Category: Venture Capital
We are starting to work on the teaching materials for the 3rd edition of Venture Deals, which is coming out in the fall of 2016.
If you have either taught or taken a class using Venture Deals and are willing to talk to our publisher at Wiley about what kind of teaching materials would make the book even more useful, please send me an email.
As part of this, we are doing a refresh of the Ask the VC website so if you have suggestions for that, just toss them in the comments.
Signups are open for the second Reboot VC Bootcamp happening January 19-22, 2017. It will – once again – be at my house in Longmont, Colorado.
If you are interested, here are some reactions to the first Reboot VC Bootcamp.
We had the first Reboot VC Bootcamp several weeks ago in Boulder. Based on the feedback and the experience, we’ve already decided to have another one, probably early in 2017.
Three of the participants – Steve Schlafman, Rob Go, and Josh Guttman – wrote posts about the bootcamp. Since the content was confidential, each of them is careful about what they say and does a good job personalizing the experience.
In A bunch of VCs went on a retreat. Here’s what happened Steve lists 16 things he took back with him to New York and his daily life from the bootcamp. To get a feel for them (and hopefully inspire you to go read the whole post), here are the first three:
- When your inner and outer self aren’t in sync, it creates personal dissonance that results in being afraid, feeling unsafe, etc..
- If you ask a founder how you can help, it means you haven’t been listening close enough. Be fully present.
- Being a great board member or investor isn’t about having all the answers and fixing things. Don’t underestimate the power of listening and supporting.
“The idea is that one’s “shadow” is a deep rooted thing (not necessarily good, not necessarily bad) that exists in one’s psyche that drives your choices, behaviors, or emotions. The shadow is often linked to early, memorable childhood experiences, and is reflected in multiple arenas of life over and over again. The challenge occurs when one is unaware of these influences, and as a result, it drives him/her to make decisions or react to circumstances in a less than ideal way. Often, we can go years not really understanding how major decisions have been guided by hidden motivations, and that can get in the way of being the best leader, friend, or team member one can be.”
Josh wrapped the summaries up in his post Keeping it Real with an overview of the structure we used for the bootcamp
Practical Skills + Radical Self-Inquiry + Shared Experiences = Enhanced Leadership + Greater Resiliency
followed by a good discussion around imposter syndrome, which came up a few different times and manifests itself in many different ways in our daily life, especially around entrepreneurship and investing.
It was deeply enjoyable to host this event at my house and spent a few days at a very emotionally intimate level with some VCs I know and have worked with and others that I met for the first time. I was a player-coach for the weekend – participating instead of facilitating, but also co-hosting with Jerry. I was concerned that this would be a challenge, but in hindsight it felt very natural to me. And, during a session where I became Jerry’s focus, I realized something profound that I had never put together before about my relationship with power.
To everyone who participated – thank you for being brave and taking the risk to engage at the level that a Reboot bootcamp demands.
This weekend I’m co-hosting the Reboot.io VC Bootcamp at my house in Boulder. It starts tonight and goes through mid-day Sunday. It’s an experiment with Jerry Colonna and about 15 other VCs to see if the Reboot.io bootcamp construct works with VCs, where the tag line for the experience is:
Practical Skills + Radical Self-Inquiry + Shared Experiences = Enhanced Leadership + Greater Resiliency
It’s either going to be valuable to this group or not. We’ll know more on Monday. The only way to learn is to try.
As part of the pre-work for the weekend, I went back and re-listened to several of the Reboot.io podcasts that Jerry recommended in advance (for you Soundcloud people I made a Reboot.io VC Program collection.)
So, my brain was already trending toward the headspace around radical self-inquiry in the context of venture capital. Yesterday, Fred Wilson wrote what is the best VC-related post of 2016 so far titled Losing Money. In addition to exemplifying the notion of radical self-inquiry, it is filled with gems about how to think about struggling companies and what to do with them in the context of a VC portfolio.
Go read Fred’s post Losing Money right now. I’ll be here when you get back.
When I woke up this morning, I noticed a tweet from Rand Fishkin aimed at me and Fred.
— Rand Fishkin (@randfish) April 7, 2016
Fred answered “it is one of my weaknesses that I let a bad experience sour me on a market for life.” And, I’ve seen some of Fred’s own behavior around this, as he won’t touch anything hardware-related at all because of some miserable hardware-related failures during the Internet Bubble (or is it “internet bubble” now that the AP Style Guide says not to capitalize internet.)
But I had a different response to Rand’s question “Do you regret every investment that fails?”
I’d like to think that I no longer regret any investment. As Fred discusses in his post, many VC investments fail. I’ve yet to meet a VC who says “This is a totally shitty company and a lousy opportunity so I’m going to invest in it anyway.” When a VC makes an investment, she is incredibly enthusiastic about the opportunity. If you know that failure is part of the process, then there is enormous emotional dissonance that gets generated if you regret the investment in hindsight, as you are going to have a lot of regret over the years as a VC, which I think creates a very negative feedback loop in terms of how you think about new investments.
Instead of “regret”, I think it’s much more important to embrace failure as part of the overall experience and focus on learning from every investment that fails. And, a failed investment often has many lessons – some new and some old. Some of these lessons are temporal and while others are foundational. In Fred’s post, he opens with:
“I remember back in the mid 90s, I used to say with some pride that I had not lost money on any of my VC investments. Then one day, someone told me “then you are not taking enough risk.” I ended that streak of not losing money on VC investments in the late 90s in a series of epic flameouts. I lost somewhere between $25mm and $30mm on one single investment. I am not proud of those mistakes. They were stupid. I am ashamed of them to be honest. But I learned a lot from them. Not only was my “winning streak” a case of not taking enough risk, it was also a case of not enough learning. The go-go Internet era of the late 90s fixed both of those things for me. I took more risk and learned a ton.“
The bold section is what I’m trying to say. And, when I say “embrace failure”, I’m not suggesting that one be proud of failing, but I also don’t think there’s any shame in failing. There’s only shame in not learning.
The second part of Rand’s question “Or do you ever think ‘I’d place that same bet again'” is more complicated for me and my view diverges from Fred’s quick response of “it is one of my weaknesses that I let a bad experience sour me on a market for life.” For starters, I don’t think of my investments as bets, so I have an immediate knee-jerk reaction to characterizing investments as bets. That always creates fog for me in answering something, so I have to let the fog clear. Then, given that we invest in a set of themes over a very long period of time, a failed invested is a fundamental component of our ongoing learning in a theme. So I thought hard about what about a failed investment would cause me not to invest in some aspect of the investment again.
The answer appeared before me as “bad people.” My favorite entrepreneurs to back are ones who have had success and failure, so I’m very comfortable making multiple investments over time with people I trust and enjoy working with, even if we’ve had failures along the way. But if the people are fundamentally dishonest, immoral, unwilling to listen and learn, or behave in what I consider to be inappropriate ways, I don’t want to work with them again.
So the essence of regret for me comes from when I make a mistake around people. This is not only the founders but also co-investors. And, after 20+ years of doing this, I’m much better (but not perfect) in figuring out in advance who I shouldn’t work with.
I’ve accepted that in the end we all die. So, as part of my own radical self-inquiry, I’ve tried to isolate and limit my own regret to situations where I spent a lot of time and learn (or teach) nothing. Fortunately, this rarely has anything to do with the investments that I make.
The retrades have begun. Since the beginning of the year, I’ve experienced four retrades – two early stage, one growth, and one late stage – and I’ve heard of a number of others.
If you’ve never experienced a retrade, or don’t know what I’m talking about, it’s the situation when you have a firm deal agreed upon or a term sheet signed and are proceeding to closing a deal, when the investor (or acquirer) decides to change the terms of the deal. And, in case you were wondering, it’s always to make the terms worse, not better.
This happens regularly in M&A deals especially with buyers who are buying thinly capitalized companies or ones who don’t care about their long term reputation. It’s very prevalent with buyers who over time get the reputation as bottom feeders and is often something floated during the diligence process to test the conviction of the seller.
However, for the past six years or so, I haven’t seen retrades from VCs or angels investing in companies very often. Occasionally a deal will fall apart in diligence, some famously so, but they rarely have been retraded.
This lack of retrades, however, is not the historical norm. When I started investing in the 1990s, I experienced a lot of retrades from VCs at many different stages. While a term sheet isn’t binding, part of the reason it tended to be long and complicated was to avoid the retrade dynamic and spell out all the terms of the deal explicitly.
In the late 1990s into the mid 2000s, I viewed the risk of a retrade as continuous background noise in any deal – investment or M&A. The notion of deal certainty became important to me and I started spending more time working with investors and acquirers who I believed had a very high likelihood of following through on what they said they were going to do. In contrast, once I found myself being retraded by someone, I noted it and had a higher bar for working with them going forward, since I expected there would be a future likelihood of a retrade if I did something with them.
By the late 2000s, I had stopped being emotional about the notion of a retrade. I viewed it as a normal part of business, which impacted an investor or acquirer’s long term reputation, but was woven into the fabric of things.
And then the retrades more or less stopped. From 2010 forward, the entire VC market shifted into a mode that many describe as “founder friendly.” Investor reputation mattered at both the angel and VC level. Retrades were a huge negative mark on one’s reputation and word got around. As more and more investors showed up, valuations increased, and time to close a deal shortened, there was little tolerance for a retrade, so they disappeared.
As we are now about five months into a broad market reset, both for public and private market valuations, the retrade has reappeared in private investments. The first indicator of it is that it now takes longer for a deal to close. I expect the days of transactions closing 15 days after a term sheet is signed are probably gone for a while. While some lawyers are breathing a sigh of relief, a deal that takes more than 30 days to close often starts to have a little bit of retrade risk. And, when a deal stretches out over 60 days, there’s a lot of risk around deal certainty – both retrade as well as a full deal collapse.
Recognize that I’m talking about investments, not acquisitions. I never saw the retrade dynamic go away with certain buyers and certain type of acquisitions. However, what’s notable to me on the investment side is that the retrade is happening up and down the capital stack.
Mark Suster wrote a great post yesterday titled The Resetting of the Startup Industry. Go read it now – I’ll wait.
Once again, as we find ourselves in the middle of a significant public market correction, especially around technology stocks, there’s an enormous amount of noise in the system, as there always is. Much of it is very short term focused and, like a giant tractor beam, draws the conversation into a very short time horizon (as in days or weeks). And, rather than rational and helpful thoughts for entrepreneurs, it often brings out the schadenfreude in even the most talented people.
Mark’s post is one of the first in this cycle that I’ve seen from a VC giving clear, actionable advice . One of my favorite lines in buried in the middle:
“I’ve heard enough companies say “we simply can’t cut costs or it will hurt the long-term potential of the business” to get a wry smile. We entrepreneurs have been spinning that line for decades in every boom cycle. It’s simply not true. Pragmatic cost cuts are always possible and often productive.”
Many companies have hired ahead of their growth rate because they had the cash to do so. In our portfolio, we generally don’t have this problem because we aren’t big fans of either (a) overfunding companies or (b) escalating burn rates based on headcount. But, occasionally we find ourselves in the position on the board of a company where, as you look forward, you realize you are burning more than you should be for the stage you are at. As Mark suggests, this is a moment when you can proactively make pragmatic cuts. It will suck for a few days but feel a lot better in the long term.
But, more importantly, is another point Mark buries later on, which includes an awesome post of his from 2010.
“If you need to clean up your own cap table first – while very hard to do – it will make outside funding easier”
Again, go read the post now – I’ll wait. It’s so nice there are other great VC bloggers who write this stuff so I can just point at it.
I learned this lesson 127 times between 2000 and 2005. I started investing in 1994 and while there was some bumpiness in 1997 and again in 1999, the real pain happened between 2000 and 2005. I watched, participated, and suffered through every type of creative financing as companies were struggling to raise capital in this time frame. I’ve seen every imaginable type of liquidation preference structure, pay-to-play dynamic, preferred return, ratchet, share/option bonus, option repricing, and carveout. I suffered through the next financing after implementing a complex structure, or a sale of the company, or a liquidation. I’ve spent way too much time with lawyers, rights offerings, liquidation waterfalls, and angry/frustrated people who are calculating share ownership by class to see if they can exert pressure on an outcome that they really can’t impact anyway, and certainly haven’t been constructively contributing to.
I have two simple rules for founders in my head from this experience. First, make sure you know where the capital is going to come from to fully fund your business. You might have it in the bank already. Your existing investors might be willing to provide it. Or you might need to raise it. Until you are consistently generating positive cash flow, you depend on someone else for financing. And, in this kind of environment, that can be very painful, especially if you need to go find someone who isn’t already an investor in your company (e.g. your insiders require there to be an outside lead, or you need to raise much more capital than your insiders can provide.)
Second, keep your capital structure simple. There are three things that will mess you up in the long run:
- Too much liquidation preference: My simple rule of thumb is that if you’ve raised more than $25m and your liquidation preference is greater than 50% of your post money valuation, you have too much liquidation preference. This is a little tricky in early rounds and with modest up-round financings, as you’ll often have a liquidation preference that is high relative to your overall valuation. But, as you raise more money at higher valuations, this will normalize. Then, if you end up doing a down round, it suddenly matters a lot. Don’t worry about this too much, until you do a down round. Then use the down round to clean up your preference overhang.
- Complex liquidation preference: In an effort to keep from doing a down round, or too much of a down round, there will be tension between your old investors and your new investors (if you have them) around your new liquidation preferences. Often, there will be asymmetry between them with your new liquidation preferences having a multiple on them where they participate for a while up to a cap. Or participate forever. If you don’t know what this means, welcome to the world of terms other than price suddenly mattering, which Jason and I talk about extensively in our book Venture Deals. Deal with reality as a founder as well as an investor group and avoid this complexity – just clean up your cap table instead.
- Carveouts: After spending hours working through yet another messed up carveout that I inherited from an old bubble-era deal, I realized I hated carveouts. They are almost always written in a way that doesn’t really hold up, creates misalignment, or is a negotiating anchor in an acquisition situation. When I see a carveout being proposed these days, I know there’s a liquidation preference problem.
Mark’s post has good solutions for each of these, but the best is – as a founding team – to work with your investors to make sure that everyone is aligned for the upside case, rather than focused on protecting their capital in the downside case. For this, like so many other things in life, means “simple is better.” Most importantly, don’t be afraid to talk about it early, well before you have to go through another financing round.
I woke up this morning in Fort Worth, Texas. For the first minute I wasn’t really sure where was I but it eventually snapped into focus. This happens to me periodically when I travel.
I’ve got a stretch where I’m on the road a lot. Fortunately, I’ve got amazing partners. I was reflecting on this over a cup of stale coffee this morning.
One of our deeply held beliefs at Foundry Group is that all four of us work on, and are responsible, for every company we are investors in. We don’t have silos where there are “Brad companies” or “Ryan companies” or “Seth companies” or “Jason companies.” In about 90% of the companies we are investors in, two of us are actively involved. In about 50%, three of us are actively involved. But in 100% of the cases, we all know what is going on, have relationships with the founders and CEO, and can quickly engage and help wherever and whenever we bring something to the mix.
As a result, we’ve always been active at moving primary responsibility for a company (which we define as a board seat) between partners. This is, in effect, a simple form of load balancing that we are all technically aware of from our early investments in some companies that generated, or used, very visible load balancing products before some of these technologies started to become absorbed into the core Internet infrastructure (anyone remember early DNS round robin approaches?)
We have a full day offsite every quarter. One of the things we do is a full portfolio review. Part of that is a load balancing exercise. In addition, we do this exercise as each partner returns from their one month annual sabbatical, as the other three partners have already been handling that partner’s primary responsibilities.
The load balancing process is collaborative. We aren’t randomly moving companies around between us, but rather thinking hard about where a particular partner can help – both in terms of the specific company as well as reducing cognitive load on another partner.
We recently load balanced the companies I was primarily responsible for as (a) my load was excessive and (b) we knew I’d be on the road a lot in Q1. We made a few changes just before I went on sabbatical, talked about it a little more when I returned, and then made a few more changes two weeks ago.
As I sit here a little bleary eyed from the past few days, I realize how powerful this process is at many levels, most importantly eliminating any ego dynamics across the four of us when we think about the portfolio (as the load balancing includes a full range of companies – from those doing extremely well to those struggling.) And, I feel intense relief and satisfaction that I work with three partners who I trust as deeply as I do.
Amy and I watched The Big Short on Tuesday with my partner Jason and his wife Jenn. We were electrified as we walked out of the theater – all four of us loved it. Jason commented that it was a particularly impressive movie given the subject matter. I couldn’t stop saying “that’s the best explanation of what created the financial crisis that I’ve ever seen.”
I remember reading The Big Short in 2010 when it came out. I’m a huge Michael Lewis fan and gobbled it down in a day or two. As we walked to the parking lot, I commented that the big four actors (Gosling, Carell, Bale, and Pitt) in the movie totally nailed their roles. I particularly identified with Pitt’s character Ben Rickert (based on Ben Hockett) who lives in Boulder in the movie.
As we got into our car, Amy said, “What do you think is happening today that no one sees?” This was the underlying theme of the movie – there were some completely obvious things in hindsight going on at the time that no one saw, or wanted to see. A few did notice and made huge financial bets, in non-obvious ways – about what they saw and believed was going to happen. Their foresight and conviction paid off massively, but it scarred each of them in different ways that the movie dramatized extremely well.
I like some time to pass before I look at history. While some people are good at reflecting on the past year and looking forward to predict the next year (one of the best in the VC world is Fred Wilson – read his posts What Didn’t Happen, What Happened In 2015, and What Is Going To Happen In 2016), I’ve never been particularly good at a one year time frame. Instead, I generally like a ten year moving window to process things. So, the lens of 2005 (history) and 2025 (future) is the one I’m currently enjoying.
The Big Short is picking up major steam in 2005. The climax happens in 2008 and the denouement continues on until 2011. So, from a history window perspective, the time frame landed directly on my boundary. Subsequently, Amy and I went on a binge the past few days of other media around this, including the movie Too Big To Fail (which is really about what happened in the fall of 2008) and Inside Job (which covers a broader time range, but focused on 2005 – 2008).
As I sit here on January 2nd, 2016, I’m pondering “what is happening today that no one sees?” When I go back a decade, we were just making the decision not to raise another Mobius Venture Capital fund. My partners and I hadn’t yet created Foundry Group. Techstars didn’t exist. Venture Capital and entrepreneurship was dramatically out of favor. Early stage and seed capital was extremely difficult to find.
I remember having deep conviction that there was an enormous wave of technological innovation coming. I knew that many of the things that had been created in the Internet bubble were great ideas, but they were just – as Jerry Colonna and I like to say – a decade ahead of their time. Today, it’s pretty obvious that was correct. At the time, talking about this stuff was a conversation stopper of the sort that Michael Burry (played brilliantly by Christian Bale) seems to generate every time he talks to someone.
Unlike Mark Baum, who is based on Steve Eisman (and played even more brilliantly by Steve Carell), I’m not angry, cynical, and convinced the world is a giant, rigged, inside game. But I do believe that the vast majority of people have absolutely no idea what is really going on, especially those who are in the middle of whatever game they are playing.
While this comes out in The Big Short, it’s even more apparent when you watch (or read) Too Big To Fail. And, while watching Inside Job, you see people lying or trying to obscure the truth in almost every interview. You can’t fake reality – it always catches up with you.
In the mean time, I’m getting ready for the next season of Game of Thrones.
Two words: Mattermark Daily
When I started blogging in 2004 I think I was the third VC blogger after David Hornik* and Fred Wilson (if you were, or know, of another pre-2004 VC blogger, please tell me so I can update my historical recollection.)
I remember lots of people asking me why I was doing it. I heard plenty of trash talk from other VCs, especially second hand, such as “He doesn’t have enough to do”, “He’s not spending his time doing his job”, or “What a waste of time.” I didn’t care, as I was doing it – like Fred often said – to help me think out loud in public, learn about different things, and get a conversation going around topics I was interested in. In retrospect, it was also helping me “practice writing” and without all the practice, it’s unlikely I would have ever gotten in the rhythm of writing a book a year.
Today, hundreds of VCs blog. Some are focused on using content marketing strategies to build their brand and reach. Some seem to have a full time person on the team generating content for them. Some do it under their name; other’s do it on their firm’s web site. Even more have tried and never got past a dozen posts.
Regardless of one’s success, it’s become extremely hard to track all the new content coming out and sort the good from the bad. My somewhat up-to-date VC People Feedly collection has 139 feeds in it. But I stopped being rigorous about adding new people about a year ago and rarely added feeds that were directly on firm websites, so I expect there are probably closer to 500 active VC bloggers now. And, this doesn’t include the guest articles that regularly show up on various sites like TechCrunch, VentureBeat, and Business Insider.
Rather than struggle to keep up, I’m just defaulted to relying on Mattermark Daily to tell me what to read each day. And, I always remember what I tell entrepreneurs: “It’s just data – and it’s often wrong.” Read a lot, but always apply your own critical thinking.
*Update: Naval Ravikant told me that he, Kevin Laws, and Andrew Anker were also part of VentureBlog (dating back to 3/2003). It now appears to be Hornik’s blog.
I got the following question from a friend yesterday.
“I’ve had a few conversations recently about how individual seed investors are getting kind of tapped out – for a variety of reasons, but in general it’s not that easy to find people who are still actively investing. I don’t recall your having blogged about this – are you seeing it too? Lots of talk about Series A crunch but maybe there is a seed crunch too?”
I blasted out a response by email, which follows. If you are an active angel, I’d love to hear what you think.
I’m not seeing much evidence of this – yet …
I have seen some of the more prolific angels start to slow down because capital is not recycling as fast as they are putting it out. That’s a pretty common phenomenon. But generally the pool of angel investors is increasing and the prolific ones who have a strategy (such as the angel strategy I advocate) seem to be keeping a steady pace.
There is also a huge amount of seed capital available from seed funds. Some angels are no longer competitive as they are overly price focused (e.g. if the valuation goes above $3m pre it’s too late for me). And the convertible note phenomenon hasn’t helped as many seed deals just keep raising small amounts of convertible debt.
The supply / demand imbalance is way off. While there is an increasing amount of seed capital / seed investors, the number of companies seeking seed investment has grown much faster in the last 24 months.
Also, I think some angels are just tired of the deal velocity. You have to work at it now more to stay in the flow because there’s just so much more of it, and that makes angels, especially semi-retired ones, tired.
If there is a big public market correction and angels feels (a) less wealthy and (b) less liquid (or not liquid), you’ll see a major pullback.
I feel like we are in a sloppy part of the cycle. Everyone is suddenly nervous. There are lots of uncomfortable macro signs, but it’s hard to get a feel for where things are really heading. And, at the same time, the cycle of innovation is intense – there is a huge amount of interesting stuff being created at all levels. And there is a massive amount of capital available that is seeking real returns, vs. low single digits.