Breakeven: Another Way to Extend Your Runway
Early-stage founders have been asking for advice about their fundraising plans lately. Many are planning to raise this year after avoiding a difficult fundraise environment in the second half of last year. Many of these companies don’t have runway past 2023. They’re looking to raise venture capital to extend their runway.
If last year taught us anything, it’s that the availability of venture capital funding isn’t a given; it’s heavily impacted by macro conditions. Venture capitalists themselves were impacted by macro conditions and had a difficult time raising capital from their limited partners in the second half of last year.
Raising capital isn’t the only way to extend a start-up’s runway. Increasing revenue and reducing expenses are also levers founders can pull to extend runway. Expenses can be cut only so much, but revenue growth is limitless (hypothetically).
In today’s environment, I’m a fan of founders with limited runway taking control of their destiny by trying to get their companies to breakeven. It’s not possible for all founders, but if it is a possibility (even a slim one), it makes sense to work toward it if you have limited runway. It reduces or eliminates cash burn, extending runway. If venture capital is still an objective, it puts the founder in a better position because they don’t “need” the investment to survive. This approach has its downside, too. It could negatively impact growth. That’s not ideal, but a slower growing company is better than a dead company. If a founder achieves breakeven and manages to show growth (even slightly), it’s a good signal to investors and could increase their desire to invest.
If you’re a founder running out of runway, consider the option of moving the company toward breakeven.
New Fund Managers Must Be Good Managers as Well as Good Investors
Two emerging venture capital fund managers shared their biggest learning during a session I attended today. They said there’s a difference between being a fund manager and being an investor. They spend more time than they anticipated managing their fund versus investing. Managing a fund means doing administrative tasks like working with the fund administrator, doing people related tasks, and managing limited partners. They underestimated the amount of energy and time these tasks require. These tasks also take away from the time they can spend finding great founders to back and supporting the founders they’ve already backed.
Starting your own fund is about more than being an investor. It’s more like being a start-up founder—wearing multiple hats and being spread thin. It’s also a decade-long commitment (assuming your fund is a ten-year fund). For those who haven’t worked at a fund before, it’s even harder as they don’t have a baseline for how a well-run fund operates.
Building a successful fund requires that the founding partners be good fund managers and good investors.
A Key Insight from Former Stitch Fix President
I had the chance to listen to Mike Smith, Cofounder and General Partner at Footwork, share his experience as an startup operator and new venture capital fund manager. Mike was one of the first five hires at Stitch Fix and helped that company scale to over $2 billion in annual revenue and have a successful IPO in 2017, when he was President and COO. He and his partner also raised a $175 million debut venture capital fund. And he was part of the team that helped build out Walmart.com. Mike has a wealth of experience and, obviously, has been part of some successful outcomes.
Mike shared a ton of great insights. One that he emphasized as important to his success was this: He’ll take less talent and more team. Mike believes that large outcomes are the result of a team effort. He wants to work with people who are good team members and willing to work hard, rather than genius individual contributors who create difficult team environments.
I enjoyed hearing Mike talk about his experiences and share this insight. I can’t wait to see what he builds at Footwork.
Aggressive Negotiations Can Kill Partnerships
Today I participated in a mock negotiation session that was designed to mirror a negotiation between venture capital investors and founders. Most participants hadn’t negotiated an investment deal before, so I was curious to hear their takeaways.
One of the founders shared something that stuck with me. Their negotiation started off with aggression from the investors, which set a bad tone. And the investors were aggressive with terms throughout the negotiations. Toward the end, the investors realized they were running out of time to get a deal done and offered a better deal. The founder was so frustrated by the experience that she didn’t even realize they had offered better terms and walked out without a deal. She was stuck on the aggressiveness of the entire process and couldn’t bring herself to do a deal with these investors.
Venture investors and founders, when they come to an agreement, are planning to work together for many years. But at deal term negotiations, they have opposing interests. Today’s session was a reminder that starting off with aggressive negotiating tactics isn’t a way to begin a long-term partnership and can blow up the partnership before it even forms. The best deals are ones that everyone is comfortable with, neither side got everything they wanted, and they’re looking forward to working with each other.
1100+ Consecutive Posts
Earlier this month marked three consecutive years of sharing my thoughts publicly. I started posting on March 9, 2020 (my first post) because of a friend’s challenge. Here are my takeaways from my third year of posting:
- Reflection frequency –The more time between reflection periods, the less likely I am to uncover valuable insights because there’s more information. The more information to consider, the less likely I am to make connections between nonobvious pieces of information. Reflecting daily allows me to think more deeply about a shorter time period (less information) and identify nonobvious insights.
- Second-level thinking – Posting daily has enhanced my second-level thinking.
- Conviction – I have more conviction about my non-consensus views that have resulted from this process.
- Clarity of thought – Writing has helped me think more clearly on important topics. I’ve noticed this, and people close to me have commented on it too.
- Public thinking – Public writing leads to better outcomes than writing privately because it forces more clarity of thought.
- Second nature – The habit of posting daily is second nature to me now, which I enjoy.
- Quality – Every post isn’t going to be Pulitzer piece. That’s OK and normal given the daily frequency of this habit. Life is more eventful sometimes, and my posts reflect that.
- Appetite to learn – My appetite to learn has always been high, but it’s increased. I want to consume more information that I can reflect on and write about.
- Compounding knowledge – Consuming new information daily, reflecting on it daily, and writing about it daily is an effective process for building knowledge in a compounding manner.
- Topics – My writing has shifted from my experience as an e-commerce entrepreneur to my future as an investor entrepreneur.
I’m glad I picked up this habit and have stuck with it. It isn’t always easy, but after three years I can see that the positive far outweighs the negative. I want to keep this habit going and can’t wait to see what year four has in store!
Howard Marks is a successful investor who cofounded Oaktree Capital in 1995. As of today, Oaktree has $170 billion in assets under management, over 1,000 employees, and offices worldwide.
During a recent interview at the University of Chicago, Howard shared his interesting thoughts about a trait he believes leads to investing success: second-level thinking. He defines it as thinking deeply, differently than the herd, and better than others. Second-level thinking is about insights, he said.
I believe second-level thinking is a key to outsize success in general, not just in investing. You can’t do what everyone else is doing and achieve outsize success. Second-level thinking means taking in information and forming your own conclusions instead of easily agreeing with others. Part of that process is connecting the dots between seemingly unrelated information to produce insights others haven’t had. Those unique insights lead to conclusions and actions that differ from those of the masses. The result is outsize outcomes.
Second-level thinking is important, as it’s the intellectual process that leads to unique insights.
Weekly Reflection: Week One Hundred Fifty-Five
This is my one-hundred-fifty-fifth weekly reflection. Here are my takeaways from this week:
- Geographic diversity – I’ve been thinking about my takeaways from a chat with a16z Partner Scott Kupor. I believe network distance is the biggest obstacle to achieving geographic diversity for VC investments, but many people may not understand this.
- Patience – I had a great chat with a friend who reminded me of the value of patience. Sometimes the best things take more time than expected to play out.
Week one hundred fifty-five was a busy week. Looking forward to next week!
What’s Your Negotiating Style?
I had a conversation today about negotiations—something everyone will encounter in their life. They can be as complicated as working out deal terms for a large investment in a company or as simple as a child trying to convince their parents they should have a later bedtime. The most common example I heard people talk about today was negotiating salary with an employer.
Books and strategies on negotiating abound. I don’t think there’s a right or wrong approach, only what’s ideal for the personality of the person doing the negotiating. (Note: there are some things everyone should avoid!)
Understanding the person you’re negotiating with is important. Understanding their negotiating style can inform how you negotiate. But it isn’t always easy to understand someone’s style. One of the people I chatted with shared a straightforward approach to quickly understanding someone’s style: at the beginning of the conversation, ask them: “What’s your negotiating style?” In his experience, most people will be caught off guard. Either they’ll tell you how they negotiate, or their response will give you clues about their style. For example, someone will say they’re a straight shooter. Someone else, to keep from showing their hand, won’t give you clear answers. Either way, you’ve learned something about their negotiating style that’s useful.
I like this direct approach and plan to use it when I negotiate with someone for the first time.
Takeaways from Scott Kupor at Andreessen Horowitz
Today I was part of a group that chatted with Scott Kupor, Managing Partner and employee number one at Andreessen Horowitz. a16z, as the firm is known, is a well-known venture capital firm that helped start the trend of having a large operating team of specialized people support the needs of portfolio companies. As Managing Partner, Scott has helped steer the firm from $300 million in assets under management (AUM) to over $30 billion in AUM since 2009.
Scott had a lot of great things to share, but one thing especially stood out to me. He talked about the need for geographic diversity of VC investments. The Bay Area has historically been the center of the industry. This has created a challenging dynamic.
- Founders outside the Bay Area have a hard time getting funding. This means that founders working on problems experienced by broader society but not so much in the Bay Area are less likely to receive the capital needed to solve them. Said differently, some of society’s big problems go unsolved.
- Lots of people fishing in the same pond creates an interesting dynamic for return on venture capital investment. It becomes increasingly competitive as abundant capital chases scarce opportunities to invest in an exceptional founder solving a big problem. As the competition increases, the valuation increases. As the valuation increases, the potential return on the investment is reduced.
I totally agree with these points and all the other great ones that Scott made. He made a strong case for geographic diversity of venture capital investment. Hopefully Scott and the a16z team will spend more time getting to know Atlanta and its start-up ecosystem and learn for themselves why Atlanta is ranked the best place to live in the U.S.
Founder Hack: Treat Sweat Equity and Financial Equity Differently
Some founders seed their companies with their personal capital in the early days. There are a variety of ways to handle this, with a loan from the founder as a shareholder being the one I’ve seen most. When a founder plans to grow their company quickly and raise venture capital, they have another option: they can classify their capital as an investment in the company. The easiest way to do this is through a convertible note or simple agreement for future equity (SAFE).
Why would a founder want to do this? For many reasons. One is that it helps to separate sweat equity from financial equity. If a founder must leave the company for some reason and their equity as a founder doesn’t vest, they still have their financial equity. The founder will own a percentage of the company based on their investment, regardless of what happens with the equity tied to their employment.
There are other benefits too, such as owning—for the financial equity—preferred equity versus common equity.