192. Secrets of Sand Hill Road (Scott Kupor)

192. Secrets of Sand Hill Road (Scott Kupor)
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Scott Kupor of Andreessen Horowitz joins Nick to discuss Secrets of Sand Hill Road. In this episode, we cover:

  • When Marc and Ben first reached out to you about joining A16Z, you hesitated. Why?
  • “When Marc and Ben first started A16Z, they described a founder’s leadership capability as “egomaniacal”… what do you think they mean by that and do you share this belief?
  • What are the key factors in determining if venture is appropriate for the new business and its founder?
  • How should one decide how much to raise?
  • Scenario I’ve heard all too often… founder goes out to raise their next round, they’ve more than doubled the business, hit major milestones but the offers are less than double that of the last round. Scott, can you talk us through the valuation mistakes you most often encounter?
  • Founder has started fundraising… the first step is to get their foot in the door. Talk us through the right and wrong way to get a meeting.
  • You mention the 5 pitch essentials in the book – can you talk us through each?
  • We’ve done an episode with Brad Feld where we went into detail on the Term Sheet… both Economics and Governance. I don’t want to cover each term today but first, related to Economics, what’s different now about the Economics terms or the negotiation than what you saw maybe five years ago?
  • Same question for Governance, what has changed and what are the key terms in focus?
  • Do you have any guidelines on how much of their business founders should sell in any given round?
  • So the next topic, we’ve all seen before, assuming you’ve been doing this long enough, but a founder is struggling to raise, has little capital left, and is scrambling to get creative. What are some of the more common mistakes and outcomes you see in this scenario?
  • Why should entrepreneurs care who the LPs are behind the VC fund that’s investing?
  • We could spend hours discussing boards… any key items you’d like to highlight w/regards to boards?
  • Talk us through the acquisition process?
  • IPO process?
  • Great summary section where you talk about good VCs… can you recap your thoughts on what Good VCs do?

Guest Links:

Key Takeaways:

  1. As an entrepreneur, its important to be incredibly headstrong, knowing the odds of success are against you. Scott looks for founders that have a sense of vision, purpose and willingness to “walk through walls” when times get tough, who recognize early on that the process of building a company is a challenging one.
  2. Key factors in determining if venture capital is appropriate for your business include, alignment from an incentives perspective with the capital that your considering taking to the company and being comfortable with the tradeoffs that come with taking that money.
  3. At Andreessen Horowitz they wanted to design the firm around what a young CEO needs and how they could we use the brand of a16z to provide relationships that can add value. As a result they created a set of operating teams, where they build relationships with people in various areas of expertise and ultimately connect them with their portfolio companies. Ideally this will enable companies to grow more rapidly and allow inexperienced CEOs to stay in that seat longer and grow with the company. 
  4. When deciding on the right amount to raise, it’s important to ask yourself, “what do I need to sufficiently de-risk the ability to raise the next round at a price materially higher than the prior round.” Typically a 2x step up is a reasonable target. 
  5. In order to avoid making valuation mistakes, Scott shares the importance of thinking very critically at the time you take a round and evaluating your confidence level. Also evaluating if the expectations and valuation that this round set for the next round investor, put you in a good place to top that desired valuation.
  6. The worst mistake you can make as an entrepreneur is to take a small amount of money at a very high valuation. This ultimately sets an unrealistically high marker without giving yourself the runway needed to clear that hurdle. 
  7. Part of what makes a good founder is their ability to find creative ways to make things happen, that others can’t. A good way to demonstrate that skill set is by being resourceful and figuring out a way to get a warm intro to a VC rather than reaching out cold. 
  8. Scott gives an overview of the 5 pitch essentials as outlined in his book – 1. The concept of market size. 2. The team – Articulating what makes you unique and why the VC should back you. 3. Product – VC’s often recognize that the product will change and evolve over time, therefore it’s important to demonstrate how your team will evolve with it. 4. Go to market strategy.  5. How much are you going to raise and what milestones do you have?
  9. At the early stages, team is the biggest determining factor because its the one constant element that will not change. It’s important to identify early on if the team fundamentally has the expertise and all necessary intangibles that uniquely set them up to navigate through all the ups and downs that come with fundraising.
  10. The balance of power has dramatically shifted between VCs and entrepreneurs within the last five years. Money has no longer become a scarce resource and entrepreneurs are now in the drivers seat. Today, terms that create misalignment between both parties are much less in favor than they have been historically. Also, the size of fundraising and valuations across the board have jumped up 1 level.
  11. Scott shares guidelines on how much of the business founders should sell in given rounds – Seed related rounds often tend to see 15 -20% dilution, Scott believes 10 -15% percent is reasonable. If you think about it as a principal in the company, that gets you 40-55% as you’ve gone through a B round, where hopefully your ready to scale the business. 
  12. If you find yourself in a situation where your struggling to raise, the best advice Scott shares is to be honest with yourself and the VC in order to have a real conversation on why the business may not be working. If you come out of that meeting with conviction that there is still an opportunity there, the next step would be to figure out how to finance through this, set the company up for the next round and get the company back on the right track. 
  13. Entrepreneurs should care who the LPs are behind the VC fund that is investing to identify if they have staying power and if that firm will be there for the long haul. 

Transcribed with AI:

0:03
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

0:22
Welcome back to TFR today we have Scott Kupor from Andreessen Horowitz. Scott recently released his book Secrets of Sandhill Road venture capital in how to get it. Today we unpack the key elements of the book and how founders should think about both the raise and venture building process. Here’s the interview with the Great Scott Kupor of a16z.

0:49
Scott Cooper joins us today from Menlo Park. Scott is the managing partner at Andreessen Horowitz. a16z is a Silicon Valley based venture capital firm investing from seed to growth with 2.7 billion under management. And they have investments in a firm Airbnb, Coinbase, and Pinterest, among many others. Scott is also the author of the nationwide best selling book Secrets of Sand Hill Road, venture capital and how to get it. Prior to a16z. Scott worked as a vice president and general manager of SAS at Hewlett Packard, shortly after HP he joined Opsware, where he held numerous executive positions. Scott, welcome to the program. Thanks.

1:28
Glad to be here.

1:29
Yeah, can you tell us a bit about your background and your path to venture? Yeah,

1:33
so I got here, I guess a little bit of a circuitous path. So I was actually intending to be a lawyer, and figured out somewhere about halfway through law school that that wasn’t the path I wanted to be on. Luckily, that was around the time of the.com. Boom. And so I managed to kind of parlay my legal background into an investment banking job taking tech companies public in 9798 99 timeframe, through that process got introduced to Marc Andreessen and Ben Horowitz, when they started a company called loud cloud in 1999. And I’m now going on 2020 years of working with the two of them. So it’s been a fun and interesting ride, for sure.

2:06
I’m sure. I’m sure. So when exactly did you join Andreessen, kind

2:10
of before the beginning. So what happened was lab cloud, we sold eventually to Hewlett Packard in 2007. And I stayed until actually first part of oh nine, Ben and Mark, I think exited probably a year later, and oh, eight. And then we started kind of the two of them were angel investing. And we started talking about gee, you know, this could be exciting and interesting if we could do it on a bigger scale and have bigger impact. And so kind of, you know, third quarter of Oh, eight, we decided it would be interesting to go raise a fund. And we went out and did that and just eclipsed our 10 year anniversary last month. Wow.

2:40
Awesome. Awesome. Well, congrats on the the anniversary. Thank you. And Scott, rumor has it when Mark and Ben first reached out to you about joining the firm, you hesitated? Why?

2:52
Yes? Well, you know, it was funny, because so I was at the time, as I mentioned, I was at HP and my family, we were actually living in North Carolina, because we’d moved out a couple of years earlier to run a business there that that Opsware had acquired. And if you recall, when we were talking, it was basically summer of oh eight. And that, of course, transitioned into September of eight, which was when Lehman Brothers, of course, miraculously disappeared from the world. And so my hesitation was mostly around gee, you know, what’s the likelihood of being able to raise a venture capital fund going into the middle of the greatest, you know, financial crisis we’ve ever had. And, you know, so that was kind of my hesitation, what my wife reminded me which was true is we also took loud cloud public in 2001, which also turned out to be the middle of the.com crisis as well. So we figured maybe, you know, kind of, if you could do it once, you could do it a second time and ultimately got over that hesitation.

3:39
Got it. Got it. Well, you know, I want to talk about your book today. You wrote Sand Hill Road, I’ve been fortunate to read it fantastic book. If you’re in the audience, and you’re a founder raising capital, it’s excellent. If you’re a VC or early stage investor, that’s deploying capital also very, very useful tool. So Scott, you know, first off, I’m reading early chapters, and I come across this statement about how you know, when Mark and Ben first started the firm, they described a founders leadership capability as ego maniacal. What do you think they mean by that? And do you share sort of that belief in in what you look for in founders? Yeah,

4:22
I think maybe in retrospect, the use of terms was not a good one. It was a it was a it was intended to be a euphemistic way of saying, you have to kind of be incredibly headstrong, probably partly delusional, in some respects, to start a business just knowing that the odds of success are against you, and that probably most people are looking at you and constantly telling you why your idea will fail. So the idea was not to necessarily back insufferable people, although sometimes they can make great entrepreneurs. But the idea was really to back people who just had that sense of vision and purpose. And quite frankly, a willingness to walk through walls when times got tough. And I think that’s generally been reflected in the types of entrepreneurs that we back to people who are brilliant technologists in there. All right. But who also recognize that the process of building a company is an incredibly challenging one? And if you’re gonna sign up to this, you really have to just understand that going in and really make sure that doesn’t cloud your judgment going forward?

5:12
Yeah, yeah. I think we talk a lot at our firm about the irrationally obsessive, yes, we I think that’s a good way to think about it. Yeah. Which we consider ourselves to, in a way, but let’s dive into to the founder side here. So what are some of the key factors in determining, you know, I’m the founder, determining whether I should raise venture capital or not, if it’s appropriate for my business? Can you talk about some of those factors that should weigh? Yeah,

5:36
I think the big thing to think about is go back to first principles, which is what are venture capitalists looking for, and I talked about this in the book, of course, but and, you know, you know, this having been in the business that most of what we do, unfortunately, doesn’t turn out to be very successful. So you know, we lose money on probably up to half of what we do. And so the only way, you know, certainly for a firm of our size, the only way that our business works is we’ve got to have one or two or three outlier companies that can become a Facebook or a Google or a, you know, Lyft, or slack or things of that sort. And so if you think about that, from first principles, that I think as an entrepreneur kind of going in part of the decision is okay, do I want to build that kind of company is that is the market I’m going after big enough? Is it in my aspirational dreams, that that’s what I want to do. And that’s not a normative statement as to whether you’re a good or a bad founder, it just may be, you may have different, you know, you may have different ideas or different goals for what you want to build. So kind of thing, thing number one to me, is that, which is are you aligned from an incentives perspective with the capital that you’re considering taking into the company? And then I think the big question after that is, okay, are you also now comfortable with, hopefully, the positive, but also some of the other trade offs that come with taking that money, right, so that means you’ve got somebody who owns part of the company, on the equity side, you’ve got somebody who’s probably sitting on the board, you’ve got somebody who’s got a vote in determining, you know, when you raise more money, when you sell the company, when you do kind of critical things over the course of the business. And, you know, I think if you believe on balance, that the value you get from that relationship is greater than potentially the imposition of having somebody else that you have to work with and talk with on the business, then, then I think it’s the right place to be

7:06
the imposition of having somebody like that. Love, it can also be like, great thought partnership, though, I would imagine a lot of the boards you sit on, you’re you’re working very closely with your founders and helping them think through strategic challenges and how to see around corners.

7:21
I think that’s right. Yeah, look, I mean, obviously, you know, I drink the Kool Aid. And I’m a believer that venture capitalists can be valuable thought partners, and also can be valuable in terms of, you know, helping you identify customer opportunities and executives to bring into the company and all kinds of other stuff. So, you know, that’s, that’s how we run our business here. So we’ve got a big operation, we have about 170 employees, and 100 of them work with our company’s post investment, helping them on everything from, you know, sales and marketing opportunities to, you know, downstream fundraising. And so, you know, we believe pretty strongly that capital alone is really not the differentiator anymore in this business. And for you to kind of convince entrepreneurs, you know, that they should work with you, you have to do something other than capital that they perceive as valuable.

8:00
Yeah, so this is probably a good opportunity for a little sidebar. So if memory serves, you know, CB insights, did a study on the most desired venture capital firms to raise from and injuries and was at the top of the list. I think that’s four distinct reasons. And I think it was very strategic, not just, you know, you’re good people. And you’re friendly. I think there’s been a lot of design at Andreessen and has set a lot of precedents for for other firms that they’ve tried to employ as well. So can you talk a bit about platform and the way you approach the relationship with startups?

8:35
Yeah, that’s, that’s great. So first of all, thank you for that for those comments. Yeah, here’s how we thought about it. Well, we started the firm, we said, look, we are interested in backing, you know, technologically innovative entrepreneurs, because we fundamentally believe we’re in the innovation business. And we recognize that in doing so that might mean, you might be backing people who probably had never been CEO before. You know, as we know, in some cases, some of them may never actually have had jobs before because many of these people are literally coming out of, you know, undergraduate universities. And so we said, Okay, if that’s kind of a little bit of the, you know, type of individual that we want to back, the question is, what could we surround that person with that might help them over time grow into and hopefully become a great CEO, recognizing that you know, what, that magic works, where you have this kind of marriage between the product visionary and the CEO, you know, you can build companies like, you know, a Facebook with Mark Zuckerberg or an Amazon with Jeff Bezos, you know, you can have this kind of founder led company that ultimately becomes, you know, incredibly powerful and important in their industry. So what we did was we said, we’re gonna design the firm around that, and you’re exactly right, which is we said, okay, what are these people need? Well, if you’re a young CEO, you probably don’t know a bunch of customers who could buy your product. So could we basically use the brand of Andreessen Horowitz to build relationships with all the most important customers and business development partners, and then, you know, kind of provide those relationships and those opportunities as introductions into our portfolio company. You know, thing number two was we said, Okay, you probably don’t know executives, you don’t know CFOs and heads of sales. In some cases, you may not even know number one, when’s the right time to bring in those people? And if you do, you may not know exactly, you know, for example, on a CFO side, do I want someone who is really good at financial planning? Or do I want someone who’s really good at control oriented aspects of finance. And so we said, great, you know, let us basically build a team who will go and make sure that we know all the relevant people in those jobs, who could be downstream, you know, potential executives in our companies. And so we kind of went through, on and on and came up with basically a set of what we call operating teams, with that express purpose, which is we ought to go out and build relationships across these different areas of expertise. And where appropriate, let’s connect those relationships into our companies. And the success case, hopefully, is that enables our companies to grow more quickly than they would have otherwise. And hopefully, it also enables, you know, potentially more inexperienced CEOs to kind of stay in that seat longer and be the long term CEOs who can, you know, ultimately build these tremendously valuable businesses?

10:54
Is there a way that you allocate access to resources so that, you know, some portfolio companies don’t overuse maybe an allocation, while others can’t get access to some of your services? Because they’re focused elsewhere?

11:07
Yeah, it’s, uh, you know, look, it’s always a fine balancing act. But you know, like any business, of course, we’ve got finite resources. And so we do have to always kind of think about resource allocation, you know, the way the way we do it is, nothing is prescribed and required here. So everything, of course, you know, the entrepreneurs can take or not as they see fit. And then what we try to do internally inside the firm is to say, Okay, let’s review on a regular basis, you know, where are we spending our time? And is it? Is it effective? And is it helping the companies? And if so, then in general, you know, our direction will be let’s continue, and let’s, you know, potentially even double down on resources. But you’re absolutely right, which is looking at, you know, the law of large numbers is just such that, you know, everybody can’t use every service all the time. And so we do have to be careful about trying to balance out those resources. But do it in a way that’s, of course, respectful to the entrepreneur, and make sure that we’re not certainly doing something that would handicap their business.

11:54
And then at the partnership level, when it comes to either deal flow or working with portfolio companies. How do you guys divvy up responsibility? Yeah,

12:02
so the way we think about it is kind of there is the job that we call general partner. And most of that job is, you know, you should be out identifying new opportunities, you should be, you know, obviously evaluating and making investment decisions, and then you should obviously be sitting on boards and working to help those companies be successful. And, you know, that’s probably not a surprise to you to hear that job description. And so everybody’s got their portfolio. The way we run it, though, is in addition to that, because we have this 100 person operating team that kind of sits, you know, alongside the GPS, a lot of the day to day interactions with a company happen at that team level, as opposed to the GP level. So a perfect example would be, you know, if the company decides they want to hire a CFO, you know, we know the GP obviously, is gonna be a critical part of that decision. But we don’t need the GP to necessarily know who are the 10 best CFO candidate outs out there, we don’t necessarily need the GP to be involved with the entire kind of, you know, qualifications process and screening process and initial evaluation. And so a lot of that our teams who are just professional in that area can do that much more effectively. And then they can keep the GP informed as to what’s happening, and then bring the GP in at the right time where we feel like okay, now we’ve got a couple of candidates that makes sense that are really down to the, you know, final stretches here. And so the way we kind of think about it is could we disaggregate the job of the GP, such that a lot of those kinds of, you know, network facing functions that can be staffed and managed by, you know, people who are experts in that particular area, that those can be handled by the operating teams, and then the GP hopefully has a lot more time to spend directly with the CEO on, you know, strategy and business planning and organizational development and the other areas that we think probably the GPs are uniquely suited to be able to engage. Got, it

13:39
makes sense. So circling back to, you know, the book and fundraising and founders going for capital. I’m a founder raising my first round, how do I decide how much to raise? Yeah,

13:51
this is one of these things that I find people don’t give a lot of thought to, unfortunately, and it’s often the amount of money often is a number that they heard from someone else in their, you know, kind of friend or professional cohort who recently raised money. And the right way we like to counsel entrepreneurs is the right amount of money to raise in this round is, what do you need to sufficiently de risk the ability to raise the next round at hopefully, you know, a price materially higher than the prior round, and there’s no magic to this, but you know, I’d say, a 2x step up would be a reasonable target for you to think about in terms of valuation from one round to the next. So, you know, that to me, is the conversation that you know, as an entrepreneur, you should be having is okay, if I need to achieve these milestones at the series B, let me then work backwards at my series A and say, Okay, how much time will that take me? What do I think the resources are required to get there and therefore, X amount of dollars is the right amount of money to raise. And you might have a range and you might say, Gee, with $5 million, I could do this. But gee, if I had $8 million, here’s the incremental, you know, milestones that we can accomplish. And that at least gives you in the VC an opportunity to say, okay, you know, do we feel like that incremental investment for the potential higher dilution that might take from the entrepreneurs and as well for the higher We’re kind of capital exposure it might take for the VCs is a reasonable way to approach going into that series B with a with a head, head of steam that really allows us to accomplish that objective. So that’s kind of the way I would at least think about the calculus.

15:11
Always shocking to me when you’re in late diligence with a founder, and you ask them, you know, what are the key milestones OKRs KPIs that you need to hit 1218 months from now to raise that double or more, and they’re at a loss? And maybe that’s part of the relationship is working through those things. But yeah, just making sure you know, what those goals are, and what those milestones are is kind of the first major step before you ever take on venture capital.

15:37
Yeah, I think that’s right. Yeah, it look, I guess, in some respects, it’s understandable that entrepreneurs might not know that just because like many of these people, as we talked about, right, are doing this for the first time. So you know, I agree, I think that’s a good role of your venture capital partner to say, okay, great. If I give you this amount of money, you know, let’s build out what is the plan look like? And let’s pressure test it and see if it makes sense. And I think that’s a reasonable conversation to have. I agree. If you’ve got if you’ve got no sense, but as an entrepreneur, you probably have more work to do before you approach your venture capital partner. But it does seem like it’s an exercise that, you know, certainly could be collaborative with your VC partner.

16:09
Yep. Yep. So another scenario that I’ve heard, all too often founder goes out to raise their next round, right. And they’ve, let’s say they’ve more than doubled the business, they’re hitting milestones, things are progressing in the right direction. But the offers are less than double than that of the last round. Scott, can you talk us through maybe the valuation mistakes that you’ve encountered?

16:30
Yeah. So I think there’s a couple of reasons why, you know, you may double the business, and the valuation may not double, you know, one is certainly outside your control, which is, look, it may just be that the market has changed, and maybe we valued revenue, or we valued growth differently. And now, you know, kind of the public markets have traded off 1000 Points or something. And so people are just revaluing, and rethinking how they values businesses, you know, there’s not a whole lot you can do around there. Other than of course, if you, you know, feel like you can predict the markets try and anticipate that at your earlier financing, which is probably unlikely. But more often, I think what happens is, a new investor may come in and say, hey, that’s great that you’ve doubled, but oh, by the way, you raised you know, $10 million at your Series A, and you had a 40, or $50 million valuation. And so a lot of that growth was effectively already embedded in that price, which is, you know, effectively, you’ve ratcheted up expectations for that next round investor, based upon the kind of amount of money and the valuation you raised at the prior round. And this is one of these tricky ones, as you probably know, which is it’s really hard with a straight face as a VC to tell an entrepreneur raise less money at a lower valuation. Because you know, not surprisingly, you know, that self serving Lee helps, you know, you and me as VCs, you know, own more of the company with potentially less capital out. But it really does illustrate, I think, you know, an incredibly important point, which has the psychological value of always being able to kind of see the business as as much as it can go up into the right, you know, you can imagine how tough that conversation is, as a CEO. If you say, Hey, I’ve been telling my employees all along that they’re doing all the right stuff, we’ve hit all our objectives. And then kind of these numbers come in below. And now you have to kind of say, hey, you know, you have to kind of explain that to your employees. It just feels like a real kind of, it’s very deflationary from an expectations and a momentum perspective of the business. Yep. And so there’s no, there’s no, of course perfect way to manage it other than just to be very think very critically at the time you take around, which is, do I feel very confident that, you know, I can execute on what I need to execute. And that kind of the expectations that this round of this valuation set for the next round investor set me up so that I can hopefully kind of, you know, top that desired price and desired valuation in the next go round? And, you know, it’s easier said than done sometimes. But I think a critical piece for CEOs to think about,

18:33
yeah, just because you can doesn’t mean you should, right, that’s right. Yeah. Because sometimes these founders get into a overhyped market, or there’s a lot of investor appetite for what they’re working on. And they can get a much higher price and raise a lot more capital, but it does significantly increase the expectations. And they’re going to have to, you know, go out and try and raise that that major up around 1218 months from now. And if the progress and the metrics don’t follow, then it can be a challenge.

19:00
I think that’s right. And I think the the worst mistake, which unfortunately, we’ve seen a few times is you take a small amount of money and a very high valuation because it’s available to you. And now you’ve kind of got the worst of both worlds, which is you set this high marker, you know, for valuation perspective, but you haven’t given yourself the runway needed to be able to clear that hurdle. And so look, I mean, if you’re, you know, kind of in a situation where you got people throwing money at you, and it’s great valuations and you ultimately feel very confident in what you can do, you know, at least make sure that you’ve got sufficient runway so that you can meet or and or exceed those in heightened expectations. Yep.

19:32
Yep. So Scott, a topic I love that you cover in the book is getting your foot in the door. Right? Yeah, just getting the meeting with the VC is kind of a major, major early step toward getting funding. So can you talk us through the right and wrong ways of getting the meeting? Yeah,

19:48
what I’ve talked about in the book is and you know, I think this is human nature is it’s you know, one way of course is you could call the email people and some people do respond to that but part of the process I think of getting into a VC is it’s an opportunity for you to reflect to the VC kind of your scrappiness and and you know how you’re going to kind of act as a CEO to the extent they fund you. And one way, I think, to demonstrate that is to figure out, Okay, do I know somebody? Or do I have at least you know, kind of one or two degrees of separation to find a way to get a warm introduction to somebody who, you know, otherwise? I may not know. And, you know, it doesn’t always work that way. And, you know, this is an issue, of course, that comes up a lot in the industry here, which is, gee, if it’s such kind of an insider network, how do we make sure we continue to create better diversity and better opportunity for people who are outside those networks? And those are completely fair and reasonable arguments. But you know, if you think about part of what makes a good founder is, are they kind of, you know, scrappy, and do they think of creative ways to kind of just make things happen that other people can’t, and you’re gonna have to do that in terms of getting access to customers and getting access to employees and ultimately, getting access to investors is a good way to demonstrate that kind of skill sets. So using, you know, your your resources to find a warm way in is by far prep bolts, and just kind of, you know, sending cold emails over the transom

21:02
a grid, you go on to talk about the five pitch essentials in the book, talk us through each of those five essentials. Yeah,

21:10
so I’ll try to do them, hopefully, quickly. But I would say, you know, number one to think about is kind of the concept of market size. And again, that goes back to this foundational incentive structure for the VCs, which is, you know, most VCs want to invest in big markets, not because they are necessarily, you know, big market bigots, but but because they know, they’re going to be wrong a lot of the time. And so they need a couple companies ultimately, to be right and to be very right to subsidize, ultimately losses on the rest of the portfolio. So big market is kind of thing number one team, to me is number two. And the way I the way I like to describe that is the question for you as an entrepreneur is why should this VC back me and my team versus any the other teams that might come in today, or over the next six to 12 months with a similar idea in a similar market, and you know, your ability to articulate what makes you unique and different? What experiences have led you to this idea how you’re going to build a team, how you think about things is, you know, an incredibly important factor, and particularly the early stage, when there is no parkmore, there’s no product is probably actually probably the most important evaluative tool that VCs will use. Third is product and I put, I put a product third behind Team in particular, because it’s not that it’s not important, but it’s that VCs, I believe, recognize that the product is going to change and evolve over time, you know, as you get into market. And so they’re more interested in what I described as kind of the idea maze, which is, how did you decide that this product made sense for this given market based upon the currently available information that you have on this market? And then ultimately, therefore, how will you kind of evolve and, you know, kind of adjust your thinking on product, as you get, you know, as you get information, you know, into, you know, that informs that decision? Yep. I’m not sure if I’m going in order now. But before would be thinking about kind of go to market, which is how are you going to actually sell and market the services to the consumers or the enterprises? And again, here, I think the key is not necessarily that you know, everything, or that you can say exactly what is customer acquisition costs gonna be? Or what’s lifetime value going to be? And obviously, if you know those things, that’s wonderful. But it’s more again, your line of thinking, which is, okay, I’ve got a product I’m trying to sell into enterprises, what are the methods by which I believe I’m going to be able to access those customers? And you know, where do I think it needs to be from a cost efficiency perspective, to be able to support either an outside sales force are inside sales force. So things of that sort are relevant again, around your thinking more so than what the actual spreadsheet says. And then I think the final thing around pitching is, you know, how, I think what we talked about, which is, look, how much money are you going to raise? What milestones is that going to entail for you? How do I know as a VC that, you know, kind of that sufficiently de risked relative to what the next round investor might be looking for? And so that’s at least, you know, if you could cover most of those five things in you know, an hour or less, I think you’re doing pretty well?

23:46
Are you one that prioritizes those things, you know, I’ve, I’ve read a lot from from your partner, Mark, who has famously said that that market is the most important thing, they’re all important, but is the most important. You mentioned the idea maze. And, you know, Chris Dixon is, has written a lot about that, and has written a lot about product, amongst other things, I would tend to think, you know, they’re all very important, but are you one that subscribes to? You know, these have a priority order or not?

24:14
Yeah, I think it’s a little bit stage dependent, but the way I think about it is market is kind of markets kind of a little bit of the thing, you have to at least get your head around to decide is it worth spending any more time on the on the opportunity? And I know, that sounds kind of harsh, probably to say but, you know, in market is market is kind of a little bit of, you know, it’s a question of question of how big can this be? So let’s just assume everything goes, right. Let’s assume like this company is great, the people are great, the products great, what can that business look like over time? And I think if you can at least get your head around, okay, I can see how this could be a standalone public company. And it could be worth you know, hopefully several billion if not more than that over time. You know, it’s a little bit of to me, it’s kind of the primary checkbox before you kind of dive into the other ones. And then particularly at the early stage, I think team really becomes you know, the primary determining factor because all these other things we know we’re going to change products gonna change your go to market plans are probably going to change as you start going, what probably doesn’t change is does the team fundamentally have the kind of domain expertise that uniquely sets them up, and the leadership skills and the kind of storytelling skills, all the other things that all the other intangibles go along with that to kind of, you know, wander through what is going to be a series of potential pivots and ups and downs and things of that sort. And so I would tend to emphasize that probably more so than, you know, over even product itself, at least at the very early stage

25:28
of it, love it. So you know, you really unpack the term sheet in the book, which, which was fantastic. We’ve done that on the show, we’ve gone pretty deep on economics and governance. So I don’t want to rehash too much today. But can you kind of give us some highlights? Or, or maybe talk about what’s different now? Related to Yeah, let’s go to economics first. So what’s different now on economics terms in indoor negotiation, that maybe is a change from 510 years ago?

25:56
Yeah, I think the biggest difference now, and it really comes through both on economics, as well as on the kind of governance side of things is just the balance of power has dramatically shifted between entrepreneurs and venture capitalists, probably certainly over the last 10 years, but maybe even as much as the last 15 years. And what I mean by that was, you know, kind of in the, you know, in the, quote, old days, you know, in the early days of venture, kind of the thing that venture capitalist had was they had the money. And so if you were an entrepreneur, you had to go to the person who had the money in order to get it. And therefore, you know, all of the things be equal, the venture capitals probably had more control and leverage over the transaction, you know, what’s happened in the last 10, or 15 years is, as you know, very well is money, money has just no longer become a scarce resource, there’s plenty of it out there. And so, you know, the entrepreneurs, quite frankly, are in the driver’s seat of having choices of who they work with much more so than, you know, certainly was probably the case historically. And so I think if you think about that, from an economics perspective, probably two things, two things that have changed. One is just that, you know, terms that kind of create misalignment between entrepreneurs and venture capitalist, I think, are certainly much less in favor than they might have been historically. And so an example of that might be something like a, you know, an anti dilution ratchet, right, which, you know, we don’t need to go in detail, but you know, for your listeners, is the idea that effectively, the venture capitalist gets complete price reset at a future round, if you end up raising at a lower valuation. Yep, you know, most people will have some form of anti dilution treatment, but the kind of severe form of that kind of full ratchet, I think those things are, you know, really kind of few and far between, you know, as are things like multiple liquidation preferences where, you know, kind of AND, OR, and also participating preferred liquidation preferences, right, where the VCs kind of get to double dip, they get their money back, plus they get to participate as an equity investor, I think a lot of those economics certainly have changed. And, quite frankly, I think for the better more towards entrepreneurs as their as their kind of has certainly escalated. The other thing I was gonna mention real quick, is a more general thing. And we see this more in the valley here. And it’s probably true in other markets, but you would know better than I, whether it’s true also in your market is, because you’ve got things like seed and other kind of, you know, precede now and all these you know, there’s there’s kind of it used to be, you know, we just used to have angels, and then we’d go to an A round, right, and now you have, you know, angels and then potentially pre seed and seed, the positive version of that is, the companies when they get to an A round are probably at a higher state of maturity than historically they were. And as a result, I think what’s happened is you’ve kind of had great inflation, essentially, along each step of the curve, which is, you know, kind of an a round today probably looks more like a, a be rounded, you know, 10 or 15 years ago, and probably a seed round today, it looks more like an a round, so kind of everybody’s kind of jumped one grade level. And so I think you see that also in kind of the size of fundraisers and valuation across the board.

28:31
Do you think an unintended consequence of of that is that founders end up having less equity when they get to those later rounds?

28:39
Yeah, I think it can actually, this is something we talked about in the book, which is, you know, I think what we often see sometimes is entrepreneurs sometimes, you know, for your listeners, right? This, this idea of notes of kind of seed notes has become obviously very popular out here. And again, you could tell me what it is in your market. Notes or, yeah, notes in sales, right. And notes are great in many respects, right? Because they’re simple, and they’re easy. The challenge of sometimes is exactly what you describe, which is, you don’t really ever quite internalize as an entrepreneur, exactly how much of the company you sold through notes, because it’s not until you go raise that a round or the whatever price drops you do, where, you know, the lawyers all of a sudden show you the cap table as they’re converting these notes. And you start to realize potentially what the dilutive impact of these things can be. And so I think you’re right, which is a you know, an unintended consequence more generally is, you know, there are there are more places along the capital curve to raise money. And if you don’t either understand what you’re raising and or make sure that the milestones that you’re going to deliver with that money are you know exactly what is needed to continue kind of on that up into the right graph. You can certainly wake up at a relatively early stage and find that your own economic interest is materially less than you thought it was.

29:48
Well in their discipline and focus issues with the notes right, there’s so fixable, and you can raise so easily when you’re not requiring everyone to get together on the same day to wire the capital and I absolutely find the milestones to find the time schedule, then you know, a new person shows up offering you money at a higher cap and saying, Hey, we can provide all this help, it’s hard to turn that down. And before you know it, you’ve loaded up so much capital and so many notes, it’s pushing up the post money on the series and creating a lot, a lot of challenges.

30:18
Yeah, I agree with you. I mean, look, and this is, you know, again, this is not always a popular position. But, you know, I think Fred Wilson over at Union Square did a good job at a blog post of outlining a lot of these issues is, you’re exactly right, that the ease and the kind of, you know, convenience of which you can raise these notes, unfortunately, doesn’t drive, not in all cases, but at least has the risk of not driving the same level of discipline around objectives and milestones. And, you know, the worst case scenario is, you’ve done a great job building the business. And now you want to go raise more capital, and a new investor comes in and says, gee, you know, I love what you’re doing. But I feel like you as the CEO and the team are just not as incentive anymore, because you’ve you’ve, you know, gotten so diluted over time. And either that results in that investor not wanting to participate at all, or it results in a deal where that investor comes in, but only with the introduction of, you know, a new option pool and other things that obviously can be diluted to your early investor. So it just creates a weird dynamic that I agree you could avoid, if you’re just very clear about every time you raise capital, what am I getting from this capital? What am I gonna deliver with it? And does it help me achieve that goal of you know, kind of maintaining it up into the right valuation curve? Right, right.

31:20
Yet, very quickly, I just want to say that, you know, you said earlier that you, you saw this trend and this change, and that, you know, things are getting more founder friendly. And I think you may be doing yourself a disservice, because clearly, you identified a trend at Andreessen, but I think you’ve also been a part of the trend, you’ve been a driver, in a way, I mean, you know, with your sort of pioneering efforts on platform, and I’m not trying to stroke the ego. I mean, I believe this, many others believe this, and many others have written about it, but both Andreessen and you know, maybe some other firms, like first round have really kind of been a driver of this movement, not just following a trend?

31:56
Well, first of all, I appreciate that. And, yeah, look, I mean, it goes to kind of, I think, where we talked about earlier, which is fundamentally, I just don’t think we live in an era anymore, where capital alone is the defining characteristic of the of venture capital firms, I think there will always be somebody who’s got more money than we do. And there’s gonna be somebody who has a lower cost of capital. And so I think we’re in a good spot. I think, you know, if we’ve done anything, I think it’s been, you know, for the better, which is we’ve, you know, gotten entrepreneurs to the point where they recognize hopefully, that there is, there is hopefully a unique value that different venture capital firms can offer, and that we ought to compete on that basis, quite frankly. And, you know, it’s great that we can offer capital, but there are plenty of places to get capital. And so ultimately, I think the question is, what else besides capital? Do you think, you know, a VC can add value? And if they can’t, then, you know, it may not be the best source of financing, quite frankly.

32:44
So Scott, do you have any guidelines on how much founders should be selling in any given round? It’s

32:50
hard to know, it’s a good question. I mean, I guess I think about it in very rough terms that, you know, oh, let me tell you what I see these days. And I think these are probably, you know, reasonable, which is look, you know, seed related, and I mean, related in the sense that, you know, kind of precede everything else, you know, you probably tend to see 15 to 20% kind of dilution, on those types of rounds across, you know, hopefully not more than one or two rounds, at the a round, you know, it’s still pretty typical that a new investor certainly would like to own 25% of the company. But I’d say probably, you see a range of probably 20 to 30%, would be fair, in terms of kind of what people actually sell. And then it gets a lot harder at the B rounds, just because as you know, some of these things just escalate incredibly quickly, but I would say probably, you know, 10 to 15%, is probably a reasonable way to think about it. And then above that, you know, obviously extremely variant. But I think if you could see if you could think as a, you know, principle on the company, you know, collectively what does that get you that gives you kind of, you know, somewhere between 40 45% to 50 55%, maybe as you’ve gotten to, you know, through a B round, where hopefully now you’re really kind of scaling the business, that’s probably a reasonable rule of thumb to think about.

33:55
got it got it makes sense. So I want to transition slightly. But the next thing I want to touch on, which we’ve all seen before, assuming you’ve been doing this long enough, is a founder that’s struggling to raise their next round, right? Yeah, their capital is, is being spent fast, they’re scrambling to get creative. They’re trying to figure out new ways to raise what are some of the common mistakes you’ve seen founders make? And maybe some of the outcomes you’ve seen in this scenario?

34:21
Yeah, well, I mean, I think unfortunately, you know, it’s common that, you know, many people, you know, realize realize later than they should, the benefit of obviously, you know, recognizing if the business is on or off track relative to a fundraise and being able to kind of make the appropriate cost adjustments that are needed to do that. So, you know, that’s, that’s a hard thing to do. And unfortunately see that a lot. I think, though, if you find yourself in that situation, the biggest kind of challenge I see and I guess the biggest advice that we’d like to give to entrepreneurs is, you know, be honest with yourself and be honest with your venture capitalists and have the real conversation which is, you know, is the business just fundamentally not working and not fixable. So in other words, maybe we just went into a market that wasn’t a good market. or for whatever reason, it’s not as big as we thought it was, you know, that’s kind of one discussion to have, in which case, you know, probably the right answer is, you know, let’s figure out a way to kind of gracefully, you know, wind things down and make sure that employees are taken care of as humanely as we possibly can. But I think the intermediate case may be just, hey, look, it may be that maybe it’s not working for other reasons. So maybe we still feel good about the market and where we’re going, but maybe we just hired too fast and therefore consumed too much capital, you know, ahead of progress. Or maybe we, you know, had a misstep, and we hired the wrong head of sales, and therefore, you know, we lost time and momentum to get to that next milestone. And I think if that’s the case, and you know, kind of you as the entrepreneur still feel like the opportunity is there, I think the right conversation that I have is okay, like, what do we do to fix this. And as unpleasant as it is, you know, probably in those cases, you’re going back to your existing VCs and saying, Hey, we still believe here’s why, you know, can we, you know, basically, effectively, you know, do a round of financing, where we reset the valuation, et we kind of, you know, changed expectations and objectives for kind of what we’re going to do with that capital. And importantly, you know, as well, I think we re incent the team to make sure that the most critical asset of this business, which is the, you know, the employees actually still feels like they are incented, to go do what they need to do. And those are hard conversations, and kind of the initial instinct often is, hey, let’s kind of kick the can down the road. And let’s just put a bridge node in and see what happens. And, you know, at least from experience, you know, what I’ve seen over the years is that rarely kind of solves the problem, you’re basically just kind of postponing the inevitable. And I think the better thing to do in those cases is decide like, do you still have conviction? And is there still a business there? And if so, figure out how do you actually finance through this? But most importantly, you know, to go back to what we’ve been talking about, for a long time, how do you set the company up for that next round of financing, to be able to kind of clear all the hurdles that need to clear and make sure that you get the company back on the right trajectory? And, you know, it’s never a fun conversation. But I think with the right partnership with VC firms, you know, you can do that. And you can do it in a way where it’s still, you know, kind of not incredibly diluted to the existing people. Because the VCs recognize that, look, if they’re gonna put more money in us, they need to have a team there, that’s, you know, economically incentive to get to the right outcome.

37:04
Right, right. Scott, why should entrepreneurs care who the LPs are behind the VC fund, that’s investing?

37:11
I think the main reason to care is just do they have staying power? And will that firm be there? You know, hopefully, for the 10 1215 years, that you’re probably going to have a relationship with them? Yeah. And so, you know, look, it’s always very hard, as you know, to kind of get to the bottom of that have, you know, the details, and you’re probably not going to get a VC to actually give you their LP roster, but I think you can at least get a sense for do they have LPS who understand the asset class who have kind of, you know, as close to permanent capital and long term horizons as possible, and who have been serial backers of not just this firm, but other other VC firms as a kind of proxy for their staying power, because the last thing you know, I think you want as an entrepreneur is you’ve got a great VC partner, your business is doing well. But that partner either can’t raise another fund or doesn’t have the resources to be able to kind of scale and grow with you over time. And you know, it’s just kind of the relationship you want to maximize for, you know, the long term here and not kind of take shortcuts that might have downstream implications.

38:04
Yep. Yep. Anything you want to say on boards? I mean, we could talk for hours about boards, but any key items to highlight from the book, you know, with reference? Yeah,

38:13
yeah, I’ll do it quick. I think, look, I think the most important thing on boards is, a lot of this falls on the VC. But I think it’s the entrepreneurs job and Medicaid is to manage it is, you know, good boards, I believe, are where the VC is clearly recognize the distinction between what they know and what they should do as a board member versus what the executive team should do. And, and obviously, for anybody who’s been a company, you know, this, but, you know, there’s just no way going to a board meeting once or twice a quarter, no matter how involved you think you are, that you really have any idea at the right level of depth of what the company is capable of delivering, and what the teams are doing down to kind of which engineers in which products and projects, you know, need to be, you know, greenlit or, you know, postponed. And so I think the best functioning boards recognize that look, there, their ultimate ability to kind of, you know, kind of weigh in on whether they think the company is doing well or not, is, you know, through the CEO, you know, herself. And sometimes obviously, that might mean, you know, they may sometimes they lose confidence in the CEO, but boards that overstep and try to give kind of product and strategy advice that assumes they know more than they do about the inner workings of the company, I think is often the failure case that, you know, just doesn’t end well for anybody.

39:19
You know, it’s, it’s rampant often in the industry.

39:24
Yeah, I think people are well meaning, right. I think people people want to they think they’re doing good job. The problem is, I think what people forget is, the power of a board member is just so strong, right? I mean, you can imagine, it’s just like your boss, right, which is like, if you’re, if you’re sitting in a board meeting, and a board member says something, you know, obviously, you give a lot of weight to it. Because, you know, ultimately, you report to that individual. And, you know, you certainly brought them on because you thought they were smart and had ideas on the business. But I think it’s a very easy, it’s a very easy way to cut off, you know, erode trust within the organization if the board overstep their bounds. So definitely something important to focus on.

39:56
You’re 100% Right. I mean, I’m in a situation working with an entrepreneur that But it’s gonna take another month to close his his next round. And he’s a little short on capital and wants to run a big initiative. And one of his his board members suggested, you know, he do a little bridge kind of, to our conversation before. And he did it at a 50% discount to the terms of the next round. Right? Just like oh, I mean, I know that the intention was right. But yeah, the terms are just really wonky. So now we got to try and unwind that it’s, yeah, it’s a mess. All right, you know, you had a great summary section in the book where you talked about good VCs? Can you touch on some of these aspects that make for a really good VC, and maybe what founders should be looking for? Yeah, so

40:44
you know, some that we’ve hit on, but I’d say, remember, right, these are long term relationships. So you know, I make the joke in the book that, you know, VC relationships, you know, often lasts longer than marriages, unfortunately. But you know, that, unfortunately, is true. But it’s this is so much a relationship business, and so much of what you as a founder, the value you get out of your receipt will be a function of Do you inherently have trust between the two individuals? And do you believe, you know, hopefully, that the VCs have, you know, your best interests in mind as well, which is to hopefully try and build an incredibly important and enduring and valuable business. And so, look, I think when you’re looking at PCs, you know, the personalities and the kind of relationship, you know, at the GP level is critical. We talked about some of the issues about making sure the VC has the financial backing and, you know, kind of the LP backing and others that will make them kind of long term players in this space. And, you know, could board members, you know, kind of just what we talked about, if they recognize kind of what the value they bring to the board is and again, where they should speak up, and where they shouldn’t speak up, and how to kind of provide feedback, all those things are important. And then, you know, as we’ve, you know, certainly near and dear to our heart at Andreessen Horowitz is this idea that VCs, hopefully should be more than just a sort of a check that, you know, kind of are they investing both through the GP side of things, as well as potentially in other areas of the business in trying to add value to you as an entrepreneur in ways that you actually think are relevant for your business? So you know, are they doing things that you would say, hey, you know, in the absence of their partnership, I might not be able to grow the business at the same level, or I might not have had access to that talent. Those are important things I can certainly think about that can really distinguish I think, you know, a great relationship with the VC versus one that is a fantastic source of capital, but just may not have any other value to add. Scott,

42:20
if we could cover any topic here on the program, What topic do you think we should address? And who would you like to hear speak about it? You know,

42:26
I’d love to hear and I’m sure you guys do it. But I would love to hear from the founders who didn’t succeed and kind of about their journeys, because I think we all we all get caught up in these narrative fallacies where, you know, kind of, we look at the companies that succeed, and we assume that they’re all just up into the right at all times. And, you know, you know, it because you’ve been in the business, you know, as we have for a long time. Like, that’s just not the reality world that these things are probably a series of, in many cases, near death experiences. And, you know, kind of no curve actually goes up into the right all the time that these are, you know, things that kind of go up and down. And hopefully you end up at a point higher than where you started. And so yeah, that’d be great. I always, I always love to hear from entrepreneurs about the, the hard parts of the journey that kind of got them to where they are, and even cases where they failed, because I just I think those stories are too often untold. And I think it just, it gives entrepreneurs A, it’s not a false sense of hope. But it’s a it’s just an unrealistic understanding of kind of what the journey can look like. And I think it’d be a lot easier for people to approach the journey if they understood going in what it was going to look like.

43:21
Scott, what investor not at a16z has influenced you most.

43:27
We had the pleasure of when we were at our company, loud cloud and Opsware, of having Andy Rackleff. On our board from he was one of the original founding partners of benchmark. And you know, Andy Asher was also at a firm called Merrill Picard, even before that, which was kind of the progeny of benchmark. And he’s been great not only because he’s he was always incredibly generous with his time about helping us understand what he was doing, but really encapsulating a lot of things that we’ve talked about today. So the idea, you know, Andy, I think and think I may have it in the book, he’s got this, I’ll get the exact quote wrong. But something like his view is you always invest in markets over teams, because, you know, good markets can sustain a mediocre team and bad markets always beat a great team. I think I got it, right, something like that, you know, really good thinking on that stuff. He’s one of these very critical thinkers about just kind of the role of venture capital, how it works. He teaches at the at the business school now at Stanford, and kind of, you know, you know, helps a lot of younger people out. So I always I just always been very impressed with both his intellect and his, his performance as a venture capital. So it was it was tremendous, but also his kind of, you know, thoughtfulness around the business and willingness certainly to help people like us, we were new in the business understand how it works.

44:28
Scott, what’s the one thing you know, you need to get better at?

44:32
I think the biggest thing as we need to get better at as a firm is getting in front of opportunities as early as possible. And I know that sounds a little bit like motherhood and apple pie, but I think we’ve been lucky, as a firm in that we’ve, you know, I think built a very strong brand. And we’ve got, you know, kind of great relationships in the industry. And so, we will see all the great opportunities, when in fact, they’re happening and so and that’s, you know, a very incredibly lucky and wonderful place to be, but you know, to kind of go back where we started so much of this business is a relationship business. Is that I think, the more time we are spending kind of 1218 24 months with entrepreneurs, and kind of paying it forward by being a resource to them, before we ever have an economic interest in the company, I just think that’s a much better place to be in this business. And we are, I think, doing a good job on that. But we are constantly criticizing ourselves and kind of looking for ways in which we can actually, you know, dramatically expand those efforts. And

45:20
finally, here, what’s the best way for listeners to connect with you?

45:23
Yeah, so obviously, I’m on Twitter at SK up or you can always send me an email, which I won’t give out on the air, but you can if you can’t, my guess is you can find my email. And it’s our email convention is not that complicated. So you can probably figure it out. But yeah, I’ll be and read the book and people get a referral in right. That’d be great. Absolutely. Yeah. Anytime happy to do it.

45:43
Awesome. Well, this has been a huge pleasure you guys are are true pioneers in the industry. A big inspiration as should be quite clear, based on the discussion here. So Scott, thank you so much for taking the time and everyone in the audience out there, I recommend you pick up the book. It’s called the secrets of Sand Hill Road. So Scott, thanks so much.

46:00
Well, thank you. I appreciate the time and obviously I look forward to hearing from your listeners.

46:09
That will wrap up today’s episode. Thanks for joining us here on the show. And if you’d like to get involved further, you can join our investment group for free on AngelList. Head over to angel.co and search for new stack ventures. There you can back the syndicate to see our deal flow. See how we choose startups to invest in and read our thesis on investment in each startup we choose. As always show notes and links for the interview are at full ratchet.net And until next time, remember to over prepare, choose carefully and invest confidently thanks for joining us