Lecture 9 - How to Raise Money (Marc Andreessen, Ron Conway, Parker Conrad)

Name: Lecture 9 - How to Raise Money (Marc Andreessen, Ron Conway, Parker Conrad)
Uploaded: 2014-10-21T22:53:38.000Z
Duration: 1 h 40 min 11 s

What Drives Investment Decisions in Startups?

Initial Question and Context

The discussion begins with a question directed at Mark and Ron about their investment motivations. They emphasize the importance of understanding what makes them decide to invest in a founder or company.

Characteristics of Successful Founders

Ron shares insights from his extensive experience, having invested in over 700 companies since 1994. He highlights key characteristics he looks for when meeting entrepreneurs.

A crucial factor is whether the entrepreneur demonstrates leadership qualities, focus, and an obsession with their product. This often stems from personal experiences that inspired the creation of the product.

Communication skills are vital; effective leaders must be able to articulate their vision clearly to build successful teams around them. Leadership can be learned but must be inherent to some degree.

Investment Across Stages

Mark adds that they invest across various stages (seed, interest, growth) and business models (consumer, enterprise). This diversity influences their investment criteria significantly.

Understanding Outliers in Venture Capital

Mark explains that venture capital is fundamentally about identifying outliers—exceptional companies among thousands seeking funding each year. Only a small fraction will achieve significant revenue milestones and generate most returns for investors.

The focus should always be on finding these extreme outliers rather than settling for average opportunities within the market landscape.

Strength vs Weakness in Investment Criteria

An important concept discussed is investing based on strengths rather than merely avoiding weaknesses; many checkbox deals fail because they lack unique strengths that make them stand out as exceptional opportunities.

Companies with extreme strengths may also have notable flaws; thus, recognizing potential despite weaknesses can lead to investing in future winners within the startup ecosystem.

Effective Communication with Investors

Ron emphasizes the necessity for entrepreneurs to succinctly convey what their product does within one compelling sentence during initial meetings with investors—a skill many still struggle with today.

Fundraising Insights from Parker

Seed Ground Experience

Parker discusses his seed ground experience, noting that fundraising for his current company felt relatively quick compared to previous efforts.

He reflects on a prior venture where he and his co-founder pitched to around 60 VC firms in Silicon Valley, receiving consistent rejections.

A key insight from a VC at Coastal Ventures highlighted the need for specific analysis during pitches, which they lacked.

Lessons Learned from Rejections

The VC emphasized that successful founders (like those of Twitter) could present less polished pitches and still secure funding; others must prepare thoroughly.

Parker interpreted this as motivation to become a standout entrepreneur, akin to "the Twitter guys," who attract investment effortlessly.

Business Strategy and Cash Flow

His frustration with fundraising led him to seek business models that could thrive without external capital, focusing on cash flow viability.

He discovered that businesses capable of generating their own revenue are often more appealing to investors.

Self-Assessment on Fundraising Skills

Despite being labeled an expert fundraiser by Sam, Parker admits he feels less proficient in fundraising compared to other aspects of his role.

He believes that if a business is well-positioned for success (like Twitter), it simplifies the fundraising process significantly.

Key Takeaways on Fundraising Philosophy

The discussion shifts towards the importance of bootstrapping and building strong foundations before seeking outside funding.

The Importance of Being Exceptional

Advice from Steve Martin

Sam shares advice inspired by comedian Steve Martin: "Be so good they can't ignore you," emphasizing excellence over pitch perfection.

Building a Successful Business

The conversation suggests that creating a compelling business model is crucial; if done right, investors will naturally be interested in funding it.

Challenges Beyond Fundraising

Raising venture capital is portrayed as one of the easier tasks for startup founders when compared to challenges like recruiting talent or achieving market traction.

Sam stresses that many aspects of running a startup are more difficult than securing initial funding.

Understanding the Relationship Between Risk and Cash in Startups

The Nature of Success in Startups

The speaker emphasizes that achieving success is not merely a milestone but a foundational step for startups, enabling them to tackle more complex challenges.

Fundraising Insights

A question arises about what founders wish they had done differently during fundraising.

The discussion highlights a critical gap in understanding the relationship between risk and cash management among entrepreneurs.

Onion Theory of Risk

The speaker introduces the "Onion Theory of Risk," which suggests that startups face multiple layers of risks from day one.

Key risks identified include founding team risk, product risk, technical risk, launch risk, market acceptance risk, revenue risk, cost of sale risk, and viral growth risk.

Peeling Away Risks

Founders should view fundraising as a process of systematically reducing these risks by achieving specific milestones.

Each funding round (seed, A round, B round) should correspond to the elimination of certain risks through demonstrated progress.

Strategic Fundraising Approach

The speaker critiques current trends where founders focus on raising large amounts without strategic planning. Instead, they should align fundraising with tangible milestones and reduced risks.

Tactical Advice for Founders During Fundraising

Importance of Trust and Documentation

Founders are advised against asking investors to sign NDAs early in relationships as it may signal distrust.

A significant mistake noted is failing to get commitments in writing; this helps avoid misunderstandings later on.

Efficient Fundraising Process

Founders are encouraged to expedite their fundraising efforts without letting personal ego interfere; it's just one step towards broader goals.

Follow-Up Practices

After receiving verbal commitments from investors, founders should promptly confirm these via email to ensure clarity and accountability.

Meeting Dynamics

Investment Strategies and Processes at SV Angel

Overview of SV Angel's Investment Approach

SV Angel focuses on seed-stage startups, aiming to be the first investor in these companies.

The typical investment range is between $1 million to $2 million, with syndicates often involving five or six other investors when they invest $250k.

The team at SV Angel has grown to 13 members, with a shift away from individual due diligence towards collective project support for maturing portfolio companies.

They maintain a selective investment strategy, investing in one out of every 30 opportunities reviewed, averaging about one investment per week.

Their network is extensive; they primarily source leads internally rather than accepting unsolicited proposals.

Evaluation and Decision-Making Process

Opportunities are evaluated based on short executive summaries submitted by founders; quality submissions are crucial for consideration.

A voting process among team members determines whether to initiate contact with potential investments, emphasizing the importance of timely decision-making.

If initial discussions are promising, further meetings are scheduled where background checks and market evaluations occur before making an investment commitment.

Transitioning from Seed to Series A Investments

Criteria for Series A Investments

At the Series A stage, top-tier venture capitalists typically invest only in companies that have successfully completed a seed round.

Companies usually raise around $1 million to $2 million during their seed financing phase before moving on to Series A funding rounds.

Exceptions and Notable Cases

Rare exceptions exist where successful founders bypass the seed stage directly into Series A funding due to their established track record and prior relationships with investors.

An example includes a founder previously backed by angel investors who is now launching a new venture after a successful exit.

Importance of Networking and Referrals

Building Relationships with Seed Investors

SV Angel receives approximately 2000 referrals annually through its network, predominantly from seed investors who play a critical role in facilitating introductions for later-stage funding rounds.

Effective Introductions Matter

Founders should prioritize selecting high-quality seed investors as they lay the groundwork for future fundraising efforts through valuable introductions.

Strong introductions from respected individuals significantly increase the likelihood of success compared to lukewarm referrals.

Identifying Suitable Investors

Guidance for Founders

Finding the right investors can be challenging; resources like Y Combinator (YC), which provides guidance on reputable investors, can be beneficial for founders seeking connections.

Negotiating Seed Funding and Valuation Insights

Understanding Investor Perceptions and Valuations

The speaker reflects on initial misjudgments regarding potential investors, noting that some who seemed promising were ultimately disappointing during the seed round.

A discussion arises about how to approach negotiations and determine appropriate company valuations, highlighting a lack of initial knowledge in fundraising.

The speaker shares their experience starting with high valuation expectations ($12-$15 million), which were met with skepticism from investors.

After adjusting the valuation down to $9 million, demand for investment surged, indicating a psychological threshold for seed-stage funding below $10 million.

It is noted that there are fluctuating thresholds for seed-stage companies that influence investor willingness to invest.

Key Takeaways on Fundraising Strategies

Founders should aim to raise only what they need without overextending themselves; minor differences in raised amounts (e.g., $6 vs. $12 million) may not significantly impact the company's future.

Questions arise about the maximum equity percentage founders should sell during seed rounds; insights suggest 20%-30% is typical for Series A funding due to venture capitalists' ownership preferences.

Selling more than 30% can complicate cap tables and create challenges for future funding rounds, emphasizing the importance of maintaining sufficient equity distribution among stakeholders.

Founder Ownership Considerations

At the seed stage, it’s generally advised that founders retain 10%-15% equity to ensure motivation and commitment towards building the company.

Founders must assess at what point dilution becomes demotivating; excessive dilution can lead to ownership stakes falling below sustainable levels (e.g., under 5%).

Impact of Cap Table Management

There are instances where companies have been deemed uninvestable due to poor cap table management, with outside investors owning too much early on (e.g., 80% ownership).

Meeting Google: The Early Days of a Tech Giant

Introduction to Google and Initial Connections

The speaker recounts meeting Google through Stanford professor David Cheriton, who was an angel investor in both Google and the speaker's fund.

Investors are encouraged to share insights about interesting companies, highlighting the collaborative nature of venture capital.

Jared, another investor, provided access to valuable deal flow from Stanford's computer science department.

Discovery of PageRank

During a conversation at a party, the speaker learns about "Backrub," an early project that would evolve into Google.

The concept of PageRank was revolutionary in 1998; it ranked websites based on their relevance determined by user traffic and links from other sites.

The original algorithm focused on identifying quality content based on website popularity.

Investment Journey with Google

After waiting five months for an opportunity, the speaker finally meets Larry Page and Sergey Brin for an investment discussion.

Google's founders were strategic; they required Sequoia Capital's involvement due to competition with Yahoo!, which influenced their decision-making process.

Airbnb: A Missed Opportunity Turned Growth Investment

Initial Hesitation and Later Involvement

The speaker discusses not being early investors in Airbnb but participating in its significant growth round in 2011.

Despite initial doubts about Airbnb’s business model, it is believed that this investment will become one of the most successful growth investments ever made.

Understanding Outliers in Venture Capital

Venture capital often revolves around outlier ideas that may seem absurd initially; Airbnb’s concept was considered unconventional at first.

Recognizing missed opportunities is crucial; initial skepticism towards Airbnb’s model proved incorrect as customer behavior indicated strong demand.

Philosophy Behind Multistage Investing

The firm adopts a multistage investment approach to rectify earlier mistakes and invest more significantly when necessary.

Evaluating Founders: Key Traits for Success

Assessing Founder Maturity

Observations about founders' career progression highlight how some grow into leadership roles while others struggle under pressure.

Successful hyper-growth companies often have young founders who must manage large operations effectively; maturity plays a critical role in this success.

Team Dynamics at Airbnb

All three Airbnb founders demonstrate exceptional maturity and adaptability as they navigate company growth challenges.

Tech Crunch Headline and Company Founding Insights

Importance of Co-founders

Every company has a CEO, and finding a co-founder who is as good or better than you significantly increases the chances of success. This was pivotal for Airbnb's rapid growth.

The phenomenon of having a single dominant figure like Mark Zuckerberg at Facebook is an outlier; successful companies typically have strong teams.

Rethinking Fundraising Strategies

Conventional wisdom suggests raising money is essential for operational needs, but some founders view it as a means to facilitate exits or acqui-hires.

Choosing investors with valuable networks and domain expertise can add more value than the capital itself.

Decision-Making in Fundraising

While raising money can aid in achieving exits, this should not overly influence decision-making; focus on selecting the right investors instead.

When starting a business, it's crucial to be precise about capital requirements and milestones to avoid complications later on.

Managing Capital Investment Risks

Onion Theory of Risk

The "onion theory" emphasizes that as more capital enters the business, understanding risks and staging milestones becomes increasingly critical.

Raising too much money in early rounds can lead to significant issues down the line due to cumulative dilution.

Operational Excellence

For businesses requiring substantial investment over multiple rounds, operational excellence becomes vital. Investors will scrutinize management capabilities closely.

A well-prepared business plan conveys operational excellence and helps attract necessary funding while ensuring clarity about risks involved.

Investor Relationships: What to Avoid

Identifying Bad Investors

Investors lacking domain expertise or connections that could benefit your company should be avoided; their primary interest may just be financial gain.

The Importance of Choosing the Right Investors

Long-Term Commitment in Business Partnerships

The journey of building a successful company is likened to a long-term commitment, comparable to a 10, 15, or even 20-year marriage.

This duration often exceeds the average length of an American marriage, emphasizing the seriousness of investor relationships.

Investor Selection as a Marriage Analogy

Selecting key investors for your company is as crucial as choosing a life partner; both require careful consideration and alignment of values.

Founders will face significant stress and challenges alongside their investors, making it essential that all parties share common goals and ethics.

Learning from Experience: First-Time vs. Second-Time Founders

Second-time founders tend to take investor selection more seriously due to their previous experiences with challenges in partnerships.

It’s vital for entrepreneurs to invest time in understanding potential partners, akin to how one would approach selecting a spouse.

The Lifelong Investment Philosophy

At SV Angel, investing in entrepreneurs is viewed as a lifelong commitment; they aim to support every venture an entrepreneur undertakes.

Evaluating Respect and Insight During Initial Meetings

In initial meetings with potential investors, it's important for founders to feel respect towards them and recognize their insights into the business.

A productive first meeting can provide clarity on future directions and indicate what working together might be like.

Constraints on Venture Capital Investments

Limitations on Investment Capacity

SV Angel has established a comfortable investment pace of one company per week due to staffing limitations.

Quality Over Quantity in Investments

Prioritizing value addition over quantity is preferred; focusing on existing companies rather than spreading resources too thinly across many investments enhances overall impact.

Conflict Policy Considerations

SV Angel maintains a written conflict policy but typically avoids direct conflicts by not investing in competing companies unless disclosed transparently.

Trust as the Foundation of Relationships

Trust is emphasized as critical for successful partnerships between founders and investors; without trust, collaboration should not proceed.

Opportunity Cost in Venture Capital

Understanding Opportunity Cost

Investment Strategies and Decision-Making in Venture Capital

Understanding Investment Losses

The primary concern for investors is not the immediate loss of capital (e.g., losing $5 million on a failed investment), but rather the implications of that investment on future opportunities.

Each investment decision eliminates potential conflicts, as firms typically only invest in one company per category to avoid competition.

Conflict Policy and Opportunity Cost

Investing in a company like MySpace prevents future investments in competitors such as Facebook, effectively locking out other opportunities within that category.

Investors face uncertainty about future companies; investing too early in a non-winning venture can block access to more successful options later.

Opportunity cost also includes the limited time and bandwidth of general partners (GPs), who can only manage a finite number of board positions.

Capacity Constraints in Venture Capital

Each GP can handle approximately 10 to 12 boards, meaning every new investment reduces available slots for future deals.

This concept parallels Warren Buffet's analogy of "punching holes" on a ticket; once all holes are punched, no further investments can be made.

Evaluating Pre-MVP Investments

It is increasingly easier to launch MVPs (Minimum Viable Products), yet some companies seek funding pre-launch or without traction.

The key factor for investment at this stage is often the founder and their team rather than the product itself, as ideas may evolve significantly over time.

Characteristics of Successful Founders

A lower valuation typically accompanies pre-user investments unless founders have proven track records or prior successes.

In sectors like enterprise software or SaaS, it’s common for companies to require significant initial funding before developing an MVP due to customer needs for complete products.

Board Structure Insights

Trust among board members is crucial; having familiar partners can alleviate fears regarding arbitrary decisions like firing CEOs.

Understanding Power Dynamics in Venture Capital

The Role of Board Structure and Investor Control

Most power held by VCs stems from protective covenants in financing rounds, limiting founders' actions such as taking on debt or selling the company without investor consent.

When a company is performing well, founders often have significant leverage over investors, regardless of board structure or covenants.

Even less favorable investors are likely to support founders' decisions if the company is thriving, as they want to benefit from its success.

Consequences of Poor Performance

In challenging times, the protections established for founders become irrelevant; they must seek additional funding and lose control to investors who hold all the cards.

During financial distress, terms are renegotiated regardless of prior agreements; this highlights a fundamental rule in fundraising: control shifts based on performance.

Insights from Board Experience

The speaker shares that after 20 years on various boards, votes rarely matter; decisions tend to be made unanimously or nearly so based on consensus rather than formal voting processes.