How much do you want to sell for?

As our portfolio matures, I increasingly see the importance of the question “how much do you want to sell for?” From initial investment decision, to bringing on new follow-on capital partners, growing teams and ultimately exiting, this is a critical question for founders and investors to ask each other at each step to optimize ultimate liquid outcomes.

Some say, ”focus on building a really big business and worry about how much you sell for later.” The problem here is everyone has a different definition of “big”, so how do you know you are aligned with the investors and talent you add along the way? The “how much” question is akin to asking “how many kids do you want?” when courting your spouse! Better to address these life changing questions early.

Asking “how much” engenders valuable discussions between founders, investors and potential investors. It surfaces views on how much each party thinks the company is worth now, how much they think it can be worth, whether incentives and goals are aligned and discovery of everyone’s risk disposition. I think of risk disposition as a founder or investor’s willingness and perceived self-capability to bring a company from what it’s worth now to something bigger or much bigger later. These variables inform the conversation differently, depending on the stage of a company:

At early stage, first investment: I was recently meeting with an entrepreneur who had done a phenomenal job launching his company and getting to nearly $1M in revenue run rate. Given the dynamics of the market and the vibes from the team, it wasn’t clear they believed they could (or wanted to?) build a really big business. For simplicity in venture, I’d call a really big business one that gets to at least $25M in revenue and has the potential to sell for $250M. So I asked them. “What do you want to sell for?” One founder said, “well, I think this round will be valued at $10M, so if someone offered me that, we would seriously consider it.” The other founder nearly choked on his tongue.

These two founders had not discussed how many kids they wanted to have, and the discussion revealed big differences in belief and risk disposition. The first founder thought his business was worth $10M now, and he was open to cashing in versus trying to make something bigger – clear risk aversion. The other founder felt differently. The answer also made clear to me that the first founder questioned either the market potential or his own potential to build a big company. Both make the opportunity a non-started for us, and nor would they want us involved if a small exit is their goal. Why sell 20-30% of your equity if you think you might exit the company soon for a modest number? We would also have welcomed the question being flipped – it is surprising how rarely entrepreneurs ask us what we are trying to achieve in outcomes.

When bringing on your next investor: Inevitably, follow-on rounds bring up the discussion of what a business is worth now since valuation is a key metric in fundraising. But asking the “how much” question is even more important than in your first round, simply because there are soon to be more and more parties that can get misaligned. For example, a company doing $10M in ARR doubling each year may have several types of choices for a new investor. A multi-stage venture fund may be looking for a 10x opportunity, put in 25M on $100M and want to sell for >$1B – and be willing to take the extreme growth and scaling risks to achieve that. A growth stage fund might instead be looking to do $25M on $80M (with another $20M in secondary) and in order to achieve 3-5x via a $400M exit. This is a much less risky path that also allows early founder and investor liquidity. If your existing board is aligned with the first more aggressive partner but chooses the second instead for nice liquidity, expect a lot of pushback at your first board meeting to planned spending and ramp. In reverse, the first investor will quickly tire of a management team that does not prove to execute aggressively enough. Often these financing decisions will be further complicated by a potential acquirer suddenly making the “how much” question very real…

When approached by an acquirer: This is where the rubber meets the road – creating value is critical, but capturing it is how you get paid. Whether near a financing event or otherwise, how a board manages a potential acquisition must start by asking “how much do we want to sell for?” This will reveal any recent changes in founder and investor views and help define a reservation price at the bottom and reach goal level at the top. We have seen management teams engage deeply with acquirers on valuation before this type of board discussion, a huge mistake that puts the management team out on a limb in negotiating with the acquirer, risking having to backtrack.


There are other important realities and insights surfaced when asking “how much” at each of the stages outlined above:

  • Peoples’ answers are always changing, so you need to actually ask the question and not make assumptions during “life events”. Most people’s answers will continue to go up (sometimes rapidly!) when things are going well. When things are going poorly, investors’ answers drop much faster than entrepreneurs’. This latter point creates tension when it comes time to “finding the company a home” or “recovering capital”.
  • Asking “how much” gives you more variables to play with in reaching a favorable financing or acquisition deal. Basic negotiation theory says the more variables you have to move, the more optimal a deal can be for more people. For example, in a situation where a company is deciding between being acquired or raising another round of financing, asking the sale price question may surface investors who have a lower price expectation (perhaps actually lower expectations for the company) and can be offered liquidity via a secondary in a financing. That leaves the believers left to keep building towards the larger outcome. Likewise, if you find a founder’s takeout price is lower than investors, it may be a good time to discuss some founder liquidity to increase their willingness to take risk or increase openness to hires that can take the company even further.
  • There is often confusions among entrepreneurs why an acquisition price now is usually higher than a financing price now. In other words, if the acquirer is offering me $100M, why are investors only giving me a pre-money of $60M? There is plenty of economic theory on this – liquidity preference, control preference, etc – but the bottom line is it is the case most of the time, so don’t be surprised.


While discussing sale price should only be a rare distraction from building a company, there are times when it makes all the difference in the world. Happy building and happy selling!


Four paths to entering B2B markets and clearing table stakes

As modal B2B software investors we frequently see entrepreneurs struggling with the drag of table stakes. How do you focus resources on an innovative or novel approach to the market when customers keep asking for table stakes? An example of this problem: Let’s say a company, Resu, is developing a software that reads knowledge worker resumes and culls an applicant pool to the best 20% using AI. It’s simple, you dump 1000 resumes in, set some basic preferences, feed in the job description, and voila, you end up with the 200 best for a human to read. The entrepreneur goes to sell it and hears the following:

Enterprise: “Hmmm, not sure our HR people will trust this and whether legal will be okay with it given fair employment laws. Also, do you have admin controls, workflow for recruiters to track everything and single sign on?” ⇒ DEAD END! (for now)

Medium business: “Hey this is pretty cool. I could see us using it since our resume volumes for postings are nuts. But I really need it to integrate with our ATS, or offer the same functionality. We’d be open to switching.” ⇒ Promising, but still need to meet table stakes.

Small business: “Wow, I’d really like to try it.” ⇒ Seems like a great fit, but welcome to small contracts and churn.

Hourly worker business of any size: “We don’t really get resumes, but could you use social profiles and other data sources to do the same culling if you have an applicant’s email address?” ⇒ Did we just stumble on a new market?

In each of these conversations, table stakes play a different role in the customer’s perspective on adoption of innovative and differentiated capabilities as follows:

New offering

For enterprise, table stakes contribute a significant part of product value when new technologies become available. Process continuity, organizational inertia, need for integration and controls (eg, barriers to change management) are all high, and a desire to do things different and better are lower. In other words, don’t fix what ain’t broke. This often changes with time after a new innovation is introduced and becomes more market accepted. Medium sized businesses are a bit different. They are more flexible and open, but still need to meet table stakes – at least in terms of integration, or alternatively to match the features of any system that will be replaced.

Small (often non-consuming) businesses are different. A small business may not use an existing recruiting management solution, whether ATS or other, because it can’t afford or doesn’t value the core functionality enough, in-fact making it a non-consuming business. The small knowledge worker business makes only a few hires a quarter, so funnel management and schedule workflow aren’t nearly the pain that resume culling is to the owner/CEO who has to do it by hand for every hire. If Resu can solve this primary pain and ultimately bring basic ATS functionality as well, this becomes the classic “disruptive innovation” opportunity described by Clay Christensen. A small business may also already use an ATS but not get bogged down in table stakes when trying something additional in their stack since things like admin controls, single sign-on and workflow add relatively little value for very small companies.

The second type of non-consuming business here is the hourly worker company that has the general problem of credential and experience scoring but has never had inputs to do it before because resumes are less common among hourly workers. While applicant tracking systems are widely used in hourly worker business models, the value is primarily funnel management, not input scoring. What if Resu could change the way these companies hire by crunching social and other public data? That could be another type of disruptive play in the “hourly” economy… not a feature in a product, a new product in the existing HR stack, nor a classic low-end entry disruption. In a way, it’s a technological innovation that creates a new market.

Reflecting on these examples, four market entry strategies emerge within the context of innovation type (disruptive, sustaining, table stakes) and breadth of product (platform, product, feature)


The background coloring reflects the attractiveness of market participation in terms of when to enter and then exit as an entrepreneur or investor. Borrowing from Christensen’s framework, “Disruptive innovation” implies broadly the use of a novel technology or approach to make a business problem cheaper, easier or accessible to solve. “Sustaining innovation” then keeps that disruptive innovation ahead of competitors that enter with something similar, and “table stakes” means falling behind. The best companies first disrupt and then sustain. The average company goes through the full arc.

Working backwards there are four main market entry strategies:

D) Entering the market as a feature is the least attractive. What makes something a feature versus a product? A feature is something a customer looks at and says, “I like it and would use it if it were part of this other product.” Typically there is little to no willingness to pay for it as a stand alone product. Chatbots – in particular those without very strong AI – strike me as being very “featury”. They are useful as an additional form of user interface on a software product, but end consumers don’t want to pay extra or separately for privilege to use them. Most B2B software companies considering chatbots will build their own or quickly buy one of the many stand-alone solutions that have popped up in an early exit. We don’t invest in features because while the outcomes can be fast, they aren’t often large

Drivers of success include: distribution relationships; prolific integration; early relationships with potential acquirers (often from distribution and integration partners); build to sell/exit via capital efficiency

C) Wedge in stack is a more attractive entry. Here there is enough value that customers are willing to pay for it in their existing tech “stack”, but the product needs to integrate well with other products/platforms from the start. This strategy usually starts with medium sized business customers and moves upstream for the reasons described above. Of note, big companies can be built with this strategy but must ultimately choose to become a broader platform and bigger part of the stack (the bent arrow). ExactTarget, for example, was not a full marketing platform when it started; it was an email marketing product in the larger marketing stack servicing small and medium sized businesses. They moved upstream to enterprise and became a full stack provider, partially through organic development as well as acquisition… before a $2.6B exit. When wedge strategies remain just another product in the stack (the straight arrow), they tend to have moderate exits.

Drivers of success include: Early integration with top 5 tech stack participants/partners; scalable distribution channels, either through top 5 tech stack participants/partners or intermediaries in the value chain (integrators, VARs, etc); development customers large enough to have influence on integration partners when ecosystem is not open; rapid product expansion to reduce threat of stack participants fast following and to increase ability to displace other stack players more broadly over time; momentum and access to capital for tack-on acquisitions and mindshare expansion

B) Non-consumer entry is a platform play where a startup enters a market where products are too expensive or don’t meet the needs of a certain (and large) sub-segment. Here the platform is a simplified, cheaper and more accessible solution – the classic Disruptive Technology entry. Both Salesforce and Dropbox are perfect examples. Originally, Salesforce was an affordable and easy way for small businesses to adopt CRM… and of course Salesforce moved up market over time as most software successes do. Dropbox made a similar play in storage and sharing among prosumers and small businesses that couldn’t afford or deal with the hassle of on-premise shared drives, remote backup and expensive online data rooms. Needless to say, when successful, these are big outcomes.

Drivers of success include: Highly effective self-service or high velocity sales model (due to low dollar value sales); clear positioning to underserved or down-market segment; rapid sophistication of product to expand up market; network effects (a la Dropbox)

A) New market platform is the last entry strategy. Here a “platform” is launched from the beginning to solve a business problem for which a solution doesn’t already exist. Gainsight in customer success is the probably the most notable recent example of this. These are few and far between because most platforms and stacks are already defined. Incidentally, Gainsight is built on Salesforce, so a new stack wasn’t needed in this case to create a new market platform.

Drivers of success include: Unique market opening ⇒ think Gainsight’s perfect timing as SaaS becomes a big market ⇒ controlling churn is king to the model ⇒ rise of customer success as a business function ⇒ and so… customer success needs its own operating system. Superior thought leadership and branding to define and evangelize a new category. Early adoption by customers seen as industry innovators/leaders

My hope is these strategies crystallize common market entry modes, their tradeoffs and how investors might view them. Happy building!

Flying for money: How to raise Series A and B outside Silicon Valley

Our strategy – serving our mission of great returns for our investors and entrepreneurs – is to assist our portfolio companies in raising a strong late Series A or B funding from a large fund, often (but not necessarily) coastal. Once through the gauntlet of finding product-market-fit, building out a team and finding repeatable sales, our post-seed and early A companies must attract additional capital in order to scale. While there are several terrific local funds that focus on these types of checks, I can count them on one hand. That’s not enough frogs to kiss in an obtuse funnel. Further, the bar for our companies is higher than for Silicon Valley companies; after-all, there are multitudes of interesting companies being built in the Bay Area, and getting on a plane requires more effort and time for VCs than driving down Sand Hill Road.

We have been lucky – and our founding teams skillful – in seeing some of our companies attract follow-on rounds from top coastal and regional funds: Accel (twice), Bain (twice), Edison (twice), Drive (thrice), NEA, Battery, Bessemer, Pritzker, Safeguard, Naspers, Ascension, Baird, Jump and more. Below is a summary of our 7 years of experience helping portfolio companies attract follow-on capital. Only our top ~30% of companies have been able to attract follow-on capital from the coasts. While the vast majority of our companies raise follow-on, fewer pass the “get on a plane” test.

Here is the “how to” in ten steps for a top startup trying to raise Series A and B capital from afar, with some insights following. Of note, this is not the process for, seed and post-seed fundraises. Those are largely a local game and often happen with little past history because the stakes (check size for investors, and control loss for founders) are lower, and there’s not much past to work from anyway! So, for A and B:

  1. Start planning for your next round as soon as you close your last. You need 12 to 18 months to build relationships you don’t have. Think about the milestones you must hit to raise that next round and incorporate them into your operating plan now.
  2. 12-18 months out: Visit the coasts and have a bunch of intro conversations via warm introductions, so funds start tracking you. Say, “we’re not raising yet, but we want to share our story and tell you what we’re going to accomplish before we raise.” The pool should be 10-15 VCs. Include favorite funds you know from the last raise and add new ones. Be selective, balancing towards VCs that have either shown genuine in-bound interest in your company, have made other investments in your space or have a history of investing in your region. Prepare a deck; you will use it some but not all of the time, depending on VC personality.
  3. 6-9 months out: Visit again and show them with a deck what you’ve accomplished. Drop the several funds you didn’t like from last visit and add a few new ones, while communicating your rough timing for a raise. The pool is still 12-15 now, and you’re probably getting a sense for those with the best mutual affinity and interest. Keep detailed notes from your meetings on the recurring questions that come up; you’ll want to answer those questions in your deck and in future meetings. Bring more than the CEO to these meetings, usually another co-founder (CTO, CPO or COO) or a killer CxO you hired. You need to show VCs this is a team effort and that you can find top talent and build great teams outside of SV.
  4. 5-6 months out: It’s go time. Prepare a deck, do practice pitches with your board and insider VC partnerships. Have them play a new VC that doesn’t know you and ask you hard questions, focusing on the key recurring questions that came up from VCs during your prior visits. Iterate on the deck and prepare a data room.
  5. 4-5 months out: With a short version of the deck, fly out again and do a round of 15-20 coffee chats – 10-12 from your existing pool and 5-7 new ones (see below for why you are adding new ones at this stage). Ask qualifying questions to understand if they are really interested. Tell the VCs that you are not yet formally fundraising but will be in a few months.  VCs love to feel like they are seeing you early before others, and these coffee chats will do the trick.  If some of these firms show significant interest, you can allow them to dig in a bit by providing limited data beyond the deck, but try to slow-roll them so they can’t fully pre-empt the fundraising process. Ideally you eventually want all term sheets to arrive within a few weeks, and using data room access as a gate is the best way to do this.
  6. 3.5 months out: You are now formally fundraising. Continue video and phone conversations with your favorite 15+ firms from your last trip and eventually narrow this pool down to the 12+ with whom you would really consider working. Make the data room available to them and field data room questions by phone.
  7. 3 months out: Encourage the 8-10 most engaged to visit you in person for a deep diligence meeting with you and your team. During those visits, set expectations for term sheet timing.
  8. 2.5 months out: Fly out for partner pitches with the funds that have (or have told you they will) issued term sheets. Bring a team trio: CEO + CTO/CPO + COO/VP Sales. Bringing the sales leader is important to answer the question, “how will this $10-20M of investment drive revenue?”, while your technical leader (CTO/CPO) shows coastal firms that good software can be built outside the valley.
  9. 2 months out: Get term sheets, negotiate and sign. For the best companies, expect 1 of 2 funds that visit you to issue a term sheet (a conversion rate that would be higher in the valley).
  10. Close your round. Note: plan to still have at least three months runway left when you close. It usually takes 4 to 6 weeks from term sheet signature to close.

There are several themes that underlie the outline above. They are important:

Develop real relationships: A successful fundraise requires many touchpoints with investors – a major investment of time. It’s simple; you need to build real relationships for investors to want to get on a plane, wire you millions of dollars and then visit four times a year for the next 5 to 9 years! The most likely investors to give you a term sheet are ones who’ve known you and/or your investors for a year or several years. The least successful fundraisers we see (holding company quality constant) are the CEOs/founders who view fundraising transactionally, don’t invest in building real relationships or behave too cute or opaquely with investors. VCs are people too, so you might as well enjoy getting to know them!

Rely on your inside investors: The best entrepreneurs may complete 10 or 12 fundraising experiences in their lives – investors navigate hundreds. Enlist your inside investors to help hone your story and deck, make investor intros and serve as a back channel with interested investors whom they know. When considering an out-of-town investment in particular, potential investors will factor how existing local investors can impact the investment and how they are to work with. In this sense, existing relationships between local and coastal investors matter and can be used to a company’s benefit. We’ve even seen back channels save a financing a few times when the process goes off the rails.

Get warm intros: While it’s a VC’s jobs to take meetings, you are much better off with a truly warm intro versus a sort-of-warm intro or cold outreach. Warmth of intro goes from hot to cold as follows: (1) hot: get intro through VC’s existing portfolio company CEO that is “killing it”, (2) existing investor with whom target VC has invested before and invests earlier than target VC, (3) influential ecosystem player such as managing director at YC or Techstars who knows both the company and investor, (4) successful startup founder/exec who knows the industry and the VC, (5) portfolio company CEO that is not killing it, existing VC who invests at same stage as target or other VC that has decided to pass, (6) other randos, and (7) ice cold: cold email, LinkedIn message, twitter message (though that was cute a few years ago).

Focus on investors with a history of investing in your geography: Firms and partners develop “bus routes”. If a VC partner is already flying to a city for an existing investment, she or he is much more likely to consider another investment in that city. Likewise, many firms tend to have geographic biases. We chuckle when we hear one of our companies has met with Andreessen Horowitz. To the best of our knowledge, A16Z has invested twice in the Midwest in their existence. We wish it was more! Either way, it pales in comparison to Bain Capital Ventures, for example, which has invested five times in our geography just in the past 18 months.

Keep fresh blood circulation: While the investors you know the best are the most likely to invest, you can’t rely too heavily on an aging cohort for two reasons. First, many of the investors you knew in your prior rounds will “stage-out” as your company grows. Second, there are a host of reasons why investors with whom you’ve developed great relationships and should be a fit won’t engage or put in a term sheet. Just a few examples: (1) just did another deal and doesn’t have more bullets this year, (2) ended up investing in something competitive or at least adjacent, (3) was considering adding your city on their bus route but added another instead, (4) loves the deal but doubts she or he can get their partners’ support, or (5) just not feeling it. This need for new blood explains the VC cohort additions at each trip above and the bulge of new firms at step 5. If you have an exceptional story, there will be some buzz about you in the market by step 5. That makes it a good time to meet new funds who have heard the buzz or have a thesis in the market and therefore may be able to move fast. You never know.

Mind the plane test: The plane test is simple. If you are talking to a coastal investor who has not yet gotten on a plane to come visit you, they are either not far along in their process or not very interested. We have only ever seen one term sheet (of many) without a visit. And why would we? Imaging someone investing millions of dollars sight unseen.

Every meeting is a performance: I suppose this is true of life in general, but certainly fundraising. We’ve seen great companies err in several ways in this respect: not preparing adequately, the CEO going it alone, being cryptic about data and company performance, or talking about crazy price ranges in first meetings! Investors like investing in CEOs/founders who have a handle on every detail of their business (requires preparation!), that have built great teams, who are transparent, and who know the market will determine the value of their company. You’d be amazed by how many CEOs turn off investors in first meetings talking about too large rounds with too large prices. Save that stuff for late discussions and instead say, “we’ve accomplished a lot since our last round and can really use $XXM to accelerate growth; we’ll see how the market prices but believe we’ve earned a strong up round.”

August and December are no-go-zones: While, in fact, the VC lifestyle no longer matches the entrepreneurial meme that VCs vacation all summer and all of December, why test it!? Trying to land term sheets in late summer or late Q4 is a fool’s errand. Practically, step 7 should be underway by June or October respectively.

This post was written with my Partner, Ira Weiss, with inputs from several of our portfolio companies. Thank you!

Why I’m long the US economy (and millennials will buy cars and houses)

I’ve spent the last year scratching my head over the continued (and rapid) stock market rise amidst government uncertainty at home, geopolitical threats abroad and an increasing and ominous distance from our last recession. Large tax cuts for corporations certainly explain the recent run-up, but what of a near doubling over the last five years despite relatively flat GDP growth? What gives?

I am increasingly convinced the optimism ties to an impending once-in-several-generation consumption and investment boom kicking off as the millennial generation matures into peak child bearing and earning years. For those of you who read my posts for discussion of esoteric SaaS metrics, apologies, this is a big picture one!

Below is a GIF of the US population trend since 1990. (hooray, I made a GIF!) It shows a welling of the millennial wave, now eclipsing the baby boomer bulge.

Population GIF - Find & Share on GIPHY

We hear about this, but it is perspective altering to actually see the trend. The millennial wave now eclipses boomers for two reasons. The boomer bulge is declining as many reach the end of their lives. Meanwhile, the record levels of immigration seen in the US from the late ’90s through the mid-2010s have largely bulked up the millennial wave since its native creation in the 80s and 90s. Immigrants tend to be younger, working age or with children soon to be. This isn’t a political piece, but I’m certainly happy to have a larger working population in the US because of this trend.

This millennial boom is entering prime childbearing and earning years, the former being the largest driver of consumption (nesting), and the latter the means of consumption. This picture is quite changed from the 2010 archetype of millennials returning home to live with mom and dad after a failed job search in a post-financial-crisis economy. While it is true that millennials suffered cyclically oversized unemployment after the financial crisis, relative employment level by age has normalized. But, of course, that doesn’t stop them from whining 🙂

The next decade will also buck the belief that millennials will be different – not get married, not live in the suburbs, wait to or not have kids, not make big purchases in favor of sharing economy and experience consumption. Millennials certainly drove the urban resurgence, but many cities have already experience “peak millennial”. Rents in posh 1 and 2 bedroom apartments are starting to decline. Where are Millennials going? Millennials represent 34% of home purchases in 2017 (the largest group), 66% of which were first time purchases. And wait for it, more than 90% of these purchases were single family or townhouse, with the smallest percent of purchases being of apartments (only 1%) of any age group. They are moving out of the city; what, are they going to buy cars next? Yes. Millennials likely surpassed both Gen X and Babyboomers in new car purchases in 2017. Millennials nest too, and it’s hard to rely on Uber when two car seats follow you everywhere.

This is only the beginning. Fewer than 50% of millennials have had children yet, but most want to. And while marriage is delayed versus other generations, Millennials are compensating by having kids outside of marriage anyway. More babies, more spending.

The other big trend is that millennials are now moving through the steep part of the income/age curve:

Source: Bureau of Labor Statistics, 2017Q2

While the youngest millennials fall into an age/income bracket with median incomes around $30K/yr, the oldest millennials have reached the asymptotic median income for 35 and above of around $50K.  The bulge will only continue to move toward this higher level, enabling more spending.

Is this enough to offset the aging and retiring boomers? Well, for the first time in a century, US life expectancy has leveled out, or even dropped. This is good and bad news. The bad news is we may not live the longer and longer lives we once thought. The good (economic) news is that the expected drag from a bulge in retired non-“producing” population is likely to be lighter than once anticipated. We might also expect a higher participation in the workforce from millennials than among baby boomers given greater acceptance (and often expectance) that women enter and remain in the work force. Surprisingly, however, millennial labor participation is lower than in recent decades, perhaps a hangover from the stunting unemployment millennials initially faced during the financial crisis. We’ll see if this sustains, however.

So, if there’s a lot going for the american economy, should we all go out and buy more equities? Nothing above divines a stellar ’18 or ’19 in the markets. In fact, there feels like a lot more black swan risk in ’18 than in the prior few years. Hold onto your seats if domestic or geopolitical issues turn the wrong way: Watergate saw a 24% market decline from break-in to resignation, and we’ll be worried about more than the market if nukes fly. Nevertheless, between millennial trends and our continued leadership in technology innovation, the fundamentals are good, and I am long the next decade.

Is your startup shock resistant?

A friend and I were discussing Chicago’s appointment of a Chief Resilience Officer, a role that focuses on the city’s ability to recover rapidly from economic, environmental or health shocks. This and Fred Wilson’s Worry post got me thinking about how shocks differ from other risks and how startups and investors digest and plan for all types of risks.

A shock is one type of risk – characterized by low probability but also high magnitude and high energy. The meaning of probability and magnitude are straight forward, but how about energy? Energy is the speed with which something of high magnitude happens. For example, a cyber security breach for a startup (or any company) is a very high magnitude event that also happens extremely quickly. Trust crumbles, and customers seek a new solution immediately. Here is how I see startup risks and where shocks fit in:


“Normal” stage-appropriate startup risks:

Entrepreneurs and investors spend most of their time thinking about the upper left-hand quadrant, lower energy and magnitude risks that are high probability. These tend to be stage appropriate and include everything that “can” and will go wrong in a startup like:

  • Early startup challenges: finding PMF, key hire failures, economic scaling of sales
  • Competitive issues: new entrants, pricing wars
  • Product failures, big bugs and other operational glitches
  • Normal economic cycles that dampen demand or capital access (down cycle) or make talent scarce (up cycle)

Each of these risks is likely to impact a startup along its journey, and collectively they kill most startups. However, none alone or once is likely to be the death knell of startup. While some early startup risks (eg, finding PMF) ultimately beat startups, these are risks that a startup has years and many tries to overcome.

Inherently weak models:

The upper right-hand corner covers high energy/magnitude, high probability risks that create inherently weak startup models. Business models that rely on ethical misappropriations are an obvious in this category. If you are beating the competition or making money by cheating, you can’t expect that to be sustainable. This Fortune article highlights the natural tension of startups’ trying to make something from nothing while avoiding clear ethical violations like those at Theranos, Zenefits and even funds like Rothenberg. While I acknowledge there is a grey area, the truth is most of us know an unethical business model or practice when we see it. Further, the probability of getting caught increases the more successful one of these models becomes – an inherent disequilibrium that is the universe’s check and balance system. I’ve shared more thoughts on startup ethics here.

Extremely high burn without commensurate levels of revenue and revenue growth is the other mode of inherently weak model that we see. How much burn is too much? The rule of 40 captures the tradeoff nicely for late stage startups. For companies between $3M and 10M in revenue, we get nervous when burn rate is >$500K a month unless the company is clearly growing 150-200% (eg 2.5 to 3x) a year or more. For companies less than $3M in revenue, we get nervous when burn rate is above $300K per month unless the company is clearly 3x ing. When these conditions aren’t met, companies set themselves up for massive cuts and talent losses that are hard to recover from.


Shocks are different from both categories above because they represent the type of high-magnitude but long-tail outcomes that people are bad at predicting. There was much talk about shocks as a risk factor – and increased planning for them – after September 11th and the 2008 financial crisis. Shocks come big and out of the blue, leaving little time to react. Startups should think about, plan for and (when possible) avoid these types of exposures. There are a number of shocks startups can face, but here are a few of the most common:

Single point of human failure: Startups struggle when a “cult of the CEO” culture or a single founder becomes too powerful. This is true in the early stages, and of course the world knows about Uber’s recent woes with Kalinik at the late stage. In short, good governance and a strong team of leaders is important to uninhibiting a company from those who create and run it. Human failure shocks also include risks associated with married or dating founders (whose breakup can be a startup’s undoing) or to the risk of a solo founder becoming debilitated. There are always exceptions, but as much as possible, avoid, avoid, avoid.

Platform dependency: A much decried startup risk in a world where Facebook, Google, LinkedIn, Twitter, et al are increasingly dominant, platform dependency is truly shocking in speed and magnitude when it goes awry. We have seen three or four of our companies navigate this type of shock, with only a 50% success rate. Most people think of platform dependency as a product built or dependent on API access to another major industry player that brings additional value to that player’s platform (or extracts value from it…). But platform dependency can also include single buyer/distributor situations. In particular, the few startups we’ve seen that have found effective reseller channels are often overly reliant on one or two, a major business risk.

What to do about platform risk? With so many innovation opportunities that necessitate platform dependency, it is too hard to avoid altogether either as an entrepreneur or investor (though we try!). To mitigate the risks, we look at alignment in the dependency. The many companies that used to extract value from the LinkedIn API were not well aligned with LinkedIn, and some were outright competitive. It is no surprise access was shut down for most. These startups didn’t send checks to LinkedIn and were effectively leaching LI’s data. One could argue that many of these companies actually had a high magnitude, high probability risk – an equilibrium that was too good to be true, like pirating cable service from the utility pole! On the other hand, companies built on or connected to Salesforce often expand Salesforce’s product in directions Salesforce doesn’t go, helping to keep ecosystem customers happy while sharing some of the revenue with Salesforce. This is not without risk if Salesforce decides to make a product that competes, but it is at least more stable.

Cyber security: Every company, big and small, is at risk of cyber security breaches and threats. As we know from Target and Equifax, breaches can destroy customer goodwill and shareholder value practically overnight. Because any vendor is a weak link to large customers, startups need to be as good (or better) at security than big companies. If things go wrong, there isn’t a strong brand or scapegoat game to fall back on as at large companies.

This is true both for insider and outsider attacks. The normal democratization of information at startups doesn’t work when customers’ personal or financial data is at risk, as Twitter recently learned with a rogue employee shutdown the POTUS account. With respect to outside threats, startups typically put cyber security under the CTO. Good place to start, but startups that are a particular target (those with consumer or customer financial or health data) should institutionalize their cyber security departments well below $10M in revenue, with a Director or VP level information security hire to own the risk. This is just one action among several startups should take to attenuate cyber risk.

Macro risks: The financial crisis was a big shock to startups too! Which is to say that big macro risks like terrorism, storms and unusual financial cycles can significantly upset a startup’s trajectory. How do you plan for these? Terrorism and weather shocks are geographic. If you are in a high-risk geography, you should have a plan for both day-of response (with respect to employee safety and production/data continuity) and resilience (how you will recover operations and work with affected customers, even with reduced staff and facilities).

Financial crises require a mind-set shift for startups. “Growth at all costs” must become “protect the base”. Customers – whether consumer or B2B – will have much less appetite to buy, driving CAC up. Meanwhile access to capital from VCs will be reduced. That combination makes a focus on growth ill-conceived. Instead, focus on keeping your existing customers happy so you can live to fight another day on the other side.

Low, low: 

No need to talk about the lower magnitude, lower probability risks. You can’t worry about everything!