Monday, September 19, 2016

Should you take small checks from deep pockets?

So you’ve recently started a company, you’ve started to talk to angel investors and seed funds about your seed round, and suddenly a large VC appears on the scene and wants to invest. What should you do?

First of all, congrats. If a large fund wants to invest in your startup, that’s a great validation. Second, if you can get the brand, credibility, network and support of a Tier 1 VC into your startup early on, that can be extremely beneficial. So you should definitely consider it. It’s a complicated question, though, and you have to carefully consider the pros as well as the cons.

In this post I’ll try to shed some light on this question. As a disclosure and caveat, being a seed VC I’m not a disinterested observer, since we occasionally compete with bigger funds on seed deals. I’ll try to be as unbiased as possible, and if you disagree with my views you’re more than welcome to chime in, e.g. in the comments section.

Further below is a simple matrix that might be helpful to founders as they consider having a large fund participate in their seed round. But first, in case you’re not familiar with the issue, here’s a quick primer. If you know what the “signaling risk” debate is about, you can skip the next fext few paragraphs.

Some years ago, many large VCs – $200-400M+ funds that typically invest anything from $5M to $20M or more in Series A/B/C rounds – started to make seed investments, placing a sometimes large number of oftentimes tiny bets in very early-stage companies. The intention behind these investments is not to make a great return on these initial bets. Consider a $400M fund that invests, say, $250k in a startup. Even if that investment yields a rare and spectacular 100x return, it means only $25M in exit proceeds for the fund. That’s a lot of money for you and me, but not a lot of money for a $400M fund that needs around $1.2-1.5B of exit proceeds to deliver a good return to its LPs. If a large fund writes a tiny check (i.e. tiny relative to the size of the fund), there’s almost zero chance that the investment will move the needle for the fund.

So what is the intention behind these investments? The answer is access to Series A rounds. The idea is that one invests, say, $250k in 50 companies, watch them carefully and then try to lead (and maybe pre-empt) the Series A rounds of the ones that do best. Even if most of these seed bets don’t work out – as long as the VC gained access to a handful of great Series A deals, it’s money well spent. At least superficially it makes a lot of sense for large VCs to employ such a strategy. Whether it’s also a good strategy in the long run, or if it leads to brand dilution and eventually adverse selection, is a different question and beyond the scope of this post.

For entrepreneurs, more VCs investing into seed rounds means easier access to capital. And as mentioned before, founders who raise a seed round from a large VC also get the benefit of getting a brand name VC on board early on and potentially they can tap into the firm’s support network. So far, so good - sounds like a win/win.

The downside of taking a small check from a large investor is what’s called “signaling risk”. What this refers to is the situation that arises when you want to raise your Series A round and your VC doesn’t want to lead. In that case, any outside investor who you’re talking to will wonder why your existing investor – who as an insider has or could have a great understanding of the business – doesn’t want to invest. Everybody in the market knows that if a large VC invests small amounts the purpose is optionality, so if the VC then doesn’t try to seize the option, people will wonder why.

There might be good reasons why your VC doesn’t want to invest despite the fact that your company is doing well, and you might still be able to convince other investors to take the lead. But as you can imagine, it won’t be easy: Investors see large numbers of potential investments and have to decide quickly and based on incomplete information which ones they take a closer look at. That’s why they are highly receptive to any kind of signal. If they hear that the large VC who did the seed round doesn’t want to do the Series A, they might not even want to take the time to dig in deeper and might pass right away. As Chris Dixon wrote in a post some years ago, “If Sequoia gave you seed money before but now doesn’t want to follow on, you’re probably dead.”

Long story short, raising a seed round from a large VC has clear upside but also big risks. How should founders decide?

Let’s look at the data. CBInsights has some very interesting data which shows that statistically, startups that raised a seed round from a large VC have a higher chance of raising a Series A later on. What the data doesn’t tell us is whether that is (A) because these startups benefitted from having a large VC on board early on or (B) because they were better companies than the average seed startup in the first place. Since the analysis was based on ca. twenty Tier 1 VCs – Benchmark, Sequoia, Union Square etc. – I believe there’s no question that the subset of startups that received seed funding from one of these firms is of much higher quality than the overall average. These firms all have massive deal-flow and are the best firms in the industry. They know how to pick well. I’m sure both (A) and (B) play a role, but since we don’t know the relative impact of the two factors, the statistics don’t answer the question.

Another, maybe more helpful way of looking at it is this:

1) Does the VC act with conviction or does he/she just want a cheap option, as Fred Destin put it.

2) How confident are you that you’ll have strong traction by the time you want to raise your Series A?

Putting these two factors together gives you a simple matrix:

Here’s how to read the matrix:
  • Top left: If the level of conviction of BigVC (at the time of the seed investment) is high and your traction (by the time you want to raise your next round) is extremely poor, there’s a chance that BigVC will put in some more money (to give you a chance to figure it out, turn things around, pivot,...). It’s not very likely, but since it’s easier for a large VC than for small investors to finance your company for another six months or so, having a large VC on board might be advantageous if you end up in this cell of the matrix. Based on this logic, my verdict for this scenario is slightly positive (that is, if you expect to end up in this cell, take money from BigVC).
  • Bottom left:  If the level of conviction of BigVC is low and your traction is extremely poor, BigVC will most likely not give you more money and probably nobody else wants to invest neither. In this case, the fact that you’ve raised money from a large VC probably doesn’t matter, but it further reduces the chances of raising from other investors. My verdict: Slightly negative.
  • Top middle: In the high-conviction / OK-ish traction scenario there’s a decent chance that BigVC will finance the company through a few iterations or pivots, something that is harder to do without a big investor on board. On the flip side, if BigVC does not invest in this scenario, that will create a very bad signal (as explained above) and greatly reduce your chances to raise from other investors. My verdict: Hard to predict, it can go both ways, so let’s say neutral.
  • Bottom middle: If BigVC invested with little conviction and your traction is OK but not great, it’s very likely that BigVC will not invest further. This is extremely problematic as it creates a bad signal (as explained above) and greatly reduces your chances to raise from other investors. My verdict: Strongly negative.
  • Top right and bottom right: If you have excellent traction, everything else doesn’t matter that much. If BigVC wants to lead or pre-empt your round, you might save a lot of time (but you might not get the best valuation). If BigVC doesn’t want to invest for some reason, you’ll find other investors, but it will be harder. My verdict: Slightly positive for high-conviction, slightly negative for low-conviction.

If you’ve read until here and you’re more confused than when you started to read, here’s the take-away of the analysis:

If the big VC who wants to invest in your seed round acts with little conviction, i.e. he/she really just wants a cheap option, you’re better off saying no regardless of what kind of traction you expect to have by the time you raise the next round. There’s very little upside but very strong downside. So if you have the opportunity to raise a small amount from a large VC and you know that the fund places dozens or maybe even hundreds of these bets, my advice is to say no.

If the big VC acts with strong conviction, there’s strong upside but also significant risk. In this case I don’t have a general advice, and the right decision depends on the level of conviction of the VC and on the value-add that he/she delivers. There are a few things you can do to to find out more about the strategy and value-add of the investor. First, ask the investor how many seed deals the firm has done in the last years and in how many of these cases they led or strongly participated in the A-round. Second, talk to a number of founders who have received a seed investment from the firm and ask them how it's like to work with the firm. Keep in mind that however you decide, it's an extremely important and irreversible decision - so think through it carefully and do your due diligence.

Saturday, July 16, 2016

From "A as in Amiga" to "Z as in Zendesk"

In the last few weeks I participated in a few interviews/discussions to talk about SaaS, entrepreneurship, venture capital and related topics that are near and dear to my heart. If you're interested in me rambling about some of my earliest entrepreneurial adventures (hint: C64, Amiga,...) and how I found Zendesk (hint: luck), and if you don't mind listening to a heavy German accent and lots of "UMs" and "HMMs", here you go. :-)

1. The Twenty Minute VC
Listen to the podcast on ProductHunt, in iTunes or download the MP3.

2. "Managing your startup with data" at B2B Rocks in Paris

3. Interview with Seedcamp's Carlos Espinal 

Thanks to Harry, Carlos and Alexander for inviting me!

Sunday, June 26, 2016

A better way to visualize pipeline development? (WIP)

When founders show me their sales pipeline, the data is typically visualized in some variations of one of these formats:

When I see charts like this, I often find it hard to quickly wrap my head around the data and draw meaningful conclusions. Sometimes, important numbers are missing altogether. In other cases, they are there but are shown on another page or in another report.

I then find myself wonder about questions such as:

  • The pipeline is growing nicely, but how much are they actually closing?
  • How long does it take them to move leads through the funnel?
  • Are they purging their pipeline or are they accumulating a lot of "dead" pipeline value?

With this in mind I tried to come up with a new way for high-level pipeline development visualization, one that makes it easier to quickly get to the key take-aways. If you're interested in the (preliminary) result only, check out this mockup. If you'd like to learn more about my thought process and some additional details, read on.

The key problem that I have with the standard ways of looking at pipeline development is that it's hard to follow how deals move through the funnel. I've always thought that pipeline development charts should work a bit more like a cohort analysis that allows you to follow a customer cohort's development over time, and so I mocked up this:

The "pipes" give you a better understanding of what happened to the leads in a certain stage and month. For example, you can see that of the $1.6M that was in "prospect" stage in January:

  • $750k (47%) stayed in "prospect" stage
  • $500k (31%) were moved to the next stage ("demo/trial")
  • $350k (22%) were lost/purged

The next step was to add a few additional months to the mockup:

This unfortunately made things a little messy, and people will probably feel overwhelmed by the amount of numbers. One solution, if someone decides to build a little application like a add-on, could be to hide all of the pipe numbers by default and show them on-hover (maybe with an option to show them all at once):

What's still missing are some aggregated key metrics ...

... and a better way to quickly grasp how these numbers have changed month over month:

Here's one mockup with all three elements on it:

What you can quickly see in this example is that this imaginary startup is adding an increasing dollar amount of prospects to the pipeline and keeps closing deals, but the rate at which it moves leads to the bottom of the funnel is declining. At the same time, the percentage of lost deals has been growing slowly, while the percentage of deals that remained in the same stage has increased sharply, indicating an increase in sales cycle and/or a poor job of pipeline purging. This has already led to a shrinking bottom-of-the-funnel pipeline, and if the company can't figure out and fix the cause of that development, it will soon close less and less deals.

All of this is something that you can immediately see by looking at these charts and numbers and which I think is usually harder to see by looking at traditional pipeline charts. What do you think? Looking forward to your comments!

Friday, June 03, 2016

SaaS Funding Napkin, the mobile-friendly edition

My "SaaS Funding Napkin", published a few days ago, got lots of love on Facebook, Twitter, etc. Thanks everybody! Some people (rightfully) mentioned, though, that the image is hard to read on mobile devices. So if a napkin has a good format for a desktop or laptop screen, which real-world-analogy could be a fit for mobile screens?

You guessed right.

Here you go (please scroll down or click here).

Tuesday, May 31, 2016

What does it take to raise capital, in SaaS, in 2016?

When we invest in a SaaS startup, which almost always happens at the seed stage, the next big milestone on the company’s roadmap is usually a Series A. If you carry this thought further and assume that the biggest goal after the Series A is to get to the Series B (and so on, you get the idea) it sounds like turtles all the way down. But financing rounds are obviously not a goal in itself. They are a means to a bigger goal. Some SaaS companies got big without raising a lot of capital – Atlassian, Basecamp and Veeva are probably the most famous examples. But they are exceptions, not the rule. According to this analysis of Tomasz Tunguz, the median SaaS company raises $88M before IPO.

So what does it take to raise money for a SaaS company in 2016? With constantly rising table stakes and a fundraising environment that looks quite a bit less favorable than last year’s, I believe the bar is higher than in the last 18-24 months (although raising money is still much easier than it was in “Silicon Valley’s nuclear winter” in 2008).

Below is my back of a (slightly bigger) napkin answer to this question.

A few important notes:

  • The assumption of the information in the table is that the founding team is relatively “unproven”. Founding teams with previous large exits under their belts can raise large seed rounds at very high valuations on the back of their track records and a Powerpoint Keynote presentation.
  • Some of the information is tailored to enterprise-y SaaS companies. If you have a viral product (like Typeform or infogram), some of the “rules” don’t apply.
  • If you have virality and a proven founder team, you’re Slack and no rules whatsoever apply. :)

(click here for a larger version)

PS: Thanks to Jason M. LemkinTomasz Tunguz, Nicolas Wittenborn and my colleagues at Point Nine for reviewing a draft of this post!

[Update 1: Here's a mobile-friendly version of the napkin.]

[Update 2: And here is a Google Sheet version for better readability. :) ]

Monday, April 11, 2016

Introducing the French Cloudscape

For some reason we keep finding great early-stage SaaS startups in France, and it's not because of my command of the French language. In the last few years we've invested in four awesome SaaS companies from France: Algolia, Front, Mention and Critizr. We recently did #5, which hasn't been announced yet, and are in advanced talks with a potential #6. Besides our SaaS investments, we're also proud investors in StarOfService, an online marketplace to hire a wide range of professionals. Something is clearly going on in France, and we like it.

Our good connection to the French startup ecosystem was one of the reasons why we picked France as the first country for our "European SaaS Landscape" project. Another reason was that Clément not only speaks French, he IS French, and knows the market very well.

Without further ado, here it is: an industry map of the most important SaaS startups founded in France.

To learn more about our methodology and some of the insights we got while doing the research, check out Clément's post on Medium. If you have any questions, comments or suggestions, give us a shout!

Wednesday, April 06, 2016

Truffle pig reloaded – Point Nine is looking for an Associate

About three years ago, we were looking for an Associate to join Point Nine and put up this landing page:

We called the position "truffle pig", because just like a truffle pig is digging up the best truffles from the ground, we as an early-stage VC try to find the best startups among a large number of potential investments. I have to give full credit for the truffle pig analogy to Mathias Schilling and Thomas Gieselmann of, by the way. "Truffle pigs" is what they (young VC Associates at that time) called themselves when they approached my co-founder and me back in 1997 after having stumbled on this website. Fast-forward almost 20 years and we still haven't found a better way to describe the role. :)

Anyway, our search three years ago led to two fantastic truffle pigs, Rodrigo and Mathias, both of whom got promoted to Principals at Point Nine in the meantime. And today we're excited to kick-off the search for a new Associate. Here are all the details.

This is an incredible opportunity for a young, super-smart, super-driven person with outstanding analytical skills and a solid user interface. I'm pretty sure that it took me more than 10 years to get the expertise and network which you'll get during three years in this job. 

If you're interested, please take a look at our job ad. If you know somebody who could be great fit, please pass on the link. Thanks!