I’ve seen many founders make this mistake over the past 7 years, so I thought it was worth a post.
Surprisingly, one of the hardest types of VC pitches (and one that a lot of founders struggle with) is the pitch to existing investors.
This is the “update meeting” to the broader investment team of an existing VC. Often, this might happen relatively early in the fundraising process, but sometimes, it happens later. Sometimes, the fundraising process hasn’t really started yet (in the eyes of the entrepreneur). So, they are surprised when they walk into an “informal update” and realize that the entire partnership has assembled to critique their business.
Entrepreneurs struggle with this for a couple reasons:
1. Too casual. These meetings are almost always couched more casually then they really are. That’s because as the VC, bringing in a portfolio company to update your team does seem casual. But to the founders, this is a very high stakes pitch. It’s the job of the other members of a partnership to press on a company and keep their partner honest and offer fresh perspective, so although the environment will be friendly, the folks in the room are likely to take a more critical eye on the business than one would think.
2. Assuming too much. It’s easy to see friendly faces in a partnership pitch and think that everyone in the room is up to speed.
As a result, these pitches often dive quickly into the details, and fail to present an emotionally enticing story-arc. Big mistake. Even though other members of a VC team have some context, you can’t assume that they are fully informed and have seen the narrative unfold. In fact, these pitches are tough because you have to cater to both folks who are pretty unfamiliar with the business, and others who are intimately involved. On top of that, VCs are always asking themselves, “how would other investors evaluate this opportunity.” So even if they are aware of the details, failing to cast an exciting vision can lead existing investors to think “maybe there will be future financing risk for this company.”
3. No practice. Often, by the time you get to partner meetings during an external fundraise, you have honed your story through repetition and practice. In this case, you probably haven’t had much practice, and practice would seem contrived anyway since it’s just an “internal update”.
4. No sense of competition or external validation. All fundraising conversations are easier when there is a sense of competition that
creates both external validation and/or FOMO. With internal pitches, it’s harder to create this. Usually, these meetings happen at the beginning of a fundraising process, so it’s hard to create external validation. Also, as an existing investor, there is an assumption that even in a pretty competitive round there will be the ability to do one’s pro-rata and maintain ownership. The investors have a very strong sense of security, which makes it tougher for founders to get investors hot and bothered.
So, what should a founder do? Couple thoughts,
1. Practice. Find some insiders who are relatively small investors that do have experience with this but aren’t likely to influence the round dynamics significantly. Practice the real pitch with them, and do so in a realistic setting so it really does feel like a pitch.
2. Create some external demand. Even if it’s new angels or strategics, it’s helpful all around to show some external demand for the company’s equity. I wouldn’t front run a ton of VC conversations, but some outside validation helps a ton.
3. Own it and deliver. Realize that this is going to be one of your harder pitches and treat it as such. You have to captivate with your story, but show complete mastery of the details, for an audience that doesn’t feel like they are at risk of missing out. It’s tough. Don’t take it lightly, and be prepared.
Everyone knows that nobody gets consumer in Boston. If you want to invest in the next great consumer company, you better be in Silicon Valley or New York. It’s just a given.
It turns out that claim is total BS. Boston has amazing consumer companies, but the region gets no love for some reason.
Case is point are three really interesting companies that have come to prominence over the last year or so. Care.com, Wayfair, and Simplisafe.
When I ask consumer internet investors about their areas of interest, I hear three things these days.
1. Network effect businesses.
3. Connected Devices.
Funny enough, all three are represented here. Care.com is a classic network effects business. The more and better the caregivers in the network, but more valuable it is for consumers. The more consumers, the more attractive it is for caregivers. Care just went public, is an $80M+ revenue business, and has a multi-hundred million dollar market cap (not a vapor private valuation).
Wayfair is a great ecommerce company going after one of the largest and underserved categories – furniture and home goods. The company is no longer really a secret, and is doing over $1B in revenue. They compete against current (or former) darlings like Fab and One Kings Lane that celebrate great taste and design. Sorry, those companies aren’t in the same league.
And just this week, it was announced that Simplisafe raised $57M from Sequoia. What a beautiful business – nice hardware revenue + recurring subscription in a big category. Oh and they have over 100K customers. Pretty darn impressive and totally disruptive. Connected devices is a pretty new meme, and Simplisafe is probably the most interesting company in this category next to Nest.
So, why doesn’t Boston get more love on the consumer internet side? Couple thoughts.
1. Main Street Stories. I could say that Boston is just far away from the major media centers, and thus doesnt’ get enough attention, which is true. But deeper than that, I think there tends to be a practicality to Boston companies that is a little less media friendly. The three businesses above don’t market themselves in flashy or audacious ways. They tend to market in a main street way, and talk to everyday consumers about their problems and value proposition. One of my friends in Boston admitted that he had never heard of Simplisafe until “one of my friends in Indiana bought it and installed it (and loved it)”. What are other companies that built huge businesses focused on regular people as customers? Ebay, Amazon, and Netflix come to mind. If you are going to be huge, main street is the way to go. But the stories aren’t necessarily that sexy.
2. Too early? This is counter-intuitive, but Boston startups I find are often too early. Simplisafe started before connected devices were cool. Wayfair started before the resurgence of ecommerce. Zipcar was way before Uber and Lyft (and I’d argue still a more disruptive model). Taskrabbit, which started in Boston, is the poster-child of the outsourced service economy. Runkeeper predates most companies in the quantified health space. The list is long. But sometimes, the earliest companies just don’t get the same attention.
3. Not enough “mediocre” companies. I can’t quite explain why, but I notice that Boston tends to have quite a few really great, sustainable consumer companies. But relative to the great ones, much fewer “ok companies” or flame-outs. That seems like a good thing, but it really isn’t. For an ecosystem as a whole, it’s really great to have a large number of people who have been involved in companies early that had some promise, had some success with their product and marketing, but didn’t end up making it. The skills around going from zero to 20MPH are really valuable and needed. But in a market where there are fewer of these, you tend to have a lot of people with experience getting from 30-60MPH and beyond, but fewer who are adept at doing what it takes to get things off the ground. You need flameouts and ok companies to produce great ones.
But overall, I think there is one major issue at work, and it does come down to the culture and high-brow intellectualism of this market. No one wants to look stupid. And because of that, when someone does look stupid, people are quick to pile-on and be nasty and snarky.
Journalists don’t want to look stupid by talking about a crazy consumer company as the next great thing.
Founders don’t want to look stupid by beating their chest and shining the spotlight on themselves in case the spotlight shines on them when things go wrong
Angels don’t want to look stupid by having the large number of losses required to catch winners, or get crammed down by VCs investing big dollars ahead of them
VC’s don’t want to look stupid by investing in things too early, or trying to use capital as a weapon only to go down in flames
And when a town is NOT the center of the tech sphere OR the center of the media universe, the bar is higher to get noticed, so the risk is magnified.
Don’t be afraid to look stupid.
The dynamics of a series A round have changed in recent years. As seed rounds have become much more common, it’s been said that the “seed is the new series A”. This is sort of true – it used to be that Series A’s would often happen pre-product, and certainly before product-market fit. With capital efficiency, companies in certain sectors have been able to do more with less and show some market traction even after a pretty modest seed round.
The end result though is that the dynamics around series A rounds has started to seem pretty murky for entrepreneurs. But for investors who see a lot of these deals, it’s not as unpredictable as it seems. Below are some broad guidelines on the major topics around series A’s that I hear entrepreneurs thinking about.
VC Ownership: Institutional VC’s that lead series A rounds still target ownership in the 20%+ range. Historically, VC’s wanted a bit more, 25% or so, but 20% is a threshold that has been around for a long time. This hasn’t really changed. As a result, questions around valuation are less about “what is the value of this company” and more “how much capital is a VC willing to part with to buy 20%?” This is why larger funds are on average are able to be a bit more aggressive on price than smaller funds because they can stretch to invest a bit more to get the ownership they are looking for in a competitive situation.
This leads to some interesting sub-dynamics, especially when a larger VC is in your seed round. In theory, if that VC is really excited about the opportunity, they should be willing to pay a higher price for the series A than anyone else because they are already partial owners of the company. It’s a lot easier to get an investor from 7% ownership to 20% vs. getting a new investor from 0% to 20%. In practice however, this doesn’t happen as often as you think, because large VCs that bore the seed risk will often feel like they ought to get higher than 20% ownership because they put in the hard work early in the company’s life.
I find that it’s also pretty typical for an existing VC investor to be willing to syndicate the deal with another outside investor. This enables the large VC to have another deep pocket around the table post Series A to be able to add capital into the company with less friction in both a good and bad scenario. In that case however, the founders might end up taking a lot of dilution. The existing investor will need to buy up to get to 20%+, and the new investor will want to buy 20%. This potentially makes it all worthwhile if the round is pretty large, and this is how some series A rounds end up being $10 – $20M of new capital, rather than the more standard range of mid single-digits.
Speed and Timing: Insitutional seed rounds typically provide companies with enough cash to take a company around 14-18 months. This assumes some increase in burn over time, but the capital could also be stretched to go longer. As an entrepreneur, one could always make the argument that it’s best to keep operating longer and show more progress before raising to get the best valuation possible. In practice however, many companies that have the most successful series A fundraises raise their rounds much sooner, often <12 months from the seed. This happens for three reasons.
First, time is of the essence. Waiting 6 months longer to raise may improve valuation in the short term. But having the capital in the bank to make the most of an attractive opportunity sooner usually is the better move overall and will enhance valuation in the long term. Second, when things are working, founders will usually lean into the opportunity with the capital they have, which will reduce runway but make their growth curve steeper. Third, it’s more advantageous to raise capital when you don’t need it, and having a nice buffer gives you more boldness to negotiate a better deal.
This certainly is not to say that companies that take longer than 12 months or raise their A are not successful. In fact, there are a quite a few examples of companies that needed to raise extensions of their seed to get to a place where a successful series A could happen. But for companies that have something that is working, I find that being more aggressive and raising sooner tends to be better at the series A stage.
Who To Choose?: Series A investors are almost always going to want a board seat, and it’s very hard to get rid of a board member that you don’t like. Therefore, who invests is much more important than valuation. 10/10 times, I will recommend that a founder go for the series A investor that they have good rapport with, trust, have aligned vision with, and they believe will most impact the long term performance of the company. Investors that will pay a higher price but have misaligned styles and goals just aren’t worth it.
Valuation: Taking my own advice, I propose thinking about valuation in terms of round sizes. There are broadly three buckets of series A’s, and therefore, three valuation buckets.
- Solid Series A: New VC investor invests $3 – $4M and owns 20-25%. This suggests a post-money valuation range of $12M – $20M. Remember, usually the round is bigger than just the capital that the new investor puts in because of pro-rata rights or other smaller angels that may want to participate. That’s why I’m focused on post-money here and solving for the ownership ranges of the new VC.
- Great Series A: New VC investor invests $5 – $6M and owns 20-25%. This suggests a post-money range of $20M – $30M. These are terrific series A outcomes.
- Outlier Series A’s: Outliers exist with extreme traction and/or extreme competition for the deal. In these cases, a new VC investor invests $7M+ for 15% – 20% ownership. In these cases, the new investor may break their rule to own less than 20%, and is writing a large check for series A standards. This does not happen that often. Sometimes, you see rounds like look like huge series A’s and it’s discouraging to entrepreneurs. The reality though is in those rounds very rarely happen and/or something else is going on. Something else might mean that the total dilution is a lot higher than one would think because an existing investor is also buying up. It might mean that the “seed” was actually quite a bit bigger than the typical institutional seed, so the company has already taken in a fair bit of capital.
Founder Liquidity: It used to be that founder liquidity would almost never happen until very late into the life of a company. Today, it’s become a tool that is used earlier to better align incentives between founders and investors. Usually, it’s not a huge amount of liquidity – often a few hundred thousand dollars to a million max. It’s enough so that the founders will feel emboldened to step on the gas and go for a big swing rather than play it conservatively to preserve value, but not enough that they won’t work maniacally hard to win. I personally think this is a reasonable thing, especially when founders have gone a long time with limited pay and/or are struggling with the dilution of a big round. It’s not uncommon these days to see some founder liquidity in the series B and C rounds of companies. It’s still very unusual to see them at the series A stage as usually, an investor wants every dollar to go into the business they are investing in. But it’s not entirely out of the question, and can (in very rare instances) be orchestrated in large series A rounds when there is a huge amount of competition and investors are scrambling for ways to get as close as possible to their 20% threshold. But overall, I’d recommend not even considering this until later in the fundraising path of your company.
We have always been believers in trying to be helpful to the entrepreneurial community through the content we publish on our blogs. But we find that these only go so deep, and at times, certain practical topics warrant more attention.
This is why we are going to start publishing a series of “Growth Guides” over the next 6-12 months. The point of these are to:
- Take on topics that we often here as questions that are held specifically for early-stage companies in their first 12-24 months of life
- Offer more practical insight than what one could gather through blogs or Quora and bring in both our perspectives and those of other experts in the field.
- Present information that is actually useful to founders and their teams. So in addition to some theory or broad commentary, these will include actual hacks and other tips and playbooks that are immediately actionable for a founder or an early team member.
We launched our first one of these around content marketing for startups. It’s a form of marketing that we often hear a lot of questions about and can be effective for early stage companies. But it’s also a form of marketing that is very noisy, so we tried to cut through the noise and present something that is practical but has sufficient depth. It also helps that Jay, our Director of Platform and Community led content marketing efforts at HubSpot prior to joining.
Looking forward, we are going to be publishing more of these, and I’d like ideas for common topics that early stage founders and team members care about. It can be anything from mission critical stuff, or even more mundane stuff that takes up time and makes you think “why hasn’t anyone just figured out the answer and told all of us founders?” Here are a couple ideas that we’ve been throwing around, but I’d love to hear from you what we should include!
Current possible topics are:
- Hiring your first five engineers
- Product management before product-market-fit
- Seed stage board decks and board management
- Interviewing and reference checking
- Tools, providers, and services. All the stuff you will need after raising your seed round, but don’t really want to research
- How to incorporate user feedback into product decisions
- Performance marketing tests that you should do before PMF
Others or more broad suggestions? All thought are welcome. And again, check out our first Growth Guide on how Content Marketing can be used for startups.
There is a ton of chatter today in the news about the expiring lock-up of Twitter shares and what it means for the company and its prospects long term.
There have been a ton of headlines over the past few weeks comparing Twitter to Facebook. The narrative goes something like this: “Twitter usage is not growing fast enough, therefore, it will never be as mainstream as Facebook, and thus, is a much less attractive company long term.”
I don’t have a meaningful horse in this race, as I don’t own any Twitter stock. But I’ve had a long held belief that most people make a flawed comparison between Twitter and Facebook. Facebook is a social network, and Twitter is a media company. Two totally different types of businesses.
But beyond that, I have a pretty strong belief that in the long-term, Twitter will be a thriving service much longer than Facebook.
Why is this? Facebook wins so long as it is the dominant communication medium between one’s social network. But what we’ve seen is that there is massive fragmentation happening around this use case, and it’s only accelerating. Want to send messages to your friends? There are dozens of messaging apps for that. Want to interact around products? There are networks like Pinterest for that. Want to interact around photos and media? There are others for that. Facebook totally realizes the threat of this network fragmentation, and so far, has masterfully used M&A as a means to stave off massive losses of mind and time-share of their users. But it’s amazing to think that in the short history of the company, they’ve already had to address the threat/rise of massive services and been forced to pay ungodly amounts of money to keep them (and their audience) within their ecosystem. I think that this is just evidence that the pressure on Facebook to maintain its network dominance will only get greater and greater, and at some point, there will cede their position. It will happen faster than people think.
I find Twitter to be pretty different. Twitter wins as long as it remains the easiest, fastest way that anyone publishes to the public. If the content producers leave, the service will die. But as long as the content producers find value, the service will have immense value. And that value is not entirely captured by the number of times one’s Twitter feed is refreshed. It exists every time you hear a news story mention content that was generated on Twitter, when you see photos from faraway places capturing major moments through Twitter, or when you consume other content or information that is surfaced to you because of what is trending on Twitter.
The importance and impact of the Twitter ecosystem goes way beyond page views. As a result, I just see it as a more durable property long term than Facebook. It’s a lot harder to think about competing content publishing services that have been a real threat to Twitter in the past few years. There have certainly been fewer threats than Facebook has faced. If you were to compete against Twitter on this dimension, I don’t know where you would even start.
All this said, Twitter’s ability to monetize does (currently) depend on the size of their direct audience on their own stream. And the growth challenges certainly dampen some of their prospects. Perhaps it is true that Twitter’s valuation is pretty rich compared to its current revenue generation potential. And perhaps Twitter is never destined to be at the scale of Facebook, and thus is overvalued now. But I do think that in the longer arc of time, Twitter will survive, and has a better chance of thriving.