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Bad Advisors: The Problem with Localism

TL;DR Nutshell: One hour with an advisor who has exactly the domain expertise your company needs could be infinitely more valuable than 100 hours with someone who doesn’t. Yet, unless you live in a large ecosystem, that all-star may not be in your city. So go find her. Time is precious and mistakes are costly. Never put localism before competence and results.

Related Reading:

My wife loves farmers markets.  I love healthy, delicious fresh food, as well as supporting decentralized agriculture over conventional mega farms.  But I also personally have a ‘thing’ against rewarding inefficiency and mediocrity. I dislike the way in which a lot of the pro-local ethos appears to almost celebrate how badly businesses can be run – hand-made, hand-picked, artisanal, small batch, etc. etc. If it doesn’t actually produce a tangible benefit to the consumer (better taste, as an example), why should I wake up early on a Saturday morning just to reward your bad business skills?

Funny thing is that there’s one local farm here in Austin that has begun to just dominate farmers markets. More variety, more staff, consistent quality, better pricing, even better branding. They’re everywhere. I love it, and whenever I have to go to a farmers market, I usually just end up shopping at that one booth. And when I’m not at a farmers market, I’m probably shopping at Whole Foods, which is the farmers market fully self-actualized. Say what you want about its prices, but John Mackey and WF took the pro-local, pro-environment, humane food value structure and scaled it (out of Austin) like no one else has since. And it is spectacular.

Touchdowns; Not Pep Rallies. 

Now back to tech. Celebrating your local business / startup ecosystem is a great thing. There’s deep value in the close, repeat relationships and networks that develop through working with people within your city. But with that being said, there is still a completely unavoidable fact: nothing comes even close to supporting a local startup ecosystem as much as the building of scaled, successful tech companies. All the meet-ups, startup crawls, networking events, hackathons, pitch contests, publications, parties, etc. are great and important in their own way, but, to repeat, nothing matters more than the building of great companies. Touchdowns. Wins.  Pep rallies do not attract the kind of deep talent that ignites a local economy; awesome companies do.

Once you accept that building successful companies trumps all else, there’s another unavoidable fact: working with highly competent, experienced advisors with truly valuable insight for your specific company, whether they’re in Silicon Valley, Seattle, Los Angeles, New York, Austin, Houston, Boston, London, Dallas, or wherever, comes first, second, and third before working with someone who may be more accessible to you locally, but can’t deliver nearly as much value. 

If it’s my company, my capital, and my employees on the line, I ain’t got time for the guy selling his tiny backyard tomatoes across the street, even if he knows everyone in town. I need that big, juicy peak game stuff, and if I have to go to the coasts to get it, so be it. Hit your goals with quality, imported help (if necessary), and you’ll sow a dozen A+ farmers in your city for the next entrepreneur to reap. THAT’s how to support your ecosystem.

Bad Advisors <> Influencers. 

Bad advisors are usually influential, well-known people in a local economy. They aren’t bad people. They just don’t have very useful advice, and often give bad advice, to early-stage founders. 

If you want to start a startup-oriented business – let’s use an incubator as an example – and generate a lot of buzz around town, you are going to want to work with the influencers in your community. They know whom to call, what strings to pull, and can even usually put in some cash, to help establish your incubator’s brand around town. What do all of those influencers expect in return? Profit? Perhaps. But more often than not, they want access. They want to be involved. How can they get involved? As mentors /advisors.

So it should not surprise you that when a new incubator, accelerator, co-working space, or other startup-oriented org launches in your town, a significant portion of the people involved will be there not because of the value they can bring to startups, but because of the value they brought to the person starting the incubator, accelerator, or what not. They may be C-suite executives at a prominent local company who have never worked anywhere with fewer than 200 employees. They may be wealthy businessmen in industries totally unrelated to your own. Sometimes it’s just a guy who is really F’ing good at networking.

It’s an unfortunate fact of reality that many business referrals, even in tech ecosystems, are made more with an eye toward perpetuating the influence of the person making the referral (reward people who refer back, are part of your ‘circle’) than the value that the recipient of the referral will receive. Finding people who care more about merit than about rewarding their BFFs is extremely important for a founder CEO. Those people will be honest with you when there simply isn’t anyone in town worth working with. I find myself saying that often about lawyers in specific niche specialties needed by tech companies, although increasingly less so each year.

Widen your network. 

The take home here should be to (i) understand why those influential (but sometimes clueless) local people are being pitched to you as advisors, even when they don’t really have very good advice (but they may have money, and it’s green), and (ii) go find the advisors you really need, wherever they are. But please save your equity for the people actually delivering the goods. Vesting schedules with cliffs. Use them.

Videoconferencing is pretty damn good and cheap these days.  I use it with clients all the time. LinkedIn and Twitter make it 100x easier today to expand your network than even 10 years ago. Hustle. Every founder team does not need to fit the super extroverted, Type A entrepreneur stereotype, but I’ll be damned if any company can succeed without someone who can get out there and shake the right hands.

Interestingly, some people are working on building curated (important, get rid of LinkedIn’s noise) marketplaces to help founders find well-matched advisors, hopefully at some point across geographic boundaries. Bad Ass Advisors appears to be the best example I’ve seen thus far. If BAA doesn’t become a hit, something like it will. The value prop is obvious.

 Most startup ecosystems have some awesome people to work with. Find them. Local can be valuable.  But as your company grows and evolves, don’t let the geographic boundaries of your city force you to settle for influential, but not very useful advisors. Customers > Community. All day. Every day. Never forget: you’ll help your local economy and ecosystem far more by going big and going far than by going local.

Should Non-SV Founders Use SAFEs in Seed Rounds?

Nutshell: Because of the golden rule (whoever has the gold…), probably not – at least not for now.

Background Reading:

For some time now, there have been people in the general startup ecosystem who have dreamt that, some day, investment (or at least early-stage investment) in startups will become so standardized and high velocity that there will be no negotiation on anything but the core economic terms. Fill in a few numbers, click a few buttons, and boom – you’ve closed the round.  No questions about the rest of the language in the document. For the .1% of startups with so much pull that they really can dictate terms to investors (YC startups included), this is in fact the case.  But then there’s the other 99.9%, much of which lies outside of Silicon Valley.

Much has been written about how SAFEs were an ‘upgrade’ on the convertible note structure, and in many ways they are.  But anyone who works in technology knows that there’s a lot more to achieving mass adoption than being technically superior, including the “stickiness” of the current market leader (switching costs) and whether the marginal improvements on features make those costs a non-issue. And any good lawyer knows that when a client asks you whether she should use X or Y, she’s not paying you for theory. You dropped that sh** on your way out of law school.

This isn’t California

From the perspective of founders and startups outside of California, which are the focus of SHL, the reality is that going with a SAFE investment structure is very rarely worth the cost of educating/convincing Texas angel investors on why they shouldn’t worry and just sign the dotted line. The entire point of the convertible note structure, which by far dominates Texas seed rounds, is to keep friction/negotiation to a minimum.  Yes, there are many reasons why equity is technically superior, but that’s not the point.  You agree on the core terms (preferably via a term sheet), draft a note, they quickly review it to make sure it looks kosher, and you close.  You worry about the rest later, when you’ve built more momentum.  Professional angels know what convertible notes are, and how they should look. They also know how to tweak them.  In Texas, many of them still do not know what a SAFE is. 

And, in truth, many Texas angels and seed VCs who do in fact know what a SAFE is simply aren’t willing to sign one. The core benefit of SAFEs to startups is that they don’t mature, and hence founders without cash can’t be forced to pay them back or liquidate.  To many California investors, this isn’t a big deal, because they’ve always viewed maturity as a gun with no bullets.  But Texas investors don’t see it that way.  Many find comfort in knowing that, before their equity position is solidified, they have a sharp object to point at founders in case things go haywire. I’ve seen a few founders who rounded up one or two seasoned angels willing to sign SAFEs, only to have to re-do their seed docs when #3 or #4 showed up and required a convertible note to close. It’s not worth the hassle, unless you have your entire seed round fully subscribed and OK with SAFEs

Just Tweak Your Notes

The smarter route to dealing with the TX/CO/GA and similar market funding environment is to simply build mechanics into your notes that give a lot of the same benefits as SAFEs. A summary:

  • Use a very low interest rate, like 1-2%. – Many local angels tend to favor higher interest rates (seeing 4-8%) than west and east coast seed investors. But if you can get a very low rate, it’s more like a SAFE.
  • Use a very long maturity period, like 36 months. – 18-24 months seems to have become more acceptable in TX, which is usually more than enough time to close an equity round, or at least get enough traction that your debt-holders will keep the weapons in their pockets.  But if you can get 36 months, go for it.
  • Have the Notes automatically convert at maturity –  This gets you as close to a SAFE as possible, and we’ve seen many angels accept it. If you run out of time and hit maturity, either the angels extend, or the Notes convert, often into common stock at either a pre-determined valuation (like the valuation cap, or a discount on the cap), or at a valuation determined at the conversion time.

How successful you’ll be at getting the above is just a matter of bargaining power and the composition of your investor base. Austin investors, who think more (but not completely) like California investors, tend to be more OK with these kinds of terms.  In Houston, Dallas, or San Antonio, you’ll likely get a bit more pushback.  But that pushback will almost certainly be less than what you’d get from handing someone a SAFE.

Closing Summary: There isn’t, and likely will never be, a national standard for seed investment documentation.  Every ecosystem has its nuances, and working with people who know those nuances will save you a lot of headaches. In Texas, the convertible note, however suboptimal, reigns supreme. Respect that reality, and work within it to get what you want.