A16Z - A16z Podcast: Raising Money and Valuing Startups -- What Happens When Things Don't Go As Planned? lyrics

Scott: This is Scott Kupor, and I'm here with Danny Shader, CEO and founder of Pay Near Me and also Danielle Morrill, the CEO and founder of Mattermark. Thank you both for joining us today. What we thought we'd talk a little bit about today is valuation trends, what's happening and then in particular the kind of the idea of what are the pitfalls, or what are the things you should be trying to solve for when you're raising money and, and in some cases, is it worth stretching for valuation? Is it not worth stretching for valuation? So we'll cover a bunch of topics but I think we'll kind of start with, with that. Danielle: Okay, yeah! Scott: So, Daniel maybe what will be great is, you know, given kind of your business—obviously where you guys are washed in, kind of, data and certainly you're kind of the voice of what's actually happening and particularly in the early stage venture capital world. You know, what are you seeing either valuation trend wise or in terms of your conversations with the entrepreneurs about they're approaching valuations in this market? Danielle: Yeah, it's a couple factors. One is that you can do more with money now than you used to be able to. So, if you raise five or ten million dollars, that money could go a lot further. I remember the first startup that I worked on, we raised a pretty large venture round just to get servers. So, even Amazon web services alone, it's just a huge impact. So, you got that side of equation and then I think you're also seeing these really ma**ive rounds because what I'm seeing is really competitive deals where investors feel like there's not that many super unicorn potential start-ups. They want to pile into those and so that, that drives the valuation just because the founders don't want to give up, you know, beyond a certain percentage of the company. You kind of have two different factors that play pushing valuations higher when it comes to their like, competitive deals but then I think the middle—my question to this whole conversation is, “Isn't the middle is pretty much still the same or has it really actually shifted the whole thing?” Danny: Danielle, I've got a question to you about that. One of the rumors you hear about some of these super high variation deals is that they have a high headline number but there's a lot of preferences—this or that being preferred over others, and it seems like, that has really negative implications for the new common shareholder employee who joins—which, you know, I'm old fashioned but that seems like that's not necessarily an interest of the company long-term. Scott: Yeah, I think that's right at least certainly, you know, that ones we've seen particularly where you start to get to either you know the hedge fund community or in some cases you know, buyout firms who are now kind of doing these later-stage private rounds. You definitely see more structured deals, there's no question about that, right? You either see you know, some type of ratchet or full of ratchets or you see kind of various price resets and…you know, I think the big question we don't know is obviously what will happen when and if those actually come to play? Since we've all been lucky enough to kind of live through five years, plus now, of, you know, an incredible market. Danny: [laughs] Yeah! And I'm old enough to have been through the last time, you know, the first time we saw one of these bubbles and it didn't end so pretty, so… Scott: I was going to say, you can probably, you can probably give a perspective on that so…you know what happens for you know, those, those entrepreneurs who haven't actually you know, been privileged to live through the crash? What happens? How do you think about the employees in this context, how do you think about down rounds you know? What are things that people ought to keep at the back of their minds is they think about stretching for valuation? Danny: I don't know that stretching for valuation's a great idea. Unless you have incredible certainty on your deal, right? And you absolutely know that there's gonna be another round behind in it at a higher valuation either because you're pressing about the overall capital markets or there's just, you have such insight into your own business that you just know it's exploding. Then, you're setting yourself up potentially for a world of hurt, if you overreach now and then you have to get money behind it. Trip's a ratchet in the current round or frankly just sends a psychological signal to the universe that you've lost momentum, particularly for you're in to this one high flag momentum-based deals. That doesn't feel like goodness to me! My general philosophy—and maybe this is why I'm not super wealthy or something—but my general philosophy is there's plenty of money to go around if this thing succeed and so the number one objective is to make sure that you always have enough capital to keep going, no matter what happens in front of you. Scott: Right. You know, Danielle, you mention this concept in your opening remarks about—number one this kind of bifurcation between kind of small amount of money at the early stage and then this bigger rounds later stage and then you asked the question about the middle which I wanna come back to in a bit. But on the later rounds, as you kind of talk to entrepreneurs or at least as you kind of, you know, look at the data, you get a sense that there is almost headline number envy or competition among entrepreneurs that you get this idea that, “Gee, so and so did a deal at 5 billion and now, you know, 5 billion is now the new you know, the new high watermark for how this things should go.” Do you have a perspective on that? Danielle: Ah, I mean, I think one of the really confusing things is when we're talking about those kinds of valuations, there's always this question of like, “What would the public market price this company's at?” Because in the past, they probably would have gone public. So I think it's may be less of comparing to other private companies and more saying, “Well, this is basically an alternative to going public, so what do we really think, um, that would look like say we did it in 5 years?” I think you see a lot of those conversations and so as you start, you think about the kind of investors in the deal. Later on, it's not just your VC investor. It's also people who are investment bankers, who now don't have enough public deal flow, or family offices and people who wanted to deploy really large amounts of money, and I think it's actually…What I'm saying is a lot of the pressure is coming from that side. “We don't wanted to deploy 30 million dollars. We wanted to deploy a hundred million dollars because we don't have enough places to deploy its capital.” For founders, that's really weird because they like, well, if the advice I've been getting forever is, take the money where you can get it. So, I think that is a big factor. Danny: So, that's interesting. So, in some respects, which I totally agree with in terms of there's new money coming in right so we have definitely seen to your point, you know, mutual funds, hedge funds, private equity guys, family offices… And are you, are you saying at least in some respects that the valuation you think is being driven by people wanting—those investors wanting to put larger amounts of capital to work and the entrepreneur on the other end saying that, “There's only so much dilution I'm willing to take!” And so, we're kind of, we have this kind of natural, almost forcing functions up in terms of round sizes? Danielle: Yeah, I think it's a major factor. A huge piece of this is I think there a lot of new funds. So, funds that maybe have been around but they haven't been investing in startups, and what they want is they want some logos in their website with legitimate like, significant chunks of the company ownership, where they can peg the value of the fund when they go to raise fund two, “Hey, we got into Zynga. We got into Twitter. We got into Facebook.” I mean, you at Andressen Horowitz and you guys did this when you start your fund and I think it's really smart but I think now that that pattern seems to work, people are saying, “Well, I wanna find these sure-bet companies!” And in order to pay up enough to get a meaningful chunk of them, they've got to put a lot of money in. So that's another major factor, I mean, we had so many new funds are being started right now, so many new people are entering startup investing right now. It's not just on the angel side of things. Danny: It just what strikes me, it seems that there's a real flavor of the month dynamic—or maybe it's really a flavor of the year dynamic to sectors that are hot and that are not hot, and I wonder about people who—and you mention Zynga for example, right. The things that you think are the name that you want on your website, whether or not that's gonna be true, you know, when you actually need to go raise that fund and what the implications are for that across the value as a whole. I mean, you know, I see some…In the world I live, and I see, in the payments world I see valuations that I can't understand how they'll ever be an exit for a lot of this deals. And so, my biggest fear just an entrepreneur trying to run things rationally is that some of those guys are gonna crash and burn and drag the entire rational segment of the market down with them. Scott: Right. Danny, you know, I want to go back, you said that which is, how will there be exits from this—right? So it seems to me there's also some Rubicon you cross where at some point the valuation in which you raise is so high that now you've taken a whole segment of potential M&A buyers out of the market. Danny: Sure. Scott: And you are, at that point, either wholly dependent upon being you know, Bloomberg and having a private company for the rest of your life which can be a very, you know, profitable and fun thing when it works— Danny: [laughs] And probably that doesn't fit very well with your venture guys! [laughs] Scott: And that's right. The venture guys probably at some point would want to get their money, all right. Or you really are almost, you really are beholding now to the public market at some point to actually create an exit. Do you think about that, as a CEO that, you know, kind of, “Have I, you know, reduced the number of options I have for the ultimate exit when you're raising capital at these higher levels?” Danny: I tend not to think about it that way. I just tend to think about sort of, at what price would I come into this if it were me? To try to make sure that we're pricing in some—Well, first of all, we don't set price. The market sets the price, right? But when people have proposed things that are, that are started too high, I've tried to signal bringing them down which is a delicate balance. Scott: You may be the first CEO I ever heard say that. Danny: Well, you know, like I said I'm old and I've been around and I've seen this end badly and, and you know, if you're doing something as ambitious as we are, where you know that you're gonna consume a reasonable amount of capital on the way there, you wanna make sure you've got access to capital the whole path because at the end, the outcome's gonna be great. I've been fortunate to have good outcomes but I've also consumed capital on the way to getting there. You don't wanna be on the place where you know, the thing blows up, or frankly you just have to stand in front of your employee-base and explain to them why you're having to reprice all their options or that, you know, re-invest or do something like, that's, that's no fun. Scott: Yeah, that's interesting. So, in, in sub respects is almost you know, how much capital do we think we need to get to that exit or the goal we're trying to get to and then making sure you're kinda backing down and saying, “Look. If I take 50% of it now at this round, I know I still have 50% left to go and making sure that there's…they'll still be attractive investment opportunities for later people once they come in.” As opposed not to taking the money off the table in the, you know, B round or the C round or whatever the case may be. Danny: That's right. And I, I think another point is there have been companies in the valley that have sort of had a golden path all the way. The one I always historically thought of was eBay. Maybe Facebook is the new example of that. But every other major company I knew, you know, I've known whether or not it was Apple or Netscape or Sun or—pick your favorite, you know, whatever era, most—Google, they all have these near-d**h experiences. So, unless you're unbelievably prescient, and your model is right, which you know, they seldom are…that's a heck of a bet to make, on knowing whether or not you're gonna need capital again or not in the future. So, and again, when these things work, they work so well that who really cares whether or not you're taking the last nickel off the table there or not? Danielle: I totally agree with that. Danny: And by the way, the other, just a subtle point, but I think it's important, you know, it's—I wouldn't go so far as to say it's a “sacred relationship” but it's a really important relationship that you have with your investors. And I think it's really important that, that that relationship is good through good times or bad times, and nothing will set up that relationship to be bad during bad times is if you over promised when you raised the money and then disappoint. 'Cause now you've broken this bond of trust you need when you're, you know, whether the inevitable storms that are gonna happen as you go along. So, I don't know how you get that top dollar unless you start weaving—Well, there's gonna be a temptation to weave a tale. And I don't think that's necessarily long-term healthy either. So there's all these sort of reasons to come together that suggest being rational and open and not too greedy, is wise. Scott: Danielle, you were trying to jump in there. Danielle: No, I just wanted—speaking for the earlier stage perspective, I think a lot of things you guys are talking about, founders are not always thinking about it in the beginning. So, like building out a model have a long-term in thinking about all the money are gonna take in over the course of the company is something that—I mean, we've done this now because we have revenue so we're starting to thing about like, things like, how long do we run before we raise again? Things like that. But early on, I think, in maybe the first two major venture rounds. I'm not even sure long-term founders are thinking. I'm not sure they are thinking how much capital they'll consume or about the investor relationship, I mean, I think that stuff starts out sounding like things we just say. Danny: Yeah. Danielle: And that at some point…So I definitely talk to the founders who thought companies are there further along or it's still their first time and they're saying, “Yeah? I thought that was just stuff people blogged about…and now I'm seeing it's true…” [All laugh] Daniella: You know, like, raising their C or their D round. So I always think there's this disconnect between the stuff we talk about and like actually making sure you do it. I mean, I may be one of the downsides here is people are raising—I'm one of these companies—raising these big seed rounds so we don't have boards for a really long time. Scott: Right. Danielle: Like I don't have any board members so… Danny: What is a seed round Danielle: I go to my advisers and I'm trying to work with them and think through a lot of these questions with them but hopefully a board would help with that long-term thinking. So, I wonder how much the breakdown of the early stage piece actually really affects what's happening in the later stage with valuation. Danny: And what was your seed round, by the way? How large was it? Danielle: Basically there were two seed rounds, so we've gone to like a raise like little over 4 million in total. Danny: And so, I mean, in my life, that was called an A and sometimes an A and B. Danielle: Yeah. I'm basically calling it a weird A. Danny: So is the definition of a seed that it wasn't priced and there was no board, is that what—? Danielle: Correct. Yeah, it's very confusing to founders. I mean, I ask some people show this call as an A without being more honest and they say, “Well, that's not equity.” And then yes, some of the people say, “Well, I mean, that's a lot of money! Call it an A!” So what it is, I don't know. I mean, as far as I'm concerned it's just we're not dead and we're gonna keep growing. [Danny laughs] Scott: Well I think it's really interesting, the point you raise about founders not, not necessarily thinking about this stuff, I would just say, you know, from the perspective of the deals that we see…I think almost to a fault, everybody historically underestimates how much capital they will actually need to get to either the next milestone or to an exit. If I could you know, if I had a dime for everybody who told us this was there last round to financing when they came and they pitch us. You know, it would all be out of this business and doing something else but it is true. I think people, either, they either a**ume that the business will work perfectly well—in which case they won't need money or they certainly aren't considering the downside, and I think the challenge particularly in this market is even in the case where things are working well, you often then want to go raise more capital to go accelerate the growth, at an even faster pace and open new markets and deal more new products and so, we, we tend to at least historically see—almost everybody historically underestimate the amount of capital required to get to some ultimate outcome. Danielle, the other thing on the…maybe just to come back to one of the point you mentioned which was this idea that in some cases the round sizes at the later stage are growing in part because the investors wanna have some ownership that's meaningful in these companies. There's, there's another potential interpretation which at least I see in some of our companies which is there's an offensive reason to raise a lot of money to those valuations and that is kind of a little bit to Danny's point which is, “Look, if you're gonna, if you're gonna stretch for valuation, you better take as much money as you can possibly get at that valuation to give yourself way more running room than you ever think to kind of insulate yourself for a macro changes that might kind of impact the financing environment.”. Do you, do you see that at all or do you think that's part of kinda the calculus that people are thinking about? Danny: Is that, is that what you meant by offensive or did you mean like the uber-lyft thing where like if you raise enough capital, you can there's a price war. Scott: Well, I think that's another, that's another. Right, that's another version of offensive too. Danny: Okay. Scott: I almost think of it as kind of, “How do I increase the margin of safety for myself?” By saying, “Okay, look. If I'm gonna stretch, I know I have to do, I have to do double what I thought I was gonna do in order to be able to clear that for the next round.” So one way to insulate against that is just take as much money as I can possibly get, given that you know, the dilution is relatively nominal to this prices. Danielle: Yeah. I mean, I think that's totally accurate. I think in other pieces that these companies are like engines where you can put in money and you can get out money. And so, Uber at this point, they probably have a pretty clear vision for markets they need to enter to grow. So if you're gonna undertake the same effort to raise a hundred million, why not raise 200 million? Like not even just from the stretching perspective, but from the, like, “Look, we have something that works here!” It's not so often you find something that works so I want you to put as much fuel to the engine as possible. Scott: Right, and the marginal—once you're already fund raising, the marginal cost that extra dollar isn't really that high as long as long as you're willing to take whatever minimal dilution that that actually entails. What about Danny? You know, you've probably seen this unfortunately, but how do you¦ how do you have the conversation with employees so…? I can remember very clearly when we were at Loudcloud and Ben I think talk about the story in his book but, we raised money in early 2000, we raise about 700 pre…120 million dollars, so 820 post. And you know, Ben and I were of course hi-fiving ourselves and thought it was great, because it was you know, the market was starting to turn. It wasn't clear yet that we were going to Armageddon but it certainly felt that way, and you know, a few months earlier, companies that we you know, were in our general space like you know, Equinex or others raised at a billion dollars and you know, we had an all-hands meeting where Ben, you know, very triumphantly announced this financing and it kinda felt like everybody breathed a huge sigh of disappointment basically that we hadn't cleared the billion dollar mark, you know, that we'd only gotten to 820, this was now of course you know, 9 months after we founded the company. Danny: [laughs] You slacker, you! Scott: Exactly! So, I'm curious from your perspective, right, this concept sounds great which is, “Gee, let's leave a little money on the table even in the normal circumstance and not stretch for the last valuation.” But how do you handle and how do you deal with kind of employee expectations around that and them saying, “Gee! My company maybe doing you know, less well than I thought it did because they couldn't attain a valuation that you know, other guys in the space are getting!”? Danny: Well, let's start about the current company, pay with me, which is in a space that nobody's in processing electronic transactions with cash. Right? There's, like, nobody. Right? And people don't understand it. Well, we sort of made a conscious decision that, that we would be the sort of the tortoise and not the hare and that we wouldn't try to recruit people who were looking for the next hot thing, that we wanted people who valued what we were doing, thought they could learn a lot, thought it would be a high quality environment and that they could frankly last over the long run to the extent that we do and do things like, we don't have an office near at train station, right? Intentionally, like we're self screening for that. So, and everybody who interviews we'll say, “Just to be very clear, we could completely fail.” Right, and so once you've got the people on board who are in board because they like what you're doing. They think they're gonna learn a lot. They like the people they're working with. They trust you. Then, you've created a culture of trust that is inherently sustainable. That wouldn't work if you were in the ride sharing business or you know, some of these other just unbelievable spaces that have huge momentum where you've got to throw every inch of you know, coal in a fire, that you can at once. But it's internally consistent. Our values are consistent with our financing structure, are consistent with our business model, are consistent with the environment we are working. By the way, I happen to believe that, you know, at the outcome, we end up with this incredibly profitable, super defensible business. Ahh, and we'll probably have seen a bunch of fashionable waves of you know, that will move through, like, “Oh! I wish we were in the, you know, check ins business or something.” You know, all the things that come along the way that been hot and then weren't as we moved along. Scott: Right. Danielle, maybe you can address this one, which is kinda the other side of the employee issue is, is there a price at which you've now done a disservice in terms of being able to recruit new employees in because once you raise at, you now, 10 billion, 5 billion— Danny: With a 3X [laughs]. Scott: Right. And you know, you've got potentially right structured stuff, right? You've got liquidation preferences on top of that, do you think employees, particularly given how competitive the environment is around here, employees kinda say, “Gee! I can go take you know, stock at whatever price it' gonna be based on the 5 billion dollar round.” Or, “I'm way better off you know, joining Danielle, where you know, she's so much earlier and you know, there's a such greater upside to the extent of the you know, the business turns out to work.” Do you have a sense of how people are thinking about that? Danielle: Yeah. I mean, we have people who you know, we're competing with other companies and they tell us what offers they're looking at are like so you know, we run those numbers a lot. Sometimes we win those deals and sometimes we don't. I think it comes down to time horizon, so people who want a quick win, you know, going to a big company that you know, looks great on the resume, people know what it is, got stock that might have liquidity soon. You know, to certain people have what they were looking for actually you can find people that are just hop from, from you know, midstage start-up to midstage start-up as pretty much a tactic. But I think it's pretty smart actually. I was kinda on that path I guess before starting my own company. It's a pat on myself on the back, there. But earlier stage folks you know, I think what they're thinking is they want a place where they can see their impact against the price end to end so they wanna come in now and they wanna be here for 5 years. Or at least they can imagine staying for 5 years so it seems like it's a little more personal preference. I just want to chime in though on one of the pieces of this which is the idea that like, a 6,000 person company or whatever, I don't know how is big—Uber is huge right now, but not that big yet. But everyone gets stock option which is actually kind of, kinda odd at that stage. So I think that's another interesting Silicon Valley thing like—it doesn't have to work that way but it was tons of other ways to incentivize people, beyond stock options. So… Scott: Do you think, do you see anything, do you think that's changing or no? Are you seeing anything that's—? Danielle: Oh no. I don't think that's changing—but maybe I'll change it! Because I just think that it's confusing, because I think that doing the math stock options is one of the things that I've had more awkward conversations about that either you know, with employees at my current company, with people who reported to me at Twilio… people just worrying about that, it's so confusing to them. And there's much more straightforward ways to incentivize people that don't require always a control macro factors they can't affect. So, I just feel like, it's almost like we've taken stock options and we've hyped them up more than we should have because then you, you do have this trust problem whereas you do have to do something for the survival of the company…Now you're telling a couple thousand people, “Hey we're sorry. We repriced this.” I can't even imagine that you won't lose people from that, ultimately. I mean, I know companies that have. Scott: What's different now in this environment, versus Danny particularly for you kind of having raised money now across a couple of different cycles? Is there anything different you see either in terms of you know, you know, how investors are approaching some of these companies, how employees are thinking about you know, options here, how you know, people think about valuation? Is there, is there any kind of material differences, say now, between kind of the environment the way it was you know, pre-bubble? Or in kind of you know, the, you know, mid 2000s and that is—are new issues that we haven't seen before? Danny: Honestly, I question differently. I can't figure out if it's different or I'm different because now I'm old when before I wasn't? But the, the level of confidence and certainty that this is all gonna work out great among the younger crowd, umm I think because haven't seen what we've seen, really creates—And the fact that this, it's an order of magnitude, more capital being deployed, creates a generational gap in expectations and style to me that is profound and it keeps striking me and to all the other old folks out there on the call, I mean who are listening to this I mean, I don't think it means you have to start thinking like a different generation thinks but I think it's worth knowing that we really view the world differently. This ended so badly. And last time it was, you know, people who did early AMT exercises and literally went bankrupt…I don't think that happens this time but there will be—I think this party ends and it will have an ugly end, and there will be people who have an expectation for what their lifestyles will be and have dialed in a bunch of very important life decisions to that who were gonna not be happy with what happens and— but you can't, it's like you know, it's like telling stuff to my teenage daughter, actually. Scott: It's a little bit like fighting the last war Danny: Yeah. You just gotta live it. So, that's what I perceive is different. Scott: Yeah. Danielle, do you have a perspective on that? Do you think entrepreneurs this time are, are either, to Dan's point, either more or overly optimistic or…just don't have an appreciation of kind of what things could look like if the market were to turn? Danielle: Yeah. I mean, I think there's the kind of people who are into consumer products because they don't know anything about the world. So, like, I'm gonna bash on the young people because I'm one of them! But, I think what's different is there's some people who are really like, getting into SAAS. They went and they worked somewhere from like two or three years, right out of college. They found the process that they had to deal with really crappy, and they're building solutions for that, and I feel like, that is different. I feel like, I worry mostly for my peers that choose to build consumer products because it is totally like you said, it's either gonna be huge or it's going to be nothing. I guess, this is—Again I can't tell if it's me or the market but I'm running a SAAS company and I feel like recurring revenue and, and understanding SAAS business, that doesn't require like a really involved enterprise field cycle. Like, I don't have a suit on to sell, like, $6,000 a year product. Umm, I think that's new. And again, there are ton more opportunities that kind of an unexplored space. I think the public market doesn't even know how to evaluate, really. It's relatively new to in this, in the big scheme of things so I wonder if that's something that's different that might be more lasting. Umm, I don't know if it is yet, but even you know, taking lessons from that and applying them to consumer models maybe interesting, too. Scott: Yeah. All right. Let me just see—Let me just try and wrap since we're out of time here. Let me just a couple of takeaways at least I heard in the conversation. You know, one is when you're thinking about valuation and kind of deciding between you know, how, how much do you wanna stretch, it sounds like one of the biggest takeaways people need to be thinking more about is…What does that next round look like? What are the milestones I have to achieve to be able to get there? Umm, you know, how, how you know, what could, what could go wrong in the scenario where I might not actually not have given myself wiggle room to get to that next upround of financing. Danny: Let me try to characterize it in a different way which is…The only thing that matters is the end. [laughs] And so, all of these things that happen in the interim don't matter. So, have a long planning horizon, and—and those will fall out of that as well a bunch of things about how you deal with your employees and partners and everybody else. Scott: Right. Good. All right, well, I think that's great place to end it. Thank you Danny! Thank you Danielle! And we're signing off. Danielle: Thanks! Danny: Thank you!