Posts from entrepreneurship

Executive Sessions and Continuous Feedback

I’ve written about these two related but different topics before but I’ve been doing a lot of board meetings as we kick off 2019 and I am reminded of how important both are.

At the end of every board meeting, the board should meet alone with the CEO in an executive session, followed by a session without the CEO, followed by a session where at least one director, but possibly all of the directors, meet again with the CEO.

This requires a fair bit of time to do right. These three back to back sessions will easily take thirty minutes to do right and could take as much as an hour.

When a board meeting goes three or four hours, it is tempting to wrap when everyone has “hard stops” and punt on these executive sessions.

But that would be a big mistake.

CEOs need to know where the board stands on the meeting, the big issues, the team, the strategy, and most importantly the performance of the CEO. And CEOs need to know that in real time and all the time.

The big problems that I have run into with companies over the years often have to do with misalignment between a management team and the board, and most acutely misalignment between a CEO and the board.

A process by which the CEO gets real time, regular, in person feedback from the board will alleviate many of these issues. These can be hard conversations and they can be difficult for the CEO to understand and process. None of this is easy stuff. But when people know where they stand and can react to it, things go better. It is when people don’t know where they stand and are grasping for straws when things go most badly off the rails.

The executive session/feedback process is also used by audit committees to manage the relationships between the board, CFO, and external auditors. I have found that they are incredibly important in that setting too.

If you aren’t doing executive sessions with your board, start doing them. And if you do them, but you skimp on them frequently due to time issues, shorten your board meetings and protect your executive session time. These sessions need to come last and that makes protecting them challenging but I believe a board meeting without an executive session is a bad board meeting.

Audio Of The Week: Flip’s Susannah Vila

Flip is a USV portfolio company. They provide a suite of services to renters that allow them to easily flip out of leases and move when they need to with the cooperation of landlords.

Before Flip was a USV portfolio company, it was angel funded by the Gotham Gal and Flip’s founder Susannah Vila went on the Gotham Gal’s podcast last month to talk about how she got the idea to start Flip and how she has gone about building the company. It is a great listen.

What Is Going To Happen In 2019

Hi Everyone. Happy 2019.

Today, as is my custom on the first day of the new year, I am going to take a stab at what the year ahead will bring. I find it useful to think about what we are in for. It helps me invest and advise the companies we are invested in. Like our investing, I will get some of these right, and some wrong. But having a point of view, a foundation, is very helpful when operating in a world that is full of uncertainty.

I believe and have been telling those around me that I think 2019 will be a “doozy.” I think we will see major dislocations in the leadership of the United States, a bear market in stocks, a weakening economy, a number of issues with the global economy including a messy Brexit and a sluggish China. All of this will lead to a more cautious stance by investors in the startup economy. And crypto will not be a safe haven for any of this although there will be signs of life in crypto land in 2019.

Let’s take each of those in the order that I mentioned them.

I believe that we will have a different President of the United States by the end of 2019. The catalyst for this change will be a devastating report issued by Robert Mueller that outlines a history of illegal activities by our President going back decades, including in his campaign for President.

The House will react to Mueller’s report by voting to impeach the President. Which will set up a trial in the Senate. That trial will go so badly for the President that he will, like Nixon before him, negotiate a resignation that will lead to him and those close to him being pardoned for all actions, and Mike Pence will become the President of the United States sometime in 2019.

I believe this drama will play out through most of 2019. I expect the Mueller report to be issued sometime in the late winter/early spring and I expect an impeachment vote by the House before the summer, leading to a trial in the Senate in the second half of the year.

The drama in Washington will have serious impacts to the economy in the United States starting with our capital markets.

The US equity capital markets enter 2019 on shaky ground. Though the last week of the year brought us a relief rally, the markets are dealing with higher rates, some early indications of a weaker economy in 2019 (possibly due to higher rates), and, of course, the potential for the drama in Washington that we’ve already discussed. Here is a chart of the S&P 500 over the last five years:

I expect the S&P 500 to visit 2,000 sometime in 2019 and then bounce around that bottom for much of the year. This would represent a decrease in the S&P’s trailing PE multiple to around 15x which feels like a bottom to me given the recent history of the equity markets in the US:

S&P PE Multiple (source http://www.multpl.com/)

Interest rates have been rising gradually in the US for the last three years. The Fed has taken its Fed Funds rate from essentially zero three years ago to almost 2.5% today:

Source: https://www.macrotrends.net/2015/fed-funds-rate-historical-chart

The rates that are available to consumers and businesses have followed and I expect that to continue in 2019. Here is a chart of the interest rates on the three most popular mortgage products in the US:

Source: https://www.amerisave.com/graphs/

When it gets more expensive to borrow, marginal projects don’t get funded. And what happens at the margin has a much larger impact on the economy than most people understand. No wonder the President wants to fire the Fed Chairman.

I expect the combination of higher rates, uncertainty in Washington, and storm clouds globally (which we will get to soon) will cause business leaders in the US to become more cautious on hiring and investment. Consumers will make essentially the same calculations. And that will lead to a weaker economy in the US in 2019.

The global picture is not much better. The eurozone is about to go through the most significant change in decades with some sort of departure of the UK from the EU (Brexit). It remains unclear exactly how this will happen, which in and of itself is creating a lot of uncertainty on the Continent. I don’t expect most businesses in Europe to do anything but play defense in 2019.

Probably the biggest unknown for the global economy is the resolution of the ongoing trade tensions between China and the US. It seems inevitable that China will make some concessions to the US to resolve these trade tensions. But, of course, what happens in Washington (first issue) may impact all of that. In the meantime, the uncertainty around trade and exports hangs over the Chinese economy. China’s GDP has been slowing in recent years as it achieved relative parity with the US and the Eurozone:

Source: https://tradingeconomics.com/china/gdp

Any significant trade concessions from China could impact its growth prospects in 2019 and beyond, which will take the most powerful engine of global growth off the table this year.

So all of that is a pessimistic take on the broader macro environment in 2019. How will all of this impact the startup/tech economy?

The startup/tech economy is somewhat immune to macro trends. Many startups and big tech companies were able to grow and expand their businesses during the last financial downturn in 2008 and 2009. Some very important tech companies were even started in those years.

The tech/startup economy is driven first and foremost by technical and creative (ie business model) innovation. And that is not impacted by the macro environment.

So I expect that we will continue to see big tech invest and grow their businesses and do well in 2019. I expect we will see IPOs from big names like Uber/Lyft/Slack, although I also expect those deals will get priced well below the lofty expectations they have in mind right now. Some of that will be because of weak equity markets in the US, but it is also true that most of the IPOs in 2018 also priced below the lofty “going in” expectations of founders, managers, boards, and their bankers. The public markets have been much more sanguine about value than the late stage private markets for a long time now.

However, I do think a difficult macro business and political environment in the US will lead investors to take a more cautious stance in 2019. It would not surprise me to see total venture capital investments in 2019 decline from 2018. And I think we will see financings take longer, diligence on new investments actually occur, and valuations to come under pressure for even the most attractive opportunities.

But all of that is going to happen at the margin. I expect 2019 to be another solid year for the tech/startup sector as we are in a possibly century-long conversion from an industrial economy to an information economy and the tailwinds for tech/startup vs the rest of the economy remain in place and strong.

Any set of predictions for 2019 from me on this blog would not be complete without some thoughts on crypto. So here is where my head is at on that topic.

I think we are in the process of finding the bottom on the large, liquid, and lasting crypto-tokens. But I think that process could take much of 2019 to play out. I expect we will see some bullish runs, followed by selling pressures taking us back to retest the lows. I think this bottoming out process will end sometime in 2019 and we will slowly enter a new bullish phase in crypto.

I think the catalyst for the next bullish phase will come as the result of some of the many promises made in 2017 coming to fruition in 2019. Specifically, I think we will see some big name projects ship, like the Filecoin project from our portfolio company Protocol Labs, and the Algorand project from our portfolio company Algorand. I think we will see a number of “next gen” smart contract platforms ship and challenge Ethereum for leadership in this super important area of the crypto sector. I also expect the Ethereum open source community to ship a number of important improvements to its system in 2019 and defend their leadership in the smart contract space.

Other areas of crypto where I expect to see meaningful progress and consumer adoption happen in 2019 are stablecoins, NFT/cryptoassets/cryptogaming, and earn/spending opportunities, particularly in the developing world.

There will also be pressure on the crypto sector in 2019. The area I am most concerned about are actions brought by misguided regulators who will take aim at high quality projects and harm them. And we will continue to see all sorts of failures, from scams, hacks, failed projects, and losing investments be a drag on the sector. But that is always the case with a new emerging technology that allows anyone to set up shop and get going. Permissionless innovation produces the greatest gains over time but also comes with the inevitable bad actors and actions.

So that’s where my head is at on 2019. Do I sound pessimistic? I suspect I do, but I am not. I am incredibly optimistic, like my partner Albert and can’t wait to get going and make things happen in this new year. It is going to be a doozy.

The Profit Motive

I had an interesting conversation with a friend who operates a traditional business (not tech, not venture backed, not “growth”) last week. He buys a lot of software from tech companies and he observed that not one of them operates profitably. And that makes him a bit uncomfortable as he has always operated his businesses profitably. He mentioned to me that when he has taken capital from investors he has paid them back in full in less than a year each time, from the profits that the business is generating.

It got me thinking that there is something about tech, particularly venture capital-backed tech, that allows us to operate for what seems like forever without a need to generate self sustaining profits.

This can be a fantastic way to generate value when the opportunity is large enough (Google, Amazon, Facebook, Twitter, etc). But it is not a fantastic way to generate value when the opportunity is constrained, either by a smallish market size (TAM) or by a ton of competitors (little to no barriers to entry) or a number of other factors.

Value is generated when the capital required to get a business to sustainability (usually positive cash flow, but I will include exits here) is meaningfully less than what the business is worth when sustainability is reached.

As the capital requirements go up, because of sustained losses year after year after year, the business needs to become worth ever more money at sustainability.

The mistake I think we make in the startup/tech/VC sector is that we look at things like Google/Amazon/Facebook/Twitter, or more recently Uber/Airbnb/Slack, and we think that every business can execute the same playbook. The sad truth is that not every business can execute that playbook and, as a result, many startups consume way too much capital on the way to sustainability and value is lost, not created.

The never ending question that founders and management teams and boards face is whether to invest for growth (aka lose a ton of money) or work towards profitability (but constrain the growth of the business). It seems like every board I am on and every company in our portfolio is always asking this question.

Where I come out on this issue, and always have, is that the growth has to be responsible (positive unit economics on growth spend) and that the path to profitability needs to be well in sight. I would add to those two constraints that a management team ought to be able to get a business profitable in a pinch without killing the business, if necessary. Clearly these “rules” should not apply to very early stage companies. They become relevant and possible once a business has a growing customer base and revenue stream.

I think very few companies in our portfolio and any VC firm’s portfolio will pass these tests right now. Some do but not many. We have a few companies in our portfolio that are operating profitably. We have a few more that are in operating with profitability well in sight and could get there in a pinch without hurting the business too much. But the vast majority are burning money like its water and there is plenty more where it came from.

Perhaps it is true that there will always be money to fund burn. Or perhaps it isn’t. But even if there is endless capital, many founders and teams will wake up one day and realize that all of that burn they accumulated is now a hurdle they have to overcome. And many won’t overcome it.

The profit motive is what makes capitalism work. Businesses are ultimately valued as a discounted set of future cash flows. Positive cash flows. If you can’t generate profits in the future, your business will not be worth anything. So profits are key. And yet we don’t seem to value them in the tech/VC/startup world very much. Maybe we should.

Negotiating: Drawing A Hard Line or Building A Negotiating Cushion?

I believe that negotiating is more of an art than a science. There are certainly strategies and skills that one can develop that make for better outcomes.

But the art comes into play in figuring out what the person or people on the other side are optimizing for and adopting a strategy that reflects that.

I have found that a single style and strategy rarely works well for every situation.

Let’s take the important question of whether you should make a “take it or leave it” offer and then draw a hard line on that offer or whether you should make an offer that has a fair bit of negotiating cushion in it.

Some people like to negotiate and expect to negotiate. If you make a hard line offer and refuse to negotiate with them, they will be frustrated with you and may seek out other offers. Or if they do end up transacting with you, they will feel burned by the negotiating process and you will be starting off the relationship on the wrong foot

If you make an offer that has a lot of room for negotiating, they may actually enjoy the experience and come away feeling like they got a good deal from you.

I like to shake hands at the end of a negotiation with both parties pleased with where they ended up. That is particularly important when you are entering a long term relationship like a venture capital investment.

It is also critical to know what your “must haves” are going into a negotiation and what you can give on.

Another form of negotiating art is how you reveal your must haves and where you are flexible. I have found that it is not helpful to a negotiation to lay all of that out at the start. There is a lot of value in a discovery process. It is a bit like dating. Each side reveals a bit about themselves to the other and that is also very helpful at the start of what might be a long relationship.

All that said, there are times when drawing a hard line is appropriate. If the other side has all of the leverage then it is often best to make your best offer and say take it or leave it. If, for example, the other side has used a process to drive price discovery and possibly discovery around other key terms and has multiple offers, you are not going to win the deal with the low ball offer with negotiating room. You have to give it your best shot and then walk if you can’t win on that basis.

Like most art, it takes some time to learn all of this. You can take a class or a workshop on negotiating tactics and learn the fundamentals. I would strongly recommend that for young folks just getting started in business.

But when it comes to learning how to size up the other party, well that takes time. You have to mess up some negotiations, lose some deals, and possibly win some on terms you later regret.

It is that last bit, living with the terms you negotiate, where the greatest learnings come. I have found that a very powerful argument in a difficult negotiation is when you say “I did that once, I deeply regret it, and I’m never doing it again.”

Thinking Ahead To 2019

In the last week, we have learned that Uber, Lyft, and Slack plan 2019 IPOs. I am sure that a few more highly valued private companies are also planning to go public in 2019.

It is something that I have been expecting and predicting for a few years now. Eventually these companies that have raised a ton of capital in the private markets will choose to go public and generate liquidity for the shareholders who plowed all of that capital into them.

And yet storm clouds are on the horizon for the capital markets in 2019. Rates have risen significantly in the last eighteen months, pulling capital out of the equity markets and into the fixed income markets. There are some leading indicators that suggest a business slowdown is on the horizon, which would be the first one in the US in a decade. And, of course, the situation in DC is getting dicey and that will weigh on markets as well.

Good companies can go public in bad markets so I am not saying that the long delayed IPO plans of juggernauts like Uber will be squashed by a bear market in 2019. 

But what I am saying is that 2019 is shaping up to be a very interesting year for the capital markets that power the startup economy.

There is a big difference between the private markets and the public markets. They do not move in lockstep. For years now, the late stage private markets have been trading at valuations that are well in excess of their public market comps. That is true for a number of reasons. First, private market investors have longer time horizons and are looking for a three to five year return, not an immediate one. Second, private market investors get a liquidation preference which in theory protects them from losses. Finally, deals in the private markets clear in an auction like environment where the highest bidder wins the deal. All of these factors mean that a hot company can raise capital in the private markets at valuations well in excess of where they can raise capital (and trade) in the public markets.

But the public and private markets are connected to each other. If the Nasdaq falls significantly, and it is down roughly 15% from its highs in the late summer/early fall, then it will eventually weigh on the private markets.

And, if Uber, Lyft, and Slack do go public in 2019, where they price and where they trade will impact startup valuations, both late stage, and ultimately early stage too.

These markets, public, late stage private, and early stage private, feed off each other and the participants in one look to the others for supply of deals and liquidity. So while they may appear to be disconnected, and often are, they do ultimately sync up.

And so I’m wondering if 2019 is the year they start to sync up again, after quite some time being out of sync. And if that comes to pass, what it means for our portfolio companies and their financing and liquidity options.

Fortunately for most of our portfolio companies, and most companies in the startup sector, we have had a number of years of very flush capital markets and many companies have strong balance sheets and a lot of staying power. The same is true of most venture capital firms as the past few years have been a great time to raise capital.

So if things slow down in 2019 and I am not predicting they will, but I think they might, the startup sector is in good shape to weather it. But at some level, the startup capital markets are a game of musical chairs and you don’t want to be the one who can’t find the chair when the music stops. 

The Pitch Meeting Setup

We’ve known for a long time that one of the most stressful things for entrepreneurs when they pitch us and other VCs is the initial setup of the meeting when they need to be meeting and greeting the folks in the room and, at the same time, figuring out how to connect their laptop to present their deck.

That combo is a real challenge. Some entrepreneurs navigate it with grace and some really struggle with it. But it is a pain for everyone.

We used to have a cable that the entrepreneur could connect their laptop with but that had its own set of problems as not every laptop would work with the cable.

We use Zoom now and we ask the entrepreneur to get on our guest wifi (no password) and then fire up zoom, join our room, and share their screen.

That works better, particularly when we let the entrepreneur know in advance that is the way we do it so they can download zoom onto their laptop before the meeting.

But even with all of that, we still have this awkward few minutes where the meeting is getting set up.

I am curious to hear from all of you about the best meeting setup situations you have run into in your careers. We do not subscribe to the theory that making it hard on the entrepreneur shows us something. We do subscribe to the theory that making it easy on the entrepreneur is in everyone’s interests.

Pivot or Fail?

The Pivot is celebrated in startup land. Huge successes like Twitter and Slack are all the results of pivots. So surely pivoting is a good thing, right?

Well, I am not so sure. And I certainly don’t want entrepreneurs to think that pivoting is the right thing to do when their original idea fails. It may be better to let the failing startup fail and start over again from scratch.

I am not talking about the slight pivot; making a change in business model with the same product, selling a slightly different product to the same customer, going up market to a different customer. Those are not really pivots, they are evolutions that every startup company goes through. 

I am talking about the hard pivot. Changing the product, market, and business entirely. Essentially starting over from scratch.

And I am not sure hard pivots are good for anyone.

Here is why.

If you raise funding for a startup idea, you will take some dilution and you will have a bunch of investors who backed you and your idea and are believers in it. You will have assembled a team that you built with the original idea in your mind. 

If that idea fails and you pivot into a new idea, you will take all of those investors, team members, and dilution with it, whether or not they are excited about it.

You can always swap out old team members for new ones, and so the team issues are real but probably not as significant as your investor and dilution issues.

If you choose the pivot approach, you will have investors for the life of the pivot who did not choose to back your new business and may have no interest in it other than their financial interest. 

But the bigger issue is the dilution you take into your next startup. I have never understood why entrepreneurs would want to use a company and a cap table that they no longer own 100% of to do a new startup. They are just carrying baggage that they don’t have to and probably should not carry.

I understand the argument that starting a new company by pivoting with cash in the bank and a team that is already built is attractive and giving those back and starting over from scratch is harder. But the harder path is often the best path. And the easy path is often the harder one.

If you were able to do a startup from scratch once, I would imagine you can do it again. And doing it again allows you to keep a lot more of the new company and custom build it from scratch, putting together the ideal team and the ideal investor group.

I have always suspected that entrepreneurs also choose the pivot over some sort of loyalty to their investors. If that is the case, I would like to say that this investor does not want any of that misguided loyalty. 

The truth of seed and early stage investing is that the failure rates are very high. We write off investments in failed companies in every one of our funds at USV, usually multiple times. The Gotham Gal, who invests much earlier than USV, writes off investments at an even higher rate.

So early stage investors are used to failing. It is built into our business model. What we want in return for accepting this high rate of failure are the spectacular successes that we get when everything clicks; the right idea, at the right time, with the right team, the right investor group, and the right execution.

And while pivots can deliver all of the “rights”, I am not sure that they do that at the same percentage as the startup from scratch, given all of the baggage that they are carrying.

And there is nothing I dislike more than carrying on with something when I’ve lost interest, and worse, the founders have lost interest.

So my view is if you’ve failed, accept it, announce it, and deal with it. Shut the business down, give back the cash, and rip up the cap table. Then do whatever you want to do next. If it is another startup, do it from scratch and keep as much of it as you can. If it is something else, well then do that too.

Startups are not indentured servitude. And I have been around some that feel like it. That sucks. I would encourage everyone in startup land to reject that approach and focus on a better one. There are so many options for things to work on that everyone should make sure they are working on the right thing and excited about it. Anything that gets in the way of that is suboptimal in my view.

What Happens When A Founder Is Fully Vested?

Let’s say you are the founder and CEO of a startup and you have now been at it for four years. The company is doing great, you’ve raised several rounds of financing, you have a product in the market that is solving a real problem, you have a bunch of customers, you have a growing team, and things are stressful but largely great.

And you realize that you are now fully vested on your founder’s stock which means if you were to leave the company tomorrow, you get to keep all of it. What do you do about that?

This is a common question I hear from founders. They ask me what is standard in this situation. And I tell them that not only is there no standard answer, that this is one of the most emotionally charged issues to come between founders and their investors and boards and companies.

This situation also exists for other founders who are not the CEO, and the issues are very similar, but for the purposes of keeping this post as simple as possible, I am going to focus on the founder/CEO role.

Here are some, but not all, of the issues that come into play in thinking about this:

1/ If a founder/CEO were to leave their company after they become fully vested on their founder’s stock, the company would have to go out and hire a new CEO and that new CEO would get an equity grant that would be between 2.5% and 7.5% of the Company, depending on the value of the business. So one could certainly argue that the founder CEO ought to get similarly compensated.

2/ But that argument about how a new CEO should be compensated essentially puts on the table the question of whether the founder CEO is actually the best person to run the Company right now or if there is someone better suited to do that who could be recruited for a new market equity grant. It is often not in everyone’s best interests to have that conversation.

3/ Many founder CEOs four years in still own a lot of their companies. A typical range would be between 10% and 40% depending on if there are co-founders and how much capital had to be raised in the early years and at what valuations. For most situations, an equity grant that would be made to a new CEO is actually a relatively small percentage of the overall equity ownership of a founder CEO and in the context of that, it is not as valuable to the founder CEO as many other things.

4/ However, the founder CEO is subject to additional dilution in subsequent rounds so a new grant would at least partially offset future dilution and that is quite attractive to founder CEOs.

5/ One of the most valuable things to a founder CEO is having a large unissued equity pool from which to hire talent into their company and any allocation of that pool to the founder CEO reduces that asset.

6/ It is generally a good practice to have all executives vesting into some equity compensation. It standardizes the executive compensation program and aligns incentives.

7/ Refresh grants for executives are not usually equal to their sign-on grants. They are usually some percentage of the sign-on grant. So the same should be true of a founder CEO getting a refresh except that they never got a sign-on grant.

8/ Investors bet on the appreciation of the equity they already own not the issuance of new equity. A founder is aligned with the investors when they too are focused on making the equity they already own more valuable.

9/ When founders get diluted below double-digit ownership, they begin to see themselves as employees, not owners and that is bad for the company, the team, and the investors. For some founders, they start to feel that way at below 20% or 15%.

10/ It is hardly ever the case that what happens after a founder is completely vested is negotiated ahead of time, during the various rounds of financings, and priced in by the investors. If a founder was to pre-negotiate a new “market grant” for themselves once they are fully vested, and that was included in the size of the option pool that is set aside and baked into the pre-money valuation, investors could model that future dilution and build that into their valuation models and price that into a round. But nobody does that because founders want to maximize valuation in the financing rounds and investors assume that the founders will be happy with their initial grant or will not be around to earn it. Both parties either naively or purposefully kick the can down the road until the issue rears its head and then the emotions come out.

So what happens in practice?

It depends entirely on the situation at hand.

If the founder CEO owns a large percentage of the business, a new grant is rarely made because the value of it pales in comparison to the annual value that their founder’s equity is increasing organically.

If the founder CEO has been massively diluted and owns a small percentage of the business, a new grant is often made.

If the business is performing very well, the likelihood of a new grant is higher.

If the business is performing poorly, the introduction of the idea of a new grant can be very destabilizing and can actually precipitate a larger conversation about who should be running the company.

A common area for compromise is a new grant to the Founder CEO that is some percentage of what a “market” grant to a new CEO would be and that percentage ranges from 20% to 50% depending on the situation. The less a founder owns of the company, the higher the percentage will be and the more a founder owns, the less that percentage will be. If a Founder owns more than a quarter of the business, this is almost never done. I certainly have never seen it done for founders who own more than a quarter of the business.

I have two suggestions for how entrepreneurs should handle this issue.

The first suggestion is that you might want to raise this issue with all of your investors before you take money from them, and understand how they feel about this issue and what their expectations are so that you know that ahead of time. Do not wait until the moment to find that out.

The second is that if you wait to raise this issue once you are fully vested, do it carefully and delicately. If it is seen as a demand, it will not go well. If it is seen as a discussion about what is in the best interests of the company, it will go better.

But most of all, remember that there is no “one size fits all” solution for this situation and that you and your board will have to figure it out on a case by case basis.

Broken Syndicates

One of the most challenging situations in startup/venture capital land is the broken syndicate. It is not a topic that is talked about much, but it is fairly common, particularly for companies that succeed in building a business but falter at achieving escape velocity.

A syndicate is a group of investors that come together to support a startup financially. They tend to be built over time. Some investors get involved with a company in its seed round. Others get involved in a company in the Series A round. And some get involved in the Series B round.

By the time a startup has raised three or four rounds of venture capital, it is likely to have built a syndicate of between three and five venture capital firms and other investors (corporate, strategic, individuals, family offices, etc).

The idea is that the syndicate supports the company financially until it no longer needs capital. That can happen via a sale of the company, an IPO, or achieving profitable operations.

And that is typically what happens in the best situations, when the company executes well and finds that happy financial chart that goes up and to the right with a steepening slope. In companies like that, the syndicate almost always sticks together and more investors clamor to get into it.

And then there is the company that never really figures out how to build a business. In those situations, everyone around the table, including the founders, figure out how to wind things down, either through a sale of the business, an acquihire, or a wind down. This happens all the time and is generally not a particularly painful process.

But there is a middle ground, where the team figures out how to build a business with customers, revenue, and lots of employees. But often the business stumbles and revenues flatten and losses pile up and more capital is needed, often a lot more than the existing syndicate is prepared for. This is when there are often management changes, founders depart, and there is a lot of drama.

And holding a syndicate together during the “stumble” is very hard. Some investors are managing huge funds and need exits that will produce hundreds of millions to their fund. When they see that a company will not do that, they often move on. Some investors have small funds and don’t have the capacity to fund a company round after round. Corporate and strategic investors can lose interest when a company stumbles and they no longer believe the business is strategic to them. 

Those are the “rational” reasons that syndicates break.

But there are other reasons. There is a fair bit of churn inside venture capital firms right now. Younger partners leave to start their own firms. Or are asked to leave because they are not producing the expected returns. When a partner who leads an investment inside a venture capital firm leaves, the investment is often “orphaned” and the other partners will pretend to support it but they really don’t want to and don’t.

Or even more upsetting is when a venture capital firm finds another company in the same sector that they like more and they lose interest in your company and stop supporting it.

All of these things happen to companies who stumble and they happen way more frequently than anyone talks about. It really doesn’t benefit anyone to go public with these situations. So they are worked out quietly.

Often broken syndicates lead to early exits, when the founder(s) and remaining investors realize that they are screwed and decide to find a home for the business before they run out of gas. Many times these exits are disappointing outcomes relative to the opportunity and they can make for fantastic acquisitions.

Another thing that happens with broken syndicates is the recapitalization. This is when the remaining investors reset the valuation in order to bring in new capital, either from their funds or ideally from fresh sources of capital. The losers in this situation are the early investors, founders, and investors who walked away. 

And sometimes what happens is the business shuts down, leaving people scratching their heads. Why did that company which had lots of customers, revenues, and employees suddenly close up shop? Well the answer is often that their syndicate broke and they could not put it back together.

At USV, we have worked through these stumbles and broken syndicates many times over the years. We often find ourselves in the position of trying to put Humpty Dumpty back together again. We have managed to do that many times. But we don’t manage to do it every time. 

It is incredibly difficult work, probably the hardest work we do in the venture capital business. And we often are asked why we bother.

We have found that we can make excellent returns when we stick to our conviction around an opportunity and work to restructure the team, the operations, and the syndicate (and the valuation). We also have found that we are rewarded reputationally in the market as investors who are supportive when times get tough. And we believe that it our job to support companies and the founders who create them.

We wish everyone in venture capital land saw things the way we do, but they do not. And that is the reality of the world we operate in. 

Founders need to understand all of this when they put their syndicates together. You should ask around about the investors who want to put money in your company. Look for companies that have stumbled and get to the people who know what happened in those situations and ask about how their investors behaved. That will tell you a lot.

The bottom line is that syndicates are fragile things. They break. And putting them back together is hard. So figure how to build one that is strong and will stay strong. The best way to do that is to under promise and over deliver on the business plan. But you can also do yourself a lot of good by finding resilient investors and getting them into your cap table. So do that too.