Funding Climate Outside the Money Regions

Whenever I talk to a startup person outside our region (investor, journalist, etc.) they like to ask about the current funding climate in our region. Money is always a popular topic, especially when the economy is hot and startups are en vogue (bonus: public SaaS valuations are at an all-time high). Only, the funding climate outside the money regions (CA, NYC, etc.) hasn’t appreciably changed in the last 2-3 years.

More money is sloshing around on the sidelines waiting to be put to work. Limited partners have huge commitments in funds and venture investors are trying to put the money to work. Yet, this is primarily for growth/later stage investments when the metrics are solid and it’s clear the startup is going to win, simply a question of how much. For these growth/later stage investments, investors will travel. Distance is a pain but not that big a deal. If you can write a $50M check and underwrite a 3-5x return in 3-5 years, it’s a pretty easy ‘yes’, especially if there’s a direct flight (the money people still hate layovers).

Early stage investments — primarily post-seed and Series A — are still quite limited. The number of investors that focus on this stage (say, $750k – $3M in revenue) hasn’t appreciably changed, thus the number of startups that raise rounds in this stage hasn’t change (without more investors, the quantity of these types of fundings won’t increase). Investors at this stage often write checks that are larger than angels can put together, so it isn’t possible to bypass this funding source with more non-institutional money.

Seed/angel rounds are still the most challenging area. Idea stage startup are plentiful, but highly risk-loving capital is not. Local investors are still primarily wealthy people who didn’t make money in technology, and thus their appetite for startup investing is relatively low. To grow the angel community, we need to have more large startup exits. Today, there’s a strong cohort of local growth stage startups valued in the hundreds of millions and a few in the billions. Once this wave of startups, typically 5-10 years old, reaches exit maturity, expect the local angel community to ramp up and hit a new high.

While the funding climate hasn’t changed recently, the overall tenor of the startup community is humming along nicely. Look for the funding climate in the idea/seed stage to grow nicely in the next 3-5 years once we have a wave of big startup exits.

Dilution Dance for Each Financing Round

10 years ago when we went out to market to raise money for Pardot, potential investors talked about wanting to buy 33-40% of the business in the Series A. As an entrepreneur, the thought of selling that big of a chunk in one single round bothered us, and we ended up passing. Fortunately, we were able to get to a nice exit without raising institutional capital. Now, typical funding rounds are in the 15-30% dilution range (not counting growing the employee option pool, which usually adds 5% more dilution).

Today, entrepreneurs have more choices. Options like revenue financing, investors that will do straight secondary (liquidity for the entrepreneur), and more varied pools of money (e.g. family offices doing venture-like deals, etc.) were unheard of in the past. It’s a great time to be an entrepreneur.

Another feature of today’s market is that you can sell even smaller chunks of the business, especially if the startup is considered “hot.” Investors are sitting on so much cash, many of the rules like “I need to own 20% of the company” no longer apply. If you want to sell 10% of the startup, many more investors are likely interested, assuming it meets their criteria.

Entrepreneurs would do well to find the balance between selling as little of their startup as possible and raising enough money to reach their next milestone or inflection in the business. Times are good, so it’s advisable to raise a little extra, but of course that’s extra dilution as well. There’s a dilution dance with each financing round, and entrepreneurs with desirable startups would do well to assume the standard “rules” are all negotiable.

‘I’ vs ‘You’ When Giving Advice

Back in 2008 I had the opportunity to join Entrepreneurs’ Organization (EO) and go through a day long program called Forum Training with the excellent Ellie Byrd. In addition to meeting a number of great people, the most valuable education to me was learning about the Gestalt Protocol.

The Gestalt Protocol, in it’s simplest form, says to share personal experiences for the purpose of giving advice only using ‘I’ and never ‘You.’ Most often, when people give personal advice based on their experiences, it’s in the form of “You should do X because that’s what worked for me.” Instead, remove the use of ‘You” and reword it with ‘I’ so that it’s like “I did X and here’s what I learned.”

When giving advice, especially from a person that’s in a position of power or more experience, it’s too easy to start telling the other person how to do things, even while they lack the details and context of the situation, beyond what they’ve been told. In addition, when receiving the advice, it becomes less valuable when the advice comes across as directives without the corresponding experience and learnings behind it.

By following the Gestalt Protocol and using ‘I’ instead of ‘You’ when giving advice, it becomes more about experience sharing and letting the other person understand what did, and didn’t work, from a similar situation in the past, without passing judgement on the specifics of the current scenario. Personal experiences, delivered via the use of ‘I’ make for much better sharing and mentoring.

Mentors would do well to follow the Gestalt Protocol and focus on sharing personal experiences.

The Struggling Executive Who’s Really a Manager

One of the more common conversations I’ve had with entrepreneurs scaling their startup goes something like this:

Me: How are things going?

Entrepreneur: We’re having a hard time with leader X?

Me: Why’s that?

Entrepreneur: It feels like he’s always reactive.

Me: What do you mean?

Entrepreneur: Well, we keep having issues in his department and it feels like they’re things that shouldn’t be issues.

Me: What should he be doing?

Entrepreneur: He should be proactively spotting things that could be potential issues and addressing them so that they they’re non-events.

Me: Sounds like the struggling executive is really a manager, not an executive.

I’ve had this conversation with entrepreneurs numerous times and it’s always the same issue: a person was put in an executive position and they aren’t really an executive, they’re a manager.

Managers see short-term, right in front of them, and are often reactive.

Executives see long-term, around corners, and are proactive.

Managers bring problems forward.

Executives bring solutions forward.

Now, not all managers are like this and not all executives are like this, but the key difference between and a manager and an executive is the ability to see further out into the future and proactively get things done.

The next time you’re having an issue with a leader, ask the key question: are they a manager or an executive?

Why the Lack of a Strategic Plan?

When meeting with entrepreneurs I like to ask to see their strategic plan. Many times, I require seeing a simple strategic plan as a prerequisite before meeting so as to have a more informed conversation. Only, the vast majority of the time, no strategic plan exists, simple or otherwise. Then, when a strategic plan is present, and we go through several of the items, it becomes clear that it’s out of date and/or not remotely achievable. What gives?

I hearken back to the early days of my first startups and realize I never had a strategic plan. My strategic plan was Herb Kelleher’s famous quote:

We have a strategic plan. It’s called doing things.

While that worked well for me with a tiny team and few moving parts, as team and complexity grew, I needed a way to align everyone around a common, high-level focus. Enter the strategic plan.

Now, I believe, even with limited people and resources, a strategic plan is worthwhile. As a tool to communicate with employees, advisors, mentors, and investors, it’s invaluable.

One of the reasons so few entrepreneurs spend time on a strategic plan is the belief that it’s time consuming and difficult. From my experience, the simpler, more concise, the better. Here’s a simple guide for a basic strategic plan:

  • What do you do? Why?
  • Who do you serve? Why?
  • What are the measurable goals? Current values? Target values?
  • What are the priorities? Who owns them?

https://twitter.com/davidcummings/status/1134546561730584576

More complicated strategic plans are less likely to be updated and maintained, rendering them nearly useless. Finding a balance that has enough value but isn’t cumbersome is key.

Entrepreneurs should build, regularly update, and share their strategic plans. Keep it simple. Keep it accurate. Keep it worthwhile. Strategic plans are a valuable tool every entrepreneur should employ.

Statute of Limitations on Experience

Last week I was talking to an entrepreneur and she started asking me questions about recruiting best practices. How do I recruit engineers? Where do I find them? How do I build a high performance engineering culture? All great questions, but is my personal experience out of date?

This prompted me to think about the role of experience, more specifically recency of experience, in helping entrepreneurs. When an entrepreneur asks me for help, it’s most likely due to the success of Pardot. Only, Pardot was nearly seven years ago.

Since we sold Pardot, I’ve started several more startups but never got to product/market fit, making it feel like there wasn’t as much experience gained. Now, the investing and co-founding side has proved more successful than expected, but I’m a layer removed from the front line decision-making.

When does advice become stale?

When does the statute of limitations for experience occur?

Some of my recommendations should be timeless. Build regular simplified strategic plans. Be the best place to work and the best place to be a customer. Develop a meeting rhythm. Culture is the only sustainable competitive advantage completely in control of the entrepreneur.

Yet, my more specialized knowledge is dated. SEO? Marketing automation? DevOps? Agile? UI/UX? Recruiting? I’m feeling stale on a number of things that were stronger a few years back.

Now, my approach is to focus advice on high level startup and leadership strategies, and away from specific tactical things we employed at Pardot. Today, it’s more sharing personal experiences, mental frameworks, and startup strategies leaving tactical items to other practitioners with fresher knowledge.

General experience is invaluable, tactical best practices age over time.

Mind the Valuation Gap

Recently I was talking to an entrepreneur that’s raising a round and the topic of valuation came up. Valuation is always a sensitive issue. Entrepreneurs, rightly so, figure they should get the highest valuation possible. Investors, on the other side, want the lowest valuation possible that still wins the deal. Only, we’re in unusual times with valuations at or near their all-time highs (excluding the dot com days, of course).

Entrepreneurs need to mind the valuation gap.

The valuation gap is the delta between what the public market multiples currently support and the valuation private investors are willing to invest. For example, if super high growth SaaS companies trade at 8x run-rate on the public markets, and an entrepreneur raises money from an investor at 12x run-rate, there’s a 50% valuation gap.

Assuming superb execution, the startup will grow into the valuation and skip over the gap. For entrepreneurs, the risk is raising at too high a valuation and not growing into it. One of the worst possible outcomes for a venture-backed startup on the fundraising treadmill is to have a down round. Startups are essentially broken when they raise a new round of funding at a valuation lower than their last round.

The strategy for entrepreneurs: find a balance between the best valuation possible and the best valuation that ensures a strong likelihood of a higher valuation in the next round. There’s no right or wrong answer, but there’s often an answer that makes it easier to sleep well at night — find that one.