I’ve had multiple conversations with emerging managers currently fundraising over the past few weeks, and the common theme, outside of the usual no’s, seems to be that larger LPs are saying, “If you were raising a larger fund, we would invest.”
And so there’s this catch 22 in the market right now. In one Fund I GP’s words, “either raise a larger fund and be told by the large checks that they don’t do Fund I’s. Or do a smaller fund, and be told by the high quality LPs that they’re too small.”
As a note, for the uninitiated, most large, seasoned LPs usually don’t want their check to be more than 10% of the fund. Why? Too much exposure in a single asset. And the need to diversify. Every year, there are really 20 great companies that are made. Or on the higher end, as Allocate’s Samir Kajirecently wrote, “30-50 companies drive the majority of returns.” Your goal as an LP, is to get as much exposure to those as possible. And they rarely all come out of just 1-2 funds.
If LPs are open to taking up more than 10% of the fund, they usually come with rather aggressive terms. For instance, investing into the GP stake, as opposed the to the LP. That’s a conversation for another day though.
As such, I’ve seen many a manager play both angles. They call it the “toggle.” If we raise a target of $10M fund, we’ll only do pre-seed. We’ll also have no reserves. If we raise a $25M fund, we’ll have 20% reserves and more seed checks. But if we’re able to close a $50M fund, we’ll have 33% reserves and do 50% pre-seed and 50% seed. The deltas between some fund managers’ targets and caps have grown as wide as the Grand Canyon. I was chatting with a Fund I GP yesterday who had a $10M target with $40M cap. Still relatively reasonable. Another GP raising their Fund I two weeks ago told me he had a $15M target and $70M cap. Far less reasonable. In fact, I might even say, a $15M fund and a $70M fund are two completely different strategies.
So begs the question, as a Fund I or II GP, is it worth raising a larger fund to possibly close large LPs or staying disciplined in your pre-product-market fit fund?
Spoiler alert… I don’t have the silver bullet. So if you’re looking for one, this blogpost isn’t worth your time.
But if you’re not, here’s how I’ve been thinking about it.
The short answer is really, whoever’s willing to give you money. Not the most sophisticated answer, but if you know large LPs well and they’re willing to invest in you, go bigger. Otherwise, you need to consider a more grassroots approach.
If you have a strong, portable, relevant track record that’s either returned good distributions already OR that has persisted for at least 6-7 years, larger LPs may be more open to investing in you. If not, you may need to play the numbers game with smaller LPs, that are liquidity-constrained as of now. And for that, you either take smaller checks, or prove you are the best option for their $250K LP check, that it somehow outcompetes the S&P, 3-year treasury bonds (because of interest rates), real estate and so on.
Also, remember that LPs are always nice in meeting #1. I’ve heard of very few instances where they’re not. A lot are just in exploratory mode. No pressure to commit. You will also need a great barometer of what nice looks like and what kindness looks like. Otherwise, you will waste a lot of time.
What does that mean? It is easier for a large LP to tell you “I will invest if your fund was bigger” than to tell you “No.” It’s the equivalent of VCs telling founders, “You’re too early for me.” And the same as recruiters and hiring managers telling job candidates “We have a highly competitive pool, and while we loved meeting you and you’re great…” There might be some truth to it, but a lot of smokes and mirrors, and a fear to offend people. I get it. We’re all people.
Just don’t lie to yourself.
Taking the hard road, which will be true for the vast majority of managers raising now, is to keep the fund size small and disciplined. Aim for a minimum viable fund. And deploy.
The minimum viable fund
Simply put, what is the minimum you need to execute your strategy? To set yourself up to raise a larger fund 1-2 funds from now?
What assumptions are you trying to prove?
What does your ideal Fund III look like? And What does fund-market fit look like to you? Be as detailed as you can. It could be that you’re getting four high quality deals per quarter. And that you have $30-40M to deploy per senior partner. That you’re leading rounds for target post-money valuations between $10-20M. That you have early DPI from Fund I by then. And so on.
Then work backwards. If that’s what Fund III looks like, what does Fund II look like? What does Fund I look like? As you’re backcasting, to borrow a Mike Maples Jr. term, each fund when you work backwards in time is focused on testing 1-2 key assumptions that you and LPs need to get conviction on. Assumptions that require data.
I’ll give an example of one kind of assumption. Your ability to win allocation.
If Fund III is where you lead pre-seed and seed rounds and have strong ownership targets, then Fund II is where you have to test if founders and other downstream investors will let you take pro rata for more than one round. And, if you can win or negotiate for that pro rata. It all comes down to, will a founder pick you over another awesome, possibly brand-name VC? And if so, why?
Some LPs prefer co-investment opportunities. And while it is helpful for them to go direct, part of the reason for it, is even if your fund can’t execute on the pro rata, just the ability to negotiate that is powerful for the day you need to lead. And if that’s Fund II, Fund I may be, can you win allocation in hot rounds and/or can you discover non-obvious companies before they become obvious?
Let’s say your Fund I is focused on the latter. You’re probably investing on $5-10M post-money valuations, and you’re going to try to maintain 5% ownership till the A-round. That’s $250-500K checks. $250K would be your base check, trying to get at least 30 shots on goal. That’s a $9-10M minimum viable fund, hoping for more than a 2% outlier rate in the generalist market, or north of a 10% outlier rate in bio, hard sciences, healthcare, or deep tech space.
Any less than 30 companies, you’re going for the hyper-concentrated portfolio and it’s a lot more about ownership and the greater the pressure, you need to pick well. But the goal is to get to a 3x net minimum for your fund by the time you get to a Fund III.
I heard from LPs with more miles on their odometer that once upon a time, it was normal for GPs to give undeployed capital back to their LPs. Circa 2002-2005 vintage funds. Where GPs don’t execute on 50% of their capital calls. But we don’t live in that era anymore. For better or worse.
Some LPs don’t even want their capital back early because then they need to pay taxes AND find another asset that compounds at the same or better rate your fund currently is. Say 25% IRR or CAGR. That’s hard. Because minus the inflated marks of the last 5 years, 25% is a hard benchmark to hit for the vast majority of funds.
So sometimes to be the best fiduciary, that means raising a small fund today (easier to return too) to set you best up for tomorrow.
The questions to ask
If you are in the midst of conversation and trying to court a large LP, do ask the following:
Have you invested in an emerging manager in the last two years? — If not, you’re unlikely to be their first. If you’re not seeing demonstrable progress from intro to partnership meeting to diligence within three meetings, move on. If they did so, 20 years ago, doesn’t count. That means investing in emerging managers is not top of mind for them.
What is your minimum check size? And how often, if ever do you deviate from it? If so, why was the last time you did so? — Multiply this number by 10. If it’s greater than your fund size, you might find more success elsewhere.
What is the typical process look like? — Find out what their process is and see if you’re progressing forward. If not, very clear they may not be interested.
(If the person you are talking to does seem to really like you) What are the questions you’re being asking in your investment committee? — Figure out the bottlenecks as soon as you can. And determine if that’s something you can solve for in the near future or not. If it’s track record, you realistically can’t.
What is the thing you hated most in the last few years? — Understand their red flags early on in the process. And cross your fingers, it’s not something that’s relevant to you or your fund. If it is, move on.
Of course, the above, while useful pre-qualifying questions, are mentioned in broad strokes. Your mileage may vary. Have there been examples of large LPs betting on small funds? Yes. But far and few in between. But don’t expect you will change many minds.
In closing
Fundraising is all about momentum and time you’re in market. You can theoretically spend six months trying to close one large LP, but your time might be better spent closing smaller checks in the beginning from people who believe in you and strong referenceable names. And if you so choose, come back to the large LP in the second half of your fundraise.
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The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
In one of the recent All-In podcast episodes, Bill Gurley shared that both VCs and LPs aren’t marking down their portfolios. For GPs, inflated numbers helps you raise the next fund. For LPs, they’re given their “bonus on paper marks. So, they don’t have an incentive to dial around to their GPs and say, ‘Get their marks right.’ ‘Cause it’s actually going to reflect poorly on them if they were to roll those up.”
The last few years, enterprise value has been largely based on multiple expansion. The truth is we’re not going to see much of it in the incoming years. Even AI that’s exploding right now will see a contraction of their multiples in due time.
Companies that should not be in business today will see their ultimatum too in the next few years. Hunter Walk recently wrote “they’re 2017-2021’s normal failures clustered into current times.”
So, while some GPs do pre-emptively mark down their portfolio by 25-30% — we’re seeing this behavior more so in pre-seed and seed funds — the only people in this whole dance that are incented to mark down portfolios are new LPs trying to figure out if they want to commit to a new fund.
And while the advice applies to newer VCs, the same is true for experienced investors. Of course, most investors aim to be in the upper right-hand corner, but that’s really, really hard. In truth, most notable investors fall in two cohorts: marketers and tastemakers.
Marketers:
Share a high volume of deal flow,
Lower quality opportunities,
Have relatively low conviction on each deal compared to their counterparts, the tastemakers,
Have comparatively diversified portfolios,
And could have adverse effects on branding and positioning in the market.
Tastemakers, on the other hand:
Share a lower volume of deals,
Usually higher quality opportunities,
Higher conviction per deal,
Have comparatively more concentrated portfolios.
And the downside may simply be the fact that their volume may not warrant raising a fund around, and might be better off as an opportunistic investor.
And speaking of concentrated versus diversified, the interesting thing, as Samir Kaji shared on his recent podcast episode, is that “at 85 companies [in the portfolio], you had over 90% chance of getting a 2X. But a very low chance at getting anything above a 3X. And with smaller portfolio sizes [between 15-25 companies], there was much higher variance — both on the top and bottom. Higher chance that you perform worse than the median. But a much higher chance of being in the top quartile and even beyond that, in the top decile.”
It’s also so hard to tell what high quality companies look like before the liquidation event. Naturally, high quality funds are even harder to tell before the fund term. It’s ’cause of that that a few LPs and I wrote the post last week on early DPI. But I digress. At the end of the day, many, for better or worse, use valuation and markups as a proxy for quality.
But really, the last week’s valuation in this week’s market environment. Rather than chasing an arbitrary number, a lot more LPs when evaluating net new fund investments, and GPs making net new startup investments, care about the quality of the businesses they invest in. It’s not about the unicorns; it’s about the centaurs. The $100M annualized revenue businesses.
Samir Kaji’s words in 2022 ring true then as they do today. “Mark-downs of prior vintages are starting to occur but will take some time given valuation and reporting lags.” We’re still seeing many who have yet to go back to market. As many say, the flat round is the new up round. But until folks go back to market, there are many who won’t jump the gun in writing down their portfolio. But they are cautioning themselves, so that hopefully they won’t make the same mistakes again. The goalposts have changed.
I’m reminded of Henry McCance’s words channeled through Chris Douvos. “When an asset class works well, capital is expensive and time is cheap. What we saw in the bubble was that capital got cheap and time got expensive.”
We’re now back at a time when capital is expensive and time is cheap.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
Some of you reading here are busy, so we’ll keep this top part brief, as an abstract sharing our top three observations of leading fund managers.
Generally speaking, don’t sell your fast growing winners early.
Except when…
Selling on your way up may not be a crazy idea.
You might sell when you want to lock in DPI. Don’t sell more than 20% of your fund’s positions unless you are locking in meaningful DPI for your fund. For instance, at each point in time, something that’s greater than 0.5X, 1X, 2X, or 3X of your fund size.
You might consider selling when you’ve lost conviction. Consider selling a position when you feel the market has over-priced the actual value, or even up to 100% if you’ve lost conviction.
You might consider selling when one is growing slower than your target IRR. If companies are growing slower and even only as fast as your target IRR, consider selling if not at too much of a discount (Note: there may be some political and/or signaling issues to consider here as well. But will save the topic of signaling for another blog post).
Do note that the above are not hard and fast rules. Every decision should be made in context to other moving variables. And that the numbers below are tailored to early-stage funds.
Net TVPI Benchmarks from Years 5-15Net DPI Benchmarks from Years 5-15
Let’s go deeper…
On a cloudless Friday morning, basking in the morning glory of Los Altos, between lattes and croissants, between two nerds (or one of whom might identify as a geek more than a nerd), we pondered one question:
Everyone seems to have a financial model for when and how to invest, but part of being a fiduciary of capital is also knowing when to distribute – when to sell. When RVPI turns into DPI. And we haven’t seen many models for selling yet. At least none have surfaced publicly or privately for us. The best thought piece we’ve seen in the space has been Fred Wilson’s Taking Money “Off the Table”. At USV, they “typically seek to liquidate somewhere between 10% and 30% of our position in these pre-IPO liquidity transactions. Doing so allows us to hold onto the balance while de-risking the entire investment.”
As such, it gave birth to a thought… What if selling was more of a science?
What would that look like?
Between two Daves, it was not the Dave with sneakers and a baseball cap and with the profound disregard to healthy diets, given the fat slab of bacon in his croissan’wich, who had the answer there.
“To start off, in a concentrated portfolio of 30 investments, a fund returner is a 30x investment. For a 50-investment fund, it’s 50x. And while hitting the 0.5x DPI milestone by years 5-8, and a 2x DPI milestone by years 8-12, is the sign of a great fund, you shouldn’t think about selling much of your TVPI for DPI unless or until your TVPI is starting to exceed 2-3x.” Which seems to corroborate quite well with Chamath Palihapitiya’s findings that funds between 2010 and 2020 convert have, on average, converted about 25% of their TVPI to DPI.
“Moreover, usually you shouldn’t be selling more than 20% of the portfolio at one time (unless you’re locking in / have already locked in 3X or more DPI). You should be dollar-cost averaging – ensuring time diversity – on the way out as well. AND usually only if a company that’s UNDER-growing or OVER-valued compared to the rest of your portfolio. Say your portfolio is growing at 30% year-over-year, but an individual asset is growing slower at only 10-20% OR you believe it is overvalued, that’s when you think about taking cash off the table. Sell part (or even all) of your stake, if selling returns a meaningful DPI for the fund, and if you’re not capping too upside in exchange for locking in a floor.”
Meaningful DPI, admittedly, does mean different benchmarks for different kinds of LPs. For some, that may mean 0.25X. For others that may mean north of 0.5X or 1X.
“On the other hand, if a company is outperforming / outgrowing the rest of the portfolio, generally hold on to it and don’t sell more than 10-20% (again, unless you’re locking in meaningful DPI, or perhaps if it’s so large that it has become a concentration risk).”
I will caveat that there is great merit in its counterpart as well. Selling early is by definition capping your upside. If you believe an asset is reaching its terminal value, that’s fine, but do be aware of signaling risk as well. The latter may end up being an unintended, but self-fulfilling prophecy.
So, it begged the question: Under the assumption that funds are 15-year funds, what is meaningful DPI? TVPI? At the 5-year mark? 7.5 years in? 10 years? And 12.5 years?
The truth is the only opportunities to sell come from the best companies in your portfolio. And probably the companies, if anything, you should be holding on to. By selling early, you are capping your downside, but at the same time capping your upside on the entire portfolio. When the opportunity arises to lock in some DPI, it’s worth considering the top 3-5 positions in your fund. For instance, if your #2 company is growing quickly, you may not be capping the upside as much.
Do keep in mind that sometimes it’s hard to fully conceptualize the value of compounding. As one of my favorite LPs reminded me, if an asset is growing 35% year-over-year, the last 20% of the time produces 56% of the return. Or if an asset is growing 25% YoY, if you sell 20% earlier (assuming 12 year time horizons), you’re missing out on 45% of the upside.
As a GP, you need to figure out if you’re IRR or multiple focused. Locking in early DPI means your IRR will look great, but your overall fund multiple may suffer.
As an LP, that also means if the gains are taxable (meaning they don’t qualify for QSBS or are sold before QSBS kick in), you need to pay taxes AND find another asset that’s compounding at a similar or better rate. As Howard Marks puts it, you need to find another investment with “superior risk-adjusted prospective returns.”
And so began the search for not just moolah in da coolah, but how much moolah in da coolah is good moolah in da coolah? And how much is great?
Net TVPI Benchmarks from Years 5-15Net DPI Benchmarks from Years 5-15
Some caveats
Of course, if you’ve been around the block for a minute, you know that no numbers can be held in isolation to others. No facts, no data points alienated from the rest.
Some reasons why early DPI may not hold as much weight:
Early acqui-hires. Usually not a meaningful DPI and a small, small fraction of the fund.
There’s a possibility this may be the case for some 2020-2021 vintages, as a meaningful proportion of their portfolio companies exit small but early.
In other words, DPI is constructed of small, but many exits, rather than a meaningful few exits.
TVPI is less than 2-3x of DPI, only a few years into the fund. In other words, their overall portfolio may not be doing too hot. Obviously, the later the fund is to its term, the more TVPI and DPI are alike.
As a believer in the power law, if on average it takes an outlier 8 years to emerge AND the small percentage of winners in the portfolio drive your return, your DPI will look dramatically different in year 5 versus 10. For pre-seed and seed funds, it’s fair to assume half (or more) companies go to zero within the first 3-5 years. And in 10 years, more than 80% of your portfolio value comes from less than 20% of your companies. Hell, it might even be 90% of your portfolio value comes from 10% of your companies. In other words, the power law.
GPs invested in good quality businesses. Some businesses may not receive markups, but may be profitable already, or growing consistently year-over-year that they don’t need to raise another round any time soon.
Additionally, if you haven’t been in the investing game for long, persistence of track record, duration, and TVPI may matter more in your pitch. If you’ve been around the block, IRR and DPI will matter more.
As the great Charlie Munger once said, “selling for market-timing purposes actually gives an investor two ways to be wrong: the decline may or may not occur, and if it does, you’ll have to figure out when the time is right to go back in.” For private market investors, unless you can buy secondaries, you’ll never have a time to go back in until the public offering. As such, it is a one-way door decision.
Some LPs are going to boast better portfolios, and we do admit there will be a few with portfolios better than the above “benchmarks.” And if so, that’s a reason to be proud. In terms of weighting, as a proponent of the power law, there is a high likelihood that we’ve underestimated the percent of crap and meh investments, and overestimated the percent of great investments in an LP’s portfolio. That said, that does leave room for epic fund investments that are outliers by definition.
We do admit that, really, any attempt to create a reference point for fund data before results speak for themselves is going to be met with disagreement. But we also understand that it is in the discourse, will we find ourselves inching closer to something that will help us sleep better at night.
One more caveat for angels… The truth is as an angel, none of the above really matter all that much. You’re not a fiduciary of anyone else’s capital. And your time horizons most likely look different than a fund’s. It’s all yours. So it’s not about capping your downside, but more so about capping your regret. In other words, a regret minimization framework (aka, “spouse regret/yelling minimization insurance”).
That will be so unique to you that there is no amount of cajoling that we could do here to tell you otherwise. And that your liquidity timelines are only really constrained by your own liquidity demands.. For instance, buying a new home, sending kids to college, or taking care of your parents (or YOU!) in their old age.
But I do think the above is a useful exercise to think through selling if you had a fund. You would probably break it down more from a bottoms up perspective. What is your average check size? Do you plan to have a concentrated portfolio of sub-30 investments? Or more? Do you plan to follow on? How much if so? And that is your fund size.
In closing
Returning above a 3x DPI is tough. Don’t take our words for it. Even looking at the data, only 12.5% of funds return over a 3x DPI. And only 2.5% return three times their capital back on more than 2 separate funds.
In the power law game we play, as Michael Mauboussin once said, “A lesson inherent in any probabilistic exercise: the frequency of correctness does not matter; it is the magnitude of correctness that matters.” Most will return zero, or as Jake Kupperman points out: More than 50%.
But it’s in the outliers that return meaningful DPI, not the rest. Not the acqui-hire nor really that liquidation preference on that small acquisition.
At the end of the day, the goal isn’t for any of the above to be anyone’s Bible, but that it’d start a conversation about how people look at early returns. If there is any new data points that are brought up as a result of this blogpost, I’ll do my best to update this thread post-publication.
Big thank you to Dave McClure for inspiring and collaborating on this piece, and to Eric Woo and all our LP friends who’ve helped with the many revisions, sharing data, edits, language and more. Note: Many of our LP friends chose to stay anonymous but have been super helpful in putting this together.
Footnotes
For the purpose of this piece, we know that “good” and “great”, in fact all of the superlative adjectives, are amorphous goalposts. And those words may mean different things to different people. This blogpost isn’t meant to establish a universal truth, but rather serve as a useful reference point for both LPs, looking for “benchmarking” data, and GPs to know where they stand. For the latter, if your metrics do fall in the “good” to “great” range, they’re definitely worth bragging about.
And so with that long preamble, in the piece above, we defined “good” as top quartile, and “great” as top decile. “Good” as a number on its own, enough for an LP to engage in a conversation with you. And “great” as a number that’ll make LPs running to your doorstep. Or at least to the best of our portfolios, leveraging both publicly reported and polled numbers as well as our own.
Our numbers above are also our best attempt in predicting steady state returns, divorcing ourselves from the bull rush of the last 3-5 vintage years. As such, we understand there are some LPs that prefer to do vintage benchmarking, as opposed to steady state benchmarking. And this blogpost, while it has touched on it, did not focus on the former’s numbers.
EDIT (Aug 18, 2023): Have gotten a few questions about where’s the data coming from. The above numbers in the Net DPI and Net TVPI charts are benchmarks the LPs and I agreed on after looking into our own anecdotal portfolios (some spanning 20+ years of data), as well as referencing Cambridge data. These numbers are not the end-all-be-all, and your mileage as an LP may very much vary depending on your portfolio construction. But rather than be the Bible of DPI/TVPI metrics, the purpose of the above is give rough reference points (in reference to our own portfolios + public data) for those who don’t have any reference points.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
I recently learned that in FISM competitions — competitions hosted by the International Federation of Magic Societies (if the letters aren’t in order, it’s because FISM is in French not in English), that the judges don’t have to award any prizes. Meaning if they don’t think any of the magicians and their acts are up to par, they don’t have to dole out a first, second or third place. And according to Simon Coronel, it happens quite often. The goal is simple. That winning first place should mean something. Not just because you’re better than the rest that day or that year, but that you really deserve to stand among the greats.
And it got me thinking. Are there other fields that should strive for the same level of rigor?
For instance, does an Oscar need to be awarded every year for each category?
Or an Olympic gold medal for each event every four? (Although a caveat to my own, if the rules change, like when in 2010, they banned male full-body suits when swimming at the international stage, then there should be a reevaluation of excellence.)
And there might be some years that the best prize awarded should just be a second place one.
Then there are other contests, where the number of prizes only seem to increase. In other areas, namely to join certain rankings organized by members of the press, you have to pay for your spot. The latter of which I have no experience in. But had heard of accounts from friends who have.
The truth is it’s not my place to rate the world’s greatest artists or athletes. But it does make you wonder that if the magic society can hold themselves to that high of a regard, why can’t the rest of us do so?
Once upon a note
As all good Asian children did, once upon a time, I learned to play the piano since I was five. One of many teachers and admittedly the one I was with for the longest happened to this sweet lady who taught her students out of her home. And every year, usually around the beginning of summer, she would rent out a hall and host a recital between all her students. Every student (and she had 30-40 students) — from beginning to master — would play one song.
The whole recital would last about 2-3 hours. And at the close, there would be an award ceremony. For each skill category, there would be a Best of Show trophy. And for everyone else, a participation trophy. When I was first started off and was quite bad, that participation trophy felt great, even if I was only playing Twinkle Twinkle Little Stars. I put it at the top of my shelf next to my bed, so I would see it every morning when I woke up.
Then 1-2 participation awards later, they had lost their luster. The Best of Show is now what I was aiming for.
For a brief period of time, that was my goal. And eventually I got it. But I remember when I finally got it, I wasn’t nearly as elated as I thought I’d be. ‘Cause that year my teacher decided that one Best of Show wasn’t enough. Three felt right to her. To be fair, I don’t know if she had over-ordered or just felt the need to give more out due to some parental complaints. But I remember receiving mine alongside someone who I knew made a few hiccups on stage. And even though I did the best I could have, I didn’t feel like I deserved it.
So that night, I didn’t even put the Best of Show trophy on my shelf.
A side corollary to angel investing
The greatest feature of being an angel investor (as opposed to being a VC) is that you can be opportunistic. Your fund size is your own liquidity. You’re not tied down to a mandate. Or a deployment schedule. And if so, self-induced. What it means is that you invest only when you see a great company and team. Anything south of that means you don’t have to. You don’t have to award a check to a founder if you don’t feel they’re deserving of a first place. And because of that, “first place” actually means something. Not only to the founders you invest in, but to you.
That said, playing my own devil’s advocate, much of early-stage investing is luck-based game. And it is foolhardy to attribute to skill when a large amount of variables is unbeknownst at the time of investing — be it asymmetric information, or market conditions, incumbent moves, or purely black swan events in the future. The latter few, you need to count on luck more than once. And luck purely defined as “uncertainty in outcome,” in the words of the great Richard Garfield.
#unfiltered is a series where I share my raw thoughts and unfiltered commentary about anything and everything. It’s not designed to go down smoothly like the best cup of cappuccino you’ve ever had (although here‘s where I found mine), more like the lonely coffee bean still struggling to find its identity (which also may one day find its way into a more thesis-driven blogpost). Who knows? The possibilities are endless.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
Somehow do a better job of massaging the current data, which is challenging; or you have to
Be better at making qualitative judgments; or you have to
Be better at figuring out what the future holds.”
And while I go in length why the above are true in a former piece… today, I want to postulate a fourth.
Be better at listening to the silence.
Let me elaborate.
Facts and opinions
If I were to ask you, what day’s your birthday? I bet you could answer pretty quickly.
And the same would be true, if I asked you the color of the sky. Or what you ate for breakfast in the morning. Questions on facts have factual answers. There is either one immediate answer, or an answer you know exactly how to find, and at the very end, still a definitive answer. An example of the latter would be, What is the temperature right now?
On the other hand, if I were to ask you, what do you think about your life partner? The answer varies. You might say she or he is reliable. Or caring. And kind. And if I follow up with silence, you might spend some time thinking and filling the void with more words. Those words… are powerful. They simmer all of your life experiences and your stories — all your trials and tribulations, years, months, weeks, days, hours and minutes — onto a neatly organized platter for the other person. Those words that summarize it all are powerful. But what’s even more interesting to investor is the time it takes to come up with those words. That precious time, as your life is playing out like a flipbook, spends its precious milliseconds hugging silence.
No matter how miniscule those gaps are, they exist. And our goal as investors, and even more so for startup investors or emerging fund investors, with very little data to go on, is to create new datasets. In essence, to ask questions where the answers don’t just fill the air with vibrations, but to find answers that are dotted with tranquil stillness.
Great investors read between the lines. Listen to the pauses — the spaces between words. They look for the quiet thing out loud.
That silence is often more telling than anything you could put on a pitch deck or in a templated answer of “Tell me about your company.”
In closing
I know in this side of the world, we talk a lot about 10-year overnight successes. But let’s focus on the first two words of that phrase first. Ten-year. Startup journeys are long. They’re arduous. More things will go wrong than right. In the words of a serial founder with a few 9-figure exits under his belt, he once told me, “This shit sucks.” It’s tough. And if anyone discounts that — be it founder, operator, investor, friend or family — they don’t get it.
But that’s the very reason why investors look for grit, passion, and for me, obsession. But it’s also not a question we can really ask without getting a gift-wrapped, carefully-prepared answer. And so pushing the boundaries of questions is our job as investors. Why? Because even if for a moment, it sheds light into who we’re truly talking to.
And if there’s evidence of grit, passion, or obsession there, there might be something special.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
VCs win upon liquidity event. And that happens either via M&A or via going public. After that, the shares are transferred to the hands of the LPs and they choose how they’d like to liquidate or keep. To date, we have neither seen a trillion dollar acquisition nor a trillion dollar IPO. I’m not saying it’ll never happen. I’m sure it will, at some point. A combination of inflation and companies finding more liquidity when private markets are bullish.
As Charles Hudson suggests in his one of his latest posts, the venture world has been changing. What was once a cottage industry gave way to multi billion dollar funds. While there are still many small sub-$100M funds, LPs have started evaluating venture capital not as just one big industry, but segmenting it by size of fund. Small funds, sub-$100M. Medium-sized funds, $100-500M. And big funds, funds north of $500M assets under management (AUM for short). And as the Mike Maples dictum goes, your fund size is your strategy.
Returning a billion-dollar fund requires different kinds of investments and math for it to work compared to returning a $50M fund. And one day, as large funds continue to expand into multiple stages, check size, but also eventually into public markets, we might see them start to bet on trillion-dollar outcomes. Because to return a 11- or 12-figure fund, you need to do just that. But given the market we’re in now, I imagine that won’t be in the near future.
The 10,000-foot view
So the thing you have to gain conviction around, as a macroeconomist, is not how big a venture fund should be. Nor the debate on how many VC funds is too many. The number nor the size truly matter in the grand scheme of things.
For an illiquid asset class like venture, where you’re betting on the size of the home runs, not one’s batting average, what you have to gain conviction around is:
How many truly great companies are there every year
How much capital is needed to get these companies to billion dollar outcomes
For the latter, there are two main ways to get to billion dollar exits: going public or getting acquired. And while there are outliers, the best way is for these businesses to get to $100M of recurring revenue.
And everything else is downstream of that.
As an LP once told me, “In the 1990s, it took $7 million to get to first revenue. In the 2000s and into the early 2010s, it took $700K. Now it takes $70K.” With each era and each wave of technological development, founders become more capital efficient. There are less barriers to get to market. Now with AI, it might just be $7K to get to first revenue, if not sooner.
The question is how much capital is needed to get to $1M ARR. If we take a decent burn multiple of 1.5x, then we underwrite an assumption that it’ll take $1.5M to get to $1M ARR. And possibly $4.5M to get to $3M ARR. And somewhere in there, that founder will find product-market fit and turn on the growth engine. CAC (customer acquisition cost) falls. And lifetime value increases. Payback periods shorten. And if all goes well, founders may find themselves with a sub-one burn multiple. And after they hit $1M ARR, and they triple the first two years, double the next three, they’re at $100M ARR. Of course, I’m illustrating the above all in broad strokes. The best case scenario. But most things don’t go according to plan.
Then an investor has to figure out if one should only make net new investments or re-capitalize a select few of their existing investments.
Then as LPs, what is the minimum ownership percentages that can return funds at each differentiated stage and fund sizes? And due for possibly another blogpost altogether, how does a 7-8x multiple on forward-looking ARR impact round sizes and valuations across bull and bear markets?
All this admittedly is both art and science. But I will admit that larger fund sizes and playing the AUM game may not be the answer.
In closing
My friend recently sent me this letter that Sam Hinkie wrote when he retired as GM of the 76ers. In it, he quoted the great Sage of Omaha when he closed down Buffett Partnership. “I am not attuned to this environment, and I don’t want to spoil a decent record by trying to play a game I don’t understand just so I can go out a hero.” And it’s for that same reason, Sam stepped down. The same reason Jerry Seinfield turned down $110 million to do another season of Seinfeld. Even though the sequel business does quite well.
There is no shame in knowing when to hang up the cleats. And there is great power in being disciplined. In fact, it’s one of the most sought-after traits in fund managers. If not, the most sought-after.
In VC, it comes in all sizes, ranging from:
Fund size discipline. There a lot of GPs out there who have gone on to raise 9- to 10-figure early stage funds. A mathematical equation that becomes increasingly harder to prove true, given outputs need to reflect inputs. In other words, larger funds are harder to return. There are a lot of VCs who would rather play the AUM (assets under management) game than stay disciplined on returns. Not just paper returns, but real cold hard cash. In the words of my friend Chris Douvos, “moolah in da coolah.” To quote another line from Chris, “OPM (other people’s money) is like opium. It’s addicting.” Something one too many investors have gotten addicted to.
Thesis discipline. As a friend who’s been a VC across multiple economic cycles once told me, it’s much better to turn down an off-thesis hot deal led by a top tier firm than to take it.
Career discipline. To echo the words of Sam Hinkie above.
And of course, knowing that we underwrite billion dollar outcomes, rather than trillion dollar ones. Then again, that’s just a subset of fund size and portfolio construction.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
Folks coming out of school and/or are still in school often ask me how they should break into venture. It’s surprisingly a timeless question. The goalposts change every era. And as the signal-to-noise ratio and regression line oscillates in bull and bear markets, young professionals chase a moving target.
That said, while my opinions will likely change when the facts change, as of now, this is my best proxy for a timeless answer. Market risk versus execution risk.
Let me elaborate.
Early in your career, you should take market risk. Bet where others are not willing to bet. Or have the same starting point as you do. If the starting line is even, it’s all about how much faster you can run compared to your peers. And if you can outlearn them, ideally because of internal drive and motivation, you’ll be the incumbent in the space in the future.
Execution risk is what you pursue as you grow. Your network, your expertise, and your experiences make you a more robust executioner. You’re an incumbent. You’re a juggernaut. There’s no reason to focus on this risk when you’re younger because you don’t have an unfair advantage here. In fact, you have an unfair disadvantage. Others more senior to you have a better network, more expertise, and have done more reps than you have.
Steve Jurvetson recently shared the only rule of business that is inviolate. “Take any company that is large or top three in their industry. They will never lead the charge to disrupt that industry.” He goes on to say, that even in recent years, Google didn’t fight to change search until OpenAI. Apple is innovative outside their core business, but never in their core business. So as a result, innovation needs to come from the bottom. People who are willing to take market risk.
Similarly, in venture, as a young VC, you need to build your own thesis. For as long as you are investing on the basis of someone else’s thesis, you are competing on execution risk. And every VC who’s older, wiser, and more connected than you are on that thesis will out-execute you.
So… the risk you have to take is betting on a brand new thesis. That no one else is pursuing. No one else is investing by it. And that… is market risk.
The above is no less true if you’re an emerging GP. Your fund lacks the resources, likely the connections, the experience, the talent, and the ability to out-execute your incumbent on your incumbent’s thesis. The solution is to just not play when they have the home field advantage.
It’s why thesis and the question “Why does another venture fund need to exist?” matter so much to LPs betting on new fund managers.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
There was a fascinating episode on the Tim Ferriss Show recently, where we get the inside baseball on how David Maisel, founder of Marvel Studios, raised half a billion on a promise for a company who’s public market cap at the time was only a fifth of a billion. Naturally, not only was he against a lot of headwind externally, but internally as well. According to the board at the time, they would only greenlight the idea of producing their own films (as opposed to licensing their IP out) if “Marvel had no risk. Not little risk, but no risk.”
On the cusp of Captain America and Thor being licensed away, David asked the board to give him six months. The “zero risk” pitch then came in the form of external funding, huge financial upside (if things worked out), market timing, and a promise.
Financial upside for Marvel
As David puts it:
“First to my board, the argument, was if we own our own studio, it means we get the full financial upside that they understood very well.” As opposed to licensing, their traditional business model. Where Marvel only got five cents on every dollar of profit. As was the case with SONY and Spiderman.
“Number two, we decide on greenlight when the movies get made that they also understood because they only sold toys really at the time, and the toys were contingent on a movie, which they then control the timing. Now when you’re doing a public company and you’re giving guidance every year, how can you give guidance if you don’t even know what movies are going to get made? And so controlling greenlight was important, full creative control.”
Moreover, the team was able to take 5% of revenues as the producer fee AND keep all non-film revenues (i.e. toys, video games, etc.). And even if four out of the five films lost capital, they’d still make $25M in revenue each. In other words, $100M in sum. Half of Marvel’s public market cap at the time. Whose cap was only based on toy sales.
Market timing
“The bond bubble of 2004 was happening,” as David shared, “so it was a time where there was loans being made that shouldn’t have been made. And a lot of people were enamored with Hollywood as they get enamored every few years.”
Zero downside
Instead of funding the studio off balance sheet, David would go out to fundraise from others. So what was the external pitch?
“Give me four at bats, and if one of them hits, then every movie’s a sequel after that.”
On top of all the above, to me, there were some interesting terms for the investment that helped sweeten the deal:
Merrill Lynch got a 3% success fee upon the $525M closing.
David got a low interest rate loan from Merrill by getting it insured by MPAC, therefore the debt became AAA debt, which “was easy to sell to pensions and easy to sell to individual investors” in case things went awry.
Now I’m not sure if this is standard Hollywood practice. But I imagine it’s not, at least back in ’03 and ’04. I’m a venture guy after all. And as one, the above is news to me.
That said, the banks David went to fundraise from were not taking equity. It was “pure debt. So very low interest rate. And the only collateral were the film rights to ten Marvel characters of which we could make for the movies.” Which, to me, ten characters sounds like a lot for a company whose business is characters. I also imagine these were characters that had some level of historical fanbase, so they weren’t random ones from the archives.
But David clarifies. “A lot of people misunderstand that they think we pledged ten of our characters as collateral. It wasn’t that at all because in the worst case scenario, it only got collected if we lost money on those first four movies. And then those six characters, we owned all the rights besides film. And if a film was ever made by the bank, whoever collected this collateral, we got the same license fee that we get if we just license it that day to a party. So there was no opportunity cost.”
And the promise
This is history now, but at the time, was a bold claim. The idea was borne out of frustration as an entertainment investor. That:
Marvel couldn’t capture a large part of enterprise value through productions with just licensing
The first movie business was horrible. Sequels, on the other hand, were a lot more predictable. So, the focus after the first movie would not be on predicting profit, but maximizing profit margins.
So David had a thought. “What if after the first movie, every movie after that was a sequel or a quasi-sequel, which required all the characters, or a lot of the characters, to show up in multiple movies?”
The idea of sequel snowballed into what we now know as the MCU — the Marvel Cinematic Universe.
Bringing it back to venture
It’s a nice corollary to raising a Fund I, where you’re also selling a promise. A world vision. A painting of the future. Nothing’s proven yet. You’re sure as hell not selling a repeatable strategy yet, and definitely not any returns. Since there’s a good chance you haven’t returned capital to LPs before.
And this is true for not just funders, but also founders. In the words of Mike Maples, “Breakthrough builders are visitors from the future, telling us what’s coming. They seem crazy in the present but they are right about the future.
“Legendary builders, therefore, must stand in the future and pull the present from the current reality to the future of their design. People living in the present usually dislike breakthrough ideas when they first hear about them. They have no context for what will be radically different in the future. So an important additional job of the builder is to persuade early like-minded people to join a new movement.”
Dissent is a luxury
The truth is loads of people will disagree with you. You’re not looking for consensus. In fact, it’s better to be wrong and alone than right and with the crowd if you’re in the venture world. Either as a founder or an emerging GP. It’s something I recently learned from the one and only Chris Douvos. If you imagine a 2×2 matrix… On one axis, you have right and wrong. On the other, you have with the crowd and alone. You want to be in the right and alone quadrant for sure. That’s where “fortune and glory” exists. It’s where alpha exists. It is how you become an outlier and achieved outsized returns.
But the prerequisite to be there is to have the guts to start in the wrong and alone quadrant. If you start from being right and in the crowd, you’re one among many. And that doesn’t give you the liberty to have independent thinking. You’re constantly trapped in noise.
It’s as Abhiraj Bhal says. “If you are a category-defining company, you will always have a TAM question, if the category is defined by somebody else, you will not have a TAM question.” You want people to question you. And as humans, we like to fit in. But to create something transcendent, external doubt is your best friend.
As such, your promise of the future must seem bizarre.
Don’t start with the product, start with your customers
When you have a promise, admittedly, the easiest way is to start engineering it right away. Without market validation. Without stress testing. Which pigeonholes a number of founders. I forgot the origination, but there’s a great line that says, “The only difference between a hallucination and a vision is that other people can see the latter.”
And in order to test that, you need to get in front of potential users and customers first. Max, someone I had the joy of working with, once wrote the below timeless tweet:
My hot take of the day:
Most aspiring startup founders who think they should learn to code would be better off learning to write well instead.
As Elizabeth once shared: “We decided that we’d start with no product. We would not build anything. And, we just started selling ads. We manually brokered deals with publishers and advertisers and took a cut in between. We got our customers by emailing people and setting up the copy and links ourselves. People would pay me through my personal PayPal account. It was only when we realized we were onto something that we started building technology to remove bottlenecks.”
On the investor side, it’s building a thesis where great investments fall into. It’s a way of looking at the world in a perspective that may seem foreign to others, but almost obvious in retrospect. The thesis should elicit the response, “Why didn’t I think of that first?” But no matter how obvious, you are the best positioned to bring the thesis to life. That doesn’t mean you need returns yet. Although good graduation rates certainly help as a leading indicator.
In that regard, it’s quite similar to how David Maisel foretold of the Universe to come. Obvious once explained, yet still met with resistance from legacy players.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
Surprisingly, last week was the first week I’ve gone to multiple events for a given conference. Also I’m using the word “conference” very loosely here since I’m counting a tech week as one. What started off as ‘I’m going to support just one friend,’ ended up being a slippery slope, and supporting many friends, and catching up with friends in town. I mean, c’mon, how do you not at least say hi to a friend who’s flown from NYC or Miami? Perks of being bad at saying no.
That said, for the founder focused on getting to product-market fit, or actively fundraising, or the GP fundraising, your time is better spent elsewhere. But if you’re exploring and trying to increase the surface area for luck to stick, these events are great. So many fun, interesting ideas floating around.
Eight quick takeaways, before I go back and I let you go back to the rest of your week:
For VC/founder events, most attendees are founders. Smaller VCs went to the GP events. Bigger VCs just host their own.
For LP/GP events, most attendees are GPs. Went to an event of this type, and I kid you not, only met 2 LPs out of 15 people I chatted with. The rest were GPs. The folks you would like to show up at VC/founder events would rather pitch than to be pitched.
Interestingly enough, for the events that have a good proportion of LPs, most don’t seem to be investing in emerging managers. Anecdotally, have heard three of my friends who are individual LPs get turned down from LP events during SF Tech Week.
Smaller funds seem harder to raise than larger funds.
US large family office and institutional LP market is drying up. Most have overextended to buyouts and still need therapy for being burned in 2020 and 2021. For those that haven’t, they’re resorting to intros from friendlies.
Hosting your own events gives you better bang for your time than attending events.
And as one would suspect, AI dominates 70-80% of conversation.
Investing in unsexy industries is sexy. New moniker is to invest in industries where either 1/ people have scruffy beards or unkempt hair or 2/ meetings that require suit and tie.
Stay awesome, friends!
#unfiltered is a series where I share my raw thoughts and unfiltered commentary about anything and everything. It’s not designed to go down smoothly like the best cup of cappuccino you’ve ever had (although here‘s where I found mine), more like the lonely coffee bean still struggling to find its identity (which also may one day find its way into a more thesis-driven blogpost). Who knows? The possibilities are endless.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
Voila, the fourth installation of 99 soundbites I’ve been fortunate enough to collect over the past year. The first four of what I imagine of many more to come. Each of which fall under one of the ten categories below, along with how many pieces of advice for each category:
You can also find the first three installments of 99 pieces of advice for both founders and investors here. Totaling us to a total of 396 pieces of advice.
But without further ado…
Fundraising
1/ If you’re an early stage startup, expect fundraising to take at least 3-4 months to raise <$1M. If you’re on the fast side, it may take only 2 weeks. – Elizabeth Yin*timestamped April 2022
2/ If you’re going to raise a round over 6-12 months, it often doesn’t seem fair that your first commits have the same terms as those who commit 6 months later, since you’ve grown and most likely have more traction at the time. As such, reward your early investors with preferred terms. Say you’re raising a $1M round. Break the round up to $300K and $700K. Offer a lower cap on SAFEs for the $300K. “Tell everyone that that offer will only be available until X date OR until you hit $300k in signed SAFEs. And that the cap will most likely go up after that.” Why? It lets you test demand and the pricing on the cap – to see if you’re cap is too high or too low on the first tranche. – Elizabeth Yin
3/ As a startup in recessionary times, you have to grow your revenue faster than valuations are falling to make sure you raise your next round on a mark up. Inspired by David Sacks and Garry Tan. *timestamped April/May 2022
4/ There’s only going to be 1/3 the amount of capital in the markets than in 2020 and 2021. So plan accordingly. If you’re not a top 0.1% startup, plan for longer runways. Fund deployments have been 1-1.3 years over the past 1.5 years, and it’s highly likely we’re going to see funds return back to the 3-year deployment period as markets tighten. *timestamped May 2022
5/ B2B startups that have the below disqualifiers will find it hard to raise funding in a correcting venture market:
No to little growth. Good growth is at least doubling year-over-year.
Negative or low gross margins. Good margins start at 50%.
CAC payback periods are longer than one year.
Burn multiples greater than 2 (i.e. You’re burning $2 for every dollar you bring in). A good burn multiple is 1 or less. – David Sacks
6/ Beware of “dirty term sheets.” Even though you’re able to get the valuation multiple you want, read the fine print for PIK dividends, simple “blocks” on IPO/M&A, and 2-3x liquidation preferences. Inspired by Bill Gurley.
7/ “This came at a very expensive valuation with certain rights that should not have come with it — like participating preferred, which is they first get their money out and then they participate in the rest, which was OK for the earlier rounds, but not for the later ones.” – Sabeer Bhatia in Founders at Work
8/ In a bear market, public market multiples are the reference points, not outlier private market multiples. Why? Public market multiples are their exit prices – how they return the fund. It matters less so in bull markets. – David Sacks
9/ Don’t trust the “why”, trust the “no.” Investors don’t always give the most honest responses when they turn down a company.
10/ If you inflate your projections, the only investors you’ll attract are dumb investors. They’ll be with you when things are going well and make your life a living nightmare when things aren’t, will offer little to no sound advice, and may distract you from building what the market needs. By inflating your projections, you will only be optimizing for the battle, and may lose the war if you can’t meet or beat your projections.
11/ VCs will always want you to do more than you are pitching. So if you’re overpromising, they’re raising their expectations even more down the road.
12/ Five questions you should answer in a pitch deck:
If you had billboard, what 10 words describe what you do?
What insight development have you had that others have not?
How you acquire customers in a way others can’t?
Why you?
What you need to prove/disprove to raise next round? – Harry Stebbings
13/ The longer you’re on the market, the greater the differential between expectations and reality, and the harder it is over time to close your round. Debug early on in the fundraising process (or even before the fundraising process) by setting and defining expectations through:
Leveraging market comparables. You don’t have to be good at everything, but you have be really really amazing at one thing your competitors aren’t. It’s okay if they’re better than you in other parts.
14/ You should reserve 10% of your round to allocate to your most helpful existing investors. Reward investors for their help. – Zach Coelius
15/ If your next round’s investor is willing to screw over your earlier investors out of pro rata or otherwise. After they leave, the only one left to screw over is you. – Jason Calacanis
16/ “Nobody’s funding anything that needs another round after them.” – Ben Narasin quoting Scott Sandell
17/ “When a VC turns you down for market size, what they are really saying is: I don’t believe you as the founder has what it takes to move into adjacent and ancillary markets well.” – Harry Stebbings
18/ When raising from corporates, be mindful of corporate incentives, which may limit your business and exit opportunities. “I’ve often seen the structure just simply be a SAFE with no information rights. No Board seats. Check sizes that are worth < 5% ownership. No access to trade secrets.” – Elizabeth Yin
19/ LOIs mean little to many investors, unless there’s a deposit attached to it. A customer must want the product so much they’re willing to take the risk of putting money down before they get it. 1-5% deposit would be interesting, but if they pay the product in full, you would turn investor heads. – Jason Calacanis
20/ “The most popular software for writing fiction isn’t Word. It’s Excel.” – Brian Alvey
21/ “Ask [prospective investors] about a recent investment loss, where the company picked someone else. See how they describe those founders, the process, and what they learned. This tells you what that investor is like when things don’t go their way.” – Nikhil Basu Trivedi
22/ “Founders, please hang onto at least 60% of the company’s equity through your seed raise. Series A or B is the first time founder equity should dip below 50%. I’ve seen cap tables recently where investors took too much equity early on, creating financing risk down the road.” – Gale Wilkinson
23/ “One of the worst things you can say to a VC is ‘we’re not growing because we’re fundraising.’ There are no excuses in fundraising.” – Jason Lemkin. Fundraising is a full-time job, but when you’re competing in a saturated market of attention, it’s you who’s fundraising, but not growing, versus another founder who’s also fundraising and is growing.
25/ The goalposts of fundraising (timestamped Oct 20, 2022 by Andrea Funsten):
Pre-seed: $750K-1.5M round
Valuation: $5-10M post (*She would not go over $7M)
Traction:
A working MVP
Indications of customer demand = have interviewed hundreds of potential customers or users
2-5 “Design Partners” (non-paying customers or users)
Seed: $2-5M round
Valuation: $12-25M post (*She would not go over $15M)
Traction:
$10-15K MRR, growing 10% MoM
6-12 customers who have been paying for ~6 months or more, a few that would serve as case studies and references
Hired first technical AE
Series A: $8-15M round
Valuation: “anyone’s guess”
Traction:
$1.5M in ARR is good, more like $2M
3x YoY growth minimum, but more like 3.5x • 12-20 customers, indications of ACV growth
Sales team in place to implement the repeatable sales playbook
26/ Don’t take on venture debt unless you have revenue AND an experienced CFO. – Jason Calacanis
27/ When you are choosing lead investor term sheets:
For small VC teams (team <10ppl): Make sure your sponsoring partner is your champion. Why does investing in you align with their personal thesis? Their life thesis? Which other teams do they spend time with? How much time do they spend with them? When things don’t go according to plan, how do they react? How do they best relay expectations and feedback to their portfolio founders?
For larger platform teams (team >10ppl): Ask to talk to the 3-5 best people at the firm. And when the investor asks you to define “best”, ask to talk to their team members who best represent the firm’s culture and thesis. Why? a/ This helps you best understand the firm’s culture and if there’s investor-founder fit. b/ You get to know the best people on the team. And will be easier to hit them up in the future.
28/ “If you are a category-defining company, you will always have a TAM question, if the category is defined by somebody else, you will not have a TAM question.” – Abhiraj Bhal
29/ “[Venture] debt typically has a 48-54 month term, as follows: 12 months of a draw period (ballooned to 18 months over the last few years), to which you can decide to use it or not 36 months to amortize it after that 12 months. The lender at this stage is primarily underwriting to venture risk, meaning they are relying on the venture investor syndicate to continue to fund through a subsequent round of financing.” This debt is likely to be paired with language that allow the fund to default if investors say they won’t fund anymore and/or just not to fund when asked. “They typically are getting 10bps-50bps of equity ownership through warrants. Loss rates must be <3-4% for the model to work.” If there’s less than 6 months of runway or cash dips below outstanding debt, then as a founder, expect a lot of distracting calls. – Samir Kaji
30/ The best way to ask for intros to investors is not by asking for intros, but by hosting an event and having friends invite investors to the event. There’s less friction in an event invite ask than an investor intro ask. The reality is that the biggest investors are inundated with intro requests all the time, if not just by cold email too.
Cash flow levers
31/ The bigger your customers’ checks are (i.e. enterprise vs. SMB vs consumer), the longer the sales pipeline. The longer the sales pipeline, the longer you, the founder, has to stay the Head of Sales. For enterprise, the best founders stay VP of Sales until $10M ARR. For SMB, that’s about $1-2M ARR, before you hire a VP of Sales. Inspired by Jason Lemkin.
32/ “‘I have nothing to sell you today — let’s take that off the table and just talk,’ he would say. ‘My goal is to earn the right to have a relationship with you, and I know it’s my responsibility to earn that right.'” The sales playbook of David Beirne of Benchmark Capital fame, cited in eBoys.
33/ “All things being equal, a heavy reliance on marketing spend will hurt your valuation multiple.” – Bill Gurley
34/ If you were to double or triple the price of your product, what percent of customers would churn? If the answer is anything south of 50%, why aren’t you doing it?
35/ Getting big customers and raising capital is often a chicken-and-egg game. Sometimes, you need brand name customers, before you can raise. And other times, you need capital before you can build at the scale for brand name customers. So, when I read about Vinod Khosla’s advice for Joe Kraus: “We had $1 million in the bank and we didn’t know what we were going to bid. We sat down in my office, all on the floor. Vinod said we should bid $3 million. I was like, ‘How do we bid $3 million? We only have $1 million in the bank.’ And he said, ‘Well, if we win, I’m pretty sure we can raise it, but if we don’t win, I don’t know how we’re going to raise.'”
36/ “Your ability to raise money is your strategy. If you’re great at it, build any business with network effects. If you’re bad at fundraising, it’s strategically better to build a subscription business with no network effects.” – Elizabeth Yin
37/ Be willing to fire certain customers (when things get tough or in an economic downturn). If they aren’t critical strategic partners or are loss making, figure out how to make them profitable. If you can, renegotiate contracts, like cheaper contracts for longer durations. If not, let them go. Make it easy to offboard.
38/ An average SaaS business, that doesn’t have product-led growth, is spending about 50% of revenue on sales and marketing. Those that are in hyper growth are spending 60%. – Jason Lemkin
39/ “The only thing worse than selling nothing is selling a few. If you sell nothing, you stick a bullet in it and move on. When you sell a few, you get hope. People keep funding even though it’s really not viable.” – Frank Slootman
40/ If your customer wants to cancel their auto-renew subscription to your product, you should refund them a 100% of their cost. – Jason Lemkin
41/ “Your price isn’t too high. Your perceived value is too low.” – Codie Sanchez
42/ “15-20% of IT spend is in the cloud.” And it’s likely to go up. – Alex Kayyal
43/ If your customers are willing to pay you way ahead of when your service is executed, you have an unfair and unparalleled cashflow advantage. – Harry Stebbings
44/ If you’re in the CPG business, it’s better to negotiate down the contract. “You buy 75, and you sell 60, they’re going to go, ‘Ah, I got 15,000 in inventory, it’s not a success.’ If you give them 40, and then they have to buy another 20, and they sell 60, they go, ‘Wow, we ordered 50 [(I think he meant 20)] more than our original order.’ You’re still at 60, but one, they’re disappointed, and one, they’re not. You’re still playing some weird mind games a little bit so that they feel good about whatever number was there.” – Todd McFarlane
45/ “If you are under 100 customer/users, get 20 of them in a Whatsapp Group. You will:
Get much higher quality feedback, faster, on the current product.
They will be WAY more proactive in suggesting future product ideas and helping you shape the product roadmap.
It will create a closer relationship between you and them and they will become champions of the product and company. People like to feel they had a hand in the creation process.” – Harry Stebbings
46/ Create multiple bank accounts with different banks to keep your cash, to hedge against the risk of a bank run. The risk is very unlikely to occur, but non-zero, especially in a recessionary market. Inspired by SVB on March 10, 2023. More context here, and what happened after here. Breakdowns here, here and here.
47/ “Keep two core operating accounts, each with 3-6 months of cash. Maintain a third account for “excess cash” to be invested in safe, liquid options to generate slightly more income.” – A bunch of firms
48/ “Maintain an emergency line of credit. Obtain a line of credit from one of your core banks that can fund the company for 6 months. Do not touch it unless necessary.” – A bunch of firms
49/ In case of a bank run: “1/ Freeze outgoing payments, let vendors know you need 60 days, 2/ Figure out payroll & let your investors know exactly when cash out, 3/ Attempt emergency bridge with existing investors; hopefully reasonable terms or senior debt (but given valuation reset this is a HARD discussion for many), 4/ Figure out who can take deferred salary on management team, which will extend runway, 5/ Make sure you communicate reality to team honestly so they can make similar plan for their household, 6/ Make sure you talk to HR about legal issues around payroll shortfall — which hopefully this doesn’t come to, 7/ In future, keep cash in 3 different banks.” – Jason Calacanis
50/ “Whenever a CEO blames their bad performance on the economy, I knew I had a really crappy CEO. ‘Cause it wasn’t the economy, it was a bad product-market fit. The dogs didn’t wanna eat the dogfood. Sometimes the economy can make that a little worse, but if people are desperate for your product, it doesn’t matter if the times are good or bad, they’re going to buy your product.” – Andy Rachleff
51/ General reference points for ACV and time to close are: $1K in 1 week. $10K in 1 month. $100K in 3 months. $300K in 6 months. And $1M in 12 months. – Brian Murray
52/ A B2B salesperson’s script from Seth Godin. “Look, you’ve told me you have this big problem you need to solve. You have a five million assembly line that’s letting you down, blah blah. If we can solve this problem together, are you ready to install our system? Because if it’s not real, let’s not play. Don’t waste my time, I won’t waste yours. You’re not going to buy from me because I’m going to take you to the golf course. You’re not going to buy from me because our RFP is going to come in cheaper than somebody else’s. You want my valuable time? I’m going to engage with you, and tell you the truth and you’ll tell me the truth. You’re going to draw your org chart for me. You’re going to tell me other complicated products you’ve bought and why your company bought them. And I’m going to get you promoted by teaching you how to buy the thing that’s going to save your assembly line. Let’s get real or let’s not play.” – Seth Godin
53/ “The job of a pre-seed founder is to turn investor dollars into insights that get the company closer to finding product-market fit.” – Charles Hudson
Culture
54/ Deliver (bad) news promptly. Keep to a schedule. The longer you delay, the more you lose your team’s confidence in you. For example, if your updates come out every other Friday, and you miss a few days, your team members notice. Your team is capable of taking the tough news. This is what they signed up for. Explain a stumble before it materially impacts your bottom line – revenue. Inspired by Jason Lemkin.
56/ “It’s easier, even fun, to do something hard when you believe you’re doing something that no one else can. It’s really hard to go to work every day to build the same thing, or an even worse version, of what others are already building. As a result, there was a huge talent drain from the company.” – Packy McCormick
57/ Lead your team with authenticity and transparency. “Employees have a ridiculously high bullshit detector, more so than anyone externally, because they know you better. They know the internal brand better.” So you have to be honest with them. “Here’s what we’re going to tell you. Here’s what we won’t, and here’s why.” Set clear expectations and leave nothing to doubt. – Nairi Hourdajian
58/ When someone ask Jeff Bezos, when does an internal experiment get killed? He says, “When the last person with good judgment gives up.” – Bill Gurley citing Jeff Bezos
59/ “Getting too high on a ‘yes’ can prepare you for an even bigger fall at the next ‘no.’ Maintaining your composure in the high moments can be just as important as not getting too down in the low moments.” – Amber Illig
60/ “Most have an unlimited policy paired with a results-driven culture. This means it’s up to the employee to manage their time appropriately. For example, no one bats an eye when the top performing sales person takes a 3 week vacation. But if someone is not pulling their weight and vacationing all the time, the perception is that they’re not cut out for a startup.” – Amber Illig
61/ “Whenever we’re dealing with a problem and we call a meeting to talk about the problem, I always start with this structure. We are here to solve a problem. So the one option that we know we’re not going to leave the room doing is the status quo. That is off the table. So whenever we finish this meeting, I want to talk about what option we’re taking, but it’s not going to be what we’re currently doing.” – Tobi Lutke
62/ “[Peter Reinhardt] would put plants in different parts of the office in order for the equilibrium of oxygen and CO2 to be the same. He would put noise machines in the perfectly placed areas and then reallocate the types of teams that needed to be by certain types of noise so that the decibel levels were consistent. What I don’t think people realize about founders is that they are maniacal about the details. They are unbelievable about the things that they see.” – Joubin Mirzadegan
63/ “Leadership is disappointing people at a rate they can absorb.” – Claire Hughes Johnson
64/ Page 19 Thinking: If you were to crowdsource the writing of a book, someone has to start inking the 19th page. And it’s gotta be good, but you can’t make it great on the first try. So you have to ask someone else to make it better, and they have to ask another to make their edits even better. And so on. Until page 19 looks like a real page 19. “Once you understand that you live in a page 19 world, the pressure is on for you to put out work that can generously be criticized. Don’t ship junk, not allowed, but create the conditions for the thing you’re noodling on to become real. That doesn’t happen by you hoarding it until it’s perfect. It happens by you creating a process for it to get better.” – Seth Godin
Hiring
65/ Hiring when your valuation is insanely high is really hard. Their options could very much be valueless, since they would depend on the next valuation being even higher, which either means you grow faster than valuations fall (market falls in a bear market) or you extend your runway before you need to fundraise again.
66/ It’s easier to retain great talent in a recession, but much harder to retain them during an expansionary market. Talent in a boom market have too many options. There’s more demand than there is supply of talent in a boom market.
67/ If you’re a company with low employee churn, you can afford to wait a while longer to find someone who is 20% better in the role. – Luis von Ahn
68/ “[Fractional CMOs and CROs often] want to be strategists. Tell you where to focus, and what to do better. But the thing is, what you almost always just need is a great full-time leader to implement all the ideas.” – Jason Lemkin. The only time it works is when the fractional exec owns the KPI and the function, where they work at least 60% of the time OR they work part-time and help you hire a full-time VP.
69/ Hire your first full-time comms person after you hit product-market fit, when you are no longer finding your first customers, but looking to grow your customer base. – Nairi Hourdajian
70/ “Ask [a high-performing hire] if there’s someone senior in her career that’s been a great manager, and if so, bring them on as an equity-compensated advisor to your company. If there’s someone in industry she really admires but doesn’t yet know, reach out to them on her behalf.” Give her an advisor equity budget, so they can bring on a mentor or someone they really respect in the industry. As a founder, create a safe space for both of them. Monthly 1:1s and as-needed tactical advice, introductions, and so on. And don’t ask that mentor to give performance feedback “because if so it’s less likely they’ll have honest, open conversations.” – Hunter Walk
71/ Hire talent over experience for marketing and product. “In marketing and product I prefer people with less experience and a lot of talent so we can teach them how we do things. They don’t have to unlearn anything about how they already work. We teach them how we work. For developers it might be different because it takes a lot of time to be a really good developer, and it’s relatively easy moving from one environment to another.” – Avishai Abrahami
72/ If you’re going to use an executive search firm to hire an exec, ask the firm three questions: “1/ Walk me through your hardest search? 2/ Walk me through a failed search? 3/ Why did it fail? 4/ How do you assess whether an exec is a good fit?” You should be interviewing the firm as much as the candidate. Watch out for “a firm with a history of candidates leaving in a short timeframe. Avoid firms that recycle the same execs.” – Yin Wu
73/ Before signing with any recruiting agency, ask “What happens if the person hired is a bad fit? (Many firms will restart the search to align incentives.) Is there a time limit for the search? (Some firms cap the search at 6 months. We’ve worked with firms without caps.)” – Yin Wu
Governance
74/ “The higher the frequency and quality of a young startup’s investor update, the more likely they are to succeed in the long run.” – Niko Bonatsos
75/ Five metrics you should include in your monthly investor updates:
Monthly revenue and burn, in a chart, for the whole year
Cash in the bank, at a specific date, and runway based on that
Quarterly performance for the past 8 quarters, in a chart
Target for the quarter AND year and how you are trending toward it
76/ Another reason to send great, consistent investor updates is that when prospective investors backchannel, you want to set your earlier investors up for success on how they pitch you.
77/ If you don’t have a board yet, still have an “investor meeting.” “Create investor meetings where you invite all your investors to do an in-person + Google Hangout’ed review every 60 days. They don’t have to come. But they can.” – Jason Lemkin
78/ “[The] most important measures of success for a CEO [are] internal satisfaction, investor relations and consumer support.” – Bob Iger
79/ “Entrepreneurs have control when things work; VCs have control when they don’t.” – Fred Wilson
80/ If an investor really wants their money back (usually when VCs have buyer’s remorse), there are times when they force you to sell or shut down your companies. Instead, ask them, “What would it take to get you off my cap table?” – Chris Neumann
Product
81/ “The ones that focus, statistically, win at a much higher rate than the ones that try to do two or three things at once.” – Bruce Dunlevie, cited in eBoys
82/ Once you launch, you’re going to be measured against how quickly you can ramp up to $1M ARR. One year is good. Nine months is great.
83/ The more layers of friction in the onboarding process (i.e. SSN, email address, phone number, survey questions), the better you know your user, but the higher the dropoff rate. For PayPal, for every step a user had to take to sign up, there was a dropoff rate of 30%. – Max Levchin in Founders at Work
84/ “Product-market fit can be thought of as progressively eliminating all Herbies until there are no more Herbies. Then, you’re in a mode where you can invest in growth because it’s frictionless.” – Mike Maples Jr. (In the book, The Goal, the trek is often delayed by a large kid called Herbie. As you can imagine, the group only moves as quickly as their weakest link.)
85/ “There’s a ruthlessness in the way Dylan finds sources, uses them and moves on.” – No Direction Home. Be ruthless about how knowledgeable you can be about your customers, about your problem space, and about your product. The knowledge compounds.
Competition
86/ “If you patent [software], you make it public. Even if you don’t know someone’s infringing, they will still be getting the benefit. Instead, we just chose to keep it a trade secret and not show it to anyone.” – Max Levchin in Founders at Work
87/ If you know you’re building in a hot space, and your competitors are being bought by private equity firms, share that with your (prospective) investors. The competitors’ innovation slows, and optimizing for profit and the balance sheet becomes a priority when PE firms come in. – David Sacks
88/ “As a startup, you always want to compete against someone who has ‘managed dissatisfaction at the heart of their business model.” – Marc Randolph
89/ “You cannot overtake 15 cars in sunny weather… but you can when it’s raining.” – Ayrton Senna. It’s easier to overtake your competitors in tough markets than great markets.
90/ “Having a real, large competitor is better than having none at all!” – Anna Khan
Brand/Marketing/GTM
91/ If you’re a consumer product, your goal should be to become next year’s hottest Halloween costume. Your goal shouldn’t be fit into a social trend, but to define one.
92/ Don’t be married to the name of your company. 40% of NFX‘s early stage investments change their names after they invest in the seed.
93/ The viral factor doesn’t take into account the time factor of virality. In other words, how long it takes for users to bring on non-users. Might be better instead to use an exponential formula. “Think of a basic exponential equation: X to the Y power. X is the branching factor, in each cycle how many new people do you spread to. Y is the number of cycles you can execute in a given time period. The path to success is typically the combination of a high branching factor combined with a fast cycle time.” – Adam Nash
94/ In a down market, you may not need as big of a marketing budget as you thought. Your competitors are likely not spending as much, if at all, to win the same keywords as before.
Legal
95/ “Nothing is more expensive than a cheap lawyer.” – Nolan Church
The hard questions
96/ “I’d love to kill it and I’d hate to kill it. You know that emotion is exactly the emotion you feel when it’s time to shut it down.” – Andy Rachleff, cited in eBoys
97/ “Inexperienced founders are usually too slow to fire bad people. Here’s a trick that may help. Have all the cofounders separately think of someone who should probably be fired, then compare notes. If they all thought of the same person…” – Paul Graham
98/ When you’re in crisis, find your OAR. Overcorrect, action, retreat. Overcorrect, do more than you think you need to. For instance, lay off more than you think you need to. Actions can’t only be with words. Words are cheap after all. And retreat, know when it’s time to take a step back. “Sometimes you just have to do your time in the barrel. When you’re in the barrel, you stay in the barrel. And then you slowly come out of it.” – Nairi Hourdajian
99/ “A half measure is usually something a management team lands on because it’s easy. If a decision is easy, it’s probably a half measure. If it’s hard, if it’s really damn hard… if it’s controversial, you’re probably doing enough of it. The other thing is a half measure often doesn’t have an end result or goal in mind. If you have a really specific goal, and implementing that goal is difficult, that’s probably doing your job. That’s probably what’s necessary.” – Tom Loverro
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