What’s the third option for a company exit?

playbookFor many years I’ve been tutoring founders on ways to exit their startups. And each time I explained that there are three ways: going public, being acquired, or paying off your investors I felt a little silly offering the third alternative, as I’ve never heard of anyone doing that!

But the article Benching your VC: The employee buyout playbook by Yaacov Coehn co-founder and CEO of Harmon.ie is worth reading, even if your company is not currently in a position to be acquired.

The article is a case study in a management buyout of a venture capital-funded startup. Here’s the essence of the story in the first paragraph:

Grow or sell? It’s the ultimate dilemma for startups. This dilemma can become even more acute when you’re the CEO of a VC-funded startup. You want to develop your product, while driving sales and marketing, so that the business can reach its full potential, but your VC’s fund has reached maturity and they want you to sell your company to a larger firm. What do you do when your values as a business leader come into conflict with your investors?

Not only have three of my startups been acquired, but I worked on acquiring three companies when I was working for the Thomson Corporation (now Thomson Reuters). So I’ve seen both sides of this dilemma. Fortunately for me, our investors were tremendously supportive in all instances; we didn’t have to battle with our boards over deciding to sell the company. Although the VCs were far more aggressive in setting the asking price!

Yaacov Cohen takes you through his experience step by step as he negotiates a management buyout of his company. The obvious question in this situation is, “Where do  you get the funding?” In this case, the capital came from three sources: management’s pension funds, friends and family, and a bank loan – which represented 75% of the purchase price.

I’m not going to reiterate Cohen’s story, but it’s worth recapping the happy ending to what was a difficult multi-month process:

No matter how you slice it, an MBO will drastically change a company and how it does business. Among our employees, we see a new sense of shared ownership and shared responsibilities. No longer “just” employees, the staff is motivated to go many extra miles to get things done, because they have a stake in the results beyond their paycheck. We were able to attract new talent to the company. We were able to attract new talent to the company including a VP of AI and an experienced GM for our North American business. We also leveraged the MBO to attract industry leaders to our newly appointed board of directors, so even as an employee-owned company, we are receiving top-notch guidance from an independent board.

Even the customers have been affected for the better:

Our customers have been impressed, too. Because the people they are working with are now owners, customers feel they are getting better service and results from their relationship with the company.

One of the sayings I use in my mentoring is “He or she who has most options wins.” Yaacov Cohen’s story proves that the third option for a company looking for an exit – buying out the investors – is not simply theoretical, it can and has been done successfully.


What’s the average age of the successful entrepreneur?

Screen Shot 2019-09-03 at 9.01.31 AM

The media has done an excellent job of promulgating the myth of the whiz kid entrepreneur, likely galvanized by Mark Zuckerberg and the monumental success of Facebook. The typical Silicon Valley success story leads with the Stanford student, or better yet, a Stanford drop out, who raises millions of dollars to build a world changing company.

And from where I sit, mentoring students and recent alumni of MIT, the myth certainly seems true. Even the alumni skew to being less than 30 years of age. I’ve yet to see a faculty member and I think perhaps only one or two staff have appeared in my ventures to be mentored queue.

Of course, I’ve seen studies showing that startup founders tend to be far older than the Mark Zuckerbergs of Silicon Valley fame, but I largely dismissed those studies as they included founders of small, no-growth businesses like pizza shops and dry cleaners, not the fast growth startups I’m used to working with. These studies showed that owners of small businesses tended to be in their late 30 and 40s.

However, new research by the economists Pierre Azoulay of M.I.T., Ben Jones of Northwestern, J. Daniel Kim of the University of Pennsylvania and Javier Miranda of the United States Census Bureau, provides the first systematic calculation of the ages of the founders of high-growth start-ups in the United States.

This research is highlighted in The New York Times article Founders of Successful Tech Companies Are Mostly Middle-Aged by Seema Jayachandran.

After stripping identifying information, the government provided the researchers with a data set including 2.7 million business founders. The researchers calculated that the founders’ average age was 42. And for the founders of the 0.1 percent fastest-growing firms, the average age was 45. Firms that were successful enough to have an initial public offering or be acquired by a larger company showed the same pattern: Their founders were generally middle-aged.

The bulk of the article focuses on Tony Fadell, founder of Nest Labs, father of the iPod and key player in the development of Apple’s iPhone. His story is well worth reading about. But unfortunately the author misses a key point about entrepreneurs and why their age averages out to 42 years: I wager that a large number of successful entrepreneurs are serial entrepreneurs. Serial entrepreneurs often try, but fail at their first or even second startups. But they perform the number one job of the founder: to learn. And they apply that learning to their following startups and thus avoid many of the mistakes first time founders make. It is unfortunate that the census data the study relied upon did not provide data on how many businesses these founders started or co-founded.

Back in the last century the received wisdom amongst VCs was to be leery of funding founders who had already tasted success. They reasoned that successful entrepreneurs would lose that lean and hungry drive so necessary to building something from nothing. Now, three decades later, venture capitalists learned what Hollywood knew years ago: better to back a director who made one film that flopped that someone with no directing experience whatsoever. I’d venture to say that there is now a positive bias in favor of serial entrepreneurs, successful or not. In fact many VC firms have “entrepreneur in residence” programs to bring their successful founders in house in the hopes that they will help the venture firm spot winners or even start a new company, to be backed, of course, by the hosting VC firm.

So what’s the lesson in this new study for founders? If you are young you can leverage the bias in favor of youth: risk-taking mindset, raw problem solving capability and pure energy. And if you are headed towards middle-age, or even there already, you should position yourself as older but wiser, with great examples of how you have learned from experience. Either way, founders are the product – the best investors put their money on great founders, not great ideas. Great ideas are cheap, not so great founders. Finally diversity  wins when it comes to teams. So if you are a recent graduate make sure your co-founders have experience working in startups and in tech companies. And if you graduated some time ago, then play up your experience and look for younger teammates. As I say to my mentees, marketing is 90% positioning. As a founder you are marketing and selling yourself constantly: to investors, employees, partners, the media, vendors and others. Play to your strengths and build a team that can cover for your weaknesses.

The startup investment timeline

vc process

One issue that continues to surprise me in meetings with founders is their expectations about how long it takes to raise capital. I recently met with a couple of founders who thought they could raise angel capital in a month! I thought it would be helpful to put together a typical timeline for raising capital from professional investors. You might be able to raise capital from friends and family in a month, but you should plan on taking six months from a standing start to raise capital from VCs or angel groups. There may be an angel who falls in love with your venture or who is a total newbie who will invest sooner, but that’s the exception, not the rule.

Typically it will take you 6 months from the day you start to the day the wire transfer is in your company’s bank account or the check clears the bank. It can take a lot longer.

Day One

Here’s what you need to get started:

  • a one-page, highly graphical executive summary
  • 30 second pitch
  • 4 minute pitch
  • 20 minute pitch
  • list of investors who are a fit for your company – meaning they have invested in other companies in the same or similar space previously
  • warm introductions to investors who fit your profile

Here’s what you need to do. Email your one-pager to the partner at the firms you are targeting. Make this a personal note referencing the introduction from your mutual acquaintance and requesting a meeting.

One week

Follow up your email with a phone call. If you don’t connect leave a succinct voice mail message. Turn off caller ID, then keep calling but don’t leave messages. You don’t want to look like a pest! Try calling first thing in the morning, many VCs get to the office very early – say 7:00 am and call late at night, say 8:00 pm. You job is to get the meeting! If necessary settle for a video call, but not a POTS voice call. That way you can have your executive summary available on the call.

One month

Congrats! You got the meeting. But investors are very busy. So the time from your phone call being answered to getting a meeting can be 4 weeks. That’s the good news. The bad news is that your meeting is not with the partner, but with an associate. Associates can’t make investment decisions; they screen for partners. Make sure to follow up your meeting with the associate with an enthusiastic email covering any points missed in the meeting.

Two months

Congrats again! The associate likes your venture! He’ll setup a meeting with a partner. But the partner’s on vacation so it will take a while. Keep pushing your venture forward! The more value you create the higher your valuation.  For the next meeting you will need a set of financial statements (income statement, balance sheet and cash flow), sales projections, unit economics –  but far more importantly, your financial assumptions.

Three months

Finally you get to present to a partner. He asks a lot of tough questions but you have prepared for virtually of them, which blows him out of the water. The demo of your product has him leaning forward. He tells you that he’s so excited he’s going to invite you back to meet another partner.

Three and half months

You blow away the other senior partner as well! Next step? You get to present to the entire firm. It’s show time. But keep in mind, all investment decisions by partnerships must be unanimous. Just one naysayer can kill your deal, so don’t ignore anyone.

You prep for the partners’ meeting with a friend or two who have been through it and role play with you.

Four months

You ace the partners meeting! Next step is due diligence. You need to get to everyone who you have ever worked with and prep them for a partner’s or associate’s call. Just to be on the safe side you talk to your kindergarten teacher as well. To prepare you put together a binder of all contracts the firm has entered into, the NDAs the staff and execs have signed, your cap table (which better be accurate and clean), references for the entire senior management team, a list of customers to call  – in other words every possible document an investor might want to review and contact information for anyone they might want to talk with. Your job one – make the investor’s due diligence process as simple and easy as possible by providing them needed contacts and documents. Job two, have you done your due diligence on the firm? You may want to bring in an experienced CFO to help you prepare the due diligence folder. There are many available on a consultant basis.

Five months

Congrats again! You passed due diligence with flying colors! The firm tenders you a term sheet. You have it reviewed by your attorney, who has seen hundreds of them. You have reviewed it with your consulting CFO. Both advise you to accept it, as you don’t have the time to get into a negotiation with this firm over a fair offer, as you are running out of cash.

Six months

You are invited into the VC’s offices to sign a zillion copies of the funding agreement.  Two weeks later the investment is wire transferred to your bank. Congrats! The
pre-season is over, time to play ball!

Note: it’s been several years since I’ve raised capital so this process may have changed somewhat, though from what I know from founders and mentors, it hasn’t changed much. And every investment is different. Just keep in mind it will take longer than you think, so manage your cash accordingly.

What do VCs look for in startups?

desktopThere is a lot of advice on how to develop an investor presentation, I have plenty myself on this blog. But looking at an investment not from your perspective as a founder but rather from the perspective of a VC can yield some useful insights. Dr. Jitendra K. Das, Director of the FORE school of management makes a couple of useful observations about venture capital funds before launches into his list of what VCs are looking for in startups;

  1. The age of the specific fund that the investment is coming from. Once a founder has found a partner in a fund who wants to invest in his venture their due diligence needs to ascertain the age of the fund. Dr. Das provides a helpful example of a fund raised in 2010 with a tenure of 7 years, looking at an investment in 2014 would have looked at a time horizon of only 2 – 3 years.
  2. Pareto’s law applies to VC funds. It projects that only 20% of a fund’s investments will return 80% or more of its returns. The other 80% are either outright failures or what VCs call zombies, companies that trundle along with no exit nor returns in sight

I’m going to go through all of Dr. Das’s elements from his article What Venture Capitalists Look for in Start-ups, but with my own take on each of them, referring to relevant posts on this blog. I will also provide definitions for common investor terms, like step up.

Team Strength

I was taught by VCs that their first and most important criteria in making an investment is the team. And looking at the team, the CEO represented about 70% of the decision. This is where a team of all-stars will lose to a team of hard workers who are well-aligned and extremely hard workers. A team must be aligned across values and goals and relentless or it can’t win.

Pain Points Addressed

Otherwise known as the customer problem, the cliche question, Are you a pain pill or a vitamin? Here I disagree with Dr. Das. Focus on the most important pain point of your customer; trying to address multiple pain points is a formula for losing focus. And what is the customer currently doing to reduce this pain?

Business Model

Here again I disagree with Dr. Das. Many startups don’t have a business model at zero stage, but have brilliant founders, great technology, and a huge market. Google is the canonical example; they had no business model as a raw startup. Their ad auction model only developed after several years. However, it cannot hurt and will help, if you can pose multiple business models which you plan to test.

Market sizing

Dr. Das states This is usually looked at top-down, i.e., from total population, to addressable market, to planned reach, to market share. I advise my mentees against this model. Founders should project their addressable market from the bottom up. For example, if your business model is direct sales, you need to build a model that includes what size territory your sales people will cover, how much revenue that can drive, how many sales people will be needed to cover your addressable market, the average revenue per sale, etc.  Top  down projections done as a percentage of total market are scorned by VCs. They usually take the form of, There are over a billion people in China and they all need toilet paper, so if we just get 1% of the population buying into our subscription model to our very unique and truly revolutionary toilet paper, we will be making $15 million in year one and by year five we’ll be a unicorn, a billion dollar company! Not.

Progress Achieved

This is generally known as traction. Traction is customer focused; how many paying customers, what is your customer growth rate, ARPU (Average Revenue Per User), etc. Unlike market projections, this has to be hard evidence, not visionary projections. It’s what you have done, not what you hope to do.

Competitive Landscape

As the barrier to entry for new companies get progressively lower, thanks to cloud platforms like Amazon’s AWS, VCs get more interested in who your customers are and what your sustainable customer advantage is. When I was starting companies the number one question from all VCs was What will you do when Microsoft decides to enter your market? Today it might be one of the FANG – Facebook, Amazon or Apple, Netflix and Google. Fill in your favorite incumbent company. Focus on how you will sustain your competitive advantage both against the big, slow giants and the fast, nimble newcomers.

Financial Highlights

What’s most important is not your Excel spreadsheets, which VCs will either ignore totally or give all your projections a 50% to 75% haircut, but what are your financial assumptions for both operating costs and revenues?

Fund Asks

Also known as your raise and your use of proceeds. Your raise should last you 12 to 18 months, depending on your burn rate – how much cash are you spending per month? What milestones will this investment help you to reach? Will you need further rounds to reach cash flow breakeven – in other words when will your venture be self-sustaining and not need any more investment?

Valuation Ask and Equity Structure

This combines one of the most difficult tasks, valuing a company and one that should be straightforward, who owns what percentage of the company – otherwise known as the cap table? If you have already sold equity you will have to demonstrate why your valuation has risen, known as the step up.  Present a range, based on similar ventures and the same stage as your venture, known as comps. VCs will push very hard – downwards! – on your valuation. So you need to do a lot of homework on this one. Tie in your traction and all available evidence to back up your valuation.

Exit Options

Here’s another place where what I was taught by VCs differs completely from Dr. Das’ recommendation. While times may have changed I still think the best answer to this is “We plan to build a great company!”

As Doctor Das notes, this list is only a high level overview of what investors are looking for. There are several posts on Mentorphile on this topic including Questions to address before raising capital, Investors questions to address and A VC’s questions mirror those of a good mentor.

Finally review the post Some less than usual VC questions you may need to answer.

And once you are in an investor meeting and you are asked a question you don’t know answer to, there is only one correct response: I’m sorry but I can’t answer that question right now, but I’ll get back to you on it in the next 24 hours. There’s nothing worse than trying to bullshit a VC, they are extraordinary bullshit detectors!

A successful founder on how to pitch – including a founder’s biggest challenge

the problem

Henry Ward’s first start, Secondsight, was an abject failure. But Manu Kumar, an investor in venture capital firm K9 Ventures, gave Ward an idea for a second startup that resulted in Carta,  a platform valued at $1.7 billion for buying and selling shares in private companies. (Kumar is a cofounder.) But that’s not the point of Business Insider’s interview with Ward, The founder of billion-dollar startup Carta dissects the pitch decks that helped him raise $448 million.

While there are probably thousands of articles on how to pitch, including several on this blog, what’s rare and valuable is to have a successful founder walk through his pitch decks that succeeded in raising almost half a billion dollars.

I was pleased to see Ward promote the book The Presentation Secrets of Steve Jobs, by Carmine Gallo, my favorite book on how to do a killer presentation. One of Jobs’ and Ward’s key takeaways is to practice. As the old joke goes, a musician asks someone on the street, “What’s the way to Carnegie Hall?”, he replies, “Practice, practice, practice.” Not enough presenters memorize not only their presentations but their every move and expression in delivering their pitch, just like an actor memorizes their part. Ward used to write out his pitch literally word for word. Once he did that he could improvise.

Ward explained the entire business model of Carta in just three slides. As he says, make every word and image count.

Ward has an interesting argument on what an  early stage pitch deck should accomplish. While I, and many others, see it as a “convincing game” Ward sees it as getting the investor excited about the venture and thinking about what the company can become in the future. He sees the pitch process as a filtering process, the founder needs to keep going until he finds an investor “that’s passionate about the problem you’re solving.” Investors who are not excited will ask a bunch of questions about what could go wrong in your business. An investor who gets excited will ask about what could go right! He could tell in 10 minutes whether an investor would invest in his venture or not.

Ward had a great tagline for his business, something all founders need to work on: “Nasdaq for private markets”. Still persistence is what paid off, he had to go through about 70 angel investors to get a few who were truly excited. And those investors would then call other investors and say, “Hey you should check this company out.”

Ward sees The Problem as the key slide in any Series A  deck.  What Ward calls the “domino chart” is a bar chart that illustrates the network effect of Carta’s business model.

An important point that Ward makes is that financial slides are NOT public. His deck had about 10 financial charts including payback period, average contract value, net dollar retention and margin assets. Metrics are vitally important in providing a snapshot of the company. Ward’s comps were all mega successes like Google, Facebook and LinkedIn – all companies that leveraged the network effect to world domination.

Because VCs are looking for grand slam home runs, Ward articulated a vision that went 20 years out! No five year plans for him! Another key point is to fish in the right pond. Carta was a fintech company. Ward took 30 meetings on Sandhill road and didn’t get a single term sheet. He then went to New York City. Result: three firms, three term sheets. As he says, “fintech infrastructure just wasn’t a Silicon Valley thing in 2014.”

Ward recommends that founders have a set of pitches: the 30 second version, the elevator pitch; the two-minute version, the intro pitch; the 10 minute version for recruiting an executive; and a 30 minute pitch for investors. As Ward says, he can do these pitches “in my sleep now and you will too if go out there and do the reps.”

His biggest problem in his first pitches was demonstrating that he had a large enough market – not an uncommon problem. Beyond product-market fit Ward talks about message-market fit. That means finding the message that will resonate the most with investors. He recommends that you practice your pitch with CEOs who have raised money. And by constantly iterating on your pitch you can figure out what is resonating and what is not.

If there is one big takeaway from this interview it’s practice, practice and practice some more. But make sure that you are iterating your pitch, it doesn’t help to keep practicing a pitch that doesn’t resonate with investors. And how do you measure resonance, the level of excitement investors demonstrate. It’s that easy to see and that difficult to achieve.

Why is seed funding down when VC funding is way up?


As a mentor, I work exclusively with early stage companies. When these companies go out for funding they are looking at friends and family, angels and angel groups or VCs that fund seed rounds.

Unfortunately as the Wired article ‘Blitzscaling’ Is Choking Innovation—and Wasting Money, sub-titledVCs are making bigger bets on fewer startups. It’s this unconsidered, money-slinging strategy that led to Uber’s and Lyft’s dud IPOs seed funding is down even while total VC funding is way up.

VC investments last year set an all-time record in the US of $132 billion. This sounds like great news for founders. But deal size has been steadily growing. Do the math, bigger deal sizes equates to fewer deals. As the author, Leonard Sherman asks: why has the number of seed funding rounds—the entry point for most entrepreneurial journeys—declined so sharply over the past five years, despite the fact that the cost of launching new ventures has never been lower?

In 2000 Leonard Sherman’s company needed only one institutional funding round of $15 million to launch his company. But here’s the difference between almost 20 years ago and today. Then virtually all that capital was consumed by the need to buy and maintain servers and storage devices, to write highly customized code for every business process, and to build market awareness through expensive, inefficient mass marketing channels.  Launching that same venture today would probably cost 90 percent less, thanks to modern enabling technologies: open source computing, rapid wireframe and product prototyping tools, contract manufacturing, fulfillment-as-a-service, web-store design, cost-effective social media customer targeting, and cloud-based services like Amazon’s AWS, Google’s Cloud Platform and Microsoft’s Azure.

So that sounds like great news for founders, and it was for the 15 years of the new millennium, as the number of angel and seed deal rose steadily. But:

over the past five years, entry-round investments have declined by more than 40 percent, while average deal sizes have risen. The primary reason is that early-stage VC funds generally have found it more lucrative to place fewer, bigger bets, rather than spreading investments more thinly. This practice delivers a big win when the bets pay off—particularly for seed VCs with higher ownership stakes. But now, more than ever, entrepreneurs find themselves folding for lack of seed funding.

This is the driving reason behind the decline in seed stage deals. That, as well as new sources of capital making huge bets, like Softbank’s Vision Fund’s $300 million investment in dog walking service Wag. But that’s peanuts compared to Softbank’s $10 billion funding for co-working office-space startup WeWork.  (However, WeWork’s losses are accelerating even faster than its revenue growth.)

This flood of late stage capital into relatively few companies leaves less money for riskier bets on startups. But having vast sums of capital does not guarantee business success. Today’s VCs would do well to look back to the successes of companies based on the strength of their technology and business models, not venture capital: the total VC capital raised by Amazon ($108 million), Google ($36 million), and Salesforce ($64 million) prior to their IPOs and subsequent value creation would barely register as a single supergiant round in today’s blitzscale funding environment.

The poor IPO performance of companies like Uber and Lyft, which both raised billions of dollars in VC financing, might help turn the tide against late stage mega-financing and perhaps more VCs will look to spreading their risk by investing in more seed stage companies, which can ultimately provide enormous returns as have Amazon, Google and Salesforce. Until then founders would do well to look at various alternatives to VC funding such as angels, angel groups, crowdfunding, convertible debt, SAFEs, strategic investors, grants like SBIR, incubators, royalty-based funding, and such novel, nascent funding sources as digital tokens and the JOBs act.

For a bit more detail on alternatives to VC funding take a look at the attached presentation I gave last night to a sub-group of the MIT Post-Doctoral Association on different ways to raise capital: Financing a Startup

Dilution: a 4-letter word for founders


Like it or not, virtually all tech startup founders will face dilution, the erosion of the percentage ownership in the venture they founded due to having to sell off their equity to finance the venture.

The article Dilution: The good, the bad and the ugly by Bernard Moon is a recommended tutorial for founders before you begin the process of raising capital. Keep in mind the source, Bernard is a VC at SparkLabs Group. If you want the VC perspective on dilution for founders their experience of investing in more than 230 companies is well worth reviewing.

For those of you not needing Bernard’s math through possible seed rounds to how future rounds dilute your ownership, I’m going to just highlight some words of wisdom to keep in mind regarding valuation, perhaps the most contentious issue both for founders   and investors (it’s a zero-sum game). While Bernard does a good job of defining a Good Series B (excellent execution) versus a Bad Series B (poor execution or mismanagement; product too early or too late; longer than projected sales cycles or market forces outside the founders’ control) he avoids the nightmare scenario I’ve posted about previously: asKryptonite for founders – the down round. 

As noted previously, trying to predict revenues for a startup is exceedingly difficult. But you should know your operating costs and be able to predict them with a reasonable degree of certainty, especially fixed versus variable costs. Typically founders are too optimistic and underestimate both the time and funding to ship their first product and to generate customer revenues. No matter how much contingency you build into your numbers things will just cost more and take longer – that’s just the way it is.

But there are two things you need to focus on in your projections:

  1. How much capital do you need to last 12 – 18 months?
  2. Will this amount enable you to hit the milestones needed to raise your next round?

Fund raising is extremely resource-intensive for the CEO pitching innumerable investors, so I’d err on the side of raising enough capital for 18 months, even if that results in somewhat more dilution. If you fall short of your projections, be prepared to answer these investor questions:

  1. Did you overestimate your sales’ ability?
  2. Was your capital efficiency significantly lower than projected?
  3. Is there really a large (and growing) market for your product?
  4. What mistakes did you make? What should you have done differently?

Investors are looking for founders who learn from their mistakes and use that learning to course correct. Humility is in store if your falling short is due to mismanagement or failure to execute.

There are two ways to gain a reasonable valuation and avoid undue dilution:

  1. Execute on your plan – hitting major milestones
  2. Competition generates value – have at least two term sheets

Here’s a great quote from Bernard:

Your goal is to create investor interest from multiple firms while generating the least amount of friction to quickly close your round. It might be a difficult balance between knowing your value but respecting what investors are looking for, but don’t kill your fundraising efforts by not being flexible on valuation. Remember, it’s not all about the money and your ownership percentage. If one of our portfolio companies had a term sheet for a $10 million pre-money valuation from an unknown family office or an $8 million pre-money valuation from a top-tier venture capital firm, we would tell them to take the lesser valuation, even if it’s a smaller gain on our books.

Having raised multiple rounds for VC-backed companies, I can attest the wisdom of Bernard’s words. But there are a few things I would add. First of all, know whether your first investor has deep pockets and is prepared to participate on future rounds if you hit your milestones. Angels and strategic investors may not. It’s not a good signal for new investors if institutional investors don’t participate in future rounds – you better have a very good reason. There are other ways to raise money, such as venture lending and warrants, that may work for you depending on if you have a capital intensive business with hard assets. Even if you don’t hire a full-time CFO I highly recommend you have the help of an experienced CFO to help you prepare your financials (and determine concomitant dilution!) for various scenarios. The return on investment in paying a savvy CFO can be 1,000X or more. When playing with VCs you want to try to level the playing field as much as possible. Your Board of Directors should have experience raising venture capital and be able to provide not just contacts, but valuable perspective and insight on the fund-raising process.

Finally, be careful to manage the expectations of the senior team and anyone else with options or restricted stock. They are all going to expect a step-up in your next round of financing – in fact they are counting on it to get them on the road to building their personal wealth. Much  better to under-promise and over-deliver.

What’s the difference between SAFE and a convertible note?

SafeFor the past 20 years or more I’ve seen convertible notes as the best instrument for founders taking on a seed investment. Selling equity when you are a very early stage startup is very difficult for one simple reason: it’s impossible to set a valuation that is fair for both the entrepreneur and the investor. It’s a zero sum game: investors want more equity for their dollars and founders want more dollars for their equity. And there is only 100% equity to incentivize not only founders but future executives and staff. Trying to predict the future value of an early stage company can become an exercise in frustration.

So you might say, why not just get a loan? But banks and any other financial institutions want one important thing for a loan: collateral. Collateral is something of value – your house, your car – that they can repossess if you default on your loan. But banks aren’t about to repossess your code or your prototype – neither has value to them. Thus comes the convertible note, which is a type of debt that makes sense for both the early stage investor. i.e. angels, and the founder, and it has been the standard for years.

There are two key features to a convertible note, the discount and the valuation cap. The discount rewards early investors for taking on larger risks than later investors by offering them the right to obtain shares at a cheaper price than that paid by Series A investors once the Series A round closes. So if Series A investors pay $1.00 per share,  holders of convertible notes – and a startup may have several – get to convert their loan amount at typically a 20% discount, thus enabling them to buy shares for not $1.00 per share but 80 cents. The market tends to set the typical discount rate, thus eliminating a lot of negotiation and frustration between founder and investor.

The valuation cap sets the maximum value of a company when the Series A closes. Again that provides a benefit to the holders of the convertible note as the know in advance the minimum number of shares their loan will convert to. In other words they know the worst case scenario in advance. Setting the cap, however, can be more contentious than the discount rate. Just like ordinary loans, convertible debt contain an issuance date, an interest rate, and a maturity date. But repayment is made with equity – or not made at all if the company goes belly up before raising a Series A.  The investor has the option of choosing between the lower of either the discount or the cap conversion. The conversion price that’s the lower of the two methods results in more shares issued to the early investor upon conversion.

So what the heck is SAFE and why was it invented? SAFE is an acronym that stands for “simple agreement for future equity” and was created by the Silicon Valley
accelerator Y Combinator as a new financial instrument to simplify seed investment. Here are the key variables and how SAFE differs from convertible notes which I have taken from Melissa Hollis’s article Seed Investment: Comparing SAFE and Convertible Notes with changes and annotations based on my experience dealing with convertible notes. 

1. SAFE Offers Simplicity by Minimizing Terms

One problem with convertible notes is that they have a lot of moving parts. And every lawyer likes to write his own version – similar to NDAs – there is no industry standard convertible note. SAFE simplifies things by eliminating two moving parts: the interest rate and the maturity date (these are hangover variables from typical bank loans).

2. Different Points of Conversion to Equity

There are two different points when it comes to triggering conversion of the loan to equity.  A convertible note can allow for the conversion into the current round of stock or a future financing event, a SAFE only allows for a conversion into the next round of financing. So again, SAFE is simpler.

SAFE converts only when you raise any amount of equity investment unlike convertible notes which trigger only when a “qualifying transaction takes place” (more than a minimum amount dictated on the agreement) or when both parties agree on the conversion.

Finally raising common stock doesn’t trigger a conversion for a SAFE investor (keep in mind that VCs always invest in preferred stock, with its preferences over common stock).

3. The Valuation Cap

Typically convertible notes come with a valuation cap and SAFE may not. But as above, this is the sticky negotiating term with either convertible notes or SAFE. However, by foregoing a valuation cap  you could be diluting your shares and your future investors’ shares when you go to raise your Series A.

4. Early exits

What happens if the company is sold before raising a Series A? Both convertible note and SAFE investors give the investor a return. SAFE gives the investor the choice of a 1x payout or conversion into equity at the cap amount to participate in the buyout. Obviously who the acquiring company is and the state of their stock will decide which route the investor takes. Convertible notes typically have a 2x payout.  Here’s a case where the convertible note is actually simpler than a SAFE, but may make it less attractive to the investor.

5. SAFEs have no interest rate

SAFES are not debt, they are defined as a warrant. A warrant gives the investor the right, but not the obligation, to buy shares at a certain price before expiration. Convertible notes are loans, and as such carry an interest rate, which in my experience generally runs about 8%. Again SAFE has fewer moving parts, meaning fewer elements have to be negotiated, providing a simpler instrument with an advantage for the founder.

6. Maturity date

If you have been paying attention to this point you know that SAFE is not a debt instrument so it doesn’t have a maturity date. Convertible notes do. So what happens when you reach the maturity date of a convertible note? You either have to pay back the principle plus interest – just like a normal loan or you convert the debt into equity. If you are running out of money you certainly can’t afford to pay back your note! So SAFE is a lot safer in this regard. I’ve yet to hear of a company that paid back its convertible note!

7. Administration Fees and Services

Typically neither a SAFE nor a convertible note comes with any admin fees or need for professional services, e.g. legal or accounting, although theoretically a SAFE could trigger the need for a fair (409a) valuation to formalize your company’s common stock value.

The bottomline is that SAFE is simpler, with fewer moving parts and thus less chance of getting into a fractious negotiation with your investor. The best way to determine which instrument is best for you, however, is to work through the decision trees for both options and create cap tables on a Series A for both options. Like any decision, scenario planning is usually the most effective means of decision making. That means translating legalese into practical business consequences. Get used to it, that skill will often be needed by any startup that grows successfully.

Being neither a lawyer nor an accountant I can’t give you a qualified opinion on which is best for the founder. Offhand one would think that an instrument created by an investing company, i.e. Y-Combinator would favor the investor. But I believe the reason that Y-Combinator created the SAFE is that at the extraordinarily high volume of startups it invests in the efficiencies of simplicity of SAFE outweigh the small advantages to the founder.

Pitch tips from a leading VC


A recent megatrend that has greatly benefited founders has been the willingness of leading venture capitalists to share their knowledge with founders. Brad Feld of Foundry Group, Fred Wilson of Union Square Ventures, and Guy Kawasaki, Garage Ventures have lead the way. (What do they have in common? They’ve all met me!). Now they are joined by Scott Kupor, the managing partner of Andreessen Horowitz (a16z), whose portfolio includes multi-billion unicorns like Lyft, Slack, Pinterest and Airbnb.

I became aware of Scott Kupor’s book via Carmine Gallo’s Inc. article Five Essential Pitch Tips According To A Legendary Investor Behind Lyft, Slack, And Airbnb. Carmine is the best writer on how to do a presentation that I know of. You can search my blog for mentions of his books, which are all highly recommended. Start with The Presentation Secrets of Steve Jobs, a classic. Carmine has been writing for Inc. for some time and I make sure to never miss an article of his.

Despite all the books and articles I’ve read about how to do a VC pitch I learned a lot from Carmine’s interview with Scott Kupor. You can watch the video, which is embedded in Carmine Gallo’s article. Here are the five tips from Scott Kupor with my annotations.

1. Market Size

It’s interesting that Scott puts market size first. Of the three main determinants of a VC investment, team is usually put first, followed by either market opportunity or product/secret sauce. But I find that founders have the most trouble with market size. Either they make the beginner’s mistake of taking some arbitrary, and far too large, percentage of a large market (“If we just get 15% of the entire $92 billion shoe market …”), or they muddle through some proxies for their market. Read my post Sizing your market opportunity for a more sophisticated approach.  But Scott has a unique approach:

It’s an entrepreneur’s job to be a “patient and inspiring teacher.” In other words, don’t assume that your audience—even one made of up VCs—understands your market or its potential size.

This goes back to the need to tell a story rather than just recite dry statistics or show complex graphs.

2. Team

As I tell founders, there are two questions a VC has to answer in the positive to fund you: Is this a billion dollar idea? and Is this the right team to execute it? Too often I find entrepreneurs, especially students and recent grads, focus on their academic credentials – their list of degrees from prestigious universities – rather than one thing: what expertise and experience does their team possess that in Kupor’s words “… make this team – hands down – the best team to approach this idea?”

3. Product

Here’s an interesting point from Scott Kupor: “investors love to learn and are fascinated by how something works.” He uses the term “idea maze” for the twisting, turning process that turns an idea into a real world product. But that’s understanding your idea maze is not enough! Investors want to know why your product is 10X better than the existing alternatives along the typical dimensions: faster, better, cheaper, easier to use. Peter Drucker is responsible for this, as he stated that a new product must be 10x better to displace an incumbent product. And note, VCs will tell you they need to make 10X their investment to have a successful fund. Show them enough 10Xs and you may just get funded! 10X would make a great name for a company if it weren’t already taken.

4. Go-to-Market

Like market opportunity this part of the pitch tends to be a weak spot for the founders I mentor, perhaps because virtually all of them are first timers. Those who have previously founded a startup or worked an an early stage company realize how important the customer acquisition part of their pitch is. Kupor says this is often the most underdeveloped section of the pitch, especially for early-stage companies. You need to present a combination of your business model and marketing plan that demonstrates you know how you will acquire customers at a cost that is just a small fraction of their lifetime value. In other words, profitably. You don’t need complex spreadsheet models forecasting 5 years of financials. What you do need are sound assumptions derived from a lot of first hand interaction with customers.

5. Planning

Planning boils down to one thing:  what milestones will you reach with the money you are raising in this round? A corollary of this is, how long with this round last? A range of 12 to 18 months is typical. Fund raising is resource intensive for founders, so you don’t want to have to raise another round too soon. On the other hand, if you are going to grow at the dizzying rate that VCs expect, you are going to need more funding in less than two years.

I teach founders that the job of their product is to make its users successful and satisfied. And when selling to the enterprise find a product champion who will see that by driving adoption of your product for their firm they will be rewarded. If you can make your customers successful, your venture will be successful.

Scott Kupor makes a similar point about VCs. They want to look like heroes to their customers: their limited partners whose money they are investing.  So, consider VCs as your customers and thus it’s your mandate to help them succeed by making your company a success.

Why shouldn’t you raise money now?


I’ve outlined numerous reasons to raise money now – the pros, as it were. But raising capital is a two-sided coin, usually many of them, so here are the cons.


The name of the game in startups is focus. Raising capital is a very difficult and intense process that will distract the CEO/founders from the venture’s main business: building product and acquiring customers. In fact, I can’t think of much else that is more distracting other than a major rift between founders. It can easily take six months from the time you start your capital raise to the time your funds are wire transferred into your bank account. That’s a lifetime in a startup.

Resource limits

Draining limited resources – namely the CEO/founder’s time – is perhaps the biggest reason to avoid raising capital, especially from venture capitalists, who can drag out the process unless you can create a strong sense of urgency, which probably has to be a very real threat they will lose a deal they really want. CEOs in startups are completely different than CEOs in mature companies, as CEOs are also individual contributors, either in sales, business development, product development, customer support or all of the above.


When I was raising capital way back in the last century the rule of thumb was that VCs would take about 35% to 40% of your equity in the Series A round, leaving the company with 60% to 65%. Today I’m hearing that it’s more likely 50%. I only have a few data points on this, so check with your friends in the founder ecosystem. VC’s also insist on the founders setting aside roughly 20% for future hires – note well that the company takes this dilution, not the VCs! So the founders now are left with about 40% to 45% of the company they started – a minority interest! There are two good ways to avoid dilution: one, finance your company with customer revenue, grants, and friends and family money; the second is to build substantial value before raising money: large numbers of customers, very rapid growth in customer base, and running the company on customer revenue and perhaps friends and family money. The longer you wait to raise capital the less equity you have to sell to acquire the same amount of funding. That’s why it’s not now, but perhaps later.

The battle over equity allocation

Here’s another rule of thumb, mine: the earlier the stage of the company the more difficult it is to allocate equity fairly. For example, let’s say you haven’t yet built your product. How do you measure the contribution of the tech team? You have to bet something on the future value of their contributions. Similarly how can you evaluate the contribution of sales, marketing or business development team members when you are pre first customer ship or even pre-revenue! Again waiting until you hit some major milestones like first paying customer or even breakeven will enable you to better evaluate the contribution and thus the equity allocation of each team member. See Chapter Six: Reward Dilemmas: Equity Splits and Cash Compensation in The Founder’s Dilemma by Noam Wasserman.

Giving up control

With a Series A round your investor will most certainly take a Board seat. If you syndicate your round you might end up with two VCs on your Board. And if you have given up 50% of your equity on the first round the second round will put the VCs firmly in the driver’s seat, if they aren’t already. As CEO are you prepared to report to a Board of Directors? Are you certain your investor is as much aligned with your interests as possible? Giving up control is one of the major reasons I hear from founders for not raising capital, now.

Constant pressure for hyper-growth

Once you accept VC money you have bought a ticket on a rocket ship which must reach escape velocity or fall back to earth in a ball of fire. The pressure to grow at virtually all costs will be unrelenting. If you thrive under this type of pressure that’s good. Otherwise you might want to think of another way to finance your venture.

To sum up, the key word in both this and the previous post on reasons to raise capital now is now. You and your team need to establish measurable milestones for at least the first 12 months of the company’s life. Then you need to decide what will be the triggering event to start to raise money. Absolutely the best time is when investors are calling you. That’s why, while you are building your product and your company, you also need to create buzz. Buzz will help generate incoming contacts by job candidates, prospective partners, and it is hoped, investors.

Finally if you decide the time is now, take a look at my post Are you investor ready?



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