Post Category → Founders

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 and the general Silicon Valley community – isn’t necessarily aligned with their own.

While I’ve worked 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 and employees 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.”

Lies About Startup Legal Fees

It usually takes experience in the market for business people to truly understand the realities of hiring and working with lawyers. I can’t tell you how many times I run into first-time founders who’ve been fed absolute nonsense from ‘advisors’ ‘mentors’ or similarly named people about their ‘secrets’ for managing legal spend. The truth is that unless you’ve taken a company from seed to Series A, Series B, Series C, to an exit in which a serious party on the other side actually diligenced the legal history your ‘secrets’ put together, your theories about lawyers are hot air.

Failed companies never pay the price for poorly managed legal; unless the failure was the result of the legal problems, which does happen. Successful companies, however, pay deeply for legal mistakes. It’s  just a question of timing. There are definitely steps you can take to prevent legal spend from getting out of control, but it requires separating reality from delusion. The below is my attempt at doing that.

1. Software automation (or free templates) will not replace your lawyers, or dramatically cut legal spend.

See: Luddites v. Tech Utopians. New market entrants in technology have a tendency to come out with guns blazing, promising their ability to cut out enormous amounts of waste as reason to adopt them. Sometimes they’re telling the truth. Other times it’s well-calculated hyperbole.

Virtually every serious automation tool that has emerged with “cut huge amounts of legal spend” as its primary selling point has evolved into a tool for lawyers. Why? Because, contrary to some popular opinion (and marketing talk), good lawyers really aren’t charging hundreds of dollars an hour to just fill in numbers or check off boxes. Good tools are very helpful for making lawyers/firms more efficient, and you want lawyers who use those tools, but a piece of software isn’t going to replace your lawyers any more than a piece of software will replace your software developers.

Yes, there is form-filling and box-checking ripe for automation, but it’s not nearly as large of a percentage of legal spend as some let on; and the low-hanging fruit is already eaten by software like Clerky or Ironclad.

2. Handling it yourself won’t save you legal fees.

I could write an entire book listing all the “hold my beer” moments I’ve encountered with someone on a management team thinking that they were wisely saving legal fees by taking an issue into their own hands, and it then predictably blowing up in their faces.  Part of it boils down to simple sloppiness. Other times it’s a clear case of someone not knowing what they don’t know.

There’s a related dynamic here to the first point about technology companies overstating their ability to cut legal spend. Anyone selling anything (a product, a service, themselves) has to justify it somehow, and “those damn lawyers” are a great bullseye. A COO / CFO wants to justify his salary, and an easy way to do that is by claiming to ‘save’ you legal fees via DIY legal work. You’re not saving anything. You’re magnifying your fees (cleanup is $$$), but deferring them temporarily.

3. Quickly hiring an “in house” lawyer won’t save you a dime.

CEO: “We’re thinking about hiring an in-house lawyer to save some legal fees.”
Me: “Great. What’s his/her starting salary?”
CEO: “$95K”
Me: “Going to be complete shit, and will cost you 10x more long-term.”
CEO: “What? That’s more than some of our execs make.”
Me: “Senior lawyers worth having won’t even talk to us if we’re recruiting with less than $200K. And our lawyers have fantastic work-life balance. You’re recruiting in the same legal talent market I’m in. You really think you found some magic button that cuts the market rate in half?”

Look, I get it. Good lawyers are expensive. Really good lawyers are even more expensive. Fact: Talent is expensive. Everywhere. Make it incur three years of opportunity costs (law school) and a small mortgage (about $200-225k for law school, all in) before it can hit the market, and it gets a whole lot more expensive. 

Last time I checked a solid software developer will cost you six figures in salary; ignoring equity. And ‘coding’ mistakes are 10x more fixable, and potentially less costly, than legal mistakes. It is absolutely the case that a small portion of the tech community arrogantly believes that engineering talent is the only talent really worth paying for. Good luck with that.

I’m not trying to defend what lawyers make here (I don’t need to), but what I am saying is hiring lawyers has the exact same talent market dynamics of hiring any other kind of professional.  So you say you’ve found a lawyer willing to work for a lot less. Congratulations, you caught lightning in a bottle; found a rupture in the space-time continuum.

Or you just found a lawyer completely lacking in the experience/skillset needed to actually replace the work outside counsel (including a set of specialists) is doing for you. There is definitely a time to hire a general counsel, but for it to actually make sense mathematically and not result in extremely expensive mistakes, it’s usually much later in the company’s history than you think. Past “startup” territory.

4. Flat/fixed fees don’t “align” incentives with your lawyers. They lead to rushed work and poorly negotiated deals. 

Take two law firms that charge you the exact same amount to close a deal: one firm bills by the time they actually worked, the other on a flat fee. The flat fee firm is rewarded for (i) not negotiating deal terms, (ii) delegating to inexperienced staff who are “cheaper” (to them), and (iii) working off of rigid rules/checklists that can be automated, instead of flexibly assessing the context. In other words, flat fees incentivize lawyers to rush their work, which is dangerous for high-stakes legal issues where the “client” (often at early-stage an inexperienced entrepreneur) doesn’t know how to fully assess quality.

For more on this, See: Startup Law Pricing: Fixed v. Hourly. Flat fees don’t “align” incentives with your lawyers. They reverse them, often making them more dangerous. For low-stakes, highly standardized work (like formations), fixed fees can be generally benign. For high-stakes and high-complexity work where the “client” doesn’t have the experience to assess quality, don’t reward lawyers for cutting corners.

5. A few real truths about legal spend. 

A. Compensation and specialization drive talent quality. Quality prevents errors, and therefore controls fees long-term.

Fundamentally, two things drive lawyer recruitment (I know, because I recruit for E/N): compensation and quality of life. Very large firms generally have terrible quality of life for their lawyers, for a number of reasons too complex to discuss here. But that’s why large firms have to pay their lawyers the most.

In-house positions and boutique firms are recruiting pipelines for what I call “BigLaw refugees”; talented lawyers looking to still get paid well, but take a moderate pay cut (sometimes) in exchange for the ability to keep their marriages in tact, and their kids out of therapy. But as discussed above, to get the full-time attention of those lawyers, even with great work-life balance, you still have to pony up in amounts virtually no true startup can afford. That’s why outside counsel (‘fractional’ lawyering) is valuable.

And working with lawyers who specialize in emerging tech/VC work will ensure you’re paying for talent experienced in the kind of legal work you actually need. See: Startups Need Specialist Lawyers.

B. Law firm “overhead” increases legal spend above base lawyer compensation, but enables scalability and quality. 

On top of the money paying a particular lawyer’s salary, you have the ‘institutional overhead’ of the firm that employs the lawyer. For a deeper discussion of law firm overhead, see: Startups Scale. Solo Lawyers Don’t. 

Companies who think only large firms with the highest rates have the best lawyers (compensation) are ignoring the interplay of overhead and compensation. If you cut overhead intelligently, you can still pay lawyers very well, but at lower rates to clients. The issue is how much overhead to cut out.

Institutional overhead, properly structured and right-sized, is not wasted money any more than the ‘overhead’ (on top of salaries) of any company is wasteful. In law, it enables recruitment, technology, training, staff, and other infrastructure that turns a set of lawyers into an integrated legal services provider, with bandwidth that can be optimized to keep work moving.

Think about what type of company you want to build long-term, or at least expect to be for the next 5 years, and ensure you engage a firm with the right institutional infrastructure (overhead) to serve that company. Very very large firms are designed for unicorns, and require the most ‘infrastructure,’ and therefore overhead.  In fact, the majority of what you pay large firms is paying for infrastructure. Are you planning to be a unicorn?

We are quite honest in saying that, as a high-end boutique firm, our target client is looking to (realistically) exit at under $300MM. We don’t work for unicorns; nor do we try to.  But we also don’t work for small businesses hoping to sell for a few million.

We pay our lawyers compensation that is highly competitive with large firms, which (again, a talent market) ensures quality. Our lawyers also bill about 25% fewer hours per year than BigLaw lawyers, which improves their quality of life (helps recruiting/retention).  But because we have dramatically lower institutional overhead, our rates are lower; although nowhere near the lowest.

In my experience, the size of your Series A round is usually a pretty good indication of the type of company (exit size) you’re trying to build; companies truly going for unicorn status raise much larger rounds. Pre-Series A, the majority of serious tech companies require some accommodation to manage their legal budget; no matter how efficient their lawyers are.

If Post-Series A, your company’s legal bills still seem completely unmanageable, that’s often a good indication that the law firm you hired is too big for what you’re building (non-unicorn-track using a high-infrastructure unicorn law firm); assuming your expectations on what the bill should be simply aren’t unhinged. Remember, small firms can have very high quality lawyers, because they aren’t paying them less. They just have a leaner infrastructure designed for non-billion-dollar clients.

C. Flexible pricing / payment from a quality firm is 1,000 times better than “going cheap.” But be realistic about the budget. 

If you get anything from this post, it is this: good, scalable legal counsel costs real money, like any talent. There is no magical software, recruiting strategy, or template on google that will get around that. Anyone who thinks they are cheating this rule, and have somehow found bargain-basement counsel that works, is just not yet hearing the ticking of the time bomb they’ve turned on in their company.

The absolute best strategy for engaging serious legal counsel, but not going bankrupt on legal fees is to ensure that:

  • you’re working with lawyers who have the right specialization for what you need;
  • at the right quality level, and with right-sized overhead for the scalability you need; and
  • who will flexibly work with you on budget/payment at the very early stages.

Law firms who specialize in emerging tech work are not new to the challenges of very early-stage startups trying to manage a legal budget; at all. It is deeply engrained to each lawyer’s expectations. And there are a lot of levers that those firms can and will pull for clients they want to work with: discounted fees, deferred fees, equity arrangements, etc.

The key part is “clients they want to work with.” They are selective, because they have to be.  Serious law firms are not in the game to work on mickey mouse fixed-fee or discounted projects to eternity; nor can they afford to be. They do that to scale down for valuable prospects with the right potential lifetime value (LTV) as clients, but who need help when the budget is slim. That’s why any early-stage, limited budget company that approaches a serious law firm should be ready to “pitch” their company to the firm.

For high potential companies, great tech/VC lawyers will be flexible on budget and payment as long as the founders are reasonable in their expectations. And the best way to be reasonable is to follow the points in this post. Accept that you need good legal talent, badly. Accept that it costs real money, and that you likely can’t afford the full cost up-front, and that’s normal.  If you’re as good as you hope you are, you will find a way to navigate that reality.