Start-ups as a Unique Asset Class
Yesterday I shared my thoughts on ways entrepreneurs can derisk without selling their entire company. A friend reached out after reading the post and we had a conversation about private companies as an asset class to invest in. He isn’t involved in tech or start-ups, so I enjoyed hearing his perspective.
My friend views high-growth private companies (i.e., start-ups) as a truly unique asset class. He thinks a start-up is an amazing investment opportunity when it’s generating profits (not breaking even or losing money). The ability to generate more cash than the company needs to maintain a high growth rate is what makes it an attractive investment. He sees a supply-versus-demand imbalance that these companies can benefit from. Historically low interest rates have investors seeking higher returns. More investors are seeking this type of investment opportunity than there are companies that meet these criteria. As valuations for these companies rise, the return on invested capital goes down, but if the company is growing at a high rate and generating surplus cash, the return is probably far better than the return on holding cash in a bank account—a great investment.
My buddy makes some good points. If you can build a profitable company that’s growing quickly, it’s unique and hard to replicate. The higher the growth rate and the higher the profit margin, the more unusual the opportunity. If the entrepreneur can receive meaningful distributions without affecting the growth rate, the entrepreneur can derisk without selling ownership in the company and while the company quickly appreciates in value. That’s an amazing position to be in as an entrepreneur.
I think my friend makes a strong case for why entrepreneurs should maintain ownership of profitable high-growth companies. Having been an entrepreneur and having close friends who are founders, though, I can definitively say that everyone’s situation is different. Every entrepreneur must decide for himself or herself whether that advice works for their circumstances.
Founders Can Derisk without Selling the Company
A lot of entrepreneurs have a goal of selling their company. It makes sense when you think about it. They often take below-market or no salary for years. During the seven to ten years or so that it takes to scale a company, most of them transition to different life stages (marriage, family, home purchase). These and other factors can put immense pressure on an entrepreneur over a long period of time. The pressure can motivate them to carry on through tough times. It can also be a factor in setting a goal to sell.
When I talk with entrepreneurs, I like to understand the “why” behind their desire to sell in X years. With some digging, I often learn that what they really want is to derisk their financial situation. They decide to sell because it’s the only option they know of to get some liquidity. I define derisking as removing enough financial pressure to be comfortable—not to be in a position where they can do whatever they want without having to work. Maybe their home and their children’s educations are paid for and they have some savings. They’re not flying around in private jets to their multiple homes.
There are lots of options that allow entrepreneurs to derisk without selling the entire company. Secondary share purchases are one tool. Raising a round of capital through investors buying shares from employees or executives is common. Private equity and venture capitalists do these deals regularly. The founders can maintain a controlling majority ownership and continue to execute on their vision for the company. One founder friend likes this route because it “takes the edge off.” I know another founder who took this route so he could “swing for the fences” without worrying about his family. Because he knew that his family was comfortable, he felt good about growing more aggressively and making some bold bets.
If you’re trying to build a large company, know that there are ways to derisk during the journey that don’t require selling your company. Also, be mindful that most investors understand the desire for some security once enough scale is reached. Most will want to work with someone who’s focused on building something big, not ejecting at the first offer to sell the entire company.
$100K Investment from Outlander and Women Who Code Atlanta Supports Female Founders
Outlander Labs and Women Who Code Atlanta held a virtual pitch competition today. It was an opportunity for innovative women-led startups in the Southeast to compete for a $100K investment. Lots of great applicants were whittled down to the following six finalists:
- Boddle Learning – An interactive and adaptive math game that helps kids learn in a fun way
- BRIDGE – A mobile app that allows consumers to discover local businesses via video
- CaseCTRL – A surgery coordination platform that simplifies the logistics of surgery planning and improves the patient experience through AI and predictive analytics
- Eyegage – A mobile app that quickly and accurately determines drug and alcohol levels by using computer vision to analyze characteristics of the eye
- SoleVenture – An all-in-one back office and HR platform for freelancers
- Trado – A platform that uses machine learning to voice-record stories and turn them into books delivered to your door.
I enjoyed hearing from some great founders who I’m sure will go on to do amazing things. I’m looking forward to tracking each of these companies.
I’m happy to announce that Eyegage was the winner! All the companies made outstanding pitches and I’m sure the judges had a tough time picking a winner. Congrats to Eyegage and all the other founders for building interesting companies.
Align Your Needs to Your Investor’s Style
Relationships—with founders, community builders, other investors, LPs—are at the heart of venture capital. Healthy relationships with these people and others are important to a successful fund. Over the last few months, I’ve had the opportunity to connect with more investors.
One thing I’ve noticed is that investors interact with their investments in different ways. Some take formal roles as board members, some act as informal advisors (and therapists), and others are mostly passive. To be clear, I don’t think there is a right or wrong approach—what matters is what works best for that investor. I’ve learned that each investor has reasons for their approach.
Founders need to be aware of this when raising capital. Ideally, you should think about what you want from your investor, beyond capital, and partner with one whose style aligns with what you’re seeking. Write down what you need help with. As you speak with investors, ask how they can help you—and how they’ve helped others—in those areas. The responses can help you identify the right investor for you.
Losing a Deal
This week I had a setback that stung badly. I’ve been working with an entrepreneur on an investment. He’s smart and has built a great product. I was excited about partnering with him to help him reach his full potential. Then, at the last possible moment, the deal fell apart.
The news caught me off guard. I thought about it a bit, and the next day I talked with the founder and wished him well. I offered to maintain our relationship and share my experiences as a founder with him. We discussed some of the things he’s learned and agreed to touch base soon. He even wants to make an introduction to another founder. The conversation ended on a very positive note.
Winning the opportunity to invest was my goal, but it didn’t happen. In business sometimes things don’t work out, and that’s OK. Though I lost this opportunity, I built a good relationship with a strong founder who’ll go on to do interesting things. I’m excited about watching his journey, sharing my experiences when he asks, and helping him if I can.
This was a loss as an investor, but it won’t be my last. I learned a lot. Most important: handle losses the right way and maintain relationships.
Lingo Matters a Lot: Do Your Homework
I was a nontechnical founder who used technology to scale CCAW. I’m often asked how I went about it. Full transparency: I got lucky. I was fortunate enough to be in the right place at the right time to build relationships with talented technical founders. But I also made a point of researching and preparing. I was determined to understand the tech-y world they lived in. It wasn’t fun or easy, and I went through a period of discomfort, but I grew from it. In the beginning, I had a bad case of imposter syndrome. I felt out of place and often had no idea what they were talking about. But as I’ve written before, I took mental notes and made a point of researching and understanding (at a high level) concepts that were new to me. There were some embarrassing moments, but over time I gained a decent understanding of things.
To this day, I’m still learning. When I meet with early technical founders, I use the same approach: I ask questions and research what I don’t understand.
One of the things that used to trip me up was terminology. I simply didn’t know what certain things meant. This can be detrimental to early founders trying to raise capital. Fair or not, investors expect founders to know certain acronyms and other terminology. Here are two good resources for this:
As Roman philosopher Seneca said, luck is what happens when preparation meets opportunity. If you’re an early-stage founder considering raising capital, make some time to prepare by learning the lingo of the investor world. Your efforts could lead to the luckiest break of your life!
Capital is one of the highest hurdles early entrepreneurs encounter. Most people won’t work without compensation and most vendors won’t give away goods or services. It’s easy to see why lack of capital can be a challenge. When I meet with founders at the idea stage, though, I often remind them that capital alone won’t lead to success.
Capital is a tool. It helps you acquire the resources you need to build a vehicle that will carry you (and others) to your destination. The tool and the vehicle are cool, but what counts is the destination. Without it, the tool and vehicle have no purpose.
The most successful entrepreneurs I know all had a vision for their company early on. They saw a problem and envisioned a solution. Where others saw obstacles, they saw opportunity. In my opinion, it was their vision that allowed them to become successful. Sure, the capital they raised along the way (if any) was helpful, but the vision was indispensable.
If you’ve identified a problem you want to solve, consider taking time to develop and expand on your vision. If you’re successful in solving this problem, what does the world look like? Share it with people who can battle-test it and help you make it better. This simple exercise will be valuable and help you convince others (including investors) to join you on your journey.
What I Learned in School Today: Fundraising Timing
Today, Outlander Labs hosted its first Outlandish Speaking Series. It’s our way of giving Southeast founders the opportunity to hear from high-quality speakers they otherwise might not. At today’s event, (click "View Details"), Eric Feng, Facebook’s head of commerce incubation, shared insights about the importance of timing in start-up fundraising. Eric was a Hulu founder and general partner at Kleiner Perkins; he’s seen start-up life from a variety of angles.
Eric’s insights were fantastic. Here are some of my core takeaways:
- Missionaries vs. mercenaries – Missionaries are better entrepreneurs than mercenaries because they’re driven by passion. This video explains it well.
- Runway and risk – Fund-raising adds runway to remove risk and grow value. As you raise later rounds of capital from investors, you should be removing risk with each round. For example, you shouldn’t be raising your series B funding without building a product and understanding whether prospective customers want what you’re building (i.e., whether there’s a product–market fit).
- Seed stage – Early investors (pre-seed and seed) understand that pretty much everything is a risk because they’re investing so early in the company’s life cycle. You may have only two people (not a full team), the product might barely work (implementation risk), and you may not have a clear idea whether people will pay for your product (so you don’t have a product–market fit yet).
- Opportunity window – Understanding whether something is an opportunity or a window of opportunity is important. If a window will close on the opportunity, consider grabbing it as soon as you can. Later may be too late. All opportunities aren’t equal, so don’t wait forever if you see a good one.
Today’s session was great and Eric was an amazing speaker. He has a wealth of knowledge that he readily shared with the audience. I’m looking forward to next month’s Outlandish Speaking Series. If you’re interested in attending or seeing other Outlander events, feel free to check them out here or here.
Is Your Business Idea Capital-Intensive or Capital-Light?
In years of consulting with large corporations, I learned a few things. Purchasing inventory requires a lot of capital, and companies sometimes struggle to unlock that capital. They often resort to selling inventory at a loss just to get their capital back. Warehousing inventory is another financial burden. Leasing space to house inventory and hiring people to manage the warehouse is a big expense.
When I started CCAW, I had all these things in mind. I knew I wanted to help consumers acquire the parts they need, but I didn’t have the capital to accomplish this in the traditional manner. Bootstrapping forced me to get creative. I found ways to leverage the existing warehouse infrastructure and inventory of suppliers and manufacturers. We did it manually at first, but once we figured out the winning formula, we built technology that allowed us to scale it. We were able to do this in a very capital-light way (relative to others in our industry). Most of our capital went to hiring people and building technology.
Entrepreneurs setting out to solve problems should think about the amount of capital required. Will you need trucks, machinery, inventory, or legal help to bring an MVP of your solution to market? What else?
Most businesses will fall into either a capital-light or capital-intensive bucket. Great businesses can be built either way, but knowing early on which bucket you’ll be in is important. The amount of capital required will have a big impact on things like company strategy, your ability to raise capital from investors, and barriers to your entry.
If you’re thinking about entrepreneurship and have a solution in mind, take the time to understand whether it’s capital-intensive or capital-light. This will have a big impact on your decision-making!
Google Supports Black Founders with $5M
Earlier this year, Google’s CEO expressed the company’s commitment to racial equity. One of the initiatives it created was the Google for Startups Black Founders Fund. The fund provides Black founders with a share of $5 million in non-dilutive cash awards (i.e., Google has no ownership interest in the recipient companies). The grants were for $50,000 to $100,000. Each founder will also receive hands-on support from Google to help grow their company. Here are a few Atlanta companies that received awards:
- Clubba – Virtual after-school clubs for kids ages 7 to 13 led by college-student counselors
- Countalytics – Computer vision and machine learning to help clients save money by managing inventory more efficiently
- Kommute – Video messaging platform that helps teams communicate, collaborate, and connect remotely using the power of instantly shareable video
- MantisEdu – Immersive high-tech learning activities for students
- Musicbuk – Virtual education marketplace that gives students access to trusted, vetted, professional musicians for one-on-one music lessons
The full list of companies, with founder contact info, can be found here.
Congratulations to all the founders who received awards. And kudos to Google for this initiative and the impact it will have on the community. I’m excited for these founders. The sky is the limit!