152. Cram Session, Episodes 96-103 (Nick Moran)

The Full Ratchet Cram Peter Boyce David Verrill Lindel Eakman

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Welcome back to TFR for another Cram Session. In these special releases, we have aggregated the takeaways and tips from previous episodes. In this installment, we will be recapping the following episodes:

Transcribed with AI:

welcome to the podcast about investing in startups, where existing investors can learn how to get the best deal possible. And those that have never before invested in startups can learn the keys to success from the venture experts. Your host is Nick Moran, and this is the full ratchet.

Welcome back to TFR for another cram session. In these special releases, we have aggregated the takeaways and tips from previous episodes. If you’d like a focus refresher on previous topics covered, stay tuned for this cram session.

Coming up next are the takeaways and tips from the episode student focused VC funds with Peter boys the second awesome time there with Peter discussing student focused VC funds. Peter is just a super generous guy. So if you’re related to this topic in any way, I’d highly encourage you to connect with him. All right, let’s

recap the key takeaways. Takeaway number one is called growth drivers of student focus funds and student entrepreneurship. So Peter and I discussed how universities are increasingly playing a role in supporting entrepreneurs, where historically that has not been the case. Let’s go through some of those factors that are influencing this growth. First, Peter talks about the increase in entrepreneurship focused classes. He also talked about the rise of computer science. Then we discussed how innovation such as AWS, GitHub, and Stripe, have all significantly reduced the cost of starting up and getting products into the hands of customers. We talked about developments around University infrastructure, allocating more support, money, classes, and space for startups. Peter also mentioned how there were students that were increasingly trying to understand what are the sources of capital? Where can we find mentors? And how can we connect with VCs. He cited the increase in content that’s available to help entrepreneurs navigate what it means to start a company. He talked about the resources that are unique to universities that make them advantageous to starting a company. We also discussed the outlier success of companies that have come out of universities, some big names startups that have achieved significant success, which has driven even more students to become entrepreneurs. And the final point that we reviewed had to do with the alumni network, and the support that this network has given through angel investment, mentoring, advising, and how this has always been the case. But more recently, these folks have further organized into angel groups, and even created funds to help in a more systematic way. Okay, key takeaway number two is called process in mechanics of the student fund model. Peter and I reviewed how this all works for rough draft and how they work with the students to get these startups funded. First, Peter talks about how students are really the core of the program. This is not as investor driven as traditional VC firms. Rough Draft will recruit the student leaders that become representatives for them on campus. Those student leaders may be running clubs, hackathons, informal social events, and have already been identifying companies that are great on campus. And then after a rough draft recruits those leaders, they meet with them every Monday. And those student leaders will invite the best two to three startups to pitch. And throughout this process, they move very fast. The student team and the folks from rough draft will make a decision on the same day of the pitch. And they will invest up to 25k. And in certain cases, they’ve partnered with first rounds dorm room fund when the startup needed up to 50k to reach the next milestone. And all of these are done on notes and the notes are uncapped. Okay. The third and final takeaway is called major learnings from going through the process, Peter talked about a number of things that they’ve learned and insights that they’ve gained from executing this strategy. The first point was that one of the best ways to get people together from varying schools and get their enthusiasm and engagement up around startups was to host more offline opportunities. These allow people to get together in a low stakes, non transactional sort of weigh. And many of these offline events are inclusive of all schools, which allows more people to be brought together in a more social environment first, before ever considering working together to Peter, this feels like the right order of operations. Get to know people before you decide to work together. Another side benefit that Peter cited of this entire process is that they get exposed to what’s in vogue on the college campuses. Many of us who are no longer You’re in our early 20s cannot pretend to be what’s hot in tech amongst today’s young people. This whole effort gives a rough draft unique insight into what’s going on on college campuses. Another point that Peter discussed was that when he was initially considering this effort, they feared that a lot of the best CS talent might just go to grad school, they might quit the startup and decide to get a masters. Yet, they’ve actually seen the opposite. Many strong teams have persisted with the startup despite great internship job and advanced degree opportunities. And the final major learning that Peter articulated, had to do with the speed that some companies reached success, the team at rough draft did not anticipate how quickly some of these companies could accelerate to the next level, he never imagined that they would make a 25k investment and have a team raised one to $2 million a month later. While I imagine there are many of these startups that don’t pan out and have their issues where we there are others that are capable, and have the right formula for success. And that’s a great transition to our tip of the week. And this week’s tip is called vote early vote often. With a tip like this, you may expect that I’ll try to say something clever about the unprecedented political race for the US presidency. But no, this is not a show about politics, even if I’m borrowing a political phrase. The reason for the title relates to the Student Focus initiatives and the long term value that they may drive. There are a few things that we’ve heard over and over again on the show, an investor who identifies a phenomenal team working on the wrong problem. And in many of these cases, the investor chooses to pass, but others have talked about how they’ve made small bets early not on the idea, but on the people. Others have become advisors for the startups, helping them fail fast or prove them wrong. In each of these cases, the investors see some remarkable ingredients for success. Maybe the entire recipe doesn’t make sense. But the key elements, namely the founding team, causes the investor to vote with their time or their money. Another situation we often hear about on the show has to do with the strength of relationships. Some investors are completely passive, providing no value beyond easy money. They throw 100k in to top off around, and the startup never hears from them again. Other investors are very hands on, as we discussed in episodes 55 and 56. With John great house from ring con Venture Partners. This group gets very involved very early and builds a trusting relationship with the entrepreneur. Both totally different strategies with their own merit. But as we can see from today’s discussion, there is tremendous value in making early bets on great people. Peter votes with his time and with money. He gets involved mentoring and coaching the student leadership team and the startups they’re investing in. He builds relationships, not transactional in nature, rather those that can only be forged through good times and bad. If one of these startups achieves success, what investors are they going to want to work with at Series A, if the startup fails, but the founding team learns from it, and goes on to build something remarkable? Who do you think they call first? My bet is on Peter boys and the team at General catalyst. With entrepreneurs rough draft votes early and votes often, they embed themselves into the founders story from the beginning. Peter also talks about startups that they review at General catalyst, those that are much further along where many more chapters have been written. But for those funded through the student fund, rough draft isn’t just reading the early chapters, they are helping to write them.

Coming up next on that takeaways and tips from the episode public policy for angel investors with David Verrill.

It was a big thrill to have David here on the program. Let’s recap the key takeaways from the interview. The three takeaways that we will review we’ll recap the top three priorities of the ACA. They were the capital gains exemption for small businesses, the issues with regards to the Jobs Act and the accredited investor definition. Let’s start with number one, the capital gains exemption. This was part of the American Taxpayer Relief Act. And it refers to a qualified small business tax exemption. Those that invest in a company that is a C Corp can get As tax exemption if they hold the company’s equity for five years, in the event of an exit section 1202 provides a 100% capital gains tax exclusion. This percentage has changed over the past five years. But for now, it’s 100% going forward, and an investor just needs to make sure that a company is subject to Q SBS treatment in the term sheet. With the two primary issues being that as the C Corp and it’s held for five years. The ACA is effort has been trying to get this holding period down from five years to three years. And they’ve also been trying to get the same treatment for LLCs that currently exists for C corpse. And recall from the interview with de Berkus, that the clock does not start until debt is converted into equity in the case of a convertible. So if you do a convertible note, that five year clock is not going to start until there’s an equity financing round. And the last tip that David gave us is that this also passes through to funds, whether it’s an individual investment or one done through a fund, as is the case with hub angels. Okay, key takeaway number two is called issues related to the Jobs Act. The major problem here is that general solicitation had had an unclear definition. This is when an entrepreneur is publicizing their fundraise. Remember that if a founder solicits, then they are subject to special filings, and also must verify the financial accreditation of each individual investor. And David and I discussed the haloes Act, which exempts a business plan contest or a demo day from this general solicitation issue. This haloes Act was passed by the House, but it still needs to go through the Senate. So it is not currently active. And there were five criteria that we talked through that must be met for one of these gatherings to be considered a demo day and exempt from the general solicitation. Number one is this event has to be sponsored by federal, state or local governments, a university, a nonprofit, an angel group, or a venture forum. Also, the advertising cannot refer to any specific offering or securities by the issuer. Item three is that the host organization doesn’t make investment recommendations or provide any investment advice. Number four is that the host organization does not receive compensation for the event, which would require registration as a broker dealer or an investment advisor. And finally, number five is that no specific information regarding a securities offering is communicated. However, on this point, the bill does say that the following can be disclosed. First, that the issuer is in the process of offering securities or planning to offer securities, they can also reveal the amount of securities being offered that have already been subscribed for. And finally, they can talk about the intended use of the proceeds for the offering. You know, from my standpoint, these allowances keep the situation a bit unclear. On one hand, the Act says that no specific info regarding the offering can be communicated. On the other hand, it says that a startup can disclose that they are raising the type of amount of securities, what’s been invested to date, and the use of the proceeds. Those to me sound like details of the fundraise. So for now, I think we should wait until the halos Act is passed, and then get clear direction on what details can be revealed and what cannot. Okay, and key takeaway number three had to do with the accreditation definition. David talked about how under Dodd Frank, the SEC must review the accredited investor definition every four years. And the SEC has been late in deciding this since 2014, when they were scheduled to conduct the review. And recall that an accredited investor must have either a 200k of income or 300k of income with their spouse, or be a million dollars of net worth excluding their primary residence. When this issue was raised in 2014, the SEC considered doubling the accreditation requirements. But this would have eliminated over 60% of the angel investors in the United States. There are about 400,000 active angels in the US, more than half of which would not meet these requirements. Fortunately, through David’s and the ACA is efforts, the conversation went from reducing the number of angels to keeping it the same to potentially increasing the number of angel investors by expanding the accreditation definition with a measure of sophistication. Those with the wherewithal, if not the income requirements, could also Angel invest. And the final point that David wanted to make related to some of the priorities for the ACA had to do with the 99 Investor rule. Currently, in any deal or in any fund, there’s a cap on the total number of investors that can participate. And that cap is 99 individuals. The ACA has been trying to expand that number so that more individuals can participate in an SPV for a single investment or a fund.

Okay, let’s wrap up with a tip of the week and this week’s tip is called dumb money breeds lazy behavior. In today’s interview, David warned about the potential hazards of crowdfunding. His take is that startup investing is a very risky asset class, one where experienced angels can lose a lot of money. It requires experience sophistication, due diligence, and organized strategy to access and invest in the best entrepreneurs. And it’s just a lot of hard work. While he supports new money being invested in startups, his concern is that these investors may not know how to protect themselves in a specific investment, and also from fraudulent actors selling the dream of the next Tech unicorn. And when a class action lawsuit occurs related to crowdfunding, it will also disparage the angel investing asset class, I share David’s concern, but for today’s tip, I want to consider the effect of dumb money on founders. Examples like crowdfunding for equity don’t just adversely impact those deploying capital, but also those that are raising capital. As I see it, there are three types of dumb money, money that’s too early, too much or from bad sources. First, let’s talk about money. That’s too early. Often inexperienced investors are quick to pull the trigger on big ideas. But therein lies the problem. These are ideas not viable businesses. And when a first time entrepreneur takes money at the idea stage, their risk is removed. Many will find out that the idea is unrealistic. The problem doesn’t exist, the customers aren’t interested in their solution. Or worse yet, the founder their self isn’t passionate about the business. Sometimes the best thing an investor can do for a founder is just say no. Founders can learn much about themselves and their businesses in the early days without external financing. Okay, let’s talk about the second type of dumb money, which is too much money. In my first year of angel investing, I cut a check for 50k to an early stage company that had just launched. They closed a total of $300,000 from a small syndicate of angels, and commenced an aggressive marketing campaign. Four months later, the money was gone in their only major learning, these marketing channels aren’t going to work. They hadn’t tested a range of traction channels and found the avenues to double down on. Rather they tripled down on a hypothesis and now had nothing to show for it. Now 300k Doesn’t seem like a lot of money. But it was both too early and too much. They didn’t need 300k to throw at marketing. They didn’t even have a strategy with a set of KPIs to measure against. Look, sometimes a big infusion of capital is just what a company needs to reach the next level. But in many cases, too much money drives lazy behavior. With this startup have blown 300k of their own money on ineffective marketing. Likely not, they would have found the channels that drive the most ROI for their time and money, which is ultimately what they did once their cash reserve was gone. And finally, the third category of dumb money is from bad sources. This is the one that bothers me. Most founders want the quickest path to capital, and I can’t blame them for that. But at times this results in raising from the wrong folks at the wrong set of terms. Or instead of raising the money themselves. They hire a broker dealer known to take up to 10% of the total capital raised to fundraise for them. I understand that we all can’t be experts in the fundraise process. But finding an advisor is a much better path than outsourcing completely. And does one really believe they’re going to get smart capital from top tier investors when they use a broker dealer who’s shopping it around to anyone and everyone. These folks have their own best interests in mind, not the entrepreneurs. Be careful when incentives aren’t aligned. And of course, you also have the party rounds, lots of checks in small amounts from no strategic or professional leader. This happens in the angel ranks and is certain to occur with equity crowdfunding, with no leadership representing the group who is responsible for protecting them, who will build a relationship with the entrepreneur and help them Through the growth phase, no one. And if the entrepreneur achieved success in spite of their suspect investors, then they may have to deal with messy cap tables and or extraneous reporting requirements when speaking with series A investors altogether not a good situation. While more money into more startups is a good thing, let’s not lose sight of what’s really important. Real companies building real value. And sometimes money can get in the way of what’s really important. All money is not smart money, and dumb money breeds lazy behavior.

Coming up next are the takeaways and tips from the episode The limited partner with Windell Ekman, such a huge pleasure for me to have the opportunity to speak with Lindell. Let’s recap key takeaways from the interview. key takeaway number one is called types of LPs. Of course, in the LP environment, we usually classify them as retail and or institutions. First, let’s talk about retail investors. These are high net worth individuals investing their own capital. And this includes just individuals and family offices, family offices, of course being high net worth individuals that employ professionals to help them allocate their capital and invest across different asset classes. The second category was institutional investors. These are large pools of capital with professional staff, long time horizons and commitments at the asset class level. This includes University endowments, pension funds, both public and private insurance companies, collective vehicles, these Oh CIOs, the outsourced CIO institutions, that Lyndell said acts like an outsourced endowment staff, which manage groups of smaller endowments delivering some benefits of scale. And finally fund of funds. Much like founder group next where LPS invest in the FG next fund, and then Lyndell uses that capital to invest in up and coming VC funds. Okay, key takeaway number two is called the six categories required for investing in a VC fund manager. Lindell talked about his six major items that he looks for in every GP that pitches to him. Number one was a sourcing advantage. How will the VC fund manager be able to source better deals than other funds? Number two was internal team dynamics. How are the interactions and interrelationships between the general partners? Number three was a strategy of portfolio construction? Does the font size reflect the strategy? Does the manager understand how to build a portfolio and hold themselves accountable to it? Number four was performance. Is there a track record? And how have previous investments performed? Number five was external relationships? How is their external relationship with other LPs and GPS? What kind of partner are there? Is there overlap with foundry? Do they know how to act on a board of directors? And in this case, can the LP boundary group do direct investments together? And do they want that direct involvement? And finally Lindal six point was on legal terms, does the limited partner agreement include some non starters. And finally, Lindal concluded by saying that at a high level, he’s just looking for a cogent plan of how the fund manager is going to build their business. And even if it’s not an immediate fit, he likes to maintain and build a relationship over time to see if that fit develops for the next fund that the manager raises. And key takeaway number three is called issues and challenges with limited partners. lindo called out a number of the challenges that he’s seen in the limited partner community and the way that they invest, the first of which was gatekeepers, especially with the large LPS out there, there can be a number of consultants and service providers that function as gatekeepers. The next area that he cited was around process and timing. Slow decisions with a longer process at multiple levels of LP organizations create a lot of friction and lack of ability to move forward in an expedient manner. The next item he cited he called D versification. This is where many LPS have over diversified, which limits their ability to outperform, as returns regress to the mean. Next was compensation. These professionals in the LP community in some cases may be managing $15 billion portfolios or greater. Lindell talks about his team of five I bet you TIMCO managing $5 billion, which is a billion dollars per person. So while their efforts have substantial impact, with significant levels of assets managed, these professionals are often grossly underpaid. The next item Lyndell talked about was the denominator effect of market fluctuations. So as the assets under management move up or down, the allocation to different asset classes must be forced corrected to keep the percentage the same. This can be really challenging, especially when a small percentage of a portfolio at one of these institutional LPS is allocated to venture capital. With huge swings in the market, the venture capital allocation percentage can swing wildly in relation to the target percentage initially set out. And with venture capital, it’s very difficult to get money out once you’ve committed it. So in these cases where the allocation needs to be adjusted down, the only lever that the LP has is to stop making new fund commitments. And Linda’s final point here was on misaligned incentives. Lindell talked about how LPS aren’t rewarded for risk, they’re rewarded for IBM stocks. This has created an environment of misaligned incentives where LPS can’t take the kind of risk they’re required to to meet their return expectations. Okay, that wraps up our key takeaways. We’ll move on to the tip of the week and this week’s tip is called Access is everything. In the recent interview where Colin Keeley interviewed me, he asked me for the most important lesson I’ve learned after 100 episodes and three years of investing, and my answer was access. In today’s interview, Lindell also cited the value of access in his list of six things he’s looking for in a VC fund manager. Number one was a sourcing advantage. How will the GP source and close better deals than other funds? What is their differentiation that provides them that sourcing advantage? While Lyndell values the relationship he builds with first time fund managers out imagine even the best relationships don’t result in investment when no sourcing advantage exists. Just the other night, I was out to dinner with some friends. And the guy sitting next to me, who I was meeting for the first time, was proudly speaking of his investment in a Blackstone fund. He spoke as if he had some superior selection strategy, yet any of us have access to the public fund he was describing. I kept my thoughts to myself then, but I will share them now that Blackstone fund that anyone can get in is not the one the best investors get in. Those funds are close to the individual retail investor. Only large institutions with big cheque sizes and standing relationships will get an allocation in the best private equity and hedge fund products. And this access limitation exists across investment classes. Rarely can the no value add investor get into the best investments. This is likely why the vast majority of high net worth retail investors in the states have never invested in venture capital. They can’t get access to the best returning funds, ie the sequoias and excels of the world. They don’t have a big enough check size to get in with the medium sized solid returners, and they wouldn’t even know where to begin with trying to select emerging fund managers. Those that have the best access, move up the food chain quickly and attract larger professional capital. But Lyndell is making investments in first time fund managers. He’s not even attempting to access Sequoia, he’s looking for the next Sequoia were at least the seedlings of it. By betting earlier on first timers, he can access the most innovative minds in venture at a much smaller check size. And when a GP has success, Linda will likely have the opportunity to continue investing in future funds. In a way he’s buying an option. As an investor in both Union Square and founder groups first funds, Lindell identified some rising stars in the industry, and he rose with them. A similar parallel exists with seed investors and the startups they invest in. If one makes an early bet and gets a pro rata, they can continue investing for the lifecycle of that business and ride the wave with them. So for all the investors out there, how do you think about access? Who do you partner with that has a sourcing advantage? Is your method for finding and closing startups unique? If so, there are LPS like Lindell that are looking for you

With that will conclude this cram session installment. Jump on the TFR website at full ratchet.net today to sign up for the newsletter, and receive all the info on special content, episodes, and the best articles written on startups every week. Until next time, over prepare, choose carefully and invest confidently. We’ll see you next time.