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One area that is generating some discussion, though not nearly enough, revolves around annual startup liquidity programs. As an owner of equity in a startup, its value is minimal or non-existent for the majority of the time. However, there are occasions when it becomes valuable – even life-changing. Nonetheless, converting startup equity into cash is consistently challenging.

But it doesn’t need to remain this way.

In the past month, I received an invitation to participate in a tender offer for a startup I am involved with, facilitated by Carta. As the leading cap table management software, Carta also provides a platform for secondary auctions. Although I decided against selling any equity, I found the process to be efficient and straightforward. Despite overseeing cap tables for tens of thousands of startups, Carta’s site indicates that they have only executed 200 secondary offerings. Evidently, the market hasn’t fully embraced this concept, whether due to disinterest or perceiving the process as complex and burdensome. I am inclined to believe the latter, especially for companies of scale (generating a minimum of $10M in revenue with a last round valuation over $100M).

An enterprising entrepreneur needs to build a SaaS system that empowers companies to run annual startup liquidity programs outside the context of cap table management.

My recollection of this idea was rekindled last week during a conversation with a non-tech entrepreneur. He co-owns a traditional private business operating at a significant scale. For decades, they have conducted an annual liquidity process at the year’s end. Over time, they have cultivated a list of pre-approved potential buyers. Every October, shareholders are approached to gauge interest in selling their shares. Interested shareholders are furnished with historical share prices from previous years and are asked to specify a target sale price. In November, interested and vetted buyers are informed about the available share quantities and are invited to give their desired purchase amount and price. Finally, come December, a structured process is run whereby potential sellers, in the order of their submission, are presented with an offer price and granted a week to decide on the sale. If the offered price equals or surpasses their specified price, declining to sell comes with a five-year restriction on selling the equity – a penalty for bypassing the process. Of note, there are no associated commissions or transaction fees for this buying and selling process. The company provides this service free of charge to its shareholders.

While startup liquidity typically revolves around financing rounds at the request of new or existing institutional shareholders, it need not be confined to this limited occurrence. With some effort and a system, I am confident that many more startups at scale would implement an annual liquidity program.

The absence of liquidity is a major issue for startup shareholders. Yet, for the private companies that have reached scale, this problem should not persist. Startups should consider an annual liquidity program and improve the industry.

In the past couple of weeks, three different friends have reached out for assistance in evaluating a potential private tech investment. In each case, these individuals are not tech investors, nor are they investing alongside an expert. Typically, these opportunities emerge through connections like a friend of a friend within a civic group or a social club. Being a cool tech startup idea, it’s easy to get excited and want to write a check.

My recommendation:  invest alongside an expert that has done similar deals in the past. 

In instances where no experienced investor is simultaneously committing under the same terms, work to find one. Much like the Lemon Law, there tends to be an information asymmetry in selection. This implies that when professional investors have opted out of an opportunity, it increases the chance it’ll get to a non-professional investor. This particular investment could potentially be the one-in-a-thousand home run or, conversely, it might be a dud. Part of the fun lies in dreaming about the possibilities.

When the next angel deal or private tech investment opportunity arises, find an expert and get them to invest alongside.

Last week, I was talking with a successful tech entrepreneur regarding ideas to expand the local tech investor community. This encompasses both angel investors and limited partners interested in investing in local venture capital funds. It’s a topic I’ve been contemplating and discussing with ecosystem leaders for over 15 years. There’s no easy answer.

The crux of the issue lies in the fact that the majority of wealthy individuals in the community accumulated their money through ventures outside of tech startups. Consequently, tech startups are often perceived as unconventional and risky financial investments – a perception that is not entirely unfounded. After all, it’s rare to encounter an industry that assesses valuations based on revenue multiples rather than profits. Moreover, the illiquid nature of tech investments means that a considerable amount of time (usually 10-12 years) elapses before any financial return, in stark contrast to real estate or stock market investments.

So, what are some potential ideas to address this challenge? Here are a few suggestions:

1. Casual, Monthly Angel Investor Group: Organize a simple and informal angel investor gathering on a monthly basis, where a local service provider can sponsor food, and entrepreneurs can pitch their startup ideas. The goal is to create a regular event that brings current and aspiring angels together (similar to the concept of Angel Lounge).

2. Formal, Monthly Angel Investor Group: Establish a more structured angel investor group where local angels commit to an annual investment amount, pay dues, set up committees, and follow a more organized approach. Typically, such groups involve more active participation and consist of a larger membership (like ATA).

3. University-Connected Alumni Angel Investors: Develop a network of angel investors who exclusively invest in startups affiliated with universities, including students, faculty, and alumni. Host regular events and pitch sessions, particularly during homecoming and alumni weekends (see Duke Angel Network).

4. Mix and Mingle Across Angel Investors: Bring together various angel groups a couple of times per year for networking and mutual learning. This could involve casual angels, serious angels, university-affiliated angels, and others.

5. Occasional Events for Local Venture Fund Limited Partners: Organize panel discussions with 2-3 local venture funds to educate potential limited partners about the role and focus of each fund. This aims to offer education and access to potential local limited partners.

6. Invite Potential Investors to Local Venture Fund Annual Meetings: Encourage potential limited partners to attend annual meetings hosted by venture funds. These meetings often include partner perspectives on the market, guest speakers, portfolio entrepreneur presentations, and networking opportunities – an ideal platform for deeper engagement with the fund.

Growing the local tech investor community by attracting more angel investors and limited partners to local venture funds is a challenging and never-ending process. The most effective approach involves fostering successful startups that lead to lucrative exits, thereby generating local wealth. However, the next best thing is steadily expanding the local tech investor community with a multi-decade horizon. The best time to start is now.

Last week, I had the opportunity to engage in two meetings with community leaders, where we delved into ways to foster the growth of our local startup ecosystem. Our discussions covered a variety of topics, from supporting entrepreneurs to identifying funding sources and implementing programs. One key takeaway I emphasized was the importance of envisioning the local startups in a funnel context, with a wide top and a narrow bottom representing the number of startups at each stage of development. To make an impact, it’s essential for the community to narrow its focus and concentrate on a specific segment of the funnel, ideally a niche one.

To better illustrate the concept, let’s consider the following stages of the startup funnel:

• Pre-Idea: At the broadest part of the funnel, numerous individuals aspire to become entrepreneurs, actively seeking ideas, co-founders, timing, and other critical elements before taking the plunge.
• Idea: The next section of the funnel comprises entrepreneurs who are working on their ideas part-time, as side hustles, attempting to validate the market, secure initial customers, and raise funds from friends and family.
• Seed: The middle of the funnel is occupied by startups with a full-time team, a modest customer base, seed funding or credit card debt, and active efforts to achieve product/market fit. This stage is particularly delicate for startups.
• Early: A small segment, featuring startups generating revenue ranging from hundreds of thousands to low single-digit millions, have achieved product/market fit, established a repeatable customer acquisition process, and often secured angel and venture capital investments.
• Growth: The final, narrowest segment of the funnel showcases startups with revenues exceeding $10 million, a substantial employee base, and a focus on scaling their operations. These startups significantly contribute to job creation, wealth generation, and overall community impact.

By using these stages as a framework, we can effectively categorize and prioritize various programs, events, and initiatives. Initiatives that attempt to address multiple stages often lose their effectiveness, as the needs and challenges faced by entrepreneurs differ significantly based on their growth phase.

For community leaders aiming to make a difference, it’s crucial to strategize with an awareness of the different stages within the startup lifecycle. Identifying a specific niche and offering tailored support for that segment can lead to more impactful and successful outcomes. Of course, these segments of the funnel can be further refined based on industry, vertical, founder types, and other sub-segments.

Enhancing the local startup community requires a targeted approach that aligns resources and initiatives with the specific needs of startups at various stages of development. By honing in on a particular segment of the funnel, we can foster an environment that nurtures thriving startups and promotes an entrepreneurial ecosystem for our community’s long-term growth and prosperity.

Last week served as a poignant reminder of the lasting importance of cultivating relationships over time. Three examples highlight the value. First, upon learning about the launch of a new Intown Golf Club in Columbus, Ohio (and Philly!), a friend immediately offered to facilitate introductions. Second, a different friend sought my assistance in resolving a technical matter, and I was able to provide an excellent referral. Last, a friend shared that they were on the verge of making a significant hire, and he noted it was someone I had introduced to them several years ago.

During my early years, I didn’t place much emphasis on expanding my network, engaging in only occasional networking activities. However, my perspective changed after reading Keith Ferrazzi’s excellent book, “Never Eat Alone” (summary). Ferrazzi helped me grasp and appreciate the true value of building relationships and connecting with individuals who share similar interests. To put these ideas into practice, I adopted a strategy of scheduling lunches with different people every day of the week. I also leveraged industry groups and leadership groups, such as the Entrepreneurs’ Organization (EO) and the Young President’s Organization (YPO), to establish a diverse network of people. Now, decades later, I find myself continually amazed by the ways in which I have been able to provide assistance to others and receive support from a wide array of people. 

My entrepreneur recommendation is to be deliberate in cultivating relationships and consistently paying it forward by helping others. By doing so, you not only enrich your own life but also create a positive ripple effect within your network. Start building relationships.

Recently a friend asked how things were going in startup land. With the continued overall economy still growing and the jobs report strong, he was curious how that translated to the startup sector. My summary: our industry is defined by lean times and inside rounds right now. 

On the lean times front, startups are a struggle as companies are still cutting budgets and reducing spend to handle slowdowns in their own industries. Things haven’t fallen off a cliff. Rather, business is OK therefore tech spend is OK. Only, this is compounded by higher churn from the small percentage of companies that are struggling. This is further compounded by layoffs that already happened, and now at renewal time, it’s a downgrade. Fewer new sales and more challenging renewals are a recipe for continued lean times. 

On the fundraising front, very few deals are getting done. Entrepreneurs are doing everything in their power to avoid having to raise money as valuations are still dramatically lower than 18 months ago. And, with interest rates expected to rise two more times this year, startup valuations have a chance of going even lower (higher interest rates make risky investments like startups less attractive). 

Modest angel and seed rounds are still getting done while later stage deals aren’t. The most popular rounds right now for startups that are performing: insider-lead financings. Many entrepreneurs want to keep burning cash, albeit at much lower rates, so as to continue investing in areas of the business. Existing investors know the business best. Instead of raising a big new round, they’re doing smaller inside rounds.

While there’s no timeline for return to normalcy, it feels like several more quarters of this. Today, it’s lean times and inside rounds for startups.

The post on Customer Value Financing from a couple months ago triggered several questions and comments from entrepreneurs, including quite a bit of interest.

Customer Value SaaS Financing

Fellow entrepreneur Jermaine Brown shared with me information on how customer value financing works via the business Lemonade and it’s filing.

Being publicly traded, Lemonade has to share some details, not just ones dressed up in marketing speak. From the Form 8-K:

Under the Agreement, the Investors will provide up to $150 million over a period of 18 months to the Company for the Company’s sales and marketing (“Growth”) efforts. Under the Agreement, subject to certain terms and conditions specified therein, at the start of each Growth Period, the Investors will provide an Investment Amount equal to up to 80% of the Company’s Growth Spend with respect to a particular Reference Cohort.

During each Growth Period, the Company will pay to the Investors an amount equal to the Investor Sharing Percentage of Reference Income generated during the Growth Period corresponding to such Disbursement Date for each Reference Cohort for every Growth Period until the Investors receive an amount sufficient to attain an effective Internal Rate of Return of 16% across all cash remittances associated with specific transactions, at which point all future Reference Income is retained by Company.

Loosely translating, this describes the following arrangement:

• Up to $150M available over 18 months
• Effective loan amount of 80% of sales and marketing spend per month (defined as a cohort and potentially a different time period like quarterly)
• Company pays back investors using the new revenue from each cohort until there’s a 16% internal rate of return (roughly an interest rate compounded annually)

In this high-level example, the costs assigned to customer acquisition and the percent of customer revenue that goes to pay back the investors is not described. As a guess, it’s likely some type of 90-day average of sales and market costs and the full gross margin as the answers.

As part of the deal, Lemonade put out a press release announcing the arrangement as a thank you to their capital provider, General Catalyst.

Finally, a corresponding blog post that provides more details titled Lemonade’s “Synthetic Agents”:

Lemonade’s “Synthetic Agents”

The term “synthetic agents” is an analogy to revenue sharing with insurance agents, and the thing they are pitting their model against, yet this also applies to other types of businesses that have a cash flow gap between the cost of signing a new customer and the gross margin received. David Skok captured this best in his SaaS Economics post showing how more growth requires more cash. Customer value financing is just as applicable to digital insurance companies as it is to SaaS companies.

Look for customer value financing to become more popular and common in all recurring revenue businesses. It’s a huge win for entrepreneurs and much needed in the market.

Recently I was talking to an entrepreneur about the changing startup landscape and the big slowdown in growth rates and funding. After initial frustration that the boom times were over, he’s now excited for this new era with a focus on excellence across the board. Many elements of the business were given less attention or hastily constructed due to the frenetic pace of growth.

Now’s the time to upgrade the startup’s functional areas.

While growth rate is still one of the biggest drivers of valuation, there’s a mind shift, albeit for a limited period of time, to focus on refurbishing core elements of the business in anticipation of the next level of scale. Internally, the trick is to frame it as a rebuilding or upleveling mission, one that’s aligned with the larger vision.

Many years ago at Pardot, we debated this intensely for product development. Our heavily funded competitors were constantly rolling out new features and modules while we were more resource constrained. We made the decision to alternate quarters between extensive new feature development and general product health (code cleanup, refactoring, technical debt, DevOps, etc.). Internally, we knew that if it was a “features” quarter, we’d be cranking out new product releases, and new features to help customers be more successful. If it was a “bugs” quarter, we’d put much more focus on fixing issues, cleaning up technical debt, refactoring clunky components, and many other important areas of the product. One quarter for aggressive new innovation, one quarter to upgrade the quality of the existing functionality.

When we sold the business, the acquirers commented that in most cases a startup’s sales and marketing is far ahead of the product’s robustness and reliability. In our case, the product’s technical underpinnings were ahead of our sales and marketing. We focused on technical excellence and delivered.

Now’s a great time to assess every functional area of the business and spend internal cycles leveling up people, processes, and technology. Cruft builds over time and needs to be revisited on a regular basis. Now is an exceptionally good time to upgrade functional areas.

For several months now ChatGPT has been one of the most popular, and profound, topics of conversation. It’s still mind-blowing to see it write an article, then change the writing style (make it sound like a pirate!), then give it feedback on what you like and don’t, via chat. From numerous conversations with friends and family, the big question keeps coming up: do you use it on a regular basis, and, if so, how?

Well, after signing up for it 6+ months ago, my weekly usage of it is for brainstorming.

Need a new product name? ChatGPT.

Need some ideas for a new blog post? ChatGPT.

Need insight for a new market? ChatGPT.

Need a starting point for a new initiative? ChatGPT.

Lack of effort to start brainstorming no longer exists. Let ChatGPT do it for you. Writer’s block no longer exists. Tell it what you want and it gives you something. Occasionally, it’ll hallucinate but the vast majority of the time it’ll give you value.

And, no, this wasn’t written by ChatGPT. Yes, I was tempted.

Time to brainstorm? Think ChatGPT.

As an entrepreneur who’s interviewed hundreds (thousands?) of people over the years for jobs, I’ve developed a set of “go to” questions that I like asking. Only, as with anything, the list has evolved over time as some become stale and new ones feel more effective. Having done it so many times, I’ve become a connoisseur of interview question and enjoy continually tweaking them.

Just recently, I heard a new one that I really like and added to the list:

How lucky are you?

I want to hear that the candidate believes some part of their success came from timing, other people helping, and/or other contributions that were lucky along the way. It’s also a form of asking if a person is humble and grateful without using those words. For these reasons, and more, I like this new interview question.

The most important interview question is related to the startup’s core values. Whatever the values, there should be one or more questions per value that pertains to it without asking about the value explicitly. With our people values of positive, self-starting, and supportive, we have a unique line of questioning that are traditional interview questions. Value-question alignment is the most important part of the interview process, even more than the subject matter competency.

Another set of questions I like is based on the chronological in-depth survey of the candidate’s past. The goal is to spend 3-4 hours with the candidate to understand their career arc and details that paint the most complete picture. Simple, superficial chats aren’t enough.

Entrepreneurs would do well to put together a Google Doc or Notion Doc with a running list of their favorite interview questions. It should be a living doc that’s visited regularly, and when a new question emerges, add it to the list and continually experiment with them. The better the interview questions, the better you understand the candidate.