I’ve been investing for about 2 years now, and I’ve noticed that investors fall roughly into two camps. I call them tops-down and bottoms-up investors.
Tops-down investors
These are investors who want to be sold on the big vision — where is your company going? What trends are you riding on to make this successful? How big can this get? Market size?
Bottoms-up investors
These are investors who want to be sold on your traction and progress. Are your unit economics good? How are you acquiring customers? What steps are you doing today that can be scaled?
Using this to your advantage
Neither pitch angle is right or wrong, and all investors want to know both angles to a certain extent. However, I’ve found that investors tend to gravitate towards one type of pitch or the other.
For example, Dave McClure loves hearing about traction. If you happen to run into him at an event and have only 30 seconds to pitch him, spend just 1, maybe 2, sentences on the high level vision and trend you’re on, but focus most of your time on KPIs and the progress you’re making. Pitch something like this:
Hi Dave – can I tell you in 30 seconds about my company Hippos R Us? Hippos R Us is an online store where you can buy hippos. We are riding on changes in housing regulations and the growing trend of apartment buildings allowing large pets. We have sold 100 hippos in the last month and have sold $200k topline in the last 6 months. We have 50% margins. We are raising $250k to fuel our growth and pour more money into Facebook ads. Does it make sense to chat more about this?
Note that this pitch mostly focuses on progress and what you are doing to move your business forward. It is all about growth, growth, growth. This is a good way to rise above the noise — there are so many entrepreneurs out there who are trying to sell a dream but haven’t done anything with their business. By illuminating your traction, you can be amongst the top 10% of seed stage entrepreneurs who have actually made progress on their companies! While this pitch doesn’t say anything about the market size, note that it does touch on riding a growing trend.
In contrast, other investors prefer big vision pitches. For this kind of investor, spend more time on why your company changes the world, what is causing this shift in the market, or why this is going to be super big, and spend just a couple of sentences on your progress.
For example:
Hi Ms. MoneyBags – can I tell you in 30 seconds about my company Hippos R Us? The birth rate is declining in all industrialized nations. People don’t want children anymore, but yet they need emotional satisfaction, and to fill this void, they have been buying pet hippos. In fact, the pet hippo market has been growing 1000% year over year for the past 5 years, and apartment buildings now allow them as pets. Hippos R Us aims to be THE PLATFORM for purchasing and managing pet hippos to provide people with emotional satisfaction. This makes our total addressable market $5B. Since we started 6 months ago, we now have more than 100 accounts under management. Does it make sense to chat more about this?
Note how this pitch is largely about the trend (why now?) on which Hippos R Us is riding. Also, this pitch sells a much bigger vision — this is a platform that ultimately helps people with their emotional needs; it’s not just about buying and selling hippos. Again, in order to rise above the noise of all the entrepreneurs who are just selling an idea and aren’t doing anything, you’ll want to mention a bit about what progress you’ve made to date.
Ultimately, you’ll want to craft your pitch to sell both the dream and your progress. If you have some insight into who you’re pitching, you can cater your blurb or elevator pitch accordingly. Often, I see a lot of entrepreneurs are really good at creating a pitch from one angle, but the best ones are able to incorporate key elements of both tops-down and bottoms-up pitches. You don’t have time to dive into the weeds in just a few seconds, and so deciding which points are important is key.
Yesterday, my employer 500 Startups organized a conference in LA called the Unity and Inclusion Summit. The focus was on diversity issues in startups, and one of the central topics was on unconscious biases in the industry.
This is a really important issue that often gets shoved under the rug. I can’t begin to tell you how many times I hear people say stuff like, “Oh, well, I don’t see a problem — Silicon Valley is a meritocracy.” Or, “This issue is a gender issue; it doesn’t apply to me.”
But this could not be further from the truth. Everyone should be concerned. For me, one of the big problems that I have with the current startup ecosystem is that I think there are a lot of founders who don’t get a fair shot to demonstrate their merit when it comes to fundraising. That’s a priority issue that needs to be solved. Unconscious biases in how investors assess founders can be tied to gender or race, but it extends much further than that. For example, there are investors who have unconscious biases against introverts or non-pedigreed founders. If you have a certain kind of foreign accent, you should also be concerned about investors who are unconsciously (or consciously) biased against you.
The problem is that it’s hard to know to what extent there’s a lack of meritocracy. If a female founder gets dinged, is it because she didn’t get a fair shake? In this industry, frankly speaking, most founders are not going to be able to raise money. The odds of raising are against ALL founders. Period. So, if you get dinged, you can’t simply say, “Oh it’s because I’m a woman that I wasn’t able to raise.”
Investor Paige Craig of Arena Ventures eloquently theorized yesterday at the conference that part of the reason we have this big problem with unconscious biases in this industry is that we don’t have a framework to assess founders. I think this is spot on. Assessing founders is highly subjective. I hear my peer investors (both at and outside 500 Startups) say things like, “Oh, that founder is so sharp,” or, “That founder has a lot of hustle.” Do you really know after meeting someone for just a handful of times if someone is smart or has hustle? You don’t really know the person. What you do know is that you are taking your life’s experiences and trying to superimpose what you’ve learned about other past people you’ve met who seem similar and apply them to the founder at hand.
My framework
As Paige mentions, the way to really tackle unconscious biases when making investment decisions about founders is to have an objective framework. Here’s mine; it’s a work in progress:
I value these 3 traits of founders: speed to accomplish things, learnability, and tenacity (there are, of course, other characteristics that are very important to me in choosing the people I do business with more generally speaking, including honesty and integrity, but for founders, I focus most on these 3 traits as a starting point.)
It’s important for me to be able to point to enough facts for each of these characteristics.
1. Speed to accomplish things
One of the best indicators that I’ve found to measure speed is if a founder says he/she will do something by a specific constrained time and then does it (and repeats this pattern consistently).
For example, if I meet with a founder this week, and he says that he will do xyz by next week, when next week rolls around, I might check in and see if he has done it. If this pattern is consistently positive for several weeks, you’ve got someone really special here.
I realize this sounds ludicrous because shouldn’t everyone be able to follow through with what he/she says he/she will do? As it turns out, most founders I meet are not able to do so. Something comes up and task xyz doesn’t get done. Or maybe the founder is not good with time management or scoping out reasonable goals within short periods of time. Or maybe there is conflict with the team, and the founder isn’t able to work with people well. Or maybe the founder is distracted by speaking at too many conferences. It doesn’t matter the reason a founder doesn’t accomplish his/her micro goal. The ability to quickly accomplish tasks that you set out to do is a very objective criterion that I like to use when I assess founders.
When we say things like, “Oh she is such a hustler,” we really should say things like, “Oh this person sent out 2000 outbound emails last week. And 1000 the week before.”
2. Learnability
This is a tough criterion to assess objectively.
To a certain extent, this criterion is tied to coachability. If I give a founder a piece of feedback this week, has he/she changed something about himself/herself or the business by next week? At the same time, I don’t necessarily believe that my advice is right or best; in fact, it’s a founder’s job to assess whether or not to take advice. If a founder doesn’t take my advice, I’m ok with that; it isn’t a negative mark, per se. If a founder does take my advice, and implements it quickly, that’s an indicator that he/she can learn quickly.
Other ways I assess this is when hear from a founder about a time he/she taught himself/herself a new skill. When I hear about how he/she accomplished his/her goals, I ask about what he/she had to learn along the way.
Instead of saying, “This founder is smart,” which is subjective, I prefer to say, “This founder learns quickly because he/she taught himself/herself enough Python last week to throw up this script to scrape ABC.” Starting a company requires founders to constantly learn new things quickly, so this is a really important piece of criteria for me.
Learnability is very different from being “smart.” People who go to, say, Ivy League schools have proven they have strong skills in being able to take tests and do well in them, but these skills are very different from the ones you need to run a company. They don’t transfer over at all. The best founders are constantly learning new skills they don’t already have and are mastering them quickly.
3. Tenacity
The last piece of criteria is also really hard to assess objectively. If a founder has a story about how he/she powered through a difficult situation (cancer, a rough childhood, etc.), then that’s a plus. Most people don’t have a crazy adversity story, so this one is tough. Often, I just end up not having any data points on this criterion.
These are the three characteristics that I look at most when I evaluate founding teams and try to come up with facts to support a case for each point. This isn’t always easy, but the more facts there are under each of these, the easier it is for me to assess a founder.
Of course, founder assessments alone do not make an investment decision. Other criteria are just as important and in some cases more important: market, whether a company will be able to raise further, existing traction, product-market fit, etc. Given that assessing a founding team is a really critical component to evaluating an early stage investment opportunity, being objective here is really important. At the moment, my framework for this is OK, but it can definitely be improved. I’m open to any thoughts, suggestions, and feedback.
As an entrepreneur, it never even crossed my mind to think about how investors decide which companies to invest in. Lots of investors blog generically about how they invest in great teams, big markets, maybe some traction, yadda yadda yadda. Regardless of the VC — whether it’s a big VC that will lead your seed, series A, series B, etc. rounds or a small micro VC that will only write a small seed check — they all generally think about the same characteristics of your company. They may have differing theses on these characteristics and form different conclusions, but they all look into the same things.
Except one.
There is one criterion that micro VCs must consider when deciding to invest in a company. And no one talks out loud about this.
Whether or not a company can get downstream capital from other investors in the future.
A micro VC, by definition, writes small seed checks and doesn’t do any follow-on investing. This means that once they have written their check, the firm cannot carry the company further. Certainly they could help with advice and introductions — but not with money.
There are exceptional cases where a company will never need to raise again after a seed round and will still be able to continue its growth, but this is a bit of a rarity. A micro VC must consider what will happen if a company is not able to raise beyond the seed check. Will the company go under? Will the founders be so tenacious that they will keep ploughing through no matter what?
This makes it difficult for micro VCs to make contrarian bets – investments in companies that few or no other investors will touch. Most micro VCs will pass outright. Contrarian investments are often companies that are in:
Competitive markets
Markets that other investors hate
Unusual markets that most investors don’t think about, think are small, or think are insignificant
At 500 Startups, we are not really doing follow on investments these days, and so when I meet a founder and have conviction to invest, I have to believe that he/she will be able to raise beyond my small check. I’m pretty upfront with a founder in telling him/her that I think it will be difficult for him/her to raise further. Often, I’d want to know what would happen if he/she were not able to raise beyond my check.
Personally, I’m comfortable making a contrarian bet — even as a small investor who isn’t able to write a follow on check (after all, Google was like the 8th search engine in a super crowded space…). BUT, I have to have a lot of conviction that the company has above-and-beyond more tenacity and survivability than what I would expect from other companies AND that the outcome, if all went well, would be more lucrative to my firm than alternatives. Essentially, I’m expecting them to prove out equivalent progress to their fast-growth peers and sit out one round of funding, hoping that the next set of downstream investors will pick them up after proving out more.
Competitive markets
If I’m making a bet in a competitive market where there are multiple alternatives, usually, I’ll drill into the details, differences, and nuances of the product and user experience a lot more than, perhaps, a company in a more empty market. It’s these details — this experience — that often makes all the difference.
It has to be a BIG difference, not just incremental, in order to win in a competitive market. Sometimes it’s not the product or the user experience that makes this 10x difference — sometimes it’s in the business model — but I’ve found it usually ends up trickling down to the user experience as well.
Markets that other investors hate
Markets tend to be cyclical. One of my pet peeves is that markets go in and out of favor – usually for no good reason (though not always). Usually what happens is that investors have poured too much money in a given space, and then a few high-flying companies in that space end up going belly up. Then, everyone else up-and-coming in that space suffers because investors are no longer excited about investing in more companies in that space.
Unfortunately, if you’re in one of these spaces, there isn’t a whole lot in your control. It will simply be harder to raise money. It doesn’t mean you have a bad business – it just means that there may be less investor appetite for your business at this time. The good news is that all of these markets are cyclical, and so your business may come in favor with investors in a few years again.
Unusual markets
I think this is changing but still has a ways to go. If you’re serving a customer base that either few investors understand or understand as a lucrative or big opportunity, then investors may just pass outright. In the past, this has been more of an issue because a lot of investors have traditionally had a similar worldview. With newer investors and firms emerging with different perspectives, you may be able to find someone with a similar thesis if you look hard enough.
All-in-all, if you have a company that falls into one of these categories, you should know that micro VCs, in particular, will need to find more conviction than usual in order to invest in your company. They simply cannot carry you beyond their initial check and rely so much on downstream investors to help their companies in the later stages.
I previously alluded to some of my goals for 2017 with an overarching goal of focusing time on pre-seed companies. To be clear, 500 Startups is not making a shift in its priorities — these are merely my own personal views and activities (500 invests in all areas of the “seed spectrum” but with a big focus on post-seed). I’ll talk more later about why I’m spending more time at pre-seed, but for the time being, I wanted to start sharing some more details about my plans.
Rejectionation
The big activity that I’m working on this year is my side project Rejectionathon, which I experimented with last year. It stems from the issues I had when I was first starting my company LaunchBit. Namely, I was afraid of rejection, which meant that I was timid when it came to anything that could possibly end with a rejection — sales, fundraising, partnerships, etc.
Last year, Rejectionathon took the form of an event where teams would run around undertaking challenges that would set themselves up for rejection. This helped people build a thicker skin for that one day, but it wasn’t directly applicable to people’s businesses.
This year, we’re iterating on this concept and expanding it worldwide. The next Rejectionathon on January 29, 2017 in Mountain View will be different. You’ll still be challenged and will set yourself up for rejection, but there’ll be some major differences:
1. It will be directly applicable to your pre-seed startup and will help you advance your startup.
The challenges will no longer be all about borrowing money from strangers or serenading people on the street. Most of the challenges will be focused on helping you move the needle on your business. Challenges will involve pre-selling, doing fundraising pitches for your company, and getting feedback on your product.
2. It will be more focused. The January event will be focused on hardware companies.
If you have a hardware company, the next event will be catered to you. We’ll have challenges around customer development for hardware companies, pre-sales for physical products, and fundraising.
Even if you don’t have a hardware company or any company yet, you are still welcome to participate. Just know that the angle will be about hardware companies.
3. We are capping the event at 30 people.
Our past Rejectionathons have been larger events, but in order for attendees to receive personal attention, we’re capping this at just 30 people.
Rejectionathon is like a mini-hackathon for business people. Bring your idea or existing company, and you’ll use the time to advance the business side of your startup while building a thicker skin.
I’d encourage you to sign up today with my special code of 50% off EYFRIENDS. Early bird tickets end today.
So you’ve raised some money, and now it’s time to make your first hire or two. This is where a lot of entrepreneurs make their biggest mistakes. Your first couple of hires solidify your company culture, which sets the tone of the rest of your company. Most entrepreneurs tend to look at candidates purely based on skill. But looking at a person based on just one axis is a huge fallacy.
People aren’t drones — their skills are affected by all kinds of things: happiness, friendships, and camaraderie at work; independence and autonomy; the job itself; growth potential; etc. The people with the best skills for the job can be your worst performers if the environment isn’t a good fit for them.
When I started LaunchBit, I made the mistake in the beginning of dismissing things like setting your company’s mission statement and values, from which company culture and hiring culture develops. It was only a few years later, after my co-founder Jennifer coaxed me into taking a meeting with a potential startup coach, that I started looking at culture. It was probably one of the best meetings I’ve had in my life, but it was much too late for our company to be only starting to look at that.
Setting your company culture consciously from day 1 is probably the most important thing you can do for your business and hiring. What do you value? What sort of employees reflect those values? If teamwork is one of your values, it doesn’t make sense to hire someone who is very strong technically but isn’t a team player.
This isn’t a post about setting your mission statement or your team values, but before you make your first hires, you should come up with a rough outline of that mission statement and those values. Then, take a first crack at writing down what your employee persona should look like. We all do this with our customers all the time — we write down what a typical customer looks like, but we don’t do this for our own companies. Aren’t your employees just as important as your customers? At some companies, employees are considered even more important!
Here’s a quick persona of what I’m looking for in all of my team members at 500 Startups:
Open minded
Brings diverse backgrounds, perspectives, and ideas to the team
Good sense of humor; doesn’t take himself/herself too seriously
Efficient; able to build processes to scale activities
Competent skills
Decent organizational skills
Eager and quick to experiment and try new ideas to solve problems
Once you have a list, it’s important to think about the ramifications of bringing onboard a new employee to your team and impact on that team as well as your ability to hire going forward. My friend and former colleague Andrea Barrica wrote a great piece on diversity debt – namely, if you have too many of the same kind of person at your company, it will hinder your ability to hire other types of people going forward. In this post, she focuses more on race, gender, and sexual orientation, but this also applies loosely to other areas as well. For example, if you have too many extroverts, they may drown out any new introvert hires from being heard. It’s important to keep this in mind.
Beyond this, it’s also important to visualize how your employees will work. Will they be remote? Do you expect them to stay really late? Will they work all the time? Do you expect them to socialize with each other? Do you expect them to be like family? Or just colleagues you see in the office? Will you offer awesome compensation? Or do you see your group as a learning environment?
All of this is an exercise that’s worthwhile for every hiring manager to do — not just startup founders — because this really sets the tone for how your group or company will congeal and work together. This is something that took a long time for me to figure out and that I wish I’d paid attention to several years ago.
If this is your first time raising money, the mechanics of how investors buy into your company can be very confusing. Here’s a quick primer on how investments tend to work in startup companies at the seed stage.
Note: this is super basic, and there are a lot more details that will not be covered here.
Equity
Traditionally, investors have invested in companies to receive equity, or shares in a company. This is the easiest method of investing to understand as well as the most common way of investing worldwide. Simplistically, if I’m an investor who is interested in buying a percentage of your company, I’ll offer you money, and you’ll send me a certificate indicating how many shares — how much of your company — I own.
The number of shares that I’ll own is based on the price per share that we had mutually agreed upon. Let’s say there are 1M shares in your company, and let’s say I’m interested in buying some of these shares and have $100k to invest. We first mutually figure out a price per share, and let’s say that the price we decide is $1 per share. This means that I will receive 100k shares for my purchase (which is 10% of your company). The physical manifestation of this investment is a certificate that says that I now own 100k shares. Later, if you sell the whole company to Google at say $5 per share, I will earn $500k for a net gain of $400k.
The concept of equity rounds (also called priced rounds) is very straightforward. Investors worldwide are familiar with and are used to investing in priced rounds. And as you raise money at later stages, you will most likely be raising equity rounds.
Once you find investors who want to invest and agree on the price per share, everyone knows just how many shares they are getting, and everything is clear.
But, legally, equity rounds can be quite expensive to complete. Lawyers can charge as much as $10k-$30k (in the US) to draft and execute the legal docs for an equity round, and traditionally, founders are responsible for paying for this as well as investors’ legal costs! I personally think this is ludicrous, but this is still common practice. So, in the aggregate, it is possible that you may be required to pay as much as $30k-$50k to get an equity round done. Newer VC firms, though, typically do not pass their costs to their startups, which is much more progressive.
Additionally, the legal docs around equity rounds typically specify a threshold that must be met before the round is complete. For example, if a startup is raising $1m in a priced round, this means that the startup must find enough investors to invest (in aggregate) $1m into your company at specified terms within a certain time period. If the startup is only able to find enough investors to commit to investing $700k, the startup receives NO MONEY, and the round does not get completed. The results are binary. You either raise your full amount or nothing at all. This means that if you are doing an equity round, you need to run your fundraising process very well to ensure that you raise the money you want; your timeframe for raising this round is limited. It also means that the time between when your first investor commits to investing and when you get your money can be quite long — it can take months!
Usually, an equity round is kicked off by a “lead investor.” Typically, this lead investor decides the terms of the round and also invests the majority of the money that will go into your company. That lead investor will also usually help you fill out the remainder of your round with other investors. For example, let’s say you find a lead investor for your $1m round. He/she sets the valuation of your company and terms of the round. He/she may then invest say $500k, and he/she may help you find other investors who will make up the remaining $500k.
In the 1990s, your first round of financing was typically a Series A round between $1m-$5m. Expenses were a lot higher just to get a company off the ground, and so even the first round of financing was large. These rounds were typically done as equity rounds and were led by VCs, since so much capital was required. In addition, the legal costs were just a small drop in the bucket compared to these round sizes.
Convertible Notes
In the 2000s, however, the cost to start a software company decreased dramatically. No longer do you need to set up your own servers in your office. No longer do you need to build a lot of tools – many B2B SaaS companies and infrastructure companies can now do all of this for you. So, startups started raising seed rounds — rounds that took place before a series A.
A few years ago, these seed rounds were typically < $500k, and most teams only did one seed round with angel investors — independent rich individuals — before raising a series A round.
Because equity rounds are much more suited for bigger financing rounds and are a slow way of raising money, convertible notes are better suited for raising these smaller seed rounds. It just didn’t make sense to spend 10% of your round on legal costs and have to wait for months before receiving the money when the angel investors writing the checks were open to moving equally as fast as the entrepreneur.
Raising money on a convertible note is fast — you get your money as soon as an investor signs. It’s cheap (there are a lot of convertible note templates on the internet). There is no minimum amount you need to raise in order to get your money.
A convertible note is a simple document that is effectively a loan. People investing on convertible notes would invest money, and in return, receive an IOU for that amount plus some level of interest at the end of some agreed upon time period (typically 1-2 years). In some sense, angels began to act like banks giving entrepreneurs loans.
However, unlike regular debt, convertible notes had a special kicker. Convertible notes allow investors the option of converting the money into stock at the next priced round; investors essentially have the option to get their money back + interest OR receive stock when the company did the next priced round.
Technically speaking, when the maturity date comes around and the startup has not yet raised an equity round, an investor could call the note, which means he/she could ask for his/her money back plus the accrued interest for the duration of the note. What happens if your maturity date comes up and you don’t have the money to pay it back and are not raising an equity round? You can discuss with your investors if they’d be willing to extend the maturity date by a year. This is quite commonly done, so don’t be afraid to ask.
Most Silicon Valley investors won’t call your note when the maturity date arrives. This is because, if you have the cash to pay the note, it must mean that your company is doing well, so an investor would prefer to have equity in your company instead of the debt repaid in cash. If your company is not doing well, you wouldn’t have the money to pay off this debt AND if you do, removing the money could cripple the company. So, calling the note is detrimental in most cases.
Outside of Silicon Valley, there are a lot of investors who don’t care and may call your note on the maturity date. Be careful in choosing your investors — especially if an investor has never invested via a convertible note before.
So let’s say a startup raises an equity round from a big VC after raising a convertible note round. How does an angel investor convert his convertible note into equity? The convertible note specifies the mechanics in which the investor receives shares. Those conversion rules, however, are conditional — the price at which a convertible note converts into equity during a priced round is dependent on the valuation of the equity round. So, when an investor puts money into the company on a convertible note round, he/she doesn’t know how many shares he/she will receive until later. This ambiguity is sometimes a deterrent to investing on a convertible note, especially outside Silicon Valley.
Lastly, because convertible notes are technically debt (even though most investors convert their notes to equity later in priced rounds), it’s unclear what the tax implications are for both investors and companies. At the advice of some accountants, some companies issue 1099s to their investors on the accrued interest — even when they are not paying their investors this accrued interest. Other companies don’t do this because they are not actually paying their investors any money. On the flipside, investors will often pay taxes on this “accrued interest” even though they are not receiving any cash. This is another deterrent to investors investing on a convertible note.
Convertible Securities
As a happy medium, both YC and 500 Startups created Convertible Securities. Convertible securities have properties that are akin to both equity and convertible notes.
Convertible securities, in so many ways, act like convertible notes. Like convertible notes, there is no minimum amount you need to raise to get your money; they are a cheap, free, and limited legal bill; and they can get signed quickly.
BUT, the biggest distinction is that there is no interest rate. Convertible securities are not loans. As a founder, you do not need to worry about investors asking for their money back because there is no maturity date, and investors do not have to pay taxes on any so-called accrued interest.
That said, convertible securities are still new and a lot of investors are unfamiliar with this format of investing. Also, there is still the ambiguity about the price per share at the time of signing, which may make some investors feel uneasy.
All in all, this is probably my favorite format of raising money at the seed stage. More later on the details and nuances of some of this.
I feel so lucky and grateful to have such an amazing family. Juggling our household schedules isn’t easy — especially with all my trips (Asia, Europe, LatAm, Canada, US) in 2016. Those trips are a blast to be able to meet so many amazing driven entrepreneurs, but I realize it’s my family who ends up picking up the slack at home in order for me to do this. I don’t ever forget that or take it for granted.
2. My 500 Startups family
2016 marked my first full year as an investor. I never intended to go into VC. Honestly, I never thought I would work for someone else for so long (just passed my two year mark at 500)! I’ve been fortunate to have had the chance to see, champion, and be a part of so many deals — probably more than most people will see over a lifetime, and it’s been amazing to learn so quickly from those. Most of all, I’ve appreciated having the best team ever. Teams and culture are the lifeblood of any company (including VCs), and it’s teams and culture that make people happy with their work — not compensation and not the day-to-day work itself. I feel lucky to have such a great team.
3. My blog readers
My new year’s resolution for 2016 was to consistently blog at least once a week. In the beginning, I started the blog because writing was cathartic for me and was a way for me to write down what I was advising founders already on a 1:1 basis. I thought that keeping up the blog would be very difficult for me, but in the end, I missed just 4 weeks and ended this year with ~3k email subscribers. Thank you for reading!
4. My Rejectionathon supporters
This year I started a half-day event called Rejectionathon to help entrepreneurs get over their fear of rejection. It took me years to get comfortable with being rejected while I was selling ads for LaunchBit, and so I started this in order to help entrepreneurs develop a thicker skin more quickly. At these Rejectionathons, entrepreneurs would receive a list of challenges and would run around trying to accomplish those challenges. The challenges ranged from really tough tasks such as asking a stranger if he/she could help you figure out if your deodorant is working to easier tasks such as high-fiving a bunch of people in a restaurant or bar. Special thanks to my Rejectionathon co-founder Thea Koullias, whose primary gig is being the CEO/founder at Jon Lou, who has helped me pull this all together.
Goals
These past couple of weeks, I’ve had some time to sit around and think about how I want to change things up in 2017.
A few goals and things I’m looking forward to this year on a professional front:
1. Focusing on earlier stage entrepreneurs
One of the things I’ve seen over the last couple of years is that a lot of seed investors start out investing in idea-stage entrepreneurs but as they build a track record and raise bigger funds, they tend to move downstream and invest more money in later stage seed companies. My own employer 500 Startups is a great example of this. Newer VCs, who don’t yet have a lot of deal flow then fill this void and the cycle repeats itself. Because these investors don’t yet have a brand, entrepreneurs often don’t know they exist, and funding at this “pre-seed” level is very difficult to come-by.
When people say “there are more seed investors” than ever, usually they are talking about the ample seed dollars available for companies who are already thriving and growing. But if you are just starting out and don’t yet have traction, this doesn’t really apply. There are a couple of things that I aim to expand on in 2017 to help with this pre-seed stage and a couple more ideas that I have in the works that I’m not ready to announce yet.
A. Changing Rejectionathon
One of the issues that I see with so many pre-seed entrepreneurs (including myself when I was starting LaunchBit) is that so many people are incredibly timid in approaching activities that could lead to rejection. Founders at this stage often are too afraid to sell products, establish business partnerships, or ask hard questions when fundraising because they are afraid of being rejected. When we go through about 20 years of school, we never once learn how to develop a thicker skin, and yet, it is probably one of the most important skills you can develop in life. This is what we set out to help entrepreneurs with via Rejectionathon.
Being able to get over rejection quickly to build momentum and traction is particularly important for the pre-seed stage because you just don’t have any runway to sit around and lollygag. I’m going to talk more about this in a future blog post, but we are changing the nature of Rejectionathon. It will still be a difficult set of challenges for entrepreneurs to tackle — to help them get over their fear of rejection. But, we’re tweaking things so that it will be directly applicable to their businesses so that they can make progress on their startups while at a Rejectionathon. In addition, in 2017, we tested the Rejectionathon concept domestically, but we plan to roll out more of these worldwide in 2017.
In 2017, I am aiming to blog 3x per week. Don’t worry, it won’t just be me blabbering more. I still plan to only write about 1-2 posts per week with my own thoughts on fundraising. But, towards the end of 2016, I started experimenting with other activities on my blog including “Ask a new investor” which is an interview series to highlight new investors and allow a curated group of entrepreneurs have a remote conference with them. This is still in experimental stages, but the initial feedback from the first one was promising, so I plan to tweak this concept more and continue it in 2017. The goal here is to illuminate more new investors (which is a fundamental problem at the pre-seed stage) and also make it easier for entrepreneurs to approach these people to better understand what they are looking for.
I’m sure many of you have seen this 2×2 matrix before. This way of thinking drives how I structure my life, but it is so easy to fall into the trap of doing activities in #3. This year, I aim to be better at this by doing these things:
A. Ignoring more emails
2016 was the first time I ignored a lot of emails. At first I felt guilty. (I still haven’t written back a whole bunch of people who applied to our seed program in the spring of 2016! :( ) But the reality is that unfortunately, there just isn’t enough time in the day to respond to every email. :(
This has forced me to think about both my professional and personal email differently. I now have more canned responses and automated emails than ever in order to write emails faster. And I’m much more adamant about taking action right away on emails. Either I respond or archive an email. But, I shouldn’t let it sit around. If an email sits around, it means I won’t respond to it ever, and I plan to be more decisive and proactive about that this year.
B. Moving more conversations to email
In addition, I now have gotten comfortable taking more initial conversations with people over email. And then later moving them to phone if it makes sense to hash through the details. A lot of my best mentors are people I’ve primarily talked with over email, and at first I had wondered just how helpful that could be compared to a phone call. But, I’ve come to embrace email as a conversation medium and have learned that this allows both parties to respond whenever it’s convenient — even if it’s at 2am. Phone calls, in contrast, need to be slotted for specific set times and don’t always fluidly work into schedules.
C. Outsourcing
I’ve written a bit before about outsourcing various personal chores. In 2017, I hope to do more of this.
In addition, I’m always interested in playing with new tools to help save time. I’m most interested in tools that can help me respond quicker to emails while on the go. What I would really love is to be able to just quickly send a voice memo as a response to an email. I don’t need a voice-to-text translator — I just want to be able to respond in some format quickly because that’s better than no response.
If you have any tools that help you with productivity, I would love to hear about them!
3. Exercising!
Lastly, I quit exercising for the latter 5 months of the year in 2016 because of my travel schedule. In 2017, I’m going to resume swimming and hope to sign up for 1-2 lake races. I never swam on a team as a kid and took up swimming just a few years ago because it’s a low impact exercise. So I’m still a novice here and have even watched YouTube videos to improve my stroke! In the past, the races in the Bay Area I’ve done and have really liked are the Tri Valley Masters Del Valle Open Water Festival in Livermore and the Splash and Dash Evening Series in the Stevens Creek Reservoir in Cupertino. (The water is warm at both events and the best part is that they have hot dogs and pizza! :) )
Dearelizy: What’s reasonable for a founder salary? For example: I’ve got 13 years of professional experience, an MBA and I have run several of my own businesses.
– Salary Concerns in LA
Dear Salary Concerns: Hmm…lots of thoughts here…
1) Your MBA doesn’t matter here
Sorry. Your MBA is good for negotiating a salary at large companies or even possibly for jobs at other people’s startups but not with yourself and the company you own. When you own such a large equity stake in your own company, you should be looking at the tradeoff between short term gains (your salary) and long term gains (the worth of your company and what it could be with the extra investment of cash that you are not taking as salary).
I understand that you may have paid a pretty penny for your MBA (I certainly did), but hopefully you were able to recoup the cost of it prior to starting this company.
2) There are lots of other considerations
I’ll break these down here:
Location
Although I think you’re in LA, I’ll speak to this more generally. The cost of living will influence your salary a lot. The cost to get a startup up and running in the Bay Area will probably be about 2-5x higher than, say, in Las Vegas. And if you are in Chiang Mai, starting up will probably be 5-10x better economics. So a “reasonable salary” will depend a lot on location.
Your runway
This is tied to how much money you’ve raised and/or how much money you are profitably making. If you have a long runway – say, 18+ months – then I think it’s OK to pay yourself better. But if you are going to run out of money in, say, 3 months, you may not even want to pay yourself anything. If you’ve raised money, you should aim to have at least 12 months of runway, preferably 18-24 months.
Venture backing
If you’re not venture backed, you have more optionality. If your company is set up as a partnership, for example, you may pass through all of your earnings as part of your partnership, effectively removing all cash from the entity. But if you are venture backed, you’ll likely re-invest all profits into the business instead of issuing cash bonuses or higher salaries.
Your equity stake
If you’re a “founder” brought into a startup a bit later and are given, say, 5% of the company (on a vesting schedule), this is very different from being an “original founder” who likely owned 25-50% of the business starting out.
If your equity stake is much more akin to an early employee’s stock plan, then your salary should be what an early employee at a startup earns rather than a founder’s salary.
3) I get it — you really want me to put numbers on this…
But everything I just wrote was vague. It doesn’t help anyone figure out what their actual salary should be. So, here are some rough ranges of founder salaries that are fairly common amongst ventured-backed, seed companies in the San Francisco Bay Area. Unfortunately, I’m not aware of salaries in other markets, so if you’re outside the Bay Area, you’ll need to ask other founders.
Raised < $500k: In this range, a lot of startup founders pay themselves < $50k per year. If you have a team of 4 people, aren’t making any money, and have minimal other expenses, then you can see how this raise can last you 1-2 years to get you to your next milestone. Ramen, baby, ramen.
Raised $500k-$1.5M: In this range, you probably have a slightly bigger team – say, 4-8 people – and some of these later hires are going to be commanding closer to market-rate salaries. On the flip side, you may be generating some revenues to offset costs. Again, shooting to have at least 12 months of runway, a typical founder who has raised in this range but is generating limited revenue is probably paying himself/herself $50k-$75k per year. If you are generating a fair bit of revenue ($1m net runrate), then you might be paid a low 6-figure salary.
Raised $1.5M+: Lastly, if you’ve raised a large seed round, you’re probably a post-seed company indicating that you have significant revenues ($1m net runrate) coming in the door. You are likely paying yourself $75k-$125k at this point.
4) Burn rate is a signal to investors
Your overall burn rate is a signal to investors. It gives them a sense of how seriously you want to invest in the longterm viability of the business as well as how well you manage cash.
If your burn is “too high” per your stage of the business, this could hurt your ability to raise money. Some investors also ask about how much money you are paying yourself and will use that as an indicator of commitment. Here are some other people’s thoughts on founder salaries that I think are spot-on. Post-seed rounds are a bit more akin to series A rounds these days, and so you should adjust your definitions to reflect these responses, which are a couple of years old:
Over the last year or so, I’ve been writing about tactical fundraising to try to help new entrepreneurs with their seed rounds. But, having been there myself, I realize that even with all the help in the world, it’s still really really hard to raise a seed round. Everywhere I go — whether it’s here in the Bay Area or on the road — entrepreneurs tell me that it just takes so much time to connect with investors. Entrepreneurs whom I meet aren’t lazy, but when faced with balancing the needs of a business and spending the time networking with investors, it’s a hard tradeoff.
So, I’m trying a little experiment here on my blog. I’m starting an interview series with new investors — both new VCs and angels. I want to try to connect relevant entrepreneurs with new investors and help new investors get more qualified deal flow and exposure.
We’ll see how this works out, but for the time being, I’ve invited a few active investors to do guest interviews with me in the coming weeks. All of these investors have done at least one seed investment in the last 6 months, but most have done many investments. I want to make sure that all of my guests are actual investors and not just posers or investors who are sitting on the sidelines.
These interviews will be done online but will be highly interactive. I’ll ask questions during the interview, but I also expect attendees (entrepreneurs) to bring their own questions. This means that the attendees will be highly curated. In order to attend, entrepreneurs will need to fill out a quick application form, and I’ll pick entrepreneurs who are a good fit to join me in a conversation with my guests. And I’ll share those applications with my investor guests as well as with 500 Startups. If there are more qualified applicants than slots, first priority will go to my newsletter subscribers. Afterwards, I’ll publish the interviews to the public on my blog.
I’m pleased to announce my first guests. They are the founders of a new VC firm called SoGal Ventures, Pocket Sun and Ellie Galbut. They run the same firm but cover slightly different areas, so I’ll be interviewing them separately.
About Pocket (from the SoGal website)
Pocket Sun founded SoGal, one of world’s largest communities of diverse entrepreneurs with 10 chapters worldwide. She has advised on dozens of startups across Los Angeles, Silicon Valley, China, and Southeast Asia. She was on the cover of Forbes Asia as a 30 Under 30 in Venture Capital, a LinkedIn Top Voices in VC & Entrepreneurship, and was featured on BBC, CCTV, Inc., The Straits Times, Harper’s BAZAAR, etc.
Born and raised in China, Pocket is bicultural and bilingual. She holds a Master of Science degree in Entrepreneurship and Innovation from University of Southern California, and a Bachelor of Business Administration degree from College of William & Mary.
Pocket will be joining me on Tues 12/6 at 9pm PT and in her words, invests in:
Smart Hardware
Next-gen Consumer Tech
AI-powered Enterprise Tech
Diverse Founders
Teams based in Asia
Pre-Seed/Seed Stage
About Elizabeth
Elizabeth Galbut is a venture capitalist and business designer. Prior to finishing business school, she founded A-Level Capital, the first student-led venture capital firm powered by Johns Hopkins students. Prior to graduate school, Elizabeth was a strategy & operations consultant at Deloitte Consulting focusing on large healthcare clients. Outside of her client-facing work, she contributed to business development efforts that led to over $200M of new work.
Elizabeth holds a MBA/MA Design Leadership Dual degree from Johns Hopkins University and Maryland Institute college of Art. She is also a proud alumnus of Georgetown University and London School of Economics.
Ellie will be joining me on 12/13, tentatively at 1pm PT and in her words, invests in:
Health Tech
Next-gen Consumer Tech
AI-powered Enterprise Tech
Diverse Founders
Teams based in the US
Pre-Seed/Seed Stage
Ellie also separately also invests on behalf of A Level Capital, which is a VC firm for Johns Hopkins students and recent alums. And, she’ll be looking at relevant deals for that fund as well.
To apply to join one of their interviews, please fill this out below:
When I was an entrepreneur, it never crossed my mind to wonder how VCs measure their success — but I should have thought about it. Following the money can really help illuminate VC behavior and their incentives.
The #1 problem with the venture capital game, in general, is that actual success is measured over decades, not years. It means that investors will not know if they are any good at investing for decades. Any investor who tells you otherwise is BSing you.
So, as an entrepreneur, you might be pitching to people who may not even be good investors. I’ll be the first to admit that I don’t know if I’m a good investor or not, and realistically, I won’t know for at least another decade when I see how all my investments shake out. It takes a long time to see the results of a startup that does well.
This means that in order to measure milestones along the way, investors must come up with proxies for success. This is necessary but far from perfect.
So while I’m waiting for my portfolio companies to either die or go IPO, what am I looking at as indicators of success and failure? Primarily these things:
Companies dissolving
Companies exiting
Companies raising equity rounds
All of these are concrete events that attach a numerical value to a company. Obviously, when a company dissolves, it’s typically worth $0 (in most cases, there are no sellable assets).
Companies that exit are valued at whatever the sale is. If it’s an all-cash deal, it is easy to understand, and the value is what it is. If a company sells for stock or partial-stock, then it’s more complicated, depending on whether the acquirer is a public company or a private company, and we don’t need to dive into that in this post.
And, lastly, when companies raise an equity round, there is another investor who has (in theory) done due diligence and assessed that a company is worth a certain amount. But as we’ve seen, these valuations can be hocus-pocus — even at later stage rounds, we’ve seen lots of companies of late fall from grace and become massively devalued overnight when they cannot raise their next round at a higher valuation. If a company raises a good round, it gets marked up to the new value. If a company takes a down-round, it gets marked down.
But what if a company is growing revenues but hasn’t raised a round in a while? Shouldn’t they get a bump up in valuation? Intuitively, you might think, “Yes! They are now worth more than before.” But let’s say we have a company that raised a convertible note round at $3m cap 12 months ago. At that time, they had no revenue, and now they are doing a $500k revenue run rate. When people invested in that round, there was an inherent assumption that the company would make money at some point and that the expected value of the company over its lifetime would be $3m. That’s what that valuation means (in theory): how much the company is expected to be worth over its life. Otherwise, there is no way investors would ever value companies that are making no money at $3m. So, now that the company is doing $500k run rate, should the valuation go up? Well, maybe not. After all, we expected them to make $3m over their lifetime — this was already baked into the prior valuation. Many investors would choose NOT to mark up the company at this point even though they are making more money. (For those who want a more sophisticated read on this, I highly recommend Scott Kupor’s post on valuations. However, these other methods do not apply particularly well to early stage investing, in my opinion.)
Now let’s say we have two portfolios of companies.
Portfolio 1:
3 companies
Last valuation for all: $3m cap convertible note
Recent raise: $1m for each company. Equity rounds of $10m pre.
Traction at last raise: None have revenue.
Current traction: None have revenue
Portfolio 2:
3 companies
Last valuation for all: $3m cap convertible note
Recent raise: none.
Traction at last raise: None have revenue.
Current traction: All are doing a $1m run rate
For simplicity, let’s say all companies in both portfolios are in the same industry so that we can compare apples to apples. You and I might say, “Wow. Portfolio #2 is crushing it. These founders are really selling.”
But at a VC firm, we would mark up the companies in portfolio #1 because they have all raised equity rounds at $10m pre. Portfolio #2 hasn’t, and for the reasons above, we would not mark them up even though they are making money. Interesting…
Now, let’s take this a step further. A common intermediary milestone for most investors is IRR (internal rate of return) of the fund. This is calculated based on the events above. Dissolutions and cash-exits are accurate representations of a company’s value, but most events tend to be fundraising events since dissolutions and exits only happen once in a company’s lifetime. So, there are a lot of unrealized gains built into the IRR of an early fund. Furthermore, we’ve established that companies don’t get credit for revenue — this does not get factored into IRR calculations. IRR calculations are based on two things: changes in a company’s value and the time-scale on which this happens. So, one way to maximize your IRR is if you have a portfolio of companies who are able to raise quickly and frequently and at higher and higher valuations. In many cases, companies that can achieve this are typically also making a lot of money (hopefully profitably), but this isn’t necessarily true. Also, think about the flip side. Companies that are making a lot of money profitably and don’t raise do not help an investor increase the IRR of his/her portfolio.
Let’s take this one step further. Typically, VCs raise a fund every three years. Investors in VC funds — referred to as Limited Partners (LPs) — look at a number of factors in deciding whether to invest in a VC firm, but the IRR of past funds is an important criteria.
Putting this all together:
1. VCs are incentivized to bring in portfolio companies who can boost their portfolio IRR quickly. This helps them raise their next fund. This is what keeps investors in business — raising fund after fund.
2. VCs mark up portfolio companies when they raise money at higher valuations, and these markups get factored into IRR. Company progress on KPIs, including revenue, typically do not get factored into IRR.
3. Therefore, VCs are incentivized, in the short term, to invest in companies that can raise their next round relatively quickly. This is easier for investors to achieve when they pick companies that:
This is why investors like it when startups think about growing fast to raise the next round (as opposed to getting to profitability and growing more slowly on profits). This is why investors don’t want to hear about entrepreneurs selling early (sub $1B businesses). Obviously, in the long-term, investors do care about the actual outcomes of its portfolio companies because ultimately, that is what matters. Since that is so far off, however, this explanation should hopefully illuminate how the VC industry views the short-term — and you should care because VC incentives explain so much about why VCs act the way they do.
Tactical fundraising by Elizabeth Yin 
