Tag: Capital Efficiency

Cheetah in the Rainforest: 2021 Vintage of Venture

“A firm writing seed checks without specific competence in that stage is like a cheetah in the rainforest. The beast is a wonder of nature that can run at a top speed of 60-70 mph in the African grasslands. But place it in the Amazon rainforests, and all its wondrous capabilities will amount to zilch. It’s just not built for it!”

Most 2021 vintage startups got VC ‘cheetahs’ on their ‘rainforest’ Boards. Surviving the new reality that faces them, will require a cathartic reboot.

Had an interesting conversation with a Bay Area-based founder a few weeks back. His startup is in the high-ACV enterprise space wherein the product is solving an intense and wide-ranging problem that is especially applicable to large companies. He got off the blocks in 2021 with a mid-single digit $Mn pre-seed round by a top-tier VC at the idea stage itself. A start that most founders dream of!

However, now two years down the road, the situation on the company’s Board is far from rosy. The company has gone through tumultuous times that are typical for any 0-to-1 startup. While the founder has kept his chin up during this phase, he is very disillusioned with the VC’s advice, behavior & general stance so far. When he shared some specific examples of this with me, my first reaction above all else was that this firm clearly has little past experience of portfolio management at the seed stage & in particular, what founders need in order to navigate its inherent complexity.

As I started relating this to many other founders I have met this year, a pattern is clearly emerging in the 2021 vintage of startups. Specialist VCs who have mainly invested in the Series A & beyond space in the past, went upstream & wrote massive pre-seed & seed checks with minimal or no traction. They were probably under pressure to deploy or get early dibs on the best teams as later stage valuations were going to stratospheric levels.

Seeing these companies now, after most of them have almost consumed their 24-month runway, I am seeing how the lack of milestone-based capital sequencing & strong stage-firm fit has created many fundamental issues with their core:

1/ Armed with big checks from large AUM firms, founders ignored the scrappy, capital-efficient approach right out of the gate. Instead, they bulked up teams & spent disproportionately on go-to-market even before problem-solution fit. Now in hindsight, they have ended up creating fragile organizations that are at the mercy of the macroeconomy & availability of follow-on capital.

2/ Many of these VC firms have put relatively inexperienced team members on the boards of these companies. My guess is because in their overall AUM game, these types of really early investments are probably considered highly risky “option bets” with low stakes in general & therefore, good learning opportunities for more junior members.

While experience by itself doesn’t make anyone a good or bad VC, pre-seed & seed stages of venture capital demand much more art & judgment in company building from all stakeholders. A firm writing seed checks without specific competence in that stage is like a cheetah in the rainforest. The beast is a wonder of nature that can run at a top speed of 60-70 mph in the African grasslands. But place it in the Amazon rainforests, and all its wondrous capabilities will amount to zilch. It’s just not built for it!

It’s a bit counter-intuitive but in my view, the best VC talent (best = strong fit from a personality & skills perspective) needs to be involved in the earliest stages of company building. There is a reason why YC has a strong moat in that stage, & why while most fresh MBAs can invest & do portfolio management at Series A & growth funds, pre-seed & seed needs artists like Paul Graham & Semil Shah that are few & far between.

One of the things I would like to see coming back into the startup ecosystem foundation post this venture downturn is the importance of “capital staging” – rigorously thinking through how the company should be capitalized at the earliest stages, what kind of investors should be assembled for it, the mindset, approach & time a specific company would need to iterate towards problem-solution fit & eventually, product-market-fit.

I would like to see the return of angels, domain operators & specialist boutique VCs partnering with founders at the earliest stages of venture. We need some version of the Arthur Rock & Ron Conway models but modified for this age. These types of stakeholders in turn, would educate and/ or encourage founders to be scrappy, agile and perseverant during the 0-to-1 stage, supporting them in building the most optimal path to the next base camp.

Closing thoughts specifically for the 2021 vintage startups – while it’s not easy to rewire the foundational DNA of a company, it’s not impossible. While the lesser gritty teams will flame out, I am also seeing founders who are acknowledging both the mistakes of the past as well as the new reality that faces them and are determined to learn & re-invent themselves. Even though as an investor, I am not too excited about the 2021 vintage the way it looks & is behaving right now, I will be more than eager (& rightly so!) to back its re-invented & re-wired v2.0.

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Understanding Fixed vs Variable Costs as a Founder

To be capital-efficient as a founder (also applicable to life, in general), when evaluating various cost line items or taking on a new cost, have a clear understanding of “Fixed” vs “Variable”. Variable Costs are driven by your intended “velocity” and therefore, can be controlled during tough times via a frugal approach (cut variable marketing spend, let go of expensive contractors etc.). Fixed Costs don’t care about your velocity and will keep eating you up (housing rent/mortgage, office space, full-time salaries etc.). They are much harder to control, given they reflect a certain baseline you have up-leveled your startup (or life) to. Paring down Fixed Costs will require more drastic down-leveling, including completely letting go of certain assets or experiences.

The issue with Bay Area startup environment today is extremely high Fixed Costs (housing, child-care, salaries etc.). These are uncorrelated to the actual state or momentum in your startup so founders have no choice but to live with them. You can’t be frugal with Fixed Costs beyond a point, as they are driven by the external environment, not the choices you make. This, in a nutshell, is the real challenge facing Silicon Valley founders.

Here are some ways to proactively manage your startup’s Fixed Costs at early stages of the Company:

  1. Explore building a non-Bay Area distributed team — to balance output with salary costs, at least until you see the business momentum required to support Bay Area salaries.
  2. Be generous with equity, (relatively) tight with cash — I know this is a hard one, especially while hiring engineers in today’s market. But as founders, we need to be disciplined about this. I would rather wait out for the right candidate who believes in aligning incentives with the real situation of the startup. For instance, if someone is asking for high cash compensation in a pre-PMF startup, this means they are not the right fit for this stage. I am all for doubling-down on higher equity, even higher than market standards, for early risk-taking hires. But every $ of cash being paid out needs to have a solid justification. Anyone who seriously wants to join a really early stage startup, needs to understand and appreciate this viewpoint.
  3. Try converting Fixed Costs into Variable Costs — some ideas could be paying sales people more on % of sales commissions and less on fixed; going for an “on-demand” co-working space with elasticity to quickly scale up/ down; keeping specific functions eg. designers, content writers etc. (these functions need to be chosen really carefully) on contract per “as-needed” basis, instead of full-time etc.
  4. Be frugal on G&A — optimize costs on office space, service providers, vendors, food etc. In particular, Bay Area startups have a tendency to splurge beyond their means on fancy office spaces, lavish off-sites, dinners at marquee restaurants, expensive swag etc. These non-core costs tend to add up and hit your budget more than you might realize.
  5. Leverage free ways of brand-building — instead of spending tons of $$ on brand marketing to drive early awareness (eg. conference sponsorships, which are essentially Fixed Costs), leverage free channels such as blogging, building a community on social media (Twitter, LinkedIn, Quora etc.), podcasts, creating a compelling website, white-papers, research articles, invited speaker slots etc. Early stages of a startup are all about cost-efficient marketing. This can only happen when founders focus on the above channels to build their startup’s brand, their personal brands as well as communities around their product. Austen Allred, Co-founder and CEO of Lambda School, is doing this very smartly.

Would love to hear what ways of Fixed Cost management have worked well for your startup.