tech | growth | venture | 2017 September
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Over the last 18-24 months, as we were working to evaluate the product-market fit of an early stage venture capital firm focused on emerging ecosystems, we met with several entrepreneurs. The goal was to gain insight into the strengths and weaknesses of their respective ecosystems and determine how we could best solve their problems.

Lately, as we’ve become more public about our intentions to invest, I’ve noticed some founders who approach us don’t feel comfortable being completely clear in their intentions for meeting.  I’m unsure if this due to the current atmosphere in these ecosystems, if we aren’t doing a good enough job in expressing our desire to help founders to the best of our ability, or I am naive and should always expect to be pitched.

Regardless, I strive to tailor the circumstances of the meeting to the appropriate levels, and to quote Jason Calacanis, when it comes to meeting founders “there’s nothing I love more.”

The reason I do this is that I want to be known for always having time for founders.  People tell me, “I know you’re really busy, I don’t want to keep you.” But it’s my job to meet with founders.  There is nothing I love more.  – @jason

If I know your intentions for our meeting, it allows me to optimize the time we spend together by adjusting three important aspects to any encounter.

1) Setting – If we are meeting as an opportunity for both of us to expand our network, I’m more likely to suggest lunch or a coffee due to the more relaxed nature of the conversation.  However, if we’ve agreed to a pitch meeting our conference room is preferred.  First and foremost, the founder now has the choice of how they’d like to present their deck, if at all, and they don’t have to do so on a laptop screen at an awkward angle inside of a loud coffee shop.  Secondly, it provides me the opportunity to take better notes and in turn offer much better feedback regardless of our investment decision.

2) Preparation – I am a huge fan of Cal Newport’s Deep Work and Greg McKeown’s Essentialism which means I’ve learned to immensely value other’s time as well as my own.  If we are meeting as a casual get to know you, I’ll do some light research on you so that I am able to anticipate your needs and how I can help. However, my preparations for pitch meetings are often much more in-depth and take up large portions of my day.  It’s crucial to me founders leave those meetings feeling as though they got something other than another opportunity to pitch and if I’m surprised by the pitch I won’t be able to be adequately prepared.

3) Time Allotment – This one might be a little more counter-intuitive.  If our meeting is a more casual, networking style encounter, I’m more likely to be strict with my time. Whereas during the more formal pitch meeting, I’ll put a 30-minute buffer on the back-end to allow us to go over.  The last thing I want to do is rush out of what is a vital conversation for both parties.

I hope this list encourages founders to feel as though they can be open with their intentions in meeting with me moving forward.  The best part of my job is meeting with people who are on the front lines building businesses that could potentially change a major part of our lives.  Running a business is often a 24/7/365 endeavor, and my goal is to ensure I don’t waste a minute of an already precious resource….your time.

Recently, CrunchBase published a new case study on early-stage funding including the different types of deal structures, priced (equity) and unpriced (convertible notes or SAFES).  The post was a useful, if very high level, overview of the early-stage funding process.  However, due to this simplicity, the article painted a naive picture of how unpriced rounds often work in practice. While notes and SAFES have become the norm in recent years, it doesn’t mean they should be, especially in underserved ecosystems like Texas, Pittsburgh, or Atlanta.

In these metros, early-stage capital is scarce, thus increasing an investor’s negotiating leverage.  Given that context, fundraising is often an extremely difficult hurdle to navigate for local entrepreneurs. Ultimately, unpriced rounds making up the majority of early-stage deals in emerging ecosystems can be shortsighted.  Over the long term, it can limit a startup’s ability to raise future rounds and hinders the ecosystem as a whole by sometimes forcing great entrepreneurs to start companies in more favorable markets where investors are accustomed to optimizing for a startup’s long term success.

It’s easy to forget that, just 130 miles outside Chicago, is the University of Illinois’s main campus. “Remember, Marc Andreessen was building Mosaic at U of I, and Max Levchin,” probably best known as the founder of PayPal, “was down there too.” Carter relayed the story of how Levchin came to Chicago to raise money for his first startup, he was spooked by the terms put forth by the independent investors he spoke with. He probably left for the Valley because we [Chicago investors] couldn’t structure a deal,”  – Jeffery Carter, Hyde Park Angels

Convertable notes and SAFES only make the process more confusing by putting off the valuation and thus hiding the potential ownership (i.e. possible dilution) at the time of conversion especially in cases where the startup has raised more than one note on varying terms.  I believe some investors do like this opacity.

Entrepreneurs are not the only ones put at risk by unpriced rounds of fundraising, the investor hasn’t actually put themselves on the cap table which leaves open the possibility of issues such as the renegotiation of their terms by the next lead investor. This puts the seed investor in the awkward position of getting the terms they believe they negotiated or being the “bad guy” who could potentially spoil the next round.

The goal of any aspiring startup ecosystem should be collectively working to eliminate onerous term-sheets to better incentivize founder upside for the ENTIRE lifecycle of a company, not maximizing the “paper” upside of one investor for one round. This perspective enhances the goodwill between investors and entrepreneurs while encouraging both sides to continuously participate in the scaling of great companies.  We achieve this by taking four simple steps:

  1. Use priced seed rounds whenever possible.  Legal fees used to be the main sticking point for doing an equity term-sheet but now the prices can be fairly comparable.  As mentioned above, there remains little reason to delay valuation for sophisticated investors.
  2. Provide extreme clarity in the event the round must be a note or SAFE. One of the best practices we’ve implemented is showing our entrepreneurs pro forma cap tables in the event of down rounds and at the “cap” set in the term sheet.  This allows us to highlight the various levels of dilution possible for founders.
  3. Simplify the terms. We advise the startups with which we work to offer only one round of convertible notes with the same terms to all participants. As Fred Wilson has recently pointed out, $1-2M “feels about right” for the as the maximum size of the raise. Obviously, this depends on the product and other factors affecting the anticipated runway.
  4. Provide a list of established VC resources and discussions of notes.  By doing this, we allow founders to do the research themselves and collect opinions from both sides of the table.  Y-Combinator, Fred Wilson, Seth Levine, and many others have written extensively on this topic.  We encourage founders to seek, and in many cases we provide, these resources.

Anyone who has discussed venture investing with me knows I passionately dislike unpriced rounds though that doesn’t mean I won’t do them.  The ultimate goal for us has, and will always be, to partner with the best possible companies. However, if we do participate in Notes or SAFES we work extremely diligently to make sure the terms are clear and founders thoroughly understand the pros and cons of the structure.

I caught up with a friend yesterday who is an up-and-coming architect in the Austin area and it turns out we are facing a lot of the same challenges in launching a new venture.  We both are working to optimize processes in order to spend the most time possible on the core aspects of our firms.

During a 2016 shareholders meeting, Elon Musk said “We’ve realized that the true problem, the true difficulty and where the greatest potential is, is building the machine that builds the machine. In other words, building the factory.”  Similarly, Homebrew’s Hunter Walk has been quoted as saying “the company is the first product, and you have to be really intentional about how you build it before it’s ready to scale.”

This highlights an important reality of building a great company or product: the processes and frameworks put into place will often decide the level of success achieved and those operational components should be designed with the end-goal in mind. As my partner Jonathan recently wrote, the best of the best almost always “perform the common uncommonly well.”

1) Start EarlyThe larger a company grows, the more difficult it becomes to put processes in place.  This one is straightforward, as a startup begins to scale it becomes exponentially harder to move everyone in the same direction.  Getting a group of 10 engineers to agree on a product development methodology is easier than asking 40 to do the same and infinitely easier than asking a team of 100 or more.  This isn’t just an engineering or product problem, the same rules apply to marketing, finance, and sales. Bonus: it will make cross-functional execution that much easier.

2) Overly-Simplify: The best early-stage companies have an innate ability to focus when it is most difficult to do so.  Early-on, startups are vulnerable to chasing shiny objects as everything feels like a big opportunity.  Instead, avoid temptation and focus on executing toward one core product or market.  Example tactics to accomplish this include: shorter meetings (i.e. standups), picking 2-3 metrics that are core to success (ex. contribution margin and conversion), and selecting 1-2 strategic priorities per timeframe.

3) Scrutinize: Be honest with yourself.  One of the most effective practices I’ve seen teams use is the agile concept of a retrospective.  This gives teams the chance to discuss what’s working, what isn’t and ideas for improvement.  The most crucial element to this step is accountability, without it, these meetings don’t help move the company forward but instead become chances to be overly critical without inspiring action.  Begin each “retro” with a review of how well the team executed on previous takeaways and keep score.

Operations within early-stage companies often get overlooked as there are more exciting challenges to tackle.  When processes are in place, no one notices because things are running smoothly and challenges do not begin to surface until later in the game. However, neglecting them is akin to puncturing a boat while it is still in port; it may leave the dock, but it won’t make the entire trip.

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