pandora switch to a advertising model and get out of the subscription radio game.

As a founder, it’s important to understand that venture capital firms are not your friends. In fact, some of the more aggressive outfits will not balk at taking advantage of founders who don’t have a strong grasp on how to structure a capital deal.  Pandora’s story underscores the need for entrepreneurs to have expert legal and financial advice in place early on in the game, so they can protect their personal interests when VC firms come calling.  Ideally, this should come from an independent advisory firm that does not have a brokerage or investment banking arm which may be more interested in maintaining a continuing relationship with VCs.

Shameless plug: We can’t pass up the opportunity to say that Washington Square Capital Management was founded precisely so we could provide unbiased advice on investments and financial planning to our clients. As an added kicker, we enjoy working with entrepreneurs and technologists so much, we waive our minimum investment requirements. To get a flavor, read our post on Personal Finance 101 for Aspiring and Successful Entrepreneurs. To learn more, reach out to us via e-mail (info at wsqcapital dot com) or call us at +1-646-619-1156.

Image credit: F.S. Church


As of this article’s publication date, Washington Square Capital Management and its clients do not hold positions in either company, this may be subject to change. We  may in the future acquire positions in other companies mentioned in this post. This article is not a recommendation to buy, sell or hold any securities mentioned.

Personal Finance 101 for Aspiring and Successful Entrepreneurs

Personal Finance 101 for Aspiring and Successful Entrepreneurs

We read a number of startup, entrepreneur and venture blogs with great interest, and since many of our clients are entrepreneurs we have an interest in matters that touch on personal finance issues specific to them. We were struck by Fred Wilson’s blog post on his own experience recycling capital earned from investments in startups and how this has sometimes led to difficult times with his personal finances. He writes about how very early, concept-stage companies are financed in the US by angel investors and why that has been difficult to replicate elsewhere (i.e. not venture capital firms). His post is worth a read, and it got us thinking.

One thing that sets the US apart from most other parts of the world is a willing group of investors who are prepared to fund concept-stage companies, and who rely largely on their own experience founding similar companies in the past.

The second reason we think this happens in the US more than in other countries is far more tenuous and abstract. It’s trust. In many other parts of the world, legal systems and societies are not mature and trusting enough to permit someone to invest as an angel and not be branded a fool or worse if things go wrong. We also suspect that the number of charlatans masquerading as “entrepreneurs” is higher in other parts of the world than it is in the US.

Fred is focused on startup financing and advocates angel investing for successful entrepreneurs. Our view is a little different: we think successful entrepreneurs should capitalize on their unique hard-won insight into their industry and opportunities to judiciously fund startups, but we also believe there is a role for opportunistic investments in the public market  (stocks, bonds) in a successful entrepreneur’s portfolio. We also firmly believe successful entrepreneurs should set aside an income generating, ring-fenced portfolio that is robust enough to support them and their families if their angel investments fail spectacularly.

Some successful entrepreneurs may also need help controlling their urge to spend on expensive toys, but that is a different discussion.

The challenges faced by an aspiring entrepreneur are of a different cast.

Based on our own experience founding a business from scratch, and from working with clients who have done similar things, we’ve created a short check-list aspiring entrepreneurs should at least consider before diving head-first into a startup. Most of them relate to personal finance, some of them delve into the realm of personal fulfillment, a necessary discussion since starting a business can be such an emotional and stressful exercise.

  1. Evaluate yourself: are you ready for everything the world and your startup are going to throw at you? Will you be able to work outside your comfort zone, sell when all you’ve done is analyze (or vice-versa)? Will you be able to view your friends who remain in the corporate world in the right perspective as they fly around business class and wield expense accounts? When the romance of being an Entrepreneur/Business-Owner/CEO dies and you’re fixing the thirty-eighth thing to go wrong this week or reliving the latest deal that fell apart, where will the reserve to keep going come from?
  2. Evaluate the business you’re entering: particularly what the relative value of sweat and capital are in the business. This will tell you a lot about what you need to bring to the table and how you should treat partner’s contributions (in both sweat and capital).
  3. Get buy-in from your family and friends: They are along for the ride. Whether you acknowledge it or not, you are going to cause them financial and emotional stress as your business gets going. Make sure they know that.
  4. Be Cheap: You will have to become an arch conservative, make sure you are ready to cut expenses to the bone. Figure out what’s essential to retain your sanity and keep that.
  5. Be fair to your partners: Your ultimate success will depend on this more than anything else. Joel Spolsky has a great post on how to allocate founder’s equity, you should read it.
  6. Know when to quit (in advance): There’s a point where it makes sense to quit. Or regroup to fight another day. Think about what that point is for you along emotional, temporal and financial axes.
  7. Protect your fortress of solitude: Keep a reserve of both emotion and money, so you can, if necessary, exit gracefully to stage right.