Note: Before we get started, a surgical procedure that had some complications in my family kept me away during April and for a third of May. In June I got COVID, with fever and the whole shebang. I’m still in recovery mode. If you sent me an email or message, it’s most probably in the +10K message piled up, begging for attention. Please send it again, next week, so I can get to it. Thank you for your patience.
Back in April, when I first started writing this, the original name was the 100M oasis. After several hospital visits, complicated nights and a lot of waiting time, I found out that the world is infatuated with failed or problematic startups, that entrepreneurship tv series are a hot topic and that the American dream is still very much alive in the Pop Culture. Even in these tumultuous times of war, inflation, market crashes, unfulfilled crypto promises and global warming, the least risk averse and more naive people are dreaming of building the next 100Bn empire.
The warnings are out there, media has enough stories of failure, harassment, lawsuits, jail, tears, and fraud. Still, even in those problematic tales, the Billionaire last name appears constantly as an invitation for the brave and bold to change the world and acquire a last name that only a few hold. Most of the times, when things go wrong, the founder is portrayed as the villain. In some cases, she most definitely is, but in most cases I believe the lack of industry knowledge, hard work, and FOMO, make the investors the bad guys. The companies couldn’t have gotten there without investors’ money.
What the fuck are you talking about, Carlitou? We, investors, bring the light, money and are hand tied to the will of our master, “the founder”. - Mmmm, no. - We are fueling transformational founders, teams, and ideas. We’re adding fuel to the fire. When the companies are creating value for all the players in the ecosystem it is a good thing. When we add fuel to a devastating pile of burning bullshit, that bullshit will grow and burn everything around it. Yes, clients, employees and investors. Some, even in those burning cases, will profit. In a post from 2015 I wrote harshly about Uber’s valuation, it was probably a good thing that I passed on Uber when it was offered, even today it will be a loss. It was probably a bad thing because that logo in my portfolio would have told everyone that I was playing with the big boys.
Sorry fellow investors, but when we (investors) don’t do the homework, we create a mess. Our money and decisions affect the startup environment and ecosystem. The same thing goes to small checks from families and family offices.
In these tumultuous times, the times when becoming a billionaire in 10 years is possible, have brought, for some strange reason, the idea that companies are worth several times over their revenue, profit or even lack of profitability. It’s not only related to the hype of the public markets, but also to the hype that founders and investors are creating about startups. You don’t need to be Uber, Lyft or WeWork to be valued at very high multiples, you only need to be a founder with the ability to get money with an idea, deck, MVP, early revenue, or a great vision. In my opinion, that is your job.
As a founder your job is to present and execute a vision that is so compelling that your investors and clients can’t imagine a future without your company. The problem comes when money in love with this vision or with the founder comes into play, without a proper due diligence, without understanding what the constraints of a company or founder are, what the market looks like and what will need to be true to create a huge win. Most of this money comes from family offices pouring money into startups for a lack of a better asset, high net worth individuals investing directly in startups without proper due diligence, with very small market and technology knowledge. They, like everyone else, are chasing the golden goose.
I don’t mean that you should not invest in startups but do the homework, a proper due diligence, speak with the other investors, understand the product, service, market, team, potential, founder motivation, etc. You have 1 in 10 chances to get your money back and a fraction of that to receive meaningful returns. If you are an expert in the industry your chances improve, if you are able to create value for the company, your chances get above 1/10, if you are able to bring real paying clients, most probably the company is going to survive. If you are on the bench seeing how everything evolves, your strategy is called praying. Just like Wags from Billions says: “The bigger the position the more stress on the research”.
Do the homework, founders will start conversations with “There’s a lot of money out there”, “Money is a commodity”, “We are looking for investors that can provide value, not only capital”. Some will present term sheets with valuations 50x their revenue. Can a company that has $2M in revenue really be worth a $100M? I don’t know, I don’t think so, you need to do the homework to figure it out. In our next blog we’ll discuss valuation.
As founders it is very tempting to boost your company’s valuation, just be aware of the future, the short- and medium-term future. Probably in 10 years, if you are a unicorn, Google’s motto “growth will fix everything” will come to life, and your company could look like the WeWorks and Ubers of the world. But in the next 18 months, what’s going to happen if you raised with a mega valuation and you are now unable to achieve the promised milestones? It doesn’t matter if someone is giving you 30X or 50X, it is an anomaly. What you are looking for is a partner, someone that gets you and gets your clients. You are looking for your next spouse, not for someone just to have a good time with. You are looking for an investor that will be with you for the next 10-12 years building your dream, accompanying each other while growing together, learning and teaching, nurturing from each other experiences. No, it doesn’t matter if he or she is super-hot with a 30X check. What matters is how that relationship and check are going to age. Just like in a marriage, divorce, lawsuits, and tears can happen. Together you are taking care of the company, the baby. When you take an investor’s money, it becomes his baby as well, and you are accepting that you are going to sell your baby, to a private entity or to the public. Sorry, but once you accept that check you don’t work for you, you work for the company and its stake holders, and your goal is to create a 100Bn empire, not only for you, but, for your company’s stake holders as well.
Investors are a small piece of the mix, the company will be a reflection of the founder. If the founder is unorganized but super creative, the company will be unorganized and super creative, if the founder is a great negotiator but a terrible builder, you will have great deals and a shitty product, if the founder is super likable but unable to compromise, everyone will love the company, but hard decisions won’t be taken. You can help and complement with your skill set or by bringing in someone who can do it, but in reality, the company will be the reflection of the founder. That is why when things get out of control the founder or CEO is ousted. They are right when they say they are the company, but in reality, the company is not them, the stakeholders are the company. This is just one of the tens of nuances you need to take Into account when making an Investment decision.
Here are the 8 homework assignments for a minimum viable due diligence (MVD), and as a bonus, I’m sharing a template of what we use when taking a look at companies.
1. Meet the founders and the team.
I recently met a founder that people referred to as “a force of nature”. That’s good, but that force of nature is nothing without a team. Who is in the founding team? Why are they in those positions? How they are connected? How much time have they worked together? How do they make decisions?
Early on in the previous fund we met one of the founders and people in the team, the other founder (the technical one) was too busy building the product and unable to make the trip. Long story short, they got into a fight and sued each other. The one that was running the company felt that co-founder wanted everything for and the technical co-founder saw nothing but trouble in getting organized and having corporate governance. We never interviewed them together. We fucked up, and now the company is a write-off.
From early-stage to an exit it takes 7 to 12 years. How will the team and the founders see at each other in the future? How will they grow, in what areas? What are they interested in? Why are they doing it and do they have what it takes to create a $1Bn empire? If you are investing, you need to have answers. If you are the first money, this is the most important thing you need to know. Do you believe the founders are going to make it? Are they willing to work for next 12 years at an obnoxious pace together? The ability of the team defines where they will be in the market.
2. Have a clear understanding of the problem they are trying to solve.
This might sound like a cliché, but really you need to understand what you are buying into. And most importantly, don’t fucking invest if it is a solution looking for problems.
If you don’t understand the problem, or it doesn’t seem obvious, bring in the experts. If you have no idea where to start finding answers, the opportunity is probably not for you. Don’t get involved in problems that are so removed from you that they sound unreal. Solving problems through entrepreneurship is what this is all about. Sometimes new markets arise with technological innovation, but technological innovation is not enough to create a market.
3. Test, touch and see the product.
The product that the company is building should be the solution for the problem. You as an investor need to, at least, agree that what the company is building is a solution. When you love the solution, it is easier to make an investment decision.
Don’t be naive, if you think that the company/founder will change the course of what they are building to build your idea, that is not going to happen. I made that mistake. I believed that my suggestions would be heard, and that the product built would reflect my idea and go on to market strategy. Of course, it didn’t happen; as I said, companies are a reflection of their founders and their products and offerings and what they already planned to build. You might think that small changes are feasible, but unless there is officially a board, and you are the product expert, changes are probably not going to happen. If you are not officially hired as a product leader or manager, your suggestions are just that - suggestions.
Something that I believe needs to be set is a product roadmap. These ideas of building things on the fly or that the CEO is the product manager simply create a lack of product ownership. If you’re taking about enterprise software, your company loses the opportunity to gain traction with the clients. A product roadmap is needed, even if you are going to change it with clients’ feedback. If the company says they have a product, test it. If they have a MVP, test it. If they don’t have a product, the road is a long one. If they have anything, fucking test it. If you don’t, don’t be disappointed when they finally show it to you. You are most probably thinking about software, but this applies to furniture, drinks, rocket ships, food and everything that is not a service, and even then, test the fucking service.
4. Meet and interview other investors, advisors, and clients.
I believe it is necessary to understand why someone else is investing or already invested in the company. If they made a due diligence they can probably share it, but if not, at the very least they’ll be able to explain why they made an investment. The advisors, most of the time, are industry experts providing guidance and business introductions to the young founders. They can tell you why the company, product, technology is interesting and why they will win. Some are also market insiders and you can learn a ton about the market that you are looking to participate in, at the end they are advisors to the company. If the company has a board, call the board members. And finally the clients, the clients will give you a sense of why they are clients.
This will all bring some light to the financial information and business KPI’s. Every industry has its own KPI’s, you should understand them and ask for them. For the founders, investors that are not in the industry will need to be educated and VCs that are specialized we won’t take the time to learn about a new industry, don’t waste your time.
5. Contrast your skill set, abilities, and network with what the company needs and will need during its life.
You might find out that your network and skill set are not exactly what the company needs. One question we ask to ourselves with every investment is: If something happens to the CEO, are we able to function as CEO? Is someone in our team or extended team able to lead the company to a successful exit? If the answer is no, it speaks to our lack of knowledge of the market, the technology and the problem, or we simply don’t like the team that much.
Be true to yourself. If you can’t do it, most probably you should either invest less or invest along with someone that is able to make the company a successful company. In our experience when we struggle to find a candidate that could lead the company to succeed, it is clearly an investment that we don’t understand very well, and it should be a pass.
6. Define how are you going to help.
Do you want to be a board member? It seems that everyone wants to control the company and the founders. The board, of course, offers some degree of control, but in my opinion it’s a position to serve the company and its stakeholders. It is a lot of work, and you need a real time commitment. Again, be true, are you able to serve the board? Do you have the time? Do you have the skill set? Are you really a subject matter expert?
You can be an advisor, help the founders and company from a different trench. In my opinion, influence is more important than control, you already vetted the founders and team, you already believe that they are going to make it. Board members should work, get things done and make things happen. It is not a ceremonial place for you to sit, be reported to and share all your wisdom, get to fucking work while representing your investment or investors. Also, if you’re a founder, you should find what are the motivation and values of your potential investors and board members. Money comes with a plan, just make sure that plan is aligned with your plan.
7. Define a plan on your side for the investment.
When will the company raise more capital? What will the valuation look like? Is it a one-time investment or will you participate in the next rounds? Will you have the money to continue investing? What’s your threshold? When will you stop investing? Will you be using your pro rata rights?
This plan will allow you to understand what an exit will look like in terms of multiples and what will need to be true to achieve your desired multiple. Sometimes the companies grow a lot, but they sometimes also raise a lot of money along the way and what looked like a 20x is in reality a 12x or an 8x. Model that to figure out what is a real potential outcome. Speed, valuations, and margin are important for your multiple. Imagine a company that achieved 10x revenue growth in one year with a lot of free cash flow, vs a company in the same industry that raised 10X revenue as an investment to achieve the same 10x growth in revenue. It’s different. Understand the differences and plan accordingly.
8. Learn about the rights and responsibilities that you are signing when investing.
Understand clearly every document, don’t rely only on what your lawyers tell you. You, of course, can always go to your lawyers, but it is a great use of your time to understand the implications of every clause. Imagine different scenarios where those clauses are not only used when things go wrong, but also when things are going right. You can write those scenarios and review them when the company reaches milestones or decisions need to be made.
a) Do the homework.
If you were the nerd in school and everyone asked for your notes, keep on tracking, learning, and researching what successful investments are made of. If you were one of the cool kids in school, start doing homework or start working with an uber nerd. Data to insights can be used as a slogan for almost every great investment company. If you follow your gut, fine, let the research back your gut. If you like the spray and pray strategy, fine, invest in 500 startups to make sure it works.
Just remember that with every investment that you make, you are responsible for what the company is generating for humanity. I hope that you really invest in companies that truly want to make the world a better place. Mission alignment is key to a successful partnership. Great companies have great investors and great investors invest in great companies.
These last 3 months have been very challenging personally. I remember reading a book several years ago that claimed that there are only 3 important things: health, wealth, and children. Without health there is nothing, creating wealth for humanity is the mission and your children will carry your legacy of doing well by doing good. I agree.
Take care of yourself, I will do the same.
Un abrazo,
Carlos Ochoa