The Gotham Gal loves this conversation with Sarah Beatty about her Montgomery Builds project and suggested that I give it a listen. So I am doing the same with all of you.
Posts from entrepreneurship
The Gotham Gal and I met when we were 19 and got married when we were 25. We lived together for most of those six years before we got married. By the time we tied the knot, we knew each other very well.
While venture capital investing and marriage are two different things, I think there are some things one can take from love and marriage into the world of startups and venture capital investing.
One of them is the value of long engagements.
I have never understood why founders want to run a lightning fast process to select business partners who they may have to “live with” for the next seven to ten years.
And yet we see this behavior all of the time. Often it is driven by other VCs who toss in “preemptive term sheets” thus turning a fundraising process into a sprint.
What I would prefer to see, and do see in many cases, is a founder who takes the time while they are not raising money to build a number of relationships with potential investors and then engages those investors in a process when it is time to raise capital. I like to call this process the “long engagement”.
It might sound like a lot more work than the fast and furious fundraising process that many founders are running these days.
But I don’t think it is a lot more work. Building relationships over a six to twelve month period can take the form of an occasional face to face meeting, emails back and forth, and even a few visits to the office by the investor. And none of that has to have the pressure of a pitch, an ask, and a price.
For the investor, this is a much better process. It allows them to see the founder and the business execute over time. It allows everyone to develop comfort with each other.
I would argue that it is a much better process for the founder too. It let’s them see which investors are truly interested in their business, their team, their product, and their success. It also reveals which investors are “here today, gone tomorrow.” You want the former on your cap table, not the latter.
It is easy to get caught up in the game of startups and investing in them. A fundraising process is at its heart a competition. And everyone wants to win. But you don’t get a trophy for winning this game. You get into a relationship. Often a very long one. So I think stepping back from the game theory and stepping into the relationships is the way to win long term. Which is the only form of winning that really matters.
Startup companies go through a number of phases as they mature from an idea, to a small team, to a growing team, to a small company, to a big company.
And along this journey, the leadership team you need changes. You need little to no leadership structure when you have a small team, you need some sort of leadership structure when your team is growing, you absolutely need a leadership team when you become a “company”, and the leadership team becomes incredibly important when you become a big company.
In the last week, I’ve had several conversations with CEOs in our portfolio who are leveling up their leadership teams and are recruiting executives from larger organizations.
I’ve counseled them to make sure that they hire executives who have a lot of risk tolerance.
High growth companies that emerge from a startup situation tend to be volatile. They have a lot of turnover in their organization, they have moments when the cash balances get low, they sometimes face existential risks.
If you have executives that you need to spend a lot of time comforting and solidifying, that’s not good. Ideally your leadership team is your steadying force and if you are steadying them, then your setup is suboptimal.
It is always tempting to bring in people who have operated at a scale well beyond where you are. And I am not saying you should not do that. You should. But just make sure they can handle the heat in the kitchen because it’s gonna get hot sometimes.
I was talking recently to a friend who advises a lot of boards. I asked him his view on boards overall.
He said that he saw two styles, both of which he found problematic.
The first style is the “rubber stamp board” that does whatever the CEO asks of them.
The second style is the “meddling board” that acts like it is running the business.
He told me he sees very few boards that manage to strike the right balance.
I sit on a lot of boards and have been doing so for thirty years now. I have been on rubber stamp boards and I have been on meddling boards. And I agree that both are problematic.
What I have learned over the years from those not great experiences is that boards must respect the line between governance and management and never cross it. But they also must govern. They must push back on things that don’t make sense and they must exercise the authority that has been vested in them by the shareholders.
This need to strike the right balance exists in many other contexts in our lives. It is the essence of good parenting. It is the essence of good management.
To a large extent boards reflect the CEOs that report to them. Strong willed successful CEOs can often construct rubber stamp boards because that is what they want. And weak ineffective CEOs find themselves with meddling boards who are trying to manage the poorly managed company from above.
Neither of these situations is good. The weak and ineffective CEO should be replaced by the board instead of trying to manage from above.
And the strong willed CEO must have checks and balances placed on them, no matter how well they are doing.
A great board chair can be transformative for a board. They can stop the meddling and force the necessary management changes. And they can stand up to a strong willed CEO and build the trust and respect that can lead to a well functioning board.
This is why I do not believe that CEOs should chair their boards. They should find someone who has a lot of board experience, knows how to strike the right balance, and vest in them the authority to lead the board to the right place.
I have been on boards that do strike the right balance and are chaired properly. It is a pleasure to work on these boards and a well functioning board is a thing of beauty. Every CEO should want one.
I wrote a blog post about this topic in November 2010 that has become one of the most searched on and referenced AVC posts of all time. The numbers in that blog post are long out of date and so I now have a popup on it warning people not to use those numbers. However, the methodology in that blog post remains sound and is used by many startup companies.
Yesterday, Matt Cooper, the CEO of our portfolio company Skillshare, published a very detailed blog post on how Skillshare uses that methodology in their employee equity program.
He includes updated multipliers for the NYC startup market in that post, which is something many readers have been asking me for over the last few years.
The reality is that these multipliers differ from market to market. They are highest in the Bay Area, high in NYC/LA/Boston, and lower in other parts of the US and in Europe, and even lower in other parts of the world. And, like all markets, they change over time. So it is hard to maintain a valid set of multipliers and I have given up on doing that. A startup could be created to maintain those numbers, or an established company like Carta, which has access to the raw data, could do it.
But even with the vagaries of what multipliers to use, the methodology that I laid out in my initial blog post on the topic is best practice in my view and anyone who is struggling to figure out how much equity to be offering employees would be well served by reading Matt’s post.
One of the traits of successful founders is their ability to turn a loss into a win.
You take a lot of losses as a founder, particularly in the early days. Investors pass on your funding pitches, people pass on your job offers, customers pass on your sales efforts, competitors take your customers and your employees, you get sued, you miss critical ship dates, morale tanks, and on and on and on.
But inside of each of those losing moments is the opportunity to turn it into a win.
You lose out on an important hire and in a pinch you promote a promising person from within and they turn out to be a superstar.
You lose out on a hotly contested sales opportunity and you do a post mortem with the customer and learn that you have a huge hole in your product and you fill it and start wining business.
You whiff on financing effort and so you cut your burn, execute for three more months, and go back and get term sheets from everyone you talk to.
My point is that losses are opportunities to win. You just have to see them as such and find the win in the loss.
This is all about resilience, optimism, and tenacity. The most successful founders have it in spades.
And it can be a learned skill. But you have to get your head in that space to learn it.
On Friday, I had two separate conversations with founders about fundraising strategies.
Both had an easier path that would likely get them to a closing quickly but might cost them some economics and a harder/longer path that would allow them to maximize economics.
I gave them both the same advice which is that certainty of close is super important, particularly early on in a venture when you see an opportunity and want to capture it before someone else does.
Most decisions are not black and white. There is usually a lot of grey in between. Fundraising is always like that. There is rarely an obvious right answer.
Many founders are advised to run a competitive process, get as many quality offers as you can, and use that competitive dynamic to maximize economics.
While that is a great strategy if you have the luxury of time on your side and the ability to spend several months focused on raising capital, there is often merit to the quick close that maximizes certainty over other things.
Both conversations on Friday ended in a discussion about people and how important they are in all of this. The answer to that is that they are the most important factor of all when raising capital.
If you are comfortable with the people involved and have a high degree of confidence that they will be great partners, then everything else is secondary. That is true for at least the first five years of a venture. At some point, in very late stage or public financings, the people issues lessen and you can optimize for other things.
But early on, if you optimize for anything, optimize for the people you work with. Otherwise you are taking on risks that can and will blow up in your face.
After that, I might put certainty of close next on the list, as long as the economics of the “bird in the hand” are ones you can live with and the people are known quantities. You can rarely go wrong with that combination.
I was reminded yesterday how much of a shit show raising seed capital via SAFE notes is. I can’t and won’t get into why I was reminded of that, but let’s just say nobody wants to go there.
So I thought I’d repost the important parts of a post I wrote on this topic a couple years ago.
I have never been a fan of convertible notes. USV has done quite a few convertible and SAFE notes. We are not opposed to convertible and SAFE notes and will not let the form of security the founder wants to use get between us and investing in a company that we like.
But I continue to think that convertible and SAFE notes are not in the best interests of the founder(s).
Here is why:
- They defer the issue of valuation and, more importantly, dilution, until a later date. I think dilution is way too important of an issue to defer, for even a second.
- They obfuscate the amount of dilution the founder(s) is taking. I believe a founding team should know exactly how much of the company they own at every second of the journey. Notes hide this from them, particularly the less sophisticated founders.
- They can build up, like a house of cards, on top of each other and then come crashing down on the founder(s) at some point when a priced round actually happens. This is the worst thing about notes and doing more than one is almost always a problem in the making.
- They put the founder in the difficult position of promising an amount of ownership to an angel/seed investor that they cannot actually deliver down the round when the notes convert. I cannot tell you how many angry pissed off angel investors I have had to talk off the ledge when we are leading a priced round and they see the cap table and they own a LOT less than they thought they did. And they blame the founder(s) or us for it and it is honestly not anyone’s fault other than the harebrained structure (notes) they used to finance their company.
The Series A focused VC firms that often lead the first priced rounds get to see this nightmare unfold all the time. The company has been around for a few years and has financed itself along the way with all sorts of various notes at various caps (or no cap) and finally the whole fucking mess is resolved and nobody owns anywhere near as much as they had thought. Sometimes we get blamed for leading such a dilutive round, but I don’t care so much about that, I care about the fact that we are allowing these young companies to finance themselves in a way that allows such a thing to happen.
Here are some suggestions for the entire angel/seed sector (founders, angel investors, seed investors, lawyers):
- Do priced equity rounds instead of notes. As I wrote seven years ago, the cost of doing a simple seed equity deal has come way down. It can easily be done for less than $5k in a few days and we do that quite often.
- The first convertible or SAFE note issued in a company should have a cap on the total amount of notes than can be issued. A number like $1mm or max $2mm sounds right to me.
- Don’t do multiple rounds of notes with multiple caps. It always ends badly for everyone, including the founder.
- Founders should insist that their lawyers publish, to them and the angel/seed investors, a “pro-forma” cap table at the closing of the note that shows how much of the company each of them would own if the note converted immediately at different prices. This “pro-forma” cap table should be updated each and every time another note is isssued. Most importantly, we cannot and should not continue to allow founders to issue notes to investors and not understand how much dilution they are taking on each time they do it. This is WRONG.
Honestly, I wish the whole scourge of notes would go away and we could go back to the way things were done for the first twenty years I was in the venture capital business. I think it would be a better thing for everyone. But if we can’t put the genie back in the bottle, we can at least bottle it up a bit better. Because it causes a lot of problems for everyone.
Entrepreneurship and startup investing is a long game. It requires patience, resilience, capital, commitment, and much more.
But even so, the average life of a venture capital investment is seven to ten years. It is rare for it to go longer than that. But it can happen.
Yesterday marked the end of an almost twenty-year relationship between me and what was once a startup and is now a fairly large company called Return Path. We announced yesterday that Return Path is being acquired by Validity.
My former venture capital firm, Flatiron Partners, that has not been actively investing since 2000, made its final investment in Return Path in mid-2000. I joined the board shortly after that and have been working with the founder and CEO Matt Blumberg ever since.
In many ways, this company and this entrepreneur define my career more than any other. Matt and I stuck with this company and each other for almost twenty years and in the process built an incredibly trusting, supportive, and, ultimately, profitable relationship.
We had partners in this long game. Brad Feld and Greg Sands joined the board a year or two after I did and they are among my closest friends in the venture business now. And we have had incredible independent directors like Scott Petry, Jeff Epstein, and Scott Weiss. The management team has turned over something like a half dozen times in twenty years but a few leaders have stuck it out including Jack Sinclair, George Bilbrey, and Ken Takahashi. All of these people are responsible for an incredible journey that I have gone on for the last twenty years with this company.
Matt and I have been through a lot together. We had a least four or five near death experiences when we should have lost the company but did not. We had a deal to sell the company fall through the night before the closing. We sold lines of businesses, we bought lines of businesses, we did several large reductions in force, we did several big expansions. We hired and parted ways with many executives.
Through all of that, we celebrated with each other, yelled at each other, cried with each other, annoyed each other, frustrated each other, and supported each other. Matt has made me a much better investor. He has taught me so much about supporting entrepreneurs, building and leading a great board, and hanging in there against long odds for a very long time.
When you see me do something, say something, explain something, here or elsewhere, my approach and philosophy comes from my experiences and nowhere did I get more experience than my time working with Matt and Return Path. So if you are getting any benefit from me, you are getting that benefit from Matt too.
I hope to work again with Matt and his team on another company or two or three. Hopefully they won’t all take twenty years.
In evaluating leaders, at the top of a company, or in the ranks of company leadership, an important quality that I look for is followership. Specifically, will the team line up behind this person?
Of course, leaders have to have other qualities. They need to have domain expertise if they are leading a specific function, they need to understand the needs of the business and the sector that it is operating in, and many other things too.
But what I have learned is that followership is super important. If the team doesn’t line up behind a leader, it is extremely hard for them to be effective.
For internal promotions, it is relatively easy to see followership and promote people who have it. You can also help people develop the management skills (listening, communicating, etc) that lead to strong followership.
When hiring someone from the outside, determining if they will have followership is harder. You can reference for this quality. But to some extent followership is a function of the culture of the organization. Someone who had strong followership in one kind of organization may not find it in another one.
It can take a leader some time to develop followership, particularly if they are hired from the outside. The team will need some time to figure out this new person, how they operate, and how they feel about them. But if a new leader has not developed the followership they need to lead the organization, or a part of the organization, within six to nine months after joining, then it is likely that a change will need to be made.
When developing your own organization and internal leaders, you should be very specific about followership and the need to develop it on your team. You should help mentor and coach younger managers on how to develop it and you should move quickly on leaders who don’t have it and won’t develop it on their teams.
It is always so impressive to me to see what leaders with strong followership can accomplish, when everyone is lined up behind them and delivering on what they ask of the organization. That is what I would wish for every organization, but sadly many don’t have it and they underperform as a result.