Rand Fishkin

How do venture capital deals fall apart? Those who want the inside scoop should look no further than Rand Fishkin’s more than 5,000 word treatise on how a recent $24 million venture deal with an undisclosed New York venture capitalist fell through.

I’ve covered the venture capital beat for more than a decade, and I can confidently say that I’ve never read anything quite like this. The SEOMoz CEO said he wrote the piece so that others can learn from the experiences and “possibly avoid some of the mistakes, pitfalls and pain we faced.” But I get the sense that the essay is a bit cathartic for the entrepreneur — who despite admitting some mistakes along the way — feels a bit burned after the New York VC firm pulled out of the deal at the last minute.

He writes:

“Phone calls and meetings are one thing, but this wasted a massive chunk of our time, energy and emotion. Putting faith in the process in the future would be hard – if a deal can fall through this late, when we weren’t even pitching but got pitched… Well, I just don’t know. Everything about this feels wrong.”

Fishkin’s piece includes emails between him and the venture capitalist (names are redacted), as well as the slide decks that he used to woo investors. (There are also wonderful nuggets about raising money like when his wife baked some cookie bars for the partners at Ignition, a previous investor in SEOMoz which supported the current funding efforts).

An investor email indicated that things were not going well

As I’ve written in the past, Fishkin brings a new definition to the word transparency. He’s been writing about the startup and venture capital process in great detail for many months on his blog, but I am sure that even he didn’t expect things to turn out this way.

Fishkin floats several reasons why the deal blew up including a slight downturn in revenue for June/July; the erratic public markets; and an ill-timed VentureBeat story from earlier this month. (We set the record straight on the information floated in the piece in this GeekWire story: SEOMoz considers $20M to $30M VC round, but Rand Fishkin says no ‘done deal’ yet)

After all is said and done, Fishkin writes that he’s actually pretty happy that the deal didn’t come together.

“The best part about this otherwise frustrating result is that we didn’t end up signing a deal with a firm who didn’t truly believe in us, our market or our future. Despite our positive experiences with Neil from March – July, the last couple weeks clearly showed that he would have been a poor choice for our board of directors. Whatever caused the cold feet, it’s better now than after the investment, when a wrong choice could have made life unpleasant for everyone for many years to come.”

In a follow-up, I asked Fishkin if he’d ever consider taking venture capital after this experience.

“Honestly, right now I feel very jaded about VC,” Fishkin tells GeekWire. ” But, that said, I recognize that making a statement like ‘I’ll never raise money again!’ could be overkill. I got dumped once in college, swore I’d never date, then met my wife. So…”

In the comments of the post, Fishkin receives support and accolades for sharing his story. But most folks agree that the particulars of the situation just “suck.” That said, Fishkin tells me that he’s glad that he wrote it.

“Definitely a lot of catharsis happening here,” he says. “In fact, honestly, finishing the post yesterday was the first time I felt good about the experience since things started to go sideways.”

John Cook is co-founder of GeekWire. Follow on Twitter: @geekwirenews and Facebook.

Comments

  • Guest

    It is often said that the greatest men must sometimes take a step backward so that they may then take two steps forward.

    Godspeed, Rand, in mustering the strength to move forward despite this temporary setback.

  • Victor

    I am very grateful for Rand’s post. My initial reaction is that this merely confirms my own experiences with a lot of VCs. As an entrepreneur, Rand is in a pretty good position and this is probably a blessing that the deal didn’t get done. 

    After diving into the post a bit more, I can also see why the VC is skittish. I am inclined to believe the timing had a great deal to do with it, I don’t buy the excuse about “July numbers”. When the public market takes a 20% dive, one would expect the private valuation to take a hit as well, but how do you go back to renegotiate? And imagine just how that conversation would be like. Also, this is a very richly valued deal on an absolute basis. I might be off a bit on the exact numbers. But Rand indicated SEOMOZ will net something around $1M for 2011, so post money the company would be valued at nearly 90X earnings!!! When the stock market is tanking, a deal like this becomes elective. 

    Lastly, this has nothing to do with the deal, but it does bother me from an entrepreneur, and it speaks not so positively about talent cost in Seattle. I am utterly blown away by the monthly fixed payroll cost of nearly $650K for a 30 person company. We are talking about almost $250K per head in cash compensations! How the heck did head count cost get so carried away in this town? 

    Again, very very grateful for Rand’s willingness to share his experiences. His post has to be one of the most valuation reading I have come across. 

  • Victor

    I am very grateful for Rand’s post. My initial reaction is that this merely confirms my own experiences with a lot of VCs. As an entrepreneur, Rand is in a pretty good position and this is probably a blessing that the deal didn’t get done. 

    After diving into the post a bit more, I can also see why the VC is skittish. I am inclined to believe the timing had a great deal to do with it, I don’t buy the excuse about “July numbers”. When the public market takes a 20% dive, one would expect the private valuation to take a hit as well, but how do you go back to renegotiate? And imagine just how that conversation would be like. Also, this is a very richly valued deal on an absolute basis. I might be off a bit on the exact numbers. But Rand indicated SEOMOZ will net something around $1M for 2011, so post money the company would be valued at nearly 90X earnings!!! When the stock market is tanking, a deal like this becomes elective. 

    Lastly, this has nothing to do with the deal, but it does bother me from an entrepreneur, and it speaks not so positively about talent cost in Seattle. I am utterly blown away by the monthly fixed payroll cost of nearly $650K for a 30 person company. We are talking about almost $250K per head in cash compensations! How the heck did head count cost get so carried away in this town? 

    Again, very very grateful for Rand’s willingness to share his experiences. His post has to be one of the most valuation reading I have come across. 

    • http://hark.com David Aronchick

      Your math is off dramatically… In the post he says $11M revenue projected, at 83% margins = ~$9M.

      10X gross profits is not insane at all – the reverse. It’s totally reasonable for a fast growing company.

      • Victor

        That’s gross margin. Net margin is around $1M. I think he confirmed in his slide deck as well.

        • http://hark.com David Aronchick

          True, but gross profits of $9M is substantial, and it makes complete sense that they are investing in additional heads now to grow revenue tomorrow. 

          You’re comparing Apples to Oranges – current net profits and headcount costs are investments in future revenue. Gross profits (and gross profit growth) is more accurate to where things are today.

        • http://hark.com David Aronchick

          True, but gross profits of $9M is substantial, and it makes complete sense that they are investing in additional heads now to grow revenue tomorrow. 

          You’re comparing Apples to Oranges – current net profits and headcount costs are investments in future revenue. Gross profits (and gross profit growth) is more accurate to where things are today.

          • Victor

            I beg to differ. Rand was candid in saying his business is vulnerable to elements outside of his control. Having high fixed costs such as staffing makes a business less flexible when there is problem in the business. You simply cannot dial down when things don’t go as planned. As a business owner myself, I am all too painfully aware of how this can be a serious problem.

            Yes, we all like to think we are somehow invincible and invest for future. But as an investor, you only have the current numbers to make a valuation judgement. So focusing on gross margins can lead you astray. An an entrepreneur, we all like to emphasize our positive attributes when making a pitch, things such as high gross margin. 

            Look, I don’t have a dog in the hunt. I am said that I am truly grateful for Rand to do this. I doubt very much I would want to put my business under the microscope to allow people like me to dissect in a public forum. That said, having been an investor myself, I can totally understand why the VC got skittish, but that doesn’t make their behavior any more excusable. 

          • http://hark.com David Aronchick

            I understand your perspective, but this is a private equity firm. Their goal is to find higher risk, higher payoff investments. If they wanted 20% net profits, then you would invest in Apple or Microsoft and be done with it. But you can’t possibly get the kind of returns these guys need by doing that.

            Further, salaries are the easiest thing in the world to dial down if things do go as planned – you lay off people. The 83% gross margins means that even IF you had to completely dial back, you’d still make a mint without having to invest a lot of money up front.There’s a very good argument that if a company has a higher net profit than 10%, you’re probably doing it wrong, because you’re not investing enough. Here’s a list of America’s top companies – the vast majority of which have similar net profit percentages (and much lower growth projections, Moz 2x’d their revenue in 1 year!) http://money.cnn.com/magazines/fortune/fortune500/2011/full_list/

            No one is saying this isn’t risky, or that Moz is invincible, but this is a really standard deal.

          • Victor

            Ultimately it is about margin of safety as investors. I recently made an investment in a non-sexy tech company at 0.5X sales, this for a business with gross margin of 70% and growing at 50% a year. The deal was done in July and the market tanked promptly afterwards. Would I even consider rescinding the deal? No way! Not at the valuation I got, I would do this kind of deal in any market condition. The valuation was simply too low, I will get the return of my principle in less than 3 years for the valuation I paid just from earnings alone. 

            I just don’t believe the margin of safety is anywhere near the same ballpark for the Moz deal. Ultimately I think that is the main reason the VCs backed out. That said, for all the pain and suffering these guys made Rand and his team go through, there should be a better way to make things right. Perhaps a breakup fee of some kind that can be negotiated upfront just for them to kick the tires. We are still in a climate where the entrepreneurs have the upper hand. 

      • Victor

        Also, his monthly salary burn is $650K, which amounts to almost $8M. So the $9M doesn’t exist.

    • Guesty

      Victor: where did you find the $650k number? I can’t find it. Thanks.

    • http://www.facebook.com/profile.php?id=691349391 Rabi Satter

      “When the public market takes a 20% dive, one would expect the private valuation to take a hit as well, but how do you go back to renegotiate? ”

      In one of my last startups we were doing the last of our due diligence. My interview which was the VC vetting my experience and deciding if they trust me as CTO. By the end of the meeting, I had passed with flying colors. The only thing left was having the deal sheet sent over to our lawyer to sign and for me to fly home and start packing to move to San Francisco. Unfortunately it was the week of March 13, 2000. The NASDAQ plunged and by wednesday was down 9%. Our attorney doubted we would even get a deal sheet.

      We did but our valuation was slashed by over 70%. The CEO and I decided to close the doors rather than accept. It turned out to be the right call as the carnage that year was massive.

      • Victor

        Brutal! Thanks for the story!

  • http://twitter.com/briancrouch Brian Crouch

    The outreach / marketing success that SEOMoz is having, the killer products they offer, and excellent service they provide leads me to believe that they’ll build the revenue far above that VC round within a few years, but without the strings. Self-funded is always better.  

  • http://www.facebook.com/people/Jonathan-Sposato/786250122 Jonathan Sposato

    rand thanks for sharing this.  i found this highly useful as an entrepreneur, but also as an angel.   its a great reminder that which side you’re on, people’s time and efforts are valuable and one shouldn’t jerk people around.   

    more generally i think you have a great business.   some of your numbers revealed remind me of picnik’s at some stage in our growth cycle as well, and i know from talking with you over the years that you are highly reasonable wrt managing costs and growing thoughtfully.  thus i fully believe that you will go on to build a great business and this ‘un-raise’ will simply be a footnote.

    thanks again for your candor and bravery in sharing with us all.  

  • Anonymous

    Sounds like they might be onto something
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