The Fundraise Overplay

In poker, beginners tend to make a consistent mistake: they overplay their hand. Overplaying a hand is when a player bets big because they think they have an amazing hand, when in reality something like two pair is just a decent hand. In other words, the bet size gets way past the reality of the player’s hand.

I have seen something like that happen in fundraising. And I almost fell for it myself when I was a founder.

The fundraise overplay is when a founder tries to raise a round that is way disproportionate to traction, the opportunity, the team, or some combination of those variables. Like in poker, sometimes a weaker hand with a big bet will flop a great result - but most of the time, the overplay means the person betting just gets burned.

I remember with one of my raises that I tried to raise $5M on crazy terms… when we had 6,000 users who weren’t paying. Yep, totally nuts.

Yet in the end, we had a stellar team that was one of the top open source companies on Github, and traction was starting to ramp up, so we got a few termsheets for lower amounts and went with one of them.

So initially I had done a fundraise overplay, but corrected myself and realized that a $2M additional raise was exactly where we deserved to be - instead of getting the raise and reality even further apart.

The mistake I see founders make, especially in an over-heated environment that is analogous to playing with a table of very loose players, is they overplay their hand. From there, they try to raise way more than the stage they are at (or at a way higher valuation), continue to overplay their hand, and then try to come back when no one is bidding at that high price. 

The problem is this: in poker, you just lose a hand and go to the next one. In startups, if you overplay your hand and get called bluffing, you might have just sunk your company.

brentgrinna

brentgrinna:

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There has been a lot of commentary recently stating that MBAs, and Harvard MBAs specifically, aren’t very good startup founders.

Only 12 of the 39 companies had any MBAs within their co-founding teams…only three had at least one co-founder who went to HBS.” – Dan Primack of Fortune

“I would bet a large amount of money that the overwhelming majority of us would not look favorably on a company started by one of you” - Chamath Palihapitiya on Harvard MBAs

Fantastic post from Brent. Driven by data, not opinion. 

The summary: “But data shows that on a relative basis, MBAs are a part of a very large relative share of those unicorns, and Harvard MBAs are a part of a massive relative share of the MBA unicorns.”

CRV sees itself as having been lucky — particularly in attracting talented entrepreneurs. He explained, “Entrepreneurs are the stars of our universe. We want them to dream the biggest dreams possible. To use a baseball analogy, the best hitters strike out six or seven of every 10 at-bats. But knowing they will strike out a lot does not discourage them from swinging for the fences.”

Why do these entrepreneurs chose to take capital from CRV? “Research at Harvard Business School and the University of Chicago shows that success begets success. Firms that have made winning investments build credibility. We have 43 years of operating data and entrepreneurs see us as supportive, helpful, and straight-talking. And luck played a role. We have had success when we weren’t expecting it and vice versa,” said Auerbach.

We’re grateful every single day for the founders who partner with CRV. And while I’m proud of the results of the past decade (having been a CRV-backed founder of an acquired company myself, just not one of those unicorns), you should see our current founders too… they’re busy building the next generation of enduring businesses. 

We used two criteria to identify the best VCs – first, they have had three or more billion dollar tech exits since 2004 in our tech Unicorn VC analysis, and second, they have received grades of “AAA” or “AA” in CB Insights’ Investor Mosaic models. These models are used by LPs to monitor and select VC firms.  AAA-rated firms are the top 2% of firms and AA represent the top 10%.

With these two criteria, 12 VCs remained on the list.

We then looked at all companies these VCs first invested in each year since 2010, and broke these investments down by the stage at which their first investment was made. We also tracked the stage breakdown over the past four years to see if there has been a shift in the VCs’ focus.

The investor with the highest proportion of early stage investments is Charles River Ventures, who invested in 90% of their portfolio at the Seed or Series A rounds.

It’s great to see this independent research and analysis speak for itself. It shows our team at CRV have stuck to our knitting - continually backing world class founders from the very beginning and helping them however possible on the path to building enduring companies.

A compass, I learnt when I was surveying, it’ll point you to True North from where you’re standing, but it’s got no advice about the swamps and deserts and chasms that you’ll encounter along the way. If in pursuit of your destination, you plunge ahead, heedless of obstacles, and achieve nothing more than to sink in a swamp… What’s the use of knowing True North?

Daniel Day Lewis in Lincoln

(via Slava A, aka coffeemug)

Tactical advice for seed stage budgeting

When I started to write this post I realized I had a lot of value locked up in old emails between my fellow founders. So what follows are direct quotes that I have made anonymous, and they are from a few years ago. Not surprisingly, I find these nuggets of wisdom still hold true:

  • I justified it with a budget. [Investors] don’t really read those at the time (nobody objected that I had engineers budgeted at $Xk) but they do expect you to hold to it, so try to put some real thought into it. They also definitely want to see 18 months of runway.
  • I can share my budget with you if you keep it deep dark confidential and realize that it’s proved way wrong.
  • Don’t be over-optimistic on payroll costs. Yes I am the lowest paid guy in the company.
  • Do not attempt to hold your breath while running a company - pay yourself tight but pay yourself enough to live your life without learning how to cook in your non-existent hours.
  • You cannot get away from offering healthcare to your employees. I think I pay roughly $500 / month / employee can’t remember precisely.
  • Assume $1500 a month for “other.” You always spend it. Travel, conferences, pizza, lunch, whatever.
  • Don’t fuck it up ;)

That last one surprisingly gets sent among founders very often. And yet the reality is that a budget is going to always be precisely wrong (if you can model the future perfectly, you’re in the wrong business). So think about your seed stage budget as guidelines, not rules.

By early 2009, a few million dollars from CRV was in the three-year-old SaaS company. With this new cash, Svane started to hire additional developers.

To be closer to Yellurkar, the trio started talking about possibly moving the company to the U.S. For Svane, he had always wanted to live in the U.S. at some point. Plus, they would be closer to investors, and their customers, which at the time, were mostly based in California. But the challenge of moving families away from home was daunting.

As Zendesk was contemplating the move, a bunch of VCs started calling. Many, including, Yelp, Twitter and OpenTable-investor Benchmark Capital, caught wind of Zendesk through portfolio companies using the customer service software. In a period of 10 days, three different Sand Hill road VCs flew in.

For Svane, Yellurkar had always felt like a member of the team since he joined, so the barrier to accepting another VC was high. It’s not that he didn’t trust institutional investors, but after being burned, he was wary of VCs who didn’t want to get their hands dirty. He knew Zendesk still had a long road ahead and he wanted a partner, not just an investor.

We really don’t talk about ourselves at CRV - we prefer for our work to continue speaking for itself. And more importantly, we prefer to always give credit to our founders - they are the real geniuses, no matter what. In the case of Zendesk, they are particularly brilliant!

But when articles like this come out crediting CRV as the very first VC and more importantly as a true partner to founders, it warms my heart. In this specific case, I love the public credit to my partner Devdutt Yellurkar for his work, support, and partnership with a great company like Zendesk.

Judging whether a startup might make it or not requires a large number of datapoints, each of which is by itself of little value. A good proxy for the value of a public company can be hacked together from just a few datapoints – earnings, assets, etc. This is not true of early-stage startups. There is a lot of work to be done figuring out what the right information that needs to be disseminated is and how to make sense of it.
Jerry Neumann

Today’s innovations are tomorrow’s table stakes

At LearnBoost, we built one of the top open source companies in the world. Part of how we did that was an “innovation” at the time (early 2010), in terms of being prolific in the world of open source, creating much more value than we captured, and then using Github to extend our recruiting reach. Our team members created and open sourced many major Node.js libraries (socket.io, ExpressJS, mongoose, etc), which in turn caused many top developers to want to work on our team. We had a backlog of very high class developers who wanted to work for us!

It’s no surprise that a few years later it is now table stakes in developer recruiting to open source and mine Github to find great individual talent, teams, and so forth.

It’s true across the board: today’s innovations and hacks become tomorrow’s table stakes. 

So what are you going to do? What’s your “innovation” as a startup founder?

One thing you can do is act quickly when you’ve stumbled upon an innovation. You’re to tap the well of that innovation as often as possible. I know we did at LearnBoost - by recruiting an “extra” engineer who would be our primary open source presence. I figured that having a talent like TJ on our team (more open source followers than nearly every company on Github) would create more value for the world and for us than anything else. In hindsight it’s a no-brainer, but you can’t believe the investor pressure I felt to not increase our burn on “frivolous things”.

In the end, it worked out and our company was acquired by Automattic, the company behind WordPress. The team we built was a key piece in that acquisition.

The broader lesson: try your best to find a pocket of innovation and tap into it as much as possible before people even realize what you’re doing.