Ask the Users

TL;DR: Blogs, social media, and public endorsements are all noisy, and often false, signals about a person’s real reputation in the market. The only way to get the truth is to “ask the users,” and in a way that allows them to speak the truth without negative repercussions.

I’m going to keep this post as simple as possible, because the message, though extremely important and often lost on people, is quite simple.

Should you join a particular accelerator?

Ask the users – the companies that have already gone through it.

Should you accept money from a particular fund or investor?

Ask the users – the portfolio companies that have already taken money from them and gone through ups and downs.

Should you work with a particular mentor / advisor?

Ask the users – the companies they’ve already advised.

Should you use a particular law firm, accountant, or other service provider?

Ask the users – their existing clients, particularly the ones who’ve gone through a major transaction.

One of the most dramatic, impactful things that the internet (and services like LinkedIn, AngelList, FB, Twitter) has done is made it 10x easier to connect with other people to get direct, unfiltered, off the record feedback on their experiences in working with others. It has made BS a whole lot harder, and ultimately improved behavior across the board. But that brings up some important points worth keeping in mind as you “ask the users”:

A. As much as the web has made finding direct feedback easier, it’s also magnified the opportunities for untruthful marketing.

Blogging and social media are great ways to get a feel for a person’s persona – or at a minimum the persona they want to display publicly, which itself is a valuable, albeit noisy, signal. However, never underestimate the capacity for sophisticated players to whitewash their online reputations. What you see on a blog, on Medium, or on Twitter is marketing, and it’s only with due diligence that you verify it’s accuracy.

And yes, that speaks for this blog and my own social media presence as well.

B. Do not assume that a public-facing endorsement is reflective of that person’s true opinion.

Reality check: people use public endorsements as currency. A VC will make their investment, or assistance on some project, contingent on the expectation that founders say a few glowing things about them on Twitter. A lawyer will agree to discount a fee if they can get a great LinkedIn recommendation. An accelerator will make an intro if the founders will write a great Medium post.

Public endorsements, though valuable as a signal, are fraught with ulterior motives. In short, they can be, and often are, bought.  I know plenty of people who, for some quid-pro-quo arrangement, have given public endorsements for market players whom they would NEVER recommend privately. Do not take a favorable public comment as reason to avoid doing private, off the record diligence.

C. Ignore the opinions of sycophants.

Every ecosystem is full of people who will sing the praises of anyone influential simply because that influential person could get them business. It may be too far to call some of them spineless, but ultimately they lack the personal brand independence to speak accurately about other peoples’ behavior. No one is perfect, and if someone’s review of a particular player feels totally over-polished, it’s probably because they’re not telling you the truth.

You want feedback from serious, honest people who are willing to speak their mind (but see below).  Not a bunch of random cheerleaders.

D. Talk privately, and don’t reveal whom you’ve spoken to. 

No one who has an active, ongoing relationship with someone wants to damage that relationship, even if they’re not entirely happy with it. Doing so is irrational. If I’m in an accelerator, I still depend on that accelerator’s support, so don’t expect me to go on the record for badmouthing them. The same goes if I’m in a particular VC’s portfolio, or working with a particular law or accounting firm.

This is why it’s extremely important to do “blind” diligence; meaning if you are diligencing X by asking Y, you absolutely do not want X knowing that you asked Y. If a VC tells you to ask a specific company about their experience in working with them, then they know exactly whom to punish if you end up walking. If you go through their portfolio and personally decide whom to ask, you remove that ability, and therefore dramatically increase the likelihood that you’ll get honest answers.

And it should go without saying: phone calls or in-person meetings. Don’t expect honesty in a forward-able e-mail.

E. Focus on patterns, not a single review.

Even the best restaurants have the occasional negative review because they either were having a bad day, they simply weren’t a good fit for the particular patron, or – and let’s be honest here – sometimes the user is a pain in the ass. The customer is always right? Nope, sometimes the customer is a moron.

Don’t assume that you’ve got the full picture from simply asking one person. Ask a few, and the line drawn from the dots will matter much more than the individual data points.

F. If you can’t diligence, you need a right of exit. 

The stakes are highest for relationships that you really can’t extricate yourself from. A serious investor is the clearest example. Never take money from a VC without performing diligence.

However, for other service providers – take an advisor/mentor for example – there are other mechanisms to de-risk things. If they’re getting equity (which they often are), a “cliff” on their vesting schedule is the best one; typically 3 or 6 months. That should be enough time to understand the reality of working with them, and make corrections if it’s a terrible experience. Solid contracts help here, with clear, painless rights of termination.

However, a word of caution – all the contracts and lawyers in the world will not protect you from the enormous cost and time suck of working with sociopaths. Even if you don’t have the time or ability to diligence their “users,” you should at a bare minimum vet them personally with interviews, questions, and other ways to get a general feel for their personality and values. If you have good instincts for judging people – and if you’re a CEO I hope you do – you will be able to filter out most assholes.

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.”

Startup Accelerators: Bundled and Unbundled

TL;DR: Elite accelerators have cemented themselves as the universities of the entrepreneurial world; offering a bundle of resources in exchange for a price (tuition in form of equity). The most elite absolutely deliver on their promise. But as with education, that bundle of resources can be unbundled, and that’s what’s happening among entrepreneurs who don’t need or want the “full package.”

Background / Related Reading:

What is the purpose of universities? It depends on whom you ask. Employers who are honest will tell you it’s mostly one thing: curation; various filters (admissions, testing, etc.) to help sort out who the good candidates are from the bad. If you ask students, you’ll likely get more varied responses. For some, it’s about preparing for a successful career, including building a network that you can leverage for your career. Those are the pragmatists.

Others will get a little more poetic and talk about how universities are a place to ‘find yourself,’ and be exposed to experiences and knowledge that stretch you beyond the narrowness of your upbringing.

The value and purpose of accelerators tracks almost exactly the above points about universities; just replace “students” with “entrepreneurs” and perhaps “employers” with “investors.” Pragmatically, accelerators offer entrepreneurs a curated bundle of resources (a network of entrepreneurs and advisors, faster access to investors, education, some initial money, etc.) in exchange for a price: usually 6-9% of equity, with (sometimes) heavy anti-dilution rights, and pro-rata rights.

Better curation leads to a better network and bundle, which leads to even higher quality, which further enhances the network, etc. It feeds on itself, at least when it works. And for a handful of top accelerators it works very well.

And of course there are certain accelerators who push beyond pragmatism and aim for loftier, more romantic goals than ‘just’ offering a set of resources: helping entrepreneurs build friendships, find greater meaning in their businesses, being part of ‘something greater,’ etc. It sounds very similar to how more liberal artsy universities pitch themselves to students. And you can verify from certain founders (not pragmatists) that the right accelerators do deliver on that kind of experience; that the accelerator was “life changing.”

Here are some thoughts, based on conversations I’ve had with founders and my own observations in the market, about the evolution of accelerators and how entrepreneurs are likely to engage them going forward.

1. Top accelerators have corrected an imbalance between the strength of founders’ networks and those of VCs.

In doing so, elite accelerators have ‘unbundled’ some of the ‘value add’ aspects of how venture capitalists, and other service providers (like law firms), traditionally used to sell themselves. First-time entrepreneurs often start out with virtually no network. VCs and law firms would pitch themselves to these entrepreneurs by emphasizing not just the core service they provide (capital, legal services), but that using them over someone else included access to their network. I’ve written before about law firms that pitch magical access to investors. 

A founder who gets into a top accelerator, however, gains access to a vast, well-curated network of other founders, mentors, potential hires, etc. When they shop for a law firm, they’re now much more interested in the actual service quality of the firm, rather than some lawyer’s half-baked ability to make investor intros. And having access to many resources that they once would’ve relied on VCs for, founders can focus on other variables in investor diligence; like how helpful they are on the Board.

In some ways, the resources that top accelerators give founders have upped the ante on what “value add” from institutional investors really means, and has put some traditional VCs in the same category as prominent angels or well-coordinated angel groups: checks, perhaps with a few intros, but not much more. Some VCs really do add value. Others mostly just provide large checks; which is perfectly fine – you want big checks – but some big checks are smarter.

2. However, there are still a lot of founders who don’t pursue traditional accelerators, and never will.

Traditional, fully bundled accelerators – the kind that involve months of full-time commitment, a demo day, and giving up a large amount of equity in exchange for the large “package” of resources described above – heavily slant toward young, first-time founders. As they should: those are the people who have the most to gain, and the least to lose, from the full accelerator experience.

As influential as accelerators have become, an enormous amount of our client base doesn’t go through them, and hasn’t tried to. The reasons vary:

(i) I’ve got a family and don’t want to move across the country for several months;

(ii) I’ve got my own professional network and don’t see the cost of the accelerator as worth what it can deliver to me; or maybe [and this last one is worth a discussion]

(iii) I can hustle my way to access the people I need – who are now easier to find thanks to the accelerator – without actually joining it.

3. Without tight integration, unbundling of non-elite accelerators is inevitable.

No matter how many MOOCs, Khan Academies, apprentice programs, degree-less job openings, Thiel Fellowships, etc. arise to eat away at the dominance of the 4-year university model, Stanford, Harvard, and MIT aren’t going anywhere. The exact same can be said for the most prestigious accelerator programs.

But outside of the true elite, the traditional format and cost of accelerator programs is likely not sustainable. Very little of what most accelerators offer founders (curated groups of people) is proprietary in any way; nor can it be viably cut off from the market to restrict access to only those who ‘pay’.  The content that is proprietary is *usually* not what draws founders into the program. I’ve seen some accelerators try to get control over ecosystem resources by playing gatekeeper. I’m sure you can predict how that ended for them. Don’t try to ‘gatekeep’ entrepreneurs.

If entrepreneurs are good at anything it’s being resourceful and gaining access to resources (including people) that are visible in the market. And accelerators, through a few years of curation and operation, have made those resources a lot more visible.

Yes, I know several entrepreneurs who are happily tapping into the networks of accelerators without actually going through them. And it’s not surprising, at all. They’re doing what entrepreneurs do. I’m sure the accelerators themselves aren’t even surprised. The networks of accelerators are effectively the compilation of smaller networks of individual people, very few of whom are beholden to any accelerator. And as is now common knowledge, modern tools have made networking 10x easier and more transparent than it was even 5 years ago.

So what does this mean? It means that outside of the very elite accelerators with the tightest integration and network effects, you’re probably going to see experimentation with smaller, more targeted, lower ‘cost’ alternatives. Some will still be called accelerators; others won’t. If the ‘price’ drops to 2% instead of 8%, a little boost in finding investors may be worth it. Maybe programs targeted toward educating founders in a Khan Academy way will pop up, perhaps just for cash.  Although YC appears to be building that, for free.

Prominent angels and advisors may band together to invest very early, and get a little extra equity for value-add advisory; their brand serving as a signal (via great curation) to larger, later-stage checks. Even certain targeted co-working spaces are playing a role, adding on some value add programming/events to sell their real estate.

I can’t predict where it will all go, but I can already see bits and pieces of the unbundling occurring.  My advice to new founders is always to approach accelerators just like they would approach any other resource or service provider in the market: (i) what is the cost, (ii) what do I get for that cost, and (iii) is it worth it, given alternatives available in the market. And always *always* ask the users.

Some founders will continue to pursue the very elite accelerators, and for good reason.  Others will over time find ways to access just the parts of the accelerator “bundle” that they need, and for the right price, all made easier by the foundation laid by the original accelerator boom. 

Even if most accelerators as we know them don’t survive, the people who built and ran them made enormous contributions to the market, and will surely find other ways to keep participating in their ecosystems. What’s definitely clear is that it’s never been a better time to be a tech entrepreneur.

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.

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.

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.