Signaling

Another quarter has passed and it seems that we have little “news” to report from the venture ecosystem. New records were set for venture funding since Q1, when the previous record was set. We are seeing the impact of the continued return to offices and normal life in the US. Hopefully, this new variant will not create setbacks, as we are witnessing in Israel.

As we consider these trends, one thing becomes clear: the pace for venture funding has sped up significantly for “hot” deals while it may have even slowed for every other company looking to raise capital. This dichotomy is enhanced between those companies that truly standout and those that still have much to prove.

To be sure, in both camps there are winners to be found and losers to be avoided. But identifying them becomes more complicated since previously valuable signals are now blurred. For example, time to closing a lead investor and agreeing on terms is not necessarily a good indicator anymore as to the strength of the team or opportunity.

It may be taking longer than expected because demonstrable performance metrics have expanded and a renewed expectancy of potential returns in other sectors (real estate? NFTs?) might make venture funding slow down considerably in the next 12 months. On the other end, a top-tier-fund term sheet presented within a week of a first meeting shouldn’t carry the full weight of the brand name investor who clearly could not have completed the necessary diligence to invest with conviction.

Problems with signaling have always existed. The most common being “why aren’t previous investors joining the current round?”. This is a valid question in some instances and less so in others.

For example: In the past, if a company was accepted to an accelerator program and didn’t get funding from the accelerator, or its affiliates, after “graduating” then this was a problematic signal. The solution? The accelerator programs give everyone equal funding. This was like a participation award.

However, the accelerator leadership knew which were the truly exciting companies and wanted to invest more in those. They are in this to make money too. So maybe they added an additional funding tranche which were given only to companies which hit certain milestones. This could be a requirement to raise a follow-on round within X months of graduating the program, for example.

This would then allow the accelerator team to “push” the company in front of friendly investors who are connected to the program. These investors would lead a round and the accelerator would join in. Not entirely kosher, but actually seems fair to me. Clearly the companies not being recommended are getting dinged and not enjoying the full prestige of the accelerator brand. And I am sure it is not always entirely based on performance or potential. But I am not a huge fan of participation awards. So unless the original funding was designated for use during the program to cover expenses and allow the company to take advantage of the opportunities the program creates, then this model seems to be required due to market forces. There are some programs that state this clearly and structure the support accordingly.

[As an aside, I fully recognize that what I am describing contributes to the lack of diversity in tech. It could also be used as a way to “level” the playing field unfairly if the dial were turned to the other end of the spectrum. Extremes are not good place to play.]

Accelerators are either investors themselves or backed by investors. Alignment needs to be created to accept the best companies, work with them all, but then continue to invest only in your best bets. A good selection process will help minimize the drop-outs, but I’d be surprised if anyone could have a perfect record.

This is what good investors learn quickly, and what I am learning the hard way. Every investor invests in people. They believe in them and their ability to execute on their grand vision to make the world a better place. So when things go sideways we try to help them get back on track. But when do you know that it is time to let go and focus your energy on your winners?

The famous scene in Glengarry Glen Ross (1992), where Alec Baldwin’s character Blake is giving the Always Be Closing speech*, was given new meaning for me during a great Sales class in business school. Another layer was added to the A-B-C of sales. The key is to invest in your A players as they will generate the greatest return on investment. Support your B players to see if they can become an A level player. But cut your C players as quickly as possible since they aren’t carrying their weight and can sink the entire ship if resources are wasted trying to help them get to B level. They are just too far away from the A level players you need in your organization to be successful. First place gets the Cadillac, second place gets the steak knives. Third place prize? You’re fired.

This is true for investments as it is for team members. Though sometimes the team member is just not a good fit for the specific company or the specific role. “Firing” a portfolio company is something that I am not prepared to do, unless they have crossed a line. We won’t bail when times get tough, but we might be less involved if our efforts are not well received or misplaced. After all, Like all investors – we invested in the people, right?

As I shared this story with a couple of founders this week, I made it clear that both of these situations – firing a team member or watching a company fail – are really hard to navigate. Assuming you are a decent person with a smudge of empathy.

* I read on IMDb that this speech was not part of the original play on Broadway but written by David mamet specifically for Alec Baldwin who performed it magnificently such that in later stage productions it is often incorporated.

Another VC Fund?!

I’ve been spending a lot of time thinking about what differentiates us as an investor. This was triggered from two different directions. The first is the explosion of new venture funds. It seems everyone I talk to is raising a fund these days. The tech media headlines indicate lots of capital looking to be deployed, at all stages. Differentiating your product is necessary to stand out in a crowded market.

The second, and more important consideration is rather from the other side of the table – why would a founding team choose us as an investor in their company? To be clear, it is a founder’s market today. These large amounts of capital looking to be put to work has led to a rise in valuations and we are seeing deals closing faster than ever (at least for the 15 years I’ve been exposed to venture, I was focused elsewhere in the late ’90s – early ’00s).

[As an aside, the above concerns me because it seems that one of two things are behind it. Either investors are making bets (no other word for it) without doing the necessary diligence. Or, investors are backing “cookie-cutter” founders without considering the hidden-potential of diversifying across first-time founders, female founders or minority founders. Others have written at length about these meaningful topics so I will refrain from digging in here, though that should not diminish from the importance of the conversation.]

Coming back to thoughts on differentiating SapirVP as an investor, we always refer to our tagline of: “Mentorship Driven Investing”. Is this really differentiated? – Today it seems that every micro-VC team claims to be “founder friendly” and “value-add” investors. Are statements like these based on the assumption that every other fund is not adding value? Only emerging managers can add value?

Maybe. We have all met investors who were less engaged and less helpful. These are probably not good early-stage start-up investors, or not a good fit for the company. Some advance diligence regarding the investor may have helped the company avoid that experience. Maybe not. Either way, these investors are not the majority and the market forces should be working against bad players so that they don’t stick around for long (though performance cycles in venture are long, so this is all relative). Most investors, even those who have already had great success and have $B AUM, are in this business to add value. As it should be, because: Venture Capital is a service business.

We only have two types of customers: Founders and LPs.

For LPs the service is primarily financial – take their capital, invest it, report on your progress and do your best to return exciting multiples within a reasonable timeframe. Some LPs are looking to create impact, increase diversity or identify potential strategic value. However, for most LPs the transaction is a financial investment at its core. The service elements here seem clear. Good GPs will be transparent and can stand out by offering unique opportunities of value creation for the LP. While popular in all VC pitch decks, I am not sure that a “unique” investment thesis is enough of a differentiation in today’s market. It is probably more important to show “product-market fit” between the fund (team, size, geography, focus) and the strategy.

Founders should also be sure that they are getting a service. The service level should fit the needs of the company. Industry expertise as well as stage expertise. A biotech spin-out from MIT establishing a scientific innovation as a commercial offering needs a different type of “added-value” than a Series A consumer product company looking for hyper-growth. Some founding teams are seeking the “roll up our sleeves” hands-on involvement to navigate the early-stage foundation-forming period, while others are content with taking capital from an investor and then only engaging with them once a year for the annual update (I advise all founders against this, for various additional reasons detailed in a separate post).

Founders should choose carefully which investors they choose to engage. Not all capital is equal.

The most common term thrown around by VCs is that they are “founder friendly”. Like many informal terms, this seems to mean different things to different people. I’ve found that the gap between speaker and audience can be pretty big when it comes to understanding what this term means.

For us this means that we recognize that the founders are the company. The investor is just along for the ride. Our mission is to find the best way to add value during the different stages of the journey. This can vary from team to team and from company to company. This is what we mean by “Mentorship Driven Investing”. It is a tailored experience, based on the core foundations of our mentorship-model, establishing this relationship even before we invest.

I just threw out another vague term…. Let’s unpack this further.

I’ve come to define Mentorship as the combination of Experience and Empathy. Experience is valuable, but it needs to be shared in a way that it can be received and make a difference. Sitting around telling stories of your glory days will provide few practical tools/lessons for a founder. Using a story to illustrate a situation or share a new perspective will create new neural connections and inspire innovative thinking.

Mentorship is showing, not telling. The mentor serves as a personal example and as a guide. But you can’t just do it for someone else, as they will never learn to do it themselves. And you don’t need to have all the answers. Just ask thoughtful and thought-provoking questions.

The mentor should always be there to help pick up the pieces and help make course corrections. Mistakes will be made and **** happens. It is not about you (or your ego), it is about the founders building an amazing company.

Mentorship is not about being a friend. Friendships may (and should) develop. But the mentor need not try to be a friend, especially if it will make it impossible to have the necessary open conversations about what is best for the company. A mentor is also not a teacher, at least not in the sense of making rules, handing out tasks or giving exams. Inspiring creative thinking and continued learning are great.

I think that we embrace the service mentality in a unique way, but we don’t say “founder friendly”. How then should we convey this to the world?

Earlier this week, my friend Shimon – a successful serial founder/CEO – told me that he thinks that we are “Founder Respectful”. He said some very nice things about our approach vs some of the investors he has dealt with. My takeaway from that conversation is that the empathy element we incorporate into these relationships – as mentors, not friends or investors – is where we truly stand out. It makes all the difference to the founder. This in turn gives the company a better chance of success. Said success should result in those multiples of returns we look to provide to our other customers, the LPs.

Creating alignment across the LP-GP-Founder ecosystem. Multitiered value-add. Practicing what everyone preaches: “It is all about the people.