One of my favorite founders in Boston is Jason Jacobs of Runkeeper.  Every time I see Jason, I mention to him how impressed I am with what I’m hearing about the progress of Runkeeper.  Without fail, Jason graciously thanks me for the encouragement and then shares the many challenges they are facing how much work there is to do to achieve his vision.


When I was starting out as a first time venture-backed CEO, I was way more insecure than Jason.  I was afraid to talk about the challenges with my team or board, for fear of seeming incompetent or dampening enthusiasm for the company.  Instead I harbored the challenges internally and always talked about how well things were going, until someone would point out the inconsistency of how far behind plan we were.  In reality, overselling the progress is what made me look incompetent.  I really wasn’t effective as a leader until I started focusing with everyone around me on the problems, while using the vision to build enthusiasm for the company.


Now that I have a portfolio of terrific founders, I have consistently seen this as the operating mode of the very best ones and particularly of successful repeat entrepreneurs and great operational CEOs.  Ask the typical entrepreneur how things are going and they feign a smile and say “terrific.”  Most founders feel the need to constantly convince their investors and everyone in the ecosystem that the company is doing extremely well; that the operational plan is well within hand, and the company is consistently outpacing it’s own aspirations.  This is not a characteristic of great entrepreneurs.


My best portfolio founders spend their board meetings telling the investors what is wrong with the business and how they are trying to solve those problems.  They don’t feel that they need to oversell the progress, because the ambition of the vision is the reason that they are so passionate and the reason that all of their constituents are committed to the venture.  The good news is either in the numbers or it isn’t in the numbers.  Hand waiving undermines credibility.  By putting the challenges on the table great leaders demonstrate how on top of the issues they are.  Most board members hear the bad news and think that at least they have someone excellent who is completely on top of solving the problems.


I have way more confidence in those that spend their time unearthing and focusing on the problems than those who pretend they don’t exist.  Sharing the challenging realities doesn’t demonstrate incompetence; instead it demonstrates the exact opposite.  Keep everyone energized by the big vision, but don’t oversell the progress in achieving it.



Founder Collective II

September 4, 2012

In late 2008, in the midst of the financial crisis, a small band of founders got together and started imagining the fund that we all wished existed when we started our own companies. We felt that there was a gap in the market for a fund that was dedicated to the seed stage and run 100% by founders and for founders – we called it peer-to-peer venture capital.

Founder Collective I was an exciting experiment.  We had all been actively angel investing for several years before we started the fund, but would it work for two of us to be full-time while five of our partners ran startups day-to-day and worked for the fund part-time? Would smart entrepreneurs appreciate the unique elements of our offering and want to work with us?

Founder Collective has now been in business for a little over three years.  We strive every day to live up to our mission of being the most aligned fund for founders at the seed stage.

We’re delighted today to announce that we’ve closed Founder Collective II – a $70MM fund continuing the work that was started by FCI and based on the same founder-centered vision.

We support this vision by looking at the world from a founder point of view and focusing our investments at the seed stage.

Every person involved in Founder Collective is an entrepreneur.  FCII, like FCI, will be managed full time by the two of us, with our other partners working part time for FC while primarily focusing on their day jobs of running companies. We are proud Founder Collective has had the privilege to back our own partners, 
Zach, Bill, Caterina, Chris, and Micah, on their startups. We feel that keeps us uniquely connected to the day-to-day challenges of running a fledgling company.


By dedicating ourselves to seed, we deliberately avoid the misalignment of being a net buyer round after financing round, while our founders are net sellers.  We are not buying an option on the future. Our founders don’t feel compelled to constantly oversell to make sure we keep buying. We invest at the beginning and then sit on the same side of the table.  That makes it easy for founders to talk to us about the ground-truth of their businesses, without fear that we’ll lose enthusiasm, and hopefully puts us in a better position to help.

Founder Collective is committed to backing exceptional founders and their visions of the future.  We don’t seek out founders that validate our particular thesis within a defined set of themes.  Show us a big business that can be transformed by technology and great people eager to prove it, and we want to be part of the journey whether it’s democratizing text booksfundraising for medical care, automating agriculture, rapid testing for food safety, or rethinking ground transportation.

We are deep believers in the entrepreneurial ecosystems of our home turf of NY and Boston.  This will remain our focus, while we’ll continue to invest in the Bay Area where three of our partners now live.  

Chris mentioned in his original blog announcing FC that the word “Collective” may sound a bit radical, but it is intended to emphasize our focus on peer-to-peer investing.  Over the last three years we’ve tried hard to honor our name.  Our founders actively help each other and help our fund.  We learn from them every day.

We see Founder Collective II as the next step in building a sustainable collective that will contribute to the startup world for many years to come.

David Frankel & Eric Paley

Pitch Selection

May 1, 2012

I remember a very strange moment during my college interview where my obsession with baseball came into the conversation.  The interviewer asked me what I loved so much about baseball.  I listed several things that I love and then threw in a deeply held belief, “I find that baseball provides a metaphor for nearly everything in life.”  He seemed to find that amusing and quizzed me for some examples.  I offered many examples relevant to my life then and still have many relevant to my life now.  When dealing with lots of complexity, I often find baseball metaphors clarify things for me.  A recent metaphor has been coming to mind when thinking through our investment selection as venture capitalists.


First a bit of philosophical background – I’m a deep believer that companies are made and not born.  They can be born with terrific DNA and fail, and they can be born with terrible DNA and succeed.  All things considered, I’d take the terrific DNA every time, but this belief defies the way that most Venture Capitalists talk about companies.  I frequently hear VC’s say things after being pitched like “that’s a bad investment” or “that’s not an interesting company” or proudly state to others “we passed on that deal.”  Those are judgmental statements of DNA, but those comments don’t acknowledge that the company is dynamic and will change over time.  Not to mention that a good VC can make an impact on a company by helping focus its direction or introducing a key employee that becomes a catalyst to recreating the DNA of the company.


We see lots of companies that we think have very high merit, but we choose not to invest.  We see others with similar merit and pull the trigger on an investment.  At the moment we invest, we do believe that the new portfolio company is stronger than the interesting company in which we didn’t invest, but the future isn’t written yet and it’s all about the future, not the DNA. 


This leads me to my clarifying baseball metaphor – I’ve begun to think of investing much like a batter selecting pitches.  Pitch selection reflects a hitter’s estimation of the quality of that pitch for hitting, but it doesn’t define the outcome.  Some hitters dive for pitches out of the zone and hit it out of the park.  Other hitters swing at their perfect pitch and miss.  Pitch selection also reflects a hitter’s personal biases.  One hitter may just be more comfortable swinging at a high pitch than another hitter who likes to swing at low pitches; it all depends on what type of pitches the hitter or investor is most comfortable swinging at.




No doubt some pitches are better to swing at than others; much like funding startups with better DNA.  At Founder Collective, we are trying to swing at the best pitches that we can, but will swing and miss with some.  We’re also not swinging at lots of good pitches that other funds will hit out of the park.  I’m very happy with our overall pitch selection and think we’re going to have a terrific slugging percentage.  However, founders should understand that we don’t view the pitches when we don’t swing as bad pitches or the pitches when we do swing as probable homeruns.  We just have to keep looking for our pitch and take the best swing that we can.  It’s all about what happens next.




Startup founders have boundless ambition.  Most founders can imagine their platform concept having broad appeal and meeting the needs of many customers, with numerous products, often across many markets.  Investors love to hear about platforms and big visions for success.  This ambition is contagious but also very dangerous.


Repeat after me: “Startups Rarely Do Anything Well.”  I believe this mantra is the key to startup success.  The sooner a founder gets realistic about the need to focus, the more likely the founder will be successful.  To succeed, a startup needs to become world class at something that a large enough group of customers value.  Becoming world class at something is non-trivial.  It is very challenging for a small group of people to create something that is world class.  It is nearly impossible for that group to create multiple things that are world class.


Think of most of the fastest scaling startups of our time and how they started. Twitter, Groupon, Gilt Group, Dropbox, AirBnB etc.  They didn’t start with multiple products or even multiple target audiences.  Over time, they may have grown into broader platforms, but even today those platforms have limited capabilities that most people would refer to as world class.  Given the billion plus dollar valuations of these startups, one might expect that many of them would now offer multiple products and broaden their platforms, but looking back at the list, the range of products offered from each of these companies is highly focused.


Ultimately, the reason this is such an important mantra for startups is that success is so dependent on focus and prioritization.  A music student who wants to become a world class cello player needs to practice for hours a day.  That almost definitely prevents the same student from also being a world-class soccer player or even a world class piano player for that matter.  Being good at both pursuits is possible, but being world class at either activity requires an incredible amount of focus and prioritization of which activity to be practicing many hours per day.  The same is true of startups.  Division of extremely scarce resources among multiple goals is highly detrimental to becoming among the best in the world at something customers greatly value.  The challenge is deciding which of these goals is truly the big opportunity and justifies all the resources.  Hedging or multi-pronged ambition is almost never an outcome maximizing option.


I encourage startups to dream big, but to focus small.  While having a huge vision of the future, remember that if you are among the best in the world at solving one problem, you’ve achieved something rare. Aspiring to this goal alone is likely a multi-year rollercoaster pursuit.


The Curve of Talent

May 17, 2011

Back in 2005 at Brontes, I was working hard with our VP Engineering, Ed Tekeian, to convince a talented engineer to stay at the company and not take another job offer.  I was struck when the engineer said to us, “guys, I respect you, but I really don’t know why you’re making such a fuss out of my leaving.  I did a fine job here, but really only did what I was asked.  In truth, I’m very replaceable.”  Ed responded, “The more that you manage people in your career, the more you’ll find that it is very hard to find people who can execute well on what they are asked to do.  Don’t underestimate how valuable you are and how hard it will be to find a replacement.”  It was a very candid moment of talent assessment in which the bar of performance wasn’t innovation, but simply competently executing the expected job.  Ed was right, finding people who can do the job that is asked of them is quite hard.

When it comes to assessing talent, I’m not a believer in grade inflation.  Most people are C performers. C performers struggle to competently fill their role, but are somewhat productive with sufficient coaching. Hard to admit, but most people in the business world don’t have a particularly clear idea on how to do their job well.  It’s not just a question of experience.  I’ve seen very inexperienced people have a very clear idea of their objectives and find ways to deliver way above those objectives.  I’ve also seen extremely experienced people, who have been previously considered successful in a number of roles, but really don’t have a clear idea of how to deliver on their objectives within their function and be successful.  In many of these circumstances, when failing, these folks hide behind their experience to suggest that the objectives were unreasonable.  This problem isn’t limited to any particular type of job.  I believe this problem is true whether talking about senior executives or junior engineers.

The large company corporate world is filled with C players.  The term “Peter Principle” was coined to describe this phenomenon in which people in large companies are promoted exactly one pay grade beyond what they can competently do and then stay in that role for the rest of their careers.  Large companies thrive on inertia and the core job description of a large company employee is to keep that inertia going and do nothing to screw it up.  If last year’s top line grew 8%, the job is to grow it 8% again, not to figure out how to make a step function change and grow it 20%. In attempting to achieve that 20% step function change, there is high risk of a misstep that could lead to a decline in sales.  That’s simply unacceptable. 

Large companies fire those who get F grades, because they are not at all productive.  They accept C players, because they are somewhat productive with guidance and B players are hard to find. It is very easy for a C player to seem moderately successful when progress is largely based on inertia.   Large corporations celebrate B players who can competently complete their job with minimum coaching and maintain inertia.  These are the heroes of large corporations. Innovation within a function is risky and can threaten inertia.  

Large companies have very few A players.  A players don’t want to be at large companies because, more often than not, corporate bureaucracy and process not only fail to reward, but actually punish A players.  By putting the objectives ahead of process and politics, A players step on bureaucratic toes and don’t retreat based on false territorial claims.  Though there are exceptions, few large corporations create cultures that give A players room to win.  It’s not fun trying to innovate at a large company when co-workers feel that you’re threatening the core inertia on which the business is based.  They’ll say things like “that’s just not the way things work around here.” 

By contrast, startups have no inertia and need to create momentum from nothing.  This is a very different job. Startups don’t succeed with people who deliver at a minimum acceptable level.  There really is little room for C players in a startup.  Employees who are somewhat productive, with lots of coaching, take a spot away from potential A players that can make a major impact on the success of a startup.  Startups generally don’t even succeed with a team of only folks who understand their objectives well and deliver them competently – the B players.  Competence across a team is simply not enough to build momentum from a standing start and learn quickly to iterate on strategy and tactics.  To succeed, most startups need some core team of A players; folks who can “write the book and not just read it.” These are an incredibly rare breed of people who not only have a clear idea how to competently accomplish their functional objectives, but actually lead the organization to innovate and be world class within their functional area.  They raise the bar on the entire organization.

Those who suggest that startups should only hire A players are grade inflators.  They’re calling B players A players.  The actual A players are too rare for this to be a practical hiring plan.  I advise my portfolio companies to be cautious when hiring candidates from large companies and focus on people who have already proven they can be successful in startup environments.  Another successful strategy is to hire less experienced candidates who show enormous upside in their ability to innovate.  When managing talent, startups need to help C players transition out of the organization and coach B players on the need to not just competently deliver their function, but drive toward innovation within that function.  Most of all, celebrate the A players and give them the room to explore hypotheses and make mistakes.  When interviewing, seek hires that not only understand how to competently deliver functional objectives, but also want to innovate within their function to build momentum from nothing.  One way these candidates can be identified during an interview is when they actually teach the interviewer something about how the company can win.  The best hires are those who have time and again proven they can innovate in a startup environment.  That’s startup gold. When you find those folks, don’t let them out of the building. 



April 21, 2011

The currency of the startup and venture capital community is conviction.  Startups are born out of the conviction to leave a job and start a company that most people think will never get a customer.  They are built on the conviction of talent to join a startup, that has little or no traction, purely based on the promise of the future.  In our case at Founder Collective, our conviction is challenged every day as we decide when to take the leap and put our capital and energy behind the vision of an entrepreneur, that wants to change the world, but is at the starting gate.  Given this daily challenge, I spend lots of time thinking about where conviction comes from and how founders can convince others to share their level of conviction.

Founder Collective is a seed fund, and some of our investments are made based on little more than a founding team and an idea.  At the other extreme, I’ve tracked some of our portfolio companies for over a year, until they had early customer traction, before I had the conviction to write a check.  We invest when we have conviction about a company.  That can come pre-product, but sometimes it requires not just product, but early customer data to get us to the finish line.  Unfortunately, conviction is not a trivial thing to achieve.

No doubt this is really frustrating to some of the entrepreneurs that meet with us and don’t get funded.  I find myself in some meetings saying to the entrepreneur that I like where they are going with the company, but don’t have enough instinctual conviction to invest at this stage.  I frequently need to see some early traction before investing.  Inevitably I get a frustrated look from across the table, which often leads to the very blunt response from the entrepreneur, “but I thought Founder Collective is a seed fund.  I won’t be looking for seed funding when I have traction.”

This is one of my least favorite conversations, and I try to reconcile my feedback with the fact that we do many of our investments with little to no customer traction.  It is true that the more data we need, the less likely it is that the company will still be at a phase in which a seed fund like ours is a fit.  On the other hand, I’d say that more often than not, our seed funding is in companies that have some minimally viable product and early customer data upon which we can get an idea whether customers are engaging and buzzing about the product.

I don’t think the investor process to get to conviction is that different than the entrepreneur process to get to conviction; the challenge is at the pitch stage, when VC and founder are at vastly different points in the conviction process.  I advise entrepreneurs to take investors through their own process of getting to conviction.  What made them want to drop everything to build this business?  Hopefully that process was a good combination of instincts and various forms of customer validation of those instincts.  Entrepreneurs driven completely by instincts will typically struggle to find an investor who equally shares conviction purely based on the same instincts, unless they share similar experiences that shape how they think about the opportunity.  It’s way more effective to frame instincts as hypotheses and then show interesting early customer development data that helps validate the hypotheses.

Struggling to communicate the combination of instincts and data leading to conviction, I created the chart below to make it a bit more concrete.  Insert your own MBA 2×2 joke here…




The idea here is that some things are so instinctual for me that I need virtually no data to get excited.  That doesn’t excuse the need to start validating hypotheses, as instincts can often be misleading, but I can invest in those companies pre-product.  Other concepts don’t resonate so deeply that I can make a bet without some early customer data.  There are some startups on which I was extremely skeptical at first meeting, but data has clearly convinced me otherwise, and I could easily invest later despite my early skepticism.  Perhaps, as a seed investor, I’m too late at that stage.  In many cases, I’ve had the opportunity to back those entrepreneurs after they’ve gotten early traction.   More often than not, when I don’t invest, it isn’t because I believe that the startup is fatally flawed and won’t be a success; it’s because I don’t yet have equal conviction to the founder.  Ultimately, I can only bet based on my own convictions, and I think that’s also a good thing for founders.  I don’t think founders should want money from investors that don’t yet share their conviction. 


I was on a panel last year titled The Future of Venture Capital with four other panelists who had way more experience in venture capital.  In fact, I’m not sure what my credentials were to be on the panel, given my six months experience in the industry.  My credibility with the audience fell further based on what I think most people perceived as my naive and wacky comments.  All of my co-panelists agreed that venture capital was broken and that we’d likely see half the number of funds in five years.  All agreed that this would be a bad thing for entrepreneurs.


When it was my turn to speak on the subject, I predicted that we’d see double the number of funds in five years.  No doubt this further diminished my credibility, but I tried to explain my view that the venture industry was rationalizing and that it made no sense to have hundreds of funds managing hundreds of millions of dollars each.  Instead, we think what we were doing at Founder Collective and what our peers are doing at First Round, Floodgate, Harrison Metal, Baseline, IA Ventures, Betaworks etc. fills a big gap in the venture industry and that there is room for many sub $100MM funds.  I view this as a very good thing for entrepreneurs, but I also see this as a very good thing for larger venture funds.  In the last year, with the advent of what some are questionably calling the super-angel bubble, I believe the industry has shifted as I hoped with a much more active super-angel community and a more than tripling of the number of micro-cap funds raised.  In my view, this is a big win for everyone in the ecosystem.


There have been many blog posts lately commenting on the criticism of mainstream venture capitalists and the tension with angel/micro-VCs.  This has hit the ultimate peak with Sarah Lacy’s Super Angel/VC Smackdown with David Hornik and Dave McClure screaming at each other.  Some of this tension is only natural as we all get comfortable working together and competitive juices start to flow.  Brad Feld wrote a thought-provoking post on the topic last week.  My personal view is that this tension needs to die quickly.  Let’s all agree that most VCs dont suck and nearly all seeded startups will need VC funding to become important companies.  Its hard for me to think of a single company in our portfolio at Founder Collective that doesnt intend to raise money at some point from a larger VC. The tension needs to die quickly because we all are creating value for each other and are largely non-competitive.  Im going to try to articulate the role seed investors play in the VC industry, but first Id like put seed investment in the context of the last decade of venture capital.


Looking back, as venture funds got bigger during the dotcom bubble, they became and marketed themselves as life cycle investment partners.  VCs were sized to invest in every round of a startup, though not always lead, and maintain 20% or greater ownership in every portfolio company.  In theory VCs told their Limited Partners that they would lean into their winners, but in practice they knew it was very hard to stop investing in the underperforming companies for a variety of reasons – Rob Go wrote a great blog post on this.  The biggest challenge is that VC backed startups are rarely good or bad companies for future investment.  The world isnt so black and white.  Lots of companies have merit at inflection points, but hold tremendous risk.  Given the intention of being a life cycle funder, a VC walking away from a follow-on round of a portfolio company is typically catastrophic to that company.  If the initial investor wasnt willing to write a check and that investor had the best information, why should anyone else be willing to do so?  In other words, any deal that a VC didnt want to continue supporting would find no other venture capital support and die.  VCs didnt really want to be in the business of killing companies and turn out to be much better at company creation and support than company termination.


The implication of large funds doing life cycle investing is an implicit huge commitment to any portfolio company regardless of the size of the initial investment.  There are recent exceptions to this rule as some larger funds are making lower commitment seed investments to many startups, which can be highly problematic for founders, but historically any investment was a long term commitment unless it was performing very badly.  This was generally a good thing for entrepreneurs, because through good and bad times VCs kept writing checks (not always at desirable terms), but it created a huge burden to clear the hurdle of getting an initial check.  VCs had to be very careful in their diligence and their conviction needed to be extremely deep, as even a Series A $2MM check could be an implicit $10-$20MM commitment to a company.  Unfortunately, deep diligence and high conviction is not fully correlated to investment success, as it only analyzes a snapshot, not a movie, about the merit of a startup.  These companies need time to show their worth and truly justify the large commitment.  Historically angels have provided some capital for this purpose, but the angel community was greatly damaged in the dotcom bust and further injured by the great recession. 


This life cycle investment approach also lent itself to investing in repeat entrepreneurs and avoiding first time entrepreneurs, as VCs really had to decide out of the gate if an investment was worthy of taking a slot among a handful of deals in a fund and an implicit commitment to a big chunk of capital long term.  In essence, this market structure led to very few at bats, but lots of swinging for the fences right out of the gate.  If considered as a funnel, the structure of venture, post the dotcom bubble, looked like a thin and minor taper round after round.  Few entrepreneurs were getting at bats, but the ones who got to the plate had the benefit of an over commitment from funds that needed to put lots of capital to work in a limited number of deals and were really bad at killing the companies that did not deserve so much capital.  To be fair, this had some pretty big pitfalls for the entrepreneurs too, but thats not the focus of this post.


The common refrain of VC funds is that too much capital is chasing too few deals.  For me, this hits a major philosophical question as to whether great companies are born or are made.  If you believe they are born, i.e. they can be identified from day one and it isnt the execution that matters, probably the increased birth rate has little benefit for creating more great companies.  If, like me, you believe great companies are made, i.e., by getting more at bats, more entrepreneurs will get a chance to prove they can build great businesses and more great businesses will be created, then the increased birth rate is a really good answer to the issue of too much money chasing too few deals.


My belief is that the shape of the investment funnel is changing for the better.  Angels and micro-vcs should be focused on the seed round, creating opportunities for entrepreneurs to build validation that justifies larger commitments from larger funds.  Seed investors must also avoid signaling by keeping funds small and showing restraint when it comes to follow on financings. That way many more founders will get at bats and less capital will be overcommitted to experiments that dont merit the investment. 


The failure rate will be much higher, but Im not sure thats a bad thing. Fred Wilson wrote a great post on The Expanding Birthrate of Web Startups in which he fears that angels and small funds wont be positioned to support the growing population of funded companies.  Fred asks who is going to house, feed, school and send all these kids to college?  I agree with Fred that this is an issue, but I also think this is the creative destruction of a major improvement in the startup industry.  The market should be in a position to decide the merit of a startup without the challenges of sunk costs of a large venture fund or the signaling of a single fund determining the future of a company.  This is particularly true if the implication is that many more founders get a chance to create something of value.  Most founders would rather be funded to try and fail, than never to try at all.  After all, an implicit commitment of $10MM being allocated to a very early stage startup going sideways can be used to fund 10 similarly staged startups at $1MM and perhaps create a few companies that become rocket ships.  Nearly all of them will require more capital from larger funds at some point to be successful.  Larger funds get the benefit of seeing more validation early of a greater number of startups without the obligation to over invest round after round, which should yield higher investment returns for everyone.


Not only will this broader funnel create more companies with capital to prove value, but it will also attract more people to entrepreneurship, as founders wont be deterred by the notion that getting funding is impossible unless theyve run a company before.  I believe we’re already seeing this benefit.  This is a positive spiral that will further create more interesting opportunities for the venture capital industry.


On a macro industry level, venture capital might have the same amount or even less capital infused into startups in the coming years, but I believe that capital will be more productive as it is redirected from overfunding underperforming companies to funding the creation of more companies that have a shot of proving their worth.  I believe this is a big improvement for founders, seed investors and large funds.  


Selling Out

August 26, 2010

Ive been thinking lately about how founders should decide when it is time to sell their startups and how to put aside the different incentives that often drive these decisions.  Large VC funds have a strong appetite to fund entrepreneurs that want to swing for the fences.  This was evident in Sand Hill Road criticisms of Aaron Patzer for deciding to sell Mint for only $170MM and the coining of the term The Patzer Problem; describing entrepreneurs that are viewed as selling too early, where the return looks great for the Founders and perhaps smaller investors, but is disappointing for larger funds.

This post was also influenced by criticism I’ve heard of the East Coast, where entrepreneurs and investors are viewed as having less appetite for risk, selling startups early at the first good offer.  Bill Warner has shared some interesting thoughts on this topic and calls for Boston to strive toward more home runs in the interest of building a healthier entrepreneurial ecosystem. 

Contrasted to the Patzer Problem and the calls for East Coast entrepreneurs to aim for grand slams, is the story of Zappos, where Tony Hsieh ultimately conceded that he was pressured to sell the company to Amazon due to his investors desire for liquidity.  Finally my thoughts were advanced by the much covered decision of FourSquare to take capital rather than sell to Facebook or Yahoo.  The debate was fraught with value judgments of whether they would be selling it too early on the one hand or irrational not to sell on the other.

Understandably, investor and management self interest and incentives are very much at play in the discussion of when to sell. All of this talk of differing incentives has caused me to revisit our sale of Brontes to 3M in 2006.  We did sell early, but Im convinced that we did not only act on our own incentives.  I genuinely think that as a board we considered an objective view of when was the right time to sell the company.  That is the duty of loyalty which board members have to the companys shareholders.  A board member should be explicit about his own incentives, but put them aside to attempt to objectively measure whether accepting an offer to sell the company is the right outcome for all shareholders.  But how does a board member figure out whether it is in the interests of the shareholders to sell?  Ambitious startups have so much potential, yet are typically backed with expectation of eventual liquidity.

We did this by thinking hard about the risk that we had in front of us versus the amount we were being offered for the company.  Personally, I also considered the offer in the context of the dilution we would face as we attempted to build revenue and move to cash flow breakeven.  We had lots of clarity on that dilution, as we had a $25MM Series B financing in escrow when we sold.  With a refresh of the option pool that amounted to 40% dilution, which meant that to our existing shareholders the $95MM offer was the dilution adjusted equivalent to $160MM offer after our next round.  In other words, existing shareholders would have the same return after the financing only if we could clear that hurdle. 

Now measure the progress of the company.  We felt we had game changing technology, which was deep and defendable.  We had the potential to completely shift the way a market functioned.  We had evidence the technology worked and the system was in full beta in a form that was pretty much finalized for go to market.  Clinical results might take a while and have some rough patches, but experts would agree from in-vitro quantitative measures that the system would work clinically.  In other words, we were at a peak of hope.  We were not going to be paid anything extra for early revenues.  Such a revenue ramp was already assumed into the price.  The question was how long it would take the economic reality to catch up with hope and help us surpass the dilution adjusted offer of $160MM? 

Our best guess was three years.  Our first year plan was $3MM in revenue and our second was roughly $8MM.  It would only be in our third year of sales that wed cross the $15MM in revenue we expected was necessary for reality to fully catch up with hope to believe someone would possibly pay more than $160MM for the company.  In other words, if we hit our plan for the next three years, our company would be worth roughly what we were being paid per share today.  With all the inherent risk in our plan for the next three years, I still think thats a no brainer scenario for selling.

Value creation at a startup is non-linear.  Startups have inflection points where value increases significantly and meaningful future progress is assumed into the price of the company.  These are peaks of hope.  Startups don’t typically appreciate in value against these peaks simply by meeting a plan.  Reality needs time to catch up to the hope.  Another major inflection point needs to take place to surpass that peak in order to get a meaningfully higher price. The right question is how far away is that next peak and how much dilution will be endured in that time.

Based on this thought process, I think a rough and somewhat objective rubric can be established for when to sell: based on your plan, how long will reality take to catch up with the hope? Time is an important measure of risk in that startup visibility rarely stretches beyond 12 months. When an offer, based on reasonable multiples, is compensating a company for the past year’s performance, selling is about liquidating the asset.  When a company is being paid a standard multiple against a high confidence next year plan, selling is still largely about liquidity but does offset a year of risk in the plan.  When that multiple is applied to the next two years of risk, the board should be giving very strong consideration to selling.  At three years, I think it really is a no brainer. 

Hard to know, but I’d guess that the Patzer Problem was more about VC interests than whether it was a no brainer for shareholders, on a dilution adjusted basis, to sell Mint for $170 million.  I wonder how many years of Mint’s plan they were being compensated ahead of.  Probably they were at a peak of hope.  If so, it was a good time to sell.

Note: Obviously, this is a rough rubric and it is difficult to determine fair multiples for any early stage company.  Also, it can be argued that most of the shareholders are usually represented at the board level and therefore board members are justified in largely acting in their own best interests.  Im not as big a fan of that argument, because most companies are started with some friends and family capital, which is not represented on the board.  Also, employees must be considered.  Of course, price is only one consideration when it comes to selling a company, particularly for the employees.  These issues are highly complex and the post is a simplification, but I belive the key point is to get beyond the discussion of individual interests and get an objective view of the offer measured against the risk.


Blink vs. Moneyball

June 29, 2010

Micah Rosenbloom and I had an endless debate at Brontes about whether Blink or Moneyball was more relevant to the founder’s skill set.  Blink argues that instincts are incredibly powerful and would suggest a more gut driven entrepreneurial style.  Moneyball chronicles how Billy Beane outflanked all other major league General Managers by largely ignoring instinctual decision-making (scouting), instead using data to make decisions.  We thought of this as a spectrum where Micah leaned toward the Blink side and I leaned in the Moneyball direction – probably a good combination.  I’d argue that I’d “Blink” to form a hypothesis, but use Moneyball analytics to decide whether to execute that hypothesis and how much to invest in testing the hypothesis.

As a seed stage investor, I think about this debate frequently.  I think there are early stage startups that are designed as more “Blink” style startups that are hugely successful.  I don’t know the true story of the founding of Facebook, but my guess is that Mark Zuckerberg didn’t start by getting his thoughts into a PowerPoint, doing market research or creating a financial model.  It almost seems laughable to suggest such a thing.  He was coding in his dorm room, had conviction about something users might want and built a minimum viable product to see how they reacted.  This was the furthest thing from a designed business.  100% on the Blink side of the spectrum.

Not to put the companies even in the same stratosphere, but at Brontes we were largely a designed business.  We used our instincts to figure out where to look and then did a ton of market research and put together a detailed plan in mid 2003.  If you look at that plan today, the business greatly resembles the plan. We made pivots along the way, based on customer data, and became much more sophisticated in our assumptions and implementation, but fundamentally we’re still in the business we set out to build in 2003.  Certainly some businesses lend themselves to more instinctual management than others, as iteration cycles can vary.

Which is better? I really can’t say.  If you compare these two companies, I’d rather be Mark Zuckerberg and the valuation math is about 1 to 250 in Facebook’s favor thus far.  However, I think it is dangerous to look at extreme outliers to draw conclusions, and despite not being Facebook, I’m not sure I’d change my approach the next time.

My feeling as an investor hasn’t changed much from my time as an entrepreneur.  I’m a big fan of the “designed” startup Moneyball approach.  While I value instincts, I think our instincts can greatly bias us and that the fly-by-the-seat-of-your-pants approach to entrepreneurship statistically results in failure at an overwhelming rate over the Moneyball approach.  It suggests to me that the founder may not listen to user data and pivot quickly based on facts, but solely on instinct.  Even in a highly iterative lean startup methodology (which I deeply support), I view the analysis of the data to make quick iteration decisions as a Moneyball skill.

I’ve invested in businesses that are examples of both of these approaches, but find the Moneyball model a much easier bet.  The Blink model requires me to either absolutely share the instinctual conviction of the founder, which is rare, or ask the founder to create evidence not in market analysis, but in actual user traction metrics. Imagine investing in Mark Zuckerberg when he had the first prototype for and no user traction, it would have been very improbable as an investor to share his instincts about what would work in social networking.  Peter Thiel was a genius for making the first investment in Facebook, but consider that the investment was made after Zuckerberg amassed evidence of hundreds of thoustands users with a astoundingly viral trend line.   It was still a big and early bet, but it wasn’t made solely on shared instincts.  Arguably, at that point, an investor could take a Moneyball approach to analyzing whether the user traction would continue.

Thank You MA*

May 31, 2010

 Thanks to several local leaders in the New England startup community, June is being celebrated as Innovation Month in New England.  Rather than being abstract about the many unique ways that our ecosystem nurtures startups, I thought I’d give a direct example of my previous company, which I’m not sure could have been born and raised anywhere else.

Brontes Technologies was based on research led by Dr. Janos Rohaly and Professor Douglas Hart out of the Department of Mechanical Engineering at MIT.  The investigators were among the first research teams to be funded by the Deshpande Center at MIT, which was created by local entrepreneurial guru Desh Deshpande out of a desire to fill the gap between academic research and commercialization. 

The company was born when two repeat entrepreneurs (Micah Rosenbloom and Eric Paley), both of whom came to Massachusetts to go to business school at Harvard, met the principal investigators at a MIT 50K Competition team-building mixer.  After initial tension resulting from speaking different languages (engineering and business), the team began to collaborate well due to the clear benefits of everyone bringing different disciplines to our preparation for two business plan competitions.  The team further gained confidence in each other after being named runner up at the MIT 50K and HBS Business Plan Competitions.  The team also received help from the Venture Mentoring Service at MIT and Professors Bill Sahlman, Joe Lassiter, Rebecca Henderson and Felda Hardymon at HBS.  Additionally Brontes got exposure and candid feedback by twice participating in the MIT Enterprise Forum (Concept and Startup Clinics). 

The company was originally financed by a true angel investor who based his decision completely on trust.  That angel was David Frankel, a business school classmate of mine and Micah’s and now our partner at Founder Collective.  Without David’s trust in us, Brontes would never have existed.  Angel financing was critical as it took the venture industry a bit of time to appreciate our quirky market.  That appreciation came first from Jeff Bussgang at Flybridge Capital Partners, whom I initially met in Professor Bill Sahlman’s Entrepreneurial Finance Class at HBS.  Jeff and I built a one year relationship in which he gave us feedback and coaching and got to know our team and mission well enough to make a bet on us.  Together we rallied two other local and outstanding venture capitalists, Ted Dintersmith of Charles River Ventures and James Nahirny of Bain Capital to help fund the company.  We also added two local independent board members, Kelsey Wirth the Founder of Align Technologies and Gerard Moufflet an investor with deep ties in our industry, who both provided enormous value to the company. 

We built a team of 32 extraordinary engineers, executives, and clinical specialists with deep experience in hardware, software, optics, computer vision, medical devices, dentistry and rapid manufacturing.  We relied on local vendors for additional optics design (Innovations In Optics) and industrial design (Manta) capabilities.  Early endorsements, industry insights and market validation came from Dean Bruce Donoff of Harvard School of Dental Medicine and Doctor Gerard Kugel of Tufts University School of Dental Medicine. 

It takes a great ecosystem to build a company.  There are few places in the world that Brontes Technologies could have been born and built. Thank you Massachusetts.  


*This blog has 27 links; all of which are to Massachusetts-based individuals and institutions that contributed to making Brontes Technologies a success.