Selecting investors

There’s a lot of talk about “value-add investors”, and while most of it is ironic it is coming from a more serious place. As the power has shifted from funders to founders, it has become increasingly important for investors to signal that they’re “more than capital” in order to get first access to entrepreneurs.

Probably to nobody’s surprise, I strongly believe investors can add tremendous value to a startup beyond capital - we spend every day trying to make it easier for entrepreneurs to succeed. That said, I’ll be the first to admit we should not get any praise if a company succeeds - all credit goes to the entrepreneurs. Some might call this a contradiction: investors work to add value but in reality they don’t. This is part of today’s post on how to select investors.

While all else equal, everyone would prefer a “value-add investor”, spending all your time figuring out which investor has to most “value-add” is a mistake in my view. Generally, there are three things to look for in an investor, which I would prioritize as follows:

  1. Capital to invest.
  2. No right to destroy. (If you don’t need to fundraise, I would put this at number 1).
  3. Value-add.

First and foremost, what you select investors that provide you with the funding you need to build your company on your own. Secondly, you want to make sure they don’t have any rights allowing them to take over control of your business. And thirdly, you want to select for ability to add value. Basically, you should not expect that an investor comes in and build your company with or for you. If they do, consider yourself extremely lucky, but don’t plan for it.

This prioritization should not be confused with how to approach investors. When doing that, you should reverse the numbering of the list above. When approaching investors, you always want to signal to any investor that they’re you’re preferred investor (because of “value-add x”) - even though you are really only looking for capital. I’ll cover this in a future post.

In other news, I’m taking a break over Christmas, meaning this is the last regular post of this year. Happy holidays!

The Ask

“So what should we say our company is worth?”

This is a question I get all the time from founders planning for their next fundraise. While the answer always depends, there are generally two strategies to choose between:

Strategy A: we are raising X million on a Y million pre-money valuation.

Strategy B: we are raising A-B million in exchange for somewhere between Y-X% of our company.

There are pros and cons with both strategies, but my general advice would be to go for strategy B. Here’s why:

Strategy A is the simple option - both the founder and the funder understand it immediately. While simple, there is a downside with this simplicity, and it is twofolded.

On the one hand; if you go with strategy A and communicate an amount and valuation which is the lowest you would be able to accept to continue building your company, you risk leaving money on the table (investors would be willing to pay more). Sometimes this solves itself as you have more investors competing to fund your company, but it’s not always the case as investors can lock in on the anchor you put out.

On the other hand, if you communicate an amount/valuation on the higher end of your “scale”, your risk getting “pre-emptive” rejections from investors who believe your company is “too expensive”. They could be interested in backing you at an amount/valution you would accept but not prefer, but choose to not even take the meeting because of the communicated amount/valuation. The pool of investors to choose from is reduced, and worst-case you end up with an unsuccessful fundraise because the investors you meet (who were not that price-sensitive) pass on investing for other reasons

In short; if you go too low you risk leaving money on the table, if you go too high you risk “pre-emptively” excluding investors which again can reduce the chances of successfully fundraising. This is why I would prefer Strategy B. (interestingly, strategy B is the best option the same way a direct listing is becoming the preferred way to go public for entrepreneurs. )

The combination of the highest percentage and the lowest amount should be something you would be okay closing with, while the opposite - lowest percentage and highest amount - would be a best-case scenario for your plans. Communicating ranges (valuation and amount) means you don’t exclude anyone too early, and can have the discussion on specific terms once you’ve identified one or more investors willing to lead a financing round. At this point you have a lot more information around how competitive of a process you’ve been able to run, and hence how hard you should push for the preferred end of your “ranges”. s

Hard work

This post from Fred Wilson the other day really resonnated with me. It’s titled “Grinding”, and basically talks about how there rarely are any silver bullets - the way to solve problems is through a little bit of everything.

This reminds me of something I frequently hear: the “all you have to do is work smart” attitude - “Hard work is for suckers, I work smart instead”. I strongly disagree with this.

In my view, working smart is table stakes. There are tons of people who work smart. If you want to succeed at building something of real significance, you have to work hard as well. And of course, there people doing this as well. So you have to be lucky as well. But without hard and smart work the chances of succeeding quickly drops.

Over the past 6 years, I’ve had the privilege to observe a few hundred entrepreneurs working out of our workspace at StartupLab. I wish these observations would have given me lots of clear rules as to what kind of teams succeed, but that’s not the case. Nobody knows anything - there are no absolute rules.

Still, one thing I’ve seen again and again is that those who succeed have worked hard. It is not a two-way thing; not everyone who works hard succeed, but just about every entrepreneur I’ve seen build something of significance has put in more hours than the average entrepreneur. It’s not enough to just work smart.

I’m not saying you should push constantly yourself to burnout - that is unhealthy. But if you are only willing to put in an average number of hours, the outcomemost likely be average as well. I don’t believe in silver bullets, and I’ve yet to see evidence refuting this.

Different companies

Los Angeles has gradually become a place where great startups are built, as mentioned in the quoted tweet above. The tweet calls these startups “wildly misunderstood” companies, and that reminded me of Norway in relation to the rest of the Nordics. A few thoughts:

There is this convergence between founders and funders. While investors follow great companies, founders are also more likely to successfully build companies within domains where there are lots of investors. My view is this has happened in the Nordics: great companies have been built within certain segments (mostly consumer and SaaS), followingly more funds have been allocated to these domains, which in turn has led to more companies being built within these domains - and so on.

Then the “ugly duckling” of the Nordics emerges on the tech scene after a few too many years working on oil and gas related problems. Companies are being launched, but due to a number of different reasons (different skillsets, networks, vocabularies etc), many Norway-based founders pursue somewhat different opportunities compared to the rest of the Nordics.

A natural consequence of this is that these “wildly misunderstood” companies struggle to raise funds from VCs who, while geographically close, have spent the past decade converging towards a investing in a certain type of companies. And Norwegian founders with large ambitions have to think creatively around how to fund their companies - something I continue to see.

In this age of narrative violations and contrarianism, I’m surprised so few European investors are looking at “different” companies. To really succeed in startup investing it’s not enough to be right, you have to be non-consensus as well.

Norway has a large amount of such companies, and I hope and believe many of these companies will emerge as non-obvious winners in the years to come. It still remains to be proven that these “different” companies are good companies as well - you can’t just be non-consensus, you have to be right as well. And once this happens, you’ll see me tweeting something similar to Shaun Maguire.

Clear communication

I tweeted this a few days ago, and one of the responses I got was that I was stating the obvious. Most reasonable things are, but that doesn’t mean they shouldn’t be communicated repeatedly and clearly.

Increasingly, I’m learning how important it is for founders to communicate clearly (see another argument for this here). Clear communication is necessary to convince investors, employees and customers to join, and it is also very important for building the best possible product.

My tweet was directed at the latter; how to build the best possible product. At any given point of time, you’ll have to prioritize how to further develop your product; what features to build, what bugs to fix. This quickly turn into a question of why “job A” should be prioritized before “job B”.

The decision is much easier to make if you clearly state the different reasons to build something, as per the tweet. Generally, I would argue you should prioritize jobs reducing the probability that customers churn (obviously only to a certain point). Second, I would prioritize jobs makeing your product attractive to more customers, and third jobs that increase the revenue per customer. All exceptions apply of course, but this would be the rule to break.

With clear communication around what each job entails and why it should be prioritized, the probability of building a great product increase. And with it the chances of succeeding.

Revenue is not revenue

More revenue is always better for a company. At the same time, I’d argue you’d rather have 5 customers in 5 countries than 10 customers in one - especially if you have growth ambitions.

Bill Gurley has a really good and famous blog post called “All Revenue Is Not Created Equal” - a post that’s been broadly shared lately related to WeWork’s sudden crash. In it he talks about “customer concentration”, saying that your business is less fragile if your revenue is spread amongst more customers.

This is very true. At the same time, your list of customers represents different levels of risks (removed from the business). 0 customers: Does anyone want this? 1 customer: Someone wants this, but does this customer represent a larger group? 5 customers in 1 market: More indications that the first customer represented a larger group. Is this “larger group” local or is there an international potential for this company? 5 customers in 5 markets: Someone wants this in multiple markets. The “larger group” is not only domestic.

And so on… You probably get my argument already; don’t wait too long to test international markets if your plan is to build a large company. It’s good for your business and it’s a strong signal for investors lookin to back companies with international ambitions.

Mandatory learning

There are some things that aren’t taught at school that I belive should be mandatory learning for everyone taking part in adult life. Here’s my short, non-exhaustive list of things I believe everyone should be educated about but aren’t.

Meetings: How do you conduct a meeting? Why should you have a background, objective, question and outcome of a meeting? How do you facilitate a meeting so that is stays enough on track to get through the staged agenda without running over time? How do you make sure everyone in a meeting is included, and what is the right size of a meeting? What meetings are important and necessary? We all spend a lot of time in meetings, and too many such meetings could be run better.

Basic psychology: Why do humans behave as they do? What is loss aversion? What is anchoring? What is reciprocity bias? What is social proof? What is availability bias? There are a few more, but you get the point. These are ways we all (mis)behave, and the best way to avoid errors from such biases is awareness of them.

Sales: Whatever your position, when you reach a certain level of seniority it turns into a sales role. This is someone else’s quote originally (couldn’t figure out who), and it’s very true. Doesn’t matter if you’re a doctor, chef or CEO - when you get to the top you have to sell. Sell research, sell methods, sell your restaurant, sell your business to investors. Still, nobody I know has ever taken a school course in sales.

Email: Together with meetings, emails run most large organizations. And it runs cross-company communications. Still nobody learns how to do this right. What is inbox zero? How do you do a proper email introduction? When do you use bcc, cc, reply, reply all and so on. Basic stuff that everyone does in so many different, non-optimal ways.

The world would run much smoother if such things were also taught at school. But I don’t expect this to happen anytime soon though.

Sharing shares

One thing I find myself discussing with entrepreneurs all the time is on the topic of how to distribute equity amongst founders and employees. How to share the total number of shares amongst those working full-time in the company.

Ideally, a company would have all co-founders in place on the day the company is founded, and this group of people agree on how to compensate future hires that will be brought in as the company scales.

Unfortunately, this scenario is closer to utopia than reality. In reality, a company is started, an additional co-founder is brought in after a few months, another co-founder quits sometime after that, you recruit a super-senior executive that demands 5x the equity other early hires have been offered and so on. Reality is messy.

I rarely see companies that continuously update how they split equity amongst founders and employees. Both because this would require a lot of resources, and because it is nicely placed in the not-urgent/important quadrant of the “Eisenhower matrix”. Often, the process of redestributing shares is postponed too long - and this leads to more conflict than necessary.

What usually happens then is that people gather in a room and start throwing out numbers; “I deserve X%”, “I should have Y%” and so on. I read somewhere (can’t retrace it now) that if you ask all employees to rate their contribution to a company in percentages, the sum is closer to 300% than 100%. It goes without saying that these discussions rarely end with all smiles.

To mitigate the risk of such a discussion ending up destroying morale, I would recommend a different approach: start by establishing a framework for how equity should be distributed. This framework should consist of different principles that everyone agrees on, that will be used to guide the discussion around numbers that will follow. Which principples to include might differ, but I would at least include the following:

Step 1 > Step 10 > Step 100: All else equal, the earlier you join, the more equity you should have. You take more risk if you start the company versurs if you join post first funding versus if the company has raised big VC.

Building a company takes time: In some ways opposite to the first principle; acknowledge that the company is built over time - the idea in itself is worthless. Even though you don’t join first, you can still be instrumental in making the company turn into something of significance. And if you don’t; vesting schedules will make sure the company’s best interest is taken into account.

Uniqueness: People with skillsets that are unique and crucial for the company to succeed should get more equity than regular “employees”. Differentiate between those who act like owners and those who act like employees. Caveat; people who join early are likely to get a skillset which become unique and crucial over time as they own culture and deep know-how of a lot of stuff. If you plan on keeping people for the long-term expect them to become unique and crucial and distribute equity accordingly.

Presedence: What are the implications of anchoring on a certain number of shares early on. Not all employees nor co-founders care that much about ownership early on, and it might be tempting to be less generous because of this. This might come back to bite you because you might want to bring in people later on that care about equity and want a certain percentage, but where you’ll have difficulties offering this just because it’ll be unfair compared to former hires/co-founders.

Risk profile: There should be an inverse correlation between salary and equity. If you’re paid market, you should expect fewer shares than if you take a 50% pay-cut compared to what you’d be paid in a corporate job.

These five* “principles” are things I would discuss before entering into a discussion about numbers. If everyone agrees on the principles, you have a better “vocabulary” to bring into a discussion on specific numbers. And it’ll increase the probability of success.

  • There might be others as well - if I come to think of any I’ll make sure to add them.

Mission and Vision

Lately, I’ve spent some time exploring the company mission and vision “concept”. Both are important concepts I believe, but I rarely see them being used properly in young companies.

This article explores it more in detail. I agree with the article that mission and vision statements are often incorrectly used interchangeably, and it proposes the following definition which I like:

“Your mission statement focuses on today; your vision statement focuses on tomorrow”.

To make this more specific, let’s have a look at how Amazon work with mission and vision statements correctly:

Amazon’s Mission: We strive to offer our customers the lowest possible prices, the best available selection, and the utmost convenience.

Amazon’s Vision: To be Earth’s most customer-centric company, where customers can find and discover anything they might want to buy online.

Why is it important with these things, you might ask? Isn’t this obvious? I would argue against.

A company’s mission statement helps them in all communication - internal as well as external - with regards to whether any given activity is within or outside scope. Should we do x? Yes - if it leads to us better fulfilling our mission.

A company’s vision statement, I’d argue, is even more important - as it sets direction for the company. This is especially important in young companies - but at the same time much harder to establish. Very early on you don’t really know what your company’s target is, as it’s not always obvious what problem the company will solve.

Once it’s somewhat established what problem a company will solve, I would strongly propose articulating a vision. Maybe something like Tesla’s first ten year plan. Something that clearly communicates to the whole company what the company will become.

Having a vision in place reduces the risk of company complacency - that the apetite for growth stops once break-even is reached. Articulate a clear vision for the company, and chances you end up building something meaningful increase.

Put the gun in the other person's hand

Listened to this podcast with Andy Rachleff the other day.

While it’s two years old, the full episode is gold - featuring stories both from founding Benchmark and Wealthfront.

In the episode, he has one expression I particularly liked: “put the gun in the other person’s hand”. Meaning: if you are about to enter into a long-term relationships with someone else - you might as well try giving the other person all the power right away. Give them the gun and see if they pull the trigger.

An example of giving someone the gun is to ask them what the believe the valuation of their company should be like. If the other person tries to exploit you - walk away. If not, the test is passed and it might be someone you should work with.

Investing in startups is all about long-term. Without trust nothing will ever work. So it makes sense to put the gun to the other party’s hand immediately.