Lessons in Entrepreneurship: Emerson Spartz

I recently met one of the most interesting persons, let alone entrepreneurs, I have ever met:  Emerson Spartz, the founder and CEO of Spartz Media.    If you have not previously heard of Emerson, trust me, you surely will.  This guy is destined for continued success, and is driven by an infectious energy, a terrific intellect that runs at light speed and a real desire to "change the world". 

But, what makes Emerson's story particularly interesting, was the fact he started Spartz Media in 1999, at the ripe old age of 12.  Yes, I said 12, with Spartz Media the brainchild of a good student with an unparalleled sense of curiosity about the world, who decided to drop out of the 7th grade to follow his passion at the time: building the #1 fan site for Harry Potter fans, called MuggleNet.

With the support of his parents, two successful professionals of their own, they agreed to let Emerson start the business and continue his education as a home-schooler in their home town of La Porte, Indiana, where Emerson could customize his own curriculum.  His parents incentivized Emerson to read as many books as he could, including an economic reward of "a penny a page".  Emerson read 1000's of books about everything and anything that interested him, from fiction (books from Grisham, Cussler, Follett and Clancy) to non-fiction (the biographies of four famous people a day).  Emerson was a sponge for knowledge, and was driven by the mantra: "brains + money = smiles to infinity".

Without the help of any mentors, Emerson built MuggleNet into the dominant fan site in its space, generating over 9MM visitors per month, at its peak.  He did this by: (i) hustling for new users (via link trades with the other Harry Potter focused sites); (ii) accumulating over 120 volunteer content contributors for the site; and (iii) following the example of other fan sites as role models (e.g., The Simpsons, Lord of the Rings), which had built up professional businesses in their space.  Emerson was taught at an early age by his parents that "can't" was a four letter word in their house, and he was constantly looking for new ways to innovate and succeed (hiding his young age from potential partners).

Emerson's MuggleNet success turned him into a celebrity within the Harry Potter world.  He published three books, went on book signing tours in 35 cities across the country and even had the honor of being asked to fly to Scotland in 2006 (at the age of 18), to meet J.K. Rowling, the author of the Harry Potter books, who wanted Emerson's assistance in helping her promote her newest and sixth book in the series.   Like Harry Potter, Emerson had the magic touch, and had become the voice of Harry Potter fans worldwide via the MuggleNet website, podcasts, games and content.

But, Emerson was also craving the social experience of going to college, and handed off the day-to-day CEO job at MuggleNet to his team, and enrolled at Notre Dame in 2005.  But, Emerson was less concerned about getting good grades (which he did anyway), but again was driven by a desire to customize his own curriculum, trying to learn how people and business really behave and work.  Emerson studied an eclectic mix of subjects, including neuroscience, memory, business, politics, psychology, science, SEC filings and over 60 industry research reports from natural gas to drywall contracting.

Emerson was hunting for any patterns in commerce behavior, which he could practice and apply in real life.  He built frameworks around various topics, like persuasion, negotiation and innovation, and created scripts and tactics in the real business world.  He was trying to build a repetitious practice regime for business, very similar to the practice regime he applied as a sports athlete while playing golf or basketball, to sharpen his skills.  

After graduating from Notre Dame in 2009, he settled back in the CEO chair at Spartz Media, where he launched over 18 other website properties, the largest of which is OMG Facts, the #1 random facts website and video series (with over 33MM views on YouTube to date).  In the last two years, this collection of websites has grown to over 10MM unique visitors and 160MM page views per month.  And, the Spartz Media business has grown to millions of dollars in revenues and employs over 30 employees today.

In addition to his unique education, Emerson's success at Spartz Media is driven by the fact that he has figured out how to easily identify gaps in consumer content demand, build content/communities in those verticals and ignite the viral buzz.  He said the magic to making something go viral is to: (i) remove any barriers that impede virility (give users the tools they need); (ii) plant the seeds with the highest demanded "fat tail" content (tested ahead of time in small sample pools); and (iii) repeat the process in other like-minded communities. 

This model has led to an unbelievable 95% success rate for each site launched, with success defined as over 1MM page views per month.  And, going forward, Spartz Media is reapplying this process by launching one new site per month in new categories.  Not dissimilar to the strategy Zynga uses to launch new viral video games, or the strategies Demand Media employed to grow their content-centric business.  Emerson acknowledges that a "trends-based" content strategy may lead to user decay over time as the trend passes, but the rapid launch of new sites more than offsets any traffic losses from the old sites.  In addition, he looks for other out-of-the-box ideas that can generate "long term legs" of their own, and is currently working on two such sites, one for High School Memes and the other a World Records site. 

Emerson, may or may not raise outside capital to help him accelerate his efforts or make some acquisitions, but he has the luxury of deciding his own fate, as the current business is profitable based on his successful advertising sales model (which still has plenty of upside in front of it, by building an internal sales team instead of relying on third party resellers).  Emerson equates Spartz Media very much to a VC-backed startup incubator, funding and launching a bunch of "high odds of success" sites, to see what sticks.

So, there are a lot of interesting startup lessons for us all: (i) don't be bound by the current way of doing things (think out-of-the-box to customize your own solutions which you can be passionate about); (ii) if you don't have your own mentors or skills, look to similar case studies as role models of where to go and read up on those topics; (iii) once you have figured out your "magic sauce", look for new ways to apply those skills for new products and "hit the repeat button".

Honestly, Emerson Spartz is a case study that Arne Duncan, the Secretary of Education in the U.S., needs to learn about, so our country's broken education system can be retooled to actually produce entrepreneurs like Emerson, who are helping to create jobs and drive our economy at such a young age.  Hey Chicago, anybody we know that can help Emerson with that introduction??

For future posts, please follow me at:  www.twitter.com/georgedeeb.

Lesson #116: Seed Investment Terms & Trends

Fenwick & West, the big Silicon Valley law firm,  publishes an annual Seed Financing Survey in recognition of the growing importance of seed financing to entrepreneurs and the venture capital environment, especially in the internet/digital media and software industries.  Below is a summary of the results, based on studying 56 transactions in 2011 and 52 in 2010.

Overview of 2011 Seed Financing Survey Results

• The use of convertible notes increased by 10 percentage points (to 41% of deals), and likewise the use of preferred stock decreased by 10 percentage points (to 59% of deals).
• The median size of convertible note deals increased from $662,500 to $1 million, while the median size of preferred stock deals remained basically flat around $1 millon.
• The pre-money valuation in preferred stock financings increased from $3.4 million to $4.0 million for internet/digital media deals, and from $2.7 million to $3.5 million for software deals.
• The median valuation cap on convertible notes increased from $4.0 million to $7.5 million.  Notes are capped 82% of the time.
• If notes are repaid prior to next financing, they are typically repaid at 2.0x the principal amount, on average ($1 million note gets $2 million if company sold and note repaid).
• Notes paid an interest rate of 5.5%, on average, and had a term of 18 months, on average.  Notes were typically unsecured (96% of time).
• The percentage of convertible note deals that convert at a discount to the next equity valuation increased from 67% to 83%, with that discount being 20% from the next round, on average.
• The lead investor was a seed fund (46% of the time), professional angel (28% of the time) or VC fund (27% of the time)
• Investors were given a board seat 70% of the time in preferred stock deals, and 4% of the time in convertible note deals.

For purposes of this survey, a "seed" financing is defined as the first round of financing by a company in which it raises between $250,000 and $2,500,000, and in which professional investors play a lead role (excludes financings led by "friends and family", which terms may not be negotiated on an arms-length basis). For this reason, the survey may not be representative of all companies receiving early stage financing, and is likely over-weighted to more promising companies funded by more established seed investors.

Overview of Current Seed Financing Environment

The seed financing environment for internet/digital media and software companies is expanding and becoming increasingly varied. Not only is the amount of seed investing increasing, but the diversity of seed funding sources is also increasing (e.g., friends/family, individual angels, angel networks, incubators/accelerators, seed funds, VC's investing earlier, crowdfunding). With this proliferation of seed capital and diversity of sources, the "leverage" in seed transactions seems to be leaning in favor of entrepreneurs, as preferred stock valuations, convertible note usage and convertible note cap amounts are increasing.

For the full detailed report, please visit the Fenwick & West website or contact Barry Kramer at 650-335-7278 | bkramer@fenwick.com or Steven Levine at 650-335-7847 | slevine@fenwick.com at Fenwick & West.

For future posts, please follow me at: www.twitter.com/georgedeeb.

Lesson #115: When to Trade Equity for Services

Giving up equity in your business, as an alternative to paying cash, often sounds like a great idea to cash starved startups.  But, giving up equity in your business is often a very big decision, and can come at a long term price, both financially and operationally.  This lesson will help you figure out when it is appropriate to trade equity for services, and when you should avoid it.  As, well as certain potential pitfalls along the way.

To me, this decision often comes down to: (i) how easily can you source capital from professional investors to pay for the services; (ii) how big of a cash requirement is the project at hand; (iii) are services long term or short term in nature; (iv) how onerous are the terms; and (v) are there any other potential strings attached.  Let's tackle these points below.

When you can, raising capital from a professional third party investor is always preferred.  You always want to raise cash from equity investors with experience in building startup businesses, often with a rolodex of potential business contacts and lessons learned from their past investments.  Taking cash from a service provider is often just that . . . cash only.  But, if you have no other alternatives from professional investors, service providers can be a perfectly acceptable financing resource for you, if that is all you need and it is structured fairly.

I wouldn't be giving out equity to any and all service providers.  You should be holding your equity near and dear to your heart, and only giving it out when absolutely necessary.  The higher percentage of your company that you can retain over time, the higher your payday will be when you hit it big on the backend.  So, when considering trading equity for services, I would limit such to material projects of scale (e.g., financial benefit of in excess of $50,000 in savings).

And, on a similar note, I would limit equity conversations to service providers that are going to be long term in nature, helping you build your business over time.  For example, your tech development firm that is going to help you build your website and maintain it over time, is a much better equity partner than the firm that is going to design your logo in a quick one time project.

Now that we understand which service providers we are willing to have equity conversations with, next we have to understand how to structure these deals.  This typically comes down to the security, voting rights and valuation of the deal.  For the security, shoot for convertible note or common stock deals where you can, so no preferred stock requirements impede your ability to raise future capital.  For voting rights, it should be capped at their pro rata ownership in the company, and typically should not require any seats on your board of directors (allowing you to run the business as you see fit). 

For valuation, whatever cash savings you are realizing, should be invested at a reasonable company valuation.  For example, let's stay your startup is worth $1,000,000.  If you are getting $100,000 in cash savings from the service provider, they should get around 10% of the company.  So, make sure the percentage they are asking for is fair, in relation to your valuation.  And, always be sure the project is well-defined and the project size is capped, so project creep doesn't have you giving out twice as much equity as you originally planned.

Finally, make sure there are no strings attached and avoid other known potential pitfalls.  Things like: (i) it is difficult to keep a service provider managed on time and budget, when they are also an equity owner who needs to be treated with kids' gloves (so make sure both parties are clear their role as a service provider, meeting deadlines and budgets, will come first); (ii) make no promises about fund raising prospects, potential buyers or future valuation expectations (let them make their own assumptions, understanding they are investing in a very risky security where the future is unknown); and (iii) make sure there is a clear plan in case things are not going well together (e.g., a way to buy back the stock, keep a copy of tech code or trade out service providers, in all scenarios).

There are many other issues to consider here, but hopefully this is a good high level education to get you started.

For future posts, please follow me at:  www.twitter.com/georgedeeb

Lesson #114: "Driven to Win" vs. "Fear of Failure"

The age old debate about what fuels a startup's success is whether they are "driven to win" or have a "fear of failure".  In this lesson, we are going to try and resolve this question, once and for all.

I think both sides of this argument are pretty self-explanatory, but let's just make sure we are clear on what we are talking about here.  Being "driven to win" is an insatiable desire to be #1 in your industry, often with a "take no prisoners" mindset of growing market share as quickly as possible.  The CEOs of these types of businesses often have a deep disliking of their competitors, and see themselves in a "all-out sprint" against the CEO's of others in their space.  On the other hand, "fear of failure" is driven more by not wanting the company to go out of business, and the perceived negative impact that would have on the CEO's resume and reputation.  To me, the former feels more akin to an "offensive" strategy, and the latter feels more like a "defensive" strategy.

So, if that is in fact a good analogy, are you aware of any competition that doesn't require the proper balance of both a good offense and a good defense?  I really think if you have too much of one, without the other, your success will be hampered.  As one example from the sports world, do we all remember the failed Rich Rodriguez tenure as head coach of Michigan Football between 2008-2010.  His innovative offense broke every statistically record, as the most productive offense in the 132 year history of this storied program.  While at the same time, his lack of defensive focus, broke every statistically record in the wrong direction, as the worst program in the history of Michigan football.  This lop-sided mix of skills, resulted in a middle-of-the-road record (7-6 in 2010), and the ultimate firing of Rich Rodriguez at the end of that season.

This analogy holds true in the business world, as well.  All offense and no defense, can cripple your company.  If you are too scared to fail (e.g, too much defense), that may cripple your ability to innovate out-of-the-box ideas, that if successful, would catapult your business to new heights never before possible.  Let's use Apple as an example.  What if Steve Jobs had stayed "defensive", focusing on protecting Apple's marketshare as the leader in personal computers.  We would have never seen such great innovations as the iPod, iTunes, iPhone and iPad that revolutionalized the tech scene in the years that followed, fueling Apple's meteoric growth and stock price.  And, on the flip side, if you try to use too much "offense", you can cripple your business by growing too quickly, or running out of cash, or entering more markets than logically makes sense for your phase of development, stretching your limited resources too thinly to be sustainable.

I think this theory holds true from my personal experience while CEO of iExplore.  I was equally focused on "offense" and "defense".  I was deeply-driven to win market share and partnerships away from my competitors at the time, like Away.com, Gorp.com, and AdventureSeek.  I wasn't going to rest until we had the largest website and most strategic partnerships locked up.  While, at the same time,  I had a deep fear of failing, especially in the wake of 9/11/2001 and the negative impact that had on the travel industry.  I wasn't going to let Osama Bin Laden end my dream or taint my track record, and I fought on through very difficult market conditions, even though the odds of success were not in my favor.  Without the "offense", we would have never built up a #1 market position and partnerships with National Geographic, Travel Channel, Expedia, Travelocity, Lonely Planet, Fodors, Frommers, Conde Nast and others.  And, without the "defense", it would have been a lot easier to simply file for bankruptcy in 2001, given the uphill battle that laid ahead.

So, it is not whether you are "driven to win" or have a "fear of failure".  To me, startup success needs an equal balance of both, for "offense" and "defense".

For future posts, please follow me at:  www.twitter.com/georgedeeb

Nominations Open for Moxie Awards in Chicago's Digital Startup Scene

Created by Built In Chicago and New World Ventures, nominations are now open for the First Annual Moxie Awards, celebrating the best in digital across the Chicagoland area. Nominate your company, as well as outstanding individuals today!

If you feel I have helped your businesses, either via direct mentorship or via this blog, I would be honored to be your nominee in the "Best Mentor of the Year" category.  You can vote here, once per day through May 21, 2012.

Lessons in Entrepreneurship: StyleSeek Case Study

StyleSeek is a Chicago-based startup that has been in stealth mode for much of the last year.  They are building a men's fashion discovery and e-commerce site.  If you haven't heard of them, you surely will, post their upcoming launch in the next few weeks.  I recently sat down with Tyler Spalding, their Co-Founder & CEO, at their offices in the new shared-startup space, Catapult Chicago.  His startup story and progress to date was so impressive, I thought it deserved being the feature of case study describing the "right way" to build a startup business.

First, a little bit about Tyler.  After graduating with a B.S. and M.S. in engineering from the University of Illinois, Tyler literally started his career as a rocket scientist, with varying jobs at NASA, the U.S. Air Force and Lockheed Martin.  He was even a member of the engineering faculty at the University of Alabama and the University of Miami.  But, Tyler always wanted to start his own business.  He realized he did not have any venture relationships that could help him, so he went back to school to get his MBA in entrepreneurship from M.I.T. between 2009-2011.  But, unlike his classmates, sending out resumes trying to get jobs with the major consulting firms or investment banks, Tyler began working on his new startup in 2010, while still in school.

Tyler's idea was to build an algorithmicly driven discovery engine around men's fashion, similar to how Pandora works for music.  You click on images of what kind of cars, hotels, drinks, houses, movies, magazines, and other lifestyle topics you enjoy, and the sites profiles you against other users of similar interests, and then makes men's fashion recommendations based on the attributes that have been indexed.  Once you find products you like, you can also discover similar products (e.g., same style/fit/color at better price) or related products to complete the outfit (e.g., pants if you are looking at shirts).  As you "like" the clothes within the site, its starts to map your "Style DNA", and links you to e-commerce shopping from over 1,600 brands (e.g,. Lacoste) and 105 retailers (e.g,. Nordstrom) to buy the products you want.  That is Tyler's vision.

Before starting to build out the site, and for most of the first year of their efforts, Tyler and his Co-Founders, Chris Walti (a fellow MIT graduate with a background in data analysis and startup business development) and Brian Hawkins (a consumer marketing expert and professor at the Fashion Institute of Design & Merchandising), were religiously focused on researching consumer desires for a product like this.  They surveyed over 400 men in two hour interviews, to learn how they shopped for fashion and what they liked and disliked about the current shopping process.  Once Tyler was convinced there was real market appetite, he raised $150,000 in friends and family money and started building a minimal viable product that they could begin testing with users.  And, in doing so, built a product that would start with men's fashion, but could easily be extended into women's fashion or any other product that could be better sold through this "shopping discovery" process.  Tyler, once again, thinking ten steps ahead.

Once the alpha site was built in August 2011, he decided to demostrate it to a room of 200 students and investors at an MIT startup event.  The demo was received with terrific enthusiam as the users in the audience started to get exact matches on the types of clothing they would be interested in buying.  And, as a twist of luck would have it (which entrepreneurs always need), Tyler did not realize that the famous angel investor, Mitch Kapor, was going to be sitting in the front row that day, and change the trajectory of his growth forever.

Mitch Kapor is the Founder of Lotus, the founding Chairman of Mozilla, and an active angel investor in Bit.ly, Uber, Twilio, Inkling, StumbleUpon and over 50 other startups.  He is the #5 most followed angel investor on AngelList, the startup-angel marketplace, with almost 9,000 followers, as of today.  If Mitch likes something, then the masses usually follow.  Mitch was so impressed with what he saw at Tyler's MIT presentation, that he emailed Tyler after the event and said he was interested in investing in mass personalization stories, especially ones that lent themselves well to creating a viral buzz.  StyleSeek was off to the races.

With the potential of such a strong lead investor in place, Tyler realized it was time to make sure the managment team was fully lined up, and he added another well-known person in the fashion space: Ryan Plett, one of the leading men's style bloggers with expertise in creative and branding.  And, the outcome of the team's brainstorming, resulted in a Trojan horse in StyleSeek's go-to-market strategy: the same 100 bloggers that would partner with the company as content contributors to the site, would ultimately become the site's trusted brand endorsers once they start promoting StyleSeek post-launch to the 25MM unique visitors on their websites, creating a very cost effective and highly viral go-to-market strategy. Tyler and team had thought ten steps ahead in designing their business, knowing those bloggers would be their "holy grail", including getting the editor of GQ on board as an early adopter of the site.

And, in Tyler's traditional style of leaving no stone unturned, before closing his seed round, he started putting out feelers to 15 of the big venture capital firms in Silicon Valley, to get their reaction to the story, to know that Series A and Series B money could possibly be secured after the seed round.  But, instead of contacting them directly, he smartly asked for introductions from the portfolio companies of these firms, where he had networking relationships.  And, in the process of doing so, some of these big venture firms got excited, and were pushing Tyler to raise an even bigger round and get them involved, creating a buzz in the Valley that something hot was brewing in Chicago, wanting to be a part of this great story and team.  However, before taking in big VC money, Tyler preferred to have a more solid proof of concept and higher valuation in hand, and instead, stayed focused on the seed round.

With all the pieces of the puzzle in place (e.g., product, team, go to market strategy, visibility into long term financing), Tyler felt ready to engage Mitch to potentially lead an angel round in StyleSeek.  And, that he did, in January 2012.  Mitch promoted StyleSeek to only 500 of his followers, and Tyler had 50 interested parties knocking his door down within 48 hours, which frankly kept him glued to his email for the two weeks that followed, as he screened all these inbound inquiries (click here for StyleSeek's profile page on AngelList).  There was so much demand, that Tyler was only able to take capital from around 11 of those individuals (each investing $10-$50K), and told the rest of the angels that the round was full, which had them wanting it even more, further fueling the buzz machine.  StyleSeek recently closed this angel round of $550,000 in convertible debt, but left the door open to potentially raise more before the subscription period officially closes at the end of May.  Perhaps, StyleSeek may be the first investment of the new fund from Catapult Chicago, called Trebouchet (translated "catapult" in French), or to other Chicago investors.  Because up until this point, Tyler admittedly said "StyleSeek hadn't really received a lot of love in his Chicago home market".

Which raises the only sad part of this story.  Tyler did make the circuit of pitches to the local Chicago VC's and angels, but summarized their reaction as "wanting the product launched first and proof of concept behind the business".  Which is a typical reaction from the Chicago investors, more conservative than their Silicon Valley brethren.  But, Tyler was disappointed that not one Chicago investor was one of the 50 angels that were fighting to get into his deal.  But, he was insistent on getting "home town flavor" into his investor group for local mentorship, and successfully found a few Chicago angels to join the syndicate (e.g., Wayne Boulais, Jeff Cantalupo, Dave Hoover) .  And, I am doing my best at Red Rocket, to help him find some more.  I would hate to see this business blast off, and Chicago not get any investment credit for it.

So, what are the key lessons here: (i) do what you love and makes you happy, regardless how successful you are in your current field; (ii) know your weaknesses and get the proper education to round out your skills and network; (iii) research market desires before building out your product, to ensure market demand and to fine tune the development plan; (iv) stay in stealth mode as long as you can, until you are ready to lift the curtain (and when you do, wow them); (v) build your technology with an eye to long term growth and scalability; (vi) everybody can benefit from a little bit of luck, and getting the story pitched in front of the right audience, which lead to a major investor; (vii) that investor was the magic bullet in shaking up AngelList and raising funds in record speed (so find your own ambassador); (viii) never approach investors directly, always ask for an intro from a trusted relationship; (ix) always keep your audience wanting more--turning away investors further added to the buzz; (x) it's all about the strength of the management team for getting investors excited (find your own rock stars); and (xi) as Tyler has shown many times, always think ten steps ahead, for every aspect of the business (e.g., market research, tech build, go-to-market plan, financing).

It is too early to know if these praises are premature, as the site hasn't even launched yet.  But, Tyler and team have left no stone unturned, and my spider sense is saying great things are soon to follow.  Keep your eye on StyleSeek, as I feel Tyler's rocket scientist background, has got this rocket ready for blast off!! 

For future posts, please follow me at:  www.twitter.com/georgedeeb