Announcing XFactor Ventures: Female Founders Investing in Female Founders

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Today, we are pleased to announce and launch XFactor Ventures, a pre-seed and seed stage venture fund that will invest in 30 new companies with female founders targeting billion dollar opportunities in the coming year or two.  

Are you a female founder with the XFactor looking for funding?  If so – we want to talk to you!  Please find us online at XFactor.ventures, follow us on Twitter or reach out via email to hello@xfactor.ventures

XFactor is led by a fantastic investment team of female founders –

  • Bay Area: Danielle Morrill of Mattermark, Erica Brescia of Bitnami, Jessica Mah of inDinero, and Ooshma Garg of Gobble
  • New York: Aubrie Pagano of Bow & Drape, Kathryn Minshew of The Muse, and Liz Whitman of Manicube
  • Boston: Anna Palmer of WonderMile, who while also working on launching her second start-up, was instrumental in co-founding XFactor with me and my amazing partner at Flybridge, Kate Castle.

This team has delivered hundreds of investor pitches, raised well over $100M in venture capital across multiple rounds, hired thousands of employees and generated significant value as they have built and grown the almost dozen companies they have founded.  

XFactor’s goal is threefold:

  1. Supporting and enabling the next generation of female-led businesses.  We invest in companies with at least one female founder – the “X Factor” – who have the insight and drive to build the next billion dollar company. Our investment team are all talented and successful female founder operators that have ridden the company-building roller coaster themselves and will provide connections and “in the trenches” advice and mentorship to our portfolio companies.  Regardless of gender, a team of successful founder and leaders investing in the next-generation of founders is unique and their collective insights will be valuable to the companies in which we invest.
  2. Providing our investment team a platform and mentorship to become successful investors. We hope that, over time, this effort will increase the ranks of female investors in the venture and angel investing community.
  3. Finally, and most importantly, XFactor is focused on generating attractive investment returns by identifying massive market opportunities and backing the most talented ambitious founders (who happen to be female) based on our conviction that diverse teams will outperform in the market.  Said another way, XFactoris not an affirmative action fund with all the negative connotations that implies.  There are few things worse for a female founder than being referred to a female-focused fund with the insinuation that you are not ready for the big leagues of male dominated funds. That’s not us. We are big league entrepreneurs and investors that will hold founders to high standards and support them in building game-changing companies.

I have been a venture capitalist for almost my entire professional career, first as a General Partner at Greylock and more recently as a co-founder of Flybridge.  On a personal level, I have always been surrounded by strong women and recognize the unique value women can bring to the table.  Over the years, when I realized that my male-dominated deal flow and investment activity did not reflect those values, I told myself that it simply reflected the demographics of the B2B tech space in which I invest.  Further, when I heard stories about VCs who would ask female founders what they would do if they got pregnant, or comment inappropriately on their appearance, or get their wife on the phone to help assess an idea that was being pitched to them or, as has become so apparent in the last weeks, inappropriately turn pitch meetings into a dating opportunity, or even more deplorable, an opportunity to leverage their power to sexually harass female founders, I comforted myself by saying that was not me or my partners. Those jerks are the minority of venture investors and not the ones I work with.

But last Fall, it became apparent that being a bystander was no longer acceptable.  I was appalled that the public discourse in the country suddenly turned openly misogynistic.  And when I received a specific comment from my oldest daughter, a tech-focused junior in college, I realized I had to do something to change the venture industry. “Dad,” she groaned, “I am so tired of looking at websites of startups and seeing only men on the management team” Thus, teaming with Kate, the inspirational XFactor investment team, and all of my partners at Flybridge, we set about forming XFactor Ventures.

The venture industry needs to dramatically change.  80% of the companies that receive venture funding have male only founding teams, and only 7% of partners in leading venture firms are women.  The two are related.  Female partners are more likely to back female founders and yet venture firms pull new venture partners from the ranks of successful founders, so the cycle perpetuates.  While the funding statistics are objectively not right, they are, equally importantly, not smart.  Diverse founding teams will have a better perspective on market opportunities, how to define and market products for the widest possible audience. They will make better decisions and be more successful in attracting and retaining talent.  All of which will lead to superior investment returns.

Finally, as no post from me would be complete without a chart, I have been astounded by the change in the gender composition of my “sourcing meetings” since I started working on XFactor, and this is in the last six months while we were quietly working on this initiative.  As shown below, it turns out to find female founders; you just need to look for them.

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The entire team at Flybridge is thrilled to support XFactor and, on a personal level, I am looking forward to working with our phenomenal and unique investment team as we back and support 30 companies started by fantastic female founders with the XFactor!  

Are you a female founder with the XFactor?  Find us online at XFactor.ventures, follow us on Twitter or reach out via email to hello@xfactor.ventures.  

Fired Up By a Flybridge Family Reunion

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Last week there was an interesting piece of news in the tech world when Firebase/Google acquired the Fabric product line and team from Twitter. Over 20+ years in the venture industry and hundreds of companies, this was a first for me: two companies we had invested in merged post their respective acquisitions by larger players. While it was unusual, nothing could make me happier than to see Crashlytics, which was acquired by Twitter in 2013, and Firebase, which was acquired by Google in 2014, join forces and continue the missions they held from their founding, and our original seed investments, of improving the lives and effectiveness of mobile developers. Huge congrats to Andrew, James, Jeff and Wayne and many thanks to both Twitter and Google for their support of both companies and allowing them to deliver on their common goals.

Rewind the clock to 2011. At the time my core investment focus was on developer-driven cloud platforms and an insight that companies that went to market with products that delighted developers could achieve significant adoption and break down many of the barriers seen by companies that focused on more traditional enterprise sales models. Within this broader theme (that also led to our investments in companies such as MongoDB, Stormpath and Apiary), it was clear at that time that the mobile developer was the new rock-star and thought leader and that most new application development spend was for mobile apps. But while mobile developers were leading the way, it was still too hard and technically challenging to quickly and easily get high quality apps into the market. Over the next year, this thesis led us to make seed investments behind two phenomenal teams. Both companies started out focused on very different markets – Crashlytics on crash reporting and Firebase on a platform to allow developers to easily build serverless back-end platforms. But both had a common goal of creating innovative technologies to help developers create amazing apps.

It’s always interesting to look back on your investment successes to see what if any common traits they shared. For Firebase and Crashlytics, there were many:

  • Founded by young, passionate entrepreneurs[i] who had strong technology backgrounds, startup experience and an innate understanding of their target customer who were
  • Creating platforms that addressed large and expanding markets with a
  • Special “developer first” approach to working with the developer community that led to rapid adoption of their platforms which led them to
  • Blow away their seed round metrics within less than a year and in turn raise Series A Rounds led by their initial investors and ultimately to being
  • Acquired by leading technology companies less than a year after Series A rounds and these
  • Acquirers provided significant incremental resources, let the teams run independently and continue to innovate under their own brands post the acquisitions

I could not be more proud of both of these teams. With millions of apps and hundreds of thousands of developers now using their technologies, what each has built is exceptional and I am 100% sure, will only get better as they join forces.

[i] It should also be noted in this time of anti-immigrant sentiment that in each company one of founders was born outside the US

Flybridge Seed Graduation Rate

Earlier this week, Mattermark (a Flybridge portfolio company) posted an interesting analysis of the Seed matriculation rate from the over 2000 US-based software companies that received funding in the period from 2009 to 2012. What they found, to save you from reading the post, was that 32% of the companies that received seed funding went on to raise a Series A, 17% a Series B and 7% a Series C.

This inspired me to take a look at the software companies Flybridge seed funded during the same period. As the graph below shows, our data is quite different, with over 90% of the companies raising a Series A, just over 65% a Series B and about 50% a Series C.

fcp-seed-grad-rate-2009-12

As to why our experience is so different than industry-wide data, especially at the Seed to A fall off, I am not sure. I suspect it is a combination of factors. First, on the margin we have favored slightly larger seed financings (in the $1-2M range) and those companies have had, as a result, more runway to accomplish their goals.   Second, we have favored strong, involved syndicate partners and it is often through us, and our co-investors, that the Series A investors learn about the company (virtually all the A rounds brought in a new investor). Third, we are active seed investors, but relatively selective, so we hope there is some level of quality at play. This also means our pool of companies is not huge, so I am sure serendipity is involved as well!

In their post, Mattermark noted that there are likely three reasons for the fall off: companies failing, companies being acquired, or companies becoming self-sustaining, but that they did not necessarily have all the data to determine the relative weight. We obviously do for our own companies, so here is our experience:

  •  Of the 10% of companies that did not go from Seed to Series A, the cause was generally a failure to find product market fit, resulting in an acquihire of some kind.
  •  Of the companies that did not move from Series A to Series B, three quarters were acquired, either in a highly positive way like Crashlytics (Twitter) or Firebase (Google), or less positively in one other case. The other companies that have not raised a Series B are still running on their Series A capital.
  •  Of the 25-30% of the companies that raised a Seed, an A and a B, but not a Series C, the vast majority (80%) are still executing on their Series B capital with the remainder having been acquired.

While it is hard to generalize from one firm’s experience, as a seed stage founder the most important lesson from this analysis is to make sure you raise enough capital to achieve critical milestones, including demonstrating product market fit, and that you align yourself with investors that have the network, relationships and credibility to help you raise subsequent rounds of capital. After that, it is all about performance with the hope that you don’t have to keep raising capital as revenue funds growth!

Failed Founders

Conventional wisdom in the venture industry (and the historic data supports this), says that as an investor your odds of success are best if you back repeat successful entrepreneurs followed by backing first time founders.  Backing repeat entrepreneurs who failed their first time around is considered to be the highest risk strategy.  For a certain category of repeat entrepreneurs whose first foray as a founder did not result in success, I believe this conventional wisdom  will be proven wrong in the coming several years . Let me explain further.  

One of the biggest changes I have seen over the last 5 or 10 years is that, as the barriers to starting a company decreased so significantly, more and more founders started their first company very early in their career. Early as in in their 20s age wise and early as in the first “real job” these founders held is as the CEO of a company they founded.  And while over the last 10 years there are so many more resources to support and educate these first time founders on the art of company building, most of these first-time young founders will fail as the challenge of starting is nothing compared to the challenge of building and growing a sustainable business.  And, unfortunately, no amount of reading, learning, coaching, advising, accelerating and incubating can make up for the real world experience of doing, and many founders will and have found that their company did not survive their learning curve and on the job training.  I have talked to many of these founders and have posted a companion piece to this post on some of their key insights in the hope it will be helpful to other future first time young founders.

But back to my contrarian investment thesis.  I believe the next time around these still young, but now experienced, first-time failed founders are the lowest risk founders to back in a new company.  There are a few reasons for this:

  • Character: Almost by definition if you start a company that young you are intellectually curious, seeing problems as opportunities to build unique solutions; super motivated and willing to push through barriers; passionate and with a desire to change the world; and willing to take risk and pursue a path that is not easy as your peers join Google or Facebook or become bankers, consultants, lawyers or any other career path that shows up at university recruiting fairs.  These characteristics are what define a great founder and even though the first time did not work out, they remain core to what makes these founders special.
  • Experience: While the first time around these young founders may not have known how to hire, fire, train and develop talent, what a P&L looks like, how to spell KPI or OKR, how to pivot into a larger and better market opportunity, or how to work with a board, there is nothing like the day to day struggle of building a company from scratch to develop these talents in the most rapid of possible ways.  One founder described their failed company as an expensive MBA, but having an MBA myself I can tell you this gives an MBA way too much credit by a 100 times over.
  • Motivation.  If you are a hard charging founder with reams of self confidence out to change the world and you fail, and in most cases it will be the first time you have ever failed in any way, you likely have a chip on your shoulder and a burning desire to prove the world wrong and, in our experience, founders with chips on their shoulder tend to perform exceptionally well.

While in general I believe this cohort of second time around, first-time failed founders will out perform other founders, at an individual level the specifics matter.  So what are we looking for as we make a decision to back an individual founder whose first company did not work out as planned?  We find the following questions to be important in identifying the true winners from this broader group:

  • Did their first company achieve some level of scale and longevity?  There is a huge difference in the experience gained from a company that lasted for a few years with a reasonable number of employees and customers versus the failure that lasted only for a short time, had very small employee base and no customers to speak of.  It is the experience gained from running at some scale that will make a founder exceptional the second time around.
  • What did they learn?  When you ask the best failed founders I have met what they learned from their experience, they don’t give a short, couple of bullet point answer, but rather breakout a long analysis they did that examines all the critical decisions they made, what they learned from them, and how they could have done things differently. Founders who demonstrate that they are this kind of learning machine will be be exceptional the second time around.
  • Do they take personal responsibility?  The best founders I have met accept and own the responsibility for their first company not working out while the one’s who are less likely to succeed the second time around lay blame elsewhere or on things that were “outside of their control”.  
  • Do they incorporate their learnings into the plan for the new company?  It is one thing to have experience, learn from failure and accept responsibility, but it is the final step of incorporating all of this into the market selection, business model definition, strategy and operating philosophy of the new company that is the critical final step to take the lessons of failure and to operationalize them into success for the new company.

So if you are a now slightly less young founder who failed the first time around and you want to talk, I am all ears!

Lessons from Failed First-Time Founders

In my conversations with founders who failed the first time around when CEO was their first “real job,” I often ask about the key insights they took away from their experience.  Many founders don’t talk publicly about this, as they don’t want to denigrate their prior company and its employees, customers, and/or investors. But their insights are quite valuable to future young first-time founders and are worth summarizing and sharing.  I will focus more on operational decisions and learnings, as these tend to be most transferable, but obviously market selection matters a lot, as being in a market that is growing rapidly covers up a lot of operational sins that any founder will make.  Below are 5 takeaways that come up again and again in these discussions:

  1. Team Matters

An obvious point, but maybe not in the way you think. Who you hire is critical, but this first principle of building a company is often interpreted by young first time founders to mean that they need to hire “adult supervision” and people with the right resume.  This sounds great in concept, but in practice most founders end up hiring these “seasoned” veterans either too early, or not carefully enough, and end up with executives on their team who may have sounded great in terms of skills and experience, but have no idea how to operate in an early stage, rapidly evolving company.  

Further, bringing in a senior team too early – especially in product and customer facing positions – works to remove the founder from the front lines and slows the learning cycle.  This does not mean you should hire all your friends, as while that makes for a fun environment, it often does not put the right people in the right jobs and it’s really hard to tell your college roommate they just aren’t cutting it any more.  Instead, look for up and coming talent with skills and experience that are relevant to a portion of their new job, a history with start-ups, and prioritize above all else the cultural fit and passion for your mission. (David Cancel wrote a great post on this topic here that covers all of these points with much more expertise than I have). Remember, when you find this talent it does not mean you can check the box and move on to the next critical open position.  How you onboard your talent to make sure they are aligned with the vision, trained on key aspects of the business and integrated into the rest of the team will be critical to their effectiveness.  Finally, if you make a mistake, fix it quickly. In a small team it only takes one or two misaligned, cynical, negative assholes to screw up your company.

  1. Find your balance

A hard part for first time founders who have never worked in a company of any size is finding the right balance between being nimble, informal and on top of every detail on one hand, and putting in place rigorous formal processes and discipline on the other.  Too much process and structure too early and you slow down and are too removed from the front lines–stay informal and involved in every detail too long and you become a bottleneck and a micro-manager with a team that is not empowered.  Far easier said than done, but a few suggestions to help you find your balance:

  • Always ask yourself if you are slowing down critical decisions.
  • Decide what areas are most important to you personally, where you want to be the slowest to cede control, and be explicit about this with your team so they know your hot buttons.
  • Start with lightweight team meetings every week and then every quarter asking yourself and your key lieutenants if the cadence and process is working, or if there are ways to improve.
  • Seek out either a coach or other founders who are one step ahead of your company in terms of maturity and get their advice on how they changed their style at important junctures in the company’s life (important breakpoints are around a dozen employees, around 30 or 40 employees, and around 80-100 employees).
  1. Be on top of the metrics

Regardless of finding your balance point, one thing you can’t delegate as a founder is knowing the key metrics of your business inside and out and how they interrelate with each other.  While these change from company to company, in early stage businesses they can all be boiled down to cash, adoption, and customer success/engagement.  Know when you are running out of money to the day, and know how this changes if you grow more quickly (which often brings in the date much to the surprise of many first time founders), or more slowly.  Know how many customers/users you are adding every day/week/month and how this compares to the growth you need to achieve lift off.  Know whether you are delivering on your value to these customers/users and where you are falling short.  In addition to understanding the key metrics, set goals for how they are going to change and grow over time.  On this front, a common mistake of first time founders is setting unrealistic goals under the assumption that if you ask people for the stars you at least get the moon, but the best CEOs I know set goals that are a stretch, but most likely achievable, as this allows them to develop a culture of winning and a sense that they are on top of their business.

  1. Your Investor(s) & Board Matters

One of the issues I see over and over again with first time founders is that they got sideways with their board, and investors more generally.  This problem often starts when raising capital and the desire to take any money that’s on offer, rather than the right money.  It’s your company; so treat any investor you take on as you would any employee you take on, make sure there is alignment with your companys mission, thesis, and goals, and you should reference check them, again just as you would with a prospective employee.  Once they are involved you must maintain a healthy relationship, which starts with communicating regularly, having bad news travel as fast as good news, and not sweeping potential disagreements on direction or strategy under the rug, but rather addressing those issues head on.  A fear of many first time young founders is that the Board is looking to replace them as CEO as quickly as possible. With some investors this is indeed their pattern, so understand their biases (from talking with prior companies they have been involved with) and call out the issue explicitly as the lingering fear strains relationships and leads to less frequent communication, which only exacerbates the issue. It also helps in navigating your first set of board relationships to find a mentor or outside board member (that don’t have a significant stake in the company) to provide coaching and help resolve intercompany issues, and act as independent mediator if necessary.

  1. CUSTOMERS MATTER MORE THAN ANYTHING ELSE

And finally, another first principles comment, but remember to stay CUSTOMER FOCUSED above all else. It is way too easy to get distracted by hiring, leading, raising capital, and dealing with a Board, not to mention obsessing over competitors or what is going on in the broader market, and when you lose this focus on customer success, your company will lose its mission, and consequently, its chance to succeed.

A Founder’s Guide to M&A

As a Founder of a venture backed company, eventually the question of whether and how to seek liquidity for your shareholders will come into question.  This may come about because you are approached by a strategic acquirer or seek to go public.  As shown in the chart below, given more than 90% of tech exits in the last 5 years are via an acquisition, the odds are by far in favor of M&A as the means of driving liquidity, although of course what the chart does not show is the thousands of companies that decided to keep building instead of selling in this period.  

Graph

This data is consistent with our most recent experience at Flybridge: in 2014 we had six acquisitions and one IPO across our portfolio.  So, if M&A is the most likely exit path for a venture backed company, what should Founders think about as they approach this process?  Below I will explore questions such as 1) Should I sell my company?, 2) What is the best process to sell?, and 3) How do I achieve the best possible value for my business?  This is a long post, so if you prefer the bullet points / presentation version, it is available here.

 

The first step is to take a step back and assess where you stand in the company building process.  Is your company still relatively young and immature, but growing fast and strategically important to a number of acquirers (one of which may have approached you)?  Or is your company mature, with a well understand and profitable operating model, but perhaps growing slowly and not terribly strategically important?  Or, do you have the benefit of being strategically important, while growing fast, with a business model that is showing strong evidence of operating leverage and recurring revenue?  Making a determination as to where you are along the axes of growth rate, strategic importance and company maturity will help inform your approach to M&A.

The intersection of these characteristics can be visualized on a 2×2 matrix as shown below.  The Y-axis is a composite metric of both your company's growth rate and its strategic importance.  Growth rate is pretty straight-forward and ranges from slow, less than 20% year over year growth, to hyper growth where the business is growing at more than 100% year over year.  Strategic importance is harder to assess, but is a function of the market potential for your company, how the company fits with important high level industry trends, how threatening your success is to incumbent players in your industry, how easily your product or service can be sold through existing go-to-market channels for potential acquirers and whether your company will help drive revenues for an acquirer from other parts of their company, i.e. "drag-along" sales.  The X-axis attempts to characterize where your company is in its development.  These maturity characteristics include how well defined and understood the company's business model is, whether there is evidence of significant operating leverage where expenses are increasing at a far slower rate than revenues are growing, what characteristics the company has in terms of customer acquisition costs relative to the lifetime value of a customer, whether there are significant risks such as customer concentration or regulatory exposure, whether the business is profitable and cash flow positive and the strength and depth of the management team.

2by2

While the matrix simplifies a wide variety of different characteristics, it ends up creating four potential groups: companies that are still "Figuring it Out", companies that are showing "Hyper Potential", Companies that are "Steady as She Goes" and companies where "Options Abound".  From an M&A perspective, each of these groups will lead to very different questions to ask on whether to sell, for how much and approaches and strategies to the M&A process itself.

 

Figuring it Out:

For companies in the Figuring it Out phase that are still early, not yet growing super fast, and are not strategically important, the critical questions to ask relative to M&A relate to how much runway you have and can more capital be raised (for example, if you have 6 months of runway and no clear path to raising more money, joining forces with another company via M&A starts to look like an important strategy).  In addition, understanding why the company is not growing faster is an important question as it could be driven by a market that is slow to mature, which is harder to change, or internal execution issues, which are equally hard to change but at least within your control.  A related question is whether, if you are successful in driving growth and can figure out how to get the resources to do so, is the pot of gold at the end of the rainbow still attractive, or have you lost faith.  More broadly, this speaks to your team's motivations and desires.  Is everyone still in the boat, or are you at risk of losing critical team members?  Do you all want to stay together, but the collective risk tolerance is such that being part of a larger company would be better?  Or does the idea of being part of a bigger company give everyone the shudders?

In the Figuring it Out stage, the answers to these questions will lead the the conclusion to keep pushing ahead or to look to be acquired.  If the conclusion is to look to be acquired, the process in this stage is on one hand the easiest in that there is likely a broad universe of potential acquirers, but on the other hand the hardest as there may not be a compelling reason any one of them to need to own your company.  This suggests that the process will be very customized, company led and relationship driven as you seek to demonstrate core value that you and your nascent product or service can bring to the table.  As a result, there is not much of a role that an investment banker can play, although a third party consultant or adviser might be helpful with introductions or unique insights into companies you don't know well yourself.  Likely valuations at this stage can range from modest acqui-hires to reasonably attractive outcomes if you are able to articulate a combined growth story that gets several acquirers excited such that you can get a little competitive bidding going in the process.  Apart from a competitive process, other important valuation drivers will be the strength of your team, the willingness of critical members to stay with the acquirer and for how long, and whether you can identify ways your company will help create new revenue opportunities for the acquirer.

Hyper Potential:

Hyper Potential companies that are showing rapid growth in important market segments that are strategically important to potential acquirers are the companies that are most likely to see inbound acquisition interest, and whether to entertain these offers is often the hardest question for Founders and their Boards to consider.  At the extreme, make the right decision and you look like SnapChat turning down a billion dollar plus offer only to be valued a year later at more than ten billion or, on the other hand, Groupon turning down a $6 billion offer and struggling to ever come close to that value even after significant further dilution.  The critical question to ask at this stage is how realistic it is to move up the company maturity scale – in other words is there a case to be made for, or evidence of, a wildly attractive future business model.  Related questions include how much capital and associated dilution will be required to pursue the opportunity and how this relates to the potential value of selling now.  Further, some market segments that seem unlikely to support public companies go through a game of musical chairs whereby several companies could be competing for a limited number of acquisition chairs and thinking through do you want to be the first to sell or the last, can have huge bearing on valuation in both directions.  Hyper Potential companies, by definition, have multiple alternatives, so the most important question is ultimately what motivates the team.  My partner Jeff Bussgang previously wrote about this here, but the question comes down to the passion you have for the business, do you want to go out and change the world or is having a good win more important?  Will the acquirer help you achieve that dream or screw it up and, conversely, if you stay independent can you and your team take the company forward for many years, and if you can't and lose control down the road, do you care? 

If you are running a Hyper Potential company and you decide to sell, the process tends to be relatively fast and the buyer universe narrow.  There are very few companies that can pay the super high-valuations (by any traditional valuation metrics) required to make it worth selling at this stage, so the likely buyers are the mega-cap public and private companies and it is more likely than not that the process actually started with an inbound approach by one of these companies.  Moving forward with only one horse in the race generally does not make sense, so the jujitsu required is to quickly spin up some competing alternatives generally by leveraging the team's contacts and relationships.  Given a quick relationship driven process, our experience has been that investment bankers are more likely to interfere in the sale of a Hyper Potential company than they are to add value.  The key to driving a high valuation is, instead, making the case directly that you fill a CEO level priority for the acquirer, having multiple suitors where this is the case and being willing to walk away from the negotiating table, perhaps several times, if the offers are not at an acceptable level.

Steady as She Goes:

Mature companies that are growing steadily don't necessarily have to sell at any particular time as they are often profitable with solid business models.  As a result, thinking about market timing is the most important consideration for these companies.  If you are coming off a string of good quarters and the valuations for your comparable companies are increasing, it may suggest the time is right to look for an exit, while similar good performance in a tough market environment would suggest sitting tight.  In other words, 2009 was a lousy time to sell if you did not need to, but 2014 was a pretty good time to look for an exit.  Other considerations to think about in terms of when to sell a Steady as She Goes company are what risks there are to the downside – such as changing competitive environments, margin pressure, macro-economic risks specific to your business or regulatory changes that could be forthcoming – and what opportunities there may be to the upside that will bend the growth curve in a positive direction such as new product launches, new markets that are just being opened or potential opportunities to make acquisitions instead of being acquired.  Important questions for the team to ask themselves is how motivated they are by the day to day running of the business and can they see continuing to do so for the next few years to come.

If the decision is made that the time is right to seek an exit for a Steady as She Goes company, the universe of potential acquirers tends to be the broadest of all the categories as the company could be a fit for small to large-cap public companies, larger private companies and private equity acquirers.  As a result, the process tends to be more formal and involve broad outreach, an approach in which an investment banker can add significant value.  Valuations for this type of company tend to follow more traditional metrics and models where the acquirers will be thinking about comparable companies and their own revenue or profitability multiples.  The key to driving valuations higher will be a well orchestrated process, with multiple bidders, well articulated models of how the combined companies can generate significant synergies and a willingness to walk away and keep running the business if the options are not attractive.

Options Abound:

As the category name indicates, mature companies that are strategically important and growing fast, have numerous options.  They can keep pushing forward as a private company, they can seek to go public or they can sell.  This decision is ultimately a gut check on the business on all dimensions: does the market opportunity still appear to be unbounded, is there strong revenue visibility, does the business seem to be getting easier or harder as we scale, and do we have or can we readily build the right team?  Further, it is gut check on whether the team is up for being a public company, and all that entails, and what risks could derail the business if it stays independent versus what opportunities are created by being public such as an easier ability to make acquisitions or the publicity and credibility that comes from being public.  Having a clear point of view on the capital markers environment for your market segment and the relative values across the public markets, private markets and M&A markets as this will help you understand the financing tradeoffs.  For example, in today's market you could argue that in certain segments the private markets are paying the highest values, followed by the public markets and then the M&A market, so this would argue that for a company with numerous alternatives, financing privately and building for an exit may be a better strategy than selling now, whereas a few years ago the M&A markets were paying the highest values.  

If a company with multiple options does decide to put a toe into the waters of the M&A market, there is generally a mid-sized pool of potential acquirers from medium to large cap public companies to large PE firms.  Given the considerations around the market environment and wanting to have an IPO as a credible option, having a strong investment banker to advise the company and potentially explore a dual-track IPO/M&A process is important.   The key to driving a premium valuation will be all the process and synergy comments noted above for the the Steady as she Goes companies, but more important will be the credible threat of going public or raising a large private financing and being willing to drive the company forward independently for a number of years to come.  

 

Across all the stages, the last and most important piece of advice is to keep building your business.  An acquisition process can be wildly distracting, but even until the last minute there is a good chance everything can fall through, so figure out how to compartmentalize the efforts to make sure you don't sacrifice your company's potential along the way.  

Hopefully this provides a useful framework for thinking through the issue of whether and when to sell your company and how to best approach the process and drive value once you do decide to sell.  Once in the process, there are dozens of other considerations in terms of negotiations, structure and terms, but those can wait for another post!

20 years on

This December marks 20 years since I made my first venture investment.  I wrote about the specifics of that company here, but instead of reliving that one company, here in another bout of nostalgia I am going to reflect on what remains the same and what has changed in my 20 years as a venture capitalist.

In 2014 the US VC industry is on a pace to invest over $40B in some 4,000 companies and venture firms across the industry will likely raise over $25B.  This compares to 1994 when the industry invested $4.1B in just over 1,200 companies and raised $7.6B.  Further, the innovation is far far more global with markets such as China and India raising and investing significant amounts of capital, up from virtually nothing 20 years ago, while markets where there was some level of VC in 1994, such as Europe and Israel, have also seen tremendous growth and expansion.  The largest financings of 1994 were companies that raised $20M, while today financings of north of $100M are not uncommon and the average VC backed IPO in 1994 was for a company raising $25M at just under a $100M value after being in business for 5 years as compared to 2013 when the average VC backed IPO company raised $137M at just under a $800M value after 8 years.  So on the surface, the industry has changed significantly in the past 20 years.

Despite this outward appearance, as I thought through the day in and day out of what we do as VCs, much remains the same.  Our goal is to identify and align closely with talented founding teams, target investments into companies that can participate in or create massive markets, can scale rapidly, have deep sources of competitive advantage relative to incumbents or other emerging players, and have potential business models, often leveraging technology platforms, that show high degrees of operating leverage and recurring benefits of scale.  While the specific trends change, the industry and the companies we support continue to perform best when there are massive platform shifts under way as this creates the environment where smaller, nimbler companies can identify and take advantage of trends far more quickly than larger companies.  The industry is also still comprised, with a few notable exceptions, largely of small partnerships raising capital from limited partners with a long term outlook and an ability to manage the illiquidity inherent in financing small companies in nascent markets.  Further, we as venture capitalists now and then sell a commodity (money) that needs to be wrapped in a customer service layer that provides value to our entrepreneurs such that we can be the preferred partners for the most talented executives and have a positive impact on the companies we support.  The best VCs from 20 years ago were preternaturally curious, knew how to jump on trends early and how to work effectively to support the best founding teams, and this remains the case today.

While the day to day activities remain the same, there are clearly changes in what I see on a daily basis.  First and foremost, the average founder today is far more educated on entrepreneurship and on strategies that are most likely to lead to success.  This is in part due to entrepreneurial studies becoming a core part of college and business school curriculum, but more so due to the amazing breadth of information and case studies available at the fingertips of every aspiring founder.  Second, the venture industry is far more transparent today with the most effective VCs regularly communicating with founders via a variety of channels on trends, best practices, important issues and the specifics of their own investment strategies.  It is amusing to look back on when I wrote my prior firm's first website that this was a controversial decision given that in the prior 20+ years of their history they never even had a brochure.  Given founders with a deeper background and understanding of entrepreneurship, the third change is that VC industry as a whole has become far more specialized.  It is no longer sufficient, to deliver on our promises to founders, to be a sound source of general start-up business advice (although this still has value), but rather we also need to be deep in the markets we participate in with a clear point of view on specific strategies, tactics and resources that will be helpful to founding teams.  I looked back at the investments my prior firm made around the year I joined and they included software,  communications, biotech, healthcare services, retail, media and financial services companies.  There are very few, if any, individual venture firms anymore, that cover this breadth of activities and if they do they are either investing at a very late stage and/or with multiple teams of specialists.  Interestingly, this move towards specialization comes as the breadth of industries and market segments impacted by innovation has increased significantly which is in part how the industry is able to successfully absorb a five to six times more capital each year than it did 20 years ago.  Finally, the company building tactics employed by the companies we back have changed (product development practices, sales and marketing strategies, and approach to global markets are three areas that immediately come to mind, but this is a whole separate topic), including specifically on the investment side where there has clearly been a major shift in how companies are financed, whether it be at the startup phase and prevalence of small seed rounds, or at the later stage where the small IPOs of 20 years ago noted above have been replaced by the $50+M late stage private financing at significantly higher valuations.  

My conclusion: venture capital has indeed changed in fundamental ways in the 20 years I have been fortunate enough to be in the industry, but what makes for a good venture capitalist and what makes for a good investment opportunity has not.  I feel fortunate to have worked with as many creative and talented founders over the years and look forward to doing so for the next 20!