Part of my “time-off” this fall is to travel and explore a bit. I’m still working a bunch but trying to take a few days here and there to catch up, unwind, and help with stuff around the apartment. In October, I’m lucky to be traveling to a few events I’m really excited about it. I’ve never done this before, and it’s rare for me to travel and speak like this (especially with a kid at home), so I figured I’d share the events/links in case any of you were attending or in the area. If there’s any video of the talks after the fact, I’ll try to post them here.
Oct 7-8 | Venture Alpha West, Half Moon Bay, CA [link] [I'll be on a panel about early-stage hardware investing on that Tuesday, in the afternoon. Interesting side note is that former 49ers Quarterback Steve Young will also be speaking there.]
Oct 13-15 | Marketplaces, by Silicon Valley Bank, New York, NY [link] [This is private event on marketplaces and investing in them. I'll be in NYC the day before hanging out.]
Oct 19-20 | Rutberg Mobile Influencers, Los Angeles, CA [link] [This one is about 30 minutes south of LAX, a more private event but I think lots of CEOs are going. I'm moderating a panel on on-demand services with Tri from Munchery, Kevin of Shyp, Basti of Postmates, and maybe one more guest TBD. It's gonna be good fun.]
Oct 26-28 | Stocktoberfest, San Diego, CA [link] [I am so pumped up for this. Have heard great things about Howard's event, and I'll be on a panel about mobile technology and also (potentially) giving a talk about using startup insights to play the public stock market -- something I like to dabble in. Mostly, I'm going to meet other folks in the Stocktwits community who live and breathe this stuff and learn from them. And have fun.]
And, for a more local event I’m helping organize…if you’re in the Bay Area, pay close attention to this one…
Dec 2 | The Post-Seed Conference, San Francisco, CA [link] [In my work with Bullpen, the firm is organizing a one-day conference on Tuesday, December 2 in San Francisco. The event will be solely focused on the changing landscape in early-stage funding and finance. You can read more about it on the site. There will be many draws to this, but in particular, our keynotes for this are amazing -- a16z's Chris Dixon will be interviewed by Bloomberg's Cory Johnson; Khosla Ventures' Keith Rabois will be a featured speaker 1:1;, and I will close out the day's events by hosting a fireside chat with AngelList's Naval Ravikant. If you're an early-stage founder, investor, or writer covering the area, you should definitely explore attending. Registration information is here.]
There is a certain excitement, a certain uptick in pace, in the Fall around these parts. This year, I feel like I’ve seen enough interesting early-stage founders and companies (so much of it falls into patterns) that I sort of have a picture of what we may be talking about as September and the final months of 2014 unfold. Keep in mind that this list is about the Series A level, when bigger institutions get involved — and is by no means an indication of overall success for anyone involved, investors included. (Also, of course, we will all be chattering about Apple and the other big tech giants, as a given.)
In no particular order, here’s what seems to be entering either the echo chamber and/or mainstream conversation:
Parking: Yes, I’m obsessed with parking startups. No good reason other than I can’t wait to see the #Parkageddon hashtag spread.
Apps That Support On-Demand Economy Companies: See a company like Checkr, which helps the Ubers of the world perform better background checks and processing of labor. These startups and companies will likely need a whole set of services and have likely built their own, as well.
Apps That Support On-Demand Economy Workers: This is a category where I’m seeing tons of startups. Like Mailbox clones designed for “the enterprise,” I’ve passed, but I’m just waiting for one to have a clever hack around distribution — most likely to be the preferred vendor of a company like Instacart or Postmates, etc. There’s an opportunity for a new Intuit for 1099′ers out there, but it has to grow like a weed.
Block Chain Apps: There will be a few companies that get bigger institutional funding which leverage the block chain to handle business processes, most notably the creation, enforcement, and settlement of contracts. Yes, some of these can be mediated in Bitcoin, but it’s not required to do so.
Mobile Commerce: This is the area I’m most excited about, even more than parking! If you’re working in this space or have an app you love, please tell me. I like mobile commerce experiences that either leverage a phone sensor; or have a clever logistics angle; or leverage a proprietary data set; or even those that hold inventory in inventive ways. Of course, I’ll rarely turn down any mobile marketplace, and my old fears about mobile platform fragmentation crippling liquidity is now gone. iPhones, all the way.
Consumer-Grade Artificial Intelligence: This totally snuck up on me and I will admit I missed it, even though it was right under my nose. For the first time, I saw an app/service that uses a combination of AI and ML to do a job better than a human and solve multiple problems in the process. Then I started to think — if it can do it for this one task, why not other mundane tasks? I see no reason why not.
Interactive iPhone Notifications: No real surprise here. Borrowing from Android, iOS developers now have the power to allow users to take action on an item directly from push. Let’s go back to Uber. The app knows you’re about to leave work (you’re a pattern). The app pushes to you — “Call an Uber?” You gently slide over the push and tap “Yes.” Never go into the app itself. That is huge, and apps like Wut, Yo, and others, as well as the push notification ESP equivalents like Kahuna and AppBoy, are well positioned to secure their place in this new landscape.
Welcome to the 11th Sunday Conversation — on a Monday. While I want to name these videos “Sunday Conversation,” I came up against an opponent — the NFL ;-) Anyway, since I do these only once in a while now, I’ll likely just post them at different times. I hope you understand. In Round 4 with Keith, we revisit Bitcoin (again), we talk about the rest of the Khosla team, YC’s latest Demo Day, the motivation founders need, chatter about parking startups, and much more. Note that full audio of the conversation is at the bottom, via SoundCloud. Also, Keith and I will likely do one more (maybe in November?) and then starting in 2015, we will have a new guest for the year. That person is TBD, but the short list is awesome. Keith is a tough act to follow, no doubt. ♦
Part I, Revisiting Bitcoin And Stellar (7:23). I give Keith an opportunity (again) to revisit his statements on Bitcoin both as a currency and as a protocol, and he discusses a few investments in the space, primarily leveraging the block chain. He also discusses the relationship between Stripe and Stellar, which is worth watching.
Part II, Identifying Potentially Great Founders (8:28). Rabois goes in-depth about what intangibles he looks for in founders. This is notable because Keith is one of the few investors who will just invest in a team before any product. In this chat, he talks about how to leverage asymmetric information about people, how picking founders can be a bit like scouting athletes, and why it’s important to have a differentiated model in investing.
Part III, The Rest Of Khosla Ventures (3:28). It dawned on me that aside from Keith and a few conversations with Vinod, I didn’t really know about the rest of KV. Keith gives a brief overview, describing the firm as “irreverant, broad,” and talks about the portfolio in alternative energy, sustainability, and food/ag tech.
Part IV, “Peak Sports” Or Bubble? (6:15). Rabois explains why real-time sports dominates at aggregating consumer audiences and changing behavior given the passion (or addiction) society places on sports.
Part V, Thoughts On Y Combinator (2:51). Rabois shares his views on the latest YC Demo Day. (I had written earlier that YC is kind of a like a growing startup.)
Part VI, (Over) Optimizing In Fundraising (2:16). We discuss the pros and cons of split caps in seed rounds, and why changes in the macro environment don’t matter with respect to startups and early-stage investing.
Part VII, Parking Startups Frenzy (3:04). I’m obsessed with this lately. It’s a thing people hate, it’s expensive and inefficient, destructive. We look into why it’s happening now.
A special thanks to the team at Scaffold Labs for sponsoring the Sunday Conversation series on Haywire. Scaffold Labs is a boutique technology advisory firm based in Silicon Valley which designs and builds scientific and predictable talent acquisition programs that helps technology startups hire great people. Scaffold Labs has previously partnered with companies such as Cloudera, Appirio, and Nimble Storage, among others. For more information, please visit www.scaffoldlabs.com
Here’s a brief thought that’s come up in conversation quite a bit this week, about where consumer attention is:
In venture capital, the one of the biggest categories is consumer, because consumer-facing products and services at scale present the greatest possible market. This is, in part, what drives valuations for early-stage hot consumer deals up — the upside always has huge potential. On the web, consumer products and services could grow and scale based on the network effects of the open web itself.
But, today, we live in a different world — a mobile world. All consumer attention is on mobile, but on mobile, growth and scale are confined to a few “growth pipes” which present their own issues. For instance, gaming is an expensive category to compete in, photo and location apps are usually chased by investors after the fact, messaging apps create network effects but those options have largely been set and regionalized, and then there’s the hottest category out there today –> mobile on-demand services.
I’ve written about mobile on-demand services often here. We all get the picture. In a world where mobile scale is near impossible, better to aggregate consumer demand on the phone, but fulfill that demand through offline logistical prowess. Hence, we have Uber, Instacart, and many others. But, consumer web products could scale with much less friction. In the world of mobile on-demand services, there is significant friction — expanding geographically, hiring and training reliable labor, and so much more. As the coefficient of friction rises, so does the risk. This dissuades some investors from jumping into the space, but it also highlights the importance (or advantage) of having investors with real operational experience in geographical expansion, logistics, delivery models, and more.
There is an inherent friction to this new consumer mobile opportunity. With mobile growth elusive, entrepreneurs have shifted to transactional businesses, and with each transaction comes friction. This is both a challenge and opportunity — a challenge to those founders and investors who are concerned about friction (which is a real concern in venture investments) and an opportunity for those who can identify the categories (and the people behind them) who can overcome any coefficient of friction.
Each August, as the Fall approaches, I try to quickly jot down my “field notes” and tips for folks who enter the marathon fundraising season from Labor Day to Thanksgiving. This Fall is a bit different. More companies, even more money, and new capital sources like the crowd and private equities. For Fall 2014, no long preamble or disclaimers, I’ll just launch right into it, in no particular order:
The Jump From Seed To Series A Is Big: I hear many people in their seed round already talking about their A Round in the next year. Optimism is great, but if that’s the goal, everyone needs to be clear about how to put the seeded company on the right path. If the institutionalized seed folks are looking for six months of trailing data, imagine what the billion dollar funds want.
Don’t Get Tripped By Outdated “Round Name” Terminology: What are seed rounds? What are Series A’s? Who on earth knows anymore. Yet, I see so many folks getting hung up on what to call it that it clouds their vision and judgment. I’ll paraphrase a line from PG: “Series A is when the pros do it and call it that.”
Optimal Ratios Between Branded And Unbranded Money: Every founder is different here, no rights or wrongs. The trap is to get stuck. Some founders want some level of branded money, and some just want money. Know where you stand on this spectrum and execute accordingly. Those who want a mix of branded and unbranded can likely close quicker (as opposed to rolling closes) and save time, as fundraising is quite a distraction to product and company development.
The Trick With Introductions: I’ve seen 100s of founders do the rounds for random intros to investors they want to meet. Those rarely work, in my experience. Rather than play a numbers game, 4-5 targeted introduction requests from people who BOTH you and the investor know will be much better received. It’s really about the strength of the connection between the nodes, that’s what sets up an introduction to be timely, awesome, and potentially game-changing.
Own Your Process: Dorky as it sounds, running a fundraising process is a way for investors to see how a CEO runs process. Investors like to see someone in control, this gives them confidence. Give them something to believe in — like running the process.
The Uber Effect: Uber is the hottest company on the planet now. It’s first round was pegged at $5m, and I believe it was on AngelList. People even questioned the $30m B round from Menlo. Now everyone realizes it was under their noses, so they’re looking for not only breakout ideas, but breakout people — Travis already had a startup he slogged through for six years and was determined to the bone. Motivation reveals itself.
Conversations, Not Pitching: Speaking of conversations, the best advice I received from a mentor in graduate school in preparing for interviews was to turn any Q&A into a conversation. If you can do that, it breaks up the unnatural interrogation and allows an investor to see the range of your thinking, as well as personal characteristics. Also, I just fundamentally believe that people want to have conversations rather than pitches or business meetings — they want to be heard, they want to listen, and they want to feel as if they met someone new that they can work with. That is what creates excitement.
Start The Conversation With Traction: Here’s a bold idea — After your cover slide in the deck, have the first real slide be about traction, usage, metrics. If you don’t have traction, say that upfront and explain where you are. People will still fund things pre-traction (and even pre-product), but just be upfront about that.
Speaking Of Slides, They’re Meant To Attract Others: Slide decks are a way for investors to determine if they want a meeting. Some don’t like slide decks and want to just try the product. Either way, if you have an app — send the investor the app. If you have a deck, make it simple and attract others to want to meet you. The deck or app is just a means to a meeting where you can have a conversation in real life.
Part Of The Pattern, Or Part Of The Portfolio: When a space gets hot, investors want to meet everyone in the space. This helps them develop a thesis, meet the players, and build a pattern. When you’re talking to an investor, try to determine if you’re becoming part of their pattern or can be part of their portfolio. If things don’t move in a manner that has momentum, take it as a “no” and move on…believe me, the investor will rush to get back in touch if they come to a decision later or change their mind. I have done this too — waiting by the phone — and it’s just a bad place to be. Don’t do it! (Tangent: Read this post on “Turf Signaling” – the location of where you meet reflects power dynamics often overlooked.)
Hard Problems or Timing Inflection? A fun criticism of investors is that they (and some founders) don’t “solve hard problems.” It’s a misguided critique. These kind of investment dollars are to be applied to hard problems, yes, but what really drives this is traction, market timing, and potential for inflection. Some do it by chasing after it’s obvious, and others are able to predict when something is on the precipice of inflection. Again, there are plenty of patient investors and capital, but with companies staying private longer, secondaries available but not predictable, and so many investment opportunities around them, investors are going to naturally pick up on things that are already working — where the question isn’t “How big will it grow?” but rather “How big will it grow and how fast?”
Sophistication With Stats: A bad place to be in an investor meeting is when the CEO does not own the metrics. The metrics should be like oxygen to a CEO. Also, the way in which stats are presented (month by month rather than cumulative, properly labeled graphs, etc.) show a level of business sophistication that will be noticed.
Alternative And New Capital Sources: VC firms have used social media and content to convince you that you need it. In some cases, you do; in many, you don’t. There are now tons of alternative funding sources (you know the ones). Additionally, for companies who are growing, there is even more new money coming into late-stage private financings. This is an increase even from last year as companies stay private longer and mutual funds, hedge funds, corporates, and even SWFs are getting into the game with direct investing. There lots of money out there (some may say too much), so make your plans accordingly.
I was in a meeting the other week where someone started talking about “The Efficient Frontier.” I had heard of the phrase, but wasn’t able to immediately recall the exact definition, though it was made clearer as this person charted out the different portfolio mixes the following groups take: founders, private investment funds, and incubators. The optimal place to be on the curve, he argued, was right above the point where the return on investment would be inefficient.
As I read more about the term, I realized it can be different things to different people. Here’s the Wikipedia definition:
The efficient frontier is a concept in modern portfolio theory introduced by Harry Markowitzand others. A combination of assets, i.e. a portfolio, is referred to as “efficient” if it has the best possible expected level of return for its level of risk (usually proxied by the standard deviation of the portfolio’s return).Here, every possible combination of risky assets, without including any holdings of the risk-free asset, can be plotted in risk-expected return space, and the collection of all such possible portfolios defines a region in this space. The upward-sloped (positively-sloped) part of the left boundary of this region, a hyperbola, is then called the “efficient frontier”. The efficient frontier is then the portion of the opportunity set that offers the highest expected return for a given level of risk, and lies at the top of the opportunity set (the feasible set). For further detail see modern portfolio theory.
So, it makes sense that angels, VC firms, and the like want to be on the efficient side of this frontier. But, what then of the folks who are beneath it? It is cliche to say founders take on extremely concentrated risk, but taken within this particular framework, the majority of founders are on “The Inefficient Frontier.” The word “inefficient” isn’t a good word. It implies friction, sub-optimality, and rewards that may not be properly tied to performance. Seen in this slightly different yet powerful perspective, it is a good reminder for me (having been through one of these myself) that a founder’s frontier is often inefficient to begin with, and getting to that point of efficiency requires significant energy to overcome the brutal laws of gravity.
Every summer, I spend some time and resources to revamp my blog. Since my first post on Uber almost 25 months ago (it’s worth re-reading that one), I have posted a lot here, both analysis, videos, and stories behind the small investments I make. This summer, I’ve added a few things to Haywire, with the hopes that people who visit here and read the posts (and comments) will enjoy a little more. You’ll see it’s not fancy or slick. In fact, some of the new functionality makes the site feel a bit slower, but hopefully that’s Ok. Here’s what’s new or (hopefully) improved:
MailChimp as my email service provider. I had kind of neglected email as a channel for a long time, and that was my fault. Hopefully the emails for those who elect to subscribe will look nicer, and now I get better analytics. I’m excited to learn more about MailChimp. If any of you have thoughts or want to share some wisdom, my ears are open.
New “tiles” for Haystack investments.Check these out. They work on mobile, too. We had tried to make them cards (of course) that flip over for more information, but that was too much work, so you get these unidimensional cards instead. You’re welcome. (I am also woefully behind on writing up the stories behind my investments, but I’ve got a bunch of drafts saved up and am committed to working through them. Stay tuned.
A redo for the right rail. We included a “Popular Posts” on the right rail based on traffic, improved the search, and tightening some other stuff.
A place to post, discuss, and chat. I get a lot of cold emails. I want to answer them, and I’ve been trying to find a better way. So, I’m going to try this — by following this link, you’ll see a “Discussions” page on Haywire, where anyone can post a question (or link). I will be notified email, I’ll review, and I can publish it — and offer a public answer that lives on the blog. Or other people can answer. Who knows. Let’s see how it works. And, I’d truly appreciate any feedback you have on this.
August in the Valley always turns out to be an introspective month for me. Things slow down, people leave town, and my wife’s work is also a bit slower before kids come back to campus. This year is no different, as I’m in another transition. I have some fun and also much-needed personal items to tend to this month, and I will also take the time to reflect, recharge, and rediscover what makes me most passionate about work. Three years ago this week, I got my real start in the startup world in the Bay Area. People often just assume it all came together neatly — they see that I wrote for TechCrunch or tweet a lot and assume it was just always like that, or that I know what I’m talking about. Not true. If anything, I’m learning it all as I go along, trying to play catch up with everyone around me.
Three years ago this week, my friend Joel made an off-hand remark that I should just join his company — with the caveat that he couldn’t pay me. Jeez, Joel, thanks for the offer, buddy! Yet, at that time, after nearly 11 months of trying to crack into startups, I thought about the offer and realized — I don’t have a better choice. I emailed Joel. I think he was surprised. He replied, paraphrased: “Well, I can’t pay you, but you’ll get plenty of equity and I’ll buy you Banh Mi sandwiches every day you’re here.” Sold! Since then, Rexly somehow was acquired by Live Nation Labs, I went to Votizen (which wasn’t a great fit) and that was acquired by Causes, and Causes was just acquired by Brigade (these are all Sean Parker companies), and then I was lucky to get my first break in VC and joined Javelin Venture Partners for six months as an executive-in-residence where I began to focus on mobile technology and the iOS platform, after which I started working as a formal consultant for a small handful of companies that were designing and launching apps, and then eventually increased my involvement with Swell, where I became an employee until recently. Along the way, I was fortunate to work as a formal consultant to a variety of venture capital firms (and still do) — like General Catalyst, Trinity Ventures, Kleiner Perkins, GGV Capital, DFJ, and Bullpen Capital, among others — and to have the support of everyone I worked with to explore my interests in mobile and investing simultaneously — and to friends and mentors who helped me channel my energy into the creation of a new fund.
All the while, I have met and worked with great people whom I call friends and mentors. Just like startups fight like hell to become “ramen profitable,” looking back on my three short years in the technology startup vortex that is the San Francisco Bay Area, you could say I worked for “Banh Mi equity.” Most of the equity listed above and the subsequent events have been largely ceremonial. It’s been a fun ride to be on, surrounded with the smartest people in the world. And, here I am again, in the dead heat of August, late twilights that stretch longer, at the same desk, typing away, trying to reset, and wondering what the next Banh Mi equity package will look like. I’m in a good spot, but there’s a long way to go, and excited to let life unfold and see what presents itself.
Y Combinator has come up often in discussions of late, and whenever a topic repeatedly comes up in discussions, it’s time to attempt to structure those thoughts. Let me say upfront that while I don’t agree with everything YC does or shares on their blogs (and have written publicly about that), they are, in a way, somewhat underrated in their impact. Two quick anecdotes: I was recently at a dinner where I was seated next to a founder who has been through YC twice. “Why go back again?” I asked. His answer, paraphrased: “I like the social peer pressure of being in a group, I like the pressure that three months places on a team, and I love the network.” Two, I talked to a friend in the current batch who said YC has essentially empowered the technical to master business, and that inspires him to do the same. Pretty hard to argue with the power in those statements.
All this got me to thinking, YC is not just a “startup accelerator” or whatever it is lumped in to. From my vantage point (on the outside), it is an organization which continues to grow in influence and still has so much more room to grow. This isn’t discussed often in a structured way because the chatter focuses aroudn the brand and personalities, as well as the investors who jockey for positioning next to the graduating classes. Consider the following morsels:
Growing Headcount: People muse a16z is getting bigger. Look at the team page for YC. Lots more people to manage the growing network. Many founders I’ve talked to like being matched with an alumni mentor but it can be hit or miss (in their view, not mine) who they’re assigned to as a partner.
Extending Brand Geographically: “Startup School” as a recruitment tool has extended to New York and Europe. Why not other places, right? It’s just a matter of time. I’ve argued before that we could see YC not just in SF proper, but perhaps in NYC, Berlin, and even China as their brand grows and as they continue to perfect the model of finding talent and building products quickly.
Moving Up-Market: It feels like more and more companies are entering YC already with a product that has some traction and/or revenue. Yes, there are people who still get in without an idea, but plenty of companies are quite further along, which is, in part, a reflection of our times, where everyone has a company (or wants to found one), and what ends up separating the visionaries from the doers is evidence of real adoption, even if small.
Alumni Network As Investors: As the YC alumni base grows in size and power, those individuals will become angel investors. Of course, many already have. They are likely some of the first choices for entrepreneurs in YC, and why not? They have the most recent experience and can help guide them up to and beyond demo day. This puts competition on the early-stage players who are not in the alumni network. All’s fair in love and war! Further more, there are pre-demo days leading up to the main demo day, which means the pressure to access has increased. And, YC companies, in my view, are getting smarter each batch about the opportunities and risks associated with talking to larger institutions too early in their life cycles. This means the larger funds may have to change their approach unless they want to invest quickly.
Shifting Terms: Many assume YC charges 6-7% for each company, but as they move up-market and companies mature, and as the startup ecosystem continues to become more transparent (even for YC!), they do now negotiate on equity percentage.
Recruiting Teams To Apply: As the YC partnership extends, like with a16z’s, the partners can hear about more companies which have matured slightly and invite them to apply to YC, which is about the same thing as inviting them to pitch the partnership. In this way, they’re extending into the sales realm of traditional VC, which is super-interesting and quite smart. (A follower on Twitter commented that #YCHacks also fit into this theme, as the winning teams get an interview with YC.)
Again, YC is a force — no doubt. But, I also think its impact on individuals and companies is underrated (despite all the surface-level hype), and I think they’re planting all different kinds of seeds to extend their power and reach. As the traditional venture capital model continues to experience pressure from myriad angles (private equity, hedge funds, lowering costs of startups, cheaper financial instruments, companies started outside Silicon Valley, crowdfunding platforms like AngelList and CircleUp, and so many other factors), the impressive, expansive growth of YC should be added to the mix. YC is like a growing startup, too — it’s just under 10 years old, and not done growing and evolving. As the faces who lead it change, and as it remains nimble to change as an institution, it enjoys many advantages — just like startups do against incumbents.
Over the past few days, you may have seen a larger number of people (mostly investors) tweeting about a bizarre term: “pro-rata.” This term is a venture investing inside baseball term, but it is actually quite important for (future) founders to think about. To simplify the term, a pro-rata right is essentially a provision in a venture investment that gives an investor the option to invest more money, on a prorated basis, to maintain their ownership percentage as the valuation of a good company increases over time. This protects the earlier investors from dilution as the valuation of the company rises, and it also is a critical instrument for those earlier investors to “double-down” and put their money to work into the companies that have the best chance to return their fund.
I am writing this as someone who is learning about all this stuff as I write it — not an expert. So take the following with a grain of salt:
Larger institutions in the business of venture usually don’t invest unless they have pro-rata rights. It’s a condition of the deal, and those funds have business models which depend on at least one or two companies within a vintage which end up being the “winners” and end up carrying the fund. The larger players have been in business for a while, so they’ve had enough time to understand it; the newer entrants in the seed ecosystem mostly have not, and it seems like only now that people are understanding that, no matter at what stage, pro-rata rights are critical for investors.
Ah, but there are few assumptions around these that we must reexamine, and this is where it gets interesting given the climate:
Many angels, early-stage, and smaller check-sized investors do not get pro-rata rights. In my limited experience, I never ask for them, and if I did, I probably wouldn’t get them at all.
Now, some investors who have a big enough checkbook, a big enough fund, or a big enough brand name or expertise can lay down that having pro-rata rights is a condition of their involvement in a deal. In those cases, the founder has to chose whether or not that condition is worth it. For example, I was involved in a great seed deal where a well-known investor wanted to come (and he has very relevant experience in the space). His condition was to only participate with pro-rata, as an edict from the fund he works for. No one else got pro-rata. This is a critical point — a founder does not, in no way, have to allow these investors to have pro-rata.
Ok, well, so now that there’s an excess supply of angel and microVC capital in the system, and because many of the people writing these checks do have a business model (i.e. returning a fund based on fund economics), people are asking for their pro-rata rights and realizing just how critical they are for their fund’s performance metrics and, in some cases, survival.
Yet, what’s also interesting is that founders are now in the driver’s seat with respect to pro-rata. Consider a great seed team which raises a bit of funding, and as a condition, they do not give out pro-rata. Assuming they aren’t targeting someone specific, they could just use their leverage to set the ground rules that no pro-rata rights are given. Why not, right?
And, this is where it gets interesting for founders, especially for the ones who survive and their companies mature — they may be in a position in the future to dictate whether or not pro-rata rights are even dished out to begin with. This is the cold view interpretation, as I’m sure many founders will want to investors they’re close to and like to have them, but founders also can use them as a stick to fend off bad behavior. In the future, I believe things will trend this way. The people who actually get pro-rata rights will be the ones that either have close relationships with founders, those that bring extremely deep, relevant experience to the venture, or those who have a brand and patina that send a signal to the market. If I’m right that founders will hold back on this moving forward, this then alters the model of the early-stage funds and puts more pressure on them to have one or more of the characteristics I cited earlier. Otherwise, the money is just money.
As a frame of reference, I set out in my investing activity to assume I won’t have pro-rata because I believe that it has to be earned, over time. It’s less of a pro-rata right, but more of a pro-rata privilege. This is just my point of view, informed only by a few years…I’d love to hear what you think in the comments below.