Things have been quiet on my newsletter since my company was acquired earlier this year. I’ve been working hard to make my content better and more useful and it’s finally ready to go under a new name: Founder in Residence.

This is the last email you’ll receive from raymondluk.co. Check your inbox for my new post from founderinresidence.co.

Nothing else about your subscription changes and all of my historical content is also on the new site.

See you there!

Raymond

VCs should be mavericks chasing mavericks. But there’s also an inescapable need for proof, to LPs, other VCs and themselves.

This post from Jason M. Lemkin from SaaStr is a great example of consensus thinking about what constitutes proof in 2024:

You won’t catch me arguing that mediocre growth is better than fast growth!

But even it it’s true that “literally no VC wants to fund anyone with mediocre growth,” should it be? I bet those growth metrics are true for SaaS investors but what about everyone else?

Even with predictable B2B SaaS companies we know through experience that 200% growth early on does not mean long-term sustainable growth. It might not even mean product-market fit.

So why the focus and certainty that these are the right early predictors of success? Can we really identify true outliers by filtering for who has 200% growth at the early stage?

That doesn’t sound contrarian.

Book me for 1:1 coaching

VC incentives make it harder to be contrarian

Being a truly contrarian investor is hard. 

I already mentioned Ed Suh and you should read his excellent X post pointing out the structural reasons why it’s difficult to make contrarian bets.

Career wise, VCs need to show progress, usually in 2-3 year increments. Junior associates want to get a promotion and senior VCs want to move up to a bigger/better firm or start their own.

VCs start raising their next fund within 3 years1. In the absence of exits, which won’t happen for awhile, it’s natural to gravitate to startups that look like winners (even though you can’t know yet).

Aside from exits, which are virtually impossible to come by that early, markups are the interim markers that supposedly demonstrate positive progress. A company that is re-valued at a higher mark from a new investor can carry a VC's portfolio, driving interim IRR and TVPI. What kinds of companies tend to get higher markups faster? The ones that are perceived to be the "hottest": high profile founders with pedigreed backgrounds, sexy spaces that are in favor.

Ed Suh

If that doesn’t sound contrarian it’s because it’s not. But perception is important in the venture game:

VC is very much an image game before it is a cash distribution game. If you're in high profile companies alongside well known investors, you're perceived to be a good investor yourself (regardless of the entry price/stage or actual returns from those investments).

Here’s my visual summary:

There are very strong structural reasons why it’s easier to choose deals that appear consensus right. Those deals generate early signals that feel good and fuel career growth (and help raise the next fund).

Those other deals? The outliers? Not so much.

Share

Psychosocial barriers

It’s easy to challenge VCs to be non-confirmists but there are psychological and sociological reasons why it’s difficult to stand out.

In Breaking Conformity: The Power of One Lone Voice, Brett Beasley describes the following experiment. A person is given the card on the left and asked which line is matched on the right. It’s C. Easy right?

But in the experiment 75% answered incorrectly. Why? Because there were actors in the room who had been trained to vote for the wrong answer. When the group voted for the wrong answer most people went along with it.

This type of groupthink happens in many areas of business and in life. It happens in VC where there is pressure to show quick progress through signals like early growth and being part of a hot deal.

Left vs Right Brain Investing

All VCs should have a background in philosophy, not finance.

I think Scott Hartley would agree. He’s a VC at Everywhere Ventures and the author of one of my favorite books, The Fuzzy and the Techie.

He does a great job challenging the idea that some startups are obviously awesome (to steal a phrase from April Dunford). That sentiment is driven by left brain logic and an over reliance on early, logical signals:

…Left brain investing by logic often falls into the trap of Zeno’s Paradox. The thing you think should happen just never quite seems perfect. The team isn’t quite strong enough. The traction isn’t quite there. The valuation is just a bit too high to support the easy decision. If only things were a little different you could see it working. If only you were a little earlier you could rationalize the valuation. If you hold onto control too tightly, you will logic your way out of doing the deal. Left brain investing is great for growth-stage investor mindset. One looks at every angle and forecasts every downside explaining why it doesn’t make sense to invest. You're combating price, rather than purely systemic or survivability risk, so there's not just a binary of ways to lose, but a whole quantum of ways to lose, so it takes a lot of care. But if you hold the steering wheel so tightly as a pre-seed investor, if you fail to suspend logic to believe that the crazy can in fact happen, you might end up with a portfolio of safe doubles, but you’re never going to find true outliers. If the world is logical and calculating, you need to be skeptical and open to be different.

Scott Hartley, Everywhere Ventures

I think VCs instinctively know how to suspend logic when they meet a great entrepreneur. But just like it’s easier to say you’re contrarian than to be one, few investors openly talk about the importance of non-standard or unusual signals.

The best companies are contrarian and right, and logic alone would never get you there. Founders move fast, and have a resolution about them that sees past logic, past the need to control outcomes with reason. Similarly the believers in these companies also had the humility and childlike wonder to believe that the logical impossibility was in fact the only way the world was going to go. To them it was as obvious as Achilles beating the tortoise in a race. We all need to observe our own limitations and biases in how we approach problems. We need to ask ourselves, “how do I see the other side of the coin, how do I question my own logical impediments to get to the obvious answer?” Outliers hide in plain sight.

That beautifully sums up how VCs can benefit from a dose of philosophy with their finance.

Confessing to your LPs

It’s one thing for GPs to embrace the discomfort of backing outliers. It’s another to convince LPs. Imagine a VC fundraising desk that crossed out all the spreadsheets and market research and replaced with: Trust Us.

Hummingbird Ventures, who I wrote about in my last post, is the source of another fascinating real-life story about a GP having “the talk” with their investors.

At some point, early in their fund, founder/partner Barend Van Den Brande decided he needed to make a confession to his LPs:

“I said to my own LPs, ‘Listen guys, we’ve got to do a confession’…He proceeded to run through a hypothetical with the collected LPs. Imagine if Hummingbird had invested in all of the good companies it had seen and none of the bad ones, that it had, in effect, a 100% hit rate. How would such a record have been possible? What rationale could have led to that outcome, with the benefit of hindsight? “I told them, ‘Listen, I know this sounds like a bit like of an iffy or a shaky type of exercise. But the only way to do that is to put 80% on the founder. And you know what? I’m taking all of your money here, and for the last two years, we’ve been leaning in a direction which is super uncomfortable.’” Hummingbird could say what the assembled LPs might have wanted it to say, to spout acronyms and facile frameworks (“we are really good at acronyms in the tech industry,” Van den Brande remarked), but that wasn’t the reality of their approach. Hummingbird believed that founders were four-fifths of the equation – that was its confession. “‘We do this with your money, you need to know.’”

Mario Gabriele (The Generalist) in The Best Venture Firm You’ve Never Heard Of

Almost all early stage investors say they invest primarily in founders. But if you take the time to read about Hummingbird you’ll realize that this is not idle talk or platitudes. This was a doubling down on some truly unusual criteria for identifying outlier founders: trauma in their history, neurodiversity and not turning away from founders that looked like automatic passes for other VCs.

This worked out great for Hummingbird’s LPs but would be challenge for most.

The Power Law Challenge

Everyone knows about the power law in venture capital: 80% of the returns come from 20% of the deals. That obviously does not mean that 20% of all investments will be huge winners.

It does mean that being contrarian is essential, not optional. Otherwise even with reasonably good bets you end up with 20% of the return potential, leaving 80% to the contrarians.

I’ve mentioned only three obstacles to being contrarian, but they are important ones:

1. The venture model has built-in incentives that make it harder to make outlier bets

2. Most people are influenced by groupthink and their own biases

3. It’s more difficult to convince LPs to back a contrarian strategy

Funds can generate better returns, and more outliers will get funded, if VCs are more aware of how these obstacles subtly discourage them from being truly contrarian.

Book me for 1:1 coaching

Here’s to the crazy ones.

Be contrarian and be right.

Visionary. Outliers. Mavericks.

If you’re a founder or a VC you identify with those statements, or aspire to them. The startup gene pool is built on this notion of non-comformity. We don’t have jobs, we have missions.

Let’s question those founding myths. Not that I don’t believe in mavericks, by the way. Founders must be outliers to succeed and VC math requires a contrarian view.

But something has always seemed off when I see how early stage startups interact with early stage VCs. There’s so much focus on traction, market size, CAC:LTV and the pedigree of the team. Founders have no choice but to adapt their pitch to suit these questions.

But it all seems more focused on finding consensus, not being contrarian.

In this post I’m going to explore the myth of the “A player”. 

Book me for 1:1 coaching

Pre-Idea Stage Fund

In 2009, I co-founded (with Ben Yoskovitz, Ian Rae and Alistair Croll) an early stage fund called Year One Labs. 

Many VCs say they invest in founders but we doubled down by making a rule: we would invest in founders who didn’t even have an idea for a company yet. No pitch decks, no competition slides. We were pre-idea.

What we did care about was finding ways to get to know the founders at a deep level: their creativity, work ethic, technical and interpersonal skills and their entrepreneurial DNA (no, we did not swab anyone). We found hackathons were the best way to test that and we ran hackathons with Google and others.

Most of our founders were first timers and some of the team members only met through our hackathons.

This thesis worked well enough for that cohort to have generated a 7.5x cash-on-cash return for the fund.

I’m not suggesting our model was the best but it was consistent: when you say you only care about people then logically you shouldn’t screen for idea or pedigree. 

I think too many early stage investors have incorrectly tuned filters. They’re looking for signals of excellence but not signals of being contrarian.

The A player trap

Everyone agrees that to build a successful startup you need “A players.” Every VC is looking for them in the pitch deck. Founders feel they need to raise enough money to attract them. 

But is this crucial to building a successful startup, or even desirable?

First, how do you recognize an A player? Assume that when you ask who is an A player everybody raises their hand.

What signals do you look for?

• Repeat founders or prior startup experience

• Relevant industry experience

• Work experience at large, successful firms like Google, Microsoft

• Impressive academic credentials, especially for engineers

• Social signals like who you know (your network), how we got introduced

What if those were not reliable signals?

In How to be a smart contrarian (Harvard Business Review, 2021), Chengwei Liu points out that outliers are seldom found in traditional ways. In fact, you have to fight against norms that drive you, and everyone else, to keep coming up with the same answers.

He lists four ‘traps’:

Dominant logic

People tend to solve complex problems, like picking which startup to invest in, in correlated ways. Ever read advice on “how to attract VCs”? That represents a consensus view on being investor-friendly. It can be good advice but if you’re a VC and you find a startup that checks all the boxes, you will likely have found a consensus opinion, not a contrarian one. 

Elitism 

Venture capital is highly elitist. Founders are insecure about lacking some aspect of pedigree, whether that means living outside the Bay Area, not having graduated from MIT or YC, or not having a successful VC-backed startup on their LinkedIn profile. Are those advantages self-evident or should we question them?

Stereotyping

What are objective measures of being an A player? One of the world’s most successful VCs, Hummingbird Ventures (more about them later), defines an A player as someone who has trauma in their past. That is not on your typical VC list of positive signals.

Culture

VC still relies on elite networks to filter dealflow. That’s the “how you’re introduced to me is important” rule. It works to ensure only quality founders get through. But what if you’re looking for outsiders, crazy ones? That system filters them out.

Liu is talking about management in a broader sense, but I think it’s a great cheat sheet for checking your filters and assumptions. Founders should ask themselves why it’s important that co-founders have scaled a company at a well-known tech firm. That doesn’t guarantee they can help you find product-market fit. 

VCs should question if being a hot founder, or a hot deal in a hot space is consensus or contrarian. There are definitely top funds that by virtue of their size and reputation can consistently grab all three. But for everyone else it’s not a good strategy.

Here’s a fascinating example.

Hummingbird Ventures

I learned about Hummingbird Ventures in a post on . I wouldn’t be disappointed if you stopped reading this post right now and just read The Best Venture Firm You’ve Never Heard Of. It’s that good. 

Hummingbird is based in Belgium, is not a marquee brand, and has focused on overlooked geographies like Turkey, to great success. But don’t believe me. Look at the returns of their first three funds:

That’s a stunningly strong track record if you’re skeptical of a truly contrarian VC fund thesis.

Here’s the thing. They’ve found success by redefining who they consider “A players.” 

“Van den Brande and his team have driven such returns by ignoring much of the asset class’s conventional wisdom – and forging an extremely opinionated investing framework. Many venture capitalists emphasize the importance of the entrepreneur to their underwriting; none mean it quite as much as Hummingbird. For Van den Brande’s firm, the founder is not merely important; they are the only thing that matters. Forget about flocking to a hot new market or playing nice with Sequoia or Benchmark. If you want to deliver consistently superior returns, Hummingbird believes you need to find the most exceptional entrepreneurs on earth – not merely the top 1%, but the top 0.1%.”

Mario Gabriele

That’s an example of what being contrarian and right looks like as a VC. Here are two unconventional ‘signals’ they look for.

Trauma

Imagine meeting a VC for the first time where all the discussion is about your childhood trauma.

“Hummingbird believes that an experience with trauma is predictive. “All of the best people, in our opinion, have gone through a level of trauma. Where at some point life shows up and it’s not just all Tom and Jerry and cartoons. And it shows its teeth,” Van den Brande said. 

Van den Brande recognizes that this is an uncomfortable position to hold. But it seems quite clearly to be an opinion with considerable merit. For some time, research has suggested a connection between childhood adversity and entrepreneurship.”

Neurodiversity

If you follow the logic of investing in founders, you wouldn’t stop your psychological investigation there.

“The second trait Hummingbird finds predictive is neurodiversity. The fund means that in a clinical sense. In particular, it has observed a connection between exceptional entrepreneurs and some degree of Autism Spectrum Disorder (ASD). That may come with associated traits like bipolar disorder and dyslexia. “Just in the Hummingbird team, we have three people with dyslexia out of ten,” Van den Brande said. He hadn’t known that during the hiring process, only discovering as much after the fact. To the Hummingbird GP, it feels potentially indicative of a certain type of thinking or cognitive orientation. 

Again, there is compelling evidence for Hummingbird’s observation. Research studies have demonstrated a connection between mental health issues and starting a business, another topic explored in The Generalist’s piece on entrepreneurship. The study we discussed found links with bipolar disorder, ADHD, and OCD.”

The more I read about Hummingbird’s story the more I questioned why their approach seemed so strange. Shouldn’t their abnormal be more normal?

Bad Pedigree

All of Hummingbird’s successful bets were on founders from non-traditional backgrounds, i.e. their pedigree sucked. 

Take, Sidar Sahin, founder of Peak Games. This is what a first impression of him would have been:

“Before continuing, pretend for a moment that you are in the Hummingbird investor’s shoes. You meet an entrepreneur who has had both successes and failures. He is now building a new company, Peak Games, that seeks to capitalize on the “social gaming” market, a category that piggybacks off social media platforms like Facebook. It is competitive, with Zynga already three years old. He has a big, lofty vision. You find him slightly awkward. 

You ask some questions. You learn about his past. About his wins and losses. You talk to references – they are unspectacular. You learn he has raised no money, and knowing the immaturity of the Turkish venture market, you can be confident that no capital will rush in.”

If you’re an early stage VC this is an automatic pass, not a $500k check that Hummingbird wrote in 2010, which (plus a bridge round) turned into a $276 million (54.4x) return.

Lean in to the outsiders

Not all outliers are good founders. Not all contrarian views are good investments. You still have to be right.

But purely from a returns perspective I don’t see how you can be “contrarian and right” without poking holes in the myth of the A player. 

This might insulate founders from feeling insecure and not pushing ahead because they don’t have all the cool qualities they think VCs are looking for.

It might allow startup ecosystems to start valuing being off the beaten path.

It would cause seed-stage funders to question their shorthands and filters which rarely get questioned in the rush to be “in the know”.

Those quality filters are doing the exact opposite of what they’re supposed to. They’re filtering for consensus picks when they should be filtering for contrarians. 

Book me for 1:1 coaching

It’s only been a week since I wrote about Sam Altman being fired and hypothetical reasons why the board could have been justified. Altman is back and some board members have been replaced. But as I said before, this is just the opening move in an inevitable governance shakeup. Because no matter how much power the CEO has the governance structure remains a charity controlling a for profit company.

It’s clear from all the heated commentary about OpenAI that governance is an under-explored topic in startups.

I’ve created four case studies each highlighting a hypothetical board room scenario.

Cast your vote then read the discussion points.

Book me for 1:1 coaching

Case Study One: Early Exit

You are a VC sitting on the board of StartupX. The company has done so-so but still has potential. They need to raise more capital if they want to survive and grow. You are at the end of your fund’s lifecycle and are not raising a new fund. Your LPs are pressuring you to find liquidity.

An industry partner makes a good offer to buy the company for cash. The founders want to raise money and keep going.

Discussion

Voting No and agreeing with the founders means voting against your interests. You can’t invest in the next round since you aren’t raising a fund. You are turning down guaranteed liquidity for your LPs for an uncertain future.

From the founders’ perspective you are an ideal board member. But how will your vote be judged if the company eventually goes under? Were you truly doing your duty to build shareholder value for all shareholders, not just the founders?

Voting Yes puts you at odds with the founders and other investors who want to reinvest (and are able to).

Selling now may actually be the more reasonable option for StartupX. But how do you balance your fiduciary responsibility to the startup with your fiduciary responsibility to your fund and its LPs?

Case Study Two: A Conscientious Objector?

You are a renowned climatologist asked to join the board of OpenVolt, an energy startup. The CEO wanted to ensure there was an independent voice to represent society’s concerns about climate change. As a condition to joining you were granted a special right: at any time you could trigger an external review of a decision you felt would caused significant harm to the planet.

OpenVolt has become a worldwide leader. A new discovery promises to accelerate its growth even more. However, a senior engineer reaches out to you with a concern that this new technology has negative climate impacts that are not being considered. You raise the issue with the CEO but they dismiss it.

Discussion

This is your chance to play OpenAI board member.

I made it easier to vote Yes by not making it a vote to fire the CEO. But there would still be consequences. An external review would halt progress just when the company was taking off. It would destroy your relationship with the CEO. And if the review was negative you would be the director who cried wolf. How could you stay on the board?

Voting your conscience, and doing your fiduciary duty as a director, is not an easy choice.

Voting No is the easier choice. It’s one engineer’s word against the CEO’s. You were brought in to be independent but you still have a duty to protect the interests of all stakeholders, including shareholders and the CEO.

But even if the risk ended up being untrue, it begs the question: under what circumstances would you trigger the review? What would be your red line and how important would it be that others agreed with you?

Case Study Three: Rich or King?

You are the founder/CEO of a Raymond’s List, a marketplace startup. You’ve raised some money but you and your co-founder still have 2 of 3 board seats.

With new funding the board will grow to 5 and you have the right to appoint 3.

If you appoint an ally, i.e. someone you trust and can control, you protect against votes going against you, including being fired. You could instead select an industry expert who would add a ton of value, but they might not vote the way you want.

Discussion

If you’re a founder, how you voted probably says a lot about your preferences for being Rich vs being King/Queen. The data is fairly clear: giving up control results in a higher payoff for the founder.

But seeing Sam Altman get fired taps into that part of the founder brain that has nightmares about being fired from the company they founded. Most founders I know would vote for the “ally” and retain control. They would probably point to founders like Mark Zuckerberg who have retained control.

This is an interesting dilemma. When you’re forced to accept a board member from an investor it’s easier to see the glass as half full: that person could add value, be a mentor and push you to be your best.

But would you make the decision to lose control of the board voluntarily?

Case Study Four: The Insider

The founder of Raymond’s List (Case Study 3) asks you to be an independent director. You’re excited because you are looking for more board experience and his startup is hot, with name-brand VCs.

At the first board meeting the CEO announces incredible results. This is taking off like a rocketship.

To keep the velocity high he proposes outsourcing a significant amount of work to another company, Olameda Research, that he wholly owns. This will allow the company to achieve the highest velocity growth. Since the CEO controls the company there is less risk of overpaying or fighting with a vendor.

But he needs to do the deal now and wants a quick vote to approve.

Discussion

To armchair board members, voting No seems obvious. And yet a large number of boards do just that and agree with side deals that clearly benefit one party. We find out about it when things collapse, like they did with FTX.

Why do they do that? In this example it could be that in the heat of the moment there would be incredible pressure to solve for the issue at hand (growth opportunities) over potential future issues (conflicts of interest).

There are definitely valid reasons for voting Yes. For example, the CEO could agree to accept market rates, or recuse himself from the negotiations. Dealing at non-arm’s length may not necessarily be a conflict if it is transparent.

That leads to a reasonable third option: slow down and insist on due process. But this too has problems. As a board member voting not to approve an easy solution you will feel pressure to deliver your own solution. Isn’t a board member’s job to build shareholder value? Decelerating growth does not seem to do that.

Conclusion

Many people reduce board governance to a simple statement like “to create shareholder value.” But that is an over-simplification. It’s not always obvious how to do that, especially for startups.

I’m very interested to see how people vote. If you feel you need to add explanations, leave a comment. No matter how you voted it should be evident that not all decisions are obviously right or obviously wrong.

Book me for 1:1 coaching

People in tech have universally condemned Sam Altman’s firing.

The reaction by VCs and the business community has been apoplectic. He’s a superstar who built the world’s most important startup. What was the board thinking?

The majority of OpenAI employees have threatened to resign unless Altman is reinstated:

Founders have spoken up: boards are bad and you’d better watch out or they’ll come for you too!

Everyone is blaming the board. To most, it’s obvious they messed up. They’re “inexperienced” and “not qualified.”

I have a more provocative question.

Under what circumstances would the board be 100% right?

Book me for 1:1 coaching

An intentional governance structure

In case you didn’t know, this is OpenAI’s structure:

It’s not a typical structure and may not even be the best structure for OpenAI. But it was intentionally structured this way.

The company that makes ChatGPT, OpenAI Global LLC, does not have its own board of directors. Directors sit on the board of OpenAI Inc., the public charity. No investors, not even Microsoft, have a board seat.

The board is also majority independent. That’s not an accident. I guarantee you that your board is not majority independent.

If you follow the lines marked “control” in the org chart you’ll see that this entire structure was designed to fulfill the parent company’s mission around AI. Even profit, the ultimate long-term driver of a startup’s equity, is capped.

Independence by design

So we have a structure designed to allow a majority independent board to act independently of the profit entity.

That says one thing: we value that independence as a failsafe, i.e. against artificial general intelligence being a threat to humanity.

This grinds against the “go fast, break things” mantra of tech leaders.

But not all tech leaders.

In March 2023 many signed an open letter calling for a 6-month pause on AI development (which did not happen). One of those signatories was Elon Musk, co-founder of OpenAI.

A hypothetical defence of the OpenAI board

Only a handful of people know why Sam Altman was fired. But rather than speculate, let’s examine how they’re being criticized.

You can’t fire a CEO who has delivered such incredible results.

The OpenAI charter does not mention profit or shareholder value. It says “our primary fiduciary duty is to humanity.” The success of OpenAI as a company is not the main measure of the CEO’s performance.

If all the employees quit that proves the board made a mistake.

It will definitely be hard for OpenAI to achieve its mission without people. But if the board felt the CEO was acting against the charter, their duty would be to ignore the risk of a mass exodus of staff.

They didn’t consult investors like Microsoft who had invested billions.

A heads up would have been nice but the org chart is clear. No investor has a board seat or a vote on governance matters like firing the CEO. It will be difficult for investors to sue the board when the charter explicitly makes profit and shareholder value subservient to the mission.

They are slowing down the progress of AI development just when it is taking off.

This is true. But the mission is “to ensure that artificial general intelligence (AGI)—by which we mean highly autonomous systems that outperform humans at most economically valuable work—benefits all of humanity.” There’s no mention of speed being a benefit and many will believe the exact opposite.

I think it’s more than possible the board did not go rogue or act out of sheer stupidity. Instead, they felt a line was crossed that caused them to go with the nuclear option of firing the CEO.

Stakeholders vs governance

What’s happening with OpenAI is a conflict between an historically-successful company and its original social mission. The loudest voices right now are those that can’t believe such a successful startup is being gutted by bad decisions.

But corporate governance is not just about the majority exercising their control (though the tech industry has a strong libertarian impulse that is just that).

OpenAI may have an unusual structure but it’s not unique in serving multiple stakeholders. All companies do that when they balance shareholder value with the needs of employees, customers, the environment, and society.

Here’s an interesting thought from Gavin Baker:

Whatever has happened between the board and Sam Altman is just a prelude to a much bigger fight over OpenAI’s mission and governance.

Book me for 1:1 coaching

When investors have to chase deals they call the market ‘frothy’.

When the situation reverses, founders call VC terms ‘punitive’.

It’s a tough fundraising environment right now in 2023 but it’s inaccurate to say it’s “investor friendly.” The higher risk in the market affects both investors and founders.

That can lead to confusion on the part of founders as they face falling valuations, down rounds and bridge rounds, changing deal terms and different exit possibilities.

No one wants to think about what could go wrong in their startup. But it’s essential to understand how in order to navigate the path forward.

Book me for 1:1 coaching

Down Rounds

A down round is a fundraising event where the (pre-money) valuation is below the previous round’s (post-money) valuation. A flat round, where the valuation stays the same, is essentially a down round due to the time value of money.

Almost 20% of funding rounds in 2023 have been down rounds according to Carta. This is not good news for startups but it should help de-stigmatize down rounds for founders: you’re not the only one!

The fact that the market wants to re-price your shares should not be a surprising phenomenon. Things happen in the market environment that are out of your control (these days, take your pick.).

Also, the other side of your “change the world” disruptive story is the inherent risk that entails. Innovation is unpredictable, which creates both the opportunity and the need to constantly re-adjust. 

Take Loom’s recent exit to Atlassian for $975M in cash. 

That was a down round.

The Series C was raised at a $1.5B valuation but the final sale was done 35% less than that. 

Founders and employees still netted $400M so no one thinks of this exit as anything but an amazing success

A16z’s 1x liquidation preference saved them from losing money on their investment. They still lost in the sense that their returned capital did not earn anything during that time. But it doesn’t seem unfair because the company raised on a $1.5B valuation only to sell 35% less in a short time. 

So not all down rounds are bad, and not all investor-friendly terms are unfair.

Bridge Rounds

A bridge round is when a startup needs more money to reach its next milestone but isn’t ready, or able, to raise a completely new round.

There are many legitimate reasons why companies need to bridge, external and internal. Or you could just be executing really poorly. Believe me, investors will spend time trying to determine which case applies to you.

Like down rounds, bridge rounds have grown significantly, up to 38% of all rounds in Q2 2023.

This obviously reflects the longer time periods between rounds due to the higher bar required to raise the next round. More time equals the need for more money.

For early stage startups who already have raised Safes, beware the dilution of stacked post-money Safes. As I explained in my post on cap tables, each post-money Safe has built-in anti-dilution. The more you raise the more shares that investor is entitled to so they maintain whatever % ownership was promised in the post-money cap.

When you think about it, every company is a bridge to some future milestone. So reducing burn and gunning for profitability is also a good way to bridge.

Deal Terms

The pendulum has swung back to VCs and tougher deal terms are back.

Scott Hartley from Everywhere Ventures wrote about it recently in Crouching Tiger, Hidden Terms. Pitchbook also covered some of the “cap table chaos” out there in Investor-friendly terms rankle startups’ early backers.

Here are some of those terms broken out into whether they focus on more control, or protecting downside or upside.

Control

• More categories of vetos

• Lower spending thresholds before requiring board approval

• More board seats

Downside protection

• 1x liquidation preferences (very few deals without this)

• Anti-dilution (including capped, post-money Safes)

• Higher interest rate on convertible notes

• Cumulative dividends

Upside protection

• Lower valuations

• Multiple liquidation preferences (2x, 3x)

• Pay to play

Note that these are not only investor friendly but new investor friendly. They can require concessions not only from founders but from previous investors especially if they don’t re-invest or have anti-dilution protection.

Early Exits, Slower Growth

I wouldn’t necessarily say that selling early or growing more slowly is ‘wrong’. But they are definitely bad outcomes from the perspective of the VC who foregoes a return that will move the needle for their fund.

An openness to selling earlier for a lower valuation may be the optimal outcome for many startups in this environment. Well, unless the value is so low an investor with a liquidation preference gets all of the proceeds.

In a tough market, any exit is better than none. The product, IP and people live to fight another day.

Of course another option is to get off the venture path altogether, grow more slowly but hit profitability faster. This is not an easy change to make because your cap table probably has funds who need to get their money out vs an exit, not a stream of dividends.

But startups who are able to reduce burn and focus on profitability have both options: never to have to raise (but setup a tough negotiation with existing investors) or go back to the market later in a much stronger position (minus the hyper growth).

The Bottom Line

In an uncertain market there are a few things founders can do to chart the best course.

Think about your payout

Very few founders ever think about the potential payout of their ownership in their startup. It’s so far in the future and you aren’t building a company just to make money right?

But using a simple (well, fairly simple) tool like a decision tree to map out the future can be incredibly useful. No, it does not help you predict the future.

But it does something more useful: it creates a mindset where you accept that there are multiple paths and possibilities, each with their own probabilities of success or failure.

Thinking about what could go wrong allows you to better understand that although you should always negotiate for the best deal, both you and your investors need to build in mechanism and protections for when thing happen unpredictably.

Do you want to be Rich or a King?

One of the most uncomfortable conclusions from The Founder’s Dilemmas (Wasserman) is this: founders who had the most control had the least financial return. I haven’t seen an update on this, which was published in 2006, but I can see no reason why it would have changed.

This doesn’t mean you should find every reason to give up control, i.e. do not try this:

VC: I want 3 out of 5 board seats

You: Hell, you can take all 5!

VC: 🙄

You need to question your assumption that each piece of control you give up somehow hurts your ability to get what you want. The data says otherwise. That means you should try for the best terms but maybe not die on that hill.

Stop worrying about style points

In startups there is always this undercurrent that there’s a “right” way to do it. The right pace, the right amount of funding at the right time, and with the right investors of course.

Tougher times, like the one we’re in now, force those assumptions into the light where they can be debunked.

Whether you’re having difficulty raising money or contemplating a down round, keep your focus on building your company, not fitting into some fictional mold.

I recently came across Braid, a fintech startup that closed in September 2023. The founder, Amanda Peyton, wrote a courageous and thoughtful debrief which I highly recommend founders read. By the way, I think she is overly harsh on herself. So many things that look like mistakes are only that in the perfect light of hindsight.

Amanda talks about getting the timing wrong by waiting too long to raise money, then not being able to when she felt the time was right:

The game of company building, especially startups, is unpredictable. It’s not only impossible to be predictable but it’s not even the desired goal. We would have so much less innovation if we merely achieved what we set out to do.

Things going wrong are not negative signals for some future VC. They are part of being a founder and part of the whole concept of ownership.

I can’t second guess Amanda’s decision to delay fundraising. But when she says “Every dollar a startup can raise is a gift. For a time I lost sight of this” I think what’s she’s saying is she briefly lost sight of what could go wrong.

It’s never the part that founders like talking about but it’s built into the game we’re playing.

Book me for 1:1 coaching

Spreadsheets are good for calculating cap tables, but not good for explaining how the basic mechanics work. The result is that too many founders, and some investors, find cap tables confusing.

This video tutorial uses a visual approach to constructing (and deconstructing) cap tables. Along the way I cover these topics:

• founder splits and reverse vesting

• concept of dilution

• how (and when) Safes convert

• the difference between creating the ESOP before and after VCs invest

• preferred shares

• liquidation preferences

• exit waterfalls

Book me for 1:1 coaching

One of the core beliefs in startups is the value of stock options for incentivizing employees and sharing in the upside.

Options are how startups say “we’re all in this together.”

Carta recently released its State of startup compensation, H1 2023 with data from 40,000 startups.

Founders should read this report (and the equity Addendum). It’s a data-driven way to check some of the conventions and rules of thumb around the ESOP.

Book me for 1:1 coaching

Size of the ESOP

At the Seed or Series A the ESOP, post-investment, is typically 10-15% of equity, fully diluted.

Two early stage VCs I spoke to both said they target an ESOP of 10%:

“Assuming a normal cap table, we push for 10% post investment. 

The reason is that we want them to have a robust ‘budget’ of options including buffer to give out to future execs and team members or to top up the founders.

The reason for buffer is to have a margin of error/flexibility but also because we are not diluted by the initial ESOP top up vs. future top ups.”

Isaac Souweine, Partner at Pender Ventures

“Generally speaking we like to see a top up of the ESOP to about 10% post funding. The amount is based on what the board and management think is needed to incentivize the existing and new employees to hit the next meaningful milestones.”

David Nault, Co-Founder and General Partner at Luge Capital

According to Carta, the median early stage ESOP is 12.9%.

I do not have access to the underlying data but this might be saying that founders assume the ESOP should be higher, eg 15%, while VCs expect 10%. If this is the case founders should stop doing that because, as Isaac pointed out, the initial ESOP dilutes founders only.

Keep in mind we are talking about the total size of the pool whether those options have been allocated/exercised or not.

Equity for early employees

Speaking of actual option allocations, the median equity granted the first 10 employees totalled 4%. Even accounting for ‘buffer’ this seems low.

The rule of thumb I’ve heard is “10% for the first 10 employees.” These data say founders are not following that convention.

It’s true that equity grants have fallen by 26% in the first half of 2023 (fewer hires, more negotiating power for companies).

But I think founders are creating too much buffer with a larger ESOP pool paired with lower grants.

That doesn’t make sense when you consider the next section.

Expired options

By the end of August 2023 only 28% of vested options were exercised before they expired. The downward trend reflects overall sentiment about startups over the last 2 years. But even looking at the five years of data provided, the majority of vested options are never exercised.

This is important for founders to think about:

1. The initial ESOP is too big

2. Early employees are not being given enough equity

3. The majority do not exercise their options

Again, this is way too much buffer and it means startups are not fully utilizing an important incentive when they need it the most.

Why is this happening?

The easy answer? Employees in startups do not value ownership as much as founders would like to think. They do not want options to be used to reduce their base salary. They see their equity as more of a lottery ticket based on chance and not something they can control.

Challenge for founders: run an anonymous survey of your employees and ask how much they value the equity you’ve given them.

The harder answer is this: there’s a gap in perception about the value of options and founders themselves are contributing to it.

First, the data says founders are keeping too big a buffer of unused options. That benefits them since in an exit unvested and unexercised options are discarded. But that’s short-sighted because the value of equity should be the growth it drives by incentivizing the team.

The dilution of the ESOP is over stated considering how few options are ever exercised. So founders should spend it. Hoarding is only one way to say those options are valuable. Another is to spend it on your best people.

The other thing founders can do better is to educate their team about how the cap table works so they understand how options grow and become valuable. Don’t assume early employees understand how startups work.

I know some founders admit to not fully understanding cap tables themselves. I’m trying to help with that.

It should be part of employee onboarding to spend time learning about how cap tables work, why it’s valuable to them and, most importantly, how their contributions are meaningful.

Book me for 1:1 coaching

Previous posts in this series:

I wonder if future historians will look back at Safes and say they were a temporary invention. They were introduced at the end of 2013 when interest rates were effectively zero. By 2018, interest rates were climbing and (coincidentally?) a less founder-friendly version was introduced: the post-money Safe.

Chris Arsenault, co-founder and partner at iNovia Capital, shared this story about an unconverted Safe:

I’m assuming Chris was talking about an uncapped Safe by the way.

How many people consider what happens if convertibles, well, don’t convert?

Book me for 1:1 coaching

Comparing 4 exit scenarios

I’m going to compare Safes and convertible notes to preferred shares if no further capital is raised.

Imagine a startup that raises $1M, either as a Safe, convertible note or preferred shares. That company never raises again.

I’ve mapped out 4 exit scenarios:

1. Bankruptcy, where assets are liquidated

2. A minimal return of $1M, where not everyone is made whole

3. A good return of $10M

4. A great return of $100M

Safes

A Safe is treated no better than shareholders in a bankruptcy. It will be a write-off. When there is $1M to return, only V2 (post-money) Safes will get their money back. V1 did not have a liquidation preference.

In either of the good exits an uncapped Safe will just get their money back and a pat on the back. A capped Safe will convert into shares. In our example, $1M / $5M = 20% of the proceeds.

In other words, a cap is equivalent to an investor setting a valuation. People should stop saying Safes defer the valuation discussion.

Convertible Notes

A convertible note is ever so slightly better in a bankruptcy in case there is money leftover after creditors are paid. It’s unlikely, but non-zero. Where there is $1M to distribute convertible notes rank ahead of SAFEs and other shareholders. Plus they are entitled to interest. Again, slightly better than SAFEs.

Notes are about the same as SAFEs in positive exits considering the interest is relatively small.

But convertible notes mature, i.e. they have to be repaid. So they are much better than SAFEs in one way: they force a conversation between investors and founders about what the liquidity plan is for the company. Founders might not like that pressure but a maturity date doesn’t stop investors from being reasonable, even converting into shareholders.

Preferred Shares

Preferred shareholders get nothing in a bankruptcy. They almost always have a 1x liquidation preference so they would be made whole if there was only $1M to distribute. With the bigger exits they would earn the same as either SAFEs or convertible notes.

But being a preferred shareholder has many advantages that are well suited to professional investors like VCs.

Having a board seat and information rights gives investors more insight into this company to evaluate risk and opportunity. Protective provisions like vetos and approvals on large expenditures add additional downside controls. VCs would argue these help the company become successful.

Remember in my example neither side knew the company wasn’t going to raise more capital. That means having pro rata rights to invest would be very valuable. Those exist for Safes only if you use the special side letter. Convertible notes, eg TechStars, have them but others may not.

Summary

Taking into account the different exit scenarios and the possibility a company will never raise more money, I’ve created a table comparing the pros and cons of each type of investment:

Three insights:

1. If the trend continues, and interest rates stay high, Safes could continue to become more like convertible notes. When do downside protections matter the least? When capital is cheap. But capital is expensive now. Who wouldn’t want to be a creditor when things are bad, and shareholder when things are good?

2. If convertible notes were standardized they would be the ideal early stage investment vehicle. Founders shouldn’t care about giving downside protection and this adds useful incentive to bridge rounds. The upside is exactly the same as Safes.

3. I’m not sure why any seed fund would use a Safe instead of preferred shares. You are setting a valuation via the cap and the extra controls and shareholder rights are useful. Why not say “I’m all in” instead of “Let’s hope you find other investors.”

Book me for 1:1 coaching

Previous posts in this series:

I hate using spreadsheets to teach cap tables

Most people just tune out. Excel templates are good for learning low-level details but not good for helping founders understand the overall mechanics.

So I created a new way to explain all the elements of a cap table using Jenga blocks.

Book me for 1:1 coaching

Instead of thinking of % ownership, you should think about the number of shares you own. When you sell the company each ‘block’ gets a share of the assets. So every block added means everyone owns a little less, i.e. you dilute.

Options convert to shares later. You can reserve space on your cap table (fully diluted) or remove options not yet exercised.

Most cap tables have a base of founder (common) shares. But those could be reverse vested, i.e. they are released over time or based on milestones.

This is more fair if a co-founder leaves or can’t contribute what you agreed to. They don’t lose shares they earned.

Safes, and convertible notes, are like options: they’re not shares yet. But be careful about thinking “you’ll deal with them later”.

Especially with post-money Safes (the most popular), it’s easy to estimate what they convert into, and easy to underestimate how much you’re giving up.

This is especially important if you find yourself adding more and more Safes (stacking). One thing people do not realize is that post-money Safes have built-in anti-dilution. Even if you raise multiple rounds of Safes, everyone’s % is locked in. has a good explanation here.

There are pros/cons of using pre- or post-money Safes. But in some instances they can work out to exactly the same ownership.

Finally, this is what a seed-stage cap table could look like.

On an (early) exit, the preferred stack (including Safes that converted into pref shares) would get paid first.

That’s assuming there was a liquidation preference and the sale price was low enough that not everyone could get paid their share.

There is more that could be done with this analog approach: multiple classes of shares with different terms, secondaries, downrounds and exit modelling. Lots of wooden blocks.

But this covers the most common types of shares on the cap table and the core mechanics. No math!

Book me for 1:1 coaching

Further reading:

• YC’s Primer for post-money Safes

• Pre- vs post-money Safes explained (Capboard)

Previous posts in the series:

Last time I talked about Understanding Angel Investors.

Continuing our walk up the cap table, I’m going to talk about Safes and convertible notes since they’re the most common mechanisms used by early stage companies to raise money.

Many founders do not understand why one type is better than another, or what problems they were designed to solve.

Book me for 1:1 coaching

A quick primer on convertibles

A lot has been written about Safes and convertible notes already. I am only going to focus on what I think is relevant for founders.

Safe - Simple Agreement for Future Equity

Safes are an agreement created by YC that allows investors to invest now and convert into shares later. It has basic protections for investors, but not as many as convertible notes or buying shares.

Safes is purpose built for early stage startups who expect to raise VC in the future.

They’re also standardized and this is their best feature. Eliminating weird/clever deal terms is good for both sides but also for future investors. When they see the word Safe they know exactly what they are dealing with.

Safes are founder-friendly because they get the upside of cash now without the overhead of shareholders, until later.

It’s possible for a Safe never to convert. Safes only convert when money is raised via issuing shares or there is a liquidation event. But there is no time limit or guarantee that it will happen.

In 2017, the SEC felt it needed to issue warning to investors:

No, Safes are not un-safe. But founders should be aware that there are some things investors are giving up.

Convertible Debt

Convertible debt (or convertible notes) have been around much longer. They are used frequently in Angel investing and is favored in some industries. The best overview is still what’s in Venture Deals (chapter 8).

Like a Safe, a convertible note is an agreement to invest now and get shares later. All other things being equal, if a company raises their next round as planned a convertible note and a Safe can work exactly the same in terms of resulting ownership.

However, convertible notes are better for investors: there is a set timeline to convert, interest due and a repayment schedule.

Until they convert, investors are creditors which gives them superior claims on the company’s assets. They have a path to liquidity through interest and repayment that Safe holders do not. Having a maturity date gives them negotiating power with the company down the line.

One big disadvantage of convertible notes is the lack of standardized agreements. There are probably good legal reasons for that. But it means longer, more expensive agreements and the possibility of non-standard terms.

Side by side comparison

Founders and investors can get quite definitive when it comes to the best way to raise money. But it’s not black and white. Founders and investors have different perspectives and not every company is on the same path.

I put together a comparison of the pros/cons of priced equity, Safes and convertible notes for three different scenarios:

VC Optional

Some companies have a faster path to profit or they aren’t dead set on VC. VCs may look down on this type of company but it’s one with high optionality for the founders.

Priced equity is a good choice if founders and investors are aligned about the plan. The legal bill can be high so this makes less sense for small rounds.

An investor’s perspective on Safe might be: “why would I invest in a Safe if you’re not sure you’ll raise more money?”

A convertible note would work well in this scenario. If there is a VC round the conversion works like a Safe. But if there’s not, investors can earn interest and be repaid. No harm, no foul. If convertible notes were more standardized this would be a no-brainer.

VC Mandatory

A priced round is a good choice unless founders and investors cannot agree on valuation. This “valuation gap” may be more perceived than real though. Many founders are not aware of how narrow the range is for valuations at the early stage, even taking into account industry.

Safes were invented for VC-track startups so they make the most sense here. However, for down markets, like the current one, delayed or cancelled rounds can cause problems. You might have to raise additional Safes to avoid triggering a conversion event at a valuation you can’t live with.

Cost and complexity are the biggest downsides of using convertible notes in this scenario. If the round is larger or the investors are more sophisticated, there’s no reason not to do it.

Bridge Rounds

Raising money in between rounds is always tricky.

You can’t get a high valuation, otherwise you wouldn’t need to bridge. But a lower valuation risks dragging down the next round especially if you plan on raising soon. Many times founders just re-open the last round. More dilution but it doesn’t reset the clock.

Safes can be used to bridge if all previous funding was done via Safes. That’s called stacking Safes as mentioned before. But if the last round was equity it’s harder. Why would new investors agree to get future equity when there are already investors who got real equity?

Bridge rounds may be the area where convertible debt really shines.

Investors are already feeling jittery as they think about why this company needs a bridge vs a real round. The downside protections in a convertible note, interest and repayment, are added incentives to invest in this type of round.

This adds a much-needed sweetener to a bridge round and more founders should consider this tactic when bridging.

Summary

Founders should think of Safes, convertible notes and priced equity as valid options.

Speed and low cost are hallmarks of Safes. But they are really geared towards investors who are comfortable with “VC or bust.” Many fall into this category, but not all.

Convertible notes are good for investors who value more downside protection. Actually, it’s difficult to understand why an investor wouldn’t want that.

The most important thing to keep in mind is that investing via convertibles means a delay in being a shareholder. Often that serves founders well at the early stage. But the longer and more uncertain this “in between” stage is, the more problematic.

Book me for 1:1 coaching

What happens to the founder/shareholder dynamic when you add outside investors for the first time? 

In the last post, “What does it mean to be a shareholder?”, I explored ownership from the perspective of three founders who had just issued founder stock in their startup. 

Now they want to raise money so they have to consider another side to the table: Angels. 

Book me for 1:1 coaching

Friends and Family

Friends and family who invest are motivated more by supporting your dreams than making money. But you should always ask about their expectations especially if they have never made an Angel investment. Say the words “are you ok to lose this money?” Never assume the answer is yes.

What type of ownership should you offer?

A good approach is to say they’ll have shares that are no better but no worse than what founders have. Those are usually common shares. Obviously you will exclude special features like reverse vesting or a board seat (tip: do not put your mom on your board).

The important thing is that they’ll have roughly the same protections you do, and they’ll get paid when you do. That’s fair and also easy to explain.

One thing not to do is take advantage of their relatively light diligence to bump up the valuation. That can cause problems when more sophisticated investors disagree with that value. It’s also a signal that if that’s how you treat your friends…

Professional Angels

Organized or professional Angels are intentional with their investing. They’ve done it before. They enjoy investing in entrepreneurs but have an expectation of a return.

You can find Angels on platforms like Angelist, in Angel groups, or by asking other founders.

To understand the Angel perspective I reached out to Christopher Mirabile. He’s personally invested in 65 companies, was the Chair of the ACA representing over 15,000 Angels, is Executive Chair of Boston-based Launchpad Venture Group, and Chairs the SEC’s Investor Advisory Committee. 

So he spends a lot of time being an Angel and thinking about Angels.

What is the biggest potential mis-alignment between Angels and founders?

“One of the biggest issues is not being on the same page in terms of the capital path and exit.  There are many ways to grow and harvest a company; broadly speaking, you can raise a ton of money, spend a lot of years, and try to get a huge exit, or you can try to move quickly, be efficient with the amount of investor capital you take in and sell the company earlier in a smaller (and more statistically probable) exit.  Both paths are viable, but the capital efficient path often works out better for both entrepreneurs and investors and can provide superior IRRs, even if the cash on cash multiples are a little lower.  Neither path is right or wrong, but disaster ensues when investors and founders are not in alignment about what path they are pursuing.”

Here’s a big takeaway: there’s more than one path to success. Most founders have been trained to pitch a story of how they’ll become a Unicorn following the standard VC playbook. 

But Angels who have seen many deals have a more refined perspective. They would be thrilled with a big exit or an IPO (depending on how long it takes) but they’ve learned the value of having options, like early exits, along the way. Ask them about their war stories.

Assuming you and your Angels are aligned, I asked Christopher about how much structure is the right amount at this stage.

What is a right-sized amount of structure (eg formal shareholder agreements) for an Angel investment? Does it depend on how much is invested, friends/family vs professional Angel?  

“It does depend on how much is invested. The structure of a priced round with its superior alignment, lack of debt overhang, and thoughtful allocation of both upside potential and downside risk is always better in theory, but at the earliest stages with the very tiny rounds, the transactional costs of a priced round may not be justifiable.  I still think they are worth doing even in small rounds because they can be extended later, allowing you to amortize the transaction costs across two rounds, but for very early very tiny rounds, you see a lot of convertible securities like notes and SAFEs.”

Many founders I speak with have strong opinions about SAFEs vs priced rounds, but they don’t know why. 

When do priced rounds, i.e. selling shares at a set price, create better alignment between founders and Angels?

For starters, investing in a priced round means Angels are actual shareholders. They and the founders can prioritize building the company. In a SAFE note (or convertible note) one of the goals must be to raise more money so Angels can convert into shares.

That can cause mis-alignment if founders can’t or don’t want to raise capital in the expected timeframe.

To learn more about specific terms and protections that Angels seek, read Christopher’s article on “Angel Fundamentals: Understanding Equity Deal Terms - Investor Rights/Protection.”

Whether Angels invest in a priced round or SAFE, in tech there is almost always an expectation there will be a future VC round. This may be the plan, and the desire of the founders, but as Christopher explains below, it may not be the only path, or even the best path, for Angels.

How much should founders structure Angel deals to set the table for VCs?

“In my experience this is not a factor entrepreneurs should spend time worrying about.  They should focus on bringing in the best investors they can find in the early stages and doing it on market reasonable terms that provide good alignment.  Thinking about later investors you may or may not even work with down the road, and speculating about what their priorities might or might not be is a waste of time.  Obviously you want to avoid stupid off-market or unusual terms in your early rounds, but aside from that, what you should be focusing on is the quality of your investors and execution, execution, execution.  If you are growing well and have clear product market fit, later investors will sort themselves out.  And if you aren’t, then you are not getting good later investors no matter what your earlier deal terms are.”

Founders should understand that Angels do not just see themselves as a feeder system for VCs. Many have had bad experiences of being “crammed down” by VCs who apply the Golden Rule: i.e. the people with the gold make the rules.

I personally experienced this as an Angel investor when a VC blatantly required me to give up a large chunk of my shares, otherwise they wouldn’t invest. Still bitter.

I like what Christopher says about execution: “If you are growing well and have clear product market fit, later investors will sort themselves out.”

Wrapping up

As our three founders contemplate raising from Angels they should be thinking about the following:

1. Friends and family are investing in you and in it for the long term. Offer them shares that are as close to founder shares as possible.

2. Angels may have good reasons to prefer buying shares now vs getting a SAFE note.

3. Raising VC may be good for the business, but may not lead to the best outcomes for early investors. Be aware of that perspective.

In the next post I’ll cover things that look likes shares but aren’t: SAFEs, convertible notes, options and warrants. Ownership is getting complicated.

Book me for 1:1 coaching

Ask any entrepreneur and they’ll tell you they feel immense pride in owning something. It’s a prime motivator.

What does it actually mean to be a shareholder?

It’s an innocent question that I doubt founders spend time contemplating. 

Maybe they should. Because in my workshops I’m constantly asked about technicalities of stacked SAFEs, multiple liquidation prefs or cap table math.

Over time I’ve realized that there’s a gap in knowledge that’s driving those questions. Founders are struggling to understand why a term sheet is structured that way or why a VC is behaving a certain way.

I don’t recommend going deep into securities law. But not knowing the dynamics behind owning shares puts founders at a disadvantage, especially if they are raising money.

So for the next few posts I’m going to talk about ownership from the ground up, from the perspective of a founder-shareholder.  

I’ll start with issuing founder stock, which I cover in this post, then walk through the important ownership concepts at each stage in a startup’s life. Doing it by stage will allow founders to skip to the stage that’s relevant to them or to see what lies ahead.

How early is early? How about 4000 years ago?

Book me for 1:1 coaching

Did Assyrians invent carried interest?

Modern companies (and funds) are based on principles that were developed in ancient times.

Here's an example of a fund that existed in ancient Assyria 4000 years ago:

You’ll recognize many concepts that are the same today:

• a separation of investors and managers

• the idea of pooling risk

• profit sharing

• a set timeframe

• wanting entrepreneurs to have skin in the game

The point is the structure of this “joint stock company” satisfies a very human need to invest in and build potentially risky enterprises by a system of incentives and shared risk.

If you’re interested in the history of the company, pick up “The Company” by John Micklethwait and Adrian Wooldridge.

In the beginning there was founder stock

You just started a company with 2 friends. Hopefully you quickly reviewed my last post on founder equity splits. You divide up the initial allotment of shares.

When you receive those shares you’re now playing two roles: the investor (principal) and the manager (agent).

You’re an investor in the sense that you did something to earn that founder stock. You came up with an idea, invested money, or just signed up for a decade of hard work.

Once those shares are issued, ignoring vesting, you switch over to another role, that of the manager who does the work.

Those two roles (principal and agent) are almost perfectly aligned at the beginning of the company. Trusting management to do their job is trusting yourself.

Agency risk does not mean hiring a bad design firm

Imagine if one co-founder needs to get paid a salary but the other two can afford not to:

Already there are slightly different perspectives.

Imagine 6 months later progress in the company has not gone as expected.

• The founder getting paid might be more patient because they are getting a salary

• The other two founders might have a greater sense of urgency because they are using up their savings

This is a very basic example of agency risk. That means the potential conflict between the interests of managers (agents) and investors (principals). In this example, the founder getting a salary might have a greater interest to take things slowly while the other founders have an interest to speed up progress (to get sales or raise money).

There’s still very close alignment since all investors are also managers at this point. But the point is it’s not perfect alignment.

How to deal with this situation:

Issue, or vest, more shares, even a small number, to the unpaid co-founders. That re-balances their risk so if it takes longer to get to a revenue or funding milestones, it was worth the wait.

Rowing in the same direction

Anyone who canoes knows what happens when one paddler is not in synch. Even now I keep a mental checklist of people I will not canoe with.

Everyone talks about how important alignment is when you’re assembling a co-founding team. That’s true. But it’s true in the sense that everyone should aspire to that.

In reality, how do you know that the aspirational alignment that exists at the beginning will last years or a decade or more?

You don’t.

Fair does not mean equal

The idea of being intentional with the founding equity split is to have a fair, transparent process that survives reality.

Most co-founders believe they are equally committed and bring roughly the same stuff to the table. I question that assumption and strongly suggest you go through my template to find out.

The other thing to remember is that 99% of what builds the value of those founder shares happens in the future. The template I created is a framework for talking about what those important, risk-reducing future milestones are. Then assigning some weight to them in the form of granting shares or vesting them.

The biggest negative event, from a shareholder perspective, is a co-founder leaving early. Without a vesting schedule the remaining founders will definitely feel unfairly treated. This will also be a turn-off for future investors, but we’ll cover that in more detail when we talk about outside investors.

Basic shareholder rights

Even with only three shareholders and very few shares, there is already a basic structure you should be aware of. This is fairly standardized in startups but depends on your shareholder agreement, by-laws, initial charter etc.

Note that I am not a lawyer and nothing I write is legal advice.

Here are some basics:

• Issuing new shares - When you first start the company you can issue an arbitrary number of shares. It could be three. Or three million. Later, shareholders will need to approve the creation of new shares, eg issuing new shares to be sold to outsiders.

• Selling founder shares - Imagine one of your co-founders selling their shares to someone you don’t like, eg a family member. You didn’t sign up for that. There are usually rules that say you can’t sell shares to a third-party without approval or at least the other shareholders have a right of first refusal to buy those shares.

• Buying back founder shares - If a co-founder died, was disabled or could not do their job it would desirable for those shares to be re-acquired. This is easier said than done because establishing the market value of a private company is difficult. Luckily, shotgun clauses, where a shareholder can force a buyback, are rare in startups.

• Shareholder votes - Many things require shareholders to vote including electing the board of directors. In the early days there are rarely formal votes when three people can just decide over beers. But later there will be increasing tension between majority shareholders, particularly institutional investors, and minority shareholders who don’t want to be walked all over.

There are lots more terms and I still turn to Venture Deals by Brad Feld and Jason Mendelson as the best overview of VC deal terms and concepts. Chapter 6 “Other terms of the term sheet” covers many shareholder terms, even if it’s from the perspective of a VC term sheet. Just read the book.

Tip: standardization is always beneficial

Your mindset when creating a shareholder agreement, investor rights agreement etc. should be to be standard. You’ll rarely gain by having non-standard terms, even if they’re beneficial to you. But those will make future negotiations with investors difficult.

A good places to start: NVCA model legal documents (CVCA version for Canadians)

Wearing two hats

Even at the very start of your company, be aware that as a founder-shareholder you wear two hats.

One as principal/investor interested in generating a large return on those initial founder shares. And the other as an agent/manager who has the information, skills and resources to do the work.

Most of the time there is near perfect alignment between those two roles and among the shareholders. Negotiations between the two sides is negotiating with yourself.

But that will change over time. What’s more important than learning all the legal terms is to understand your dual roles as shareholders and managers. This colors every negotiation you will have in the future with your co-founders and outside investors.

In the next post I’ll cover raising money from outsiders for the first time and what it means for shareholders.

Book me for 1:1 coaching

This is typical. 

Whenever I meet founders I find myself wishing I could have met them earlier, especially when they were deciding how to divide ownership.

Previously, I shared A Template for Founder Equity Splits which recommended you use time or milestones (or both) to divide equity fairly.

Now I want to go one step earlier and talk about how to approach the conversation about each co-founder’s contributions and how that should impact their equity. 

Equity does not need to be divided equally to be fair, though it can be. I’ll end with a new, better version of my equity split template (V2). I’m not afraid to iterate!

Book me for 1:1 coaching

Simple or not so simple?

A company with three founders divides their shares equally. It could be one each or 10,000 shares each, it doesn’t matter.

What’s the thinking behind that seemingly fair split?

Compensation

When it comes to the fairness of how future money is split, it comes down to this:

It’s human nature to think of fairness in relative terms.

But as a mindset I would challenge the assumption that if three people start a company they should also benefit equally. We’ll dive into the details later.

Control

When you own a share you also own the right to vote, so control is a consideration when splitting equity. 

Of course there’s precious little to control at the beginning of the company. But talk to founders and they’ll tell you they’re always worried about that time in the future when they have to “give up control”.

I’m not saying control should be freely given away. But all those times you’ve fought for 51% ownership has probably not gained you much1. 

Splitting by Risk

If compensation and control are not the most useful ways to think about splitting equity, there is one area that has a huge impact: risk. 

The most valuable contribution each founder can make to the company is to reduce its risk and accelerate its growth. Those are the same thing in early startups: less risk = more opportunity to growth; faster growth = lower risk. 

Startups fail. A lot. So anything a founder can do to significantly reduce risk may be a matter of life or death (for the company).

I think this is a good way to evaluate each person’s contributions.

Some of those contributions could be:

Money

Up-front capital or the ability to not draw a salary for a period of time. Cash is extremely valuable at the beginning when capital is scarce. But it should not be overvalued. The “ramen phase” may only be 10-20% of the life of the company.

Time

You shouldn’t assume that each founder’s idea of “full time” is the same. Every person has a different lifestyle, family and health situation. Discuss expectations up front. With shares that are awarded or vest over time it’s fairly easy to adjust if people are no longer contributing the same amount.

Unfair advantages

How much would a company be de-risked if one founder had deep connections in your industry? A lot. Bringing that network, and maintaining it, should be considered as valuable as cash and time, or more. 

An extensive network is an example of an unfair advantage a co-founder could bring to the table. Others could be IP, an existing client or subscriber base, or a strong reputation.

I’ve purposefully excluded skills, eg coding, as something you should consider. Those are difficult to measure and table stakes. If someone has world-class skill at something that’s an unfair advantage.

Another way to divide equity is by each person achieving some important milestones:

Fundraising

Raising future financing rounds is a huge task that ensures a company’s survival and growth. Being responsible for delivering financing is a good milestone to unlock or vest equity. Yes it’s a team effort but it’s usually led by one person and also objectively measurable. 

Eg, for a finance person it makes more sense to give equity based on delivering funding milestone vs compensating them for the salary they could have been earning somewhere.

Sales

Especially for B2B startups, closing initial sales is game-changing. Those that don’t achieve initial sales end up exiting the game. Early sales validate, or correct, the product direction, bring in cash, and instills confidence. 

Sales of early, buggy products are also very difficult to achieve, which is why a founder who can deliver it should be rewarded with a generous amount of equity. 

Demand creation, for both B2B and B2C companies, is similar to sales: difficult to do but clears away a lot of risk when it’s done. It’s also measurable making it a good basis to reward with equity. 

Product

This is not as straightforward as it seems. Most companies will pivot which means whatever product is built will be discarded. That doesn’t mean leading product or engineering is not important. But many startups have cap tables with past engineers or CTOs who built one thing but couldn’t pivot and evolve. 

Being able to build somewhat reduces risk. But being able to adapt and change significantly reduces product, and therefore company, risk. You should split equity accordingly.

Eg, for a CTO you could grant equity when certain product metrics are achieved, rather than when features are delivered.

The new template

Here’s the new Founder Equity Split Template incorporating the above concepts:

There are two sections: Contributions and Milestones.

Contributions

These are both up-front contributions like money, and expressions of future commitments, like time. It’s up to you to define what each means, including the category of “unfair advantages.”

Applying weights to each category allows your co-founding team to be aligned on what things are most valuable. 

In my example, founders end up with an uneven split because some founders are contributing more of the things that are valuable. Eg, Founder 1 is contributing 50% of the up-front capital.

You should adapt the values and weights to your team and your startup. 

Note: you can start with the assumption that all contributions are equal and all categories are equally weighted. That just means the process is now writing down what would be required of each founder to make that true. Either way works.

Milestones

I had milestones in the old template but I found one limitation: it assumes that everyone’s milestones are in synch, and often they are not. I removed the concept of time-based phases and replaced with individual milestones. 

This means it’s possible for founders to earn equity at different times, and even that someone might not achieve all 3 potential milestones. 

Again, you need to think through the actual milestones and their weights. You could also take the approach that all milestones are equally weighted. 

The important thing is having a clear and fair record of what each founder is promising to do.

Even with milestones you might still have time-based vesting.

Putting it together

In the new template I’ve weighted Contributions and Milestones equally. The result is that each founder ends up with a similar, but not identical, equity split. Even if the numbers end up being very similar to an equal split, this future-looking template retains its fairness even if a founder leaves or doesn’t deliver on a milestone.

This template is a statement about what the founders think is important and what is expected of each individual. That sounds like a good founding document to have.

It’s incredibly difficult to address unfair equity splits later, once a company has been operating. Even bringing up the elephant in the room can put the company in jeopardy. 

Founding teams should slow down and take the time to work through this template. It’s not about punishing people or having a crystal ball. It’s about making sure the principle of fairness is true for the long-term in an environment where many, many things are unpredictable.

Book me for 1:1 coaching

More than WeCrashed, Super Pumped, or The Dropout, this series captures the frenetic pace, the heroic efforts, stupid mistakes, camaraderie and disappointments of being a founder. It can be anxiety-inducing, even if you’ve never worked in a kitchen. It’s also positive and inspiring. But not in the treacly way most people describe entrepreneurship, like this Zions Bank ad:

It’s hard for people, myself included, not to be relentlessly positive about entrepreneurs:

But maybe it’s not such a good idea to suggest everyone should start a company or that a positive mindset is all that’s needed (I know Harley didn’t say that). That seems to be missing part of the story.

You know what I think would be helpful? A dose of reality about what entrepreneurs should really expect.

Here’s my list of ten things people should think about before starting a company.

Book me for 1:1 coaching

1. Money

The reality is that there is no such thing as startup funding. Before you attract even the earliest of investors you need your own money. For lean startups you’re paying for food and rent because you aren’t earning a salary. You need cash to pay for expenses until you start making money. Who can afford to be an entrepreneur? It turns out your parents’ incomes most strongly correlate to you being a startup founder1. It’s not fair and it’s a problem. But before you start you have to have the means to live with financial uncertainty, possibly for years. That money has to come from somewhere.

2. Freedom

The number one reason people say they want to be an entrepreneur is to “be their own boss” or to be in control of their time. Nothing could be further from reality. In a regular job you may have one manager or maybe a cross-functional team you report to. In your own company everyone is your boss: your customers, vendors, the government, every one of your investors or lenders, and definitely the staff you rely on. Until the day they exit their companies, I’ve never heard an entrepreneur say they felt free. See The Bear.

3. Commitment

In Founders at Work by Jessica Livingston, Joe Kraus, one of the founders of Excite, says:

“We decided to start a company together before we had any idea what we were going to work on. But we were so committed to the idea of starting something together that we knew we were going to figure it out.”

Committing to start is easy. But most people do not spend much time thinking about the length of that commitment which, even for SaaS companies, is 10 years. It’s much higher in some industries: 30 years if you are in aircraft parts. But it’s much shorter if, like 50% of all new businesses, you don’t make it past 5 years.

4. Uncertainty

Most people want to be the kind of person who is “okay with uncertainty.” Most are not. Life and work are full of uncertainties. But two things make startup uncertainty particularly stressful.

First, it’s the sheer volume of things you don’t know or can’t control. Will your co-founder, who you split 50% of the equity with, be just as valuable in five years? Uncertain. Will you be able to raise the money you need when you need it or even make next week’s payroll? Uncertain.

Second, you have to pair your gnawing uncertainty with being outwardly certain. No one wants to hear too much self-doubt (see Doubt below). Transparency is wonderful but every founder, at some point, decides it’s in their best interest to hide some of their uncertainties.

The best way to know if you’re okay with uncertainty is to ask yourself if you’ve ever done something where a) you weren’t in control and b) you didn’t fully understand the rules of the game.

5. Pitching

Most founders love talking about what they do. Many enjoy sales. I don’t think anyone enjoys fundraising. But when you picture your future life as an entrepreneur picture yourself pitching. Because it is the thing you will do more than anything. Convincing co-founders to join you. Getting your relatives to invest. Getting people to buy. Attracting that investor, advisor, mentor. Recording that TikTok. You get the picture. It’s exhausting. And you have to do it over and over again with a smile.

6. Repetition

Pitching isn’t the only thing you’ll do repeatedly. I wrote an article called Repetition is Sexy, unironically. This is an overlooked topic because it’s sexier to talk about one-time things like bursts of inspiration, closing a big deal, or going public. The tens of thousands of hours between those moments is called running a business. In the right hands, repetition is a superpower. But make no mistake, it’s also a grind.

7. Passion

One way to kill your passion for something is to start a business around it. The little details and decisions are like little paper cuts that eventually make you bleed out. No matter what your true passion is, to run a business you need to be a generalist. In The Bear 99% of what the chef does is not cook. That is realistic. Starting a business means being okay with diluting your passion with other things.

On the other hand, and this is a bit of good news, you don’t need a deep passion to start a business. It can definitely help but then Stuart Butterfield’s passion was gaming and that company (Glitch) became a corporate communications platform (Slack). Which he’s passionate about too.

8. Doubt

There are two kinds of doubt: self-doubt and everyone telling you that you suck.

Self-doubt is something that entrepreneurs and artists share and that, I believe, is essential to creativity.

If doubt is essential it’s definitely not enjoyable. It’s hard not to have imposter syndrome when you’re trying to do something no one’s ever done before.

The doubts of others seems like something you should be able to tune out. Like, we’ve all been to Thanksgiving dinner. Unfortunately, when you have your own company your name/ego/soul is intertwined with your business. Your failures are more public and some people just like saying “I told you so.”

9. Learning fatigue

The best entrepreneurs are the ones who are constantly learning. Because the rest are out of business. There are no standard playbooks when you start something new. Even if you knew every secret of a successful billionaire you would only know what worked for a different person, a different business, in different situations at a different time.

You still need to do it yourself. That’s why they say “there are good days, and days you learn.” I hope you have many good days but I can guarantee you’ll be learning.

Over hundreds and thousands of days this is exhausting. Sometimes you won’t feel like learning about capital dividend accounts and using ChatGPT and how to be successful on Threads.

10. Opting Out

No matter how respected entrepreneurs are, only a tiny fraction of people ever become one. It’s definitely an alternative lifestyle.

Starting a company is opting out of the usual rhythm of life. Everything from when you go on vacation, who you spend time with, when you get married or have children can be impacted because you have a big, hairy, audacious competing priority.

I’ve never known anything but this irregular rhythm so I have no basis of comparison. I guess I like being a rebel.

If you’re still reading…

In case reading this was a downer, let me leave you with this:

There’s no other path in life that pays as much compound interest as being an entrepreneur.

Every experience, good or bad, and every outcome, successful or not, pays you something. An insight, a perspective, a new skill or piece of knowledge that you never would have gained before.

Use those hard-won lessons any way you like. But you won’t find any other endeavor that will force you to be better, faster.

It’s just not easy and don’t believe anyone who says it is. I’m not a fan of hustle porn but I’m also not a fan of the Disneyfication of entrepreneurship.

As Chef Richie from The Bear says, “You’re not a chef until you’ve cried in the walk-in.”

Book me for 1:1 coaching

I’ve come to realize that figuring out what’s special about your story must be your first step. Before making slides or figuring out your TAM. It will help you realize what’s essential about your pitch, remind you why you started this company, and ensure you stand out in a way that’s totally authentic to you.

Book me for 1:1 coaching

Not everything is special.

The right mindset when you start to figure out what is unique and special is to realize that not everything you do is special, and it doesn’t need to be.

Take your product: it should be impressive and you should demo it and be proud of it. But what you built is a reaction to an interesting problem. The problem, and your approach to solving it, is what is truly special.

Early stage pitches should focus on problems and solutions, not products.

What does special really mean?

Uncovering what’s special in your company means finding the secret at its core. It’s some unique insight or perspective on the world that isn’t obvious to other people. In fact, you know it’s an insight worth building a company around if most people don’t believe it.

Here’s a hypothetical example:

Imagine a company that upcycles housewares. Artists paint beautiful designs on each piece making them one of a kind. They sell for more than the original cost.

Many people would push back on the idea of paying more for used goods. It’s not obvious that the product would actually be better. But my secret is that I’ve been painting these objects for years and seen how much people covet them. That’s why I started the company.

How to find what is special.

It’s not easy to be objective about what’s special. We all think our dog is the most beautiful. I find that asking the right questions will lead you to the right place (about your startup, not your dog).

Instead of focusing on selling what you think is special, focus on asking questions. What led you to start the company? What have you figured out that others have not? What’s your most surprising metric? What was the most difficult milestone you achieved?

These types of questions keep you away from pushing your product and lead you to what is essential.

The overall question is: how did you earn your specialness?

Weighing how special you are

If you came up with an idea on Friday but worked through the weekend, what you built is not that special (yet). The “weight” of your insight cannot be big because you haven’t invested much into it yet.

Valuable insights are usually earned through some combination of:

• repetitions, think Edison’s 2,774 attempts at finding the right filament for the light bulb

• unique data, eg the output from a prototype or MVP

• some breakthrough

• surprising product traction

• industry expertise that you have, potentially pre-dating your company

Most startups avoid talking about how they earned their IP because they rush to show positive traction. This is a mistake. The iterations and failures are what created what’s unique about your company (assuming you did it).

Special = (Insight + Effort) / Context

Thanks to Vlad Loktev, former VP of Product at AirBnB, for making me think about using basic equations to get to the core of what’s important.

Figuring out what’s special is (Insight + Effort) / Context.

You need both insight and effort to earn being special (true in life and in startups). And don’t forget you aren’t the only one doing what you’re doing, that’s why we divide by Context.

Uh oh, you aren’t that special.

When you pitch a VC you should imagine all the pitches they’re hearing before yours. Stop thinking about all those lattes and massages you think they’re getting. No matter how special you are, be aware of the context of your startup. What other stories and technologies are they being pitched constantly?

A year ago, leading with generative AI was novel and didn’t need more context

Today, not so muc:

The context of mass adoption of generation AI works against anyone currently pitching it. It doesn’t mean you can’t tell a great story. It means you need to subvert expectations (i.e. the expectation you’re yet another generative AI hack).

Talk about your insight + effort that makes you completely different from other startups using generative AI. Leveraging generative AI in a unique way is an example where the technology does not need to be special as long as something else is.

There are no superpowers without heroes.

Early stage startups are mostly about people. Make sure you link what’s special about your startup with the special powers of the team behind it.

That starts with telling a strong founder origin story about why you care so much about the problem you’re solving. That tells investors you were earning your uniqueness even before you incorporated.

The same goes for your team. Don’t just list degrees and work experience. Talk about the unique skills that directly contributed to making your startup special.

Wrapping it up.

1. Most things you do aren’t special.

2. Ask the right questions to find what’s unique.

3. Talk about how you earned your insights.

4. Remember, special is relative.

5. Link what’s special to your team’s superpowers.

Book me for 1:1 coaching

One topic that never gets its due in startups is repetition. I mean the practice of mastering something. The 10,000 hours. We talk about pretty much everything else but this.

Startup advice is full of big ideas, new frameworks and inspirational stories. But anyone who’s mastered anything knows that gaining insight is only a small part of the journey. Mastery is what happens when you combine that learning with repeated practice. A lot of practice.

It’s not sexy to talk about practicing. It’s not something you can do quickly (10,000 hours is roughly 5 years of full time practicing).

So much startup advice makes no sense in the absence of practice.

For example, we tell founders what to look for in the ideal co-founder, but most have zero practice doing it. The first time they practice co-founding is when they divide the company’s equity with a complete stranger.

We talk about the importance of managing burn and “spending wisely.” But if a founder has never operated a business before, and most have not, they would have no reps to develop a sense of cashflow.

Fundraising is all about what to do or not do, or what VCs like or do not like. But all fundraising advice misses a crucial detail: practice. Most people’s idea of pitch practice is meetings with VCs who were your worst choice first.

We like to think of the best founders as elite performers, and many are.

Let’s take a look at how elite performers are made outside of tech.

Book me for 1:1 coaching

Sports

When Serena Williams hit a serve, it was the product of tens of thousands of repetitions of that exact serve. But that’s not the only thing she repeated endlessly. Footwork, strength, conditioning. Testing strategies and reading opponents.

Then there were years of daily nutrition, mental conditioning and many other repetitions that, luckily for the pros, is supported by a team of coaches and specialists.

In sports, repetition—especially smart repetition—is the only way to achieve peak performance.

In startups, we expect the performance of an elite athlete but we pay no attention to repetition. Why do we expect a first time founder to win a match if they’ve never been on the practice court?

Music

I have spent close to 20,000 hours playing piano. Music gave me many gifts but the biggest one was proof of how much one can accomplish with lots (and lots) of repetition.

Most of a musician’s career is spent rehearsing, not performing. If you’re not a musician you may not know that practice involves all kinds of torture devices. A metronome for exposing just how bad your rhythm is. Music written to work on finger speed and dexterity. Transposing music to different keys, switching hands, or playing blindfolded.

Thousands of hours of these repetitions builds a surprising result: confidence and freedom. In music it’s the freedom to have your own artistic voice.

For a founder it means having the confidence to make good decisions automatically.

The worst improvisers are the ones with no technique.

Flying

I’ve written previously about thinking of founders as pilots. Flying an airplane requires hundreds of hours of practice to be proficient (below 300 hours is called “the killing zone”).

Repetition is so highly valued that each pilot keeps a logbook of his/her entire flying career. That means every hour they spent in a plane from first flight to today is recorded. This is useful for training but also to ensure that pilots remain proficient.

The reason repetition is trained into every pilot is that when things go wrong the pilot can rely on those repetitions to speed up decision making. Some things become automatic.

Every pilot has stories of things going wrong and somehow staying in control of the situation.

You know what other activity involves lots of things going wrong? Startups.

Some unusual ideas

When you start to question conventional ways entrepreneurs are taught it leads to some unusual, but interesting, places.

We should track how founders practice.

Founders should keep track of their practice. It could be a logbook, spreadsheet or tool. What’s tracked should represent some idea of what is important to a successful business (which I know not everyone will agree with).

If this feels wrong to you remember that this is standard practice in many other fields.

This isn’t about making founders feel bad about themselves, by the way. Getting straight As on a report card does not mean you’ll create a Unicorn.

It’s about being honest about what the founder doesn’t know (or hasn’t practised). This could be core skills like selling, hiring, finance, strategy or whatever we currently assume founders will figure out (and master) along the way.

There are countless analytics tools for software. How many are for measuring founders?

Many founders should delay their start.

This might qualify for a hot take. I think most founders should delay starting their company. This is especially true if they are working with co-founders they don’t know.

We did this at Year One Labs an accelerator I co-founded 10 years ago. We ran hackathons so we could observe how people behaved. We paired up people who were complete strangers.

Most of those teams did not end up forming a startup, which is a good thing. But those that did already had valuable reps under their belt of building under pressure.

No matter how great an idea you have or how great your team is on paper, it’s better to practice first. Do a smaller project together even if it’s unrelated to your startup.

The time spent may feel like a delay but is actually an investment in your future.

We should use more simulators.

In my founders workshops I have people practice other people’s pitches. It’s strange for founders to practice pitching without practicing their own pitch. But it’s effective because it’s a simulation, not the real thing. People learn faster.

Instead of constantly explaining how VC works, I created a VC card game called Swagger that simulates investor decision making. Playing multiple rounds of the game gives founders a better feel for how VCs think versus a blog post.

Of course the ultimate tool would be a startup simulator. Like a flight sim but for startups. This could be used to train individuals and teams in many different scenarios they will likely be faced with. Outside of specialized sims for MBA classes I haven’t found anything that is a true simulator of what running a startup is like. But I definitely think it could be done.

Who wants to build this (message me)?

I don’t know how fun that simulation would be but consider this: the flight simulator market is close to $5 billion1. That’s five billion dollars spent building tech to help make pilots better. Imagine the impact of a startup sim on improving outcomes in the tech industries.

So, is repetition sexy?

I’m not advocating that entrepreneurs should get a degree before they are allowed to start a company. Freedom means the freedom to start a company any time you like. It also means the freedom to do a really bad job running it.

If there’s one thing we can learn from elite athletes or musicians or pilots it’s how repetition is fundamental to everything they do. It’s what builds the foundation of their success and what allows them to master their craft.

We have a long way to go to catch up to other industries when it comes to the value of repetition.

We shouldn’t be snobs about it. If we start teaching, talking about and doing more repetitions I think we’ll unlock a huge amount of potential in our startups.

Book me for 1:1 coaching

Tools like Grammarly already help people write. GitHub Copilot helps coders code. Expect to see AI co-pilot tools explode as more and more use cases are discovered.

Pitching is one of them.

Six months later, if you’re cheering for the human side I have good news: none of the AI tools I tested is valuable as a copilot (yet). 

That doesn’t mean my prediction is wrong. But I’ll admit I’m disappointed in the quality of what’s out there. We’re in the “look what AI can do” stage vs the “how can I make it useful” stage.

Share

What I looked for

• Story - anyone who knows my writing knows how important story is to a pitch. I rarely mention design. I looked for the use of AI to improve storytelling. Was there any value add beyond going to ChatGPT and asking it to generate my slide outlines? I didn’t find any tools that improved storytelling except when they used a fixed template.

• Presentation - design, layout, what slides were included. Some integrated with Google Slides which is a logical approach. Most had their own UI feature set and unfortunately, none of the tools created designs I would use in real life.

• Input - how text was inputted and the ROI from having to enter more text. Most had a simple text box input which is convenient but only if the output is good (it often wasn’t). A few had extensive Q&As, the longest being PitchBob and Pitch.space. The idea of a chat bot makes sense especially if you need help (which is kind of the idea). On the other hand, if it’s just a form that outputs to a standard template it’s not that useful (and not AI).

• Flexibility - I didn’t see any tool being able to generate multiple versions of a deck from the same output. This doesn’t make sense if the tool is truly AI. For me, the biggest value of an AI pitch deck copilot is to quickly generate lots of options. If it only makes one you can just use a template. 

I did not test Google Slides, Powerpoint or Canva because even if they’ve demo’d what looks like cool generative features, I was not able to test them yet. And they aren’t specific to pitch decks. I included Tome because they specifically mention the pitch deck use case even though their product is for all types of storytelling.

I provided the same basic info from my (fictional) Good Neighbors startup:

We are an app that makes it easy to share things with your neighbors like your lawnmower, tools or equipment. You can photograph things you want to lend and we automatically tag them. You can search for things you want to borrow. We charge $10/month with no transaction fees and have built in tracking and insurance. We have built an MVP, and have 800 users in one city. We are raising $1M to expand to 40 cities and hit $100K MRR. We are 3 co-founders with prior startup experience.

I did not spend time tinkering with the output because I was looking for some generative ability that was better than me doing it manually.

The Verdict: No one passed the test

But a few stood out:

PitchBob

PitchBob.io was the only product that had a copilot feel. I used Whatsapp to ‘talk’ to Bob who was generous with feedback and even some pushback. This is a good approach that I hope they develop further. Their design output was not the worst but not ready to be used in a real fundraising situation.

PitchSpace

Pitch.space had the most extensive up-front interview. It had an attractive design and I felt it had the best pitch deck advice of all the tools. But though I agreed with their advice, it felt like a static form not a adaptable copilot. Like all tools, the design output was not great.

Tome

Tome has raised more money than all of the other tools combined so I wanted to take a look. I found it difficult to find their sweet spot. As a design tool I did not think it was better than Canva. As a storytelling tool it did not do anything to prompt better stories. I think all the products need to keep in mind that my starting point today via templates is pretty advanced. No one starts with a blank slate.

Today, none of these tools is useful as a copilot for founders building a pitch deck. I define useful as better than existing alternatives.

You are better off using ChatGPT directly to build and improve your pitch outline. This gives you a better UI, in my opinion, to craft and iterate your story before you design it.

When you’re ready you can easily get a designer to help you or use a template.

But stay tuned. I continue to monitor the space and I will do another round of reviews in a few months or when something big changes. Humans should not get too complacent.

If you have experience with any AI pitch tool reach out and share you experience with me. Or let me know if I’ve missed a tool that I should test the next time around.

Product screenshots

Here are some screenshots of how each product positions itself (left) and sample output (right). Use this PDF to access clickable URLs for each product.

Share

Book me for 1:1 coaching

When founders think about their runway I wonder how many are picturing landing vs taking off? Maybe because I’m a pilot but, as analogies go, it matters which one you’re thinking about. Reducing your fuel burn helps you have a safe landing but it doesn’t help you take off. And all startups are trying to take off.

When you’re taking off you need to burn more fuel to build up the airspeed you need to generate lift. Going slower won’t help because you’ll never achieve lift off.

I’m not advocating a higher burn rate by the way. I’m pointing out that startup lingo, like burn rate and runway, are shortcuts that do more harm than good.

This is important because these days everyone is rushing to explain how low their burn is. Does that really make you a more attractive company?

Book me for 1:1 coaching

Most definition are wrong

Google “burn rate” and “runway” and you will get tons of articles that say this:

1. Gross burn = cash expenses / # of months

2. Net burn = gross burn - cash revenue

3. Runway = cash in bank / net burn

It all makes sense. But what does the ‘rate’ in burn rate mean? It’s usually an average of what you spent in the past. 

What if you spent $1k/month in the past, are spending $50k/month today and are planning to spend $100k/month in 3 months? What’s your burn rate?

As a shorthand, burn rate only works if you have predictable cash flow. That’s not the case for early stage startups. So dividing cash available by some average burn obscures the truth.

Fred said it best

Back in 2011 Fred Wilson wrote what I still consider the best overview of burn rate. He used the same broad definitions but reminded people this is a short cut, the “back of the envelope method.”

If you read his article you’ll notice that most of the time is spent talking about the exceptions to the shortcut. There could be irregular cash outflows like capital expenditures. When you get paid might not be the same as when you recognize revenue.

Burn rates can change pretty quickly.  If revenues are ramping faster than expenses consistently month after month, the burn rate will go down. And for good reason – the company is getting closer to making money, which is what all this stuff is about at the end of the day. Burn rates can also go in the other direction if expenses are ramping faster than revenues or if there are no revenues. Burn rate calculations need to take into account the fact that burn rates aren't constant. If your burn rate is going up, from $83,333 per month to $100,000 per month, then the $250,000 you have left will not last three more months. It might only last 2 1/2 months. Assuming a constant burn rate can be very dangerous. Always know if your burn rate is going up or down and include that fact in your analysis.

If assuming a constant burn can be dangerous it really calls into question why people use it at all. In the end you need your own analysis and your own answer to the burn rate question.

Burn Rate Doesn’t Matter

Another critic is Scott Nolan from Founders Fund who wrote the next great burn rate article in TechCrunch in 2015, called Burn Rate Doesn’t Matter. 

He calls burn rate a vanity metric. Cash burn is viewed positively when the cost of capital is low, and negatively when bubbles burst. What founders and VCs should care about is the rate of execution, or the rate of achieving important milestones.

I love this clarity and it’s disappointing how few people talk about this type of velocity.

A low burn rate can lead to a slow death or lost growth opportunities. A high burn can mask poor execution. As his framework shows, the ideal company has a moderate burn because it is highly efficient and fast. For this startup, artifically lowering the burn rate is “an attack on progress.”

What I find refreshing about this approach, which is still just as relevant 8 years later, is that it’s not dependent on the external funding environment. 

Regardless of investor sentiment, great companies have to spend money and shouldn’t be afraid to pitch a growth story that requires capital. But it has to be rooted in ruthless execution.

Using the Projection Canvas to talk about burn rate

I introduced the Projection Canvas as a simple but rigorous way to build up financial projections. It’s also a good way to understand and talk about your burn rate.

A Projection Canvas already contains your thinking about what future milestones are important and have the potential to change the company. This will impact your expenditures and revenues, i.e. your burn rate.

Having assumptions transparently laid out in one place also helps you feel confident about answering questions about your burn rate. 

You might decide to take all of your projected cash outflows into account and plan for a worst case scenario timeframe. That total cash outflow divided by your worst case scenario timeframe gives you an average projected burn rate that gets you to your next milestone.

Or, you might decide not to answer with a single number, but to speak to an actual cash flow projection taking into account future changes to expenses, revenue and one-time outflows. That’s going to be a more in-depth story. You can still have a single answer about your runway, but be able to go into more depth to explain how you got there.

Another advantage of building up your story from the ground up is that it addresses an important concept: optionality

Optionality vs burn rate

A major weakness of the burn rate discussion is that it reduces things to a predictable, and wrong, number. It ignores the fact that founders can and will adjust as they go along.

Given the right momentum, founders may decide to increase burn to go faster even at the expense of runway. Or they might slow down expenses and growth to buy time to close a funding round.

The point is there’s been very little discussion about what levers founders have to manage burn. Good founders think about those every day.

Instead of a single number for burn rate I think burn has 3 components that you need to think about:

1. Accelerants - These are changes to burn that increase or decrease how quickly milestones are met. These should be as high as possible, given enough capital. If you focus too much on reducing burn and you don’t talk about accelerants, you are limiting yourself.

2. Inertia - Things you need (or think you need) to keep operating but aren’t an accelerant to growth. No one will ever admit to doing things that are “nice to have” but the fact is you don’t learn about what you can live without until you survive a downturn.

3. Survival - These are changes that cut the core of the company, like founder salaries, key personnel or important projects. This is the last place to reduce because you’re starting to amputate important limbs. But sometimes it has to be done, and I’ve done it. It comes at a cost.

This is not a post about how to find areas to reduce burn, but a discussion about understanding burn in a deeper way.

Breaking down burn rate into these components has an advantage. It allows you to separate what you can reduce to be prudent and what you don’t want to reduce because it decelerates your progress.

Always keep the focus on what milestones you can achieve. To achieve liftoff that’s all the runway you really need.

Book me for 1:1 coaching

You don’t want to be the startup with a disruptive business model or surprising traction trying to pitch like you’ve made a scientific breakthrough. Don’t be the startup with truly disruptive tech that is afraid to go big in your pitch.

To tell a good story that gets you funded, you have to know what type of disruption you are. There are many types and your startup may be disruptive in more than one way. But most disruptions are some combination of new vs existing tech, and/or new vs existing user behavior.

Take Uber. When they launched in 2010 they used existing tech (mobile phones, GPS) to enable new behavior (ride sharing). Speaking of GPS, that’s an example of a breakthrough new technology that also created new behaviors, including Uber. 

Not all breakthroughs need to create new behaviors. New therapeutic technologies, including drugs, can enhance existing disease treatment. Finally, most software products, including B2B SaaS, use existing tech to improve some existing behavior. It doesn’t sound that disruptive but it can be.

The goal is not to be in the top right. It’s to know what type of disruption you’re claiming to be so you can tell the best story when you pitch.

Book me for 1:1 coaching

Who Cares?

Now you’ve figured out what type of disruption you are, you can focus on telling the story that fits the best.

Having a revolutionary new technology that will change the world is great. But you need to overcome two types of skepticism: that the tech works and that the new behavior will happen. It’s not easy and it’s not obvious. Just acknowledging skepticism puts you ahead of most startups in this category.

It’s a little easier when your breakthrough is improving an existing behavior, like a new therapeutic. Show what happens before and after your solution. Visuals help.

If you’re piggybacking on other tech trends (looking at you generative AI startups), you want to focus on describing the new behavior you enable. Be descriptive like you’re describing the scene in a movie. Visuals and animations work well. Sure, others could be doing the same thing. Your job is to paint the most compelling picture of the future.

Lastly, if you don’t have breakthrough tech or you aren’t inventing a new type of user behavior, you’re claiming to be better, faster, cheaper. That describes most new products, including Canva, which I used to design the visuals. Resist the temptation to claim you have disruptive tech and focus on your traction. What ‘secret’ do you have about the world that your product metrics reveal? That’s a breakthrough in another way.

Things change

Keep in mind that no disruption, yours or your competitor’s, stays static. There is a gravitational pull of any new technology or new behavior that means it becomes adopted and eventually becomes conventional.

Over its 30-year history, GPS has gone from breakthrough technology enabling new behaviors to being part of the technology background. It’s still arguably disruptive as new applications are built. But over time the disruption is in how companies incrementally improve how it’s used. 

Keep this in mind for your own type of disruption. Everything changes over time. 

No one said disruption was easy.

More reading on disruptive stories:

• How to tell disruptive stories, the Piggly Wiggly way

• Cheatsheet #1: Pitching a new behavior

• Cheatsheet #2: Pitching a new market

• Cheatsheet #3: How to Pitch Breakthroughs

• 50 Ideas to Kickstart Your Pitch

Book me for 1:1 coaching