Posts from entrepreneurship

Second and Third Tier Markets And Beyond

I am in Nashville for a couple days with The Gotham Gal who is giving a keynote at a startup conference today. I mostly came along for a chance to spend a couple days in Nashville. But I will also be at the conference later today to see her do her thing.

Last night we attended a cocktail party with investors from the southeast and then had dinner with an entrepreneur in Atlanta that The Gotham Gal backed a few years ago. At both we talked about entrepreneurship in the southeast and the funding environment for companies in this part of the world.

The way I think about the startup sector in the US is that the first tier is Silicon Valley. More than half of all startup activity and startup funding activity happens in the Bay Area which now includes SF and the east bay. You could simply focus on Silicon Valley and ignore every other part of the US and the world and do just fine as an investor. Many do.

The second tier is NYC and LA and Boston. Between these three cities, another third of startups and investment capital reside. All three of these startup cities are vital and growing rapidly. You could simply focus on NYC, LA, and Boston and ignore the bay area and other parts of the US and the world and do just fine as an investor. I am not aware of any firm that has that strategy as it doesn’t really make sense. But it could easily be done.

The third tier includes Seattle, Chicago, Atlanta, DC, and a few other smaller places like Boulder and Austin. I am doing this entire post from my head and not referring to any survey. There are a bunch of these surveys and I’ve read them all so I am sure this is directionally correct but I am also sure that I am missing a place or two.

This third tier is a decent place to be an entrepreneur and an investor. But there are challenges. Entrepreneurs in the third tier can access the talent and capital they need to be successful in these third tier markets but it is a bit harder to do both. Investors can be focused on these markets if they keep their fund sizes small enough or they can take a hybrid approach by being focused on these markets and also investing in the first and second tier markets. The latter is how we have always approached being a NYC centric investor.

But there is a dynamic that goes on in these third tier markets where the local investors look to investors in the first and second tier markets to come down and “validate” their investments. And the investors in the first and second tier markets won’t come down and do that without a strong local lead. This game of “chicken” happens ways too often in these markets and is incredibly frustrating to entrepreneurs in these markets. These third tier markets need a few strong Series A focused VC firms who have large enough fund sizes to be aggressive lead investors and also have the conviction and stomach to play that game. That is what USV, and Flatiron before it, did in NYC. That is what Foundry did in Boulder. That is the game Upfront is playing in LA. Every third tier market needs a few VC firms like that. And being that investor is a terrific way to make a lot of money.

Beyond the third tier lies a lot of even smaller markets. I am in one today in Nashville. It has a huge health care sector that produces a lot of entrepreneurial and executive talent. It has a decent amount of local seed capital. But it is not a major VC destination. The southeast VCs will come here regularly looking for opportunities. But it suffers even more from the issues I talked about in the third tier. The same is true of places like Pittsburgh, Des Moines, and Kansas City. I mention those three cities because USV has investments in companies in all three places.

The truth is you can build a startup in almost any city in the US today. But it is harder. Harder to build the team. Harder to get customers. Harder to get attention. And harder to raise capital. Which is a huge opportunity for VCs who are willing to get on planes or cars and get to these places.

There is a supremacism that exists in the first and second tiers of the startup world. I find it annoying and always have. So waking up in a place like Nashville feels really good to me. It is a reminder that entrepreneurs exist everywhere and that is a wonderful thing.

Filling Out A Round: When It Matters, and When It Doesn’t

Almost every financing I’ve been involved with over the years (seed, VC, growth, raising a VC fund) goes mostly like this:

  • Struggle like hell to find a lead
  • Come to terms with the lead
  • Turn your attention to filling out the round
  • The deal gets oversubscribed as all the investors that could not summon up the courage or did not have the checkbook to lead the deal scramble to get into what is now a “hot deal”
  • You end up saying no to a lot of people you wish you could say yes to

So how do you decide who to let into the round and who to say no to?

Well the truth is that it sometimes matters a lot and sometimes doesn’t matter at all.

There are two primary factors that I like to focus on when choosing who to let in and who to say no to:

  • Do they have deep pockets and have they shown a history and a propensity to follow on in future rounds. Yes means try to let them in. No means prioritize others over them at the margin.
  • Can they add value and/or will they cause harm in any way. Adding value is a plus. Doing harm is a negative (obviously). Harm should be avoided at all costs. Adding value is a nice to have but not a must have. And investors always claim to be able to add value and very few actually do. If someone has already added value without even being in the deal, that’s a strong signal that carries a lot of weight with me.

There is one other factor that is worth considering. If someone is a friend, a former colleague, a person you know, trust, like and would like to have along for the ride, that is as good of a reason as any to let them in. But just remember that having friends in a deal that goes bad is a good way to lose friends. So make sure these are friends who have lost money, can take the hit, and aren’t going to hold it against you.

So here is when it matters and when it doesn’t.

  • Seed investors aren’t likely to follow round after round and while some can add value, many don’t. I would not sweat the allocations/syndication decisions that much in a seed deal other than avoid troublemakers at all costs. Otherwise, get the money and move on.
  • VC rounds (Srs A, Srs B, Srs C) are generally where the syndicates matter the most. Find a strong lead who will take a board seat, manage the syndicate, and help you. Then if there is money left over find VCs who have deep pockets, who have demonstrated a bias to follow on in round after round, and are willing to follow your lead.
  • Growth rounds are generally where everyone wants to pile in and there aren’t a lot of board seats or governance issues to deal with. You may find investors that can help in these rounds but they are mostly about getting the money at a good price and getting back to business.

I have seen entrepreneurs try to optimize these decisions and spend a lot of time on them. Investors scrambling to get into the deal will fill your head with all sorts of promises, arguments, and the like. Which makes it even more tempting to spend time on the decision and make the best one.

My advice is to make good decisions and not try to make the very best ones. Focus on deep pockets who are known to follow on and be supportive and avoid troublemakers. Everything else is a nice to have but not a need to have.

Experiment and Scandal

We are living in a time of great experiments. They are not happening in the lab. They are happening in the real world. And they are being financed by real people. We are witnessing the de-institutionalization of experimentation. We are returning to a time when anyone can be an inventor and innovator. Some of this has happened because of the explosion of venture capital, both in the US and also around the world. Some of this has happened because entertainment and culture has embraced the world of experimentation and innovation (Shark Tank, Silicon Valley). Some of this has happened because the tools for innovation and experimentation have become mainstream and anyone can use them.

I am not thinking of one thing. I am thinking of many things. I am thinking of The DAO. I am thinking of Bitcoin and Ethereum. I am thinking of Oculus getting financed on Kickstarter. I am thinking of the launch of equity crowdfunding for everyone in the US last week. I am even thinking of things like Theranos.

All of these things are great experiments that will produce great benefit to society if they succeed. But by their nature experiments often fail. They need to fail. Or they would not be experiments.

And one of the challenges with the de-institutionalization of experimentation is that some of these failures will be spectacular. Combine that with the idea that these experiments are being funded by real people and the idea that the world of media/entertainment/culture has injected itself right in the middle of this brave new world and you have the recipe for scandal. And scandal will naturally result in efforts to put the genie back in the bottle (Sarbanes Oxley, Dodd Frank). And these regulatory efforts will naturally attempt to re-institutionalize experimentation.

I find myself wishing we could keep the dollars invested and hype down when we do these massively public experiments. But the dollar/hype cycle is a natural part of being human. Some dollars are invested. We get excited about this investment. We talk it up. More people find out about it and more dollars are invested. More of us get excited about this investment and we talk it up more. Rinse, repeat, rinse, repeat and you get unicorns and distributed autonomous funding mechanisms entrusted with hundreds of millions before anything has even been funded. Eventually some of that gets unwound and the tape is full of red.

Don’t get me wrong. I am all for distributed autonomous organizations and the innovation behind them and in front of them. There isn’t much out there that I am more excited about. But I am also very fearful that this could end badly. And even more fearful of what may be foisted on us by well meaning regulators when that happens.

So let’s celebrate this incredible phase of permissionless innovation we are in. And let’s all understand that we will have many failures. Some of them spectacular. Money will be lost. Possibly hundreds of millions or billions. Let’s expect that. Let’s build that into our mental models. So when that happens, we can suck it up, deal with it, and keep moving forward. Because an open permissionless world of innovation that everyone can participate in is utopia in so many ways. The good that will come of it will massively outweigh any bad. But bad there will be. I can assure you of that.

When You Have Concerns

I hear this said all the time – “when you have concerns about an employee, it almost always means you will need to make a change.” I hear execs lament that they tend to wait too long to admit that they made a hiring mistake and act on it. I hear them wish they trusted their gut more. And it is not always a hiring mistake. It is often a case of someone doing great in a role or an organization at at time and then failing as the org or the culture changes around them. In this latter scenario, loyalty and appreciation for contributions made loom large.

And yet that conflicts with the idea that you can grow and develop talent and you can coach people to evolve and change.

A friend of mine told me yesterday that “you have to pay attention to the key moments” when you are evaluating an employee that you have questions about. She suggested that concerns always exist and it is not true that when you have concerns, it almost always leads to making a change. And she said that culture matters a lot and can’t be sacrificed when making these calls.

I don’t do a lot of hiring and firing personally, only at the highest levels. But I do observe executives in our portfolio companies struggling with these decisions and have gone back and forth on how to advise them in these situations. I tend to like action, decisiveness, and a willingness to make a mistake over inaction, pondering, and a desire to get everything right. And so I generally coach executives to make a call and move on when they have concerns.

But the conversation with my friend yesterday gave me pause. I wonder if my advice to make a call and move on is always the right advice. I am curious how the AVC community thinks about these things. Because these are the things that matter most of all in building, managing, and leading a business.

Video Of The Week: Brian Watson On How To Email A VC

Brian Watson worked at USV from 2012 to 2014. I just came across a very short video (~2mins) in which he answers a great question (how to email a VC). I agree with the basics (keep it short, make it actionable, be real, and link to your product). Here is it in his own words.

Small Ball

Small Ball is a style of play in basketball when a team sacrifices size/height for speed and shooting. The Golden State Warriors, the best team in the NBA this regular season, are a good example of a team that often uses this strategy.

As the venture capital business and entrepreneurs are increasingly bulking up in terms of fund sizes (VCs) and round sizes (entrepreneurs), I am decidedly a fan of small ball.

Many of our best investments at USV have been in companies that never needed to raise VC or only needed to raise one round. In these situations, the founders own/owned large stakes in their companies, often north of 50% for the founding team at exit. These companies focused on a revenue/business model at launch, they kept their headcounts low until they had scale/traction in their usage, and they reinvested the profits back into scaling the business instead of external capital. My favorite example of this is Indeed where USV had to beg the founders to let us invest, only did one round of venture capital, and exited for $1.4bn and is likely worth 2-3x that number as the business has scaled massively post exit. Kickstarter, DuckDuckGo, and Zynga are other good examples of small ball in action. Zynga did raise a lot of money but it went to the balance sheet and secondaries and never was used to fund losses.

Small ball also works well in VC. It is hard to return capital to your investors in the VC business. Exits are a long time in coming and you get diluted over time and even in the biggest exits (billion dollar plus valuations), you might only have proceeds of $100mm to $200mm. If you have a fund size in the $500mm to $1bn range (or larger!), you need many of these big exits to return the fund once. But your LPs want you to return the fund three times, or more. I could never sleep at night if USV were managing a billion dollar fund. I don’t know how we would ever get our LPs back their money plus a return. I know it can be done and has been done. But I don’t really know how it happens. Getting big exits is just so damn hard.

So in an era when VCs and entrepreneurs are going for bulk, I really like the opposite approach which favors speed and agility over pounding it inside. It allows me to sleep at night, which is not that easy in our business.

Video Of The Week: The Nitty Gritty Podcast

Bond Street, a startup company that makes small business loans, has started a podcast to tell stories about small business entrepreneurs and the companies they create and run. They call it the Nitty Gritty Podcast.

The first episode features an entrepreneur who is also a friend of ours, Gabe Stulman.

Gabe is a restaurant operator in the west village of Manhattan, where we live. We started our relationship with Gabe as regulars at his first restaurant and we have gone on to be investors in all of his current restaurants, as well as good friends with him.

Here is Gabe’s story. It’s a good one.

Don’t Kick The Can Down The Road

I’ve been using this term a lot lately – “don’t kick the can down the road”. There is always a desire to push the hard decisions out. I find myself urging entrepreneurs and CEOs to make that hard call today and take the poison and move on. It’s hard for leaders to make this choice largely because of fear of the other things that will come along with that hard decision.

Bill Gurley, who I find myself agreeing with as much or more than anyone else in the VC business, has a fantastic post up about the danger of the “structured financings” that are increasingly common in the later stage VC market today. In it, he says:

Many Unicorn founders and CEOs have never experienced a difficult fundraising environment — they have only known success. Also, they have a strong belief that any sign of weakness (such as a down round) will have a catastrophic impact on their culture, hiring process, and ability to retain employees. Their own ego is also a factor – will a down round signal weakness?  It might be hard to imagine the level of fear and anxiety that can creep into a formerly confident mind in a transitional moment like this.

This is so true. I have sat in and on countless meetings and phone calls with leaders who are afraid that the whole thing that they just spent three, four, five years (or more) building will come crashing down because they take a down round. I have been through dozens of down rounds in my career. At least thirty and maybe fifty if I really took the time to count them all. They are no different than a public company’s stock price taking a big hit. It is painful to be sure. Some people will leave but they are either weak in the knees or were half way out the door anyway. But I have never seen a down round destroy a company. And I have seen many down rounds save a company.

Another place where leaders tend to want to kick the can down the road is with talented but difficult employees. They cannot bring themselves to remove the person who is providing a ton of individual contribution but is also poisoning the culture. A founder of one of our portfolio companies once told our entire USV CEO group the following story. I am not saying who because I don’t want to expose him to any issues.

We had an engineer who was the most talented and productive engineer on our entire team. But he was also incredibly difficult to work with and everyone disliked him. We couldn’t let him go because we were fearful of creating a “hole” in our organization. Finally, the complaints got so loud that we were sure we were going to start losing people over him. So we did what we were afraid to do and let him go. And we did just fine without him. The morale of the story is you are better having a hole in your organization than an asshole.

Man I just love that one. It is so true and everyone who hears it shakes their head and chuckles and groans at the same time.

There are certainly many more examples of where leaders take the easy way out and defer a difficult decision because of fear of the consequences. My message to all of you out there is “don’t do that”. Kicking the can down the road is more harmful than helpful. Take the pain today and fix your issues and deal with the consequences. You will be better off for it and so will your company.

Side Projects

Back when we started USV in 2003/2004, we used to see a lot of side projects that had taken off and were turning into companies. We funded at least one such side project, Delicious, which ended up getting sold to Yahoo! a few years later. But I remember that we would see one or two of these sorts of things every month. It was a meaningful part of the internet innovation ecosystem at that time.

Fast forward to today and we don’t see many side projects that have turned into or are turning into companies anymore. I suspect that some of that is the effort to build and launch something that can reach broad adoption is harder. You have to build for desktop web, mobile web, iOS, and Android if you want to get your app in front of everyone. Back in 2003/2004, you just had to build for the desktop web.

But I also think that it is so much easier to quit your job and get some seed funding that less and less people are building apps as side projects today. Why work 60 hours a week at Facebook and then another 40 hours a week on your side project when you can quit your job at Facebook and land $250k of seed money on the day you leave?

I think the move away from side projects toward doing a startup day one is not all good. There was something great about the ability to experiment with an idea before committing to it and before sucking other people’s money into it. When it didn’t work, it didn’t work. No need to pivot to save face or get your investors whole. Just shut it down and tinker on another idea.

I am hopeful that crowdfunding services like our portfolio company Kickstarter and others offer people with good full time jobs the opportunity to be “entrepreneurs on the side”, to test their ideas with potential customers, to build prototypes, and to see if there is excitement about the idea before leaving their job and pursuing the idea on a full time basis.

My point is that experimentation is critical. We should have lots of it. Seed capital, venture capital, angel investments, angellist, YC, techstars, etc, etc are great and fund a ton of experimentation. But they do require a commitment of time (yours) and money (mine) that isn’t ideal in many cases. So I hope that the fact that we are seeing less and less side projects is a temporary thing and that the market will correct in some way to bring them back. I think they have an important role to play in the innovation economy.

Back From The Dead

It’s Easter Sunday. A time to celebrate those that have risen from the dead.

My favorite success stories are the ones that were written off for dead and somehow pulled it out and built something lasting and sustainable.

It doesn’t happen that often to be honest. Sure there are the pivots like Odeo>Twitter and Glitch>Slack. But I am not talking about them.

I am talking about something like the Fedex story. Out of money with nobody willing to invest. And Fred Smith pulled it out and built one of the most important companies of the latter half of the 21st century. Or Apple when Steve Jobs went back and turned it around. These companies were near death. And their founders figured out how to keep them alive and then turn them into juggernauts. That’s rising from the dead.

The truth is that over the past twenty years and two venture capital firms, I could not find a great example of a portfolio company of ours that rose from the dead. There were a couple that were near dead and were turned around and got nice exits. But nothing on the scale of Fedex or Apple.

It’s really hard to go from dead to juggernaut. So when it happens, you just have to look at the experience with wonder. That’s why these are my favorite success stories.

Happy Easter Everyone.