Author: stevelord

ICOs: A promising innovation, but pitfalls abound. Photo courtesy of Christopher Michel.

Partly because of Burkland’s roots in Silicon Valley and partly because we tend to focus on newer, venture-backed companies, many of the questions we’re asked by founders and CEOs have to do with new ways of doing things. Over the past few years, nothing has captured the imagination of the startup business sector quite like bitcoin and blockchain as a whole. Entrepreneurs want to know how they can take advantage of this technology for their companies and their products. As strategic CFOs of these companies, we’re being asked frequently about cryptocurrency in general and initial coin offerings (ICOs) in particular.

Blockchain in two paragraphs

In very simple terms, blockchain originated as a massively distributed online system that validates, clears, settles and records bitcoin transactions. Since inception in 2009, blockchain has evolved to include both private and public systems that can simultaneously secure, chronologically verify, validate and record the movement of any asset from one party to another.

Why the term “blockchain”?  Transactions in the system are pooled together into a group, or block, from which alphanumeric information is gathered and combined with data from the immediately preceding group to form a complex and unique math problem. This problem is then presented to the respective blockchain’s distributed network, which uses its collective computer power to find a solution. Once the math is solved, all the transactions in the block are verified, the block in question is “sealed,” data is taken from it to form the basis of the next block, and the process starts over again – thus creating a linked “chain” of blocks.

Blockchain’s role in money

At first, bitcoin and its blockchain were focused on the use of cryptocurrency as a digital medium of exchange and thus the  potential to replace or compete alongside traditional currencies and the legacy banking networks that support them. But over the past few years, attention has pivoted to the practical applications of blockchain technology. This is because blockchains can securely and permanently record any transaction without the use of third parties. This disintermediation of middlemen adds up to very low transaction costs when clearing and settling transactions, and the technology underpinning digital ledger technology provides the ability to program “smart” contracts that can programmatically execute without the need for either side to trust the other. At scale, these capabilities are going to be particularly useful in a very wide range of industries – finance, real estate, retailing, banking, insurance, logistics, healthcare, etc.. Indeed,  it is very possible that every major corporation in the world will be using this technology (even if their customers don’t know it) in some part of their business within five years.

A common denominator in any blockchain is a token, or coin, that can act as an incentive for the network’s participants to solve for the blocks that keep the whole system humming along. A blockchain’s tokens are the fuel that establishes, verifies and records a chain’s transactions, so no token = no chain. This is where Initial Coin Offerings – ICOs for short – come in.

Blockchain role in raising capital for your startup

Blockchain startups quickly seized that the sale of these tokens – or coins – was a unique way to raise capital. Typically, an ICO involves the online sale of a pre-determined number of tokens for use or utility inside a blockchain ecosystem, usually before it is built. The startup thus raises capital without technically selling equity or incurring debt, and can fund the highly technical work necessary to build, test and deploy their system. These offerings have proven immensely popular, with the post-ICO value of some tokens quickly skyrocketing thousands of percent in secondary trading.

However, there is a catch. ICOs don’t click neatly into legacy securities laws and have blossomed primarily because they have operated outside the bright regulatory lines designed to protect investors, such as registration with the SEC and regulations against general solicitation. ICOs have been pumped mercilessly on social media, and since one can take part in an ICO with the mere swipe of a mobile phone screen, hype has quickly gotten far ahead of substance. Unsurprisingly, regulatory agencies worldwide are now catching up, taking a very close look at whether these tokens are actually securities in the issuing company, and whether their sale to a random unaccredited investor via a social media post is actually an unregistered offering of those securities. For its part, the blockchain community has argued vociferously that most ICOs aren’t equity at all, but just the pre-sale of digital usage rights that can be redeemed later for some level of utility within a blockchain. Both sides have a point.

The incredible appreciation of these tokens in secondary markets on crypto exchanges has heightened the SEC’s interest, as has the colossal amounts of capital being raised via ICO. ICOs have already brought in more than $13 billion YTD across 537 ICOs globally, according to Reuters, nearly double last year’s $7 billion and a far cry from the $1.3 billion in early-stage and seed-round funding from VCs so far this year. As far as capital formation goes, this clearly a whole new ball game.

Blockchain ICOs: A blessing and a curse

From our perch as on-demand CFOs, ICOs remain problematic because they are still in the regulatory grey zone. Beyond blocking access from US-based IP addresses, ICO issuers typically do little or no AML/KYC vetting, and don’t require anything close to accredited investor attestation. Investors in ICOs, meanwhile, have few rights and are typically not provided any company financial information prior or subsequent to the ICO. To top it off, marketing of ICOs remains wholly unregulated, and although the legal community has rapidly adopted capital structures from the Regulation D and crowdfunding worlds, concerns remain that these offerings will ultimately run afoul of SEC regulations concerning how one attracts investors.

And while more mundane, the accounting of successful ICOs remains murky, since the jury is still out on whether the proceeds from an ICO should be taken onto a company’s financial statements as equity, debt, or even deferred revenue from sale of a product. All have thorny issues; equity is out if the SEC deems the token a security, debt is a reach given the way tokens and blockchains work, and booking ICO proceeds as deferred revenue – potentially the most apt description from an accounting point of view – is problematic because secondary appreciation of the tokens could result a tremendous hit to the balance sheet when the future performance obligation created by the tokens is valued at its cash redemption value.

Hold your horses

We’re excited by the innovation in capital formation that ICOs represent. For the moment, though, they come with major implications for companies (and their management teams) not only tactically, i.e. the SEC might want to talk to you, but also strategically should a future round of financing be complicated by the consequences of using a structure few outside of the crypto world fully understand. Tread carefully and thoughtfully when considering an ICO, and don’t hesitate to contact us at Burkland for an unvarnished analysis of the pros and cons of this type of financing for your startup.

Proper financial modeling is critical, but not for the faint of heart.

Work with enough early stage companies, and you’ll inevitably hear reference to a financial model. Depending on the company in question, the model will be either a mysterious topic discussed only in hushed tones, or something casually mentioned on a Friday afternoon as a box to check in the start-up’s sure-to-be rapid ascent to riches. Neither is correct; in my experience, entrepreneurs at early-stage companies almost always approach financial modeling from the wrong angle (if at all), resulting in incorrect expectations and potentially costly decisions down the road.

Here’s a quick list of the five most common misconceptions and mistakes that early-stage management teams make when it comes to modeling.

  1. Yes, you need to do a model…and a good one. It is staggering how many young companies try to raise capital around a business plan containing only the most basic of financial projections. It is not enough to list revenues, expenses, and net profits – you have to build out a model that accurately shows the moving parts of the business you want to build. No matter how astute an entrepreneur may be in his or her field, superficial financial projections scream amateur, and won’t help the conversation.
  2. No, the model’s estimates are not cast in stone. It’s a model, after all, not a guarantee. Many entrepreneurs are justifiably wary about overpromising, but being too conservative isn’t great either – better to actually build out what you reasonably hope will happen, and back it up with logical assumptions and arguments. Institutional investors know that reality and projections will differ, and a good model can be adjusted to reflect what is actually going on as your company makes progress. That’s what models are for – they are living documents.
  3. It’s the Journey, not the Destination. Any idiot can type numbers into a spreadsheet, so don’t think fancy formulas and complicated pivot tables will impress anyone. What matters much more is the level of detailed thought you have put into how all the moving parts of the business fit together under different scenarios. Investors will generally discount your projections anyway; what they really care about is whether you have actually done the work to think through all the expected revenues and expenses in the business over the model’s time horizon, and what assumptions you’ve made to ramp them. Important: Everything is connected, so don’t model, say, 5x sales growth without thinking carefully about what it means for the rest of the business. What will it cost? At what point to do you need to add staff? And what happens when you do? Does rent go up? How about insurance? All elements of the business have to reflect what you are predicting, not just sales, clients, users, etc.
  4. Models Are Not Fire-and-Forget. A proper business model is built in a way that allows key elements of the company’s economics to be adjusted going forward. This provides a mechanism for management to not only adjust core metrics to reflect real-world experience, but also a sandbox in which different scenarios and combinations can be tested to measure what happens to your company. Many entrepreneurs make a model during a fundraising round and never look at it again; this is like installing a GPS app on your phone and never turning it on. Use the model as a tool to better inform how and when you will be impacted by various developments, and what you can do to react. Done properly, they’re particularly good at predicting when cash will run low (which helps manage fundraising activities well in advance of a pinch) and can be a tremendous resource for learning which inputs and assumptions ultimately drive the business. Operationally, this helps you focus your time and energy – and that of your senior personnel – on the areas that ultimately have the biggest impact on the business.
  5. One Size Fits All. Don’t fall into the trap of building different versions of the model to suit the different conversations you’re having, display a certain pre-conceived result, or garner a higher valuation. It’s just not a good idea. You’re crafting the question to suit the answer, which leads to merely plugging in numbers into excel (remember the idiot mentioned in #3?). Build a model that is a legit depiction of what you think might happen if all goes well – no more, no less.

Proper financial modeling is not for the faint of heart, and it’s one of the areas in which Burkland’s on-demand CFOs excel. It requires an interesting mix of accounting knowledge and good, old-fashioned operating experience to do well, which means modeling is often the very last thing an entrepreneur wants to tackle. But it’s critical to not only understanding and managing the inner workings of your company at a granular level, but also to raising outside capital, and most importantly, to understand all the moving parts that affect your own business. Take the time to do the modeling right; your company, your investors and you will be thankful you did.

Photo courtesy of Christopher Michel.

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There will be storms ahead. Make sure you learn resiliency from the ones that came beforehand.

Photo courtesy of Christopher Michel.

For millions of people in the U.S. and the Caribbean, the summer of 2017 is synonymous with tremendous suffering and loss, as one of the most active hurricane seasons in history hit their communities. As tactical response to the storms scales down and recovery begins, strategic focus will shift to making critical systems more resilient – such things as the water levies in Houston, and the power grid in Puerto Rico.

Although there is a world of difference between how governments and organizations respond to the challenges of large-scale disasters like storms and how a management team runs a business, I think there are some valuable resiliency lessons that can be drawn for startups.

When I’m not working as a consultant, I serve as a Civil Air Patrol liaison officer to FEMA’s Region II. In this capacity, I’ve worked six major hurricanes in the past several years, including Sandy in 2012 and this year’s Irma & Maria. Aside from master-of-the-obvious missives like “failure to plan is planning to fail,” here’s my top five list of lessons from disaster response every CEO can incorporate into their business strategy.

  1. Resources always govern results. There is never a shortage of demands on an organization’s resources, and the natural tendency is to pay the most attention to the fire burning brightest at the moment. However, an organization’s effectiveness is metered by the resources it can strategically bring to bear, not devote to this or that tactical fix. Avoid the trap of allocating resources (in a company, usually capital or talent) to things that are not bringing your organization closer to your broader goal. Also, avoid the cardinal mistake of not allocating enough resources to do the job at hand properly. Another landmine is the order in which you deploy your resources, which can matter as much as getting them in the first place. To use a FEMA parallel, there’s no use surging hundreds of trucks to help distribute food and water in Puerto Rico unless there are drivers on the ground to operate them. It sounds obvious, but in high-stress environments, it’s the simple and obvious things like this that will make or break the impact of scarce resources.
  2. Know what has to come first. Prioritization and precedence are critical to resource management, so knowing (or carefully planning for) what should receive support first is paramount if you are to avoid going back and doing something over again, or worse, detracting from your ability to deal with more important things down the road. Resources are almost always limited, while demands invariably outstrip supply. Management must prioritize, but it should do so more adroitly than merely forecasting an ROI on capital invested; look at your resources holistically, with your strategic goal in mind, and parse out in which order they should be expended. Bear in mind that it’s not always immediately apparent what should come first, and your decisions regarding prioritization will be based on incomplete information.
  3. Consequence management. This is one of the most common mistakes I see leadership teams make. While they may be very adept at allocating resources and prioritizing, CEOs often fail to extrapolate the broader impacts of their decisions, and how their choices may affect subsequent requirements. The more ambitious the goal and the tighter the timeline, the less likely is that you have really worked through how everything fits together, and how what you decide today may govern what has to be done tomorrow. I recommend mapping out how your decisions will move your startup towards its ultimate goal in order to see where the consequences lie.
  4. Avoid the soda straw. Every executive, commander and leader is at risk of viewing their world through the proverbial soda straw, focusing on the immediate requirements or mission they are tasked with at the moment to the virtual exclusion of everything else. This is a natural tendency: concentrate on the immediate task for survival. However, maintaining situational awareness of the entire enterprise – and its priorities – is key, no matter how exciting or promising a certain project might look today. In the disaster world, this means remembering that almost every decision comes with a long logistical and economic tail that must be managed – for instance, the person who orders thousands of first responders and military personnel to a hurricane zone must also think of the lodging, provisioning, and sanitary requirements they will place on an area that is likely to be already highly deficient in all three.
  5. Rapidly iterate based on new information. Private sector companies typically exist in rapidly-changing environments, and as the old saying goes, no plan ever survived the first hour of combat. Don’t be afraid to abandon prior conceptions about your market or customers in favor of new, real-life information you receive from the field. In this sense, treat your decisions as MVPs (Minimum Viable Products) that are just starting points from which to depart. Real-time adjustments are more valuable than anything you put up on a white board six months ago. And make decisions quickly – one of the few unassailable advantages a startup has over its larger competitors is an inherent ability to move very quickly, so use it often. Case in point: Google’s plan to use high altitude balloons to temporarily take the place of cell towers may restore mobile phone service in Puerto Rico weeks or even months ahead of any other solution available from local telecoms or the government.

In many cases, your CFO can help you not only properly define your company’s strategic goals, but also help you execute the day-to-day demands in order to reach them in a focused and efficient manner. Like with disaster response, there is no one thing that makes all the difference, but rather countless small elements that make up the overall effort. To sum up, remember another old saying: Manage the little things right, and the bigger things will take care of themselves.