185. “Blessed” Teams, Pseudo Deal Leads, and Caps at Pre vs Post (Ash Rust)

Nick Moran Angel List

Ash Rust of Sterling Road joins Nick to discuss “Blessed” Teams, Pseudo Deal Leads, and Caps at Pre vs Post. In this episode, we cover:

  • His beginnings in tech and how that led to starting the fund.
  • What’s the investment thesis at Sterling Road?
  • What’s unique about your approach that other firms aren’t doing?
  • Something that I think is frustrating for many founders is seeing these idealistic stories of founders that are raising $5M on a $20M cap with zero traction. And, it’s also misleading in that I have a number of founders that think they need to be raising a lot more than they are… very early on before indications of product fit or even a focused commercial plan. Can you talk about the profile of these teams that are able to raise seemingly irrational seed rounds and then later let’s jump into consequences.
  • The seed round has now divided into a series of phases… we have pre-seed, seed, mango seed, seed+, seed extensions, etc. We’ve spoken to Semil Shah about this and how it’s no longer a stage it’s a series of phases and gates. Can you talk about these phases and how founders should think about milestones and raise amounts prior to raising an A?
  • At New Stack we’ve encountered some strange and troubling circumstances regarding who the lead investor is on a deal and who is not. What are you seeing in terms of who takes the lead and how has that evolved over the past few years?
  • Pro Rata has always been a hot button issue, for a variety of reasons and we’re seeing some new challenges emerge as our portcos are raising up-rounds. What are the key issues you’re observing with pro rata and what’s your opinion on how it should be handled?
  • A number of my founders are either raising more in their seed round or trying to pull-in and raise their A rounds before their ready b/c everyone is sounding the alarms about an impending recession… raise the money now, before it dries up. This seems curious and a bit misleading from my standpoint… What are your thoughts on founders raising more money or raising sooner because of a potential recession?
  • I’ve been getting a number of pitch decks from so-called “CFOs” at startups… yet, upon review of a LinkedIN profile, it’s pretty clear that these folks are bankers. Are you seeing the same and what are your thoughts?
  • I think it was about eight months ago that YC changed its SAFE to a post-money cap, instead of a pre-money cap. They claimed to have the right intentions when they made the switch but we were immediately suspect for a few obvious reasons, some less so. Talk about about SAFEs as an investment instrument and your thoughts on the switch to post money caps.

Guest Links:

Key Takeaways:

  1. Founders can improve exponentially with the right coaching, therefore Ash prefers to spend a minimum of 3 months with his founders before writing any checks. This time period helps demonstrate whether the founder is resilient enough to build a multi million dollar company, which is impossible to measure in a 1 hour meeting.
  2. Ash states that “investments are relationships without divorce.” At early stages when you are primarily investing in the team, the more time you spend up front with founders, the better your ability to understand the risk factors becomes.  
  3. Ash uses the phrase “Blessed Teams” for founders that are raising seemingly irrational rounds of $5 – $10M based on a product idea only, with little to no traction or commercial plans. 
  4. The characteristics of these “Blessed Teams” include – Serial founders who have a big stamp of credibility and an overwhelming technology advantage, raising money for products in large markets that are already well funded. 
  5. Ash encourages founders to first generate individual levels of traction and prove the basics of the business out before accepting large checks from VC’s. He stresses the importance of building businesses that are sustainable, especially when we’re 11 years into a bull market.
  6. Ash outlines his standard formula with B2B companies – First get a sales funnel setup and iterate on the feedback from the first customers, then ideally find a channel to generate new leads and build a playbook for how to take leads through to deployment, and lastly develop customer success processes. This formula allows you to set clear expectations around revenue and sustainability. 
  7. There are multiple milestones and gates to go through before reaching series A, Ash defines the first milestone as a friends and family round of $100k – $250k. He shares how important this round was for him, as a founder, in terms of gauging his level of commitment early on.
  8. The next milestone would be the pre-seed round of approximately $250k – $750k or $1M, that is suited for a well formed team with a prototype in place. The gates within this phase include a general product direction and customer interest. 
  9. Ash defines the third milestone as a seed round of $1M – $3M with at least $150k ARR for a B2B saas company. He notes that this ARR is on the lower end, therefore in order to be successful, a strong team with a clear technology mote or a good pipeline is necessary in most cases. 
  10. Lastly, Ash covers the mango seed round of $3 – $5M. He highlights that in this phase it is rarely based on traction and most often based on team strength. 
  11. Across the board within any of the aforementioned milestones or phases, team strength is crucial. Without a strong team, domain expertise, or any indication of credibility, founders will most likely need to achieve higher levels of initial traction to be considered. 
  12. Ash shares his bias towards early investors gaining access to their Pro-Rata, because in exchange for the amount of time he invests in founders, he asks for the right to be able to buy up to 5% of the company in their next priced round. He believes this is the fair way to repay early stage investors by allowing them to maintain their steak. 
  13. To avoid dilution as a result of Pro-Rata, Ash encourages founders to think about their cap table from the Series B stand point, by imagining what it would look like at that time, then working backwards to map it out.
  14. Ash is in favor of YC’s change of the safe to post money cap, because he believes it provides clarity and prevents the issue of founders raising as much as they want on the notes and stacking them up.
  15. An unintended consequence that may result from this change, specifically for inexperienced founders, is the potential to experience serious dilution if they choose to raise larger amounts. Unfortunately, there are not many solutions to extending the round if they get more demand.