Sunday, July 07, 2013

Build a profitable business while spending as little as possible (the lesson of Xobni)

It's not that complicated to build a success startup.  Just build a profitable business while spending as little as possible.  It's not complicated, but it's hard.

I recently saw the news that Yahoo! had bought Xobni.  Xobni was a noble attempt to tackle the email overload problem (xobni = inbox backwards).  According to the stories I read, Xobni was bought for anywhere from $30 to $60 million.

Whenever such news comes out, I have a couple of friends who write to me, asking me if this represented a good outcome or a bad one.

My general response is that any outcome beats going to zero, but I follow that up by analyzing the financing history of the company.  Here's my analysis of Xobni:

Judging from Xobni's Crunchbase entry, the company raised $42 million dollars in four rounds of funding.  It looks like none of the rounds were down rounds, which means there was no recap.

Therefore, the $42 million has to be paid back to investors first, assuming a simple 1X liquidation preference.

Best case scenario, the company sold for $60 million, which means there’s $18 million to divvy up*.  After 4 rounds of funding, assume the founders ended up with 20% of shares fully diluted, and thus split $3.6 million amongst everyone who was there at the beginning.  If there were four founders, none of them would make even $1 million off the sale, and that's before accounting for taxes, the time value of money, and so on.

This is why raising a ton of money can be hazardous to your health.  Bootstrapped, they’d just be splitting $60 million.  Even a $5 million exit bootstrapping would be better financially.

The venture capital process rewards capital efficiency; the less you raise, the better off your outcome, especially in "smaller" (e.g. sub-$100 million) exits.

* It is possible that there was a carve out for management, but it still wouldn't represent a big windfall.


Sumanth said...

Your math and advice on spending as little as possible are both sound but specifically in the case of Xobni, they don't add up. The founders actually left the company a long time back and one of the reasons why the company has raised as much as it did was to give a secondary exit to the founders (it might have been partial but it was definitely significant). So they would have undoubtedly ended up with a lot more than $1 million each.

W. Lo said...

Hi Chris,
Thanks so much for sharing your knowledge with the world. I think the general lay person has a lot of misconceptions about how startups raise capital and how shares get divvied up whenever there's a fresh influx of cash. Could you please do a post outlining that? It would be much appreciated. Thanks!