There are a lot of folks that think that the private tech market is pretty frothy right now. Some may disagree about whether or not we are in a bubble. But it’s hard to argue against the observation that more bubble-like things are happening currently than in what would be considered a “normal” market. For example:
- We are seeing extremely healthy valuations for companies, some with very limited traction or semblance of a business.
- Very large scale acquisitions are happening for companies with little or no revenue for strategic reasons. These always happen from time to time, but they seem to be happening more frequently and at higher multiples at the moment.
- New and unusual participants in financing rounds are appearing. This includes both new funds being started with unusual backers, as well as later rounds being led by non-traditional entities.
Take your pick, weird stuff is happening. For participants in this ecosystem, what is one to do? How should you operate in frothy times? Here are a few thoughts, but I’d be curious to hear what others think too.
1. Stay in the game. It’s very hard to tell whether things are on the verge of collapse, or whether we are still in relatively early innings of a massive bull market in tech. Even if the activity in the market seems puzzling, it doesn’t mean that you shouldn’t be a beneficiary of it if you can. Even though many businesses in the first internet bubble were complete failures, some worked and are among the most important companies in existence today. Even though many people saw their wealth multiply on paper only to come crashing down, some made life changing wealth that did not evaporate. And almost everyone walked away with incredible experiences, skills, and a better intuition for the future.
2. Don’t be discouraged. It’s easy to get discouraged from time to time when blockbuster things are happening around you, but not to you. Hey, as a VC, I could get discouraged too. The day I started writing this post, RelateIQ (a 3-year old company) was acquired for ~$400M and RapGenius raised capital at a valuation of $400M. These things didn’t happen to companies in our portfolio that day. Nor did it happen to 99.9%+ of companies out there, some of which are excellent companies. To some degree, all participants in this market benefit from frothy times, but the headline grabbing events are still happening to a very small minority of companies. Don’t let yourself get too cynical or discouraged by this. Stay in the moment and play your own game. It doesn’t help to benchmark yourself with the outlier events because they are unpredictable and take a magical combination of being right, working hard, and being really lucky. Don’t give up – the harder you work, the luckier you’ll get.
3. Be realistic about what’s going on. If things are going really well, keep in mind that these are unusual times. Be humble, and remember that ultimately, the best companies in the world are real businesses that solve meaningful problems and capture some of the economic value they create (and that value is more than what it costs them to create it). When your company raises money at a sweet $1B valuation, remember that does’t mean that your company is worth $1B, nor does it mean that you are worth your ownership x $1B. It only means that someone who loves your business was willing to buy a fraction of your company’s shares with preferences at a $1B valuation. Besides, there is a lot more to happiness and self-worth than the dollars in your bank account or the value of whatever equity you own.
4. Maintain agility. Good times eventually give way to not so good times. Things could also get ugly pretty fast. Be ready to turn on a dime – the end of good times doesn’t mean the end for you, your company, or the prospects for (fill in your hot sector of choice: Bitcoin, IOT, Mobile, etc). Remember that wonderful companies like Paypal and Netflix survived the dot com crash, and companies like LInkedIN and Yelp were started in the wake of that crash. Twitter was started before the financial crisis hit, and survived, and is thriving. But raise a bit more money a bit sooner than you can. Keep in mind that you may need to get extra creative if things start to go south. Don’t get too far ahead of your skis, and you can navigate whatever lies ahead if you really have a great company.
On behalf of our team at NextView, I’m very pleased to announce that we have just closed our second fund. NextView Ventures II is $40M, twice the size of our first fund, and we continue to be exclusively focused on seed-stage companies pursuing internet-enabled innovation.
As former operators and product-oriented entrepreneurs, Dave, Lee, and I tend to think of our firm as a startup company and our approach to investing as our product. We’ve often explained to entrepreneurs that the second fund of a venture firm is very much like the series A for an early stage company. It shows that things are working and there is product/market fit, but there is a long way to go towards building an enduring company of great consequence.
For a seed stage venture capital firm, product/market fit comes down to two questions.
1) How is the portfolio performing?
2) Is your reputation in the market such that great people will want to work with you?
On performance, we are happy with how things are shaping up in our early NextView I portfolio. We have had a number of companies that have achieved successful liquidity events, including Rentjuice (acq. Zillow), Hyperpublic (acq. Groupon), and TapCommerce (acq. Twitter). As a result, we have been able to return a nice chunk of the first fund, with many of our most promising portfolio companies still in play and progressing rapidly. We have also been able to maintain a 70%+ hit rate of our seed companies raising series A’s, even in the depths of the “Series A Crunch”. The full story of the fund’s performance is still being written, but we are optimistic about what lies ahead.
On #2, we have been fortunate to collaborate with a wide group of exceptional entrepreneurs, coinvestors, and limited partners. Prospective LPs evaluating NextView tend to focus their due diligence on conversations with these folks as well as other trusted participants in the startup community that are likely to have a POV on us. Thankfully, that POV has been positive, and allowed us to bring on 4 new institutional limited partners in addition to our existing LP’s, several of whom significantly increased their commitment to NextView II. For those of you who spent time chatting with prospective LPs to build enthusiasm for our team and firm (you know who you are) we are grateful for your support and partnership over the years.
Just like any other startup, the question we are focused on post series A is whether we are doing the right things to allow us to win in a competitive market with a power-law outcome distribution. Does our strategy still resonate? Are we skating to where the puck is going? Are we hungry to keep innovating and investing internally to build on our early product-market fit?
Some of these questions led us to raise a larger fund for NextView II. We are still very small in the scope of venture capital firms, and we think that allows us to have a favorable balance of fund size to potential ownership in our portfolio companies. But a larger fund also allows us to invest a broader range of amounts in early seed rounds. There are a couple reasons for this.
First, the seed and early stage market continues to evolve. When we started NextView, it was fairly heroic to raise a $1M seed round, so a $20M fund could comfortably catalyze rounds with a relatively modest $250-$300K investment. Today, seed rounds are increasingly larger, sometimes creeping up to $2M. We want to be able to comfortably lead these rounds and speak for 1/3 – 1/2 of the capital or more. Our new fund size allows us to do that and continue to play the part of the lead investor.
This leads to the second factor. Although there are an increasing number of early stage capital sources, there remains a dearth of seed investors that are comfortable leading rounds. Our finding is that even rounds that end up largely oversubscribed often waste weeks trying to find a lead while other investors “hang around the hoop”. Part of our DNA was coming from larger funds that lead nearly all of their investments, and so we wanted to bring that behavior to seed investing. To date, we have led roughly 2/3 of the seed rounds we’ve been a part of, and even if our name isn’t the lead on the top of the term sheet, we act like a lead and drive to fast, independent decisions rather than hang back to see how syndicates take shape.
In most ways however, Fund II is a carbon copy of fund I. Same investing team (plus our new Director of Platform), same areas of focus, and same commitment to being exclusively seed stage investors. As I like to say, we are a one-product company, and that product is a highly engaged, lead seed investment. And just like any company, raising capital is not a metric of success, but merely a further opportunity to accomplish our mission.
Towards that end, we have already begun investing NextView II since the beginning of this year, and have 6 new companies in the portfolio so far. Stay tuned for more announcements in the months ahead! Follow our NextView blog here or the different members of our team. We’re excited with how things have been going, but there’s a lot of hard work ahead.
Today, we’re excited to officially launch our new blog, The View From Seed, providing insights and inspiration for seed-stage startups, founders, and entrepreneurs, from idea phase through raising Series A.
You can also check out the startup resources page on the blog, which we’ll continue to add to over time.
Why are we launching this blog, and why does it focus so specifically on the seed stage?
As venture capital firms evolve and strategies shift, we try to take the advice that VC’s give so often to their early stage portfolio companies: stay focused and be really great at one thing.
For NextView, our one thing is seed-stage innovation. Period. We want to be the very best capital partners for seed-stage technology companies in our areas of focus, and help founders give their companies the best possible start. We’ll continue to post topics a bit outside of this scope on our personal blogs, but will try to make The View From Seed the strongest collection of content that relates specifically to seed stage companies and the entrepreneurs leading them. This will include posts from the NextView team, but also from our friends in the ecosystem that have valuable perspectives to share as well.
If you have any feedback (or have ideas to contribute), we welcome them. Feel free to leave a comment here or contact myself or Jay Acunzo, our director of platform, directly via email.
Investors love to give advice. Even more so if they are board members or major investors. It’s part of our “value add”.
Some investors have a, shall we say, over-estimation of how much they know. It’s easy to make suggestions from the cheap seats, and even great investors or operators are often wrong.
At the same time, the very reason that you allowed certain people to invest in your company is because you valued their perspective and opinions. Often, investors have more experience, or at least a very different vantage point than what you might have as a founder. But how much should you listen to your investors? And what’s the right mindset to have about their advice?
I’ve seen entrepreneurs stumble at both extremes. In one extreme, I’ve seen founders start orienting towards pleasing their investors, and are looking too much towards their investors for direction. As the founder and CEO of the company, it’s critical for you to be the ultimate decider. You are the best equipped to understand all the nuances at work in your business. The buck stops with you. If you start acting like you report to your investors or your board, you are screwed. You’ll make bad decisions, move too slowly, create the perception of weak leadership, etc.
On the flip side, I’ve also seen entrepreneurs develop tunnel vision, and ignore their investors entirely. Even if there is a chorus of feedback that is contrary to their opinion, some founders will just put their heads down and ignore. Communication starts to break down and so does trust. Disfunction ensues.
The CEO of one of my portfolio companies once shared his perspective with me and I’ve always appreciated it. He said “It’s your job for you to tell me what you think. And it’s my job to process your feedback and the feedback of others, and decide what to do.” I appreciated that – it’s led to a good working relationship with this founder where I feel like I can say what I want, that it will be carefully considered, but he’ll own the decision. He’s also very communicative and honest, so whatever thoughts I have (right or wrong) are at least informed and timely.
Another portfolio company founder relayed a conversation he had with two investors in a prior company. In the midst of a difficult decision, investor A was very aggressively pushing the founder to make a particular choice that the founder believed was a mistake. In the midst of this situation, investor B suggested to the founder “just tell investor A, if I make the choice you want, will you be accountable for the results?”. Of course not.
Ultimately, entrepreneurs are responsible for the results of their decisions. Investors try to provide help and governance, but the operators make the tough calls and are accountable for the results. Make too many wrong calls, and investors may need to make hard decisions of their own as fiduciaries to our investors and other shareholders. But investors really don’t want to do this, and we are all rooting for founders to lead effectively with conviction.
In my last post about raising seed vs. jumping straight to A, I received a good comment from Chris Woods that my analysis neglected to include the impact of option pools that are created at each financing round. It was a good point, and one that is worth touching on with a dedicated post.
In almost every financing round, there is an important stipulation in the term sheet that talks about the employee option pool that will be created in tandem with the financing. Essentially, the new investor wants there to be a certain % of options available to employees after they invest.
There have been others in the past that have detailed the math behind option pools and their impact on venture deals. Here are three good ones from Venturehacks, Mark Suster, and Jeff Bussgang. The short implications are:
- You should definitely discuss this as part of your valuation/deal negotiations. It has a meaningful impact on your net dilution, and I’m often surprised how often founders don’t consider this a malleable term.
- I find that VC’s will tend to propose a larger option pool than is really needed. It’s not that we are bad, it’s that we are self interested. We know that at the next financing round, the new investor will probably want to have a certain sized pool available for future employees, so if we make the pool pretty big up front, we are less likely to share in that dilution down the road
- It does NOT make sense to try to change the rules of the game and get the VCs to handle this term differently than what is standard in the industry. You are better off in almost all cases maintaining the standard, but being savvy about negotiating this term.
- The negotiation tactic to take is to justify the size of pool that you think is reasonable. Basically, have an estimate of the hires that you are likely to make over the course of the next round and the equity packages you are expecting. Provide even an additional factor for “opportunistic hires” in case you happen to find “the best person in the world” for role X and want to bring them on prematurely. Add it up, and ask the VC why that level of options is not sufficient. It’s hard for a VC to make a principled argument in response to this that isn’t mainly self-serving. Or, it will be a good catalyst for an important discussion with the VC that will tell you a lot about how they are perceiving the quality of your team and the types of folks you need to bring on sooner rather than later.
What is a typical size of option pools that we see in the market? This tends to vary by company, stage, and completeness of team. As a result, I think most folks are kind of hesitant to put numbers out there because they can be misconstrued. But I’m going to give some ranges based on our portfolio, as I think it gives at least directional guidance for founders.
For seed rounds, we have seen options pools in the last 12 months in the range of 5% (which is low) to 10% (which is a bit on the high side). 7.5% is a pretty decent place to be. Keep in mind that these are for rounds where a) we are NOT contemplating bringing in an outside CEO and b) we believe that there is enough technical leadership in place to take the company to a good place. As such, these numbers do not contemplate an extremely senior hire that ought to take up a large chunk of the pool on their own.
For series A’s, we have seen option pools in the last 12 months in the range of 7-15%. This means that whatever % remains unallocated, the new investor is asking for the pool to be increased to this percentage. In some cases, it’s getting the pool to more or less the same size as what we had after the seed, but sometimes more or less.
As a means for comparison, historically, first institutional financing rounds used to require option pools in the 20% range, sometimes more, rarely much less. This was more in the days prior to the popularity of institutional seed rounds. Net net, I think that currently entrepreneurs are able to manage this more effectively. It’s fairly typical for a founder to start with a pool of 7.5%, actually only allocate ~5%, and then raise their next round requiring the pool be refreshed to 10%. Thus, the actual net effect is 5+10 = 15% dilution after 2 rounds, with your seed investors sharing in your dilution when you go from seed to series A.
Ultimately though, negotiating too hard here can signal a focus on the wrong thing. Investors want to work with entrepreneurs who want to build great companies, and will attract great people to do it. You don’t want to come off as overly stingy about equity to the point that one wonders whether you will do what it takes to attract the best talent to the team. But I wouldn’t shy away from the discussion either, because it has meaningful economic impact to founders and is the basis for an important discussion with your investors about how they view team building in the coming months and years of the company.