There is no word more sacred and yet over-used than “term sheet” in the entrepreneurial circle. The pursuit of the mythical VC term sheet has blinded entrepreneurs from the real goal of building a business: revenue, customers, users, engagement and retention. Securing a term sheet is about more than money — more than survival. It’s validation. It’s the exact moment when the entrepreneur, the beggar, turns into the auctioneer of precious equity. It is, in the immortal words of Mark Zuckerberg, when a struggling entrepreneur gets to turn the table and declare to the world, “I’m the CEO, bitch.”
It turns out there is a big difference between the technical “terms” of a term sheet and the complicated dance of actually receiving/procuring/pillaring a term sheet. From what I’ve learned over the years as an entrepreneur and now as a VC, the mating dance of term sheets can be put into a few genotypes.
Even before Sequoia Capital made $3.5 billion on a $60 million investment in WhatsApp, the seed- and early-stage funding landscape had already changed significantly. Most major VC firms have significantly scaled back their seed-stage investment programs.
Furthermore, many Series A funds will openly admit that the traction needed to raise a Series A today as opposed to 18 months ago is comparable to Series B.
At the same time, seed funds are raising more and more money for their new funds. Five years ago, the average seed fund was about $35 million; today, that number is closer to $100 million. The need to deploy more capital and the reality that traditional Series A firms have moved upmarket from the traction perspective for Series B-like companies has translated into seed funds happily deploying capital in companies that no longer look like “seedlings.”
What does Mark Zuckerberg, Jack Dorsey, Larry Page, Marc Andreessen, Elon Musk, and Peter Thiel have in common with me? We’ve all guest lectured at the Stanford Entrepreneurial Thought Leaders Seminar. Here is me doing my best to not embarrass my fellow esteemed lecturers. . .
Making fun of myself and the bullshit I spew on a daily basis . . .
It’s almost been two years since I co-founded LA-based accelerator MuckerLab and since then, I’ve gotten pretty good at lying.
Not the “pants on fire” kinds of lies, but more like “Pretty Little Liars” ones. These are the types of lies that VCs and accelerators dole out to entrepreneurs because they are somewhat true, mostly innocuous, often keep people from crying, but are most definitely misinterpreted by entrepreneurs.
A refresh of an old post from my now-defunct personal blog from 2008 (ya 2008!) . . . on how to build liquidity in marketplaces
Many investors love “disruptive” businesses. This is in part because these businesses are unencumbered by legacy constraints that had previously been hardwired into the companies and industries these startups are trying to disrupt. One such business model is the “online marketplace,” an entirely new business category not possible (at scale) before the Internet.
During the first dot com era, marketplaces were all the rage – with eBay leading the charge. By the end, 99 percent of the B2B marketplaces had cratered and only B2C eBay was left standing and thriving.
The prevailing consensus at the time was that B2B marketplaces were too hard (e.g. it’s really a software business, not liquidity driven) and that B2C marketplaces could not be built under the giant momentum of eBay’s “network effect.” Investment stopped, and entrepreneurs focused on other categories.
A little more than one year ago, Marc Andreessen wrote a seminal piece which has defined venture investing and entrepreneurship since. The global trend for software powered innovations to permanently impacting every part of our lives and every part of our work is unstoppable and just at the beginning. Three generations into the birth of information technology, we are at the global inflection point – while it might not seem like it today, a hundred years from now it would be obvious and self-evident. Since Marc’s prognostication, what has become increasingly clear is that the next 20 years of venture investing and entrepreneurship will also become a different animal than the last 20 years. Instead of funding or founding enterprise software companies – these new startups are increasingly hybrids. From the outside, they are vertically integrated challengers to decades if not hundred-years old incumbents. Not content to simply sell incumbents software, these companies merge domain expertise with software native DNA to attack incumbent head on. Instead of aiming for hundreds of millions of dollars in software licensing revenue – they want to conquer existing industries and aim for tens of billions of dollars in widget revenues. Yes, the stakes are much higher this time. It is good time to get into the game from either side of the table. Software is eating industries.
For the last 20 years consulting firms like Accenture, PWC, Deloitte have made hundreds of billions trying to teach incumbent companies from every single industry how to use software as a competitive and strategic advantage. Some, like Charles Schwab, have made the transition so seamlessly that they left little room for true disruption. While others, like Blockbuster, are already distant memories. Some had once argued that software is not a competitive advantage – that all the old dogs will learn new tricks and there will be little left for valley entrepreneurs and VC’s to pick over. Turns out, for whatever reason – cultural, business model, leadership, even bad luck – many incumbents have yet to figure out what to do with software, always on connectivity, and technology. 20 years since Mosaic, if they haven’t figured it out – they probably will never figure it out. The list of industries where the marketshare leader still haven’t learned how to use software to accelerate their customer acquisition, improve their customer retention, increase their customer satisfaction, lower their manufacturing cost, shorten their supply chain etc, etc is long and impressive. In fact they tend to be B2B rather than B2C companies – while the popular bet these days in B2B for many is in “enterprise software” – maybe the better bet is in betting on these software native challengers.
There are many examples already of this trend – Uber, Silvercar, Surfair, (interesting that we all piled into the transportation sector). There is, in fact, an entire technology category that fits this thesis perfectly – etail or commonly referred to as e-commerce. Instead of trying to sell e-commerce software to Barnes and Noble, Bezos decided to sell books instead. Hundreds of billions of dollars later, Amazon is one of the most valuable companies in the world. Smaller companies like Warby Parker are taking on branded incumbents in eyewear by re-inventing and collapsing distribution and manufacturing channels. E-commerce is the canary in the coal mine. Most market research analysts have e-commerce penetration into retailing at 8%-11%, yet billions in value has already been created and reaped by entrepreneurs and venture capitalists. Retail is first industry to be nibbled by software – there are hundreds more that have yet to even feel the bite. If the rest of the bowling pins begin to fall, we are in for multiple tidal waves of value creation (and destructions).
Of course this changing new venture landscape will also require different type of entrepreneurs – one that merges a software mindset with industry specific knowledge, network, and experience. These entrepreneurs were impossible to find just ten years ago – those who were born “software native” but have spent enough time in the target industry to move beyond consultant level understanding of the motivations of different actors in the business. They are early thirty-years old up and coming executives in old and un-sexy industries looking to change the world. Ironically, they are most likely not the Ivy League or Stanford grads that Silicon Valley VC’s love to back. And they are most likely not living in the Bay Area drinking the usual coolaid. These entrepreneurs and companies are just as likely to be found on University Ave in Palo Alto as they are in mid-market industrial towns like Columbus, Pittsburg, Chicago, and even Los Angeles. (yes, outside of media, LA is really a blue collar town). There will be a huge leveling of playing field for entrepreneurs and venture capitalists – that incumbents will also need to adjust and learn the new mindset. Valley VC’s and entrepreneurs will not have a monopoly in software eating industries.
For a long time, software was viewed as an enabler and accelerant for competitive differentiation for incumbents. And certainly many software companies were born and many many billions were made based on this concise thesis. But as horizontal infrastructure opportunities in software become less evident and new startup software companies focus on vertical specific applications, the opportunities for outsized returns in running a pure software company have also become more scarce. However, entrepreneurs are beginning to discover a whole new class of opportunity in combining proprietary software with new business models and processes to build companies to take on these incumbents head on. These “silicon valley-style” challengers will shower incumbents with hyper-competition, common in the technology and venture ecosystem, they have never seen in their lifetime. Venture capitalists and entrepreneurs as we know them are moving beyond the comparably tiny addressable market opportunity in “information technology” to attack every single industry in the world. As Marc would say, “Over the next 10 years, the battles between incumbents and software-powered insurgents will be epic. Joseph Schumpeter, the economist who coined the term “creative destruction,” would be proud.”
This is a guest post from my partner, erik rannala thats originally published on Techcrunch.
Much has been written about the Series A crunch that is facing entrepreneurs and their investors. Those who believe the crunch is upon us contend that a significant number of seed-funded startups will not be able to raise follow-on financing. A cursory review of the data reported recently by CB Insights would seem to support the fact that the Series A crunch is a market reality.
However, while the CB Insights data, which includes angel-funded new ventures, shows a significant increase in seed activity, the PwC MoneyTree data shows a more nuanced story. Looking at PwC MoneyTree’s almost 20 years of venture investment data (below), it turns out that the Series A crunch is a phenomenon that is disproportionately driven by, and will disproportionately impact, the bottom of the startup financing market: angel investors.
In the past 30 days I’ve had sad and unfortunate conversations with around 5 entrepreneurs about the reality that their venture funded companies are headed toward their eventual end . . . some are indignant, some are accepting, and others openly sad. All of them have lost the passion they once carried in their voices that I had admired just a few years ago. But if you looked in their eyes, the twinkle remains. “I’ll be back,” they all said to me without fail.
I have yet to find the investor hat either comfortable or empowering. I build products, markets, and companies. You might think I’m talking about MuckerLab, but really I’m just talking about myself, my career, my love. For my entire life never once did I make a career decision simply based on some calculated odds of success. It seemed cold, robotic, mercenary . . . unhuman. Perhaps that’s dumb and naïve, but I doubt Steve Jobs ever thought that hard about the probability of turning around Apple, or that FDR thought about the probability of winning WWII. Men who achieve great things (perhaps different from great men), believed in more than math – they believed in their passion, their destiny, and their moral obligation to strive for the impossible. Without these men, who didn’t believe in just the odds, where would all of us be? What would our lives and the human condition be? In fact, beating the seemingly impossible is the only reason we are all here. (Whether you believe in Darwin, God, or both.)
So here is the conundrum and paradox. While entrepreneurs are by definition foolhardy men and women who defy the impossible to chase their dreams, the investors who back them seem to be obsessed with weighing the odds rather than bending the odds. They (we?) think about how to mathematically optimize their portfolio size and diversification for returns in terms of chasing for the mythical billion dollar home run (also known as the black swan ) because given their multi-hundred million (or billion) dollar funds, these rare animals are really the only thing that drive an impactful financial outcome. (which help pay for their Maserati’s) They carefully “prune” their portfolios to double down on black swans and put to bed both failed companies as well as ones that they believe will never “turn” black. Fundamentally, failed ideas deserve to fail – it’s Darwinism – but putting to bed “healthy white swans” seems like a cruel and disrespectful act.
Are investors supposed to treat entrepreneurs as just numbers, a series of bets, a stack of chips on the roulette table? Doesn’t every entrepreneur’s dream deserve the chance to be fulfilled? While SOME venture capitalists get rich on their management fees, entrepreneurs are asked (and gladly volunteer) to empty college savings accounts, give up the most lucrative portion of their careers, live off ramen, and bet it all on black. There is no portfolio. There is no turning back. There is no alternative outcome. Its a game where the heroes are asked to kill King Wart with just 3 lives while everyone else gets to hit reset over and over again.
BUT venture capitalists have to answer to their investors as well – and the only outcome these investors care about are financially driven. This is a business after all. So where is the middle ground?
We all fall in love – at the wrong time, with the wrong person, in the wrong circumstances. Sometimes a choice was made for us rather by us. And regret could be 5 to 10 years of our lives lost. Or even worse, a walk down a one way road toward an endless horizon. Ending up with an investor can be scarily similar. I try telling entrepreneurs in my unguarded moments to find venture capitalists that care about the same outcome as they do. If they will never settle for anything less than $1B, then find guys that are aiming for the home run. If a nice fishing boat will do, don’t hook up with gals that plan to upgrade their yachts. Entrepreneurs need to surround themselves with people that respect their dreams with no judgment on the grandness of their ambitions (financially, socially, and emotionally). It is easier said than done – cause there is no level playing field. Venture capitalists drive better cars, have more zeros in their bank accounts, and (I’m sorry) generally behave like rich douche bags more often than not. Because the venture capitalist survival math favors those who calculate the odds, have a portfolio, and prune companies ruthlessly . . . most first time entrepreneurs will never have the leverage to find someone who respects their aspirations and dreams beyond the financial returns that it represents.
Lots of people talk about how the venture industry is broken from a financial returns perspective. I think it is broken for the people that matter the most – the entrepreneurs who empty college savings accounts, give up the most lucrative portion of their careers, live off ramen, and bet it all on black. Unfortunately we can’t all be black swans.
I love the lean startup ethos and methodology. It is by far the best thing that has happened to the startup community since the onset of the internet-fuel renaissance in entrepreneurship. These days at MuckerLab, we try to utter the basic concepts (mvp, iteration, hypothesis testing, customer development, etc) as much as possible to help our entrepreneurs and ourselves stay on track. People that have heard me talk at panels and conferences probably think I’ve been brainwashed by the cult of Eric Ries, and I would be flattered. BUT certainly before the lean startup movement there were wildly successful and visionary entrepreneurs. And long after “lean” becomes indistinguishable from entrepreneurship itself, there will continue to be failures and disillusioned entrepreneurs. Lean is not a panacea or a blue print for success. It’s a framework and like any framework, it can be misused. After immersing ourselves in the ethos and watching our entrepreneurs apply the lean methodology in their startups, we are starting to learn more how to adjust and adapt the formula in different circumstances.
It is certainly a lot easier to apply the lean methodology to consumer focused businesses than it is enterprise focused businesses. In enterprise, lean works, but it takes more patience, rigor, and flexibility. Customer development will always improve the signal to noise ratio for better product-market fit; but given how hard it is to scale enterprise customer development, it is extremely important for entrepreneurs to be wary of any data they are gathering given the small sample size and potential for sample biases. If possible, I like to start the customer development process with a very wide funnel as to diversify across multiple segments within the target market . . . and quickly narrow down to a specific receptive segment as additional data comes in (essentially abandoning certain customers along the way).
In addition, the enterprise software business follows adoption patterns that are significantly closer to the “Geoffrey Moore” model than the “viral” adoption model we come to expect in the consumer Internet world. In enterprise, early product market fit is just that – early. Until the product has crossed chasm – it hasn’t. In this market, the traditional top down category marketing playbook is still the only playbook to cross the chasm. CIO’s often (for better and for worse) allocate their budgets based on latest trends and research that are heavily influenced by industry analysts (Gartner for example) – so enterprise software entrepreneurs will have to invest dollar and time to slowly build mindshare for its product category and company. Initial product market fit only buys an option to play in the big leagues where old games are still played by old dogs. Most enterprise companies will not come close to achieving the types of exponential growth more common in consumer product (in which signal will overwhelm any noise) until much later in their company lifecycle.
The other interesting dynamic we are seeing is that network effects driven businesses (e.g. marketplaces, social networks, UGC applications) also require a slightly more patient and acquisition focused approach to “lean.” By definition, these businesses need a critical mass of supply / demand (e.g. users and content ) to achieve their core value proposition. As a product or feature is released to market there is a huge temptation to declare the “test” a failure based on initial data when in fact it has nothing to do with the product but as a result of the lack of content and/or users. Pinterest famously stagnated with the same basic product for over a year before hitting a tipping point and taking off once the site achieved usage and user escape velocity. In short, it is more about market-market fit than it is product-market fit. The product’s objective is to retain users and reduce transactional or communications friction, but aggressive acquisition tactics and often lots of luck is needed to truly test for product market hypothesis. There is a tremendous focus on avoiding type I errors in the lean methodology, but avoiding type II errors are just as important to the eventual success of a startup.
This is not an article I wrote – its an interview I gave and eventually published in Inc Magazine. BUT – since I had no idea I sounded so cogent and witty on the phone I thought I excerpt it here and link over
If you’re taking time to carefully perfect a business plan to help ensure your company’s model is sound and that it will be a success–stop. That’s the word from William Hsu, c0-founder and managing partner at start-up accelerator MuckerLab.
Hsu, who’s been both a successful entrepreneur and an executive at AT&T and eBay, says that starting a company is ”a career for really irrational people. In all probability, whatever the idea is will fail. Building a reality distortion field is how entrepreneurs convince themselves and their employees that this is a good idea.”
I was planning to blame it on demo day, but in reality, I am simply having writer’s block. (Another possibility, I just ran out of interesting things to say – which is very likely given how much I’ve spouted off in the past.) There is a cure; however, for writer’s/blogger’s block – its called top ten lists. The dirty little secret in blogging is that anytime you see someone posts a top ten list – it usually means that he/she ran out of shit to say. So to cure my writer’s block – here is a top ten list: Top Ten Sh*t Not to Say to a VC. (in no particular order)
10. “Blah blah blah blah . . . Daily Deals . . . Blah Blah Blah” – Its unfair, I know – consumers are still lapping up deals, and businesses are issuing coupons like never before. BUT VC’s have all moved on. The reality is that it just takes too much effort, time, and tongue twisting for a VC to tell his buddies how his latest investment is better than all the other daily deal companies that came before it. And it will take too much effort for you too.
9. “Big shots like A,B,C,D,E,F,G are advisors” – Simple rule . . . advisor AND investor is 10x better than just an advisor. Doesn’t mean you don’t want lots of advisors and mentors, you do. You want LOTS of helpful and passionate advisors – just be careful about thinking that VC’s will give a damn. I care about your ability to convince important and influential people to help you build your business (and invest) – I don’t really care who they are, and how many there are. Its not about who, its about you.
8. “. . . . Uncapped Note . . . . ” – If you are an YC company – go for it. The rest of us mortals – let’s get real and understand the point of investors is to have smart people with money on your side.
7. “I’m pretty sure my product will sell itself, I’m not worried about customer acquisition” – Saying that you are not worried about customer acquisition is like saying you are not worried about running out of gas. If you are not, you will eventually. So, pretend you are worried even if you are not and either have a really detailed customer acquisition plan or show some metrics that allay the fears that acquisition would be too expensive or will never scale. Even product purists care about acquisition.
6. “ . . .. SoLoMo . . .. ” – Pick 2 out of 3. Any two. And if you must, at least jumble up the sequence – “MoLoSo?” or “LoMoSo?” . . . just don’t say “SoLoMo.” Everytime I hear it, a tingle goes up my spine (not in a good way), and I’m pretty sure I’m not the only one.
5. “I don’t need to do market research, consumers are incapable of envisioning the future, you just have to give it to them.” – to which a VC could only respond, “I served with Steve Jobs, I knew Steve Jobs, Steve Jobs was a friend of mine. You sir, are no Steve Jobs.”
4. “My product is naturally viral” – Every entrepreneur claims to have a “naturally viral” product. Its like everyone believing he/she is an above average driver. The fact remains that average CTR on facebook news feed links are around .2% – about the same as banner ads . . . no one has ever claimed that banner ads are viral. Until a product have gone viral, its not viral.
3. “My addressable market is $XXXB” – Any marketsizing higher than $100B (actually, I would really be careful starting around $50B ) is simply not credible. It either means the entrepreneur has no idea how to segment the market to find the initial target customer segment (and thus a smaller addressable market) AND/OR the entrepreneur has no idea how to tie his business model to a market sizing calculation. (e.g. if you are selling foodtrucks , you can’t say your addressable market is the total $$$ of food sold by foodtrucks.) Neither one builds confidence.
2. “I want to build a great user experience, I don’t care about monetization and revenue.” – There are a handful of guys that can say this – Zuckerberg, Dorsey, Page, Brin, etc. Plus the only reason they can say it, is because they have proven abilities to build a large audience AND eventually figure out a way to make lots of money. Unless your last name happens to be one of those, you need to have a plausible business model (BUT typically you don’t need to have exact pricing figured out).
1. “I’m Pinterest for . . .” – You know, I cannot figure this one out. Apparently it is perfectly fine to be “AirBnB for X,” “ShoeDazzle for Z,” and “Dropbox for Y” . . . but the moment someone utters the word “Pinterest for …” everyone’s eyes just glaze over. Just don’t do it.