Not Building a Unicorn

TL;DR: In a market that has historically idolized huge, splashy financings and exits, an increasing number of entrepreneurs are realizing that everyone else’s definition of success – particularly among certain large VCs – isn’t necessarily aligned with their own.

While I work with a few companies in Silicon Valley, the vast majority of my clients are either in Austin or ecosystems that look much more like Austin than SV; “second tier” tech communities. Over time it has become crystal clear to me, and has been confirmed by CEOs I work with who spend time in both places, that the SV community has a far more binary outlook on business success than “normals” do. There is very little time for, or interest in, companies that would legitimately call a $50MM or $100MM exit a true success.

This is most clearly highlighted in the “unicorn” boom we all saw over the past few years, where founders raised very large rounds, with terms very onerous to the underlying common stock, hoping they could eventually justify billion dollar valuations to skeptical acquirers or public market investors. The result of the binary philosophy is, in fact, truly binary outcomes for founders. The handful who truly succeed at justifying their valuation in an exit achieve “buy a yacht” level wealth. And those who in a different world may have built a business that made them “merely rich,” walk away with virtually nothing; their stock under water. 

A good portion of the newer generation of entrepreneurs has, in my opinion, wised up to this reality; certainly outside of SV, where I work. They’re thinking much harder about what kind of business they want to build, and what kinds of people and resources they want to use in building those businesses. And many are accepting, and even flaunting, the fact that, while they absolutely want to achieve success and wealth, they have zero interest in following the conventional “unicorn track.” The below is a list of issues that founders should keep in mind when deliberating on their own desired path to scaling their companies.

1. The binary “get yacht-level rich or die trying” mindset is driven, first and foremost, by large institutional investors. 

Success for institutional VCs is driven not by absolute dollars returned, but by % returns on capital. If I put in $2MM and get out $10MM in a $50MM exit, that’s a solid 5x return. But if I put in $10MM and get out $15MM in a 50% larger exit, that was still a waste of my time; only 1.5x. Large funds write larger checks because they lack the mental/resource bandwidth to actively manage a portfolio of smaller investments. Most individual VCs can only support about 7-10 companies at a time. And large checks require very large exits to achieve good returns.

Entrepreneurs sometimes assume that accepting money from a large fund is better than a smaller fund, because they have more “dry powder” to deploy for follow-in financings, but this is a dangerously simplistic way of assessing investors. A large fund is much more likely to get impatient with an executive team if the business is growing, but not growing fast enough for their needs. Align yourself with a fund whose exit expectations are not totally misaligned from your own.

2. Higher valuations almost always require larger rounds, which drive binary outcomes.

Some founders assume that a higher valuation is always better than a lower one, but they are wrong.

First, investors will sometimes be willing to take a higher valuation if it means getting a heavier liquidation preference. Should you accept a 3x liquidation preference with a $15MM valuation instead of a 1x preference at a $8MM valuation? If you’re confident you’ll get a huge exit, maybe. But for normals the answer is almost certainly no. That 3x preference has dramatically increased the hurdle you need to clear in an exit before the common stock (you and your team) get anything, and it will likely get duplicated in future rounds. Onerous liquidation preferences push the common stock further under water, and increase the likelihood that the common will get little or nothing in a “merely rich” exit.

Secondly, most institutional investors have a minimum post-closing % they need to own in order to justify an investment. By driving the valuation up, you’re usually not reducing your dilution in the round; you’re just increasing the size of the check they need to write in order to get to their desired %. That can be good if you truly believe every dollar will lead to more than an extra dollar in an exit, but keep in mind that liquidation preferences are tied to dollars in by investors. If the investors have a 1x preference, a $5MM round means the investors have to get $5MM back before founders get anything; and the same is true for a $15MM round. More money raised means more liquidation preference, which again means a larger hurdle to clear in an exit before the common gets anything. Large rounds, again, drive binary outcomes.

When an investor tells you that you should keep your Series A smaller, they truly are sometimes doing you a favor. And, sorry, but if you know you’re not building a unicorn, don’t talk to your investors about why you should get that lofty valuation just because X or Y company in SV got it too. Likely exit size ties directly to what seed or Series A valuation is appropriate.

3. Angels/Seed Funds v. Institutional VCs think very differently.

Put the above two points together, and it shouldn’t require very much explanation for why Angels and Seed Funds tend to be more amenable to “merely rich” exits than large VCs. They write smaller checks at earlier, lower valuations, and therefore an exit that wouldn’t move the needle for a large VC still looks great to them. Obviously they too prefer larger exits over smaller ones, but their definition of success is still much more aligned with “normal” entrepreneurs.

Angels and seed investors may want enormous exits, but large institutional VCs need them, and they behave accordingly.

We’re increasingly seeing entrepreneurs who take on angel and seed fund investment, but are much more cautious when it comes to larger institutional checks. And as online tools and new ecosystem resources (i) allow angels and seed funds to syndicate larger early-stage rounds, and (ii) un-bundle the value-add resources once limited to larger funds, non-institutional Series As (or larger-than-usual seed rounds) are going to continue to be a thing.

It can often take a few years of being in the market to get a clearer picture of what kind of company, in terms of size, you’re likely building. It can be a good strategy to avoid making a hard commitment to an investor with hyper growth needs/expectations until you have that clarity. 

4. Understand the tension between “Portfolio” v. “One Shot” incentives.

Listen to enough VCs at large firms w/ broad portfolios talk about startup finance, and you will inevitably hear the term “power law” come up. In short, they’re referring to the fact that most of their investments either fail or merely return capital, and it’s the grand slams that make up for the other losses.

This is the distributed portfolio mindset; i’ve got stakes in a lot of companies, so it’s OK if most fail, as long as I get at least one unicorn. In fact, if I push them all to try to be a grand slam, I’m more likely to get at least one. On the others, at least I’ll get my money back before anyone else does.

The fact that (i) investors have a liquidation preference that prioritizes the return of their capital in an exit, and (ii) their money is distributed across a diverse portfolio, means that they are structurally far more inclined to favor fast growth paths that produce a handful of very large exits even if they also produce a larger number of companies for which the common stock get nothing. At its core, this is precisely why the idea that founders/employees (common) and institutional investors (preferred) are “fully aligned” economically is completely laughable. 

A strategy that maximizes returns over a diversified portfolio with significant downside protection can completely screw individual stockholders whose own stakes are limited to one company, and at the bottom of the preference stack.

Startup ecosystem “cheerleaders” who lament the lack of billion-dollar, headline-making companies in their city reflect part of this portfolio mindset as well. If I’m not toiling away for 10 years on one company, but stand to benefit from the broader ‘ecosystem,’ I may also favor a business philosophy that pushes entrepreneurs to build big, splashy unicorns (large rounds, very fast growth), or otherwise crash & burn.

Reality check: entrepreneurs don’t have portfolios, and don’t have liquidation preferences. They have one shot, and they’re slogging away 5-10 years for that one shot; not for your “ecosystem.” If I have 100x skin in a single game over everyone else, I’m going to have a fundamentally different outlook on how that game should be played.

When I hear someone complain that Texas hasn’t seen a lot of strong tech IPOs recently, my response is “so there’s no other way to be successful?” Why should we favor 1 billion dollar company over 10 $100MM companies, or 20 $50MM companies? I can think of a few arguments for why the latter is actually more robust long-term from an economic standpoint, even if it produces fewer NYT articles. It certainly provides more variety.

Obviously it’s great when any city sees a true breakout, international brand-building tech company emerge. And Silicon Valley produces, and likely will continue to produce, the lion share of those.  But those of us sitting on the sidelines, and not toiling away on one egg in one basket, need to be humbly mindful of how our discussions on success play out in the lives of entrepreneurs actually doing the work.

Elon Musk. Steve Jobs. “Change the world.” “Put a dent in the universe.” “Move fast and break things.” “Shoot for the moon; you’ll land…” yeah, ok, I think we all get it. Can we please let some entrepreneurs “just” build successful companies that make their stockholders “merely rich” – and skip the super hero cape, global domination, rocket ship, and mythological creatures? There is a big, lucrative world in the space between “small business” and “billions” that many smart, ambitious people are happy to fill. 

I think the greater awareness of this issue, and the overall shift in thinking among entrepreneurs, is an extremely healthy development for everyone. It will lead to more sustainable companies, and a healthier entrepreneurial culture. If you’re building the next Facebook, by all means go ahead, and align yourselves with people looking for a ride on that train. But the other 99.999% of the world doesn’t need to apologize, at all, for building companies that are “merely successful.”

Do my startup’s lawyers need to be local?

TL;DR: No. Most top startup lawyers have clients in many different cities, and lawyers specializing in emerging tech/startup work usually exist only in denser tech ecosystems. Familiarity with your ecosystem, and the expectations of its participants, matters more than being physically local.

Background Reading:

If you live in a small town/city and need specialized (not general practice) medical care, you most likely need to look to a larger city to find that specialist. Any kind of service provider needs some minimal user base to build a viable practice. Larger cities have a higher concentration of patients, and therefore a higher number of patients needing a particular specialty, which is what enables the development of specialist doctors.

This is why cardiologists generally don’t live in farm towns, at least not during their working-week. They live in larger cities. And neonatal cardiologists (even more narrowly specialized) generally only live in the very largest cities.

For localized work, specialization requires density.

It’s also why true startup lawyers – corporate lawyers with a focused practice in emerging tech and venture-backed companies – generally exist only in cities with dense startup ecosystems. Even with modern technology that enables casting a wider net for your market reach, most professionals rely significantly on a local client base. If that local base doesn’t exist, they move to where one does, or they change their practice to mirror the local market. Houston has among the world’s top energy lawyers, but slim pickings for technology/vc lawyers. Boston has among the world’s top healthcare lawyers, but slim pickings for entertainment lawyers (many of which are in Los Angeles). No surprises there.

So to the extent work has a heavily local component (like healthcare, and to a lesser extent law), if you need a particular kind of specialized service, you are smart to look for it in places that have a real density of users for that service. Otherwise you will end up with sub-par local providers, which can be fine if the stakes are low, but disastrous when they aren’t.

Startup Law really isn’t that localized.

It may come as a surprise to people that, for a significant portion of my client base, I have never met the principals in person; and likely never will. Videoconferencing and teleconferencing serve just fine (in addition to other tech tools). That is actually the case for a lot of lawyers with specialized practices. Most serious startup/VC lawyers that I know have clients in multiple cities. In my case, about half of my clients are in Austin (reflecting the need for a dense local base to usually build a specialized practice), and the other half are not (confirming that being local isn’t required at all).

Unlike a cardiologist, I don’t need to physically examine anyone to do my job, which makes geography largely irrelevant. Because most startups generally incorporate in Delaware for reasons discussed throughout the startup blogosphere, local state law only plays a small role in most of the legal issues that startups deal with (usually local employment law); and for those issues, most startup lawyers collaborate with local employment lawyers. The corporate issues generally require very little understanding of local state law. I have quite a few clients with lawyers in half a dozen different cities, none of which are the city where the company is headquartered. And it works just fine.

More important than truly local lawyers is lawyers who are familiar with working in ecosystems that look like your own. The norms of Silicon Valley financing and governance are very different from those of Denver and Atlanta, as an example; both what some would call “2nd tier” ecosystems.  But a Denver lawyer would be quite comfortable with Austin norms, and visa versa.

Local v. foreign specialized lawyers is about tradeoffs.

Silicon valley startups generally use silicon valley startup lawyers. Austin startups generally use Austin startup lawyers. And in both cases, that works very well, because there isn’t a cost to ‘going local.’ Being able to meet up once in a while in person with your service providers is obviously nice from a relationship standpoint. There is some benefit also to your investors being familiar with company counsel, although that issue is usually exaggerated for reasons that I’ll discuss more below.

So if you can get the nice benefits of having someone local, without many costs, going local is usually a good idea as long as you can find someone local who isn’t captive to local investor interests. And sometimes you can’t. See: “How to avoid ‘captive’ company counsel.” There is no set of advisors for whom a founder/management team should care more about their independence than company counsel.

For startups with less dense ecosystems than Silicon Valley or Austin, however, the cost to going local can be much higher. The reason VC or Angel-backed startups in Houston, San Antonio, Dallas, Atlanta, Miami, New Orleans, Phoenix, Salt Lake City, and similar cities often hire startup lawyers who aren’t local is that they (correctly) recognize that their local ecosystems (generally) lack the density to support truly specialized, scalable startup/vc law practices. Each of those cities has fantastic, very smart corporate lawyers who likely have some tech clients, but startup/vc law as a specialization is more difficult to find; although there are exceptions.

My non-Austin clients have concluded that it’s much better, and more efficient, to collaborate with lawyers in another city who’ve seen the exact issues they’re dealing with dozens of times, and have the resources to address them quickly, relative to someone who may be easier to grab beers with, but hasn’t. CEOs need to exercise their own judgment for their own circumstances.

Be careful with localism, and localist incentives.

“Localism” is a term I’ve started using to refer to the underlying, subtle incentives among ecosystem players that push them to promote local people onto a set of founders, sometimes at a very high cost to the company; discussed in the links at the beginning of this post. Ask any experienced founder, and they’ll tell you about so-called “advisors” or “mentors” in their local ecosystem who, while fun to hang around as cheerleaders, unfortunately don’t actually deliver much real advice or mentorship. There are some great advisors/mentors out there, but also a lot of duds.

There are, broadly speaking, 2 ways (not mutually exclusive) in which service providers (venture capitalists, lawyers, accelerators, accountants, advisors, etc.) build their portfolios: (A) being actually good (objectively) at their service, and (B) building relationships and generating referrals from those relationships. Most A-level people rely on both (because the first leads to the second).  But there are a whole lot of people in every business community who are quite mediocre at the actual service they provide, but are exceptional at marketing themselves and building referrals.

If my social capital is the primary way that I get business, then I’m heavily incentivized to refer to people within my personal, local social circle, even if I know that objectively, someone better may be in another city. That “someone better in the other city” has his own social circles she/he belongs to that aren’t as inter-connected (or dependent) on my own. Sending business to them makes it less likely that it’ll come back to me, unless there’s some objective reason for the referral.

I don’t mean to sound cynical about all of this. It is how a lot of good people build their practices and reputations in the business world, and it’s just fine. But it’s important for every team to to be aware of these dynamics in their raw form, and correct for them as needed. And believe me I get the “farmers market” “go local” “support the LOCAL ecosystem” aspects of promoting local people as well, even if I believe the more self-interested dynamics underly a lot of that; at least as it relates to service providers. 

There’s something noble in that, but not when it comes at the expense of founders – who are putting their entire livelihoods on the line – getting shit service. As I’ve written before, nothing builds an ecosystem more than great companies, and great companies aren’t built with mediocre people. 

Watch out for ‘captive’ local counsel.

Circling back quickly to the issue of captive company counsel is a good place to close this out. For many people in startup ecosystems, localism is driven either by self-interested referral circles, or ecosystem cheerleading.  But for the most influential players in a particular ecosystem, it can also be driven by control. Thankfully the transparency of the web is weakening this dynamic, but institutional investors with heavy local influence often like to see local VC lawyers in the company counsel seat because they’ve strategically built leverage over those lawyers by (i) being their clients, and/or (ii) pushing portfolio companies to use them as company counsel. In other words, they’re company counsel, but… not really. 

Obviously you’ll never hear anything like this stated flat out in a board meeting. What you’ll more often hear is discussion about credentials, or familiarity, or experience, etc. etc. “I’m not sure those lawyers have the right experience” or “We’re more comfortable with these guys.” As I’ve written before, sometimes those concerns have merit. Take them seriously, and if you need to upgrade, go through the process yourself to find independent counsel. But also understand how these comments are usually veiled attempts at pushing companies to engage lawyers who are captive to the investors’ interests, and unable to fully represent the company.  If your lead investors seem peculiarly interested in your using a particular set of lawyers, that’s often a good indication of whom you should avoid.

Yes, there’s some reduction of “friction” when company counsel is familiar with the norms/expectations of investors across the table. But its value shouldn’t be overstated. Sometimes what investors call “friction” is just your lawyers doing their damn job. In this regard, we have seen companies from smaller ecosystems choose to engage foreign company counsel not because local VC specialists weren’t available, but because the founder team viewed them all as captive. Sometimes (but not always) they are right. 

There’s no right answer for all companies on this issue. Specialization is important. Local can be helpful at times, but also costly in specific circumstances. But you’ll arrive at a much better decision by weighing all the variables, instead of just assuming that “going local” is a requirement. It most certainly is not.

Do I need a PPM for my startup’s financing?

TL;DR: Legally speaking, probably not. Most tech startups never prepare one.

PPM stands for “Private Placement Memorandum.” You can think of it as the private company equivalent of an S-1, the long disclosure document that companies produce when going IPO. PPMs are lengthy documents that include risk factors, financial projections, business plan information, etc.  For a broad description of what a PPM is, see this article.

In dense startup ecosystems, PPMs are rare.

Startups in dense, more mature tech ecosystems like SV or Austin usually don’t even think of producing PPMs; nor should they. Assuming that they are taking the classic approach of raising money only from accredited investors, a well-made deck and a solid operating plan are often their core needs for closing on early money. Delivering an Austin tech investor a PPM would send an immediate signal that the founders aren’t being well-advised, which itself signals poor judgment in choosing advisors. 

Asking for a PPM signals inexperience.

In less dense ecosystems, however, I do occasionally encounter tech companies who are told by advisors, lawyers, or other players that they need a PPM to close on financing. FACT: The vast majority of tech startups raising money solely from accredited investors are not creating PPMs, and legally speaking, they don’t have to.  Most repeat ecosystem players consider PPMs a waste of time and money. 

One of the main reasons that startups avoid non-accredited investors and stick to accredited-only rounds is that the legal disclosure burdens are dramatically reduced, which means no need for PPMs. In healthcare, energy, and a whole host of other industries, using PPMs in private fundraising is very common. For this reason, if your lawyer is telling you (a tech startup) that you need a PPM, that’s often a good ‘tell’ that they lack experience in the norms of emerging tech financing. 

Exercise diplomacy with more traditional investors.

All of the above being side, I have also on occasion encountered more traditional investors who, because they do not regularly invest in emerging tech companies, ask startups for PPMs (because PPMs are more common in other industries).  All money is green and, particularly for early angel money, you need to be respectful of the expectations that angels bring to the table; even if they’re ‘off market.’

In these situations, it’s best to diplomatically let them know that PPMs are not the norm in the tech startup space, and that the company would prefer (as should they) to focus its legal budget solely on those things that are truly needed.   Asking a more traditional investor what specific information she/he was hoping to see in the PPM, and trying to address those concerns more informally, usually goes a long way to bridge the gap. Sometimes hearing directly from a Tech/VC lawyer about the norms of startup finance also helps. 

Founders outside of Silicon Valley can sometimes forget that most of the resources – blogs, articles, podcasts, tweets, etc. – on startup finance and norms are, in the grand scheme of things, a tiny bubble in the overall business market.  When anyone says there simply “isn’t enough money” available for startups in Texas, or markets similar to Texas, what they really mean is that there isn’t enough money flowing into tech companies. There’s tons of money floating around elsewhere. People who can culturally build bridges between tech ecosystems and more traditional business networks have a competitive advantage in the market, and are often the ones forging ahead building new companies, and even investment funds, while others run around in circles soliciting only the ‘techies’ of the market.

Local v. Out-of-State VCs

Some things in life are certainties. The sun will rise tomorrow, you will be taxed for something… and startup ecosystem players across the world, outside of Silicon Valley and NYC, will complain about the lack of local VC capital, and the need for more foreign capital. Are they correct in complaining? I’m not going to answer that question. Too debatable, and the debate gets you nowhere.

What I am going to say, and I’m saying this as someone who manages a legal practice with visibility into a decent number of 2nd/3rd ‘tier’ ecosystems in the U.S., is that there are a lot of reasons to be optimistic about the overall trends in this area.

The Historical ‘Scarcity Culture’ of Local Venture Capital

Not just in Austin, but in many tech ecosystems that have a similar profile, there’s historically been a culture among the institutional investor community that directly reflected the scarcity of local capital, and of information about that capital. I will call this ‘scarcity culture.’ Trying not to come off as too judgmental, because all institutional capital plays a vital role in the business community, regardless of its approach, I would say that scarcity culture is largely summarized with the following statement:

“You don’t like our terms or our behavior? What can you do about it? What alternatives do you actually have?”

Does this mean that all local VCs outside of the densest markets think that way? Of course not. But it is definitely there, in a variety of ways.

Anyone with a broad enough visibility into American venture capital knows it is an absolute fact that California VCs are generally ‘friendlier’ than the VCs of any other ecosystem. By ‘friendlier,’ I mean that they are OK with higher valuations, they are more transparent in their intentions, and they tend to show significantly more deference to a founder team in terms of providing coaching/opportunities for growth as opposed to an early pink slip.  Why is that?

Is it something in the water? The weather? Have they achieved a new level of enlightenment? Hell no. California VCs have the same job as VCs anywhere else: to make money.  The answer lies in one very simple word: competition. And increasingly over the past few years it is magnified by one more factor: increased transparency through technology and decreased friction in networks. 

Competition and Reputation. 

Let’s use an analogy here.  Do you think that restaurant service is better or worse in dense urban environments relative to small rural areas? Obviously it’s better. There’s more competition.

Do you think the existence of Yelp, and the ability of restaurant goers to (i) easily find information on the past experiences of patrons of a specific restaurant and (ii) easily express their own experience about those restaurants, has improved or reduced the quality of restaurant service? It obviously has improved it. There’s a million times more transparency, which dramatically raises the reputational stakes.

In an environment where a quality founder team can, if they don’t like one particular set of VCs, walk almost literally across the street and talk to 10 more, investors have learned (rightly) that to be an asshole is to step right into a massive adverse selection problem. Combine a truly competitive market with inter-connected networks where reputational information flows freely, and you have a system that naturally corrects for bad behavior.  The really good companies, the one’s that everyone would want to invest in, don’t have to put up with anyone’s nonsense; and they do their homework. 

Contrast that with ecosystems where only a handful of investors, many of whom collude with one another, are available for companies that need serious funds, and you have a very clear explanation for why California capital is ‘sunnier.’  California VCs are more “founder friendly,’ because their circumstances make founder friendliness an almost essential requirement for deal flow. Most assholes can’t even survive in that environment, so it selects for ‘nicer’ people.

I am not saying that west coast money is all cotton candy and rainbows; nor am I saying that non-SV local VCs are all difficult to work with. But broadly and relatively speaking California VCs tend to be much easier for a founder/management team to get along with. It is also no surprise that the rise of industry/vertical-focused VC and VC ‘value-add services’ has come out of California. They’ve got to find a way of differentiating themselves in the noise.

Transparency and Friction.

A decade ago, if you needed to connect with X person for whatever reason – to diligence an investor, to connect to an investor, to find out some piece of information – you faced enormous opacity in finding a path to doing so. This opacity added friction not only to connecting with people far outside of your personal network, but also to obtaining information, including reputational information, about market players. Information is essential for separating marketing/branding from reality.

Blogging is marketing. Twitter is marketing. Talking on panels is marketing. Free office hours is marketing. That free beer at the ‘get to meet investors’ meet-up is marketing. This should be obvious to smart CEOs. Yes, this blog is marketing. Calling something marketing doesn’t mean it’s false; it just means you’re acknowledging the incentives behind it. And that you need a mechanism for verifying what you’re being told.

My method in biz dev is simple: “here’s a list of my clients. reach out to any of them, and don’t tell me which one. Ask them about our rates, and our responsiveness, and the independence of our counsel. I welcome diligence.”

Today, if I run into a set of founders who are talking to VCs, whether they are clients or not, I say “Here is a list of their past investments. Get connected to the founders of those companies, and start asking questions. And don’t tell anyone which ones you are talking to. Don’t treat any single ‘review’ as gospel, because it is a one-sided story. But look for patterns.” For a team that is even mildly good at networking, that is a fairly straightforward task. LinkedIn does 80% of the work for them by letting them know exactly who in their existing network, whether they’re local or not, can connect them to their target.

Tools like LinkedIn, AngelList, Facebook, and Twitter, and the way in which they eliminate huge amounts of friction and opacity in networking, have done two game-changing things for founders: (1) they’ve made expanding their networks beyond their local ecosystem 10x easier (I didn’t say easy, I said easier), and (2) in doing so, they have made finding accurate reputational information about market players 100x easier. That ease of accessing accurate information influences the behavior of investors in exactly the same way that Yelp influences the behavior of restaurants.

In an opaque market in which influencers can control access to people and information, you can reap the benefits of being an asshole without facing many of the costs. Today, the transparency brought about by modern tools and networks has made the costs of bad behavior 10x higher. Technology makes technology investors ‘nicer’ by opening up access to accurate information on market players. Knowledge is power. 

Improving Local VC. Accessing out-of-state VC. 

Thinking of this issue broadly with the above concepts: improving transparent access to accurate information, removing friction in expanding networks, increasing competition, I think we can arrive at some useful ideas for both improving the local investor environment in non-SV markets, and in increasing the flow of capital between markets; beyond the “great companies attract great capital” truism that rightfully causes eye-rolls among founders.

1. Founders/management need to talk to each other more, in places that aren’t controlled by the investor community. 

Information flows most freely when the consequences of sharing it are minimized. You better believe that in some markets where key players serve as gatekeepers (see: Gatekeepers and Ecosystems) the threat of being black-listed somehow for speaking honestly is real. You will never get accurate market information on blogs, on twitter, on panels, or in highly public events where anyone and everyone is watching.

To use Brad Feld’s categories: there are entrepreneurs, and then there are “feeders,” which sort of means everyone else. Events and communities where the whole ecosystem is invited are great. But that entrepreneur v. feeder divide is crucial, and there need to be ways for entrepreneurs to share information with each other, confidentially and alone.

That is the best way to create the following causal chain: (1) bad market behavior -> (2) information shared to broader entrepreneurial community -> (3) adverse selection for bad market player -> (4) correction to behavior.  You get along much better with the VC community when, instead of moralizing about their tactics and behavior, you try to understand their goals and their incentives; and find ways to align them with yours.

2. Outreach to foreign capital needs to come from people who don’t benefit from a scarcity/opacity environment.

Do not expect for a second that market players who benefit from scarcity of local capital and opacity of information will improve the environment for you. In a variety of ecosystems, I have seen circumstances in which local capital deliberately tries to keep out-of-state capital off of a cap table if it is not willing to enter on their terms. If a founder team builds local support and then themselves builds independent relationships with out-of-state capital (directly or via local relationships), that will create very different dynamics relative to a situation in which their local capital syndicates with its own existing out-of-state syndicate partners.

Is building those out-of-state relationship easy? Of course not. But it needs to start early. The companies that successfully receive out-of-state participation in their Series A round often were building those relationships at seed.  And the best intro to a particular investor is through a founder that they already invested in, so local founders who’ve accepted out-of-state capital are vital to encouraging that capital to engage more local companies. Once a foreign VC has made an investment in a city, it is a lot easier for them to look at others.

The angel v. institutional capital divide, highlighted somewhat in “Protect Your Angel Investors” is important here too. True angel investors – not the ones that behave essentially like micro-VCs, but the ones who are playing with their own money and who are really in it for more than just a return – typically behave very differently from institutional capital. They are usually more patient, more attached to the founder team, and usually aren’t laser-set on a “10x or bust” mindset that institutional investment often brings. Angel investors with broad networks can play a huge role in encouraging out-of-state capital to enter new ecosystems.

Just please for all things holy ignore any set of lawyers pretending to provide ‘special access’ to out-of-state investors. There is a hierarchy of paths to investors. If lawyers are even on it, they are near the bottom.

3. De-risk long-distance investment by improving communication.

If I’m an investor deciding whether to invest locally or make a bet on a team 1,000 miles away, I see substantial additional risk in the latter simply because of the added friction in communication. This is particularly important at seed/Series A, where feedback loops between investors and founders are more important. Think of ways to signal to long-distance investors that you will actively remove that friction.

Videoconferencing, well-done regular investor updates like through AngelSpan, committing to flying to meet-up in person regularly, are a few ways to do this. If entire companies can run with remote teams, leverage similar mechanics/tools to make long-distance startup investment seem natural and logical.

4. Reduce search costs. Successful curation is king. 

Finally, while communication issues often make long-distance investment at least seem difficult, you should never ignore the fact that to any investor, simply vetting out-of-state companies is much harder than vetting local ones. Most institutional investors build in various filters and qualification mechanisms into their pipeline/deal flow, and they often break down when looking at companies that are mostly outside of their usual network.

So creating credible, successful curation mechanisms to reduce the ‘search costs’ of institutional investors exploring non-local markets is essential. The obvious answer here is, and has been, accelerators; at least to the extent that accelerators aren’t beholden to particular local funds (in some markets, they are). The most prominent accelerators are playing extremely important roles in connecting companies in one market to investors in other markets, because those investors trust that the accelerator has done a significant amount of pre-qualifying for them. In fact, this curation dynamic is part of the core value proposition of accelerators in the first place.

Another obvious answer is angel investors with prominent personal brands. As angel investors develop broader reputations for selecting winners, out-of-state institutional capital can leverage them to reduce the search costs of exploring other markets.

So, is raising a Series A outside of Silicon Valley and NYC really hard? Absolutely. Then why the reason for optimism? Because every single variable/dynamic mentioned above is improving, and at an accelerated pace. Founders are finding each other and communicating directly, sharing accurate information about the investor community and other market players; aided by modern networking and communication tools. Local angels and entrepreneurs are actively using those same tools to expand their networks far beyond their local ecosystem. Tools for long-distance communication and investor relations are maturing. And accelerators and prominent angels are increasingly becoming curation mechanisms leveraged by institutional investors to reduce search costs and explore new markets.

We are certainly seeing all of this happening at an increasing rate in our work in the market. As additional funds that are more comfortable operating in the new environment pop up, and as geographic barriers are reduced for capital flows, the more established players are increasingly more concerned with their brands and reputation. Instead of a “scarcity culture,” an open, transparent market culture favors investors that deliver real value and build durable, authentic brands.

Raising local and out-of-state institutional capital, and ensuring you’re working with good people, is still extremely hard if you’re not in a top-tier ecosystem. And speaking as ‘just’ a lawyer, I don’t want to minimize that fact in any way.  But the truth is that it’s also never been easier, and the core trends suggest it will keep getting better. 

Founder Education

TL;DR: Accelerators have emerged as elite universities of sorts for tech entrepreneurs. But they offer a bundled value proposition at a price (in terms of time and equity) that doesn’t work for everyone. For those teams in need of just the educational aspects of an accelerator, other (quality, but lower cost) offerings are starting to be developed that should be considered.

I’m a huge proponent of curation and leveraging the knowledge of trustworthy domain experts to avoid burning time; time that could otherwise be spent running a company.

The value of curation in the lives of founders is perhaps reflected best, above all else, in the rise of accelerators. Accelerators’ core value proposition to founders is that, in exchange for (i) several weeks of their time, (ii) an equity stake, and (iii) rights to invest in future investment rounds, founders in accelerators gain virtually immediate access to significantly curated resources: investors, mentors, other founder teams, prime office space, educational content, etc.

And on the flip side, great accelerators are able to attract quality resources by promising the people who provide those resources access to a curated set of startups; saving them time from having to sort them out in the general marketplace.

Of course, the value of those resources and their curation varies wildly depending on the quality of the accelerator. Top accelerators have proven invaluable to many young, inexperienced founder teams who’ve saved countless time searching, networking, vetting, etc. by tapping into an accelerator’s network and resources. Lower quality accelerators, however, are often a time suck, and much like the “Top Startups to Watch” lists we all see get thrown around, can serve as a damaging and distracting vanity metric.

But as much of a fan as I am of great accelerators, the reality remains that accelerators offer a bundled value proposition. And not every founder team needs, or is willing to ‘pay’ for, the entire bundle. Some founders have already arrived at a successful business model showing strong traction, and are good in the advisor department, but just need connections to Series A investors.  Other teams are well-funded, and already have their own office space, but could really use some guidance on the ‘fundamentals’ of recruiting, managing a scaling company, etc. It shouldn’t surprise anyone if resources are developed in startup ecosystems to address these types of companies for which a typical accelerator isn’t the right fit.

Every now and then I use SHL to spread awareness about new resources in the market that I feel are really adding something differentiated and high value for founders relative to what’s currently available. Years ago I wrote about Clerky and how it filled a void in the market of startups that just need a super-fast, totally standard incorporation and corporate organization, and due to capital constraints are willing to go through it without a lawyer. I also wrote about how eShares was using a SaaS model to liberate early-stage startups form burning money on 409A valuations. I later wrote about how services like Bad Ass Advisors can help companies connect with specialized advisors/mentors beyond the limited roster of people available in their local market.

Today, I’m writing about another topic: Founder Education; meaning how founders can get access to the wisdom/pattern recognition of people who’ve observed dozens, or even hundreds, of startups. It includes best practices on topics like starting a company, finding advisors, finding product-market fit, using advisors, compensating people with equity, targeting investors, understanding metrics, building sales/distribution channels, etc. etc. Books and blogs are great, but they can only go so far, and sorting gold from garbage gets hard. Top accelerators have developed internal curriculums for these sorts of topics, but (remember) they come bundled with a lot of other resources, and at a price, that don’t necessarily work for all companies.

In Austin, I was recently introduced to Founders Academy; an educational curriculum designed for tech founders. It’s run by Gordon Daugherty, a very well-known and respected (including by me, and SHL readers know I’m jaded from experience) startup advisor in Austin who’s had a front seat for some time at one of Austin’s best known accelerators, Capital Factory. Gordon’s built Founders Academy into a packaged, structured curriculum for new tech founders; offered both as a set of online videos that you can buy, and also as an in-person course (taught by Gordon over a few days) that founders can sign up for.

I got some feedback from a few teams that participated in the in-person course, and they all said it was extremely valuable for the price of a few hundred dollars.  I’ve reviewed much of the material myself, and have also interacted with Gordon enough, to say that he knows what he’s talking about, and because his background is in Austin / Texas, his curriculum will resonate well with founders operating in markets that aren’t Silicon Valley.

As I’ve written about before on: Bad Advisors: The Problem with Localism, many tech entrepreneurs operating in second and third-tier ecosystems run into a serious problem when they limit their pool of advisors to their city’s geographic boundaries: they get bad (sometimes really bad) advice. Founders Academy, and other programs like it (if you know of them, leave comments please) thankfully help solve that problem by scaling the wisdom of domain experts (advisors who aren’t charlatans) in ways that are more structured and digestible than just blog posts or books.

Education means leveraging the wisdom of others, so you can avoid the mistakes that they made. For tech entrepreneurs who don’t have time or money to waste, the right kind of education is invaluable. And while top accelerators have emerged as the elite universities of the tech startup world, they clearly aren’t for everyone. It’s great to see quality educational resources popping up to fill the void.

p.s. Like Clerky, eShares, and Bad Ass Advisors, I don’t have any ownership interest in Founder Academy. The mention was entirely earned.