With Scott Orn

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Scott Orn

Scott Orn, CFA

Steve Gillan of Azure Capital Partners - A VC Firm Investing in Post Seed Startups

Posted on: 01/23/2017

Steve Gillan

Steve Gillan

Chief Financial Officer - Azure Capital Partners

Steve Gillan of Azure Capital Partners - Podcast Summary

Steve Gillan of Azure Capital Partners discusses his firm’s strategy of investing in Post Seed Stage Startups. Steve shares what he looks for in startups including metrics like Life Time Value of the Customer and Customer Acquisition Cost. Steve also shares some great stories from his day as an Operating CFO at two successful startups. Azure capital partnerspost seed investingventure capital

Steve Gillan of Azure Capital Partners - Podcast Transcript

Steve: One important thing is, venture-backed companies have become so pervasive in our culture like everybody is carrying around in their pockets or their purses or their backpacks pieces of technology from venture-backed companies and we’re using those pieces of hardware to access more venture-backed pieces.
Scott: Welcome to Founders & Friends podcast, with Scott Orn at Kruze consulting, and my very special guest is Steve Gillan of Azure Partners. Welcome, Steve.
Steve: Thank you. How are you doing Scott
Scott: I’m doing great. So we just talked for about fifteen minutes with the mics off, so we’re going to recapture everything, all of the great points we were making there.
Steve: Yes, we memorized it.
Scott: Yes. Steve is an old friend of mine, we’ve been a friend for probably fifteen years, we did a deal together way back in the day, but maybe give everyone your quick background.
Steve: Yes, so I spent a number of years at public companies in reporting and international finance operations. My first startup, Alibres, back in the late 1990 s which is when we met, and you lend us money and we paid you back, with interest.
Scott: Yes, thank you for doing that.
Steve: And then, after a couple of more startups, I’ve been at Azure Capital Partners for about seven years now
Scott: And Azure is a VC fund, early-stage VC fund, right?
Steve: Yes, so when I started back in 2009, we were series A, series B initial investments, and now out of our third fund we’re doing mostly post seed pre-series A deals, as the series A pricing and amounts got out of hand we decided let’s make earlier bets and that has really paid off
Scott: Yeah, so when a company is starting to have kind of the inkling of traction, that’s when you guys get involved.
Steve: Yes, when they’re showing, trying to show significant growth in their traction, whether it be revenues, or user growth, or some other indicator or significant biz dev deals that they’ve just signed and are about to launch, that’s when we pull the trigger.
Scott: Awesome. And maybe tell them about your role at Azure, because you have a pretty unique role.
Steve: Yes, so I am the CFO, which isn’t unique in venture firms but guys at Azure wanted me to come on board because of my startup experience, so I spent as much of my time as possible if it was my choice it would be 100% of my time helping startups, so we invested in early stages, they often don’t have a finance team, we at some point refer them to folks like you, and what we do is help them with, I help them with everything, finance, so I help them look for deals, I help them find accountants, I help them with their planning, forecasting models, I just help them with board decks, just help them make sense out of the finance systems.
Scott: It’s amazing how you name them and I want to talk about all three of those things you named but just simple forecasting, how it started, we did the same thing, we helped startups with very basic forecasting and it’s not rocket science, but a lot of times founders are technical people who are great engineers but maybe haven’t really worked for the income statement before, how do you communicate with them about this stuff, or do you have like a little boot camp you put people through, how do you teach them?
Steve: Every company is different, and, so what I kind of take them through is the whole process of what is your business, what are you trying to do, what’s your revenue model, and then let’s make that planning and forecasting model reflect your business, so often we see companies that insist upon doing gap accounting, gap accounting 90 percent of the time is just the wrong way to understand your business, right, so first you have to understand your business then put a model together in as much granularity as possible to get down to that final plan.
Scott: Yeah, a lot of times what I’ll do, and tell me if you think it is smart or a stupid, I’ll talk to them about kind of we always say like KPIs, the four or five key performance indicators. And we let those, and those might be like customer acquisition how much it costs. And, how long you hold on to a customer, like, the lifetime value of your customer and things like that, and then, we’ll use those to drive the financials, but, I always like them to then think twelve or eighteen months forward, and think about what they need to show the next venture capitalist, what proof or what traction and then work backward. Do you do anything like that?
Steve: Yeah, definitely. We always think about what is that next round, what kind of improvements do you have to show in your KPIs to get to that next round. And we are investing in a number of consumer companies so that CAC LTV model is really important, and you can calculate those things, a ton of different ways, right.
Scott: Actually do you mind walking everyone through that, because I don’t think people always know how to calculate that.
Steve: Yeah, so CAC should be pretty simple
Scott: It sounds dirty. [laugh]
Steve: Customer Acquiring Cost. Simply put, it’s the total cost you spend acquiring customers whether be search marketing display
Scott: PR.
Steve: Yeah, anyway that you’ve brought customers to your product. And, divided by the number of new customers in that month, so that should be fairly simple. But there are different ways to look at it, did you really spend that money to acquire customers that month, maybe in the following month but you still count at that month because you are going to continue spending long term. We have some companies where a customer will come to their website in month one but they might not make a purchase for four or five months, right, but you have to count that spending every month. LTV can be a little more tricky, right, there is a lot of assumptions that are going through, kind of almost like an option pricing model, like okay what do I want my LTV to be, right
Scott: Oftentimes entrepreneurs are very good at presenting the LTV that makes them look the best too, which god bless them, that’s what they should be doing.
Steve: Well, a lot of times we’ll see LTV and it’s basically lifetime revenue, that’s great but your margins are 12%, so your LTV is really small for action, right
Scott: So you acquire, dating sites, or maybe some more direct cost, I don’t know, maybe e-commerce company, an average customer is spending 50 bucks a month for 12 months that’s 600 dollars, which is great.
Steve: Right, so are they going to only stay for 12 months, in an early stage company you have to make assumptions about how long are these customers going to stay with us. Maybe that is 18 months, on average, so that would be 900 bucks, but then you discount that back right, so there is a present value of that 900 dollars you earn in the future, at whatever growth margin you are earning. And, it’s got to be all in margin too, not just some arbitrary gap, cost you get sold, you subtract out of revenues, it has to be any cost that is associated with that revenue stream, right.
Scott: Maybe you spend 450 bucks, that customer bought a bunch of furniture, and it’s 450 bucks, so your growth margin is only 450 dollars, and then maybe there is some customer support costs or other things that are going-
Steve: So it’s another 100 dollars maybe comes out of that, so that’s 350 and then you discount that bag at some interest rate so maybe your LTV instead of being 350 is 320, or something like that, and so if you are spending 500 dollars to bring that customer in, it’s not a good business.
Scott: Azure doesn’t fund that kind of companies.
Steve: No, no
Scott: Do you have a rule of thumb, like what multiple you like to see because I’ve heard some numbers kicked around?
Steve: We initially- again, it’s going to depend on the type of company, initially we want to see your LTV cover your CAC, right, because you might want to spend a lot initially to kind of build up that customer base, but eventually we’d like to see it like three times and that number is changing all the time so
Scott: I’ve always heard three axes of fundable company, five axes like the greatest company of all times, and you had this example of like one of your portfolio companies has a five axes on their first purchase, which is insane, so that’s like a company that people are probably rushing to invest there, right.
Steve: Yeah, and it’s probably not going to sustain itself, but it’s still a good place to start rather than having 0.5 LTV CAC ratio and try to dig yourself out of that hole
Scott: You made a good point there, which is companies can’t always sustain these multiples, I’ve heard this in e-commerce a lot, oftentimes kind of the first group of customers you acquire are they love whatever you are doing, you thought of this thing and they are made for you, and then as try to get bigger, you take more financing, you start kind of having to convert people who are not naturals for you but still want your product, and then that ratio kind of goes down or changes, like have you seen that in your career, or experienced that?
Steve: We make sure when we are evaluating an investment, and we continue to evaluate the companies after we invest if they do a cohort analysis, so you are kind of what percentage of your customers are staying with you and for how long. So you’ll often see after the first purchase, maybe with the subscription model, right, of the people that come to your website, let’s say 10% of the people subscribe and then of that 100% of the people that did subscribe three months from now, how many are still on it, 12 months, 18 months, and then, as you continue to go forward and acquire new customers, how does that keep rate
Scott: Yeah. And I always love, there are these vintage analyses where it’s always great when the curves all look the same over time, because then you know it’s like-
Steve: They are predictable.
Scott: It’s very predictable, yeah.
Steve: And that’s what we like to see in our companies, as well, right. And as they make changes to the business model or come up with the new or complementary business model, or acquire a small company and kind of fit that into their sales stream is that going to fit that same predictable curve
Scott: I always find the late stage VCs are super focused on predictability, which makes sense because I think, or maybe you can explain to the audience why late-stage cares more about that then someone like you who was coming in very early?
Steve: Yeah, I mean, late stage, the VCs are going to want to have a liquidity event within two to three years, versus the one to seven that the rest of us want. So you really want predictability, you want to see a good track record, so if a VC is making a late-stage investment, they are going to look for not just your performance of the last three, five years, they are going to look for your plan to performance of the last three to five years, so do you have a predictable business and have you met your plans
Scott: Yeah, that’s totally true, I mean, because for folks who don’t know, when you do an IPO, initial public offering, the management team actually goes on the road show all across the country, really the world, they go meet investment managers all over, and that same kind of pitch that you did when you are pitching someone like Azure at the early stage and you are pitching late-stage VCs, you are actually doing a form of that pitch to the public market investments, and these guys and women sitting in this room, and they hammer the CEO.
Steve: Except you are doing that pitch at a supper club in New York City versus a conference room like this one in San Francisco.
Scott: This is as cool as a super club.
Steve: It’s cool but it’s a lot less intimidating.
Scott: Did you do that for Alibris or some of your own companies?
Steve: We did, yeah.
Scott: What was that like, was it crazy?
Steve: It was, there is the travel schedule, it’s crazy.
Scott: Fill people in, those are good war stories.
Steve: Yeah, I mean, we were in London for a day, and we had I think it was seven meetings in one day, so flying previous afternoon, seven meetings the next day, I saw Eric Clapton at Royal Albert Hall that night
Scott: Wow, that’s cool, that’s awesome.
Steve: And then went home, the next morning, you know. And then after one day of rest and recovery from jet lag supposedly, I hit the road here in the bay area and then San Diego, Chicago, Milwaukee, Philadelphia, Denver, New York, so it’s nuts
Scott: It’s got to be crazy like you just stand up there and tell a story, 30 minutes at a time all day.
Steve: It is. Now, later stage companies pitching for more private equity, they could have a similar schedule, at Alibris we did for our series, I think it was series D, we traveled extensively to raise that round and we’ve seen our companies that are reaching some kind of a scale, and maybe raising their series C, they are definitely putting in many roadshows in order to raise that next round.
Scott: Is that because it’s like you are trying to tap a deeper investor base as you want, maybe there is a late stage firm of mutual fund in Boston that will invest in your-
Steve: And a different type of investors, so late stage investor is going to, for us, if we invest in series A that is kind of the middle of our spectrum, right, for a late-stage firm, one of our companies might be at the very early stage and maybe ventures become very popular here over the last five-plus years, so these later stage firms are kind of creeping earlier into the spectrum.
Scott: Yeah, what do you, and this is a load of questions, but why do you think they are creeping earlier like I have my own theory, but why did they do that?
Steve: I think they see the great returns that a lot of VCs have had, and there is a lot of press put there about some venture models don’t work and there are new venture models out there but there is still, there are firms that have great returns, and there are investments that have great returns, so I think that’s part of it, I think one important thing is venture backed companies have become so pervasive in our culture, like everybody is carrying around in their pockets or their purses or their backpacks pieces of technology from venture backed companies and we’re using those pieces of hardware to access more venture backed pieces, I was watching something on Netflix last night, “The Fall”, and psychologist was interviewing a serial killer, she was asking him questions about Facebook and it’s like it’s just so pervasive, in the culture, and there is, The New Yorker writer, local San Francisco Nathan Heller who has written stories about technology and a couple of them have been about this just how, the cultural shift is moving, the drivers of our culture have moved to the west coast, at least the northern part of the west coast.
Scott: It’s true, it’ll be even crazier when self-driving cars and some of that stuff happens, because that is traditionally a sector that like Silicone Valley never touched, now they are getting into it and that’s like, you just think culturally like how many car commercials do you see when you watch a football game, or the driving a long road trip and it’s like, that’s really going to change.
Steve: Yeah, there is definitely more VCs in self-driving cars than in beer companies, to use that football commercial analogy.
Scott: Totally. So, the late stage guys, they see opportunity, they think they can get in earlier, and get a better return and then also just, that’s just where the action is nowadays, right.
Steve: Yeah, I think so. I mean, ultimately, it’s the returns that they think they can get, but I do think there is a little bit of the sexy factor too that is driving them there.
Scott: Yeah. Did you guys ever, because you guys made a choice here like hey, we’re going to go early, which maybe you can talk about some of the trade-offs like that kind of decision for Azure comes with what’s like more risk, more return, but also potentially you could swing in this on a lot of companies and not have the returns eventually.
Steve: Yeah, I think, for the size of our fund, our last couple of funds have been just over a hundred million and you have to make bets and you have to take the appropriate risks and so if we did just traditional series A and series B we would have fewer bets
Scott: Yeah, that’s a great point.
Steve: And so, partly it’s because we wanted more at bets, and we’re investing in these post-seed companies and if a new investor comes along and puts a series A together, puts a term-sheet in for a series A, then we decide are we going to go ahead and participate in the series A and we’ve done that with a handful of them, we don’t lead the series A, generally, we don’t lead the series A on these companies, so when we’re putting a small amount of capital together, if we don’t go on and invest in the follow-on, there are a number of those who have not invested in the follow-on, then you are going to need to really outsized outcome in order to get a meaningful return, so it’s our bet that the ones that we are putting money into in the series A are going to do really well, since we have more of the ownership.
Scott: It’s a way for you guys to like double down on investment essentially. Yeah, it’s interesting because the dollar amounts have gone really big for series A, but I feel like folks like you, I feel that you’re in the sweet spot of the opportunity because you can see some form or traction obviously it’s risky, but you’re not being forced to write like a ten million dollar check or something like that, we regularly see companies raising ten million dollars series A now which five years ago just didn’t happen.
Steve: Right, the question is what are you going to do with that ten million, because, it is so much cheaper now than it was even three or four years ago, especially ten, fifteen years ago to start a company. You don’t really have to invest in anything. You can rent everything, right, you don’t have to fill your server, you need the server in first of all, you don’t need real estate is expensive but you don’t need that extra real estate with an air conditioner in it, to have your server, so you can get cloud services, very cheaply, you just don’t need the same kind of investment, that you needed in the past and I think just you don’t need necessarily to travel so much anymore, you don’t need as much office space I don’t think as you did before because people are working remotely more and more
Scott: It’s also more comfortable working closer together in open areas.
Steve: Yeah, and I see the Bay Area becoming more like New York now in terms of offices, like your office here, like you used to walk into a Bay Area startup and it was a fair amount of space for people but as real estate costs have come up it’s more like a New York startup where people are very close together and fine with it.
Scott: Yeah, we find that it actually, we actually don’t really, we have one person that works remotely and she is like our virtual office manager, her name is Liz she is a military family so she moved to Seattle and moved to Japan recently and we wanted to keep supporting her she is an amazing woman, but everyone else we have working here because we find that people learn much faster when there is just like this give and take a little bit, little buzz in the office, they are learning way faster and they can learn from each other’s mistakes, it’s actually really productive.
Steve: Yeah, we’ve made a number of investments in Canada, and we decided with this third fund to put somebody in Canada and we just hired a new person and they are going to be here for four to five months in the bay area in our office, learning how we work, we want to learn how she works, and before she moves on up to Calgary. And, it’s a great way to get people to understand how you work, and you can’t do that by having a phone call every day
Scott: Yeah, especially like in investing, because they need to know what the rest of the partnership wants to see. Otherwise, they are just bringing a bunch of deals that everyone just rejects. Real quick, what kind of stuff does Azure look for, like where are you guys investing and what is the optimal industry that you guys like?
Steve: We’ve done quite a bit of e-commerce, and e-commerce subscription businesses, so a couple of them that are notable are Le Tote, which is the women’s fashion subscription company, so it’s kind of like the Netflix DVD model, right, you pay a monthly subscription, you fill out your virtual closet, they send you five items, you wear those as much as you want or as little as you want, send the box back they send you five new items. That is growing massively.
Scott: Those are great models. Vanessa does rent a runway. Whenever we go to Vegas she always gets a dress for rent or sometimes even as a fancy wedding, and it totally, it’s great, so these, I’ve heard great things about Le Tote.
Steve: Yeah, Le Tote is more everyday women’s wear but women love it because they get new things to wear, and they can keep them and buy them in a discount if they want to keep them, and the company has massive amounts of data too, it’s a huge percentage of people the rate the products, I don’t know what overall e-commerce, what the percentage of people that rate products are, but at Le Tote it’s north of 50%.
Scott: Oh that’s amazing.
Steve: So, and those ratings are everything about the quality of the fabric to this runs a little tight, this runs a little loose, so they can hone the next shipment and that shipment after that and that shipment after that to match the person’s taste and responses to the question. That’s really smart.
Scott: Yeah, you don’t think data intruding on the clothing business, but that makes perfect sense because sometimes cloth really agrees to your skin or whatever it is or you just look great in red or look great in black and you want to wear more of that.
Steve: Right. And another e-commerce company we’ve invested in is the Bouqs.
Scott: Oh yeah, you guys are in Bouqs that’s awesome.
Steve: Yeah, the B-O-U-Q-S as in bouquet, and they are a farm to table flower company so they work directly with farms in South America and they’ve cut out, so we’re looking for new business models, so they have cut out the supply chain and John, the founder and the CEO of the company has a great slide or great graphic that shows, it’s a huge percentage of flowers in the US come from South America, something like 70%. And they all go to a warehouse and middleman in Miami and then they go to the warehouse and middleman in other parts of the country and they go to your florist and then you go buy them. And, it’s the same with the e-commerce model, so what the Bouqs does is they buy directly from the farmers, the farmers pack the nice Bouqs packaging for you
Scott: Oh they do?
Steve: They do. And then they have consolidated the FedEx shipment to the US that then goes to the customers, so you are getting flowers from them, maybe four-five days, after they’ve been cut, versus when you buy at the florist they have probably been cut maybe two weeks ago, so the Bouqs Flowers, I mean, it’s amazing
Scott: They can last another ten days, extra.
Steve: They do, yeah. Ten days, two weeks, people that I send them to say these are amazing, they are still beautiful after this long.
Scott: It’s funny you say that because one of our clients it was Vanessa’s birthday, or it was for her wedding, we got married, I forgot to tell you that. [laugh]
Steve: I think you did, I congratulated you on email, congratulations
Scott: Thank you.
Steve: You are looking much better now.
Scott: I am happier and less stress. But one of our clients actually brought in a Bouqs floral arrangement for Vanessa and I actually noticed today, when I was leaving for work like those flowers are still good, I couldn’t believe it, that was like last week. That’s really smart. So those kinds of businesses that make a ton of sense.
Steve: And then we’ve done a couple of hardware and heavy tech investments, also, a couple of Canadian ones we’ve done, one is Renovas which is up in Ottawa, and it’s a company that is developing an enabler for broadband processing to make it much faster much less power consumption on much smaller footprint. And so they’ve got, they are going to start shipping commercially early next year to some very big telecom providers and data center providers, so that is doing really well.
Scott: That’s cool. Yeah, that’s probably like old people who came out of the north tower or something like that, right?
Steve: Exactly. So it’s kind of the two ends of that spectrum.
Scott: That’s because you guys are doing like the heavy com science though because I fell like the venture guys stopped doing that for a while or maybe the telecom was sort of tough that no one wants to invest in that. So that’s fascinating, and as we’re talking I realize I should have made a couple of intros for you for people who are raising money right now in those sectors, so we’re just kind of switching gears a little bit from what Azure looks for, like, you mentioned some of the stuff you do, you help with forecasting, you help with raising capital, you help so they get their finances in order, like what are some of the things, some of the specific things you are drilling into with your portfolio companies?
Steve: You know, we talked about the CAC LTV model before, so we have, I mean, we’ll have long discussions about what are you including in LTV, what are you including in CAC and this really makes sense for your business, we also, we have invested in a number of enterprise SAAS companies as well and for them it’s really the sales efficiency model. So, how fast are you growing your sales force and how much faster is that new sales force growing your revenue and your margins and we’ve seen, yeah, we’ve seen companies do really well with that, we’ve seen companies where we need to prod them a bit more on that, but that’s a really important metric for those guys.
Scott: How fast should like a salesperson be self-sufficient- I was here like three or six months for a good salesperson, but, is it faster not, because they are more, the lead flow is better or how does it work?
Steve: You know, frankly, I am not sure, I don’t have a lot of new data on that, when I was at Fathom online which was a search marketing agency about ten years ago, we wanted a salesperson to pay for themselves within six months, so it probably is faster now.
Scott: And that’s part of that math, is once you get that salesperson paying for themselves, their contribution margins are really high because they bring more clients and as long as you are not kind of losing clients, we talked about the LTV that’s for hopefully two, three, four years and it’s just gravy after that.
Steve: Yeah, and with the enterprise SAAS companies, it’s great if they have multiple product lines because the most successful company in our portfolio enterprise SAAS company in our portfolio about 50% of their new business is actually upselling of existing customers. And, that’s just huge because your cost of customer acquisition is essentially zero, sure you maybe allocate ten percent of your lunch you spend to take your customer out is allocated to customer acquisition
Scott: How did they do that?
Steve: It’s partly through acquisition so they are acquiring companies.
Scott: Because it’s hard for an early stage company to spend a capital on a second product when they are so focused on making that because my advice is always like don’t let yourself get distracted, again, we’re working with early-stage companies, they are like don’t get distracted, make this a winner, make sure your LTV is really high and then worry about the future later, it sounds like this is maybe a later stage company that’s bought a few other things.
Steve: Yeah, It is.
Scott: That’s cool. There is something you talked about raising debt for companies and that’s a topic near and dear to my heart because my experience at Lighthouse, like, what do you advise the companies when they, some of the companies even say hey we’ve got 12 months of runway, but I’d really like to have 16, 18, like what should I do Steve?
Steve: Yeah, I mean, the first piece of advice is to look for some debt right, we’ll help you.
Scott: Go get more money.
Steve: Because we’d like them to put a non dilutive capital to work and it’s the bank landscape changes frequently too, right, so occasionally there are new players that come in, there are players that drop out, there are players that move from a very early stage to only late stage, for the reasons you were talking about before it’s more predictable, we see that they’ve had an established cash flow records so we know that they are going to be able to pay us back out of their cash flow over the next three or four years, the terms change all the time, so, for our really early stage companies we are starting to see some banks lend to the pre-series A companies.
Scott: Wow really?
Steve: Yeah. But, they are looking for two or three well known VCs that are in there, right, so they are not looking just for 28:39 because they still want the VCs to be the ultimate 28:44 which isn’t a guarantee but it is the ultimate 28:46
Scott: From a lender’s perspective, the VCs at least have a good filter, and they can always put more money in. But you know what’s funny, it’s I 28:58 that for a long time, but, I haven’t really seen banks do much, like that’s interesting, so banks are starting to get into that.
Steve: Do much in the pre-series A.
Scott: In the pre-series A, yeah.
Steve: Yeah, but, small amounts, something like 250 thousand dollar loan or up to a million, but, so what we tell companies is okay you are going to get this debt to extend your runway and the cost of that debt has to be less than the increase in valuation you are going to see from that- And if you cover it that’s great but it should be some kind of a multiple, and so we’re seeing, we help them evaluate term sheets, we always ask them to go out and get three term sheets and we’re looking for interest-only periods that is as long as possible we’ve seen up to 18 months usually 12 months
Scott: Yes, and logic on that is the longer you cannot have to pay some of the principles back, the more you can redeploy into your sales cycle and bring new clients in.
Steve: Because cash flow is so critical, so if you had that cash from the bank you don’t want to start spending it right away on the bank.
Scott: Yeah, exactly. Do you put any, because I’ve seen companies go out, some entrepreneurs say like I want as much money as you’ll give me. And I always caution them against that because there can be a pretty big hangover on the next run, have you seen that or can you explain that hangover?
Steve: Yeah, it’s usually for early-stage companies, they are not getting as much as we want them to get, right, but for a later stage company, yes, sometimes we’ll want them to go out and get say six, seven million dollars.
Scott: We want to be careful they don’t choke on too much debt, right, like that’s kind of what I was trying to say. Some entrepreneurs take too much and then they can’t get the next round.
Steve: They might find somebody who says well our minimum is 10, and they say okay, we’ll take ten but, yeah, it is, you need the right amount of debt and so that again depends on the cash in the company, what kind of investments they want to make and are they tracking towards that next round because often it could be that series C round that is used to pay off the remaining debt balance
Scott: That’s a great point.
Steve: But, sometimes a series C investors don’t want to pay off debt, they want all that series C money to go into it.
Scott: There is always like that tension, right, and I am laughing because a lot of my late stage investor friends will like, when I was at Lighthouse were like oh I hate it when the companies have debt, but that is kind of the point, like the early stage investors make a lot of these decisions, and they realize that they can use lower cost capital to boost the financial performance, so yes, the series C investors or series D investors end up paying a lot of that off, but, you know, as long as the company is doing well enough and kicking butt and tracking, they are happy to do that, because they can see that this is a potential IPO candidate, it can be a big return for them.
Steve: Yeah, and I think, back to like the companies are trying to extend their cash flows on as possible, we often have companies where they’ve gone through that 12 months interest-only period or that 18 month interest only period. And, they want tearing negotiate with the bank for an additional interest only period and sometimes they’ll get that, sometimes banks will do that because they see the performance of the company is improving, they’ve met their plans, and okay we want to re-up you guys. Never happens second time, right, sometimes a company is all one hey I don’t want to start paying that 100 thousand a month I only want the interest cost; and again, this gets back to banks will change their outlook on what stage they want to invest in and their overall outlook at the startup market. So we’ve often had companies that go renegotiate with another bank and pay off that debt.
Scott: Yeah, you can refinance a venture debt deal just like you would a home mortgage, you know, as long as there is someone who is interested in taking the risk. Are there any terms that scare you or that you caution management teams from, or how do you approach a venture debt term-sheet?
Steve: I mean, from the traditional I guess I call it traditional banks, like SBB, SNB, Square One, Bridge Bank, is getting earlier stages. They are relatively standard agreements, we try to tell them don’t get a MAC clause but I would say 98% end up with the MAC clause, right.
Scott: Some sort of a MAC clause, right. And that’s a Material Adverse Change, which basically means like if the bank determines that the company has changed trajectory or something weird happens they call a default and call back the money if they want to.
Steve: Yes, and that’s where a good relationship between the VCs and the banks are so important, because we are not going to allow the company to get to a point where this becomes a Material Adverse Change, we’re going to ensure that the company is talking to the bank and they were talking at the bank about what is going before something like that would happen and I think too that it’s important to really get to know your bank too, because in the past we’ve seen where a bank might start from a company’s perspective might start to misbehave, right, and it makes it really tough on the companies so it was about three or four years ago when one of the banks who is new to the space was offering great terms, right, longer interest only periods, lower interest rates, higher dollar amounts, and a lot of our companies went with that bank and we said this is great, it’s great because we know that the person who is running the venture arm of this bank if we didn’t know him, it might be a little tougher because we know how he behaves, we know how this credit person behaves, but if it was a brand new player in this space with all new personnel, we don’t know how they would define the Material Adverse Change, so it’s really important to know the players in the various banks.
Scott: Yeah, I saw a lot of, I know who you are talking about that and they did have a good reputation, but there are always the risks that like senior management can come in and be like oh we’re getting out of this business, do what you need to do, get our money back, you know, and I, over my years I saw not necessarily banks but others kind of special lenders coming to market and do that, and they would basically be super aggressive and get the companies too much money and then there is this adverse selection that happens to the new guys sometimes and so they could only get kind of the marginal deals, but those marginal deals often go south and then they end up starting to lose money, and then they panic and then they just clamped down on everyone, and it’s just really terrible cycle, So I actually always remember that when I am referring our clients to, I only introduce our clients to like the people who have been on the market for a long time because they don’t have that issue, and they have relationships, and I think what you are saying is that the lenders don’t want to piss off the investors, because that is like if you just think game theory, that is a repeating game like both parties want to work with each other, they are important to each other-
Steve: And the investors are their pipeline, right.
Scott: Exactly, the investors make a lot of the interest, s they are going to give every chance they can but new people may not kind of feel that way so… By the way, we could on forever here but what is something else that you really wish startups thought about or knew about before it’s too late?
Steve: Yeah, I think a couple of things, first, make sure you’ve got enough runway, whether be by getting some debt to extend your runway, or just starting that fundraising process with plenty of time. It’s interesting to me venture from startups because when a startup raises money you start that process it can take 3 to 6 months, right, and that’s a pretty long time in startup land, right, it can take 3 to 6 months and then you’re done, and sure you have a relationship with the existing investors but you’re done, but you have to give yourself plenty of time so you have to anticipate how your cash flow is going to behave over the next six months in a good scenario, bad scenario and make sure you are out there with enough time and that you’ve got the metrics to support that fundraise.
Scott: Yeah, I was going to say, it’s hard sometimes, because the companies are developing those metrics, they want to wait a while, so they can show investors something that is going to get them really exciting but then they end up waiting too long sometimes and we’ve had companies that go out to raise money with like four month left and it’s just like you are going to get, everyone is going to wait you out unless you are the next Facebook, they are going to just wait and see what happens.
Steve: And they have to make sure they’ve got the insiders on board, maybe not onboard to fund the company because they don’t do series C or something like that but make that they have support above it, and one thing we do at Azure is we put up last out there, the other firms and late-stage firms that we think would be appropriate for that company. So yeah, making sure they’ve got those runways really critical.
Scott: I was the blast actually, or I call speed dial is really helpful, because again, the late stage investors oftentimes are pipeline is early-stage investors so if you cal one of your friends who has done a few deals with you in the past and is like hey remember those times when we made money together on those companies, well I got another one for you.
Steve: Exactly
Scott: That investor is going to take a meeting very quickly. And so getting your existing investors to go to bet for you with potential investors is huge.
Steve: The second thing I wanted to talk about which can help get you that extra runway or put off that need to raise money is an experiment with things, right, one thing we did at Alibris we did experiment with changes in the business model, changes in payment patterns to our suppliers. It’s one of the most successful companies, especially e-commerce companies, they are experimenting with different product lines and as we talked about earlier about it, it’s a low cost to try things nowadays. Lower cost to start a business lower cost to try things, test things, test different things with your website, test new products, test tweaks to your products and just a little change could really propel things for you.
Scott: We have a client that had pretty, like million dollar payments kind of per month to one of their providers, their partners, and they used to pay every month and they were like you know this is just a lot of work why don’t we go back to them and see if we could pay every 3 months, like once a quarter. And now they got rid of that work but also gave them two more months of float on a million bucks, and that actually solved the major cash flow problem for them and allowed them to not have to raise more money because they were able, they were growing so fast they grew into the numbers and it all worked out, and the people the partners they were paying, just didn’t even care, they were like totally fine with it. They just had to ask.
Steve: Well at Alibris we had thousands, tens of thousands of book dealers in our network and we paid them monthly we actually went to we paid them every two weeks, but we pushed out the cycle so, like good news, we are going to pay you more often, bad news we’re going to push it out by two weeks and that put a ton of cash on the bench. And they were fine with it, once they adjusted to that initial kind of cash stream
Scott: Yeah, sometimes you just have to ask. Okay, I am going to have to have you back for another podcast because we have a lot more we can cover and this is really helpful stuff. Can you maybe just tell the audience where they could find you, where they can find Azure?
Steve: Yes, so Azure is based in San Francisco, our website is and I am
Scott: And if you want to see Steve go to awesome music venues and Steve is a big music fan so if you are into that you can follow him on Instagram as I do. Do you have an open Instagram right?
Steve: I do. sfsteveg
Scott: Okay. Steve thanks so much, seriously, this is a ton of awesome information, I appreciate it. Awesome man, thanks.

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