1. How to Raise Venture Debt

    Finding the right financing for your company is one of the most important jobs for a CEO.  For many high growth companies, this means navigating the maze of raising equity capital via friends and family, angels, or institutional venture capital firms.  As companies mature, it is often a smart idea to consider debt as an alternative source of capital to most efficiently capitalize the business.  While there is quite a bit more written about raising VC money than raising venture debt, I have previously discussed many of the more theoretical aspects of the debt side of the table.  In this post, I hope to lay out some very practical and actionable steps to consider as you look at debt as a financing option. 

    1. Figure out If you can support debt 

    For many pure startups, debt financing is not going to be an option.  Debt providers are in the business of figuring out how they can get their money repaid.  Thus, they typically look to things like operating history, a proven ability to generate positive cash flow, or hard assets as sources of repayment.  The caveat to these traditional measures is high growth companies that have raised material amounts of institutional equity capital.  Venture lenders will often look at the probability of a company raising additional equity as a source of repayment.  It’s all part of the implicit contract between lenders and VCs. 

    When considering whether your company can support debt and at what levels, it’s important to think like a lender. 

    • What will you be using the funds for and what will be the sources of repayment?  As a general rule, debt providers are willing to provide debt up to a certain fraction of the total equity (25-50%) for companies that are still burning cash but backed by high quality investors.   
    • If you’ve raised equity and want to layer in debt to extend runway to the next round, what are the milestones that you will need to accomplish to get there
    • If you’re hoping to manage a working capital gap, who are your vendors and what is their credit worthiness? For true working capital financing needs there will likely be many options from banks, specialty finance groups and other short term lenders but the cost and administrative overhead will be dependent upon the fundamentals of the business as well as the types of customers and contracts.
    • How much cash do you have in the bank and how much is your burn?  What’s your worst case number of months of runway (because this is how a lender has to think). 
    • If you’re generating positive cash flow, what level of comfort do you have with leverage against your annual free cash flow?  Debt can be much less costly than equity but comes with certain strings attached, namely a first position security interest in the company. 

    As a final point, the best time to raise debt is exactly when you don’t need it, particularly right after a round of equity financing.  This is when you’re likely to get the best terms and it usually makes sense to think about debt and get a structure in place before you absolutely need the funds. 

    2. Be prepared with the right materials  

    Different lenders will have differing needs in terms of diligence materials but below is a list of items that are fairly standard: 

    • Annual audited financials for the 2-3 most recent years: Lenders will ask for company prepared materials if you haven’t yet performed an audit (but will require an audit going forward).  In addition to verifying numbers, lenders will often use the audit to understand the revenue recognition dynamics of the business as well as any notes related to the balance sheet. 
    • A financial model for the next 12 months: Lenders love to see detail, so to the extent that you have a model which breaks out revenues and expenses by month (or quarterly) that is a plus.  Experienced venture lenders are used to looking at models and hair-cutting based on our experiences (we know they are often collections of guesses) but it’s imperative to understand what expectations are for the company.  
    • Cap Table:  Lenders will want to know who the equity holders are and how much skin they have in the game, especially if they are looking at additional equity as a meaningful piece of the risk equation.
    • A recent Accounts receivable and Accounts payable aging: Especially if you’re looking for a true working capital line of credit. 
    • A crisp powerpoint deck which highlights what the company is doing is a plus.  Most likely this is the deck you used to raise equity.  It can help with underwriting and with getting internal decision makers aligned with who you are - and thus able to better structure a facility which meets your needs. 

    3. Get feedback from multiple lenders

    While I would of course love for all entrepreneurs to only come to my favorite venture lender (and employer!) Square 1 Bank, it just makes sense to get multiple looks.  In particular, it’s important to focus not just on price but the following: 

    • Ablility for the lender to understand your business and structure a loan facility that makes sense.  Does the borrowing availability allow you to gain real leverage?  
    • Ask the lender for some references from other entrepreneurs who they’ve worked with and make a couple reference calls.  If you do, ask if the reference has ever been through a situation in which they tripped a covenant and see how the lender reacted.  You can also ask your venture investors of their experiences, as lenders tend to have multiple relationships with many firms. 
    • Communicate expectations and desires up front. To the extent you can be transparent about your desires from a facility, it will allow the lender to be equally transparent and get to an efficient outcome for everyone.  This is especially important when you get into docs and negotiate the finer points of the legalese - starting from a foundation of openness helps to make this much less painful. 

    In summary, take a holistic look at your company and it’s needs and figure out if debt is appropriate.  Once you do, you can go ahead and get the majority of your diligence materials together ahead of time.  Then, through transparent communication with multiple lenders you can set yourself up for a easy close and capital to grow your company. 

    Postscript: As is inevitable in any summary such as this, there are exceptions to every rule and it goes without saying that each deal is different, both from the lender and company side.  With that said, I think this represents a general framework for how to go about raising venture debt. 

  2. Ringing the Bell: The Square 1 IPO

    Last Thursday, March 27th I had the great honor and privilege of standing alongside about 40 of my colleagues as Square 1 Financial was officially listed publicly on NASDAQ.  To say this was a highlight of my professional career is an understatement.  Quite simply, it was one of the coolest experiences of my life to date. 

    To properly put things in perspective you’d have to rewind to January 29, 2007.  It was on that day that I walked into the doors at 406 Blackwell Street for my first day as a Square 1 Bank employee.  I’ve written before about how I got to Square 1 and how thankful I am to have had the chance to play a small part in shaping who we are today. 

    From Day 1 I have always been drawn to the Bank’s mission to be “Entrepreneurs Serving Entrepreneurs”.  We aid as capital partners and valued members of the ecosystem for the companies we serve while also getting to build a business of our own.  We went through the ups and downs of raising private capital, of navigating the economic downturn of 2008-2010, of thinking about how to compete and win for our shareholders.  

    I’m not a founder of Square 1 but was here pretty early.  And I can tell you that while we’ve grown quite substantially since 2007, it has not been a smooth “up and to the right” experience in the day to day. Any entrepreneur will tell you that the road to growth is messy, and our story is no different.  

    Which is what makes a milestone like last week’s IPO all the sweeter.  

    We were able to celebrate where we’ve come from and also raise capital for the future.  The actual experience of opening up NASDAQ was surreal.  We filed into NASDAQ studios around 8:30am and were given great instruction by the entire team.  We took approximately 6 million photos and while our cheeks hurt from smiling I don’t think anyone could stop if they tried. 



    Before we knew it the markets were opening, we were clapping and screaming, confetti flew around us, and Square 1 Bank was public.  

    imageTwo minutes later we were outside in the freezing cold for more pictures and right behind us for all of Manhattan to see was…us…lighting up the NASDAQ tower.  



    We then filed into the building and waited until just after 11:15am for the first official trade.  When it finally hit there was a chance for a few members of the team to share some great memories of the path and people who led us to the day.  It was a special time that none of us will forget. 


    What a day.  But just a milestone of the journey that started for Square 1 Bank they day they officially opened doors on August 5, 2005.  Time to go back to work! 

  3. Being critical without being a hater

    I have the great privilege of meeting with early stage entrepreneurs almost every single day.  Often these meetings consist of a short overview of what the entrepreneur is trying to build.  Then I try and ask a variety of questions to get a better handle on the vision.  Because most of these ideas are nascent and the execution is still to be done, there are often many unanswerable questions.  Or questions that will need to be answered but can’t be answered yet.  

    There is a delicate balance at this stage.  On one hand, an entrepreneur is looking for feedback which they can use to shape their business.  But the balance is making sure that this critical feedback is given in a way that is not too critical.  

    I’m sensitive to this nuance because it’s a line that I have to tread carefully - erring too far on either side isn’t good for anyone.  Because I have seen a lot of companies and know how incredibly hard they are to build, I feel it’s my responsibility to be honest and straightforward with entrepreneurs.  Sometimes my coworkers hear me on the phone and give me a hard time afterwards because it sounds like i’m only trying to shatter dreams.  They’re joking in most cases but there’s an element of truth to what they’re warning against - I don’t want to turn into a hater. 

    Things are already hard enough for entrepreneurs and there’s already enough haters in the world.  Haters can’t see anything besides what they want to see.  They’re the 490+ people who down vote a video like this on YouTube which seems positively un-hateable. 

    I want to be honest and direct without being a hater.  I want to point out the areas from my experiences with other companies that an entrepreneur will want to focus on.  But at the end of the day, I want entrepreneurs to know that I admire and respect the world of anyone who is trying to make something out of nothing.  For every question that may seem critical is coming from a desire to see more great companies built.  There is nothing that gives me more of a thrill in my professional life than to see an entrepreneur succeed in seeing his vision turn into a business.  

    So if we meet to talk about a startup, know that I value honesty and candor but above all else I value entrepreneurs.  I may come across as critical at times (which can, of course, be a critically needed thing), but I’ll do my best not to be a hater. 

    Postscript: I’ve been thinking about this a lot over the last few weeks. But this post by James Avery gave me the kick in the pants I needed to go ahead and write it.  Go read that post too if you haven’t already, it’s great. 

  4. How FilterEasy turned a mistake into a chance for fandom

    A few months ago, I met the FilterEasy guys at a conference and really loved what they were doing and how they were doing it.  The idea is simple -  a subscription service for residential HVAC filters.  You sign up for the size and type of filters that you have in your house and a recurring schedule (every month, 3 months, etc).  Then they just show up.  Filter.  Easy. 

    While the service is simple enough, I loved it because it solves a pain point for me. I’m constantly forgetting when I last changed my filters and even when I do, it takes me a week or more to go by a home improvement store to pick up more.  Getting on a regular schedule - set it and forget it - makes a ton of sense.   And the two founders, Thad and Kevin, are young, hungry and relentless (in a good way) at closing the sale.  

    So I signed up but I had just actually changed my filters and thus set up to receive my first batch 3 months later.  Fast forward to last week, when  a box showed up on my front porch. 

    Unfortunately, when I opened the box, only one of the filters was the right size.  I figured it was dumb user error on my part, but when I logged into my account I saw that I had indeed entered the right sizes.  There must have been a mistake in the fulfillment process. 

    This was a little frustrating, of course. First experience with a new service, and the very simple task of putting two air filters into a box had not gone as planned.  It’s certainly not the first impression Thad and Kevin would have wanted. 

    But what happened next changed everything. 

    I went on their website and saw a live chat option.  I opened a chat and within 2 minutes had a resolution to my issue.  An agent named Heather promised to refund me for the filter that was sent erroneously and then sent the correct one free of charge.  She was smart, efficient, and apologetic.  A day later I got a personal follow up email from Heather and a couple days later my right-sized filter was on my front porch. 

    For E-commerce businesses (and especially subscription e-commerce), customer lifetime value is paramount.  In a case like this, it would have been easy for me to lose confidence and cancel after 1 month.  Yet, the ease of solving my issue and the commitment to not only send a new one but offer a credit has turned a potentially damaging situation into a positive one.  The FilterEasy team was able to take a potential “churn” moment and turn me into a raving fan. 

    The most interesting part is that these guys are just getting off the ground and building the scale in their workforce.  I’m not even sure Heather is a full time employee (she may be but couldn’t find anything online to suggest so).  They’ve found a way to implement technology (the chat app run by Olark) to provide the service level of a large company while still keeping costs lean and focusing on building the business.  

    Keep up the good work FilterEasy.  Love what you’re doing and the commitment to getting it right even if it doesn’t go right the first time. 

    Disclosure: I’ve met the team and love what they’re doing but they are not a client, so no conflicts in giving this rousing endorsement.

  5. Who can you be real with?

    Startups are a mess.  They’re frustrating and exhilarating and stressful and full of problems that need to be solved.  The exhilaration of a startup is getting to actually solve these problems in new ways.  In your ways.  The stress comes from the fact that there are so many problems.  So. Many. Problems.  And not every problem has an answer readily available.  They take time.  And if there’s one thing startups don’t have enough of, it’s time. 

    We hear often that startups are a people business.  For all the great ideas and all the big markets it really comes down to people.  Who is going to lead these ideas into these big markets to create a new business?  Who is going to lead this living, breathing always-complicated-with-all-the-questions-and-not-enough-answers thing?  

    People do.  

    We call them entrepreneurs.  They dive headlong into this challenge and along the way they are compelled to see the vision of what “up and to the right” could be even while yo-yo-ing around between agony and ecstasy on a daily (or hourly) basis.  They sell this vision to investors, giving up a piece of their cap table in exchange for the fuel to make these dreams a reality.  In selling this vision they focus on what might be - on the ecstasy - and it’s exhilarating.  They sell this vision to employees - look what we can create! - and they build a team that can go out and execute to make vision into a reality. 

    Often this is how we see entrepreneurs. The public versions of them and their visions and the way they sell the world on how this dream can and will be a reality.  But it’s not how entrepreneurs, in their true moments of clarity, see themselves.   

    In these moments, they will tell you about the time when they weren’t quite sure if an invoice would come in from a client in time to make payroll.  Or when they knew they needed to cut a few heads to control burn.  Except those heads belong to real people and real families and real kids whose mommy or daddy won’t have a job on Monday.  They will tell you about the time when they weren’t quite sure if their company - their dream - would exist the following month.  

    Being an entrepreneur can be lonely.  While building a company that will live or die based on the efforts of the people, how many entrepreneurs take the time to find the right person who they can be completely, utterly 100% real with?  Someone who is close enough to understand the intricacies of the dynamics at play but who is not on the cap table or the payroll or otherwise directly affected by the decisions at hand.  As humans we have an innate desire to be fully known and fully loved - despite any character flaws or failings or missteps along the way.  Who, as an entrepreneur, can you go to and say, “I really screwed this up”?  

    Can you say it to your investor?  Your executive team?  Even your spouse?  

    It’s an important question to ask - who can you be real with?  Answering this question may very well mean the difference between living in the agony or living much closer to the ecstasy of entrepreneurial life, regardless of the business or financial outcome of your startup.  

  6. Getting Smarter by Asking Dumb Questions

    Like many others, I spent some time around the New Year thinking through resolutions and things I’d like to do differently in 2014.  Professionally, I’ve been experimenting with a new system for keeping track of tasks, notes, and planning.  We’re only a couple weeks in but I’m digging this new system I learned from a Thomas Tunguz blog post

    I’ve also done some self reflection with the goal of figuring out how I can better serve entrepreneurs and the community.  As a result, I’m resolving to do a better job of asking dumb questions.  

    In the startup world there are so many incredibly smart people who are pushing the envelope and doing new things within their specific industries.  When you combine the fact that these people are both very smart to begin with and also doing a deep dive in their chosen field, it can sometimes seem like you’re constantly surrounded by people who understand everything better than you do.  At it’s best, this can be extremely invigorating as you can constantly learn through osmosis and surrounding yourself with super smart people. 

    Yet, there can be an intimidating aspect to this as well - no one wants to feel like the dumbest guy in the room.  When I was earlier in my career I found that I would very often “fake it ‘til I make it” by giving off the impression that I understood much more about the intricacies of a technology or business value chain than I really did.  This is a dangerously slippery slope; I’m a huge proponent of using this strategy selectively, as it causes you to grow.  But all too often I relied too heavily on this simply because I wasn’t comfortable enough to admit what I didn’t know.  As a result, I actually hindered my ability to understand the big picture. 

    I see this at play in the ecosystem all the time from all different types of players.  There are investors who want to act like the experts in every technical domain and as the arbiters of which companies will definitely succeed or fail.  I see it with founders (particularly technical ones) who get miffed with “business folks” keep asking questions about how a technology will be monetized to turn into a business.  

    The antidote to this style is to be inquisitive.  This will require, however, a personality that is OK with asking questions that very well may be “dumb questions”.  But in taking this risk of being seen as one who doesn’t already have all the answers, I think you gain very valuable insights into the inner workings of the way people are thinking about the answers.  Because that’s the thing with startups - there are an almost infinite number of questions and very few hard answers. 

    So if we meet in person and in talking about your company I ask you something which is completely elementary, bear with me.  I’m just trying to get smarter by asking the dumb questions. 

  7. Startup Team Building and Service

    This post also ran at  Square 1 Insights

    It’s no secret that building a company is hard work. While entrepreneurial ventures can be full of excitement and energizing in many respects, they are still work and run the risk that the strain could burn out employees. Well known (and well funded!) startups will experiment with various perks like ping pong tables, catered lunches and flexible work hours in an attempt to keep employees happy while providing attachments above and beyond a paycheck. Happy teams lead to happy customers!

    At Square 1, we have been intentional and fortunate in creating a superb culture over our eight year history. Our sleek, modern headquarters in the burgeoning Durham, NC American Tobacco Campus feels much more like a high tech firm’s digs than a stuffy bank branch. A variety of intracompany events and sharp Square 1 gear has helped everyone feel part of a special team that is building a great company. Yet, we’re always looking for new and different ways to build deeper bonds and a stronger team.

    Recently we stumbled upon a new activity which has reaped great dividends as it relates to team building. What’s most interesting is that we didn’t start out looking to do team building, but instead were hoping to meet a need in our community.

    Last year we learned that the Urban Ministries of Durham operates a daily community kitchen only a mile from our headquarters. Every day, this non-profit serves meals to hundreds of homeless and indigent Durham residents. With more than 125 employees (also known as Squares) in downtown Durham, we felt a responsibility as a corporate citizen and community steward to step up and serve some of those around us who are less fortunate.

    On the fourth Tuesday of each month, we send a team of Squares to the Urban Ministries kitchen at 7:00am to roll up their sleeves, don hairnets and make breakfast for hundreds of our neighbors. While cracking eggs and plating pastries with our comrades from other departments, we’re able to connect on a different and deeper level than can ever be achieved at the proverbial water cooler. This type of interaction is almost impossible to create at a formalized offsite meeting and is multiplied in effectiveness by the fact that it’s achieved by serving others.image

    For the 20+ Square 1 team members who have volunteered thus far, it’s been an interesting paradox to find that that by waking up earlier and doing hard work, we are more energized and mentally prepared to tackle the duties of our day to day. In this case, it truly has been better to give than to receive.

  8. AngelList, Syndicates, Secondary Markets and the Opportunity for Everything to be Different

    As one who spends the vast majority of my professional life working with companies that are raising capital from angels and VC firms, I have been completely immersed in the recent developments in the funding environment.  Particularly, the change in the general solicitation rules and the unveiling by AngelList of new mechanisms for funding companies - syndicates and backers. 

    For those who haven’t yet had the time to become fully educated on Angellist, there’s a great collection of blog posts which have been curated by William Mougayar at his Startup Management blog.  

    This is a radically disruptive development in private company financing and we are at the very earliest stages, which makes this all very exciting and also a bit scary as I’m not sure anyone knows exactly how it will all play out.  That being said, here are a few of my real time thoughts: 

    Everything is now different; Everything is still the same

    The AngelList changes - particularly the ability for individuals to create what equate to mini-VC funds in next to no time at all through the Backer program - has the potential to be completely disruptive.  Investing in private companies (especially those that are early) is really, really hard to do successfully.  What may be even harder is figuring out how to convince institutional limited partners to part with their cash so they will invest in your fund so you can attempt to invest their money and generate returns that justify the risk. 

    If one wanted to be a full time investor and earn any sort of livable salary via a standard management fee (in addition to operating expenses of the fund), he or she would need to raise a minimum of $10mm in capital from external sources.  Ask any of the general partners who have been out pitching to LPs recently and they will tell you tales of horror about the experience, unless there is a verifiable track record of investing success (and even then it can be hard!) 

    Then along comes AngelList syndicates and the highest profile angels have been able to get to close to $1mm in backers in less than a week.  Take a look at an example like Dave Morin (founder of Path) who plans to invest in 12 deals a year with $50k of his own money in each deal.  As of 10/1, he has more than $900k in backers who are committing to participate in deals that Dave gains access to.  Let this sink in for a moment - Morin has effectively created a vehicle by which he can invest close to $12MM a year and only has $600k of his own money at risk (with potential upside of 15% carry on the $11.5MM in backer capital).  And all this was committed in a week or so. This is democratization of investing and it is amazing. 

    It’s not just amazing for Dave or for Brad Feld and the Foundry guys (who announced a Syndicate vehicle today as well) but for any accredited investor who has wanted access to the asset class but never had the ability to see the deals that a Dave Morin or a Brad Feld sees.  Now they can participate (passively) alongside those who get the best deal flow.  Disruptive democratization. 

    But, as the title of this section suggests, not everything is different.  If you take a look at the current list of angels with the large syndicate backings, it’s a who’s who of Silicon Valley/NYC startup-celebrities.  In other words, it’s still an old boys club it’s just that power is now being shifted in many ways to the individual and away from the centralization of the firm.  It’s conceivable that as this trend plays out that the best partners at the best firms will perhaps make a leap and fly solo. Or, perhaps a more likely scenario is that there will be new rising stars who are able to more quickly grow their careers by building a demonstrable track record without having to rise through  a partner track at a firm. 

    This leads to a second observation - Angellist and platforms like it (because there will be more) provide the technology and methodology for a new realm of investing, but it will still be mainly about relationships. 

    The reason these startup stars have been able to attract millions in backer commitments is because they have the ability to see and invest in the “best” deals. They have, as Howard Lindzon likes to say, social leverage.  So while it is easier than ever to get your money into the hands of a top tier investor like Brad Feld, and AngelList provides a mechanism for Feld to hypothetically invest in companies all over the country, the best angels have built a track record on investing in people who they know and connect with personally.  It has yet to be proven how willing investors on Angellist will be to look at deals out of their typical regions and even if they invest how valuable they will be outside of simple capital. 

    This is why historically it has been very difficult for companies outside of the very top tier VC markets (Silicon Valley, NYC, Boston) to attract any meaningful investment traction from investors on Angellist.  There are certainly outlier cases where a round is filled out or even completely done via Angellist (NC-based Spreedly has a great example here) with investors who are not known by the entrepreneurs.  But in working with 100+ companies over the last few years in the SE and Mid Atlantic that are raising money, it has almost always come down to building lasting personal bonds with investors and this is really hard to cultivate via a software platform.  So there may be lots of new capital flowing through these new, democratized channels but will it find its way to markets beyond the Valley et al? 

    Which brings me to a final thought - there is an opportunity for leaders in secondary entrepreneurial markets to emerge as syndicate leads to help identify the top emerging companies that are off the traditional investment radar. 

    The best part of this opportunity is that it wouldn’t take $1MM in syndicate backing and dozens of additional financings to make a material impact in an early stage tech market like North Carolina or even all of the broader Southeast and Mid Atlantic.  There is an opportunity for people in these markets who know the participants personally and have the know-how of the startup financing world to kickstart additional activity with 5-10 new financings a year. These leaders will ideally have networks (or begin to develop networks over time) that bridge beyond a particular region so they can serve as conduits to the larger entrepreneurial ecosystems. A dozen new seed financings a year is a drop in the bucket in Silicon Valley but could be catalytic to a market like the Triangle, and I’m eager to figure out how we make it happen.  

  9. The Most Valuable Startup Currency: Relationships

    Last week I wrote a post on Investor Psychology in which I noted that for early stage investors, there are too many variables and unknowns involved to have any degree of certainty on how things will turn out.  Investors may seem like they have it all figured out, but in their honest moments they will agree that their theses are just guesses.  This is also the reason why many early stage investors will boil down their most important investment criteria into two factors: opportunities in large, growing markets and with people who they believe can execute successfully.  If you push to find out the #1 thing that investors look for, the answer is the same 99 times out of 100 - it’s all about the people. 

    This is a very logical progression given the fact that investors are attempting to de-risk a proposition which is inherently uber-risky.  They know that they don’t know the future (and in fact that the entrepreneur doesn’t either) and the best bet for their invested capital to generate a return is to pick an operator who will be able to navigate the maze and redirect even when the first path doesn’t work.  It’s why serial entrepreneurs who have had a successful exit are able to raise money on ideas that don’t seem nearly as interesting as one that a first time entrepreneur might have.  Investors are betting on the jockey and not the horse. 

    So what is the entrepreneur’s strategy who hasn’t had a big exit before?  How do you become the type of jockey that an investor wants to bet on?  In the “regular” (non-startup) world this issue of credibility is often based on academic or prior professional credentials.  A snazzy MBA from a top tier school or prior experience at a brand name firm can be all that is necessary to score the job in the Fortune 500 company.  But remember, the entrepreneurial world is much more personal - it’s all about the people.  Everyone in the startup world is looking to work with people who they trust and like personally and who can get things done. 

    The good news here is that the playbook for how to effectively navigate this world can be taken from real life.  When you’re building relationships of any type there is a requirement to first meet someone, take the time to invest in the relationship and then show consistency over time.  The important part here is that it takes all three facets to create the type of relationships that have long term value.  So you might meet someone at an event or through a mutual friend, but it’s not until you go deeper for a one on one or show value through a curated, personal connection to a third party that the relationship can grow.  And it usually takes many of these interactions or instances to build a true relationship.  

    I have also found that the best way to build bonds is to open up beyond the basics of a business transaction and get to know a bit about each other’s personal lives.  If the startup game is all about people, you have to get to know the real person who is the investor across the table from you or the client whose business you want to win.  Taking the time to really invest consistently, over a long period of time, can have profound long term benefits.  Remember, because the startup game is all about people, it’s not about any particular deal or moment in time but about the lifetime value of the relationship. 

    One final tidbit as it relates to building relationships with investors.  There are times when entrepreneurs can become frustrated with an investor’s weak rationale for why they don’t want to invest in a company.  If the investor’s reasoning seems a bit hollow, it very well may be that they aren’t yet convinced that you’re the type of jockey they want to bet on.  (Most) investors, of course, don’t want to come out and say this, which can lead to alternative suggestions like “we don’t think the market is big enough” or “we’re not sure about Industry X right now.”  Don’t take this feedback personally - rather, go out and execute and build a track record of getting things done.  And while you’re doing this, provide periodic updates to the investor to build consistency and credibility.  It may not lead to a near term investment in your company, but it’s a great long term investment in the most valuable currency in the startup world, relationships. 

  10. Investor Psychology

    Last week I happened to be the third wheel of a conversation between two active angel investors who were talking about a particular company that was closing a round of funding (names will remain anonymous to protect the innocent).  I was somewhat familiar with the company but not intimately; thus, I was able to listen to the debate - er, conversation - with a completely open mind.

    The back and forth was particularly fascinating because the two gentlemen basically agreed on 98%+ of the facts related to the potential deal.  They were in agreement that the two founders were fantastic entrepreneurs who had put the company in a materially better position than when they raised a seed round a year earlier.  The product was fully built out now, and they had serious traction (to the tune of thousands of customers for this B2B SaaS offering).  

    The one catch - to date the software has been offered for free and there has been no proof of what % of free users will convert to paying and at what price.  Both angels agreed that the next 3-6 months will be incredibly illuminating as to whether this company will scale into a real business.  

    What the two could not agree on is the price.  But it wasn’t just a simple question of disagreement on the exact pre-money valuation.  One of the investors was an existing shareholder, having participated in the seed round a year before.  The other had already committed to the new financing round.  It took a while to get there, but after a good 15 minutes of conversation it became clear that the reason for their disagreement was 100% due to whether they were already in the deal or not. 

    In the view of the existing shareholder, it was too early to settle in on a proper valuation.  If the conversion to monetization goes well, then he feels the company will be worth 50-100% more and wished the company would raise a smaller amount from existing insiders (and potentially save some of his stake via less dilution).  Without this data, he can’t see how the new investors are justifying the current valuation.  The new investor saw it as a chance to bet on a great team and to get in before the proof points - but that it was decidedly a “bet” on execution.  

    As the proverbial fly on the wall with no particular bias, I was able to instead focus on the dynamics of the decision-making vs. my opinion on the decision.  The first thing that jumped out at me was the impact that the investors unique individual perspective has on the psychology of a particular deal.  They literally agreed on almost everything related to the company yet had differing opinions on whether it was a good deal.  Same facts, different perspectives.  This is an important concept for entrepreneurs to understand as each potential investor will have a unique view based on preconditions that may or not be related to the entrepreneur’s company.  Details such as size of an investor’s fund or a different portfolio company of the investor’s that may have gone bad in a similar industry are other examples of things that can influence decision making.  That’s why it’s so imperative to try and put yourself in the investor’s shoes to understand his mindset relative to investing or not investing in your company. 

    The far greater realization for me was this - in spite of articulate, impassioned, logical arguments from both investors about the merits and challenges of the company, the overarching reality is that neither really knows what in the world is going to happen.  All the logic in the world from the investors won’t change the outcome for the company and the investment; the onus is ultimately on the entrepreneurs and execution.  

    While it may be a bit of an ego deflater for an investor to admit he doesn’t know with any degree of certainty what is going to happen, this should actually be an admission that is freeing.  The reality is that  entrepreneurs don’t really know either - there are simply too many unknowns and too many known but unpredictable variables that are all interdependent.  Yet, entrepreneurs and investors alike have to play the cat and mouse game of pretending that they can see over the horizon.  Pitch decks are littered with with product and market visions that in reality almost never play out according to play.  And investors will often wax poetic about their investment thesis on a deal and it an all make perfect sense - until it doesn’t.  Or something changes (which it does every time). 

    The net-net on this is that we should all be ok with admitting that we don’t know what’s going to happen.  For entrepreneurs, this may mean a little less complaining about investors who “just don’t get our business”.  Perhaps they don’t, or perhaps they are simply admitting that they’re not comfortable with how much they don’t know.  For investors, it’s ok to realize these are just best guesses and bets at their core (though maybe you don’t want to phrase it as such to your LPs :)  But both entrepreneurs and investors should be commended for partnering together on this quest into the unknown as it’s the desire to go beyond the comfort of the known that allows for the excitement that draws us all to the entrepreneurial world.