Today is a big media day at Haystack Fund! Just kidding, but for some reason, previous discussions I’ve had with reporters and media all seemed to surface online today. As I was reading through them and figuring out how to share them, I noticed a theme running through the conversations.
Why all at the same time?
If I had to pick a reason, it would revolve around the idea of transparency in venture. Now, I don’t mean transparency for transparency’s sake, as many people leverage it for their own branding or marketing — and there’s no harm in that. For me, I am thinking about the future of how private companies are discovered and get financed. Part of that future, I believe, will be operating in an environment with more regulatory oversight over how reporting is conducted in the private sector. That means, how do companies report to their venture investors, and how do venture investors report to their investors, the limited partners? And, as more information is shared, how do all parties ensure the information isn’t shared more broadly without a record of who has keys? These are all pertinent yet thorny questions, and with political change in the air, I see these coming.
That theme comes out in the conversations I’ve had below:
1/ Katie Benner of The New York Times:Katie is a friend and a darn-good reporter. She has written before for Fortune, The Information, Bloomberg, and now The Times. She also wrote a great piece on how employee options work at Good Technologies, shining on a light on a topic that affect so many in the ecosystem. Recently, I spoke with her and am quoted in her article today, titled “Making Startups’ Financial Data Free And Open,” which appeared in the July 25, 2016 Times.
2/ Guesting for StrictlyVC: Each summer, I get the pleasure of writing for StrictlyVC while my friend Connie takes a much-deserved break and searches the shores of coastal Maine for rare sea glass. Last Friday, for my column, I wanted to share more details about what I’ve learned in raising three small funds. You can read the FAQ on StrictlyVC here. For some reason, I get a lot of questions about it, and I’ve committed to sharing the lessons I’ve learned (with a grain of salt) here in an open way. The angle of transparency I’m going for here is that it’s really hard to get the funds up and running. Just this weekend, I talked to a friend who has been a founder and had a huge, notable exit as an investor, and is still having trouble raising a small fund. More on this below.
3/ Interviewed by Harry Stebbings on The Twenty-Minute VC: You have probably heard one of Harry’s podcasts. This guy is a machine when it comes to creating, editing, and distributing podcasts. And, he really prepared for our conversation. In the discussion, we chat about topics such as: defining “founder-friendly;” branding in VC, experiences in raising a fund, and more. I want to stress again that Harry did a great job editing this down to 20 minutes and you can listen to my soothing voice, but not when you’re driving, please — you may fall asleep at the wheel! (Link to Apple Podcast here.)
A few weeks ago, Chris Mims of The Wall Street Journal wrote a great piece on the struggle between entrepreneurial energy spreading across the country while the dollars allocated by LPs in venture capital funds increases in concentration in the Bay Area. Specifically, Mims reports that while the share of U.S. VC dollars allocated to startups in L.A., NYC, and Boston roughly amounts to 20% overall over the past two decades, the share going to Bay Area startups has ballooned from around 30% two cycles ago to over 50% in 2016, when we saw many large funds scoop up massive LP dollars.
This is a touchy subject, because for a variety of reasons, the Bay Area isn’t the most welcoming place considering the costs and cultural corners, yet as the country emerges from the Great Recession stronger in aggregate, the “cap table” of that rebuilding has shifted dramatically to the coasts (and a few coastal cities in particular), and especially, to the Bay Area. Additionally, before I begin this post, I want to disarm the chorus in advance — I know that companies can be built anywhere, and that there are plenty of examples of VCs in the Bay Area investing outside their market, as well as great VC firms which are headquartered outside the Bay Area. There’s an advantage to being local, and those who breakthrough outside this chamber deserve extra credit, for the odds are more difficult.
The point of this post, however, is to share some observations on how location — either via proximity or distance — drives so much dealmaking, and then to share some ways to overcome geography. I’m reminded of the lyrics of a Tina Turner classic: “What’s love got to do, got to do with it? What’s love but a second hand emotion?” Just replace “love” with “location,” and the answer is: A lot.
Why is location so important to LPs, those who invest in VC firms, and the VCs themselves?
1/ Only way for VC firm to exit is IPO or exit (or selling shares in future rounds). IPOs are rare, and becoming tougher given the startup narrative to stay private as long as possible. Exits are also rare, and most of those big exits (per CB Insights) occur in California. If location drives M&A, location will also then impact where a VC allocates dollars. (Location also helps drive a closer bond between VC and founder, which helps in cases like special liquidity events for an early investor to sell shares, among other techniques.)
2/ Proximity affords VCs more time to track a founder or investment. Whereas the seed world moves on quick decisions, I’ve seen many VCs track potential investments for about a year, either waiting for the timing to be right and/or to gain a better picture of the company and team. Here, proximity drives familiarity and eases the fears of an investor who may not otherwise have enough time to get comfortable with the risk presented to them.
3/ LPs want their GPs to be active managers of their investments. It’s possible yet still hard to be an active VC or Board Member when the company is a 6-hour flight with a connection away, but yes — I know — many do it. But, that right has to be earned. If you look at the folks who do this well, they are considered rainmakers by LPs. And, there aren’t tons of them.
Ok, if this generally the reality, then what? Here’s how I briefly breakdown what startups at various stages should consider about Bay Area capital:
Seed – If you’re outside the Bay Area, raising seed capital in the Bay Area is hard. Seed capital is mostly institutionalized now, meaning those investors are investing other peoples’ money, and in order for them to get a return, they need to see a large potential multiple on what is a smaller check, and one where their stake will get smaller with success via dilution. For founders in ecosystems like LA, Boston, NYC, Seattle, Chicago, seed ecosystems have emerged thankfully to pick up the slack. Those funds can theoretically be more “active’ with their investments by being local, and theoretically help prepare those seedlings for future rounds, where the Bay Area may come into play. For those who are pre-seed or in the seed stage without much traction, it is really hard to raise a seed round in the Bay Area because local investors here have so many options to invest locally.
Series A and Series B “Classic VC Rounds” – Because of the economic incentives of traditional VC funds (firms managing $150m to $1 billion or so), those GPs have to allocate their dollars to the best economic opportunities they see, regardless of location. It is already quite difficult for a Bay Area company to get a Series A done, so imagine how that risk increases for something out-of-market. That said, and no one will say this publicly to you, but the bar is exceptionally higher for a Bay Area VC to make an out-of-market investment. Yes, they will miss good companies (as I wrote last night about Dollar Shave Club). Luckily for founders, non-Bay Area VCs will invest out of their own market, as we saw with Dollar Shave as well, or with east coast firms that invest in Europe, and so forth. For those founders who are outside the Bay Area and seeking a classic Bay Area Series A or B round, the formula to score one is to (a) demonstrate exceptional growth, where you will be offered multiple term sheets, or (b) invest in a long-term relationship that eases the fear of location in the eyes of your target VC.
Growth VC, Pre-IPO or Pre-Exit Rounds – At this point, more people want to give you money than you have room to take, and regardless of your location. So if you make it here, location doesn’t matter.
This is a tough subject to write about. I know it’s unfair, especially as so much of the rebuilding from the Great Recession is seen through the opportunity of building a business. Everyone wants to be Zuckerberg or be on Shark Tank. Everyone wants to be CEO or an investor. And while it is possible, location drives a lot of it, and that particular location isn’t an easy one to physically crack into.
I myself have flirted with the idea of not living in the Bay Area given the increased traffic, congestion, and cost of living, but then I see the power of the local network effect and get nervous. So much of what I do is a local game. Hyper-local, in fact. I’m in awe of those who do it outside the physical network because it means they are even stronger. We moved back to the Bay Area in 2011, and I wonder how hard it would’ve been even if that was pushed back a year. As I’ve shared with you all here, I’ve had a very hard time finding a space in the ecosystem and generally believe my proximity to the epicenter helped me increase my “surface area of luck.”
I wanted to write this post because this issue has come up a bunch with founders I interact with outside the Bay Area, and I know reporters or larger VCs won’t write about it because most reporters don’t understand the nuance to the financial issues like Mims detailed out and the investors don’t want to cut off any potential flow of deals.
There is a silver lining, however: With billions more people coming online worldwide over the next decade, with new geographies emerging with their own capital bases, with traditionally underrepresented minority groups begin growing into the dominant majority, and as larger Bay Area firms grow even larger fund sizes, the types of opportunities created over the next two decades may look different than what occurred over the last two decades. And, thankfully, there are plenty of LPs and VCs (even in the Bay Area) who see the opportunity and are positioned to take advantage of it — or have been taking advantage of it for quite some time (more on this in a future post). You’ll hear about those returns over the next few years.
This is going to be a fun story to write about Myra Labs.
About a year ago, my good friend Nakul told me I should meet this guy spinning out of Bloomreach — Viksit. I happen to know one of the founders of Bloomreach, who quickly pinged back to endorse Viksit as one of his top engineers. We met up last summer, and at the time, he was developing a bot for chatting inside Whatsapp. We met for coffee in Palo Alto. A few weeks passed, and we met again, and during that time, Viksit had single-handedly built integrations into other chat apps, made friends with folks who were working for Telegram, and had somehow smiled his way into developing some relationships with more closed mobile messaging platforms.
We met a few times and while I initially didn’t think it would work at scale, Viksit always had a non-obvious and insightful rebuttal to any areas of doubt. He is relentless in this way — and I will come back to this trait. As the summer ended, I hadn’t gained enough confidence in the specific application (going directly to consumers with these bots), but I had gained confidence in Viksit. This was right around the time I started my Fund III and was writing what would be larger checks (for me, relatively). I committed to Viksit that I would invest and also open my entire syndication network to him. I gave him a strong recommendation and made a ton of intros. I was searching my email for the exact date and text: August 31, 2015. In the email, I wrote:
Round: $300-350k open on $5m cap, 20% discount; Small round, just me, a Waze co-founder, and early Whatsapp eng, and the two founders of Bloomreach, where he was previously (this may be best-suited to individuals).
Background: Myra is an intelligent assistant tied to a phone number and virtual machine for each user. Viksit himself has already built integrations with Whatsapp, FB Messenger, regular SMS, and Slack.
Risk and Fine Print: I know what you’re thinking – “uh, another bot. Won’t the clients just own this like Moneypenny and FB?” So, I dragged my feet on this for the same reason for weeks, but Viksit handled every strategic question I pummeled him with for weeks. He is a very deep systems thinker and strategist, in addition to being an incredibly productive engineer. I know his former boss (Bloomreach CTO) very well and he also is investing and remarked on his drive and intellect. He’s been obsessed with all the messaging platforms, and that’s essentially why I am investing — the sheer size of all the world’s messaging clients and their restrictive power and influence over how those billions of people will use the web is super interesting to me.
Then the round started to break down. Viksit and I had a number of hard chats. I don’t mean to imply that I could save everything as I have a very small fund and rely on the broader network to syndicate and co-invest. As I replay those conversations, I know Viksit was nervous and there wasn’t much I could do except give harder advice on how to keep going, raise less, lower the cap, etc. To his credit, Viksit stayed with it. He eventually caught the eye of one of the best seed VCs out there (as well as this little, new enterprise tech company called “Slack”), and after a month of deliberation, got a larger seed round with a fantastic investor. It took much longer to happen, but it happened.
That’s the relentlessness I referenced earlier in the post. During those difficult investor meetings, Viksit slowly digested the feedback from the community — mainly that the opportunity to go direct to consumers inside siloed native messaging clients would require too much permission and, therefore, too much friction. Viksit shifted course and moved Myra away from direct-to-consumer and, instead, focused on empowering developers, big or small, to build conversational interfaces in a platform-agnostic way. In this manner, when messaging clients break out, or when new interfaces (like voice) emerge, Myra is flexible and extensible enough to handle the terrain. Additionally, their architecture can recognize similar users across applications, so that you (as a user) don’t have to worry about resubmitting your preferences within each silo each time. The machines actually learn who you are within the context of your interaction. (You can read more about Myra and link to their site here.)
In the time that we’ve gotten to work, I would say that Viksit and I have the most “tough conversations” I have with any startup. It’s partly because we are comfortable with each other and I have now known him for a year, partly because we are both prone to debate and argue in a mild yet relentless manner, and at times, it has led to one of us getting frustrated. I am sure he’s frustrated with me right now in reading this! But, ultimately, we are friends and have built up trust, as well, and he can really create a rich product and evangelize his vision to a degree that’s rare to find. I’m lucky to be a small part of it all.
Since that initial email above, the attention toward bots has exploded, this past April 2016 to be exact. I wrote about the craze here. As I surveyed the market, I was lucky in retrospect to pick Myra early because it is in the #2 category I outlined (“picks and shovels”) and, so long as they can woo developers to build with them and help them scale, the company can grow as the more activity goes inside messaging clients and interfaces, and/or becomes more conversational in nature. Ultimately, no matter what does happen, I know the Myra team will always bob and weave their way to the best opportunity — and I want to publicly congratulate Viksit on not only putting up with me, but also staying the course during a challenging market for fundraising. It all paid off for you.
Back around the holidays in 2015, one of my LPs (who is also a friend) sent me a note about a YC company from the most recent batch, S15. I had been at YC and saw the company, but hadn’t been thinking about the “AR” space. I know they’re unrelated, but previous to this, I had made one small investment in a VR infrastructure company, but it isn’t a space I would claim to know well. As a few months passed, however, I had picked up interest in industrial software and robotics, so learning about ScopeAR again proved out to be excellent timing.
Discovering and investing in a company like ScopeAR is yet another case of where the founders guide me (the investor) to learn about their technology and market in real-time. Within a few email exchanges and conversations, it was apparent to me that Scott (the CEO), David, and Graham would be easy to work with as co-founders. On top of this, I liked their enterprise and/or industrial focus (which fits within my themes), and it was immediately clear how their solution would save companies money from Day 1.
Luckily for me, by the time I had invested, ScopeAR had already won the business of companies such as Boeing, Lockheed Martin, and Honeywell, among many others. ScopeAR boasts two products to date — WorkLink (a platform to create smart instructions), and Remote AR (powering remote collaboration via AR) — which help their customers increase savings from industrial hazards, operator errors, and operational inefficiencies.
When I invested, the main interfaces were largely considered to be iOS or Android platform devices. In a serendipitous turn, I was invited by friends at SVB to a small drinks reception and conversation with Satya Nadella, who during that chat specifically called out Hololens as a major core focus area for the company in enterprise settings, and that in such settings, AR might be the first technology to be adopted on the platform. Once I heard this, I ambushed him (in a friendly way), called up the ScopeAR site on my phone and he deftly introduced me to his SF-based Corporate Development Team — I was able to follow-up and got the team in touch with Microsoft on this initiative.
That’s about all I’ve done so far, and as I write out this story, I realize just how fortunate I am that my friend tipped me off to the deal, that enough time had passed for me to develop an interest in the space, and the founders were extra nice, kept the same terms from their round, and let me slide into the deal. They did me a huge favor, and for that I am grateful and want to work extra hard for the team. I recounted this story last week at an industrial hardware meetup I co-hosted with Lemnos, and we joked that the deal was sort of like a “booty call” at the end of the round. As they say, a seed round is never closed — and thank heavens for that.
It is crazy that within a year of ScopeAR’s time in YC to now, AR has gone from a concept to something millions of consumers interaction casually on their phones, either through Snapchat or Pokemon Go, among others. In a work context, it is easy to envision how processes can be improved by using connected cameras with information overlaid on top. Given the way the winds are shifting, I look back on this investment decision with a smile. It’s easy to imagine a world in which ScopeAR’s current customers use new platforms and go deeper into various industries. And, lucky me, as I was able to hop on the train just as it was leaving the station.
When I started my third fund, Haystack III, back in August 2015, I thought I was so organized — I would build a portfolio that was evenly split across three areas of interest: SaaS, the backbone of many portfolios; consumer products and services, which are risky, yes, yet always promise the highest beta; and the world of industrial robotics, manufacturing, and sensors. Little did I know back then that, as the year unfolded, I couldn’t find the right consumer-facing opportunities for my specific tastes, while I started to go deeper into the industrial side. The result so far has been a portfolio weighted toward the industrial sector, and I’m excited to share more about the stories behind those investments as the companies begin to get their sea legs.
One of these areas is 3D printing. To those who follow, 3D printing and startups isn’t something entirely new. Companies like Shapeways and MakerBot have attracted some of the best investors in the world, and thanks to their efforts, have created the space for startups to continue to innovate in the space. Over the past year, I have met with over 30 startups focused on some angle of 3D printing, and as I started to imagine every industry potentially being transformed by having 3D printers on every shop floor, it opened my eyes to other opportunities in world of ubiquitous 3D printing.
That path inevitably led me to finding software creation and collaboration platforms for industrial 3D printing, otherwise knowns as “additive manufacturing.” I am lucky to have found and made investments in two companies: Origin, based in San Francisco; and nTopology, based in New York City. You can learn more about each company on their sites (links above), but I’ll spend a quick minute talking about each one.
Origin is a 3D printing software platform that empowers other companies to rapidly prototype products with true commercial-quality and other advanced capabilities. This is just scratching the surface for what Origin hopes to accomplish by freeing industries from having to use specific printers and/or specific materials in their additive manufacturing processes, leading to dramatically lower printing costs. Overall, the Origin Platform is designed to make manufacturing easy and inexpensive instead of the difficult and capital intensive experience it currently is. They’ve found that making manufacturing easier, as well as breaking down many of the barriers from traditional manufacturing (for example, minimum unit quantities for a product design), their customers have been able to develop entirely new business strategies. On the 3D-Printing front, Origin even “pilot” manufactures many products in-house on their own process to help inform platform development. Going forward, they’re going to release a lot of the tech they’ve developed on the actual printing process front so other manufacturers and companies can use their platform to manufacture real products.
nTopology is software company that helps engineers design better 3D printed parts. Specifically, the company makes CAD software for designing complex, engineered lattice structures. While lattices are difficult to create inside CAD systems, lattices are critical because they allow for the creator to manipulate material performance by changing the structure of the lattice. To start out, nTopology targets design engineers at industrial companies who are looking to harness 3D printing for production. In most cases, these designers have already been using 3D printing for prototyping and have felt firsthand the pain in developing lattices for printing. nTopology has attracted interest from some of the most technical industries worldwide, including aerospace, medical implants, and chemical processing, and has helped traditional companies (such as footwear and apparel) leap into the 21st Century by bringing them the power of 3D printing faster and more efficiently.
Companies are moving from using additive manufacturing for prototyping to production because of the performance improvements the process allows, mainly that with 3D printing the user can make parts that were impossible to make before. In industries where highly complex or custom parts are the norm, dramatic increases in performance lead to massive economic value. Tons of investment dollars are going into printer hardware and printing materials, causing printing costs to slowly drop. However, one of the major problems is that the software that’s used to design and print parts today was never intended for mass production. This means that trying to make better performing parts is extremely time consuming, if not impossible, with current solutions. It should be no surprise, software is the key to the explosion of 3D printing as a manufacturing process.
For me, these two investments also go beyond the analytical. I’m proud that two friends helped me find both Origin (thanks Hunter) and nTopology (thanks David), and that I get to work with syndicate investors who are great friends and easy collaborators. On top of this, working with the leaders of each company — Chris and Joel at Origin, and Brad and Spencer at nTopology — is pure joy for me. We text and talk all the time, we have real conversations, they listen to my perspective, they’re really focused on building long-term relationships in all aspects of their businesses, and they are patient in teaching me how their industry works. By now, folks may think of me as someone who writes and invests, and maybe before worked on mobile apps, but way back in my high school days, I was living in math and physics classes and (now antiquated) CAD systems, perhaps dreaming one day of doing what these CEOs are doing. Instead in college, I went down a different educational path, and I’m very fortunate that somehow I can meet and work with folks who took those CAD classes all the way to the point of reinventing how major industries manufacture. Lucky me!
Long before Instagram was created, nearly every technology observer realized the massive potential of mobile phone cameras. Kevin Systrom, the famous CEO of Instagram, once remarked on stage, paraphrased: “When the iPhone 4 launched, most people saw a phone with a great camera — we saw a great camera with a network.” Since the rise of Instagram, the race to leverage the mobile phone camera — the most important sensor in the world — has been furious. While connecting a phone’s GPS sensor to the network has given rise to a company like Uber, the mobile phone camera sensor has helped catapult Facebook into a $300B+ company; it has given rise to its notorious competitor, Snapchat; and it has given rise to, as 2016 unfolds, unprecedented effects on consumer behaviors.
Only about halfway through 2016, the harnessing, manipulation, and augmentation of the world’s most important sensor has been stunning to watch. Some effects have been a joy, such as the new app “Prisma” which uses a form of artificial intelligence (neural networks) to transform our normal camera pictures into prisms of art. The app is a creative hit, taking what is traditionally an Instagram feature and turning into something beyond what just a few engineers can build and distribute in real time. And, sadly, some effects have shown us pieces of humanity that we have often been shielded from — specifically authentic, unfiltered video evidence, in the form of livestreaming, of unnecessary brutality toward defenseless citizens and the authorities who are authorized to keep the peace. While Prisma distorts reality, Facebook’s livestreaming clarifies the dangers society faces with raw purity.
As Prisma and Facebook reshape and illuminate our physical reality, as told by our phones’ camera sensors, the latest consumer sensation to burst onto the scene — Pokemon Go — also leverages the most important sensor in the world (and also the GPS sensor, to boot!) by empowering its users to augment their reality to play a simple game built by a team with a not-so-simple story.
I remember first hearing about Ingress, the first app by Niantic Labs (which created the Pokemon Go game for Nintendo) from Liz Gannes, who I was chatting about mobile apps that could be Android-first. Back then, Niantic’s Ingress could have only been created on Android as it gave the developers root access to GMS maps. Ingress was pioneering in that it pushed players to play a massive location-based game to hunt for things by using their cameras to augment the maps on their phones. Loyal Ingress users, whether they were in a big city or a sparse suburb, could find joy in firing up the game and going on a treasure hunt, linking to new fields and players, encouraging users to travel outside into the real world, phone in hand, and as the Niantic CEO stated in this fantastic interview from 2015, to deliver “differentiated client experiences that interface into that same game world.”
There’s a significant amount of mobile product and marketing detail for me to dive into on Pokemon Go, not to mention the implications of this new consumer behavior and the newer generation (Generation Z) to follow the current favorite (Millennials) — I will write more on Pokemon Go later this week. It has reminded me of this old post I wrote.
For now, I need to catch my breath and just sit in awe of how powerful and transformative the tiny camera and location sensors in our pockets are when connected to the network, connected to other things (real or imagined), connected to latitude and longitude, and to other people we know well or we hardly know. With cheap data, robust infrastructure (to handle video transmission), cloud computing (to process precise navigation), open source software frameworks (to harness neural nets), and the creativity and courage of creators and broadcasters (whether playing a game of Go or broadcasting raw reality in the face of danger), we are collectively distorting, focusing, and augmenting our realities and reshaping how we interact with the real world.
Last December, I got into a longer conversation at a social event with someone who had lots of corporate M&A experience in tech. She said something to me that lodged into my brain: “Generally speaking, we have no interest in VC prices.” As that quote snaked its way around my brain, it dawned on me how, when considering the VC “business model,” M&A is one of the two traditional exit routes and critical to making the VC model work. Of course, this should be obvious, but replaying this quote in my head made me think, perhaps, it was forgotten during a generational transition. And, as companies stayed private longer before IPO, and as valuations rose beyond what many companies were willing to pay, I thought to myself: “I need to more people who have done this work.”
So, I spent the first quarter of 2016 trying to meet and learn from as many corporate development and M&A groups at various consumer tech and enterprise tech companies in the Valley. People were very gracious with me, making time to meet face to face or at least by phone, and being quite candid in their responses. Of course, I would never share the details of any conversation and/or tie them to a specific company, as strategies differ quite a bit between companies.
As I’ve reflected on those conversations, I’ve tried to find parallels among different companies and distilled the key takeaways as follows:
1/ Core, Adjacent, or Irrelevant: Acquiring companies are mostly interested in acquiring small teams (not taking on huge CapEx) where those team members will easily integrate into a core area for the company (say, for Facebook, live video) or an adjacent area that could be emerging over time (say, for Google, open source software). Companies view small acquisitions of talent here as an accelerant to traditional recruiting done 1 by 1.
2/ Types of Landings: Larger, material acquisitions over $100m (that need to be reported by public standards) are a different matter, which I’ll address below. For those under $100m, most of them are for specialized talent (say, cloud infrastructure experts who land at Amazon), but the smaller acquisitions of, say $20-30m, are not as common anymore. The landings are a bit harsher, say $1M or so for the key staff at a startup — i.e., not everyone on staff. Often these offers are below what the startup has raised on a theoretical “cap” in a series of seed rounds and extensions. (Some companies mentioned to me that they wanted to meet small teams who were just raising seed rounds to offer them a buyout right away — I actually referred one company to an enterprise buyer after passing on the round and they were scooped up by the company despite having trouble raising their round!)
3/ Pulling the Strings: Who makes the larger acquisitions happen? Either strong product execs from these companies, or the executive leadership itself. Benioff famously told his M&A team that he wanted RelatedIQ, and the team executed to fulfill that desire. Catching the eye of a CEO can move the needle in a very different way; for the product teams, it usually requires a bit more strategy and time, which I’ll address in #5 below…
4/ Anchored Prices Are Irrelevant: I mentioned earlier that many soft landings offers come in below what the seed stage company has mentally anchored around re: their price or value. This can continue and magnify once a startup has taken on Series A funding and beyond, especially over the last 4-5 years. In short, M&A departments have essentially zero regard for these prices, but the psychological anchoring around these prices from companies and their investors — not to mention a board’s ability to block an offer — can put the company on a path to nowhere.
5/ Relationships Matter: In #3 where I mentioned product leaders at companies holding court in M&A direction, those discussions usually start off with a relationship between the high-level execs and the particular product team. That requires a relationship. It could be a BD deal, or an API integration, or simply a cultural fit. The marketplace approach many companies have used to raise their rounds to date won’t really work here. This was an interesting finding because so much of the startup narrative is to avoid partnering with companies — and while there’s no doubt truth and limits to this, it also can grease the wheels for a better landing down the road.
About a year ago, my friend in NYC Joel pinged me about a company he had invested in. It was a short description, but I took the intro and met Jeff, the CEO of Tempo Automation, for coffee. We had a great discussion, and he had the right background in hardware, automation, and systems. My shortcoming at the time was that I didn’t totally understand his market, so I kind of asked to just leave the conversation. Jeff pressed me over email and now, looking back, was incredibly gracious and thoughtful in making time for me.
In those subsequent conversations, I saw Jeff’s measured aggressiveness emerge (I mean this in a good way) and he took the time to teach me about his world. I am looking over the email threads right now as I’m writing this, and it’s embarrassing that he put up with my questions. Nevertheless, through his relentless and thorough answers, I finally said “OK.”
Today, Tempo Automation, one of my companies in Haystack Fund #2 announced their Series A led by Lux Capital, where I am close with the partnership. The round was actually done way back in 2015. The news about their announcement reminds me what an unorthodox and lucky story it was in terms of how I got involved with the company.
That turned out to be a good decision on my part. What I didn’t realize at the time was (1) the company sits at a very dynamic point in the ecosystem for manufacturing and (2) Jeff, the CEO, is an absolute machine. As software has invaded the industrial manufacturing process (like 3D printing — which I’ll write more about soon), Tempo Automation’s factory harnesses software to make the business of hardware move faster. Tempo started by automating the most cumbersome piece of the process (logistics) and will expand into other production processes as they grow, driving time and cost savings to hardware developers. This frees engineers designing hardware to focus on what they know best and not have to become logistics experts, as well.
Other investors noticed as well. Tempo ended up going to from “seed to Series A” faster than any other company I’ve been fortunate enough to seed, and I’ve been around some fast ones. Part of that is because investors are starting to recognize the scope of the opportunity in the industrial space, and part of that is because the team’s leadership focus in pursuit of building the company. Now with a team of 25 and growing, it is humbling to look back on all my questions I peppered Jeff with. It is my job to ask questions and listen, but it’s also my job to lean in without perfect information and try to help out. I’m thankful they gave me a few chances to do so.
Disclaimers:This isn’t a doom and gloom speech. There’s tons of opportunity out there. And, this is mainly focused on consumer markets. Also, this post is a little long in the tooth. Please forgive me. I haven’t had time to write with all the little kids running around my house, but I’m devoted to changing that this summer. More soon.
It is fashionable to hold a contrarian position. If everyone believes in X, believing that things will unfold in a different direction than X — if chosen wisely — can be the key to public acclaim, riches, and legacy. Of course, there are many who subscribe to a contrarian script and are wrong — only a very select few end up being right.
In terms of startups and investing in them, it is fashionable to say, even in times of uncertainty or financial restraint, that “great companies can be built at anytime.” It is a contrarian position, in opposition to combinatory external forces — in today’s case, geopolitical risk abroad and at home, financial risk in the form of monetary policy and liquidity crunches, pricing risk as seen in the dislocation between public and private markets for technology stocks.
So, we must ask of the contrarians, are they right today? Is this, indeed, a good time to start a new technology startup? Of course it is. Time doesn’t matter. There will always be new technologies to bring to market, new teams forming that can drive value and change the world. In this narrative, many often cite companies like Airbnb, Uber, Whatsapp, and other companies started around the financial crisis of 2008 as examples that, in fact, it’s possible to start great companies during dire times.
What’s missing from that storied contrarian stump speech, however, is the fact that, at some point early in the lives of these companies — they found a growth vector. They may have spent some money acquiring customers, but they didn’t rely on paid acquisition entirely. Since 2011, when these three companies began to take off and caught the eye of some of the best venture firms in the Valley, the timing coincided with (1) a rush of cheap capital flooding into the technology startup sector and (2) a restructuring of the global economy toward technology and networks.
The result was that, in an effort to chase the growth curves of the companies cited above, investors started investing even earlier in the life of a company, sometimes just in the people themselves. Traditional venture capital firms grew in size and morphed their DNA to go beyond active board management, building batteries of portfolio services in the same vein that a private equity shop would bring with it to a portfolio company. There’s nothing wrong this shift, and many companies and LPs believe it was the right way to get the inside track on an investment (a competitive arms race) and the right way to help manage an investment beyond the limited scale of a single general partner in a fund model.
One issue, however, is that era of larger institutions making multi-millionaire investments before looking at data (including growth curves) is coming to a halt. We thought, back in January and February of 2016, that the time had arrived, but not just quite yet. At seed, companies are still being funded left and right, and even some Series As occur, but most of them are closed on the back of some type of demonstrable growth vector. It’s pretty clear for the past few months that while there’s enough to seed most people who want it, the next round requires bringing some meat to the table. Most don’t have it. They’re just chasing growth. It’s a noble pursuit, but the lifelines to support these experiments has shortened.
Put another way, there’s a slight decrease in the number of experiments being funded (it’s still huge on an absolute basis), and the amount of time allotted to those experiments will shorten. As a result, I believe the following will be ripple effects:
1/ Fewer Seeds: We’re going to have fewer quality seed deals, relative to before. Most investors downstream won’t notice this because they will only see the quality that bubbles up. People those who play in the very early stages already have been living it.
2/ Slower Rounds: As a result, the rounds will take longer to unfold. The only triggers that make a round move ultra-fast are when one of the very few credible leads makes a move and those who syndicate fawn over them, and/or when the founder knows how to play the fundraising game. The rest are much slower.
3/ Extending Runway: As most teams will spend more time fundraising and have read enough about market conditions on blogs like this (sorry), I suspect founders will be more careful about burn rate, especially as it relates to vendor burn, office rent, and most critically, headcount.
4/ Financing Extensions: These are harder to get done. They actually require real relationships with the earlier investors. I’ve participated in a few of these recently, and I’ve let many just go. The ones that work are involving investors and demonstrating progress in an authentic way. These also take a long time to get done because some people get hung up on price.
5/ Point Break: After a startup gets through 1-3 (or 1-4), it’s judgment time. Is there a Series A with a lead investor who joins the Board? Is it time to look for a strategic acquirer? Or is it time to call it a day?
And, this is where things in the future will get much clearer. One could argue it already has. There are still Series As happening, but definitely not as much. Nowhere near levels from 4-5 years ago. More founders are open to the idea of landing the company for acquisition, but even though we read about the good stories in the press, most won’t find soft landings like this. I spent all of the first quarter this year meeting with corp dev departments and M&A teams at all the big consumer and enterprise companies. They have mandates to buy companies, but probably not at the rate you’re thinking of.
To underscore, this is not doom and gloom. This is all very healthy for the ecosystem. I am still investing and excited by new stuff. But about 18 months ago, I started investing in entirely new stuff — I am excited to write more about those companies this summer as I catch up on my writing and on life. I started to invest in more frontier technologies applied to industrial and commercial settings — sensor networks, software for 3D printing machines, commercial drones, and technologies that could play a part in helping people deal with climate change, rare diseases, or even large regulated industries like insurance.
As we slip into summer and investors slow down a bit (yes, despite what they say — they do!), I suspect the fall — like every fall — will be a frenzy fundraising pitches, and that after a summer break, the investors downstream will be looking for simple evidence: Is there demonstrable momentum? Or, is this is a hot team in a big market? Or, is this on the frontier of what could happen in the next decade? If you’re a founder or early investor in a company preparing for Fall 2016, it would be wise to ask these questions and, depending on the answers, to plan accordingly.
The first notification which caught my bleary eyes Monday morning — Microsoft to acquire LinkedIn for $26 billion. Much has been written about why this may make sense for Microsoft.
What’s less clear is: What motivated LinkedIn to take this path? I’ll attempt to answer this at the end.
In my short time in they Valley, most M&A shockwaves include a large incumbent (like Microsoft) buying a small or scaling private startup (like LinkedIn buying Slideshare, or GM buying Cruise, or Google acquiring Nest, or Facebook buying Instagram or Whatsapp). In the time I’ve been here, the size of these and other outlier exits have been huge. Yuge! Unprecedented, even, and all driven by different motivations — incumbents scrambling for talent, quelling threats, or chasing the innovation frontier.
No matter the motive, the flood of liquidity unleashed by these seismic events helps keep the Valley’s startup engine humming, especially in an era when public market offerings are (for whatever reason) less desirable. We have been taught that “going the distance” in entrepreneurship is what the journey is about, to keep going as long as possible, up to the very end — to never give up. In the context of money, however, “going the distance” can often be code for “go public and let’s drive a big exit.” There’s nothing wrong with that, but the mentality changes a bit once a company graduates from startup to scaling giant to public company. Does a startup still need to keep going the distance once it’s public?
LinkedIn was one of the first in its era to go public and pave the way for its brethren Facebook, Twitter, and others to take on Wall Street road shows. Since then, as we all know, the company would, from time to time, report good quarterly earnings, but everyone in the Valley understood the product evolution and experience for LinkedIn not only didn’t improve, it devolved. There was little to no product innovation. There were Facebook-like misses on the transition to mobile, but no Facebook-like turnaround to get things right. As it went public with a bit over 100M members in the LinkedIn network, the company’s room to grow in the developed and developing world was potentially huge. It was the ultimate “data moat” company. We may not have liked the UI, but we all needed an online resume.
So, in steps the new Microsoft. Satya Nadella has proven himself in a few years at CEO to be forward-thinking, to push his company toward the dominant mobile platform (iOS), to snatch up good mobile product startups to help modernize the office suite (Accompli, Sunrise, Wunderlist, etc.), and to creep into the frontier with moves like the $2 billion purchase of Minecraft. With so much cash on hand and a mandate for change, Nadella is playing his own game of chess to help bring Microsoft into the 21st Century, to inject it with new talent, to fortify their position in mobile, and — with this latest move — to build an outpost right in Silicon Vally and get into the professional/work graph.
But, why did LinkedIn go for the sale? Why not continue to go the distance, in Valley parlance?
We may hear press release tidbits like the company is going to operate independently in Mountain View, or that the hooks into Outlook and LinkedIn will be good for users and customers, etc.
I have a slightly different view:
1/ Talent Drain: Outside of a huge acquisition, could LinkedIn have reinvigorated its ranks with new product talent to tackle head on all the product debt accumulated over the years? Talented operators want to work at Uber, Slack, and so on. It’s not clear they had the right horsepower to handle the road ahead — let alone deep linking on mobile.
2/ Product Stasis: As a result, the product became brittle and stale. Attempts to infuse it with a newsfeed or expert content didn’t produce fruit.
3/ Fragmentation of Professional Identity: The next generations of talent, in various industries, are building their reputations in non-traditional ways, through varied experiences, and don’t (yet) feel they need to go to LinkedIn or give it all of their data.
4/ Company Leadership: Much has been written and studied about founder-controlled/led companies versus those run by a professional CEO. In this case, the CEO at the time of acquisition was a professional brought in to lead the company through IPO, and while a founder was still the Chairman, one has to wonder if he weighed the choices of going back to CEO versus selling the company. It likely means the CEO, Chair, and BoD didn’t have the desire to keep going. It’s worth noting this given the cultural history above. Things end and that’s OK.
5/ Private Equity vs Acquisition: As a technical footnote, one also has to wonder if the company considered private equity as an option, though this would be a large transaction and would still result in a loss of control. By going for M&A, all cash, LinkedIn realized they’d stay around a $15-20B public company so engineering this offer would be the best they could get from any route. (Additionally, thanks to Dirk de Kok on Twitter, some outlets reporting LinkedIn had been issuing stock-based compensation at a rate that was too fast given the company’s overall slowing growth. This may have created an extra liability for the company that would’ve depressed the valuation further as accounting rules caught up with them.)
Meaningful exits of any kind in startups are rare. They often get reported when they occur, and there are so many startups and news sites to cover them, so it appears to be more common than they really are. And, while I believe LinkedIn’s move here was to package this up for another exit and stop the current journey, engineering this outcome to be so quiet and all cash was a masterstroke of strategic genius. It’s hard to imagine a $15B LinkedIn scaling again, or capturing the imagination of the next generation or even folks in the Valley.
[Quick Aside:LinkedIn is a very successful company for many constituents and shareholders. Yes, it didn’t realize it’s full potential (yet?), but by all economic measures and odds, it is an outlier. And, despite that, they opted to sell the company and give up the fight as a public entity. This may be a harbinger of sorts for other private tech companies which are valiantly trying to go the distance and become public. As we know already in 2016, it’s set up to be the lowest number of IPOs in any year. For a while, public markets valued LinkedIn almost at $50B, then slashed them to around $15B in Q1 ’16, and the private M&A market valued them at a 47% premium to the public market. If LinkedIn couldn’t draw and keep the leadership and talent needed, what shall we expect from other companies which will never even reach the $10B market cap zone? Will public markets really care about owning stocks in any companies that aren’t FANGAM or licking their chops for forthcoming outliers like Uber, Airbnb, Snapchat, and Slack? Right now, it seems doubtful, and the reality of this dislocation between public prices and private M&A will likely be the last hope for exit for many companies.]
Instead of trying to right the ship on its own, LinkedIn taking $26B cash to give up all control is a great deal for the company, shareholders, and employees. I would go so far as to say it is a fantastic display of stewardship for the company’s shareholders in working this deal to maximize a return and put an end to their current struggle. LinkedIn is lucky because the road ahead would’ve likely been boring or even bumpier than they experienced this past January.
It is also symbolic, in a way, that we mark and acknowledge the reality that the mantra “going the distance” isn’t always supposed to be a never-ending path — there are very, very few companies which can thrive for decades, and even some of the greatest economic outcomes (like LinkedIn) ride off into the sunset. Or, as Neil Young might have sang, “It’s better to cash out — than to fade away.”