The old adage of the fundraising process is that it is like getting married, not dating: once the docs are signed and money is in the bank, the relationship is for the long haul. While this truth exists on both sides of the table, the due diligence process during fundraising often feels more like an interview than a dialogue.
However, understanding fit may be even more important to an entrepreneur than to an investor. The best lead investors make game changing introductions, can foresee organizational challenges, and guide from their own experience, while the worst can pull an entrepreneur in a thousand directions, try to manage the company from the Board, or slow progress with protective provisions, redemption clauses, or other punitive terms. What’s worse, is that founders typically have only 2-3 major investors in their company while investors have a portfolio of many companies, so the impact of a negative relationship is concentrated for founders and diversified for investors. Put simply, selecting the right investor is a critical decision for an entrepreneur, but is often overlooked because entrepreneurs don’t feel like they’re in the driver’s seat. To get the right partner, founders need to ask the following questions while raising money:
1. Are you working with the person you want at the firm? I believe that the most important criteria for selecting investor is whether you are working with the PERSON you want, not the FIRM. While you raise money from a firm, the Partner leading the investment will be the one working with you and will guide the firm’s sentiment on your company. The style of an individual partner can vary significantly within a single firm. Important questions to ask are as follows: Is their working style high touch or low touch? Do they have expertise with your market or business model? Does the individual’s ability and relationships match what I need? Many VC firms are now productizing the value that they bring to portfolio companies through in house design leads, portfolio advisors / board partners, full-time recruiters, and other means. While many others follow a more “artisanal approach” – a term coined by Bill Gurley at Benchmark – of having a smaller team. One great way to test for helpfulness, is to ask for help before the deal is done. If they won’t help while trying to close the deal, what is the likelihood that they will help later on? Ultimately it is up to you to decide which type of relationship you’d like with the Partner, but it is essential that you have clarity on expectations going into the relationship.
2. Is the firm’s investment thesis aligned with your future plans? Different venture capital firms have varying tolerances for risks, holding periods, and return targets, which will bias them as Board members and shareholders when it comes time to make a critical decision. Often times, these issues are masked during the fundraising process for two reasons: 1) Entrepreneurs feel pressure to change their pitch to raise money and 2) Investors change their philosophy to win deals. On the former, it is important to tailor a pitch for each firm, but wholesale changes to the business model, capital requirements, or exit strategy at this stage are unnatural, and should only be made if they are the right choice for the business, not solely to raise money. Regarding flip-flopping Investors, firms have been known to chase returns in different sectors or say what they need to close deals, particularly during bubbles. Testing a firm to ensure that you fit squarely within their investment thesis will be important when times get tough and the firm snaps back to its core values. Ultimately, if you felt as though you were being pulled into a different direction while fundraising, then the firm is probably not the best fit.
3. Does the firm’s fund size match your future capital needs and does the firm have a track record of supporting its portfolio? If you expect a significant number of follow-on rounds, one strategy is to seek investors who have large funds that will be able to provide follow on capital. Critical questions to ask during the VC courting process are 1) how often they participate in follow on financings and 2) how much do they have reserved for future financing rounds for your investment. Big funds will have the ability to invest pro-rata in future financings or even pre-empt future rounds, thereby allowing entrepreneurs to focus on their business not raising money. However, bigger isn’t always better. With smaller funds, your company can mean more to their entire portfolio e.g. will the $1M seed investment keep the Partner from the $1.5B up at night? Maybe not, but the $10M seed fund that made a $1m investment may be fighting with you until the lights go out. Further if they choose not to invest, you can likely remove the signaling risk in future rounds. Put simply, if the firm who led your Series A, doesn’t participate in your Series B it sends a strong, negative signal to the market if they have the capacity and strategy to participate in follow-on financings. Thinking through the firm size and your capital needs is critical when selecting a partner and the right answer is highly dependent on the unique needs of an individual company.
4. When will you want to sell? Investment firms have fundamentally different incentives than founders through diversified portfolios, fixed fee-based compensation, and outsized return expectations from limited partners (LPs). Said differently, VCs are playing home run derby, while you may want to play baseball. These incentives can cause tension when the option to sell the business arises. First, I recommend figuring out your number, often referred to as “F&CK YOU Money.” Or when discussed at the dinner table: “How much money would it take for you to retire?” Then what return does this imply for the firm. If they are making less than 3x their money (“ROI”) or 10% of their aggregate fund-size in absolute profit (“Tonnage”) then you may run into issues. I am not advocating for founders to sell as soon as you receive an offer above the “number,” but I think it’s worth thinking hard about the future opportunity in the company at this point. Beyond looking inward at your own number, gaining understand (tactfully) on the following issues can help color your opinion on how this firm will react when it comes time to exit: 1) Has the firm blocked an exit when an entrepreneur wanted to sell or sold a company when the Founder did not want to sell the business and what was their rationale for doing so? 2) Do they allow founders to take some chips off the table, and if so at what stage have they allowed founders to do so? 3) When will their fund end, and how have they handled or will they treat portfolio companies that operate after their fund?
5. Trust but verify: Obtain references on how have they worked with their existing portfolio. Finally it is up to you to trust but verify everything you believe about the firm. To gather references, I think it’s important to ask the firm for their list, but also permission to go outside the contacts that they provide with an eye to speak to a mix of successes and failures.
The above questions are extremely important to ask yourself when raising money. While there are certainly one-size-fits-most firms there are no one-size-fits-all. Each startup has distinct needs and the selection of the right capital partner is extremely dependent on them. It is easy to get caught up in the capital raising process and equally as easy to want to just get the round done, but selecting the right partner is worth the effort when you find yourself in a defining moment.
After any large acquisition, “bubble talk” begins immediately. The skepticism generally centers on why a certain company was acquired at such a high revenue or earnings multiple. However, what I find most interesting about this acquisition is not digging into the financial metrics but rather the story the acquisition price per employee tells about the tech startup ecosystem.
Popular wisdom says that when too much money goes after too few ideas, there is a bubble in startup land (the Silicon Valley version of Mo Money, Mo Problems). But capital being flowing into the tech sector in itself does not cause a bubble. Instead, I believe that crashes are caused by a dilution of talent. When a team scales, it becomes difficult to attract great people because there are only so many SUPER interesting roles, and so much equity to go around. Why should a great person take a less than amazing role at a pay cut with limited equity, instead of starting their own company or getting a brand name company on their resume? This only becomes exacerbated when there is an investment boon. As more startup capital becomes available, more companies are started. Talent is scarce, but companies are mandated to grow and have to put B players in A roles. This is also why so many great companies are started during a downturn (facebook, YouTube, etc.). Less capital means there are fewer startups which means talent is more concentrated. Money is definitely flowing into startups at the moment. So why do I believe this “bubble” is different?
My answer: each team member can have a larger impact on a company. WhatsApp had 55 employees and was bought for $19B. Instagram had 16 employees and was bought for $1B. SnapChat had less than 30 (approx.) employees and had a $3B offer. In each of these companies, founders and key early employees were not diluted in a greater pool of workers and they were able to maintain influence in a more nimble organization. Leadership is able to focus less on organizational design, HR, finance, sales, and other issues and more on forming an immensely scalable, powerful product. The following factors allow companies to have a greater impact per employee:
- Distribution: Getting your product in the hands of millions billions of users has never been easier. The App Store, Google Play, Social Media, and other channels are accelerating the impact quality has on customer acquisition. The cost of releasing your product to a very small number of people was astronomical just 10 years ago, let alone when Steve Case at AOL needed to print millions of CDs to get AOL and AIM messaging off the ground. In addition to the size of the network, the connectedness of the internet further reinforces tracking, optimization, and virality of services. Build a great product and get it noticed and it can really take off. Each and every day the market grows as more people come online. And to summarize an Essay by Paul Graham with the language of Gordon Gecko: “Growth is good.”
- Advent of the API: The proliferation of the API web services enabled the WhatsApp team to punch above their weight to achieve scale. These services created an effective network of engineers at other companies that were at WhatsApp’s command. Take payment processing as an example. WhatsApp was able to leverage the thousands of engineers at Google Wallet and Paypal to handle their payments infrastructure. Or look at Snapchat. Instead of building their own server infrastructure, they have built their service on top of Google App Engine. Thousands of other companies use AWS, Microsoft Azure, or other web infrastructure services. Hundreds of other APIs can be tapped into to accelerate development, but more importantly, they allow teams to stay small, nimble, and exceptional.
The WhatsApp acquisition highlights an extremely exciting trend in the startup ecosystem: more capital in the market means more companies are being started, but a stretched talent pool will not limit the creation of great companies like it has in the past. The API and distribution mechanics now enable great people to do more with less. I am in Marc Andreesen’s camp, software is eating the world, and I believe it is still only on its first course.
 much more data, albeit stale, on acquisition price to employees available courtesy of Wired.com here: http://www.wired.com/business/2012/04/opinion-baio-instagram-trend/
Board meetings can range from extremely productive, where strategic issues are addressed, to a free for all. Mark Suster, a leading VC at Upfront Ventures, has a recent post on how to control chaotic Board discussions. He discusses a number of ways Board Directors can derail meetings and prescribes methods to avoid common pitfalls. I recommend that you read the post as well as his previous post on how to prepare for board meetings and how to set the agenda.
In addition to the issues that Suster highlights, the structure of the presentation is a key determinant in the success of the meetings. Clear communication aligns the entire Board on your vision and the chosen path to achieve your goals. Based on my experience, the most successful Board meetings start with a single framework that Cue Ball Partner, @AnthonyTjan, created. The framework is a simple 5×5 matrix with the 5 priorities spelled out on the left side of the page. Alongside each priority, you should provide a quantifiable measure of success, target date of completion, commentary on progress that was made, and proposed next steps. An example of a company’s top priorities is below:
The power of the slide comes from its simplicity and clarity. A quick glance will explain an awful lot about your company. After presenting the slide, you will immediately accomplish a few things:
- Build Alignment on Priorities: Codifying and presenting these priorities ensures that each member is in agreement on how the business should move forward, which empowers the CEO to execute. Additionally, by stating the company’s priorities so clearly, Directors will not be caught off guard by the direction of the business. This clarity promotes a collaborative dynamic between the CEO and the Board rather than a tenuous, “Board vs. CEO” relationship. A good litmus test for whether you have established alignment among your Board members is whether each member can accurately recite the five priorities of the business
- Foster Agreement on Quantified Measures of Success: Not only will Directors be able to recite the top priorities, but they will also be in agreement on how success is measured. Often Board members have different styles and different motivations e.g. some may want hyper growth; others may prefer slow or more profitable growth. Balancing conflicting opinions can be challenging, and it will be impossible if you don’t define success upfront. Working with the Board to quantify success will ensure that every one is on the same page on whether the goals were achieved.
- Update on Progress and Provide Clarity on Next Steps: Stating progress and next steps will help you contextualize past and future investments at the company. By frontloading the debate on establishing the top priorities and framing initiatives in context, you will preempt any discussion on why an investment is being made, and shift them to short conversations on what you are doing and how you are getting there. For example, if you proposed an expansion of your product to a different vertical, the dialogue would be much more effective if you could frame it within a strategic priority such as distribution to establish network effect. The positioning would focus the conversation on whether the new vertical was the most impactful tactic for expansion rather than revisiting the strategy.
- Establish Focus: The framework provides more benefit than simply being a reporting mechanism to your Board. The exercise of codifying the top five priorities will help you step back from the day to day grind to define what is most important. Dick Harrington, Cue Ball Chairman, constantly reminds me and the CEOs of our portfolio companies, that “it is better to move 5 things a mile than 25 things an inch.” While there is often so much to do at a startup, ensuring that you are laser focused on only five things at a time will make you most effective.
I recommend that this slide should be used very early in each Board presentation as well as serve as a structure for the rest of the content. In fact, if the body of the presentation is not aligned with at least one of the five priorities, then the objectives are likely poorly defined and should be revisited. After defining these priorities and whipping up a presentation, you will now be able to spend more time building your business rather than managing your Board.
You can download a template of the slide here: Priorities Slide.pptx