What I’ve Learned About Venture Funding

VC funding.

Our perspectives on the topic wax and wane with market cycles. We love capital efficiency until we love land grabs until we abhor “over funding” until we get huge distribution & ring the bell for more funding until we attract every non-VC on the planet to invest in startups until it crashes and we start the cycle all over again none the wiser. Amnesia sets in and we get back on the merry-go-round for the next cycle.

I saw this great image on Twitter courtesy of Simon Wardley, CC3.0 by SA. (blog here). It’s kind of a truism for life and certainly our industry. I see it in many newer VCs. They enter the industry knowing that they know nothing. Same as I felt. If one entered between 2009–2015 he or she is no doubt in the “hazard” phase where one need to be careful about thinking he know more about the industry than perhaps he do. We’ve had just one market since then and it could confuse one into thinking:

• every deal finds downstream investors,
• every company good or bad finds a home or soft landing (“there’s no downside, people would buy this for the IP alone”)
• you know anything at all about brazil, india, china or even saas sales, ecommerce or analytics (you know all these in a bull market)
• the more money you give a startup the faster they grow

I think I’m at the expert stage of venture capital and I mean in the Wardley sense. The longer I do this the more humbled I become. Not the kind of false, humblebrag, “I’m always ready to learn” kind of humble but the “who the fuck knows” and “G-d I hope I’m right” sort of humble. One of the most successful investors I know said privately to me, “Honestly, I’m just so paranoid that everything I knew from the last 5 years no longer applies and that I could become irrelevant overnight.”

I know what I know. I have strong opinions. But I know what I don’t know.

Here’s what I believe, but won’t claim to “know” because every time I think I know something the market seems to do something entirely different. Either lemming behavior is taking over or I’m out to lunch. We’ll see in time.

1. Too much money too early often fucks companies up
Everyone I know is raising 10 these days. And by “everyone” I mean many startups that are SUPER early in their company trajectories and ordinarily would be raising $3–5 million. No — I’m not talking about YOU — everybody is doing it. I know we spoke about it this week so it sounds like I’m talking to you. But that would be 4 companies just this week. Literally. In Fred Wilson parlance, I’m not “aiming this blog post” at you.

10 is the new 3. And yes, I mean $10 million. My friend in the Valley said to me, “$10 on $50 is the new Silicon Valley A round.”

Well. Not new. The industry did that in 2007. Until it didn’t.

“Well, do you guys do that?” says dumb, LA-based investor with “only” a $300m fund that can’t afford to play that game.

“You sort of have to in order to play in the best deals. With perfect information and too much competition you pay up or they walk right down the street and get it from somebody else.” I guess these are the luxuries of the $1bn Silicon Valley VC funds and it’s hard to bet against them since the top ones have consistently delivered returns over the decades. You get into one FB, Twitter, Palantir and that pays off pretty quickly.

I believe firmly in capital efficiency in the early days of a startup. It forces innovation. It forces the founder to spend time in front of customers. It forces teams not to expand too quickly. I know it’s easier said than done when capital is floating around and feels like it will ease up everything. I don’t blame you for taking more than you need. But if you take $10 on $30, $40 or even $50 G-d help you if you need to raise your next round and haven’t demonstrated amazing traction or you raise after the next correction. You are building a one-option startup. And I can tell you that almost certainly you will spend your money inefficiently.

2. Too much money right after you hit your stride fucks companies up
The next big problem I’ve seen with funding is companies that hit their early stride after raising their $2–3 million seed round and have enough “mo” to raise their $10 million round. But sometimes “mo” is “faux” and then … G-d help you. You take your new-found dollars and you ramp up your Facebook ads (it’s much easier than being scrappy). You want to show huge traction quickly so you can raise your $25 million round to keep up with the Joneses.

You hire too quickly. You grow from 8 to 45 people over night. Your culture suffers. Your processes creak. Your CAC stinks. Your pilots don’t all covert. And if you’re lucky and hit product/market fit straight out of the gate — awesome. But if you don’t — now you have many cynical VCs lining up critiquing your CAC/LTV ratios, your churn rates, your poor performing cohorts. And then the smell forces panic, job cuts, belt-tightening, inside rounds and buckling down to prove your worth.

The funny thing about “too much money” is that it doesn’t just come from entrepreneurs. I’ve seen many a VC firm argue that “if we give them $10 million then they will massively pull away from competition and we crowd out the market.” I’m not so sure.

I’ve seen one entrepreneur recently who did amazing things on no capital, raised a 10-ish million round and suddenly with a loose belt lost control of his business and nearly went bankrupt before cutting costs massively and is suddenly showing massive innovation and creativity again now that he realizes nobody would fund him with his losses. I don’t know if he’s survive (living month-to-month now) but I’m certainly rooting for him. It’s an amazing transformation to see.

3. Money when you find product / market fit is an extreme differentiator
And now irony sets in and I do a head check on the chart above. I know in my bones that there is a magic moment where capital plays a hugely differentiating role. As in back-up-the-truck, load on $20–30 million and let me blast the market with all I’ve got.

I’ve seen it.

I’ve seen companies who raise the mega round after they’ve truly started to scale and put scale on steroids. I’ve seen the companies that had they not raised the big round would have evaporated. I’ve seen companies who avoided the big round and then struggled without enough resources to ship products on time and then missed market opportunities and sold in mediocre outcomes as others sailed by them.

How can it be that over-funding is bad, bad, bad and then the best possible outcome and what is the inflection point? It’s subjective. I know many inexperienced market prognosticators (see chart above) claim “VC is dead,” “capital is a commodity,” “crowd-source to the finish line” or “stay lean for life” but I’ve seen directly just how much capital can separate the winners from the losers when raised at the right time.

4. Overfunding after you’ve raised your growth round to achieve “winner take most” prize puts you in serious jeopardy of fucking things up
So by my logic. Overfunding early is bad. Overfunding just after you find your swim lane is bad. Overfunding after product / market fit is essential to competing and winning.

Straightforward. Right?

Now the AP class. The mega round that follows true growth rounds will devastate many companies. Not all will be affected but certainly many will. How could that be? If the company raised it’s growth round and achieved product / market fit — wouldn’t a huge war chest be even better?

The market clearly believes that. I’m willing to play the long game and say, “check back with me in 3–5 years and let’s discuss what happened.”

Companies that are raising greatly in excess of their economic worth in today’s financial metrics had better absolutely grow into their valuations over time or hope they’re acquired before the music stops and the band goes home. Our market is simply back-logged with companies that will never go public any time soon, that are far too expensive for most buyers to take out and who feel very good on paper but have painted themselves into a corner.

Some will get out. They’ll play the long game and build great companies over the next 5–7 years and grow into their bodies. Many won’t. Founders who took mega bucks off the table already may not want to stick around beyond today’s salad days. We’ll see. But the smart money I know are already pointing out the huge chasm between private-market late stage valuations and public ones based more on rationality.

So.

What do I know about venture?

I’m not totally sure. I’ll tell you if my hypotheses — these and others — proved correct on my 50th birthday. April 30th, 2018. For now I just seek continued advise from the sages who have seen this all before and decided to drink water instead of tequila.