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Um, I'm glad we weren't recording before because my, uh, me talking about how I can't hear you through my AirPods and Skype makes for really good radio. Yeah. Podcasting. It's easy and mainstream now. So, uh, naturally there's, there's gotta be great tools for that, right? No. Um, yeah.
Limited partners, welcome back to episode two, although we're not going to number these, we decided, because then it gets confusing, where you have seasons with regular numbers and LP episodes with numbers. So welcome to another LP episode that happens to be recorded on the...
day of Halloween, so October 31st. We'll release this next Monday. Hope everyone had a great Halloween. If you hear doorbells, that means I have trick-or-treaters. Does that mean you're going to get tricked, not treated? Could very well. Ben's townhouse is going to get teepeed. If you're driving through Seattle and you see a teepeed townhouse, that would be Ben. Yeah, that's true. David, how are you tonight?
Doing good. I am here in the suburbs in Marin where Jenny and I are briefly staying with her parents while we're in between moves here. Always fun. Are you in a closet? It does sort of look like I'm in a closet. No, I'm in a bedroom, but, you know, built-in bookshelves.
Nice. Listeners, we, uh, so David and I, when we started doing episodes remotely, we started doing video on the Skype as well, just so that we can like see each other a little bit more and hand signal and make it feel a little bit more natural. Um, and we do sort of have this flunky artifact of, you can always get a little bit of like wherever we're recording from. Cause we don't like do this in the studio or anything. So, although soon, well, we have, we, we have a room that will soon be a studio in the new wave office, which I am super excited about. Um,
Going to get super professional. Yeah, that's sweet. I got to come and do an episode there at some point. Yeah. All right. So, David, I have, I think, mentioned this a little bit, but have an idea for what I want to do on the show tonight. I was talking with a
CEO at, uh, of one of PSL's companies the other day. And, uh, he brought up this blog post that Fred Wilson, uh, wrote that's totally legendary. That's the three jobs of a CEO. Classic Fred Wilson blog post of which there are many. Yes. But this is one that always sticks in my mind. Yes. Um, and that, that blog post talks about how there's three jobs of a CEO. There's the, uh, um, there's, oops, sorry. I just knocked the table there. Um,
There's keeping cash in the bank, there's setting and maintaining vision, and there's recruiting and retaining great talent. And it's a pretty hard line. There's a lot of these startup aphorisms that are very easy to sort of say and say, you know, if you're doing anything else, you shouldn't be and you should only do those three things. And of course, those three things are kind of blurry.
And it got me thinking a lot about the sort of jobs of a CEO pre-product market fit and post-product market fit. And then it really got me thinking about like, wow, what are all the things that are different pre-product market fit and post-product market fit about a company? And I thought it'd be useful to do an episode one because I'm just interested in exploring and sort of debating various definitions of that and then different things that...
I think, and you think a company should do and shouldn't do, uh, pre and post product market fit. Um, and then also, um, I just think it's an important topic to talk about early in these, these, uh, LP bonus shows because it is really, um, you know, there are many other sort of dividing lines between phases of companies, but this one is pretty,
is pretty, pretty important and pretty binary. Like if you had to define startups by the two most massively important phases that you could define them by, it really is whether which side of this line it falls on. Yeah, totally. Well, and it's,
both of us now being in the seed portion of the venture ecosystem, or I guess you Ben always have been, but me now going from being more series A focused at Madrona to being a hundred percent seed focused at wave, like this is kind of the most important question, right? Like that, you know, when we, we invest well before that, when companies are just getting started well before product market fit, but then like,
that we're asking ourselves at wave about our portfolio companies that we're talking about with them in board meetings. And, and honestly that we're finding that CEOs are asking us, like, how do we know when we have product market fit? So this is a great episode. Yeah.
Well, I also think it's interesting thinking about like, what is the job of a seed investor? It's really to, I mean, there's lots of work to be done after the investment, but on the picking side of things before the investment, it's really being able to spot a company that you believe is more likely to find product market fit than the investment market believes. And so it's about spotting,
companies that are likely, even though the companies themselves are not yet exhibiting signs that they will make something that people really, really want and be able to scale that. And so it's kind of an interesting, you know, it's like everything else in early stage investing, it's game theory. Yeah. Well, actually, it may be worth a real quick diversion here, if you're up for it, on the
a major change that has happened in the venture ecosystem over the last few years. Um, that actually I'm wondering maybe we should do our next LP episode entirely about this listeners. Let us know if you think this is an interesting topic you want to know more about, but briefly, can I let you know too? Yeah. Yeah. You let me know too. Once I actually say what I'm about to say, uh, after this long preamble, um,
Investing in companies before product market fit used to be what venture capitalists did, period, what early stage VCs did. But starting about 10 years ago and then really coming into bloom about five years ago, the traditional VCs, the Sandhill Road quote unquote VCs, abandoned that stage of investing and they moved wholly into Series A. But Series A
which used to be about investing before product market fit now is about investing after product market fit. It's about identifying companies that have it, that have traction, and then
backing them and identifying that early, but identifying it once it exists. Seed investing, just like you said, Ben, is now the realm of investing before product market fit. And that's what's opened up the opportunity for all these new seed funds that are out there like Wave, like PSL. And of course, we all have different models and strategies. But this really is the domain that true early stage venture used to be until more recently. Yeah.
Yeah. It's a great point. It's interesting actually to think about like, um, how many more divisions can we have here? But, uh, companies, basically if, if a company gets its series a funding, it's, it is an indicator that it has product market fit. Like those things are almost synonymous at this point. And it's interesting to try and think about like what post series a companies do you know that don't have product market fit and it should be extremely few and far between. Yeah. It's, I mean, at this point it's almost, it's almost tautological except in the examples where, uh,
Uh, an entrepreneur is just so well known and usually has been a successful founder in the past that they just raise a, you know, raise a series a right out of the gate before they built the product. But those, those examples are very, very rare.
Yep. Okay. So bouncing out of the investment world and into the operating world, we keep talking about product market fit. Lots of people who are LPs of the show, I'm sure know. I bet everyone knows slightly different because it is a sort of gradient to definition on a spectrum. And so let's dive in a little bit of, you know, what are colloquial definitions of this thing that we keep talking about?
And it's worth starting with sort of the beginning and who coined the term, none other than Andy Ratcliffe. Indeed. So Andy, David, he was one of your professors at GSB, right?
And then retired from Benchmark. And we could do a whole episode about them and the way their partnership works. But they are constantly having all the original partners have retired and their older partners retire and then make room for new partners who come on. He did that. And then he went and he started teaching at GSB at the business school at Stanford. And I believe that is when he started writing about this. Yeah.
Now the CEO of Wealthfront doing a lot of very interesting, it's not often you see someone that sort of successful in a venture career go back and now run an extremely successful company like Wealthfront. So Andy Ratcliffe coins the term.
Yeah. Sean Ellis also associated with sort of popularizing the term. And what is it? It's basically the clear demonstration from the market that you're selling to that they clearly want what you're selling. And that's, of course, squishy. So how else can we slice that? Well, one way that you could sort of do it that's a little bit more data-driven numerical is that you can efficiently scale your marketing efforts and maintain positive unit economics. Yeah.
So it's the notion that, you know, you have a machine that you can pour money into and know what the multiplier on that money is as it comes out the other side. And if you don't know that, and if you say, you know, I'm still a...
putting money into marketing that's sort of a test and learn. Of course, you're testing and learning on channels all the time, but to compare one channel to another. But if you're really pouring marketing dollars in in order to test and see if people like your product rather than does it come out at 10x what I put in or does it come out at 8x what I put in, then you're still sort of pre-product market fit. Yeah. And this is actually...
Well, we should get into more definitions of product market fit. This is certainly only one of them, but this is from a quantitative standpoint, what most series A investors are really going to look at when they're evaluating your company. And then certainly series B and later in growth stage investors, but sort of the canonical LTV to CAC ratios, the lifetime value that you think you're going to get out of every customer you acquire.
over however long they're going to stay with you, however many times they're going to repeat, however many months they're going to be with you before they turn. If it's on average, if it's a SaaS product, what your contribution margin is going to be after your COGS from that ratio divided by how much you spent on a marketing channel to acquire that user. And basically once you go, not just like positively, like over one is,
you know, baseline. But once you're in... I was going to ask David, what is a good LTV to CAC ratio? You know, once you're... It's a tricky question. When you're in like 2, 3, 4x range there, you're like, okay, I can feel pretty confident that a Series A investor will look at me and say like, I have product market fit by this measure. Now, of course, this is something you will optimize over time. But if you're getting...
Significantly positive ROI from an LTV to CAC ratio. That's one key measure. Yeah, good point. And it's not uncommon in the beginning. I'm sure you see this too. Plenty of our companies that they're like way less than one when you're first starting. You know, you're spending way more money than you would ever make back on a cost. But you have to do that to start getting data. Right. Yeah.
And we'll do a whole episode on, or probably many on, oh, I woke the lady in a tube. We'll do sort of several episodes, I think, on various parts of PSL's process over the course of time here. But one thing that, you know, we definitely see, hang on a sec. Wow, somehow she interpreted that as start playing music. We have to call up our friends on the Lady A team over at Amazon.
Yeah. I swear I didn't even say the... No, I'm trying to think what the syllables were that you said. No. All right. That's done. Um...
Okay. So, uh, in this particular case, one thing that we've definitely learned is with your initial CAC testing, let's say it's a, uh, consumer startup where you're using Facebook to test, like, you know, what, what are, what can you get an app install for? Or what can you get, uh, someone to pay on your website for? Um, you can reduce, you should feel fine if your, uh, cost to acquire is like three, four or five X what, um, uh,
what it needs to be. So three, four, five X, the lifetime value of that customer, because you can do, you can sort of stack iterative improvements on top of each other to, to get it an order of magnitude better, but it's really hard to do beyond that. Like when you sort of have the purest form of, do people want this? And you're able to throw up a, a,
a page that clearly advertises your value prop where, you know, there's not confounding variables of you, you miss the mark on being able to communicate to people. Um, you advertise to the right market. If, if you're, you know, uh,
15 20 30 times higher than you need to be on on cost to acquire you're pretty much never going to get there on being able to make that that cheap enough but like you say in these earliest stages it's fine to have a inverted cacti ltv ratio by by a bit to start yep totally
Okay. So one of my partners at PSL, Mike Galgan, likes to always say there is upside surprise when you find product market fit. And Mike started... This is another potential definition of product market fit. Yes. Yes. And so he was telling me about upside surprise the other day. I really like this framing. It's basically when...
things start happening that are surprisingly good. And normally in a pre-product market startup, what you're used to is pushing the ball uphill and everything is sort of harder than you thought it was going to be. And customers take more convincing than you thought they were going to be and customers end up being worth less. This is one of those things where like,
suddenly people are telling their friends and you didn't ask them to, or customers are willing to pay more than you thought. Like it turns out they already have a budget for this thing and they don't like their current vendor and you slot in nicely. Or you thought you were going to have to work really hard to bring that one candidate into your company, but like actually they email you one morning and you wake up and you're like, oh wait,
This person just wants to join, and I was really going to have to lobby them. Another example is on the sort of PR investor side. You're getting all this inbound. There's a journalist at Forbes that emails you and says, hey, I use your product. I want to write about it. And you're like, what? And when you're used to sort of pounding – How did you even find out about me? Yeah.
Yeah. When you're used to a pre-product market fit startup, all of these things like never happen to you and you're feeling like, you know, the end is near and the switch flips at some point and there's upside surprise in everything. And I really like that sort of framing and way to think about it of like a, you'll know it when you feel it. Yep. All right. So...
Maybe I want to throw out one more, which actually I think, you know, when it comes down to it, at least with series, many series A investors, the only reason
true definition of product market fit is the same as the old um i forget i always forget the name of the old supreme court justice who was trying to define uh asked to define pornography and said he couldn't define it but he knows it when he sees it and uh uh and that really is um uh i think how many people think about it and uh my favorite little anecdote on this um is uh
Airbnb after the Sequoia seed round, um, that Greg McAdoo, who was the Sequoia board member as an advisor to us, a wave was telling us that, um, you know, they invested $600,000, uh,
I forget. I think it was in 2009, either end of 2009, end of 2009 or beginning of 2010, nine months later, uh, they were in a board meeting and he was looking at the, um, the, the financials of the company and they had like one and a half million dollars in the bank account. And he was like, I think it's time for us to raise a series a and go harder into marketing. Um,
Yeah, that's pretty wild. Yeah. Yeah. It's, it's like the, all of these products where you sort of expect to need to hire some, there are these rare companies that happen once or twice a decade or maybe a little more often than that, but you know, so rare companies of the decade that do have product market fit as soon as they launch. And you said the Uber is the Airbnb is the Twitter is where, you know, from the very beginning, it's a scaling game rather than a sort of find your market game. Yeah.
Yeah, I don't think it'd be entirely accurate to say it was from the very beginning, but certainly from the point Sequoia invested in Airbnb. Yeah, that's true. There definitely was, as Brad Stone and the Upstarts definitely writes about, there was a long period of being in the woods there. So that's not totally fair.
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Like Vanta's 7,000 customers around the globe and go back to making your beer taste better, head on over to vanta.com slash acquired and just tell them that Ben and David sent you. And thanks to friend of the show, Christina, Vanta's CEO, all acquired listeners get $1,000 of free credit. Vanta.com slash acquired. Cool. So should we talk about the jobs for a CEO pre and post product market? Yeah. I think this is a really interesting thread to pull on.
Yeah. So the Fred Wilson framework, uh, is, is so great for a post-product market fit company. Like at that point, you know, it's, it's cash in the bank, it's vision and it's attract and retain talent. And, uh,
if actually there's this amazing aaron levy tweet that uh also reminded me about um that i wanted to do this episode because he tweeted this earlier this week so aaron levy the um ceo of box he's like the he's he's my favorite person to follow on twitter because he is like brilliant and witty and like very current uh and like occasionally you'll get a weird tweet that's like you should come to the box summit you're like what
But, you know, that's only like one out of 20. So it's worth it. So it is a great tweet that was starting up is the act of doing as many jobs as possible so your company can survive. Scaling is the act of shedding as many jobs as possible so your company can survive. And I think another way to articulate that is pre and post post product market fit. So it is.
Those three jobs, cash in the bank, setting vision, attract and retain talent, great set of things to be doing post PM fit. I guess we say that...
I don't like saying that, but it's long to say product market fit 150 times in this episode. But before then, I mean, the job of the CEO, I've always thought about this framework that your main job is to find product market fit and get to that place. And the set of things you should be doing are defined by getting there. And
That might include keeping cash in the bank, probably does. It might include setting vision, probably does. It, to a lesser extent, is about attract and retain great talent because you're only doing that with a handful of people rather than needing to sort of like build a scalable way to do that. A lot of the time, depending on the show too, and we think about, you know, certainly you do want, almost every startup is going to be hiring
Some people before product market fit, you know, maybe a first engineer to, you know, maybe like a community manager, maybe something. But but ideally, you want a lot as much as possible of the DNA that you really need on the founding team itself. Yeah. And really so important.
I always look at the job of the CEO or the job of the founder or founders as you're either the head of product or the head of sales. And at some point, you will transition that responsibility. But when you talk about product market fit, I mean, you're either working on fitting the product to a known market or finding the market for the product that you believe is the future. And your job is really to be focusing on one of those things. And so that means that you're doing a lot of
stuff that you're kind of like, wow, is this really the job of a CEO? I think the title CEO in these earliest stages is really like,
almost a farce. Like it should be a different title because it's, it's different than the way you would think of sort of like company builder, leader, capital allocator, um, sort of storyteller as, uh, as stages go on, it's really more about sort of the, the, the spirit guide and finding the magic. And, uh, there's a lot of different paths to sort of find that magic, but, um,
Yeah, I've always thought that the sort of best CEOs either opt into the product role or the sales role and then complement around themselves until they find product market fit. Yeah, and a lot of that depends on the type of company you are, if you're an enterprise company or a consumer company. Yeah. I would say most often...
Not necessarily always, but most often with an enterprise company, the CEO is in the head of sales role. And more often than not in a consumer company, the CEO is in the head of product role.
Yeah. And of course, this entire episode, we're going to be making these like hard lines, which are not hard at all. And there's every rule has an exception and many, you know, counter exceptions. But that's not even what I meant to say. Counter exceptions or not. Anyway, there's going to be lots of exceptions to these these rules. Indeed. And so I think so. Well, OK, go ahead. Go for it. Were you going to stay on the CEO and team pre-product market fit? Yeah.
Yes. Okay. Okay. You're not moving to post yet? I'm not. Okay. Keep going. So the other one is that when you look at a team that's pre-product market fit, they probably have zero or one salesperson. And if they do have a salesperson, what it really is is a customer discovery person. So sure, you're trying to sign up people and get revenue in the bank, but...
they're, they're sort of probably compensated and incentivized differently than you would in a, uh, post product market fit sales team that's scaling. Um, and they're also, uh, it's also a little bit of a different skillset where you're approaching it more of a conversation around, Hey, we're trying this thing. Would love to see if it, if it makes sense for you, it would love your feedback rather than, uh,
you know later on which is um you're probably looking at the three people in market right now let me tell you why we're the best one and i have this deck that clearly shows you that i've shown to 500 other people yep i agree oh um yep you want to go to post uh no no no i well i had one one other thought um and i think that's definitely what you just said is is
Mostly applicable to B2B startups. On B2C startups, I saw you had here in our little outline, and I totally agree. It's really all about product iteration. And, well, product iteration and...
customer and customer segment iteration. Andy Ratcliffe actually talks a lot about this, about how his view is that the best financial
Founding teams and founders typically take a technology innovation and think about that has happened in the market and then think about what market segment they can apply that to, who is really going to desperately want what they can do with it. Yeah.
and sometimes you don't get that right on the first shot. Uh, and so you take, uh, a lot of, uh, a lot of companies will take what they're doing and say like, okay, we, let's, who else might want it? And I think, um, you
You know, a great example of that is our most recent main episode in Venmo, which is they were taking a technology mobile based payments and initially applied it to bands and local bands at concerts. And then thought like, no, actually what this is, is like friends, you know, splitting, splitting payments. And even though it was the same product,
Yeah, that's a great point too. Um, and actually the, uh, another person I want to give, I want to mention here and give a bunch of credit to that shaped my thinking here, uh, is Sarah Inbach, who was a very early employee at PayPal and is now a prolific angel investor up in Seattle. Um, and really great. And I remember so clearly a lunch I had with her a number of years ago, um, when I was asking her, so like what, what kind of made it, what made the early PayPal team so great and
And, and her response was that what everybody in those early days at PayPal was aligned on was,
was the need to iterate very quickly and have you know the quote-unquote tight iteration loop that everybody's always talking about in startups but but iterating towards what was working always so not just iterating just to iterate she's like anytime you're doing that like you can quickly get caught in a death spiral where you're just changing things and you have no idea what you're doing you're changing just for the sake of changing but what the paypal team did and what
companies that have come out of it since have this DNA as well is be constantly iterating always towards what is working the best. Like this is working great. Great. Let's do more of that. Like let's forget what's not working great. Yeah, that's a really good point. And I always wonder too, like,
it's always hard to balance those scenarios where you're like, this thing seems to be working, but what if that thing is counter to your strategy? And you believe that's going to take you to some local minima, uh, for the company where you're going to peek out because you have in an effort to please, uh, customers given up a lot of strategic, uh, things or given up a lot of moat building ability. You know, what if customers tell you that they want something, uh, that looks like a tools business, um, and, uh, uh,
But you sort of wanted to build this platform with lock-in and network effects and ability to sort of have sustainable competitive advantage over time. I mean, I think the, I love that framework. I think in practice, I think it's hard to make sure that...
that overall framing in mind as you're thinking as a CEO or a founding team or investor or anybody about these decisions. However, I'd say PayPal is like...
I would say you can go a lot more, a lot farther towards the extremes with this than you would think. And PayPal is a perfect example. Like they started like, we're going to be money to back and forth between peer to peers via Palm, Palm pilots. Right. And they ended up like we're facilitating beanie baby transactions on eBay, you know, um,
Like that really was throwing a whole lot of the strategy and moat out with the bathwater too, because they were wholly dependent on eBay. And ultimately, as you know, we saw had to be acquired by eBay. Right. Yeah. I guess it's true that if like you are delighting customers and you're doing a lot of business because of that, there are always sort of strategic ways where you can, you can become entrenched and important in an industry. Yep.
Again, important to keep in mind, but I just think founders and board members tend to overweight the risk here versus like, hey, if there's something that people like, you should probably really scratch hard at that. Yeah. And there's a way to sort of scale it. And there's a big, deep well there of people that want that thing. Yeah. Yeah. It's a good point. All right. One other I want to touch on here is the value of a COO and the sort of difference in pre and post product market fit.
So lots of the time, or lots of times, startups will title businesses
the non-CEO co-founder as COO makes lots of sense. Um, it ends up being sort of a catchall in these pre-product market fit companies where a lot of time that person is head of product, uh, or they end up, um, doing something that's actually not a C level position. That's sort of maybe a director of operations, but, um, or there's not that many operations, uh,
I guess where I'm going with this is the value of a COO in a later stage company that's post-product market fit ends up being that the CEO is setting vision and being effectively the outside person. So telling the story, doing these things, raising money, telling the story, attracting talent, being what the company wants.
looks like from the outside. And the COO is often sort of the hammer, the one that is making sure that the business is every single day hitting the numbers that it needs to be hitting, growing where it needs to be growing, managing things like HR and payroll and hiring the right people at the right velocity and making sure that
You're on track to hit your one, three, and 12-month goals and is really sort of keeping their head down and keeping the business running. And in a pre-product market fit world, a lot of those jobs don't exist yet. Mm-hmm.
And so I think it's interesting sort of we talked about the difference between a CEO and a COO. I'm sorry, a CEO pre and post. A COO is dramatically different pre and post as well and often requires a completely different skill set. So it's very common to see someone that has a COO title sort of transition to a product title or transition to a, you know, a...
I guess any number of things and, and, um, unless they want to become a COO, which is sort of a different mentality at scale. Well, I think also the COO title in early stage startups is, um,
fraught with peril you know and uh and i would say most often actually is just a sign of like you had people that you wanted to start a company with you had one more person than you really had roles that you needed but you wanted that person involved anyway um
And sometimes that can be great, but sometimes not. And sometimes that role is superfluous. I would say the one potential exemption is if you are building a, say, for instance, a marketplace that is an operationally intensive real world marketplace where you need somebody to be the head of product for the company.
digital product experience so to speak and somebody to be in charge of going out and like acquiring supply like in the real world like i'm thinking about uber wasn't structured this way but they quickly moved to the local gm model like and the person who was the local gm in each city at least in the early days like their job was to go get drivers you know in the real world yep um and uh and and while hq was like building the app and the routing algorithms and all that
Yeah, that's a great point. Great, great point. All right. Now our little doc, you have a Bezos framework. Oh yeah. I want to make sure to throw this out there. So one of the, uh, really coolest experiences I've had, um, over the last few years, uh, and certainly one of the many cool experiences I had while I was at Madrona. So I think you had left Madrona when this happened, but do you, uh,
Yeah, I had.
And we had all of our CEOs of every company in the portfolio come. And it was like, you know, off the record, 60 minutes with Jeff. And it was completely open audience Q&A. So all for the majority of portfolio founders to just ask Jeff questions.
And somebody asked him some sort of flavor of not this question, but like, what should a CEO be? Is it still off the record if we're talking about here? Well, I don't think, but this is, you know, behind, this is only for our LPs. So of course this is off the record. Yeah.
I don't think Jeff, I don't think he's listening. B, if he is, I don't think he would be upset with us reiterating this. But basically the question was, what do you think a CEO should do? And Jeff just gave this great answer that I loved. He said, the role of
of a CEO and a leader needs to evolve over time with the company. Uh, and he was like, the way I think about this is there are four questions essentially that need to be answered in a company. How, what, who, and why? And they correspond to the various stages of the company and that he went through as in his journey as Amazon CEO. And in the beginning, the first question was how, like, I have this idea, I have this vision of, you know, Amazon, uh,
How am I and are we as a company going to create that? And that was like the main focus in the beginning and certainly pre-product market fit. And then maybe this is the post-product market fit. He said, you know, kind of you grow up a little bit. You've done the...
how, and then the most important question becomes what, like, as in things have happened and like, what are we going to do now in response to our product hitting the market? And maybe this is the, like the iteration of finding product market fit. Like we built something, we got it out there. And like, now what we got, there was response. Now what do we do now? What do we do in either from customers or from, you know, partners or from suppliers? Like, like there was definitely, there was, you know, uh, book publishers had a reaction to us. What do we do about that? Yep.
exactly. And so then he was like, okay, then if you successfully navigate that, then maybe this is really the, the, the post product product market fit stage. Then the most important question becomes who, like, who are the people who make up our company who are going to execute and build this that we know is like working. Um, and he's like, my role then completely shifted to like, I have to build a leadership team, um, which wasn't as important before they'd figured out like, how are we going to do this? And, and what are we going to do? Um, and,
And so he said, and what I thought was really interesting that like so, so few companies ever get to this last question, you know, Amazon is one of the very, very few, uh, Jeff was like, you know, it,
at this point, like the who is set, like the senior leadership team of Amazon, like they're all incredible, truly world-class at what they do. And they've been there for so long. He was like, we all like complete each other's sentences. So I don't actually worry about the who anymore. Now I worry about the why.
Like, why does Amazon still exist? Why are we doing what we're doing? Is it right to be doing what we're doing? What does like, how do we fit into the broader, like, you know, ecosystem and society? And like, is everybody aligned? And I thought that was just so cool. Like, what a great, like, yeah.
And then he added one more at the end. He was like, I guess you could also say the question always facing a CEO is, is, is when to, but when is always now. And that was such an Amazon answer. Yeah, it is. There's so much there. That's Amazon specific to like the, the last part, like the leadership team has already said, it's just about why, like,
Most companies don't grow at the pace that Amazon grew at to keep those people around like with Andy Jassy and who leads e-commerce and
Oh, shoot, I'm blanking. He's now the CEO of Amazon. Yeah, they're both CEOs, right? Like they both run amazing enough businesses independently where they weren't going to go become CEO somewhere else. So like retention when your stock price is changing in that way is not so much a problem. I also would push back that like, you know, why it's important to know your why. You can argue why it needs to be first. Yeah, right, right.
But, um, yeah, but anyway, you know, it was, uh, it was a, it was a cool, you're absolutely right. Like so many things that Amazon and Bezos say, you know, very applicable to Amazon and Bezos. Um, but I just thought it was a really cool framework. Yeah. There's one of my favorite things that's only Amazon is, uh, he was interviewed at some financial conference last year. And one of his answers, people said, are you thinking about, you know, uh, uh,
Like your quarterly reports are about to come out. Are you about to, are you thinking about reporting earnings? And he said, Oh, this quarter has been done for, uh,
nine months i mean i've known how this quarter is going to perform not you know for the last nine months my head is three quarters from now how are we going to do yep and it's just still like a wow such an amazon response that kind of machinery it's also not you know not absolutely true there's some kind of stretch there but it's a powerful uh powerful notion a good thing to aspire to yes
All right. Uh, so I have, uh, two things that I want to do on our, uh, remaining time, which is infinite, um, uh, here on the, this LP bonus show. Uh, one, I want to test, um, doing a little bit of, uh,
VC vocab sort of every episode. I think there's interesting, uh, things to sprinkle in as sort of a section in the LP show. I also, even though VC vocab is excellent alliteratively, I think it doesn't really capture what we're trying to go for here. I want to talk about sort of like VC concepts, um, and, and often in a jargony way. So it's not just like defining things, but it's, it's talking about, uh, what the connotation behind, uh,
uh, behind those phrases are. So I'm going to, I'm going to say VC jargon. Um, great LPs. Let us know if you have better, better names for any of this. Um, and then also, uh, uh, answering listener questions. We had a great one that I want to get to. Yeah.
Okay. So on VC jargon, um, I want to talk about first the concept of raising too much. And, uh, I was talking with an entrepreneur the other day who was first time entrepreneur was out raising money and, um,
was at the point where definitely still a seed stage company, definitely pre-product market fit, but sort of came and said, hey, I'm thinking about raising $5 million. And of course, one might say, David, your radar for credibility, you just went off. But honestly, it's one of these things where it just...
It's helpful to know how you're coming across going into those conversations. And it's just five minutes of someone sort of counseling you and coaching you beforehand and saying, hey, you're not really at the level as a company yet where it can garner this type of investment. And in talking about why that was, my first inclination was just to say, look, and this is putting my VC hat on, not my founder hat. So this is on the PSL Ventures side. Look, you're not yet at the level where...
you're going to be able to raise that much money. And then I thought like, what's the more, what's the better way to think about that as a company? And I think the better way to think about it is let's say you want to raise $5 million. Well, that means that assuming that you're selling 25% of the company, um, that your pre, I guess your post money valuation is going to be $20 million. Mm-hmm.
And so then in 18 months when you run out of cash or 12 months when you run out of cash, sometime in the next year to year and a half, you're going to want to go raise at like a two to three X step up from 20 million. So when you're going and pitching and raising $5 million. Meaning that the value, the pre money valuation of your next round, you want to be two to three, a multiple of two to three of the post money of your previous round.
Exactly. Because if you're not doing that, first of all, if it's less than your current round, it's a down round. It's not great. If it's flat, these things happen, you know, but they're highly dilutive and anywhere sort of less than doubling the valuation of your last round, you're not going to be happy with the dilution you're taking as a founder. Well, it's also just like an indication that you haven't built any value in the company, right? Like ideally in the interim time, you want to use the capital you raise to build value. Absolutely. Yeah.
And so this notion of like raising too much, I think as a founder, it's really helpful to think about it as, okay, if I'm raising $5 million right now, then 12 to 18 months from now, I have to justify like a $50 million post or post money valuation. That's crazy. Like oftentimes if you're thinking about where you are when you're, when you're,
when you need to go raise a seed, if thinking just like, how could I possibly in that timeframe get to the point where I could reasonably go talk to the next set of investors and say, we think we're a $50 million company.
you're, you're, you're betting on a, uh, a miracle. I mean, you're betting on some, some crazy magic event happening in the, in the midterm. And so I always think like maybe, maybe the reason to think about it as a founder of, of, okay, I'm only going to raise, you know, three on 12 posts or something. Um, and that scenario is okay. Do I feel good about, you know, a 25 to 30 post 18 months from now, certainly better than a 50 to 60. Um,
It's a little bit of, you know, funny math there, but it's... I just like that way of looking at it a lot better than, you know, am I worth investing this much money into now? Yeah. The...
That's great. I think there's, so I completely agree one. Um, and also related to that is, um, you know, there are all sorts of downstream effects of raising, um, that much money. Like your preference stack goes up by that much, meaning like, uh, you know, if you have an M and a outcome down the road where like things go sideways, quote unquote, and you can't exit for, you know, uh,
And more than the amount of money you've raised, well, guess what? You don't get any money. It all goes back to the VCs because of their preference. So anyway, all that too. But I would also say, because I've thought about this a lot too, and we have this discussion all the time with founders at Wave, just like you guys do at PSL Ventures. The bigger reason in my mind, the more important reason not to quote unquote raise too much is there's like...
I like to think of it as like the law of thermodynamics with startups, which is that whatever amount of money you raise, you will spend and you will spend it. It's like the work expands into the time allotted. Exactly. Like money expands into the, or your burn rate expands into the, you basically go raise every 18 months, no matter how much you raise. Yep.
So, and you may think you may have the best of intentions. You may say like, no, like I'm stocking up. I think there's going to be a market downturn or whatever. Like I'm going to intend to operate for three years based on this. Like you won't like the money's going to sit there in your bank account. You're going to be tempted to make that extra hire. You're going to be like, Oh, we'll move faster with, you know, our third engineer instead of just two engineers before we find product market fit. And like, you're going to burn that money. It's going to happen. You're going to spend more on marketing. Like, uh,
Uh, it's just, uh, I've seen it time and time and time again. Yeah. And, and again, there are counter examples to this. I know Twilio is definitely one where they raised a bunch of money in a series a and left it alone for years because they got profitable quickly. But, um, yes, in the vast majority of cases, I agree with you, David. Yeah. Especially in this pre-product market fit stage. Yeah. Yeah. I mean, that's the thing is you just want to be so careful about not
not raising as if you have product market fit when you don't or not overextending on that because the tough part could be if you have to go another year and a half and you still don't have it, then suddenly like it just gets harder. You're facing some people smell like, you know, employees, other investors for future rounds, like they smell that things aren't working, you know? And honestly, back to
jargon from, from our first episode about the term credible, it's a huge red flag to investors. If you're going out there and you're like, I need to raise a $5 million seed round because you're essentially telling us like, you're going to be irresponsible with your spend, you know, um, like you're not going to be scrappy. You're not going to be efficient. You're going to hire four engineers when you need to. And like, you know, yeah, it's,
It's just not going to be efficient.
That can make sense when a company has a lot of leverage. Like if a company is really hot and they're like, look, we'll raise a round right now that's not very dilutive just because you want some equity in our company and you think it's worth it to get that equity. But that should happen post-product market fit. That should not be happening pre-product market fit. Right. Wow. This ties into the theme after all. Indeed. All right. And this continues to tie in really well.
We're going to do our first listener call-in question. So listeners, if you want to be on the LP Bonus Show, either shoot us a note and I will read it on the air, or you can record a voice memo on your phone and email it to us at questions at acquired.fm. So here is one from listener Shiv Kodak.
Hey, my name is Shiv. I'm from the Bay Area. Love listening to your guys' podcast. Had a question for you on how do you think about valuations of companies, especially like frameworks to think about the valuations of companies at different stages of a company's growth. It would be really interesting to hear from actually both of you on perspectives of how some founders focus too much on the valuation number and then don't consider the trade-offs with the other terms in the term sheet. So an episode on that or just a quick topic in one of the episodes would be awesome. Thanks, guys.
All right. This is a fantastic, fantastic question. In early stage startups, you are not going to do a discounted cash flow and get to what the valuation of the company should be.
Um, and for, for, uh, listeners who, uh, didn't have the benefit of a finance class at some point in college, um, you are not going to, uh, figure out the sum of all future cash flows and discount it based on how far away those cash flows are away. Um,
So you're giving me the heebie-jeebies back to my investment banking days, Ben. There are no earnings to speak of because they're almost always that you're spending way more than you're making. And even doing a multiple of revenues is sort of shoddy at best. So here's how it ends up happening, can tell you from sort of the investor side. The valuation of companies, at least in the earliest stages, is thinking about a firm will say,
we want to make this investment. We think this is a good company that we'd like to invest in. The next question to ask is, how much of this company do we want to own? Well, since a firm only takes sort of 15 to 20 bets in a portfolio, each one of those needs to have a shot at sort of going all the way to being a huge outcome. So in that scenario, what you want to do is make it so that
if not all of your bets, you own a good amount of if it's the one that's the big winner. I mean, the toughest thing as a firm would be if you had 15 companies and the one that became a billion-dollar company
You weren't able to get a big percentage of and you're participating at like one or 2% in an IPO and you're like, oh, crap. Why did we, you know, that sucks. So investors will tend to say, look, we want to own or this round should own 20 to 25% of that company.
How much money do you need? And you look at a plan and you look at use of proceeds and what they're going to do with that money. And they say, okay, that seems reasonable. You need two, 3 million bucks to do this. Um, great. Okay. Well, we need to own 20%. So we will back into the valuation of the company. David, uh, what, uh, any, any other ways that this happens in a typical scenario or is that pretty much how your experience too?
No, I would say that is the baseline for how it gets. At least let's talk about the seed stage here for sure. The farther you get towards the growth end of the spectrum, the more it does become driven by TAM, revenue multiple, not DCF, but public comps, all that. But if we're talking in the early stages of company financing, I would say-
Oh, good. Jump in. So in the earliest stage, too, the state of the market is definitely a thing where if you if you and investor both agree that it's going to take 12 million dollars to get to the next milestone, it's kind of in most scenarios, it's uninvestable because you can't say, OK, we want to own 20 to 30 percent of the company.
so therefore, again, you're talking about the seed stage, the seed stage. So therefore this seed stage company is worth 30 to $40 million in most scenarios. That's impossible. Um, and so, uh,
There's two factors that come into play here. There's market conditions. So if it were five years ago, it would be reasonable for an early stage company to have a post money of $5 million. If it's today, it's much more reasonable for it to be in sort of the $10, $12 million range. So there's this sort of dynamic of what are other people paying for the same amount of risk right now. And then there is sort of the caliber of idea plus founding team.
And that is where you start to get into these scenarios where you can have the outliers of seed stage company needs to raise $12 million and have a valuation of $40 million because this thing, even though it doesn't have product market fit yet, is a thing I'm willing to do.
Well, I'm going to preview what may be our next episode. If, uh, if you guys are interested in this and talking about how the VC landscape has changed in those scenarios, it's when the series a firms decide to come back and invest pre more product market fit, but their fund sizes are so big now that they can write those big checks, but we'll save that for another day. Yeah. Okay. So the totally agree. The gloss I want to put on this is, um, I would say market conditions are much more about, um,
about rough again at the seed stage are about typical percentage of the company that you're going to sell in total at the seed stage. So like these days roughly you should expect you're going to sell in total 20 to 25% of your company at the seed stage when you're raising around. In other
Other times, a few years ago, I mean, that was getting crazy down to like 10% to 15%. But I think things have cooled down a little bit. And that's going to drive valuation. You're going to raise the amount of capital you need to raise. And valuation is going to be driven by... The real negotiation is going to be about how much of the company you're selling for what you need to raise. But the other thing I would say is that... Which, of course, on the investor side could be paraphrased as...
How much risk am I being paid for? And sort of am I overpaying for risk if I'm only getting 5% of a company that a few years ago I would have gotten 20% of? And so I should stop making those investments in quote unquote too frothy a climate? Or do I actually feel like I am getting paid for the risk that I'm taking?
Yep. And, and part of that scale within the range of market is, is Ben, like you were alluding to, you know, quality of founding team size, a potential market, exciting, uh,
Ultimately, that's going to come down to, in reality, the rubber's going to hit the road in terms of competition for the round. If you've got six VCs interested in leading your round and you've got term sheets from all of them, you're going to come in at the high end of market on valuation. If you've got one firm that is interested in leading your round, you're
you're probably going to come in, you know, at best mid range and probably in the low end in terms of valuation. And of course, then it gets into that question we had before about raising too much. It's in a very competitive deal where the valuation goes up a lot and the amount that you're able to raise goes up a lot and your dilution goes down a lot. You can get into these situations where you're like, oh my God,
how are we ever going to raise this next round at a, at a, Oh, and actually one, one quick aside I want to throw in here just cause this is a mistake. I see, I see it so often happening. Founders, so many founders want to make people happy. And, uh, part of why they've been so successful in their careers thus far and people want to work with them and people like them is like people love working with them. And as a result, they, they, in the,
the founders like making people happy. If you have raising a hot round, uh, at the stage or any stage, and you have lots of VCs who want to come in, you're going to be really tempted. And VCs are going to push you to be like, Oh, we'll let everybody in and just raise more money. But like,
And the easy decision is to say, oh yeah, well I could use some more money and I do want to make you all happy. And I think you all would be good partners in the business. Let's let you all in and let's raise $5 million. And so many of these big rounds, that's how you see it happening. I would really strongly urge you to fight that temptation. Um, because like the, like we were talking about earlier, the things that that does to your business, uh,
are bad. The preference stack, the getting loose with capital, not being efficient. Um, you know, part of being a founder is making really hard trade offs. And, uh, um, it can feel like if you have a hot round, especially at the seed stage, like, Oh, everything's going great. I don't have to make any trade offs, but you're always making trade offs. Right. So counterpoint, there are lots of good reasons to let, uh, uh,
more firms into the round. And if people feel like they have, so David, I think one of the things I meant more like growing the round size, uh, to do that. Yeah. Um, so I, I'll still say growing the round size irresponsibly. I don't necessarily disagree, but I, there, I think there are very good reasons to, to grow the round size. Um, if you, if you want to bring in two other firms and I'll tell you what the sort of my opinion, why you'd want to bring in two other firms in some scenarios, um, you will push down the leads ownership.
or push down the, both the ownership and the amount of cash the lead is putting in, uh, that's going to make them care less to your, to your point about when we were talking the other day, you're like, you don't have a sort of lead advocate, someone that's really like, um, you know, the, the lead investor in your company who cares a lot about you. Um, if some, if no firms have a lot of money in and no firms, uh, uh, have large ownership percentages, then the company's kind of on their own to make it happen. Um, and,
So one reason why you would want to grow the round is let's say you have like a big international, a firm overseas that has a lot of sort of customer relationships and you believe that selling onto that continent is going to be really important. Or let's say that there's a firm that has a specific domain expertise that's
that you think is hugely additive to the round with either a set of customers or being able to recruit from other companies that they've backed before. If there's reason to sort of grow the round size and grow the...
uh, the valuation, because then even though you are, um, diluting the, uh, percentage ownership that the lead can have in that round, everyone's still going to feel like, gosh, I have a decent amount of money in this company. And I really do have incentive to, to sort of care about it relative to the rest of the cash in my portfolio.
So I think you have a great point that I wholeheartedly agree with on you still don't want to incentivize a company to get sloppy. But, you know, I think that would be the other side of the coin is it can be useful to have certain firms in. I think...
The answer is always unique to every situation, of course. But I just saw I've seen it happen so many times where like firms get into sell mode because they really want and they start telling you all the great things they're going to do for you. And then the round closes and then you don't find product market fit and they don't. Yeah. Yeah, that's completely fair.
The last thing I will say on this question of how to think about the valuation of companies is in the long, long run. So at infinitum, infinitum, I don't know, 100 years from now, if your company is still around, it will be valued on a multiple of cash flows. And unit economics will be extremely important. And, you know, your business will be valued on fundamentals. Margins. Right.
it will be valued at IPO. Well, if it were 10 years ago at IPO, uh, sort of close to that these days, you have a lot of companies that are still not profitable when they're going public. So they're, they're more being based on comps than they are, um, necessarily fundamentals in the business. But if you can sort of just think about like every single round you raise and the closer you get to the maturity point of your business, the more the value of your company will be, uh, uh,
sort of exactly what the discounted cash flow says. And you can sort of think about a blend where in the earliest stages, it's 0% fundamentals. And at the, the, the furthest stages, it's 0% storytelling and mystique. And you sort of always have a blend every round that you raise through your IPO of, of sort of which, which thing is contributing more. Yep. Indeed. No.
Um, remember when we said the bonus shows were going to be like 20 minutes, typical acquired fashion. Well, we'll keep it shorter next time. Uh, she have, thanks for the great question. And, uh, thank you all for coming along for the journey with us on this little experiment. No kidding. No kidding. Um,
You are, you are all already enormous supporters of the show. So we thank you. I don't know what else we could even ask. Uh, if you feel like leaving an eye, I think that I think we would love that. I mean, tell your friends, I don't know. No, I think the biggest thing we can ask for, especially right now is just feedback, feedback on what can we do better? The first episode on this episode. Um, you know, we are, we are iterating towards success here. Yep. How can, how can we, how can we provide more value? Yeah. Cool. All right, guys, we'll, we'll see you next time.
See you next time.
