The Entrepreneur Thesis

by Mark Suster on March 1, 2010

aaron w car

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I was going to save this post for a while but the “Patzer Problem” meme has forced my hand.  I, for one, am with Rob Hayes of First Round Capital on this one.

“If we are doing things right and our company founders are successful, then over the long run we should be successful. If we get to the point where our founders are successful but we can’t be, we should be rethinking our business.”

I have a philosophy.  A thesis.  An entrepreneur thesis.  I’m not talk about the age old debate amongst investors whether you back entrepreneurs, markets or products (or as many people like to hedge – product / market fit).  I’m unequivocal on that topic.  It’s entrepreneurs I back.  I’m on the record as saying I’m 70% management, 30% market.  We’ll have that debate another day, I promise.

Today’s post is about my investment thesis.  It’s what I call the “entrepreneur thesis.”  My investment philosophy is to back the best possible entrepreneurs I can and to stick by them through the growth (or sale) of the company.  I’ve outlined already what I believe makes a great entrepreneur and I’ve stated unequivocally that this is a subjective view of what it takes.  But when I’m looking to invest the dollars that my Limited Partners have entrusted my firm with I’m going with my view.

So what is this “entrepreneur thesis?”  It’s the view that I back great entrepreneurs and help them pursue their dreams no matter what.  Sometimes this will mean we collectively double down and try to build a bigger business and sometimes it may mean selling earlier than I had thought we would.  I know this sounds Polly Anna-ish.  I’m not just writing that “I love entrepreneurs” to curry favor with startup CEO’s.  Anyone who has ever worked with me knows that I’m no pushover and I’m certainly not a wallflower.  I’ll argue my point vociferously.  But I don’t believe in betting against founders.

Let me explain.

A few years ago I was having dinner with a friend of mine who works for one of the biggest known Silicon Valley firms.  He was telling me about a deal he had done.  He invested $8 million in a company in the computer networking space.  They had an offer to be acquired for $80 million, which would have dramatically changed the lives of the founders forever.  My friend blocked the deal.  It was “only” a 2.5x for him.

His logic was, “when I invested the management team knew that I wanted a multi-hundred million dollar exit so they shouldn’t be surprised.  This return won’t be enough for me to justify to my partners.”  I literally said to my friend, “You’re a dick.  Do you not see the consequences you’ve weaved?  You’ve now got a management team that hates you.  They hate you for life.  They will tell every other entrepreneur in town not to work for you.  Presumably they are talented if they created a company worth $80 million.  They’ll never work with you again.  Nor will any of their friends or colleagues.  Are you that short sighted?”

I kid you not when I use quotes there.  My wife was really uncomfortable because she was there and so was his wife.  I’ve known this guy and his wife for a LONG time.  My wife was actually mad at me for being so blunt.  But she knows it’s a character flaw of mine so she forgives me (I hope).

To this day I still don’t understand what he was thinking.

I’ve had the conversation of what will happen upon an exit with founders so many times I feel like a broken record.  Before I outline my views let me give you one more story.

In 2006, Steven Dietz, a partner at my firm, GRP Partners, had given me $500,000 in a seed in convertible debt when I started my second company, Koral.  GRP Partners had also funded my first company.  I had an offer to sell my company to Salesforce.com in 2007.  Steven knew that from a fund perspective he wasn’t going to earn the amount of money that a typical VC might look for since we were selling early.  But he also knew that it would change my life forever.  He was grateful since I stuck with my first company, BuildOnline, well beyond when others would have (since I had taken great dilution during the dot com bust.).  He decided to let me earn.  I will never forget that.

So it was kind of obvious when Steven and Yves Sisteron (the partner on my first deal) offered me a role as a partner in their firm that I would work here.  I knew that we were aligned intellectually and ethically.  I had initially called them wondering if they’d fund my third venture.  I never imagined I would switch sides of the table.

So, to my thesis:

1. Work with the best at early stages: I’d like to get involved with capital efficient companies early in their lifecycle.  I want to back entrepreneurs that I believe have similar ethical values, are fun to work with, trust me, have big aspirations, are willing to work hard, are smart and want to have an impact on the world.  I want to see small amounts of money go in and I often tell these entrepreneurs, “I don’t have a goal for you to come back and quickly ask for more money.  Go slowly if you need.  Spend wisely – you need to “grow into your valuation.”  And by investing smaller amounts at early stages I am impacted if a quicker-than-anticipated sale happens.  I view this as The Patzer Opportunity.

2. Go in planning for a big outcome: I tell each person that I am going to work with the same story.  I hope to build a billion dollar company with them.   GRP Partners has created more than a dozen of these so as a firm we know something about creating big companies.  I don’t go into deals with a plan to sell for $20 million.  $100 million at least.

3. Keep options on the table: I believe in my bones that entrepreneurs shouldn’t “over raise” capital.  They should right size their capital raises.  That doesn’t mean being cheap.  That doesn’t mean raising the least amount possible.  But it means not over raising money.  I know I’m being vague.  Each situation warrants different amounts.  But let me give you an example.  If you can raise $2 million or $10 million up front (maybe you’re a hot entrepreneur in a hot space) I know that my vote would be with the $2 million (again depending on the situation).  If you raise $2 million you preserve your options.  Somebody may come along and offer you $25 million to buy your company.  You might like to accept that.  It might just change your life (for example if you personally own 33% of the company).  Or if you didn’t sell and the next round comes along.  You raise $5 million at a $20 million post money.  That by definition means you were hot.  You should still be able to sell for $50 million.  At each step you preserve your options.  If you go to quickly to take down a $50 million round from late stage funds you have one option – go big or go home.

4. Don’t block founders from selling: OK, so if you raise $2 million at a $10 million post money (e.g. maybe I own 20% of the company) or $5 million at a $20 million post (I own 25%) shouldn’t I block that sale of a company a cheap price?  This is the “Patzer Problem.”  Some people assert that the later stage investors didn’t make a high enough return.  My view: If you’re absolutely convinced that it is the right thing to sell I need to support you.  My bet: if you sell and I helped you earn and was a key contributor to your company then you’ll tell everybody you know to work with me.  Over time I should see great deals as a result.  When you go to do your next company (most entrepreneurs do) you’ll call me first in the way that I called GRP Partners for both my second company and my third (which never materialized).

5. Persuade you and align you to swing for the fences with me: But of course there is more to my views.  I’m hoping that when your $25 million or $50 million exit comes along I can convince you (if I believe it) that we should swing for the fences and create a larger company.  If I really believe it I ought to let you earn now by taking money off of the table.  I have already written about this.  I believe our incentives need to be aligned at this point in time.  You need to have your “feed the family” money so that you want to swing for the fences.  You also need to believe that the higher outcome is possible.  If I’m not willing to let you take money off of the table and if I’m not willing to put more money into the company to help you achieve your goals then how convinced am I really about the upside?

I’m not trying to be nice to entrepreneurs so you’ll read my blog or take my money.  It is simply the thesis that I believe in.  It’s the “entrepreneur thesis.”  Let me outline the contra viewpoint, which is seldom expressed openly, but it what I believe gives our industry a bad reputation.

• Large early stage rounds – Too many investors whose funds are too large feel that they need to put “a lot of capital to work” in order to justify being involved with your company.  So much so, that when I was raising capital in 2006 and asked for $2 million several funds told me that they wouldn’t give me money unless I’d take $5 million.  And they actually hinted that I could get a better valuation.  Tempting.  The problem is that it takes options off of the table.   And the same logic that forced them to put $5 million to work also forces them to block your sale at prices that might just change your life.

• Change management teams – A lot of well known, historical VCs have a belief that management teams are expendable.  You simply bring in a more talented team after your $10 million investors and the founders become senior members of the team but don’t run things.  I accept that this may sometimes happen.  But it’s the absolute last course of action for me.  I believe that a motivated founder trumps a well-hired mercenary CEO any day of the week.

• Outsized returns through sharp elbows – OK, here is what it boils down to.  I really believe that some firms have the strategy of edging out the entrepreneurs, bringing in a new management team, recapitalizing the company, minimizing the founders’ share and taking maximum ownership for the VCs.  This is dreadful behavior but I truly believe that some firms go into investments with this mindset.  I’ve heard very similar stories in the VC corridors.  ”Well, we’ll just do their next round and take 50% of the company.  They’re struggling to raise funds anyways.”  Look – it does happen.  And sometimes it is warranted.  I just don’t believe that any VC should go in with this strategy.  It’s why I always tell entrepreneurs to reference check their VCs.

Listen, who you work with matters.  Brand isn’t everything.  And firms that get outsized returns on occasion to so at the expense of the founders.  My thesis is that I should align myself with my customers (the CEOs) as it is the most likely path to great financial returns for my investors.  And if I’m in this business for a long time I’m betting this will pay off.  You?  Taking VC money is more difficult than marriage.  At least if you fall out of love you can legally get divorced in America.  Not so venture capital.  Raise wisely.

Update: After reading the comments I want to make one thing clear.  I don’t believe this strategy has any sacrifices – I believe it will mathematically pay off bigger over time. Why?

- getting invited to be in the handful of deals each year in the US that really matter vs. getting mediocre deals

- getting the best entrepreneurs to work with you multiple times

- finding the right balance where sometimes the “early sale” doesn’t happen because you allowed some founder liquidity (on a case-by-case basis) that enabled you to swing for the fences where other entrepreneurs may have pushed for an early exit when incentives weren’t aligned

*photo taken from the Mint.com blog

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  • anonymous
    i've seen many cases where VC will tell me that i need to raise 5-10times more money. that i need to create THE market leader and a multi hundred million company, that with the technology we have it is possible.

    The problem is for them it is a swing against the fence, they have a portfolio of investment so the strategy pay for them. But for me i believe a 20-30million company can be created but not a 100million $. after working 5 years without paying myself a salary and having spent all my savings, if at the end of the day i don't see a potential exit and reward for my works, i wouldn't feel motivated to work hard, and would just leave and start something else.
  • Mark, I don't know if you're still looking in to this older post, but you mention the problem of bigger VC firms not wanting to plump in "just" 2-3 million but pushing for a bigger round. How does one answer this question? If it's a firm I like, that will, I believe, be of great help to us? What do I say back to them?
  • dongooding
    As someone who made the transition the other way (VC to entrepreneur), I both applaud your perspective and shake my head about how the more things change, the more things stay the same. I spent a decade with a pro-entrepreneur firm (Accel Partners), whose founding partners had been in the business a long time and so they shared the long view that you bring to the table. When I left (in 1997), I funded my own business, which has its pluses and minuses; it wasn't VC appropriate, so my own aversion to bringing in venture backers is moot. When my best friend started looking for VC for his business in '98, I helped guide him to entrepreneur-friendly backers when he also had interest from "replace the founders first" VCs. He grew into the job of CEO and earned backers a decent return on the far side of "telecom winter." The lead VC, true to form, made sure that preferences were modified in the acquisition to ensure that the full entrepreneurial team would be motivated and fairly compensated, rather than screwing entrepreneurs to maximize gain on that deal.

    Roman Giverts' comment on Mint being acquired early by Intuit brings up an important subtlety that my friend's company also shows: it's not just "the founder" who is affected by the acquisition, it's the entire company. Sometimes founders may not have their interests aligned with the rest of the team, especially if it's obvious the founder won't continue post-acquisition. Taking the long view includes thinking about the entire company, since it's quite possible that future entrepreneurs are learning the ropes as junior management. Alignment of interests is not simple.
  • Roman Giverts
    I wasn't going to say anything because I knew this was just going to be a rant, but here goes:

    I think everyone has completely misinterpreted the "patzer problem." The problem is not that the VCs didn't get a large enough return, the problem is that Patzer 100% sold out, flipped early, made a decision motivated entirely by the cash. Whatever happened to entrepreneurs trying to change the world?

    Mint had potential to be a truly legendary company, it could have changed the way everyone manages their finances. Instead, it was a company that got really fast traction among early adopters and then sold out extremely early. As a fellow entrepreneur, here are the problems I have with the decision:

    1. He sold out far before Mint had any real mainstream adoption. He never changed the world!! And what's so frustrating is that out of all the shitty products out there that have no chance, this one actually had a chance. Perhaps Intuit will help develop the concept (i doubt it, more on that in a sec), but either way, it's not something he can take ownership for anymore. He's just another VP at intuit.

    2. He sold to probably the worst acquirer out there. Anyone who knows anything about tech, knows Intuit is one of the worst technology companies in the industry in many respects, especially for any engineer to work at. Mint is slowly going to be integrated into Intuit's products. The Mint brand will die, and while perhaps his vision will become reality, it will take 10-15 years at intuit. (I personally have nothing against intuit, but you dont have to talk to many people to find out its reputation).

    This is very different than say YouTube selling to Google or PayPal selling to eBay. Those companies were already mainstream, and they were able to keep their brand and relative autonomy. I believe that's why they are truly legendary, not because of the great returns they created for their VCs.

    That's The Patzer problem. He started a company that could have been great, instead in 5 years Mint will be forgotten. All that will be left will be his payday.

    That may be great for some, but shit, that's not an inspiring story that should be appluaded. Mark Zuckerburg turning down a billion and then growing facebook to be 10x that size.... now that's fucking inspiring. Zuckerberg would never give up on his vision for cash the way Patzer did. That's the story I talk about in my company because that's what building great companies is about; not patzer flipping in 2 years to a terrible acquirer. That's lame, boring, and nothing I want to be a part of.
  • Mark,

    I came across your blog yesterday after reading the post you wrote at Mashable. I'm might not be in the business of building an empire (maybe it will turn into that), but I really enjoy the content you have here at your blog. I think that what you are talking about here can not only be applied to venture capital but to life in general. I don't know what ended up happening to that networking company that could have been sold, but I would imagine it didn't do much for the reputation for your friend or his relationships.

    Today more than ever we live in a world where word can spread like wildfire and that kind of reputation could cause some serious damage to a VC overnight. All you'd have to do is be relatively influential on Twitter or write a Blog Post titled "This VC screwed me" and with enough buzz you can kill somebody's reputation over night.

    On a somewhat unrelated not, part of why I think your blog is a must read for bloggers and people who want to start companies is that blogs have to evolve into real businesses if people ever want to make a living from them. Your advice here is geared towards entrepreneurs and I think that it can help many of us evolve from just bloggers into real entrepreneurs. At some point when you're available I'd love to have an opportunity to interview your for BlogcastFM, a podcast that I run for bloggers. I think you'd bring a much needed perspective to the world that bloggers live in. I look forward to reading more of your content.
  • Great great great post Mark. This is exactly what I tell my angel investments when I am investing -- which is don't turn a variable outcome into a binary outcome. You also hit on the largest point that I always harp on that most VCs don't really raise - the protective provision around blocking the sale of the company.

    The other thing that happens to the first time CEO - and it absolutely happened to me -- is you make the mistake of taking the larger round as you are intoxicated by the attention and large potential outcome ( I did my first round of VC funding for my first business September 99, while I was growing at 400% in a hot space).

    I am always trying to help my investments learn from that mistake - and on the flip side I need to ensure for my own companies that I am not too much a prisoner of my past experience -

    really well articulated!
  • JimThompson
    Sad that you don't get it, friend. Maybe someday...
  • jenkins
    Man you are so right Mark. As the founder of two companies, one that exited for "several hundred million" dollars, I can tell you that these founders absolutely hate this person and will tell everyone that, too. Not only will they tell people that your friend overplayed his hand but that he also put the other investors and employees at risk --- because we all know that this company could very well fail now.
  • well said Mark.

    love the "you're a dick" part.

    unfortunately VCs play the "dick" role so well and so often
  • mattweeks
    Mark, thanks for a great post, and thanks @bfeld for shouting it out again. I missed it the first time around. You exemplify a pay-it-forward good-karma-points kind of guy we'd love to have on our exec team as much as we'd like you in the Partner's meeting arguing for our cause.

    So I understand your conflict in "joining the dark side" in switching sides of the table. But we need more people like you at those General Partner Monday Meetings to advocate for us.

    Entrepreneurs are a bit crazy to do what we do, and there is a kind of "band of brothers (and sisters)" ethos that depends on "great investors" to support and encourage them.

    I wish there were more like you, Brad, Rob and the other class-acts you mention.

    Keep up the great work and I look forward to working together one day.

    We "feel the force."
    :)
    Cheers,
    Matt
  • Thanks, Matt. I appreciate the kind words. Especially after the last commenter ;-)
  • JimThompson
    Dude, you sound proud that you insulted your friend in front of family and friends. Did that make you feel important? Don't you understand you can disagree with a friend without being rude?

    Jeez, read a Dale Carnegie book, for chrissakes and learn a little about human relationships and tact. Your wife was right to be mad at you.

    I don't care how many millions you have/made/won/lost/invested, if you can't behave with human decency towards another person, especially a friend, you're missing out on a whole side of life. Shape up, dude!
  • Oh, the irony of your comments, Jim.
  • LOL!!! Depending on Jim's intent, that's either the most clever comment ever on this blog, or the complete opposite.
  • Couldn't agree more - nice post, Mark.
  • Roko
    1- Second time entrepreneurs who had success with their first startup, have a better chance at succeeding the second time around.

    2- Venture investing is usually a 7-8 year timeframe.


    Knowing 1 and 2, it appears to me that a good model would be to get an entrepreneur a quick exit (2 years in)with his first company at sub 20 mil. He earns, he loves you, he owes you for making him rich, but you, you just break even. Now he is ready (experience) for the second company around, he does worry about money, and you guys are both ready to swing for the fences.
  • That's one version of my philosophy. But I hold out that the first deal might be a great concept worthy of a larger exit.
  • Nice post i enjoy reading your comments.

    I like 4#.

    My take :-
    If someone has the Entrepreneur DNA and gets a payout for a sale, most would then start looking for the next big thing, main difference being that now they know what they need to do to get it. And if they have the financial wherewithal to really go for it. So the next time they don't necessarily need to jump so soon.

    Also, if the founder thinks it is the right time to get out (to maximise their value) , then unless they are missing some information that you can provide, it probably is. They live , eat and breathe that venture. They would be up to date with industry social trends etc. If they think that this the best point for the company to make money, it probably is.
  • thealzel
    Excellent post! I'm a huge believer in aligning the interests of the entrepreneur founders and the investors to give the best possible outcome for the company. Whether that means an early exit or hanging in a bit longer because the founding entrepreneur is convinced a home run is within grasp, the exit strategy will get support so long as the interests of all the stakeholders are aligned. Lesson? Choose stakeholders carefully!
  • I wonder if your friend was a dick only because he didn't offer another option. That is, if he said "no but here is $5m for x% of your stake if it relieves tension" rather than just "no", would that have been a better option?

    Secondly, it seems inevitable that these "DST" type deals become more and more common. When a company has revenue between $10-$50m there is no market for public investors. But on the other hand you have huge amounts of unspent capital in the hands of ballooning VC funds and mid-market P/E providers.

    To me at least, it's better that those type of people provide the first stages of liquidity rather than the Doctors and Dentists being called upon by the Raging Herd in a pre-mature IPO. The 'Growth Equity' guys have to become more like public investors and they seem like the best link in the chain to be valuing businesses at this stage. It's a delicate balance as to how much of the founder's/executive's equity should be left to not screw with incentives but at the same time there seems an inevitable trend toward figuring that problem out rather than being religious of not going down the path in the first place.
  • My gut instinct is that what drove my friend was that he was a Principal and not a Partner. He didn't have the clout and he needed to show a better return to justify making partner some day. I'll never know for sure - but that is what I theorize.
  • Laurent Boncenne
    You forgot to tell us if that 8M$ funded company got sold or not (especially if they did for 200M$ or so :D )

    I'm not sure though if I understand what you say about selling early to a decent outcome. If I have you as my VC, and knowing the policy you have to yourself (I can't remember the proper word, be it in french or english.... my bad), that agreement you have towards the entrepreneur, wouldn't it be normal that instead of being furious that you blocked a deal, I'd be grateful that you let me get a better exit, or make it up to it ?
  • I don't know what happened with the company. I moved from Silicon Valley to Los Angeles and lost touch.

    re: blocking a sale - you'd only be happy with me if you made more money in the end. See one of the earlier comments where in the end the founders made nothing. This does happen.
  • sanjaymaharaj
    Great post, more then your thesis I really like your core value of doing what is also right for the entrepreneur and not always beg the question, what's my gain but what is our collective gain. I am leading a start up and I value your thoughts and comments. You invest in relationships and at the of the day that is what's important. I sum up your VC mandate as "Let's make those who you surround yourself with as successfull as you are". Keep it up you have a great moral value.
  • Great post Mark. Really, there's a direct correlation between the fund size and the VCs that deem it to be a "problem" rather than an "opportunity". Most of the smaller funds are wired to be successful on a Mint-sized deal. I think you/GRP are in the minority in terms of a fund that has >$150mm that is OK with a Mint-sized deal by looking past the individual deal towards long term relationships and reputation with entrepreneurs. For the rest of the large fund guys, the "Patzer Problem" is really a "VC Fund Size" problem. Cause I'm sure Aaron Patzer has 99 problems, but money ain't one :)
  • honam
    What a story! Loved it. Thanks for sharing Mark.

    In my experience, VCs blocking an M&A deal is quite rare. Usually, it's not an overt block but subtle words of discouragement that ends up having the same effect. VCs wants to shoot for the moon because they rely on a diversified portfolio of "options" - only a few of which have to pay off. The entrepreneur doesn't have a portfolio or fat management fees to fall back on.

    I have a good friend whose VCs discouraged an exit. It would have been worth millions to him, perhaps even tens of millions depending on timing, and he ended up with nothing (he did well later on, just not with that start-up).

    When interests are not aligned, you will get mixed advice. I've written about this a bunch of times starting with this 2006 blog post called "Venture Lotto": http://blog.altosventures.com/vc/2006/06/ventur...

    As a general comment, most board and shareholder issues of VC backed companies don't get resolved by vote. You discuss and work through issues with the key players. By the time something comes up for a vote, it's a foregone conclusion. That is the main reason that it is extremely rare to see M&A deals get blocked by a VC. It never even comes up for vote if the body language is clear.

    If a board or shareholders of a VC backed company have to resolve issues through formal votes, that is a bad sign. To me, it's a sure sign of a dis-functional board and poor leadership (by management, investors and board members). It's hard enough competing in the tech industry. If you have to fight amongst yourselves, you are doomed.
  • alexbard
    Mark - outstanding post. I think the net result of more VCs sharing your perspective would be a better environment for startup success which would lead to greater returns for funds (assuming fund investment principles are adjusted). I know a few stories of VCs blocking a deal, pouring more money in to build the "billion dollar company" and unfortunately that resulting in the failure of what was a good / great company.

    To be fair we as entrepreneurs also need to be smart about raising money and how much / when we raise. As you said raising too much (just because we can) can also have a significantly negative impact on the business depending on stage / goals.

    Great blog and advice....keep it coming!
  • Thanks, Alex. Looking forward to hearing great stuff about the progress of Assistly! Our teams using your product are still raving about it.
  • to answer your first question, of course I've got you on my RSS feed (one of my few 'must reads', even if you think entrepreneurs are born, LOL) & follow @msuster on Twitter.

    Here's some empirical evidence as fodder for this discussion - people have actually studied whether it's better to keep founders or replace them. Oversimplifying a fair bit, the data says keeping founders is usually the smart play, even without considering those who need to be replaced (or want to be).

    Better to keep & nurture (oops) cultivate your founders if you can?

    p.s. Entrepreneurs benefit from building "whuffie" with their ecosystem; you've made a nice case that VCs/angels benefit just as much from building *their* "whuffie."

    Anyway, I like your comment about the "8 years" - investing is a LTR, like it or not, so getting to know each other first is important. Even if you're a bootstrapper, get to know your bankers, etc. Our (Boise's) local VC folks, Highway 12 are always telling startups that while they may never become investable, they'd still like to get to know them - nudge them in smart directions, yes, but also building relationships.
  • what is "whuffie?"
  • from Wikipedia:
    Whuffie is the ephemeral, reputation-based currency of Cory Doctorow's science fiction novel, Down and Out in the Magic Kingdom. This book describes a post-scarcity economy: All the necessities (and most of the luxuries) of life are free for the taking. A person's current Whuffie is instantly viewable to anyone, as everybody has a brain-implant giving them an interface with the Net.
    The term has since seen some adoption as a synonym for social capital, including its use in the title of the Tara Hunt book The Whuffie Factor.
  • Reputational capital - mensch-ness? - and how can you not like the word "whuffie"? (On YouTube, you can even hear the "Makin' Whuffie" song, LOL)

    You & Brad got a lot of it... while others seems to be losing it. Whuffie points for you from your last 2 posts!

    p.s. oops! sorry - farhanlalji beat me to it.
  • Some very good points here. Hired CEO gun vs. founder matches my experience. It's wise to think twice before switching horses.
  • Amen, Mark.

    Looking forward to showing enough traction where we can have a meaningful conversation about my startup.
  • Cool. Look forward to hearing about your progress.
  • Rob K
    Mark- Great post and good meeting you at leadscon (through Jason). I totally agree, although there is a "middle way" for a big fund. They can give the founders single digit millions of liquidity (enough to buy a house but not a plane) and let them play for something bigger. Chris Dixon and others have talked about this quite a bit.
  • Yes, I totally agree. And it was nice to meet you as well.
  • Mark, interesting post as usual, and love the stories of your opinions loudly expressed at dinners ;)

    I think you present a very balanced view. My only comment would be on #3... raising more money is *also* an important way to keep options on the table in many cases. Of course it's a delicate dance between valuation, raise, "in the zone" outcomes, but sometimes a fraction more dilution for a lot more ability to control your future (e.g. runway) is the right tradeoff. As you wrote in "Time is the Enemy of All Deals," the world could change overnight.
  • Thanks. I didn't mean to imply that so I'm grateful for the chance to clarify. I definitely think that sometimes you need to raise more capital than you might otherwise do to preserve options. I've been discussing this case exactly with a CEO in our portfolio. But you do it when you've made the decision that it's the optimal trade-off for the company rather than somebody pushing too much money at you because "they need to own X% of the company." I appreciate your input - that was a very valuable clarification.
  • I've always thought that #4 made a lot of sense, but strangely that's an anathema to VCs. Most VCs fear that it "demotivates" entrepreneurs. But as you say, it totally aligns interests. But then look at the NVCA standard legal documents and you'll see all kinds of crazy language ensuring that entrerpreneurs can't sell.
  • I know. VC's want control. I went as far as defining an exit value with one company and carved out any restrictive covenants below that amount. Mostly I operate with entrepreneurs on trust.
  • Your response to Furqan and really the whole post is a fantastic show of enlightened self interest. I think the trust that you describe is both important and tricky because investors operate in the context of a firm typically.

    VCs leave firms, get hit by busses etc. so as an entrepreneur you've got to do your homework and develop relationships with others in the partnership. Dealing based on trust is always the best way, its important for entrepreneurs to realize that there is work on both sides to build that trust.
  • That's a great point. And on competitive deals I always bring in my partners whom I totally respect and trust. I knew them for 8 years before I joined. We're all different but all share the same ethical compass. It is important to know the other partners in firms.
  • One tricky thing about that is something you mention: TIME. 8 years is a great basis for a relationship. I've known the people who have funded me thus far for many years also.

    As we (and I think this holds for other entrepreneurs as well) go beyond our close personal networks for financing, there isn't enough time to build those kind of deep relationships. Diligence and reference checking are critical to closing some of that gap. But you won't be able to close it entirely and as entrepreneurs we need to think carefully about continuing that relationship building past the point at which the check clears. While that won't avoid all the potential bad behavior, a strong relationship can make an enormous difference in how a VC reacts to opportunity.
  • KevinCu
    WOW is right!! Great post and you need to take it to the next step. Only post those VC companies that you'd work with or have others come up with an online system like http://www.glassdoor.com/index.htm. Nothing like a little transparency to clean up someones VC act.
  • I generally talk publicly about the VCs I personally respect: First Round Capital, True Ventures, Foundry Group, Union Square Ventures and others - all of whom I believe in their DNA believe that the entrepreneur is the customer. For many others it's just lip service.

    re: the "bad" ones - I would never publicly discuss them. It's not my style. But The Funded has data and entrepreneurs can reference chekc.
  • KevinCu
    But the "bad" ones are ones that are not mentioned, therefore they are already suspect. But I agree that I, too, would not openly discuss them. I prefer working with people that follow these thoughts and those of Napoleon Hill's comment "I fully realize that no wealth or position can long endure, unless built upon truth and justice, therefore, I will engage in no transaction that does not benefit all who it affects." Certainly a win/win and not a win/lose or a lose/win situation.
  • Mark,

    Such an AWESOME post. The way you approach these opportunities, work with the teams, and create flexible options that inspire hard work and drive better returns is commendable. Your current portfolio companies have it good, real good. I hope we can work together soon.

    Regards,
    John
    ADstruc.com
  • Thanks, John. I hope they feel the same way. I put them all out there as references. I hope I do ok. As the CEO of one of my angel investment - it doesn't mean I give people a free ride. I push him really hard to be focused at his business and in a world where everybody loves him I'm privately his harshest critic. But I'm doing it because I believe in my POV and want him to do better and succeed (for his sake).
  • That's one of the qualities I always admired about Andy Reid as well - outwardly, support them, take the heat for them, let them know that you've got their back. Behind closed doors? Push em as hard as anyone and challenge them to reach new levels of greatness, but keep that behind closed doors.
  • Now, if he could only win a freakin' Superbowl! ;-)
  • I'd be shocked if they didnt feel the same way. Getting support and criticism from a VC that has been there before, and is doing it to make you and the company better, provides far more value than a VC just doing it because it pads his LP and company's revs. As mentioned in this post, and on other VC blogs, transparency has become king. It means a lot to an entrepreneur when they can tell where the advice is really coming from.
  • philsugar
    One thought I had intersects three of your points (take money off the table, change management teams, earn outsized rewards with sharp elbows). As a founder if your VC wants to put in a new CEO they need to let you take money off the table. Assuming you haven't run it into the ground and are forced to raise money at any terms possible, they need to buy the right.

    I'm sure there are examples where things have worked out for the founders but I was talking with a group of CEO's and long time entrepreneurs and none of us could think of an example where the founder didn't just get screwed, and I don't mean screwed a little bit, I mean getting crammed down, prison yard screwed. We were talking with a young entrepreneur who was being pushed to step down as CEO. The company was performing well, just not hitting the ball out of the park.

    Given there is some bias here as if you are hitting the ball out of the park everyone loves you even if you're an idiot.
  • I have the same experience with founders getting "crammed down, prison yard" screwed for companies that were "performing well, just not hitting the ball out of the park." It's why I tell startup founders, "don't give up your seat unless you're forced or unless you're part of the decision to give it up and it's for good reasons." And if you give it up make sure you retain some power levers. It's not true that everyone on the founding team will have this experience and leverage. Some don't perform. But having one of the founding team at the negotiating table is important.
  • philsugar
    Sounds like you've seen the same, I was hoping you could provide a contrary example. I mean we could think of literally twenty examples and not a one didn't end up like this:

    1. Bring in an expensive CEO (as a mercenary you better get paid well)
    2. The CEO brings in an expensive set of VP's
    3. Big projections get made...exactly what the VC wants
    4. The company performs well....like it had been performing because that's what the market is.....
    5. As a matter of fact since you don't have street fighters its usually worse.
    6. The company runs out of money.
    7. Let the bridge rounds begin and the commons get wiped out. (somebody needs to come up with a new name for these the only ones I can think of are just not appropriate)

    So literally you better get paid or you're screwed. Again, I'm not talking about a situation where you've underperformed, I'm talking about a situation where the market wasn't as rosy as everyone thought. Not a bad market, just not as big/fast moving as everybody was hoping for.
  • I'm afraid we saw the same film. I haven't seen a happier ending. Founders - hold on to your seats. The mercenary scenario is never fun.
  • Sammy
    +1 to that, Mark.
    Had the same scenario happen to me when a "consulting CEO" was brought in just as had gone from 0 to $2mm in revenues in a year.
    Equity crammed down from 20% to 3%.
    No rights. No say in something that I had spent 3 years on.
    Just because the VCs had over 50% control.

    You can bet that I would never work with those people again.
    Have bootstrapped my 2 ventures since then.
    Even if it has meant lower revenues etc, I know I am not going to get screwed again.

    It's not about the money, it's about being shown respect.
  • Will Z
    Great read. Working on my first startup now and just wanted to say how informative this blog has been over the last few weeks. There's a lot of info out there, but very rarely is it backed up with real field experience.
  • Thanks, Will. Good luck getting your first startup off the ground
  • Bravo - you took the words right out of my mouth. I've been a believer since day one that you should build value and keep the outstanding as low as possible - why? Because you preserve your options for the exit. Especially in a market place where the IPO has collapsed. We (the collective we) ONLY make money when we exit. If you have a 100m shares outstanding and they offer you 50m it's easy to do the math. If you only have 10m shares outstanding with the same offer the outcome is dramatically different.

    What entrepreneurs forget is that you need to think of shares as real money. Don't throw them around - they are valuable if you can execute. All I ever need to do is take one look at the cap table to see how management is behaving - it's the first indicator. You'll see it right there. After that you can dig into the financials to see what's causing it.

    When I started 5o9 I laid out exactly what I wanted for everyone (the stakeholders - Customers, Employees, Shareholders) involved. We've never deviated from that foundation since day one. And you only have to look at the cap table to see that.
  • Mark

    The intersection of financial gain and being a level human being happen infrequently. I however likewise believe that payback comes to those who act as they would want to be treated.
  • Lose a few battles to win the war. Makes perfect sense to me.

    Problem: you need someone to maintain the karma bank, if not "good" and "bad" deeds don't get recorded. The Funded is making progress in this regard, but it's not quite there yet.

    Not sure word of mouth is enough to keep score.
  • I think word of mouth and social media poise will be enough. You can't market every deal or flaunt our acts of civility daily, but by acting straight, turning on the spotlight on your beliefs (like in this blog), you build cred and it follows all of us around.

    And the big wins, when they come, shed a grand spotlight on the philosophy behind it all.
  • Good answer Arnold. I think that works for the good guys, but entrepreneurs (for good reason) are very wary of publicly bad mouthing the larger funds. This is the reason the Funded allows anonymous comments.

    I suspect a lot funds just look to the long line of starry-eyed founders queuing up with their begging bowls, and conclude there's not much downside to putting their own interests first.
  • Maybe so, David.

    There will always be more folks raising than getting it so that scarcity will create an ecosystem where founders need to line up wherever they can find it.

    But I optimistically think with this new generation of civil-minded seed funders, there is more of a chance for the entrepreneur to find a way to get to a proof of concept and market discovery and that will drive some greater equality in the later round funding. And with more knowledge on the process available from Mark and Fred, folks are just smarter.

    To your point about it being stupid to bash those you might need. Yup, being smart and praising those in public who do good, and being measured about what you can be quoted for is just common sense.

    And I've been accused lately of being too optimistic but I think I'll stick to this poise...as it motivates me.
  • Laurent Boncenne
    isn't that VCs like Mark and Fred and Brad Feld (and pretty much everyone on the investing side) who blog, are building some sort of "righteous-system" and creating an ethics charter where transparency reigns ?
  • Yes most certainly. I agree.

    They are change agents but they are not the majority by any means. That is one of the points I think David is making.
  • subbu4
    wow! that's really pro entrepreneur... i wonder if other VCs at other firms would openly subscribe/ agree with your thesis.

    totally unrelated observation: all things being equal, if our startup were to ever need venture capital, i feel like i already know several of the blogging VCs like yourself, fred wilson, brad feld etc... i think that give you all a leg up over other firms... i wonder if blogging so openly like this is part of a dedicated strategy to get good deal flow :)
  • re: other VCs agreeing - I think some will think I'm naive and others will nod their heads. Depends whether you're VC old school or new school.

    re: blogging - it started as a service. I used to read Brad Feld's blog and appreciate the contribution it gave me as an entrepreneur. Now it's clear - it is a valuable source of deal flow. Who knew?
  • Laurent Boncenne
    about blogging, it's the first time I notice that you are the only one who does not have ads.
    I've deliberately left aside seed stage investors who blogs and angel investors, still-
    it's nice to see it like that.
  • subbu4
    ha ha - that's awesome!

    not that i wouldn't feel comfortable working with another firm/ partner, but i'd say that the blogging VCs have a leg up. thanks so much - your writing is awesome, i love that you offer perspectives as a former founder and as a vc. cheers, s.
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