Deep Dive
Shownotes Transcript
Welcome to the very first limited partner bonus show of Acquired, the show about technology acquisitions and IPOs. And now in the LP show, much, much more. Much more. Thank you, everyone, for being here, joining us on this little adventure. We can't wait to see where it goes. Yeah, I think...
Um, you know, we're, we're, we started a journey three years ago and we feel like we're starting a whole new journey today. And I think, uh, it's, it's fun that it's been like three years almost to the day, um, since actually starting the show. And I think, um, a lot of you that are, are, uh, that have become limited partners have, uh, have been with us for a really long time. And, um, you know, just fun to see the, how much the show has grown, but how many, uh,
How many of you have been like communicating with us from the very beginning on helping make the show better? Yeah. So. It's been a wild ride.
So we should say a few things before diving into episode one here. You know, what are we doing? Like, what is the point of, you know, having this LP bonus show? And I suppose even before that, there are probably a decent chunk of you that are saying, why do you keep calling us limited partners? So I'm going to turn that one over to David and say, David, why did we name this the LP bonus show and why a limited partner program? Yeah.
Well, as probably many of you know, but maybe not all, the investors in venture capital funds are called limited partners. And Ben and I, of course, both being VCs, we thought now you guys are investing in Acquired. So you are...
By nature, acquired LPs. It's not totally true. There's another half of the equation there that's not actually an equity transaction. But in the same way that a venture firm looks at their LPs as the group that makes it all possible to do what we do, we look at that in the same way that we look at you, our limited partner base.
So what are we doing here in these episodes? We want to take a deeper dive into company building. Our shows normally are obviously about the exit. And while that is a really nice structure to tell a story, and we were fortunate enough to...
you know, come up with a framework that really scaled well across acquisitions and IPOs. And we think we'll continue to do well for the far future. Um, there's a lot of, uh, of sausage that goes into company making. Um, and, and there's a lot of like people that we want to bring on to talk about that with us that don't really fit into the normal structure of, uh,
Yeah, it's like...
Ben and I've talked a lot about this over the last couple of years of acquired, like it's been awesome. And our, our number one goal when we first started thinking about starting the show and then, and then all the way through has been us learning from researching and telling these stories. And we do, but we kind of joke that like, you know, both of us being involved intimately and kind of early stage company building, like we,
What we end up serving up on Acquired is like a fully grilled kielbasa for everyone that looks beautiful and tastes great. But the reality is that there is so much that goes into stuffing that sausage. And we really wanted to try and find ways to explore that. Yeah, as Scott Belsky calls it, the messy middle. Indeed, the messy middle of the sausage. Hopefully it gets cooked before you bite into it. That's right. Yeah.
Well, speaking of less cooked, another big tenet for us was that the real shows can't change. And David and I were like, well, how on earth are we going to have time to do our day jobs and do this extra content and make sure that we preserve the integrity of the main acquired product?
Um, and basically where we've landed is this is going to be pretty unproduced. So we may sometimes have worse quality if we're maybe recording it over the phone or doing something remotely, or occasionally David and I talk over each other and you'll, you'll hear way too many ums and ands and, uh, um, things that we, uh, normally would spend a bunch of time trying to, trying to make better. Um, so we, you know, we hope that's okay. Uh, let us know how you feel about it. Um, but, uh,
Yeah, I just wanted to float that with everyone. Yeah, it's like you're getting acquired without the hair and makeup done. That's right. That's right. Okay, so one other thing that I...
like thought would be cool to do on the show is give a little bit of, um, or on the LP show would be give a little bit of, uh, insight into upcoming episodes. Um, and one reason to do that is, you know, just to be able to share a little bit more, uh, with, with LPs inside the kimono of, you know, David and my planning. Um, but also because so many of you have great stories about companies that we hear about after, uh,
Uh, and you know, while that's great, it's, it, it would be great to have some of those insights before the show. And so we want to share, uh, shows we're thinking about doing in case any of you want to say, Hey, we should, we should chat before you do that. Cause I think I have kind of a unique perspective or, or belief about this company. So, um, to round out our, uh, our China mini series this season, we're definitely going to do Tencent and probably the last episode of the season. Um,
We have two ideas for the two episodes to do in the meantime, but we're not committed to this at all. One could be SendGrid Twilio. We love public-to-public mergers or public-to-public acquisitions where we get all kinds of great stuff that comes out in the SEC filings. And there's been a ton of requests for it in the Slack and over email. Yeah, we know you guys want it. We heard you.
There are like, there are also companies that, um,
I mean, we should save this from when we actually do the show, but there were like important companies in the last decade of, you know, of company building. Like just thinking about some of the first hackathons that I went to, you know, had folks from Twilio that were developer evangelists. And I think that like they were really, you know, they've just been an important company. And SendGrid similarly, you know, first, it was the first accelerator company to go public.
And then, you know, we look at the, um, you know, I don't, I think hundreds of billions of dollars, no tens of billions of dollars of, um, private company market cap, uh, from, um, from
from accelerator backed companies and, and, uh, you know, that enormous wave of future IPOs. And they were sort of the first one to, um, you know, to bring that to public market. So I just think there's a lot of really cool stories to tell there. Yeah. Also to, uh, to preview the content of this bonus episode to tools companies, Ben, how do you feel about that?
Oh, yeah. Well, as you'll hear in the Monday meeting of the investment committee of a venture firm, tools businesses are hard. And I think you'll hear that go over and over and over again if you're ever sitting in those meetings. And, you know, I think SendGrid and Twilio have proven that they can make it work. But, you know,
tools businesses tend to be very difficult to build sustainable competitive advantage and network effects and emote around it and often have sort of a race to the bottom and end up with a pricing model that's much more based on the cost of goods sold rather than value that is created. So I think, David, tools businesses are hard.
Indeed. Indeed. All right. Well, so, so that, that leads into what are we doing, uh, uh, this episode? So what are we going to do on the, um, the remainder of this LP bonus show? Um,
David and I over, uh, over drinks the other night, um, in, uh, in San Francisco, we're coming up with a long list of things that are, are, uh, terminology that you often hear in startups and venture capital and, uh, and particularly around company structure, um, that either are one jargony that, uh, uh,
are words that you wouldn't know what they mean if you weren't sort of in the biz, or two, are common words, but...
are loaded and you don't necessarily know that they're loaded. Like when someone says tools business, you would think, well, cool, I understand what they do. Like they make a thing and other business pays for it and it is a tool to enable them to make the job better. It's often a very loaded piece of terminology that says, gosh, I don't know if this can truly be venture scale and defensible over time. And we wanted to dive into some of the laundry list of those that we could come up with. Yeah.
all this coded language that has taken, you know, gosh, Ben and I've been doing this for years and like, we probably still, you know, don't even know all of it. So, but we thought we'd, we'd share it with everyone.
We want to thank our longtime friend of the show, Vanta, the leading trust management platform. Vanta, of course, automates your security reviews and compliance efforts. So frameworks like SOC 2, ISO 27001, GDPR, and HIPAA compliance and monitoring, Vanta takes care of these otherwise incredibly time and resource draining efforts for your organization and makes them fast and simple.
Yep, Vanta is the perfect example of the quote that we talk about all the time here on Acquired. Jeff Bezos, his idea that a company should only focus on what actually makes your beer taste better, i.e. spend your time and resources only on what's actually going to move the needle for your product and your customers and outsource everything else that doesn't. Every company needs compliance and trust with their vendors and customers.
It plays a major role in enabling revenue because customers and partners demand it, but yet it adds zero flavor to your actual product. Vanta takes care of all of it for you. No more spreadsheets, no fragmented tools, no manual reviews to cobble together your security and compliance requirements. It is one single software pane of glass.
that connects to all of your services via APIs and eliminates countless hours of work for your organization. There are now AI capabilities to make this even more powerful, and they even integrate with over 300 external tools. Plus, they let customers build private integrations with their internal systems.
And perhaps most importantly, your security reviews are now real-time instead of static, so you can monitor and share with your customers and partners to give them added confidence. So whether you're a startup or a large enterprise, and your company is ready to automate compliance and streamline security reviews like
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. Well, David, are there any that, let's dive in. Are there any that are particularly on the list, jump out at you, that you want to start with? Cleaning up the cap table. Yeah.
Oh, that sounds nice. He's going to do a little, little housekeeping, you know, everything's going to be sanitary. This is like the, uh, uh, the dark art of, uh, of venture capital that sometimes gets resorted to. And, uh, the, the perfect example of quote unquote, cleaning up the cap table is, uh, if people have seen the social network and the history of what happened to Facebook's, uh, cap table and ownership, uh,
After it was founded and famously Eduardo Saverin was one of the co-founders, somehow magically he ended up with a lot less ownership in the company after the early venture rounds than he had before. How did that happen? Well, there are a bunch of ways to go about this. In Facebook's case, they created and issued a whole lot more shares to everyone else in the company.
And thus diluted Eduardo down. But there are a lot of ways to go about this.
Is this also a cram down? Is that the same... That would actually be separate. Separate yet related. So cram down, you also hear about a cram down or a recap. That's where something similar is happening, but it's essentially only on the investor side. Cleaning up the cap table to me is usually referring to like, there's a founder who's not involved in the business anymore, but still owns a large chunk of it. How do you essentially fix that so that the people who are...
actually working on the business going forward are incentivized and have the equity versus someone who maybe stuck around for three or six months in the beginning and then isn't going to have any impact on the business after that. Um, cram down though and recaps. That's where, you know, if a company's, uh, struggling, uh, maybe we should also make sure to, to, um, on abbreviate in this stuff, this would be a recapitalization recapitalization. Indeed. Um,
companies maybe raised a bunch of money in the past has existing investors. Those investors have, you know, a certain ownership percentage in the company. Their shares that they bought were at a certain price, which equated to a certain valuation on the company. A new investor comes in and says, Hey, this company is struggling. I'm willing to invest, but I'm only going to invest at a much lower price. And I want to get rewarded for essentially coming into this bad situation.
That's where you can do a couple things. One, you can completely transform those shares, turn them into a separate class of shares that has much less ownership, much less preference that they would get paid back first in an acquisition.
Um, but essentially it's kind of up to a negotiation at that point, three-way negotiation between the company and the, uh, the management team who obviously wants to continue with the company, the new investor, who's excited about investing in a certain price. And then those existing investors who also want to protect their investment, but realize they're going to have to take a, take a haircut on, on their ownership in the company and maybe some of their preferential terms.
Thank you for that long definition of a thing that, you know, on the on the company building side, you sort of hope hope you're not dealing with. But sometimes the middle is messy and you have to get through it.
Indeed. So that brings up a good one. Sideways. Sideways. The definition I was thinking of is like, you know, you have in your portfolio as a VC, hopefully, you know, you have the couple of companies that are really breakout winners that are doing great. You know, they're all going up as they go to the right.
You're definitely going to have some companies that just don't work at all. They're going downwards or just flatline. But then you've got this middle, this messy middle. And what happens to those companies? Well, a lot of them, in the lingo, you'll say they're going sideways. That means they're just...
They're not going down, but they're just staying flat as they go along. Maybe they're growing at, you know, 10, 20% a year. And then what do you do with those companies? Like they're real businesses. They've got employees, they got real jobs, but like, you know, from a venture math perspective, they're not going to generate a large enough exit. That's going to move the needle quote unquote on your fund. That was another term I had in there. Um, and,
And those end up being the companies that, gosh, you end up spending so much time on because you're like, I can't... This is a real business. I can't let it down. But on the other hand, I know it's not going to generate significant returns for my fund. I have never heard sideways used in that perspective. Yeah, I don't know. That's interesting that like...
I was having this conversation. Actually, David, you and I were having this conversation with a friend a couple nights ago that most businesses are not venture-backable, and many businesses that get venture-backed are still not venture-backable. And you figured that out after the fact. Yeah. It's not apparent early. And so you want to believe that these companies can grow into these multi-billion dollar – well,
billion dollar markets and really address a large part of the total addressable market. But often case, it's not true. And so what do you do once you've raised a bunch of money and you're sitting in this situation and you know your market well and you know it's small? I hadn't heard that referred to as sideways, but it happens very often. And in fact, it's much
much more common than I think we would, we would think by reading the tech press. Yeah, totally. All right, Ben, you pick next. All right. So, uh, I think we've been talking about some sort of negative, uh, negative scenarios here. And I think, uh, and when we were brainstorming this list, I don't think it occurred to us that like, gosh, a lot of the jargon is actually referring to negative scenarios. Um, so I want to talk about the, the, the term credible. And I think that, um,
the, uh, a thing that is underappreciated and is in, to me, the most important thing as an entrepreneur, when you're, you're going and pitching your company is to be credible sort of beyond anything else. There's of course, people talk about compelling and enthusiastic and knows their numbers cold. And I think what a lot of this really boils down to is, um, are you a, uh, impedance match with the, uh,
uh, story that you're telling. So are, as are you as a person, um, coming across as, uh, uh, genuine and expert on the topic that you're talking about? And to put this in a couple of concrete examples, um, you know, if you come in and, uh,
Like if I go into a firm and I'm pitching and I say, we're going to go do X, Y, Z, and the firm asks a very reasonable question, I get defensive. And I say, well, you don't understand. Or, well, no, we're not going about it that way. If you look at it that way, then that's just not what our business is doing. A key to being credible is not being defensive.
And some of the best entrepreneurs that I see are able to take really loaded, really tough questions and really acknowledge them and talk about in a very non-defensive way why that was a very reasonable thing to ask and how he or she thinks about that.
And I think, you know, going along with not being defensive is also truly being expert. And so the, you know, you'll often get a question as an entrepreneur from someone that is potentially investing in your business saying,
you know, have you, have you talked with so-and-so? What do you think about this large? And what do you think about Google right now? Uh, exploring this space and a way to be credible is say, well, you know, um, um, I, I've talked with them, uh, and, and they're not going to go explore this for these specific strategic reasons. Or if you haven't actually done that to say, um, well, look, you know, I, um, I did the best I possibly could from the outside without actually tipping them off to my idea. And here's why I believe that that's not really what they're doing. Um,
A non-credible way to answer that is, I don't know. I mean, I don't think they're going to do this, but really I have no reason of why that's true. Or perhaps say... Or if they were, you know, he said we react. Right. Or like they haven't thought of this. Not credible. Or they're not smart enough to execute this. Not credible. And I think that...
It's really something that I try and keep in mind is like, how do you, how do you have sort of the most authentic and, and, uh, um, sort of well-sourced, well thought through conversation you can, um, when, when you're pitching your idea, which, you know, the opposite of this would be something that, uh, unfortunately the farther and farther we get into this bull market cycle, uh, is emerging more and more is, is be part of the hype machine. You never want to be referred to as part of a hype machine, uh,
which is just VC coded speak for like, this is all fluff and completely not credible. Yeah. All right. One, uh, uh, let's do, let's do a fun one here. Um, so, uh, also related to fundraising and being credible or part of the hype machine. It's one of my favorite, favorite phrases in venture, not raising right now. This is a magical phrase. Uh,
that the most experienced entrepreneurs have learned how to wield this weapon very effectively. So David, if I come to you and say, look, I have two months of cash left in the bank. I need you not only to write a term sheet in the first meeting or two here. I'm going to need to close that round pretty fast so I can make payroll. How does that come across? That comes across as desperate. And you never want to come across as desperate when you're fundraising.
And if I say, look, you know, I just raised money like three months ago, um,
my intent is really to raise in kind of, uh, uh, you know, 18 months or so, 12 to 18 months from now. Yeah. Yeah. Um, I just want to build the relationship cause it's really important to me that, you know, we find the right partners to work with, uh, and, and really be partners in the business and build it together. And that takes time and you have to build the relationship. So, you know, we're not fundraising right now, but I just want to get to know you and tell you a little bit about what we're doing. That comes across very differently. Um,
And do you like when there's a sort of, uh, you get an intro from somebody that you trust and you go and have that conversation and someone says, look, I just want to start building the relationship. Like, how do you, how do you think about that when someone tells you that? Absolutely. No, it's great. So I encourage all entrepreneurs, uh, to adopt this tool. And, and what's great is it creates immense optionality. So like worst case scenario, you are doing what you're saying you're doing.
On the other hand, everybody knows that, you know, in the back of your mind and in the back of every investor's mind who's meeting with you is like, well, if this is a really great fit and I get really excited about this, maybe I don't want to wait until you're actually out fundraising next. I want to next vocab word preempt the round, which also the farther we get into this bull market cycle is becoming more and more prevalent here.
Yeah, you don't want to be the 20th term sheet issued to a company. You want to be the first. Yeah, you want to be the first.
So it's an interesting balance because it's the tension being managed here is that the entrepreneur wants to raise money as late as possible because they want to have the most traction so they can have the most leverage and get the best terms on the round possible. So take the least dilution, have the highest valuation, highest valuation that they can comfortably grow into over time. But basically, they want to raise the most money with the least dilution possible. And
And what the investor wants is, you know, to have the most possible data on that company to be able to make the most informed decision. However, to be able to have that insight before the rest of the, the, the investing market does. And so, you know, you can do this through a really well-built relationship. You can do this through being an expert on that space. So you can sort of see their inflection point before anybody else does, but both sides are managing. That's the, the sort of very same tension. And it's a game theory dance of, uh,
um, of really trying to figure out when is the optimal time to raise how much money and on what terms. And this is where, this is where the not raising right now conversation is the perfect tool for the job. And what I would say to everyone is like really, uh, on both sides, uh, if you're, you know, everyone listening to this show is, uh,
well, actually this is a good time to step back and say one of David and my core tenets in doing the show. And I think why it's been so fun to do is we have a, like an incredible audience and every single one of you is smart and it's fun doing a show under the assumption and under the, um, you know, really, really well-founded belief that like we have incredibly smart listeners. And so everyone out here is smart. Everyone's thought through a lot of these things before. Um, and you know, uh,
You all know that sort of the most important thing here, and this really goes back to being credible, is that you fairly represent where you are. Like, you should tell your story in the best light, but it should be your real story. And the instant that you start saying, well, we're not raising right now, and like, David, I'm going to tell you we're not raising right now, you just had...
dinner with your friend last night and he told you that I talked to him yesterday and, you know, I was asking him for, you know, for investment. Like you, as soon as you do something low integrity or, or start to bend the truth too much, you've blown all your credibility ever for the rest of your career. And I think that, um, it's, it's interesting in this dance of, of, of such an important point as a, uh, if, even when you decide to use this tactic,
you need to actually not be raising. What you are doing is you are signaling to the market, hey, I will be raising in the future. I want to get to know everyone and build relationships. And if any of you should so choose to preempt the fundraising process, now you know me. Yeah. Which is another one on our list of back channel. Just operate under the assumption all the time that everyone is talking.
Yeah. Well, and this is so, you know...
So I learned this very intimately when we were fundraising for Wave. You know, there are always at least two levels of conversations going on when you're fundraising, and they're both equally important. One is the actual conversation you are having with the firm or the partner who is considering investing in you and you're considering raising investment from.
But there is this whole other shadow world of back channel conversations. And you should assume that for every, you know, every, every unit of conversation that you have directly, uh, with investors, there is, you know, somewhere between one to five times that amount that is happening behind the scenes where they're calling people who've worked with you before. Um, they're calling other people who know about the space, um,
they're talking to anyone who might have an opinion on you that they're trying to solicit.
And so, David, what are those sort of conversations? So let's say that you're – because I think a lot of people are probably curious about what this looks like. VCs have to fundraise too. And I think it's a much less blogged about, much less podcasted about part of the world than entrepreneurs raising from VCs. Right.
We're probably going to do a whole episode on this. What does it look like to try and raise a venture fund and what are the dynamics of that look like? But what information are people looking for when it's an LP doing a back channel call to really try and do a reference on someone who wants to be a VC? Yeah. I mean...
it depends a little bit on what your strategy is as a VC, but like I can say for us with wave, you know, the number one question was, will great entrepreneurs want, uh,
Wave to lead their rounds when they're raising their seed rounds or their pre-seed rounds. And so literally every entrepreneur that I'd ever worked with got called and got asked that question and directly, you know, if David were at Wave and Wave had existed when you were raising your seed round, would you have wanted them to lead above all other options that you had? And it's often as simple as that. Yeah.
All right, I'm looking through our list. What else should we cover here before we close? Well, the one that actually kick-started this idea for us, I think, Ben, you should take a stab at.
Can you define the mythical operator? So you've got operator, you've got investors, but what is an operator? Is an operator someone who is not an investor or is an operator a specific class of person who works at companies? Is it a founder? Is it an employee? What is an operator? Yeah. So a lot of times you'll have conversations with people that have a really great idea and
and are amazing at selling it, selling the vision of that and coming across as very credible. And then the question is always like, okay, but are they an operator? And to me, I think what I've come to, how I've come to think about this term is, do I feel comfortable in them doing this?
the hard work in the middle that no one has any respect for, which is the 99 people that you recruit but don't hire, so that you end up at touch points with. The product spec, when you're the CEO and you're actually...
acting as head of product for the first X amount of years, or I'm sorry, X amount of months. And so either a lot of times I like this trope that as the early stage CEO at the very beginning, you're either the head of sales or the head of product. And I think that the question is when you've
When you figure out, you know, is that person as an operator and CEO, let's say you're the head of product, like, are you a really good product manager? And if you sort of dig into the background and it's like, gosh, they were in a strategy role and then they were a consultant and then they spent some time in corp dev, they're probably whip smart and incredibly analytical. But
unproven as an operator an operator is is is i guess as i really dig into it it's have you been in the core function of of creating or selling product in a business and building a team around it and i think that um um the roots are probably much more like yeah have you have you been intimately involved in shipping product yeah or or closing sales yeah
And I think the roots of it really come much more from businesses that were operationally intense. And it's like, has this person figured out operationally how to, you know, make this crazy, crazy system works that, that involves fulfilling orders and customer service and sequencing the right timing around that. And making sure that the, this tech thing will be completed by this time when we announced this PR. And then, you know, it's, it's,
it dates to like actual operations of a business. Um, but I think the way that it's described really means more around, is it an idea and strategy person or is it someone that's going to take this and actually build it? And, um, you know, so that's the, and like all of these things, there are, um,
There are multiple levels at which these terms operate. So that's the like people within a company or a startup. Are you an operator versus, you know, more of a idea person? But then in the venture landscape, it means something related but different too, right? And it's whereas I would say in the startup landscape, like somebody being an operator is a very positive attribute, right?
If you're... Now you move into somebody who's in the investing landscape and being labeled an operator is a negative attribute. And this is like... Really? Like you don't do the investing activities well? You're really more of an operator? Yeah, exactly. Like you like... You know, you want to be... You're either too hands-on with your company. Hands-on, another great vocab word. You're...
you, you get two hands on with the companies and then you're like, you know, getting crosswise with the CEO or, or whatever functional head and you're trying to do their job. And they're like, dude, you're an investor. Like, you know, come to board meetings. Don't like be in my office every day. Um, or you just, you know, I think a lot of people who have been great quote unquote operators in businesses, um,
And then come over to the investing side. It's just so different, the job, right? And like a lot of people find that they actually don't really like it. Like you're not recruiting people all the time. You're not spending time with a team. You're not shipping product. You're not closing sales. It's a very, very different mindset.
All right. There's one more that I want to hit here. Um, and I don't know, Dave, there might be more you want to hit too, but the, uh, the one that, that jumped out at me that, uh, uh, I really wanted to talk about was why all this discussion of ownership percentage, because every entrepreneur who's ever watched, walked into any VC and tried to say, Hey, you know, uh,
we're a 15, we're worth $15 million, but actually right now we really only need like 500 K to get us to the next milestone. And a VC is like, well, that's not interesting to me because I I'm uninterested in owning what 3% of your company, um, or perhaps you have an amazing lead and, uh, you know, a firm you've worked with before, uh, has, has said, you know, I'd like to invest in you too. And you go over and say, great, there's, there's 500 K left in the round. And they say, uh,
You know, that's not going to help us meet our ownership percentage targets and we won't make investments that aren't over X percent. And you think like, what's with that stupid threshold? Like, what is, why 10 percent? Why 15 percent? Why 20 percent? If you're going to make money, you should make money on, you know, whatever percent I'm willing to give you. Right, right. Yeah.
Yeah. So this is a great topic. Um, and it essentially comes down to, I think I've talked about this on the main show a little bit too, like learning this, uh, and really feeling it intimately now starting wave versus just, you know, being an only an investor at Madrona versus starting the firm. Um,
We have to think about portfolio construction and we got hammered about this over and over again in our fundraise and I sort of knew what it meant, but I was thinking like, why is that important? But now, now that I'm seeing, like, I'm not just thinking about any individual investment we make because, you know, in an, in a, in a micro lens, of course, this is irrelevant. Like if I think your company is going to be very successful and I'm going to make a great return on the investment, it
It shouldn't matter whether I own 15 or 20 percent or 1 percent. But when you think about this in the context of a portfolio, you realize pretty quickly that if like let's take Wave, for example, we're a 55 million dollar fund.
If we owned 3% or let's make it easy, uh, 5% of a company and they exited for a billion dollars, they got acquired for a billion dollars. They went public and the lockup expired. We could, we got liquid on a billion dollars worth of market cap.
if we only own 5%, then that's only $50 million that we return. And so then we've only just returned our fund to investors. We haven't actually made any returns for them. And so then you start thinking about like, okay, well, what's the likelihood of a company getting to that point? It's pretty low. Like we're hoping that, you know,
couple companies that we invest in out of 20 ish, uh, we'll get to that point. But if it, if it doesn't, it doesn't generate huge returns for us, then it doesn't matter. We need to own, uh, we need to own, you know, 15, 20% of a company so that those very few who make it that far are actually going to generate meaningful returns for us. We own 20% of a company, for example, and they're
They and they exit for a billion dollars. Then we just forex our fund. And that's like an amazing return for everybody. So we need to be very, very cognizant of this math. No matter how excited we are or aren't about a given company, the just cold reality is most of them are not going to generate the outcome levels that we need to return our fund.
Yeah. And one of the things we haven't even talked about here is dilution. So you sort of assume that as more you raise more and more funds, at least you're going to get diluted to at least half of what your initial ownership percentage was. Especially for really early stage funds like us, like PSL.
Yep. And that makes, you know, that makes the math even, even sharper where you sort of need to even know own even more at the beginning to try and get close to that, you know, six, seven, eight, nine, 10% at the end. Um, and so the, the core assumption baked into all this is if you invest in a bunch of companies, one, hopefully we'll do super, super well and become a billion dollar company. Um, some will do pretty good, like maybe three, four or five X, um,
There will be a couple that return capital that exit for enough to get the preferred stock back. And then, you know, the rest down at the bottom will go to zero. You have two or three that go to zero. And that's the assumption baked into kind of every venture fund is that try as we might, the curve is going to look like this. It's going to be this. Is that power law distributed, David? Yeah.
Yeah. I mean, that's what people talk about it. The reality is like it's power law in that there's one or two, like I was talking about that become the big winners. What happens after that is like very much depends on, you know, the firm, how good you are as an investor and how involved you stay in the companies. This is the other area where ownership targets matter immensely and should really matter to entrepreneurs too. Is that second time spent? Well, it's time spent, but that second tier of companies, right? If I, if I'm on your board, uh,
And I own, I'm not saying I, any VC is on your board and owns three to 5% of your company. And you realize that things, you know, maybe they aren't going sideways, but you're not going to be like a runaway breakout success. There's going to be a lot of hard work recruiting executives that you need to scale the business, uh, closing deals, uh,
networking with acquirers, getting an acquisition done. There's going to be just a lot of work that your board members really not only can help with, but need to help with. Like aren't, you're not going to be able to get it done without that air cover. If I only own three to 5% of your business and I'm thinking, okay, maybe we can get this company acquired for $200 million. That's not going to be a good idea.
That's just wholly wholesale, you know, uninteresting in terms of my financial motivations. On the other hand, if I own 20% of the company and I'm thinking this could be a $200 million exit, well then shoot, that just returned to my fund and that just increased another turn and really impacted my returns. Yeah. And, and, um, the thing that I always think about with this, bringing it back to sort of why the hard cutoff when a VC will tell you we need to own 10%, we need to own 20%.
If there's only going to be a handful, one, two, three in the portfolio that become billion dollar companies, you sort of need to do the math and say, well, all of them... The one that makes it there, we need to have a big enough chunk so that that thing at least like one and a half X's the fund that we raise because...
If it doesn't, it's not like a bunch of the little ones added up are going to make a meaningful enough dent in order to help us 2, 3, 4x that fund. And so it's really all about working backwards from that assumption of there's going to be a breakout success. And of the ones that I have a shot of being breakout success, I have to be able to participate meaningfully in that. Mm-hmm.
And then that gets back to what you brought up too, which is the time element of this. You know, the, no entrepreneur should take venture capital just for the capital. Uh, you should be taking the capital because especially at the early stages, because you really believe that these partners that you're bringing up, how can you help me can help you? Yeah. And so if you, uh, if you have the ownership percentage such that outcomes are meaningful to you financially and for your fund and your own business, uh,
And you have the ability to really help impact the trajectory of the business, then that's incredible alignment. If one of those is a little bit off, then the alignment's broken and then you have a dysfunctional venture capital relationship. Yep. And so why is this important? Like, why are any of these things important? Well, it always feels to me as, I guess...
programmer, gone product manager, gone entrepreneur, and now also investing at PSL, it's always been interesting to me to look upstream of where the capital flows to you and figure out what their motivations are because I think it really helps you be more successful. The best entrepreneurs deeply understand the motivations of the VCs that are investing in them to be able to create these really win-win scenarios of...
When you're pitching, you know exactly how to pitch when you know what they're looking for and what motivates them and what would make them successful at their jobs. I think a VC understanding deeply why LPs are allocating the way that they're allocating, how are they measured on success in the very same way that an amazing B2B salesperson thinks about it. And this is a great lesson I learned at ExactTarget from a friend of the show and guest, Scott Dorsey, was how do we turn...
our customers into heroes with their customers and really putting yourself in the mindset of anybody that I'm looking to sort of sell on this or partner with or convinced to do anything with me. How do I make them, you know,
absolutely succeed. And so, yeah, I guess for me, even before, you know, before we started investing at PSL out of PSL Ventures, this was all fascinating because I think it makes you a better entrepreneur and better operator and even better, you know, employee within these companies. If you understand sort of where the upstream capital and the people that you're trying to convince to do stuff with you, where are they measured and what are their motivations? Yeah.
It's this is such an important point. I'm so glad we got here in this episode. Listeners, LPs, you can tell us if we're, you know, give us the feedback on on how this has been. And but I'm glad we ended up here. You know, when we were when Riley and Sarah and I were starting Wave.
One of the very first people we went and talked to for advice was Greg McAdoo. Greg was a senior partner at Sequoia for a long time. He led the Sequoia's original investment in Airbnb. He was a board member there for many of the early years before Greg then retired from the firm and, and Alfred Lynn took over.
But Greg was, has been an advisor and super helpful to us. The very first thing he said to us when we talked, he said, you need to understand and create alignment across everything that you do. And there needs to be full alignment between entrepreneurs, uh, ambitions and intentions and motivations, your ambitions, intentions, and motivations as general partners and, and, and founders of this firm. And all
and also your limited partners and what they intend for their capital. Uh, and, and anytime that you get something slightly, slightly out of alignment here is when you can get real, real big problems. And there are so many examples I can think of of that, you know, um, we don't need to get into all of them here, but like, uh, you know, if your LPs have a very different return horizon, uh,
perhaps a very shorter, much shorter return horizon than you're looking for as a GPS and as entrepreneurs to build the business over that can create huge, huge problems. And, and to, and to just make that, uh, crisper because return horizon is yet another fun word. If, if these LPs are saying, look, uh, we're, we're looking to sort of, um, uh,
have returns within three years and the entrepreneur is pitching the vc and saying you know we're on an amazon style 20-year journey here um actually amazon's not the best example because they ipo'd after four years or whatever but um you know if you believe that you're not if you as an entrepreneur don't have intention to uh have your shareholders be liquid for a long long time um the venture firm has to agree with that and then the lps have to agree with that and it's uh
you should be intentional about making sure that one of your first questions when you're talking with a venture firm about, um, raising money is, you know,
So are you an evergreen fund or are you a fund that invests for a 10-year period and then starts investing out of another fund? How far into that fund are you? How soon would you like an exit? I think that you won't get a straight answer to how soon would you like an exit, but starting to understand sort of at least what the sort of motivations and the forces, what am I looking for here?
Um, the incentives behind, uh, yeah, for the, for the venture investor are, um, you know, that's going to make sure that, uh, that you have that better. Well, this is what, what I realized from starting wave and from Greg too, is, is, um,
So time horizon, return horizon is the most obvious element of this, but it's not the only one. Just as if not more important is if your LPs as a venture firm are giving you capital and they really don't want you to lose that capital. They're like, you know, if you take losses, like I'm going to be very upset with you and I'm not going to come into your next fund. Well, that creates...
a massive amount of like risk aversion and, and behavior that you would then follow as a board member, right? Like if you're paranoid that any of your companies won't work and go bankrupt and you can't allow any of them to, uh, because then you're going to be quote unquote losing money in, in the face of your LPs, uh, you're going to act very, very differently than if you're, uh, if your LPs understand both time horizon and the power law dynamics of this business. And they say, I want you to take risk.
I want you to lose money because you're not going to drive big returns otherwise. And so this gets back to, again, another thing we took from Greg. At Wave, when we make investment decisions, it only takes one of us to have conviction. If two of us are against an investment and one of us is 100% for it, we will do it. We will take that risk.
Because we feel like without doing that, we would miss out on huge upside potential because it's the crazy things like Airbnb, like Uber and the like that, like no, like Rover that nobody sees coming that often all partnerships are against. Yep. Oh man, we should, yeah, we should do more LP episodes in the future that are like the greatest hits of the Rover style or like the things people were like most convinced wouldn't work and were the biggest things. Yeah.
Yeah. Well, cool. I, I wasn't exactly sure where this discussion would go, but I'm, um, even though there was a, there's like been a lot of it that, uh, um, is both negative or describing negative company building situations and also stuff that frankly, like, you know, is, is, uh, is a little sort of unsettling to talk about. And I think a lot of people, particularly in the venture industry don't want to talk about because it's not the most, um,
You don't really want to be the person who's known for talking about this stuff. It reminds me a lot of when Brad Feld and Fred Wilson started blogging when VC was very opaque in the early 2000s.
I, I think it was inspiring for so many people. So I hope that like, as, as, uh, um, as you and I sort of like continue on our, our company building journeys that we can use this as our outlet a little bit to, um, to share a lot of that transparency. Yeah, totally. And there's so much nuance to this stuff too. Yeah. Oh, for sure. For sure. Well, to wrap it up, uh,
LPs, one of the things that I think is going to make this show great is going to be to be able to answer your questions. We get a lot of questions emailed directly to us or people DM us in the Slack. And sometimes people post questions also in the general area of the Slack. But a lot of them we sort of get privately and can answer one-off questions.
And I think there's huge opportunity to get to share more of those, particularly with a little bit more of a smaller, more private group here. So we would love for you to send us your questions about this stuff in general, but also about topics covered in previous episodes and follow-ups. And maybe if you've listened to an old episode and you're like, hey, it's been two years, I'd love your take on this now, especially given this news, maybe
We would love for us to, uh, we would love to answer some of those on, in this portion. So, um, email us at acquiredfm at gmail.com and, uh, you can do that by text. So write us a regular email or what I think would be really cool is to, to build this more like a call in radio show. So if you, um, um, if you want to record yourself, like record an MP3 or whatever on your phone using voice memos or however convenient and email us, uh,
you asking the question, um, we'd love to play that sort of on the air here in the LP show and, uh, um, and be able to have, uh, I don't know. I just think it'd be cool. Yeah. Why not? We're, we're, we're experimenting back to the early days. We are. All right. Well, uh, uh, thanks for listening and, uh, we will, uh, we'll see you on the next regular episode of acquired. Yeah. Thanks for being limited partners. Truly.