54. The Path to Series A, Part 2 (Semil Shah)

The Full Ratchet Podcast on iTunesNick Moran Angel List

Semil Shah of Haystack joins Nick to cover The Path to Series A, Part 2. We will address questions including:

  • Semil Shah Series A Part 2We are all looking for great founders and teams at the seed stage. What additional team dynamics and construction may A round investors be looking for beyond what’s required at seed?
  • What exit outcome potential do A round investors require and how does that impact the way entrepreneurs should frame their pitch at this stage?
  • What is the biggest difference in the fundraising dynamic between Seed and A and why does the leverage shift during the negotiation?
  • How are LPs impacting the price VCs are willing to pay and what macro trends are causing this?
  • It seems your approach is unique from other investors…. what do you do differently w/regards to helping your portfolio companies on the Path to A?
  • Any other thoughts or advice for investors and entrepreneurs trying to obtain Series A funding?
  • There was an article from Sequoia about their scouts. Related to that… do seed investors partner w/ series A investors?

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Key Takeaways:


1- Rifles over Shotguns

Samil talked about how it’s best to have a targeted short-list of preferred Series A investors that a founder should want on their board for the long haul. Approaching this round in a targeted way shows an ability for precision-like thinking. A desire to minimize time spent b/c the founder’s time is better spent elsewhere. And it demonstrates that the founding team is willing to do some homework earlier to find the most suitable partner.

Creating a google doc of 100 investors that the startup is trying to get introductions to, is a clear signal that the thought process and approach are off. Treating this like a common application to college shows that the entrepreneur does not realize the importance of fit and that this institution will be tied to them and associated with them for many many years.

And prior to making a seed investment Semil monitors if:

  1. They have the desire to go down the VC fundraising path
  2. They have the maturity and intellectual curiosity to go do it


2- Rolling Closes and Stacked Notes

Today we talked about the rolling close, stacked notes and the problems they create. We’ve all heard the terminology from entrepreneurs. “Well, first we did a friends and family round, followed by an angel round, then a pre-seed round, then our formal seed round and now we’re doing a seed-extension.”

Not only does this undermine the stability of the company, b/c the cap table is a mess, but this also undermines the decision-making process of the entrepreneur. If the company is being put at risk with multiple tranches of stacked notes at different caps… what other suspect decisions are being made that may compromise the business? Samil mentioned that some A investors are willing to help fix the cap table, but most will not even engage until the founders have recapped the previous rounds and streamlined ownership.


3- Team, Vision, and Metrics… in that Order

Samil stressed that professional investors will still emphasize the importance of team first. VCs want to work with people they like, that they are inspired by and, ultimately, can learn from. After that, the market potential and vision of the startup are critical. Here Semil cited Chris Dixon’s excellent article, The Idea Maze, where the founder walks him through this labyrinth of how they’ll get from A to B.

And with regards to the numbers, he said that the metrics disprove delusion. Of course, it depends on the sector and company type, but the metrics should substantiate the story. If the numbers aren’t supporting the vision, then delusion may be proven.

And recall that Semil stressed the importance of progress. Many Series A investors will ask when a company was founded because they want to see strong momentum and progress. If the company has been around for a long time and hasn’t hit their growth curve, they may be looking for the milk carton expiry date.

Tip of the Week:   Lost Leverage & the Captains of Crunch


*Please excuse any errors in the below transcript

NICK: Semil, we are all looking for great founders and teams at the seed stage what additional team dynamics and construction may E ran investors looking for beyond what is required at the seed.

SEMIL: I think they just want to see a good team fully formed necessarily they doesn’t have to be but something where people are in the key functions so like you know maybe that’s the 2 founders, a head of sales and a director of engineering and maybe they got a couple of holes they need to hire eventually right.

So I don’t want to say that’s it is going to be like a whole tram but it’s like the CEO and the founders like to demonstrate that 1) they are thinking about it and thinking that it is important and 2) you can actually tract the (6:21) right.

NICK: Yeah It is a challenge, what exit all the A Round investors require and how does that impact how entrepreneurs should frame their pitch at this stage.

SEMIL: So the entrepreneurs should always be gunning for here is how we became an independent company you don’t need a bail out right, so the entrepreneur should always show a path to independence how do we become a big self sustaining company.

What investors will do behind closed doors is depending on the fund size if it is if someone is doing a $5M to $10M A round and then there is a $200M fund you know they are trying to get to a multiple where they feel like there could be an exit, right there is only 2 exit pass so they will do an exit profile and kind of say hey we think you can reach this level.

You know it kind of give ten exit to the bar but as the fund size gets bigger they need to see potential larger multiples so it is really a function of fund size. If you and I started a company and we go pitch it to a $125M fund to do $3 or $4M and ask for you know $1B fund their return profile what they need is very different.

NICK: I am trying to think was it you that wrote about a certain amount of ARR in the next 5 quarters.

SEMIL: No it is probably Tom because that is more of a SAS thing.

NICK: Yeah I got it, sorry.

SEMIL: but folks at SAS tend to look at core or data and they want to see like 6 months data they want to see that you are growing every month and that there is an average sales price ESP is high and you can sell them to enterprise. The SAS folks are kind of like the sabre magician as they are in base ball they are like the sabre metrics of SAS right.

NICK: So what is the biggest difference in the fund raising dynamics between seed and why does the leverage shift with regard to negotiations.

SEMIL: There are few points one is money and sees because there is so many people start the companies and entrepreneurs can dictate the amount that they raise and the caps that they raise them on. They can dictate the timing associated with it because they are using notes which are rolling not equity which are price at a moment in time, and frankly we are in a culture of you know we still in a Mark sucker burg social  net work this is what you do culture, right.

So that’s what happens at seed what happens at A and why things shift is because it is more of a zero in most cases not all for venture investors they have to own a certain percent for their model to work, they have to lead the round and not have other VC on the round, right.

They have to compete against other VC for a hot company so I might want to do an investment in segment IO which is a very hot size company but I would probably lose that even though I have identified it to these 3 other people who are just experts in SAS and have a portfolio and the is just going to pick them, so it is a totally different game totally different game.

NICK: Do you feel like the investors have more like the leverage at the negotiation stage.

SEMIL:  Oh yeah I mean there is no question, the only caviar is somewhere rounds now that the environment has changed a little bit a seed investor can go in and say the team is raising 50 on a $4M cap and they got a couple 400K the seed investor can go in a say hey here is 500K here is a seed investment, right, and boom I already own over 10% of your company.

And by the way if I got the cash I am hopefully picking you because you don’t need my daily or weekly help but I trust you to get to a point where once you ready for introductions we will make them for you, so there is a few cases where that applies but generally no.

NICK: Can you talk about how seeds are impacting the prices VC are willing to pay and what (#) trends are causing this.

SEMIL: Yes one is there are many more LP’s that are coming to their asset class, not that the asset class is booming it more types of so instead of just endowments, foundations, corporations, fund to fund, you now having sovereign law funds, you are having corporate balance sheet have families coming in right at larger amounts and so some of them may want to do direct investments.

So they may ask their GP’s hey we will fund you we will be your backers but we will also like to see your general flow or they may say hey I don’t like, you know I have been in this fund for 3 or 4 cycles and I think they suck now so let’s spin out a couple of the two and fund them, right because they have all the deal luck so there are a lot of new fund creations as a result of LP’s either trying to invest directly or trying to fund the people who actually have the deal flow and the brand in some cases. So that’s partially why you see the (# 11:27) of more funds being created.

NICK: You think that’s also pushing prices up.

SEMIL: That’s a very good question and I am not sure I am qualified to answer, pushing prices up, yeah because if you have more people competing if you have more funds competing for an investment and it is a good investment yes it benefits the entrepreneur because the cost capital is cheaper, so yes.

NICK: Semil it seems your approach is unique from other investors what do you do differently with regards to helping your portfolio companies on the path to A.

SEMIL: So in general I think the idea of a very active helpful roll up your sleeve investors completely over blown and a marketing tactic that people use, one to position themselves in the market and in the sales process to sell entrepreneur they use it to sell themselves LP’s and to make them look like they are active.

I like to be active in the situations that matters but I like to pick people who necessarily may not need my help for months so my view is to depict people in markets and pick products in markets and I think you being dynamic and at the point where I feel that I can help them get on the path to do a series A round hopefully they will take my advice right, sometimes they don’t you know can’t control that but I try to determine that upfront.

NICK: Any other thoughts or advice for investors or entrepreneurs trying to obtain series A funding.

SEMIL: So for funders I mean just read and listen to all the stuff I have produced in the past and really study it and listen to this interview, for investors I think I have been surprise there is very few seed investors who think about the next round methodically. Now part of that is because a lot of funders just don’t want to listen and part of that is it actually takes time and relationships to make those things happen.

I can tell you how many times that I run into a series A or B investor in the neighbourhood on the weekend and we will be texting on the week end or having a beer and I would just tell then a story about a funder and I am like she is amazing in the 6 months I have been working with her and really ramping up and they would say I would love to meet her and I would say well she is not raising and they say still love to meet her.

And so a lot of it is way, way more personal and in those situation the seed investors can’t lie, right their currency is being honest and so I would just say for seed investors who want to go in or maybe get better at it I don’t want to say that I am an expert although I am I would say it is the most specialized thing that I do is to think about that process and how other deals actually gets done.

Because it is a mix of left brain right brain in terms of making sure that the company has the proof and the provenance if you will to make it look legitimate to warrant a 60 minutes meeting of someone else’s time is very valuable but also the other softer side of hey I think this person will get along with this person, right and that doesn’t come up on the spread sheet.

NICK:  Yeah there is a sort of a personality fit with a lot of these things.

SEMIL:  That’s why I never worry about software replacing what I do because the last #(14:50) of everything I have to use my brain because it always comes down to one or 2/ 3 things that I can do and in that last moment I do use some software to get it to that point and then I pick.

NICK: You know there is this article recently about the sacoya #(15:05) scouts and how they are scattered all over the place related to that do seed investors sort of partner or have their sort of series A investors that they most often work with and then and sort of stick in paths from that stand point.

SEMIL: I think some very experience ones do so sure but not many, I think that part of my job both for the LP’s and the investors and the funders that allows me to come on and in order to do a job for them and the future is to really understand the survey landscape of who are the downstream investors that are suitable right, and to make sure that I have a good sense of who that is and that can change every 6 months.

NICK: Semil, can you talk about some of the things that you currently most focused on.

SEMIL:  Mainly the challenge has been just building long term LP relationships so in addition to the daily weekly meetings companies open up companies you already invested in trying to build a long tern relationship so that I can continued to have independent funds because it is very competitive and difficult to raise funds from LP’s it takes just a long time and it is very ineffective so that’s probably the one thing that I spend my most time thinking about and it is most inefficient use of my time but it is so very important that’s what I would say.

NICK: If we could address any topic in Venture what topic do you think we should address and who would you like to hear speak about it.

SEMIL:  I think the one thing that is kind of technical that sit between Venture Funds and LP’s is this idea of the LP and the GPs wanting to have an image that they are extremely selective versus the realities of how wide a funnel could be at the top and how you have to actually have to spray and so the very early stage of investors are accommodators 500 start up Sequoya scouts all these other things I am actually going to make poster about this it is spray and pray.

You want to just catch them you index it and obviously it has some filter so it is not completely scatter shot but it is still an index. A lot of the larger LP just want an investor to come in a pick the winner out of the hand and it doesn’t happen like that so to me the Sequoya scouts are the miracle for the trigger for me to write this poster that I am going to write which will be its not spray and pray its spray and pray plus pets and that I think would be a good issue for people to discuss more openly because it is silly to think that Venture investors knows there is A& B and that they are picking a winner they don’t know.

NICK: Any quick thoughts on title 3 and what that might mean for the start up fund raising land scape.

SEMIL:  That doesn’t sound great to me but I guess not a lot of the investors can invest in the stock market so the problem is that there is liquidity in the stock market so if you start day trading and then start drinking whisky and then stuff can goes bad you can kind of get some of it out its pretty liquid here, so I would say you know the logically answer there is it is probably okay once the liquidity is in place.

NICK: Great finally Semil what is the best way for our listener to connect with you.

SEMIL: You know this could actually been some topic because I have been thinking about this I have been over loaded with email and it is a great problem to have and I may and I am not sure yet I may ask people who want o meet me to at least get a warm intro not an intro but a warm intro like 3 to 4 lines maybe some specifics from somebody I know, because I don’t know how else to sort everything.

The only caviar is if someone is building something very specifically and knows the areas that I am investing in that’s fine. Those are probably going to be my 2 filers if they fit the criteria or is it through somebody I know that’s probably be the best way and I will write that post very soon that would be like okay here is what I.

NICK: Any points that I should direct listeners.

SEMIL: Yeah twitter or my blog is fine I mean that’s it s pretty easy to reach me I am more accessible than most and I am responsive about email as much as I can be.

NICK: Well Semil thank you so much for sharing your time today I really enjoyed your writing especially the long form stuff for some time now so please keep writing and thanks so much for doing the interview.

SEMIL: Yeah thanks for reaching out and I look forward to hearing and hopefully I didn’t say anything offensive.