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Scott Orn

Scott Orn, CFA

How do startups get to Series A? Eric Ver Ploeg, founding partner of Tunitas Ventures, discusses Series A investing

Posted on: 01/08/2024

Eric Ver Ploeg

Eric Ver Ploeg

Founding Partner - Tunitas Ventures

Eric Ver Ploeg of Tunitas Ventures - Podcast Summary

How do startups get to Series A? Eric Ver Ploeg, founding partner of Tunitas Ventures, discusses Series A investing, including timing, choosing VCs, shutting down a startup, startup valuations, and more..

Eric Ver Ploeg of Tunitas Ventures - Podcast Transcript

Healy: Hello and welcome to the Founders and Friends podcast. I’m your host Healy Jones. Today I am excited to be with Eric Ver Ploeg, who’s a venture capitalist. He’s really well known helping startups get to the Series A. His VC firm is Tunitas. Before we dive in and start asking Eric questions, let’s have a quick word from our sponsor. Hey, this is Healy Jones, VP of Financial Strategy here at Kruze Consulting, andI want to say thanks to our podcast sponsor, ARC. At Kruze, we’ve got a number of clients successfully using ARC to manage their deposits, payments, access financing, all in one place. One of the things that ARC provides that’s really great is over a quarter of a million dollars in FDIC coverage. Their insurance program goes beyond the standard limit and it secures up to five and a quarter million dollars. So, startups that have even more cash than that can go and access treasury solutions to provide yield and safety. If you’re a startup looking for a secure financial solution that can help you scale, please check out our sponsor ARC at ARC.tech. We’re back. Hey Eric, how are you?
Eric: Excellent, thanks. Thanks for having me on the show, Healy.
Healy: Delighted to have you. Really delighted to have you. I think I met you about a year, a year and a half ago, when Precursor Ventures was throwing an event and your background just immediately leapt out on me. Do you want to talk a little bit about your background? Let’s let the listeners know a little bit more about you.
Eric: Sure. Happy to do that. I’ve been here in the Valley since ‘88. Got my PhD and MBA at Stanford, and then started a couple of venture-backed companies, raised five rounds of venture, Mayfield, Kleiner Perkins, VantagePoint, JMI, a bunch of good venture firms. And then spent 11 years as a partner in two large venture firms, VantagePoint and DTCP. And then last year struck out on my own to start Tunitas Ventures. The core differentiation of Tunitas is around helping our companies raise their subsequent Series A round. My experience from founding two venture-backed companies and then the 26 venture-backed boards that I sat on as a partner in those firms, you know, most venture investors don’t do a whole lot, which is fine from the entrepreneur’s perspective. But the place where they can really add a lot of value, I felt and have always felt, is around helping around fundraising. And so, I’ve built the practice of Tunitas really around that core value proposition.
Healy: As the guy at Kruze Consulting, whose job it is to help our clients get ready for fundraising, I strongly agree that that is a place where experienced people can really help out. You’ve done it many times. Founder generally only does it a handful of times in their lives, and additionally you’re living in the market, right? The market conditions change and you can help explain to founders where the roadblocks are and where the capital is flowing and things like that.
Eric: 100%.
Healy: [inaudible 00:02:59].
Eric: Like you said, an entrepreneur who’s experienced only does it a few times in their life, whereas the venture investor … I mean, I’m actively involved with three of them this week, so you’re in the flow of information. It’s one of the few areas where the venture investors network and information asymmetry advantage actually tips in their advantage. But it’s really hard for, I think, a venture investor to become a sector expert ahead of the entrepreneurial community. But when it comes to fundraising assistance, that’s natural and baked in.
Healy: For sure. In terms of the stage that you’d like to invest, if you’re helping companies get ready for the A, are you generally investing at the seed or the seed extension? What rounds do you like to get involved?
Eric: I like to say that I try to invest three to nine months ahead of Series A. Sometimes that’s me precipitating a financing and saying, “Okay, well, it’ll just give you a step up from the last thing you did that’s fair in market value.” Sometimes it’s in the middle of their doing something like an extension and then it’s a discussion there around, like they’re asking valuation in terms. Sometimes it’s a seed round and they’re on a fast trajectory and I see that Series A will happen in that three to nine months range. I do pick that number of three to nine to make … not that nine is sort of the outside, to make it concrete and real. This is not, “Oh, some nebulous day in the future we’ll be raising Series A,” but more like, “No, we have a timeline and plan already in place.” Things can slip, but at least if you say nine months, you’re sort of thinking, “Okay, I have a plan.”
Healy: That makes sense.
Eric: Much less than three months when people show up. I want to be able to roll up my sleeves and help the company in the process. I can do a fire drill. A lot of the value add is around in-process and getting feedback from how pitches are landing. And so the three months, that’s nice to have. It can be shorter than that, but that allows for an orderly process to be run.
Healy: As an experienced VC investing before the Series A, what is the expertise and help that you can bring to help that founder get ready to have a successful Series A?
Eric: The part that’s obvious that everyone talks about is the packaging story and getting the pitch together. I think this is one of the key value-adds of many of the incubator accelerators, is they just have the founder pitch a bunch of times and give rapid cycles of feedback. It used to be six, eight years ago, you would see that as a screaming need in essentially all companies. Now, that’s become some of the time, but not most of the time. And so, more it’s around the strategy of which firms should we be pitching. They’ll often have their five company firms they’ve been talking to and building relationship with, and then they’ll have the five nirvana brand-name firms that everybody knows. And then my suggestion is always like, “Well, that’s great to start with that list of 10.” At the next tier, who are you talking to that is a firm that writes checks in your category, in your geography, in your stage? What are the attributes that you can point to? Who is the specific partner at those firms that you can get, A, is the right one for your firm, and then B, who’s going to be the person who introduces you to that person? What I find most of the time is they just haven’t thought about that part at all. They have the five relationships they’re working and those are fantastic. They have their five aspirational firms. They might not even know who the partner is at that firm, but those are great. And then the next 10 or 20 names on the list, depending on the process they want to run, it’s a scattershot. I mean it’s just crazy sometimes. And so I try to bring a quantitative methodology to figuring out the right firms and then the right partner at those firms and then what is the right introduction path because we all get so many inbound deals that most of the time you can’t really process them all as a venture investor, so it has to come from somebody you know and trust. And so, what’s the mechanism for getting that introduction path? I think that’s the next phase that I can add a ton of value. And then the next phase after that is getting the feedback. When I was an entrepreneur, embarrassingly long number of years ago, the venture people used to tell you what they thought about your business. A lot of times it was wrong because come on, they’re not working 80 hours a week like you are, but at least you learned how the message was landing. And then when information sharing got better, one entrepreneur in 50 would hear that feedback as throwing the baby out with the bath water. Just would get mad and would write mean things about the venture firm on the internet. And so, as an industry, the venture folks became a lot less willing to share their feedback. So, I can play that plausible deniability role of like, I can call the partner and they can say, “Oh yeah, we would never back that founder. That founder was like blah, blah, blah, blah.” And then they’re not going to tell me their email, nothing that could ever trace them, but they can be relatively candid. And then I can sit down with the founder and it’s like, “Here’s how the message landed.” In multiple cases I then will say, “If you want, I can sit in on your next pitch meeting as a fly on the wall if the firm will allow it. It’s a little weird but not wildly weird. And then I can be there hearing how things are landing and be able to process the feedback for you even better.” I try my best to keep my mouth shut in those meetings, and then really just act as a coach after the meeting is over.
Healy: It is hard as a founder to accept the feedback that your baby’s ugly, right? That’s really hard. When I was an investor, there were a number of times I tried to provide feedback, but eventually you get enough people who try to fight you on something where you feel that maybe you’re not providing the right feedback. How, as a founder, can you adjust your mindset to be really receptive to that “no” from the VC, to incorporate the feedback to make your pitch and your story better?
Eric: I think the first part is just to have realistic expectations about how deeply the venture investor will understand your business. When you’ve been working at 80 hours a week for years on end and you’re having nuanced conversations with other people who are working 80 hours a week in your industry, for you, very small shades of gray from an outsider’s perspective are hugely important. You want to get the world to understand how important your approach is and those things that are shades of gray. For the venture investor who’s spending a few hours a week on your sector for the last 10 months, they will never understand the shades of gray as well as you do. You can either say they’re idiots, they should drop everything and come as deep as I am in my world, and I only want to talk to the two or three venture firms partners in the world who’ve made that commitment. Or you can say, “Wait a minute, there’s a higher level of abstraction here and let me embrace, rather than as a chore, let me embrace as part of the craft of creating a great company, the ability to tell the story at a higher level of abstraction in a way that people get it, and they get what we’re doing in a way that’s compelling and interesting.” That’s maybe the first bit around mind shift change. And then the second bit that I see happen a ton is we work so hard on making our presentation that we want to transmit it, and I’m totally guilty of doing this. You’re like, “I have a compelling story. I want to tell it.” But it doesn’t engage the audience anywhere near as much as if you can get the audience to start engaging and asking you questions. And so, the nirvana is not 30 minutes of uninterrupted monologue. The nirvana is a dialogue where the investor is engaging and asking questions, and that I think can be difficult for entrepreneurs. For some entrepreneurs.
Healy: I’ve definitely been in pitches where you get talked at by the founder for 30 minutes and it does not resonate as well as the ones where you get asked a lot of questions. However, the flip side, I would say, is that sometimes the VC will ask a lot of questions and you will miss important points. I specifically remember back then when I was a junior VC. We brought in a company that I think it was pretty spectacular actually. A bunch of questions were asked during the partner meeting, and the founder never got to the competition slide. One of the partners was like, “Well, he didn’t say anything about competition. He must not be very experienced.” It was a little bit of a, “Wait a minute. You just let him get to that slide.” As a founder, I’ve got certain advice I’d like to give founders, but what kind of advice do you want to give to a founder about staying on target, staying on the pitch, versus being nimble and going in the weeds with the VCs during the pitch?
Eric: I agree that can happen, but that’s a minority of the cases that you’re much more likely … When there’s a disconnect on the story landing, it’s much more often that the founder was just talking at the investing group. Occasionally, more than occasionally, 20% of the time, the thing you’re talking about can happen. And so, the not perfect solution, but a solution is for the founder, when they’re thinking about the story at the highest level of abstraction, there are a handful, maybe three key things to communicate. And so, if you’re getting to the end of your allotted period of time and you know you’ve hit three of the four things that were on your key list, then no matter what the next question is, make sure you jam in number four.
Healy: I like that advice. That’s excellent. What do you think those three or four things are? Does that vary by company, or the three or four things you need to get across?
Eric: It really does vary by company. I don’t think there’s one collection of three or four things. Sometimes it really is the competitive slide. Sometimes it really is the market size. Sometimes it really is the awesomeness of the founding team. Sometimes it really is the beauty of the business model. There’s not a one-size-fits-all answer here. This was something that, eight years ago, was a huge screaming need. I find now that’s much less likely that entrepreneurs who already raised at least one round of funding, and maybe a second and have gone through a series of pitches and … The coaching has gotten a lot better, and so they’re much better at telling the story at that high level of abstraction.
Healy: I definitely want to talk a little bit about the market, which has obviously been challenged, and you write quite a bit about where you see market trends going on LinkedIn. But before we talk about the market, do you want to talk a little bit about what you need to look like as a business to raise a Series A right now in the fourth quarter of 2023?
Eric: This is always a important question in the ecosystem and the ready trite answers of, “You need to have $2 million of ARR and a growth rate of X.” I mean, there’s value in that and the trite answer is yeah, it’s kind of 2 million of ARR and if it’s a straight up the middle enterprise SaaS business, that number and really great growth of 4X year over year coming into that $2 million number. But then there are lots of other business models where the visibility is further out in terms of, “Hey, I’ve gotten these wonderful great risk-reducing things done. The revenue will come from them.” Or, in a lot of categories, revenue is still years away, but you’ve proven some big risk factor has been addressed. Something where if you laid out the business plan on day one and you said, “What is the biggest risk factor between here and a successful valuable business,” and you’ve knocked down that number one risk factor, well, then you’ve made really great progress. The problem is that a lot of times then an entrepreneur, who’s got things are going okay but not great, will then say, “Oh, and we’ve knocked down this gigantic risk factor. We now have a proof of concept of our product working.” If you’ve built a Star Trek transporter and you can show proof of concept that you’re moving a pen from here to the other side of the room, I’m in. I’m in. We can get you Series A, no problem. But a lot of other things you’re like, “Meh? “ Building the proof of concept of that doesn’t really reduce the risk because it was software and we kind of all knew that you could get it done, and now here you’ve spent X dollars and now it’s done. Okay, great. It did really vary, company and market dependent.
Healy: That makes sense, yeah. I would agree that every market has certain valuation or value creation milestones, and you got to tick enough of those down to be able to get that next check. One of the things I advise our founders to do, particularly for industries that I don’t know a lot about, is to network with analogous founders who are a little bit ahead; not direct competitors, but folks who are in similar enough of an industry, and try to learn from them the things that they thought were important that unlocked their next funding round.
Eric: That’s great advice. I 100% agree.
Healy: The other thing I recommend for that is that those founders are also good introductions to their VCs. Again, if it’s a non-competitive yet analogous founder, those are phenomenal ways to get into your next round’s investors.
Eric: I heartily agree.
Healy: Let’s talk about the market. It is kind of the elephant in the room. It’s not 2021 anymore. Things have corrected quite a bit. Public markets are down as well. What do you think is the health of the early stage VC and seed market, and where do you think we’re going?
Eric: I start one step back at the macro and as something of a Bayesian prior, let me first say, people who are great at predicting the actual future macro mostly don’t exist. And if they did exist, they’d be billionaires trading their own account, not giving advice to you and me. Anytime somebody says something about things are going to happen in the future macro, you should basically assume that it’s wrong. It’s a good starting point. But I do think we can make observations about the reality that’s on the ground today. For me, I think the reality on the ground today is a surprising one. We had a boom and it peaked in ‘21. We had something of a crash, but it wasn’t despondency. There was not this point of capitulation in the market where people are like, “Give up. I give up. I’m selling my last share. I give up.” I just don’t think we ever got to the point of capitulation. It’s odd to have a proper recovery without a period of capitulation and then some number of quarters of real trough where people are just despondent and the mindset shifts from things will always be good, to the mindset becomes … Mindset is like things are bad and they will always be bad, and we didn’t have that yet. And so, part of me is still kind of waiting for that point of capitulation and that period of despondency. Maybe this is the semi mythical case where the Fed actually gets a soft landing and the US is an island of relative stability in a highly unstable world, and capital flows are coming in because of that, and maybe we get to skip the point of capitulation in the period of despondency. It’s not typical that that happens, but it’s kind of looking like maybe that is happening. And so, if that has happened, then I think we’re starting to see a little bit of a rise in the data. Not I think. I see it in September and October and the first couple of weeks of November in terms of enthusiasm in the venture markets. It’s not going to be ‘21 again, but maybe we get to skip the period of awfulness and we get to just have ‘22, ‘23 were periods of, “Meh. Okay.”
Healy: Personally, I feel like I felt despondent a few times in the past 12 months, but I guess the flip side is earning five-point-something percent on your cash makes you a little less despondent, so maybe that’s-
Eric: But we didn’t have that period where every day on your newsfeed, every single article or the overwhelming majority have a sentiment of, “Things are terrible and they will always be terrible.” That’s what we had in the Great Recession and what we had in the dot-com crash, is everyone just … That was the complete mindset of everyone in the ecosystem, is things are terrible and they will always be terrible.
Healy: That’s true. That’s true. We have 800-plus clients and we definitely had a period of time, particularly into the end of Q2, where an usually large number of companies shut down, and some of which I think were pretty smart founders attacking interesting ideas and they were caught up in the capital market problem a little bit. That was pretty depressing. Of course, there were also a lot of other companies where they never really found that product market fit or go-to-market motion, and so you could understand why those ones weren’t raking it, but some other ones … yeah, it was a little depressing there for a while and I wouldn’t be surprised if we see another run up of companies shutting down end of year. It would be a natural time to throw in the towel and go and try to find something else to do. Let’s say you’re talking to a founder whose company is going to shut down. What advice would you give to them? In particular, worked with founders who have shut down and they’ve been able to go raise again successfully for another better idea. What kind of advice would you say to the founder that’s shutting their business down that would help them be ready to rebound, be ready to come back and start a new business and successfully raise capital again?
Eric: I think there are two phases and the advice is different in the phases. The first one, when you’re thinking about maybe things aren’t working here, is to really seriously think about saving the company. Even if it takes you an extra six months to get it to an exit and maybe you’re not making millions of dollars, getting to a successful exit, even if it’s really modestly successful, is better than just giving up. Better for your psyche. Better for your reputation in the ecosystem. Better for all those things. Now, what I don’t recommend is taking that logic too far and saying, “Well, we could become a consulting company and my venture investors will own 30% of this consulting company that we can keep alive through a bunch of NRE projects.” You’re not doing anybody a favor there. You’re hurting yourself and you’re not helping your investors. But if you can see it to an orderly exit that gets some money, hopefully for you, then that’s better. Then further along, if you’ve gotten to the point of like, “This just is not working,” then don’t try to make it something it isn’t. You take your learnings, you have the candid conversations with your existing investors, and you work quickly and efficiently to an orderly shutdown. Maybe you take a little vacation and regroup and recharge a bit. People say the best learnings come from failures. I’m not 100% percent sure on that. I think the best learnings come from successes, but you do learn something from a failure. You should absorb those learnings and use them to inform your next thing. If you were a founder who sort of jumped onto whatever the popular thing was that year when you founded it, I think those are harder. If you are a founder who was driven by a need to see something change in the ecosystem, there’s something problem or broken, then maybe you just take a different attack on the same fundamental broken thing in the market with a completely different approach. And then be super transparent and forthcoming with your existing investors; the goal of, I want to treat them as fairly as possible so that they would want to back my next venture.
Healy: We’ve definitely seen a number of founders finding ways to get their investors some or all of their cash back, and that’s not why a VC makes an investment, but it does feel nice to get some of your capital back. I’ve seen the VCs appear to be very appreciative of that and I see them backing the same founders again later if they feel like the founder did everything they could to be good stewards of that capital and also be realistic in terms of reading the tea leaves. But this is a hard conversations that we have with some of our clients and I’m sure you occasionally have to have them with some of the companies that you’ve invested in. It’s a little bit of an effect of the down market, but on the other hand-
Eric: I think the number one piece of advice there is to be candid and transparent with the investors, and communicate.
Healy: Right.
Eric: What you as an investor don’t want is, “Oh hey, good news. You can put in some money now. I’m going to be out of cash in two weeks.” Like, “What?” That would not happen to be since with my business model, I’m much closer to my companies and so there’s no way that that would happen. But for a lot of investors who are running large portfolio models, they’re not as close to their companies and that can be a little bit of a shock. “Hey, I’m giving up.” Like, “What?” So, don’t do that to your investors. No one likes to share bad news. It’s not fun, but you get a lot of credibility points for being transparent.
Healy: I totally agree with you. And also, being empathetic, thinking about the investor, thinking about your employees, thinking about your customers. But this did lead me to another thing that I’ve definitely seen a lot of founders ask me about and would love to get your thoughts on this. Some very large funds have gotten pretty active at the very early stage, the pre-seed or seed, and I’m hearing mixed signals in terms of the attention that the founders get. But what they do appear to be getting are pretty high valuations and it’s just interesting to see the check sizes as well. What has your experience been with the very large funds who traditionally may be sitting at Series A or Series B doing those very early-stage investments? Is that the right call for a founder to take that money, and how does the founder get the most out of that type of a relationship?
Eric: There is no, I don’t think, a one-size-fits-all answer. There are pluses and minuses associated with those checks from the large firms, but you want to be careful you’re not getting the same level of attention as you’re getting when one of their tenured partners takes a board seat. So, yes. Brand name firm X, Y, Z is investing. That’s nice, but don’t confuse that with the same situation as brand name firm X, Y, Z, and one of their tenured partners is taking a board seat. Those are totally different kinds of levels of commitment from the firm. And the trade-offs. First and foremost, you need capital. If this is an efficient way to get it, that can be great. Then the second bit is around the risk of signaling and that’s a data analysis that I should try to figure out how to do. The pluses and minus, one minus is, “Hey, a big brand name firm X, Y, Z has invested at the seed and they don’t invest at the Series A, what does that mean to the world outside?” It has some negative repercussions. Big name firm X, Y, Z did a hundred of these seed investments per quarter. We’re like, “Man, maybe they aren’t watching them all that closely.” Maybe there’s less signaling effect there than what we might’ve been concerned about five years ago.
Healy: Makes sense. That totally makes sense. Another question that I hear from founders quite a bit, and I’ve got my answer, but I’d love to hear your answer, is how do you value a Series A company?
Eric: This is always a perennial and difficult question because it has so many layers of complexity on it, and in some layers it’s just trivial and in other layers it’s incredibly nuanced. The simple answer is there’s a market rate for price. This is something different than value. There’s a market rate and if you ask five venture investors, take the name off the company and just give the relevant details, they’d all come up with close to the same number as here’s the market rate for a company in that kind of position, with how much revenue and growth and what level of credibility, the team, and what sector and defensibility business model and size of the market opportunity. You’d be shocked how close the numbers were for all of them. Because they’re all in the market and they’re all seeing what the prevailing prices are on deals that are getting done. The trivial answer is: price is supply and demand. We all are in the market all the time and we have a pretty good sense of what the supply demand market clearing price for a company with attributes X, Y, Z is going to be. That’s the trivial answer. The much harder question is, what’s the company worth? What’s its fundamental value? The job of the venture investor is to find the cases where the fundamental value is way higher than the market clearing price. In some ways that seems moronic to even say out loud, but that is the job at the end of the day, or one way to think about the job maybe is a better way to say it. And then that’s a very hard question. What is the company worth in a market where I know 0.1, 0.2% of the outcomes at the seed stage are going to generate half the profit in any given year? It is very, very difficult to assess value in that case for sure. So, a more practical answer for entrepreneurs is, talk to your friends and venture investors who are in the flow of Series A and say, “What’s the market clearing price for a company with my attributes?” You’d, I think, be surprised at how close they come.
Healy: That makes sense. I believe that that makes a lot of sense and, from my perspective, there’s always, if you can get enough VCs interested. You don’t need that many, but you can get enough interest. You can pretty quickly back into the normal market clearing price, and then you can avoid the one that’s trying to act fast, maybe undercut you a little bit.
Eric: But I think there are things that are way more important than price though. Especially if the amount of money you’re raising is small compared to the valuation, then it’s a mistake to get overly focused on valuation. The value-add of the investor and the signaling that a good investor will create is super important, and especially at the point where you have a partner who’s coming in sitting on the board for perpetuity or until eight plus years until liquidity, that matters a ton. When you’re at the seed stage, that consideration is less critical.
Healy: I agree. I definitely agree. I guess the flip side question would be there are definitely companies that last round was in 2021, at a very high valuation, and the clock is ticking here. They may not have a lot of runway. What advice do you give to the companies that are overvalued in terms of how they approach their next fund round?
Eric: My advice whether I’m sitting on the venture side or giving advice to an entrepreneur is always the same. Take the lower valuation. Work through the mechanics and unless you did something punitive in the previous round, you’ll see that it doesn’t matter all that much. It matters for your ego, it can matter for employees a little bit, but it doesn’t matter anywhere near as much as you think it does from an actual ownership perspective. But a lot of times the entrepreneur is stubborn or is overly concerned about appearances and wants to maintain that last round valuation, and so then they agree to structure. You’re like, “I’ve written those term sheets. I’ve done that in the past when I was at big firms.” You can do that and the venture investors are like, “You tell me what the valuation is and I’ll write the term sheet.” They end up painting the company into a corner, and especially at anything other than we’re about to go public kind of stage, you don’t want inhibitors on your degrees of freedom to operate. And so, my advice always is do the financing at a lower valuation. Don’t get cute. Don’t try to add some special preferences or some special terms, or something or other else, or some guaranteed, whatever. All of those things will come back and bite you later and they will inhibit your degrees of freedom to operate. No matter what side, I always say, “Just do it at a lower valuation now.”
Healy: Yeah, take that down round. It was a little bit of a leading question. We published our guide to down rounds early this year and it’s been a pretty good piece of content, but it’s also been very helpful to share with their founders who rightfully have some heartburn when they realize they’re going to have to raise a down round. It’s not a good feeling.
Eric: No.
Healy: For a number of reasons, it’s not a good feeling, but unfortunately you do kind of need to take the medicine. The place where I start to feel pretty bad is for, say, a founder who’s left or employee who’s left. They tend to get washed out or diluted quite a bit in a down round, and that doesn’t really necessarily seem fair, but that happens. That’s just how the process works unfortunately.
Eric: Especially in cases where the company’s a little profligate with their spending, and so the promise is there and they raise a round and then there’s another flat round because the promise is still there, but it’s not been as much progress and there’s just natural increase in the option pool each time, and natural increase in the stack of liquidation preferences in front of the common. And then all of a sudden you’re like, “Oh my gosh. The liquidation preference stack is, I think, maybe bigger than the company’s fundamentally worth.” Then the structure creativity comes out, and then it’s just bad. It’s bad for the common. It’s bad. It’s bad everywhere.
Healy: It makes it hard to have an exit that might’ve been okay when the liquidation preference stack is worth more than what the business is. You’re in a tough spot there.
Eric: But the flip side is there was a Paul Graham not so long ago. He’s written a lot of fantastic posts, some of the best thinking on early stage … sorry. He wrote a post about default alive and your getting to profitability. There are some entrepreneurs who’ve taken that advice too much to heart and you end up with a company like, “Okay, yeah, [inaudible 00:35:38] a million, two million of revenue and breaking even, and growing 20% a year.” You just think that’s not a happy place, right?
Healy: No.
Eric: It’s going to be super hard to raise equity money from the outside at that growth rate. And so now you’ve constrained yourself to being your team of six people, adding 1.2 heads a year because that’s how fast you’re growing the revenue, and it’s a very slow way to build a company. If you took venture money and if you’re building a consulting business, it’s like you should do that, and that’s a great growth rate for consulting business. But you shouldn’t take venture money for that business. So, if you took venture money, you are trying to build an equity rocket ship. And then to shift into a mindset of, “Hey, we’re trying to grow 20% a year so that we can always maintain control of our own destiny and never need outside money,” I think, categorically is tough advice to agree with.
Healy: You should not [inaudible 00:36:36] venture funding if that’s your goal, right?
Eric: I hate to disagree with Paul Graham because he’s written so much great stuff over the years, but that’s one place where I would nitpick with him.
Healy: Again, for bootstrap business, do whatever the hell you want. That’s great. But as soon as you start taking the equity checks for professional investors, they have a particular view and they’re going to really force you or push you in that direction. I’ve definitely seen companies where the VCs push for growth beyond what the company can profitably deliver, but that’s the venture … That’s what you sign up for.
Eric: That is the flip side. That happens all too often and the growth at all costs. I’m a big believer in understanding the unit economic model of the business. If there’s a unit economic model where every incremental dollar in produces 10 cents per month of gross margin lift, I’ll do that annuity all day long; to burn more of my money, make it less profitable, please. But too often the case is every incremental dollar is producing a penny a month in increased gross profit and you go, “Meh. I think maybe I’d just be better in treasuries than buying that equity.”
Healy: Exactly, exactly. We definitely see some of the later stage businesses are a little bit caught up in that, right? They’ve sort of exhausted the easy growth and the next incremental dollar of growth starts to get really expensive. And so, I’m curious to see what’s going to happen with some of these later stage companies as they’re burning through their capital. We’ll see. Hopefully some of them will end up in a good spot.
Eric: The free advice there is that one episode of Star Trek where Spock hits the afterburners and it makes a big flare and it saves the day. That doesn’t work. Don’t hit the afterburners and try to save the day. You want to be realistic and test out your ideas, not go all in on one.
Healy: All in on one thing. That’s probably good advice. That’s probably great advice. Well, let’s shift to some of a slightly happier thing. It does seem like the Series A market is opening up a little bit here. What do you think are the factors that are driving that? We definitely last quarter, hopefully it wasn’t just a dead cat bounce. Hopefully it was a real thing. We saw more deals happening at the Series A level in the US, what is behind that?
Eric: I think there’s a macro and a tech push. So, the macro is the stuff we talked about earlier in that maybe we have avoided a capitulation and despondency era in the markets and we get this mythical soft landing and that seems like maybe it’s happening.
Healy: I hope so.
Eric: Hope so. The second part is the AI revolution is real, and I have mixed feelings here, but for sure the use of AI in a lot of startup use cases really makes them better. And I see that even in my own portfolio companies that weren’t explicitly AI, they’re using AI to make their product and their internal processes better. And so sadly, there are a lot of folks who then take the mistaken approach of, “Oh, AI is hot. Let me start an AI company. I’m going to use AI.” And then they start looking around for problem to solve, which is a less compelling North Star for a young company than, “Oh my gosh, there’s this problem that must be solved. I’m going to solve it using … I’m going to do this. I’m going to use some humans here and I’m going to do this thing, and I’m going to do this, and I’m going to use some AI here.” And so they’re cobbling together the combinatorial goodness of all the technology that’s out there, including AI, to go solve customer problems or address a latent market need that no one else has addressed. Those are super compelling to me. The kind where it’s, “Hey, I’m an AI company and we’re going to go, ‘Oh, we’re going to apply AI to go solve that thing.’” It’s running eight years until liquidity from seed stage. Is there really going to be market hype and froth on AI in eight years? That just doesn’t seem that likely to me.
Healy: Yeah, well, we have seen our clients adopting AI pretty aggressively. I noticed that over half our clients are paying OpenAI now which, if you think about it, OpenAI wasn’t really something that you could easily purchase last year. So that’s pretty aggressive penetration. And they’re talking to the clients, they’re using it in a variety of things. Some of them are using it to just write simple marketing things or getting a little help coding. And on the other side, some are actually powering a feature using it. So, there’s a big swath of, “Hey, I’m using the API to do something amazing.” Or, “It’s just making my marketing guy more effective.” It’s pretty interesting that such a broad use case across the client base because in general when you see our clients adopting something it’s, “Oh, I’m using that for international payments.” It’s like a very kind of narrow rail that they’re using it for. This is more of a toolbox as opposed as [inaudible 00:41:47].
Eric: [inaudible 00:41:47].
Healy: Yeah.
Eric: It’s like I talk about it a little bit like the internet. It’d be kind of crazy. “Oh, I’m starting a business, but there’s no internet involved in my business at all.”
Healy: You can’t email me. Sorry.
Eric: Exactly. “Oh, I’m starting a business.” “Hey, don’t tell anybody this, but we’re going to use electricity inside of our offices. No kerosene lamps anywhere.” And you’re like, “Whoa.”
Healy: Amazing.
Eric: Okay, good.
Healy: That’s amazing. Eric, this has been a pretty awesome discussion. I feel like we’ve gone a lot of different ways. I’d love to end with one piece of advice that might be really useful to our clients and to our listeners. I want to ask about the wow factor. In your view, what is the wow factor that makes a startup irresistible to Series A investors?
Eric: It’s not a superficial … In fact, I even cringe at the notion of there’s a wow thing. Great companies are founded to go solve big problems or address giant latent needs in the market. They tend not to be ones that are just doing the same thing that somebody else is doing. And whether you call that greenfield or category creator or whatever, to me that is a much more compelling North Star for a company than, “Hey, we’re in this hot category, which maybe is driving pricing a little bit higher today but isn’t going to carry the day until liquidity.” So that’s the first thing. Then the second thing that I would think about, and so that’s sort of the admonishment to not go do what everybody else is doing. The second admonishment is standard Paul Graham of, “Build something people want.” And this is sort of Clay Christensen 101 of, “Hey, be impatient for a business model that works. Don’t go try to boil the ocean. Begin to show that the business model is working or knock down the biggest risk factors between you and that working business model.” And then the last thing that I think really gets the very best Series A venture firms excited and partners at those firms is a defensible business model. We’ve all had the experience of, we made the investment and then the company gets to 20 or 30 million of revenue and it’s growing nicely, and then all the copycat competitors come out of the woodwork and copy the bullet points off of our portfolio company’s website and put it on their website. And we know it’s BS, but it does slow down the sales cycle and it does increase your churn rate and it does create pricing problems. And so, I’ve become a very big believer in businesses where there’s inherent defensibility in the model.
Healy: Makes a lot of sense. That makes a ton of sense. Well, Eric, thank you for joining me. This was a great discussion and I’m sure people are really going to like it. It looks like you have one more thing you want to add. What is it? Go for it.
Eric: Oh, I was going to say, the dopamine hit answer like, “Here’s the wow factor,” and then it makes this great little post on LinkedIn that people can go, “Oh my gosh, that’s great.” But in reality, building a great company is a few fundamental key things and not one wow factor dopamine hit.
Healy: I don’t know. I think you actually did answer the question.
Eric: Oh, good.
Healy: So you said, “Build something people want.” That actually is good advice, and build a defensible business model. Now it’s not like those are just, “Oh, I’m going to push a button and that’s going to happen.” But yes, that is what you need to do to build a successful business. That is the actual advice of what you need to do to create a VC-backed successful startup. You got to build something people want and your business model’s got to be defensible.
Eric: Exactly. That’s a good summary. The only addition I would there is just don’t do what everybody else is doing too. Everyone knows that OpenAI has built something people want. Okay, the legitimate competitors, there’s already a handful of them. Go building another one of them is not a good idea.
Healy: That’s going to be hard, that’s going to take a lot of capital, but good luck, and very expensive as well. So, Eric, how can people find you?
Eric: eric@tunitas.vc is my email address. Sadly, in the old days I used to be able to reply to every email. Now there are some of these lists out there that I get a bunch of inbound, unsolicited great ideas with emojis in the subject line and so many exclamation points. It looks like a real estate flyer. So, if you have an idea that you really want me to be involved, I try to keep my LinkedIn list be people I actually know, not just random people I’ve met once. And it’s a lot. It’s many, many hundreds. Any of those people who know me is a great way to refer in. Or if you don’t know any of those people, then write a custom email that didn’t come from HubSpot that looks like it was sent to a thousand other prospective investors. And if you went to one of the schools I went to, if you actually know something, then show that you actually know the person that you’re reaching out to. And this is not me being an egomaniac, maybe it is, but it’s more about this is how you show to a prospective investor that you value what they do. And that’s advice I give to my portfolio companies is if you can’t tell with a straight face the partner that you’re pitching, why their money is more valuable than just the check, then should they really be on your target list?
Healy: It’s good advice. It’s really good advice. And all I was asking for was an email address. That was amazing.
Eric: Sorry.
Healy: That was great. It was really good. Thank you so much. Appreciated having you on.
Eric: Thank you for having me on.
Healy: I appreciate it. Take care.

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