Hazard Lights

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.

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!

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!

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.

2. 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).

3. 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.

4. 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 company’s 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.

5. 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.