Bad News is Good News (Building Great Founder/Investor Relationships)

 

We recently received an update report from a startup team in the Promus Ventures community. The deck was full of bad news: delays for certain product components were increasing, more bugs and unstable builds than usual, longer than anticipated QA testing, certain new hires were not working out, and a list of a myriad of other issues the team was facing.

Refreshing.

The best startup teams are the ones that show all the warts and constantly communicate how they are going about fixing each problem.Who said that building a company was easy? Finding the right people to join your team is hard enough, much less building and scaling a product that is constantly evolving. Be honest with yourself and your investors — nothing ever goes the way you drew it up, so show what’s working, what’s not and what the team is doing to keep pushing the ball down the field.

More often than not, a startup team believes that if they tell their investors all the bad news, it will hurt their relationship with their investors. They believe these investors (who are not on the front lines) will thus think the team is horrible at executing the thesis, and subsequently never introduce the company to strategic customers or put another dime in the company. Au contraire.

When an update from a startup team is devoid of numbers, only highlights new hires, new offices and industry research showing how their space is exploding, investors get nervous. The more open and honest a team is, the more trust will be built, and over time this consistency of transparency will produce deep and strong ties between a startup team and their investors. Show all the customers losses you have experienced, why each passed and what was learned. Be explicit with all the problems in the product roadmap and what is needed to move forward. The messier you are, the more honest board and investor conversations can be and more ground will be gained.

There is humility in admitting that you and your team are making mistakes and not everything you touch turns to gold. Well, welcome to humanity. Stay true to your focus, continually call out and communicate the challenges, and watch the level of help, trust and confidence rise in your board/advisor/investor relationships.

Picked the Wrong Investors for Your Startup? You Probably Forgot to Do This.

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Just as investors fire a long list of questions at startup teams (do they ever stop asking questions), founders can and should do the same with doting investors.

VCs have the benefit of being able to invest in numerous teams and themes, and thus diversify their capital such that failures don’t make or break their entire portfolio (side note: I’m starting a campaign to ban the word “portfolio” who’s in). Founders, on the other hand, are concentrating much of their personal capital into one asset: their startup. They can have much more to lose (but also more to gain).

Then why oh why don’t founding teams do more diligence on investors?You are about to get on a bus with a crew you better enjoy because it’s a long ride. Oh, and news flash: the road can (and will) get rather bumpy.

Founders may have checked off everything on their investor diligence list (meetings, phone calls, prior personal and firm investments, industry expertise, fit with team and firm, blog, Twitter feed, LinkedIn resume, etc.) but if they miss doing the reference check, they may end up with less than advertised. I am focusing here directly on the partner of a firm not the firm’s reputation, as the partner with whom you will be working is more important than the firm.

Founders will learn more about the information that comes out of a reference’s mouth than anything else about that investor. Not all the information will be glowing (especially the ones that fail), and sometimes people have differences of opinion, but on the whole a founding team will know what they’re getting after these calls are completed. The goal is to get an idea of how the investor delivered on his or her promises throughout all life stages of a startup.

Teams should first try to connect with as many investor references as possible before going to the investor. Scour an investor’s investments and connections to find people who know and have worked with him or her. Many times (hopefully) a startup will know many of these people, and if not, this may speak more to a founder’s lack of network than the investor’s.

Note: it is important to spend as much time doing the background check work before you go directly to the investor. When we at Promus Ventures go through the process of reference checks on founding teams, we have already talked to numerous people they have worked with in the past before we ask for additional personal references.

If I were a founder, and only after I could see myself giving this investor filling a coveted spot on my cap table (don’t waste their time or other’s if you’re not serious about them), I would ask this potential investor for the following reference checks:

1. Founder of company where investor participated and outcome was complete failure.

2. Founder of company where investor participated and outcome was complete success.

And if this investor is going to take a board seat, then I’d also add:

3. Founder of company where investor participated on the board (probably led the round as well so can understand that process as well).

An example: we recently finished the process of leading a round with a fantastic team that reference-checked us up and down. One of the co-founders knew three founders we had backed. The team talked several times with a vc (maybe more than one) that we had invested with on numerous occasions. I’m sure they talked to other folks that knew us as well. After these conversations, they then approached us and asked for three morereferences from founders in exactly each of the aforementioned situations.

Overkill? Nope — thoroughness. The team took their time to make all these calls because they understood the importance of the decision.

Final note: founders should recognize an investor is cashing in some of his chips by asking another busy founder to take time out of his or her schedule to talk. A team should find a way to be helpful to this person in some way rather than just getting on the phone and asking questions.

So don’t be afraid to ask a potential investor for references, regardless of who they are. Last thing you want is an investor that promised the world but delivered a goose egg. If a potential investor balks or grimaces at this ask, well, that will be an important tell in itself.that promised the world but delivered a goose egg. If a potential investor balks or grimaces at this ask, well, that will be an important tell in itself.

Serious Questions Every Startup Should Ask Now

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No I don’t think we’re in a bubble.

Yes I think we’re living in good times.

I believe every startup should dream big, be tenacious, iterate always, and change the world. But whether in plenty or in want, RIGHT NOW every startup on planet earth should take their entire core team to the mirror and ask themselves these questions:

Business Model

· Is our burn rate sustainable?

· Rinse and repeat — is our burn rate sustainable?

· How much money do we really need to solve this problem?

· When exactly do we believe we will achieve customer revenue and profitability?

· If the world falls apart tomorrow, what is the probability our valuation is ahead of itself?

· What would it look like if our next round was a down round?

· If we all had to cut our salaries by 50%, how many people would leave?

Team

· How passionate and intense is our entire team about our core thesis?

· Would our team commit to five years of doing nothing but working on this startup together?

· How have we sacrificed as a team to get here? What else may we have to sacrifice?

· Are we proud of what we’re working on? Does it change the world for the better?

· Why exactly are we here? What drives each of us?

· What mistakes have we made? Find 10 more. What have we learned from these?

· Where does each of us need to be better? How are we better as a team than apart?

· How did our funding round change us? How has not getting enough funding change us?

· Are we leading the company well? Where can we do better?

Product

· How original is our core value proposition?

· What are the strengths in our product? Cut down to top 3.

· What are the flaws in our product? Find 5 more.

· Are we impartially looking at the data about our product?

· What are the current Top KPIs we look at each day? Does entire team know these daily?

· What did we launch too slowly? What did we launch too quickly?

· How often do people say our product won’t succeed? How do we respond to this?

· Is our product risky enough?

Customers

· What do our top customers honestly think about us?

· How would we describe what our ideal customer looks like? Is this realistic?

· Do I find myself using the product because I want to or because it’s my job?

· How much time do we actually spend with our customers?

· How do we listen to our customers? Do they freely share their feedback? How can we enable this better?

Competition

· How hard is it for someone to copy our idea?

· What do our competitors do really well?

· What can we learn from our competition?

Hiring

· Do we have a list of people waiting to work at our startup? Why or why not?

· Who in the past have we hired that is not a fit? How did we handle this situation?

· How many people do we interview before we hire someone?

· When was last time we hired someone who was not looking for a job?

· Is the culture we are fostering an attractive one to the outside?

Hustle

· How strong is our customer/hiring/investor network?

· When was the last time we met with a new investor?

· How often do we listen to advice from other older/wiser mentors?

· How often do people say we won’t succeed? How do we respond to this?

· Are we doing a lot with a little? Even if we raised a large round?

Don’t let the busyness of building your business permanently descend your plane from 30K feet. Be honest with yourself and each other and great fruit will bear itself on the tree.

Loose Lips Sink Ships

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Confidential info is serious business.

I recently sat on a plane coming back from SFO and was forced to listen (for three hours plus) to a vc and startup founder in back of me loudly wax poetic about a wide range of opinions about other vcs and startups. These people should have known better, and knowing some of these companies and investors, some of their info was just wrong.

You know a lot about a startup or investor about how much comes out of their mouth. The above example is on the extreme side of cluelessness, but there are various other forms I see all the time. When you hear things like “just between you and me” or “confidentially” from people you just met, suffice to say you’re not the only one with which they’re shared this information.

Generally people share more than they should out of insecurity. They are trying to impress the other person and sharing “in-the-know” information somehow will earn their respect. Most times this instead backfires as the other side quickly judges that this person can’t be trusted.

Many years ago when I worked in M&A, you could lose your job on the spot if you let out information that was deemed confidential. I was constantly asking myself what exactly I could share with investors about companies that we were representing. I am thankful for the Managing Directors above me who continually put the fear in us about the importance of confidential information.

Nothing rocket science here, but startups shouldn’t:

1) bad mouth their competition or say things they know privately about these companies or product, even if true

2) share information about other startups or founders that has nothing to do with anything

3) talk about their customers openly and their plans (unless you want to lose them quickly)

Investors shouldn’t:

1) talk about metrics or customers of startups in which they’ve invested or seen in other startups’ decks

2) share pitch decks without getting permission from the startup

3) throw around valuations of startups, however “overvalued” they may believe they are

The world has never been flatter — information travels at the speed of light in ways you never thought possible. Just because you know something doesn’t mean you should tell even one person about it. You never know who is sitting within earshot of you.

Stacking Building Blocks (The Software Way)

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In computer science jargon, the “software stack” is software that sits on top of a system’s core kernel (or operating system). The stack gives a feature set to the operating system, expands it function and makes it sing. The more layers a developer adds to the stack, the more enriching the experience and usability of the platform.

Not too long ago, developers had few external tools available to help them build out their product. Want a messaging feature? Build it yourself. Today, the world has changed dramatically. There are now software companies that offer programming teams the ability to skip building a feature set internally and instead just hook into an external platform to customize what you want. This mindset change is one of the most exciting things we at Promus Ventures believe is happening in the software industry today.

As technology continues to reinvent everything, we are quite long this “building blocks” thesis and are investing in teams who focus on a certain customer application layer of the stack and build out a deep feature set for any company to use.

Dedicated Computing

Layer is a prime example of a building blocks company.

Layer enables developers to build their own messaging and communication features into their products so that they own the data that flows through their own product. Instead of having to hire a back-end team to code SMS, photo, voice, video, or video messaging, dev teams can use Layer’s APIs and SDKs to power their existing front-end, or even plug into their existing UI customizable components. There are now more than 10,000 companies currently using Layer’s code to build out their messaging features.

Layer has recently partnered with Mapbox to bring these tools to logistics companies. Mapbox enables developers to insert maps and location data into their stack. One should view Stripe (building blocks for payments) as well as Dispatch (building blocks for on-demand services) — in the same building blocks club.

Further, Layer today has announced the Layer Fund, which invests in fast-growing startups through AngelList utilizing Layer’s messaging products. I expect to see more “platform funds” emerge from other building blocks companies to give yet another reason for startups to use these products and integrate in their communities.

It is mind-blowing that developers today can utilize third-party APIs, SDKs and web and mobile clients to help scale their business and efficiently manage costs. It seems almost silly that startups wouldn’t leverage what these powerful building blocks companies offer. The goal is to own your data and build meaningful analyses and dashboards for your customers, not ship your proprietary data off to someone else’s platform for them to mold and fashion as they wish.

It was never fun as a kid not to be able to reach that cookie jar on the top shelf. A new breed of startups have emerged to bring these cookies down off the shelf so everyone can get their fingers in the jar. Enjoy the goodies.

Equity is Not Candy

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It happens more than you think.

Equity can get doled out in early days like candy thrown from a paradeto anyone and everyone because that’s the only currency that founders can afford to pay. We see the following situations occur more than we like:

  1. 5–15%+ of equity given to early founder/external helper and this person doesn’t stick it out, gets bored, doesn’t help, but isn’t vested in any way (traunching out equity over a standard three to four years to make sure people stay to receive their grants). This equity becomes “dead” on the cap table, and conversations start around trying to get this equity back into company hands.
  2. Main founder brings on two other founders, splits equity equally between the three (all owning 33% of common at start), gives out 2–3% to external advisors that help intro company to investors, starts giving out 5% to early CTO, PM-type roles. Team believes it needs a strong external board member so they give out another 5%+ for this (and usually this person adds little value). Company raises first legitimate round with institutional capital (call it a $2–3M round). The founders are now all sitting with ownership in the low teens and now they have to hire out the team.
  3. One founder brings on co-founder, gives 1/3 of company to him or her, and this co-founder never fits with company. Founder smart with giving out equity but company’s traction comes fast and rounds raised rather quickly with co-founder now holding 15–20%+ of common. Due to higher valuation of company, harder to figure out exit for co-founder.

Listen, stuff happens. Nothing goes the way things are drawn up. Startups are hard, and people change, give up, or never were as advertised.Incredible how much founders learn about the hiring process as they scale. (Side note — there is plenty of info on how much equity to give out to team members, and AngelList is an incredible resource to gauge market for every type of position.)

Needless to say, equity should be granted very carefully. Standard three- to four-year vesting programs should always be in place. A 15% option pool should be established early and not put together later because “we’re just heads down building the product.” Option pools should be refreshed after each financing to make sure founders have put aside enough to hire talent (call me old school). Founders should not be so willy-nilly with 409(a) valuations and do these whenever they feel like it. People should prove they are committed to the company and earn it over time.

It is messy, time consuming and involves lawyers and investors when trying to bring back large equity grants from early recipients that never should have received these grants in the first place. There is a lot of misinformation and expectations about what people “deserve” in early stages that both sides can start digging in. More often than not, it gets personal and heated.

A lot can be learned about the founding team when looking at the cap table. If too much has been spread around, it is a warning sign that the founders possibly are moving too fast, don’t have good legal counsel, or don’t know what they’re doing. Teams that are on top of their cap table and can show a concise set of investors and employees early on earn a lot of points in our book.

Our internal data has shown that founding teams with large equity stakes into the Series A produce the highest returns for investors. I’ve pondered why this happens, as it seems contrarian, but there are good reasons:

  1. Early founding teams spend copious amounts of time thinking about who to bring on and when. They are patient with their hiring and smart with engaging external advisors. They make less mistakes when hiring key roles, and when hiring wrong, quick to cut losses early. As a result, less equity is thrown around and wasted in the precious early days of a startup.
  2. These teams are conservative with their burn, and make a little go a long way. The dilution is relatively small after early rounds thus preserving early capital ownership stakes.
  3. These founders are strong leaders, and attract team members that believe in the capability of the founders to execute the long-term vision of the company. Talent flocks to these startups and founders don’t have to dole out large stakes to attract the best employees in their prospective areas. 5% of zero is zero, .5%-1% of something big is, well, much bigger than zero.

Founders should conservatively plot out how much capital they feel they will need to raise over the life of their model if things go well (and then double that). They should get help understanding how dilution will play a role moving forward if that amount of capital will be raised.

If teams take care of the small things from day one, the big things will start to take care of themselves. It is vital to understand the power of equity and the consequences of being loose in this turn. There is only 100% of equity to give out on day 1 and unfortunately this pie does not expand. Be generous but be smart, and you’ll save your team hours of heartache and expense in the future.

Wait, What Do You Do? (Your Startup Value Prop Better Be Simple)

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Put simply, one’s “value proposition” is the reason why your product works.

When an enterprise or consumer initially encounters your product, their immediate reaction will tell you if you have something that is special or just another interesting idea.

Here are some questions we like to ask startup teams:

  • What is the current pain point for the customer?
  • How is the customer hacking this pain point to find a solution?
  • How does the product destroy the hack and solve the problem?
  • How is the product different than others in the market trying to solve this similar pain point?
  • Where can this hack be applied to different industries and verticals?

When talking to a startup’s pilot customers, it is crucial we hear their immediate reaction to the product and why they need this yesterday. If customers jump over the desk and ask for the product however poor the current architecture, it’s clear the value proposition resonates high on the chart. If they hem and haw to tell us how the startup’s product will help them, it’s most likely going to be a long slog forward trying to sell users on the concept.

Just as we leave valuation to the end during our due diligence process, pricing should be left to the end of the value prop. The solution should be so great in a customer’s eyes that he or she should consider price as a secondary factor. We find that the best solutions start at generating 50%+ in efficiency and saving 50%+ in price. These can be defined in a variety of ways (it’s not just market price but human capital and hours than adds up). Delivering the price punchline should be the kicker after the initial positive reaction to the core product thesis.

Value props should inherently be simple to understand but complex to build. Founding teams must succinctly state what their product does in ten seconds or less. If you can’t communicate the power of your product with excitement and conviction, go back to the drawing board.

Building a company from nothing is hard enough — don’t make it harder by not starting with a compelling thesis that solves a major pain point in large markets. You’ll know it when you see others react to it, so keep iterating until people start falling out of their chair. Usually that’s a good sign.