Two Laws Of Startup Physics

Fifteen years into my venture capital career, I’ve come to believe there are two undeniable laws of startup physics:

Capital compounds both positive and negative formulas.

All positive formulas compound at diminishing rates of return.

1/55 1. Capital compounds positive and negative formulas

We are fond of saying, “Capital has no insights.” It doesn’t have the answers to your problems and can actually only fund two things for a startup:

2/55

“The End of The Era of Indifferent Capital”

The next year will be challenging for startups.

Promising companies will struggle. Many will fail.

The only consolation is that the "era of indifferent capital" is coming to a close – may it never return.

/🔗 What do I mean by "indifferent capital?"

Historically, VC was a boutique business where investors viewed themselves as mentors to their entrepreneur protégés. VCs were financially driven, but they also put considerable relationship capital to work in each startup.

/2

On Making Your Startup Inevitable

/1 VCs get excited about products and markets.

Founder stories certainly move the dial.

Big picture: investors want to back startups that feel *inevitable.*

More than any fact, they’re swayed by this feeling.

/2

🥇💰 On The Perils of Pricing to Perfection 💰🥇

These days I find myself talking with our founders often about the perils of pricing to perfection:

Founders need to balance the desire to optimize in the short-term against potential long-term fundraising complications.

/1 Imagine you are a “hot” early-stage startup and have $500K in ARR. VC’s are keen to invest and you get two offers:

A) $6M on $30M
B) $12M on $60M

Seems pretty obvious which one you should take, right?

/2

How do you bootstrap a $1B+ hardware startup?

SimpliSafe founder Chad Laurans recently shared some wisdom with our portfolio:

🪤 Avoid the “trap of perpetual unreadiness”
🎯 Have a hiring “hit rate”
♻️ Start succession planning from day one

Here's more...

/🧵 🎯 Have a hiring “hit rate”

If you’re scaling quickly, you’re not going to hire perfectly. However, many managers fear losing face by admitting they made a bad hiring decision. Give them a permission structure to end poor fits before they poison your organization.

/2

Founders, if I told you that you could:

🧱 Increase productivity

♻️ Reduce turnover

🤗 Build loyalty

All in 15 minutes a day, you might think I was peddling snake oil.

There’s actually an easy way to do it.

Show gratitude

Here's a simple practice that I've seen work:

/🧵 Your best people *are* being recruited.

They're being offered better titles, better pay, and the rush of being courted.

If you’re not making them feel recognized and valued at your company, they will take one of these offers.

Don’t lose them to a lack of attention.

/2

.@zachklein is one of the best design thinkers in the startup world, and he recently shared his wisdom via FC office hours with our portfolio. Three takeaways:

🪞 Being pretty is too expensive
📏 Define design success in *your* terms
🚫 Great companies say no to good ideas

/🧵 🪞 Being pretty is too expensive

Polishing a design too early in the process can lead teams to fall in love with work that doesn’t ultimately serve your startup. After you’ve devoted resources to pretty-up a design it’s hard to throw it away in favor of something better.

/2

There is huge pressure politically, economically, & socially to open school.

The APA, CDC, and most media are making homogeneous plans to address heterogeneous challenges;

We shouldn't seek intellectually thin, one-size-fits-all solutions.

economist.com/leaders/2020/0…

/1 Return to the classroom has huge advantages – it’s an inarguable point. It’s important to keep equity issues top of mind. There are also some very positive indicators that safe return to school is possible.

cdc.gov/coronavirus/20…

/2

When pitching your startup, instead of a linear flow, think of your startup’s story like a pyramid with many layers.

Each layer of the pyramid is the entire story of the company at different levels of resolution.

/1 At the top, you see the entire shape of the startup in miniature form. The tip is a word or tagline that tells the whole story. Followed by an elevator pitch etc.

In the middle tier, countless layers go into deeper detail.

And the base is made of millions of data points.

/2

Founders need to be ambitious and there’s nothing wrong with “going big,” but this mindset can lead to bad decisions and negative consequences at the early stage.

/1

https://twitter.com/Jason/status/1266157508617367552

Every billion-dollar business first needs to become a million-dollar business.

Often, the $1B+ opportunity isn’t even clear until you’ve gotten to $10M, or even $100M in revenue.

You can’t skip over these phases & those who try usually fail rather than going big.

/2

Some amazing startups were founded after the 2008 financial crisis, but we shouldn't forget the startups founded in 06-07 that survived *through* it:

Adyen
🧪 Veeva
OPower
Dropbox
ZenDesk
Wix
Hubspot
CarGurus
Twitter
Spotify
Waze
Workday

/1

https://twitter.com/yuris/status/1236380762326224896

And the list above is not comprehensive!

Navigating a financial crisis isn't easy for any company, but a startup has the benefit of nimbleness on its side.

The 2008 meltdown came at a moment of maximal vulnerability for most of those companies I listed.

/2

Startup founders: In a crisis, your cash position is your shield.

/1 “What’s your burn?” is going to be asked of many founders in the coming weeks, but before you answer, stop and think.

What’s your *actual* burn rate?

Not the autopilot number from two weeks ago, the “oh no, all our customers have abandoned us burn.”

For example...

/2

A couple of notes on Employee Stock Option Plans (ESOP):

🗜️ESOPs are as much for your benefit as your VC: There are many ways VCs can hurt startups — this isn’t one of them

🍤 Startups shouldn’t skimp on ESOPs: This is the capital you use to recruit talent

Let me expand:

/1 I recently wrote re: how founders should talk about stock options with employees.

https://twitter.com/epaley/status/1208063530123104256

Now I want to address how VCs think about Employee Stock Option Plans, why they sometimes (and legitimately) frustrate founders, and how to think of them productively.

/2

Stock options are a key lure of working at a startup. But explaining them, and particularly their value, is a challenge for a few reasons:

🤩 Expectations management

🎲 Valuing risk is hard

💱 Financial complexity

Here are some thoughts on communicating options.

/1 🤩 Expectations Management

Telling a bright MIT grad that they’re getting options that equal 0.1% of the current value of the company doesn’t sound compelling,

So a large number of startups tout the number of shares they’re offering instead.

/2

🗣️ Don't Waste a VC Pitch Arguing 🗣️

Some of the best startup pitches sound crazy, & VCs are often skeptical. But I want to caution founders not to fall into “debate mode,” & to stay focused on the sale.

Here’s how a pitch goes off the rails, & how to get it back on track:

/1 Step 1: Founder starts with a bold, but contentious claim (often not even the key hypothesis)

Step 2: VC pushes back

Step 3: Meeting devolves into an abstract debate about the unimportant claim

Step 4: As time runs out, the founder struggles to reconcile the disagreement.

/2

“Why Now?”

Most VCs will ask this.

But this question misses great startups.

Investors are asking if your oppty is:

🤖 New tech?
👽 Emerging user behavior?
⚖️ Regulatory change?

Major macro shifts matter, but special founders are often overlooked as key vector of success.
/1 Uber emerged partially because:

📱 Smartphones (and GPS) became widely available
💸 There was a lot of slack in the workforce
💳 People were increasingly comfortable transacting online/mobile

But there’s no similarly clear reason why GoFundMe emerged in 2010 and not 2004.

/2

A portfolio CEO recently asked for advice about an unsolicited offer from a good VC:

Facts:

💳 $20M/year run rate & doubling annually
🏦 Has $10M (most of the capital it’s ever raised) in the bank
💰 VC offer is $25M on a $150M pre-money valuation

What should they do?

/1 More context:

💨 The company leads its space
🔥 Current burn is ~$200K/month
📈 Planned to ramp up to a $500K monthly burn rate, irrespective of investment
🔭 Founder believes it possible to hit $50M ARR in < 18 months.

My advice was to REJECT the offer.

Here’s why:

/2

Imagine your startup had a billion dollars in the bank today. How fast would you spend it?

Default is time-based. Founders hire, commission projects, and spend on acquisition channels with the goal of surpassing the previous round’s valuation in 18-24 months.

1/11 The problem is that the "Capital First" method doesn't leave room for error.

Capital alone shouldn't lead startups to accelerate.

Confidence is the only currency that should drive acceleration.

2/11

“I don’t see who would acquire this startup.”

I’ve heard this excuse from VCs explaining a decision to pass on investing in an atypical market. It’s usually a diplomatic way to express a deeper concern about a business, and it’s often a mistake. Here’s why:

/1 We heard this all the time when pitching our startup, Brontes, in the dental industry. Turns out we and all of our competitors had meaningful exits. Brontes itself had 5 bids to buy the company in an industry that most VCs believed was devoid of buyers.

/2

It’s often said that the founder/VC relationship is harder to get out of than a marriage. Put that way, it’s shocking how few data points inform investment decisions.

That means it’s *really* important that you get them mostly right.

Some thoughts on how to do that:

/1 Here is a sample of the interactions/time spent between the founder/VC in a seed round (note that it’s often much less):

45:00 - 1st meeting
60:00 - 2nd meeting
30:00 - Video chat
60:00 - Partner meeting
90:00 - Misc. Phone/email
90:00 - Diligence
90:00 - Negotiation

/2

Even for strong startups, fundraising is a marathon that requires near constant attention for 8-12 weeks. The process is punishing, and riskier than you might imagine. You need to prep for it as seriously as you would a race.

/1 Prepare for rejection. A lot of it. A promising startup will get 17 or 18 “no’s” for every “yes.” These brush-offs often have less to do with the startup in question than idiosyncratic context or concerns for each VC. Still, it stings. Don’t get demoralized.

/2