Why Iteration Speed Decides Who Raises a Series A

I think we're coming back to a world where the answer is every successful company is a snowflake. The way that they're successful will be unique and special to that company, and trying to force them into rigid playbooks is probably a bad thing, both for investors and for the companies themselves.

It's the week of October 20th. Welcome to the Learning Corner, a Precursor Ventures podcast.

Welcome to the Learning Corner by Precursor. I'm Mia Farnam and I'm joined by our GP and Managing Partner Charles Hudson, where we will be talking through the article and Goodreads that caught our team's attention over the past week. Our first piece is written by Brian Sugar titled One Brand is Luck, two Is Strategy, highlighting the recent attention in Playbooks being created to capture DTC value through larger acquisitions in an industry where many investors have been burned. Sugar discusses the recent acquisition of Coterie, a well known diaper brand by Mammoth brands as the second major D2C brand acquisition this year, with Road Beauty coming in at number number one. Coterie was reportedly acquired for north of 650 million while road was purchased for 1.3 billion, signaling the power of identifying companies that have mastered pure play D2C as a mechanism to spot industry leaders, not the outdated wholesale retail growth metrics that have historically driven these decisions. Mammoth also purchased prior to Coterie, the deodorant brand Lumi in 2021 and doubled its business in two years without compromising the brand's integrity. Brian said, quote, you don't need $5,500 million in sales and a Walmart aisle anymore. You need brand devotion, clean unit economics, and an acquirer who knows the difference between breaking a brand and building it. So what's different here is that historically strategics waited for D2C brands to fully prove themselves out in retail before investing or purchasing, and Brian points to some failed acquisitions by some legacy giants like Unilever and Dollar Shave Club, Clorox and Birth Bees. And Brian said the lesson wasn't don't buy D2, it was don't buy DTC if you don't know how to scale without suffocating. So I wanted to pause for your thoughts because we have some great brands within our portfolio from cpg. So you've seen a lot of growth and change in this industry.

But the pleasure of co investing with Brian and I think he is very thoughtful in this category. Look, I'm not an expert in this category even though we've made a handful of investments, but my perception was always the big brands, one of their big asset is retail relationships. And so they tend to view the world through retail relationships because they've got the shelf placements at Target and Walmart and whatever the relevant set of retail partners is. And I think when all you have is a hammer, everything looks like a nail. And so it makes sense if you're like, hey, we're really good at pushing things through retail. Let's find companies that have already achieved some level of retail distribution and we can turbocharge, slash unlock that stuff for them. And if that's your playbook, you will be successful with brands and products where that's true. But if you're like, hey, we're going to buy this company that has a really different go to market motion than we do that, we're not going to break it, that's harder to do. But I don't think that's unique to cpg. I think that applies to almost every business. If you're an enterprise software company that does a lot of top down selling and you try to buy something that's PLG and you try to make it fit in your org, I think that's really hard. I also find this very fascinating because a handful of our companies where I have the highest outcome expectation are CPG companies. They're physical products companies that sell direct to the consumer as one of their core channels. And you know, two or three years ago LPs would tell me this category is dead. Why are you investing? I was like, well, nobody told the companies that the category is dead because they're still growing, going and it's a category where it's really hard to get investor capital. So in some ways you're sort of forced to run a good business. There's no other way. And it's one of those things where we've continued to invest in this category and I feel really good about the companies that we're in. And I think having more exit paths for these companies is a good thing because there are some of these brands who were the founders of like, I put 10 years of my life into building this brand. The last thing I want is some big conglomerate to snuff out the magic of what I've built either intentionally or through like negligent management. We've come full circle in some ways. Mia, it was like D2C is the future. Then everyone's like, hey, you can't scale a brand, you've got to be omnichannel. So then you got to go get. If you want to raise your series A or your B, you got to Go get an Ulta deal or a Sephora deal or. And I think a lot about, for folks, if you haven't read the Amicole, a story about the impact that going into Sephora had on her. And I've seen this even within our own portfolio. In some ways, investors started creating this model in their head about how you scale these brands. And there were a lot of brands who follow that playbook to their own peril. And so I think we're coming back to a world where the answer is every. Every successful company is a snowflake. The way that they're successful will be unique and special to that company. And trying to force them into rigid playbooks is probably a bad thing both for investors and for the companies themselves.

And I sympathize so much with founders who are building in this space because you'll talk to one investor who'll tell you, I need to see you build that wholesale in these channels before I come in. And then you'll talk to other investors at the same stage who'll say, I don't believe that you need wholesale and retail in order to succeed. I don't blame the founders for kind of being like, what route am I supposed to follow? Venture capital is the money that I want to take on into this business. But I agree with you that for some businesses, wholesale and retail have been almost like poison pills for them because then you're stuck in this funnel of hurting your margins, trying to get back on shelves, working with buyers on the other side who leave the company every single year, and then trying to chase coming back onto shelf. It is something that can potentially destroy all the magic you place into the D2C side if you don't do it correctly. Going back to kind of like where we sit at precursor, when you're super early stage like us, what signals indicate that a DC brand is ready for maybe its next infusion of capital, maybe its first partnership if it wants to go that wholesale retail route, versus a brand and company that perhaps needs to iron out deeper aspects of the business and its relationship with customers before investing further. And I know that you have other examples in different industries, so happy to open it up.

I think most of our portfolio companies, the successful ones that have gone D2C have gone from D2C to some other iteration. It's usually been pull. It's usually been the D2C pieces working. And a category manager at some company saw the product and said, we'd like to carry this. Or somebody at corporate was like, this brand is seems to be taking off. Somebody should go figure out why this is working. Or it's like, hey, we're rolling out a whole new category of naturals. Or go find the companies that have already built some audience and in some ways to analogize it to other businesses. Non cpg I meet founders who are like, if we could only get this distribution partnership with Microsoft, everything will be golden. And I'm like, well a you probably won't get it and B, the more audience and more success you have on your own, the more interested Microsoft will be in working with you. And I think the same is true with a lot of our CPG companies. The notion that you're going to go into Target or Walmart and be discovered is like backwards. It's like you go into those locations and you go into wholesale and retail when you already have built an audience in some level of demand. I'm very sympathetic of startups who are like, this could be the silver bullet for me. I'm like, it could be, but you probably won't get it.

It reminds me of healthcare too, when folks feel like once I land this pilot or contract with this payer, I'm gonna unlock so much growth. And that's just the saddest myth in healthcare entirely. If you've ever done B2B business because you have to convert all of those members who basically never interact with their payer ever. And so landing a contract with the payer is a great milestone and you should celebrate it, but it's zero conversion until you know how to reach those members which payers themselves don't know how quite to do. Hence why they're enlisting all these startups to be a better front door so it's applicable across so many industries. Our second topic is a LinkedIn post by Hadley Harris at ENIAC who shared his perspective on what the largest driver will be to determine if you raise a Series A or not. He claims it is iteration speed, AKA the speed at which you test new hypotheses, shift and pivot and launch new ones and have more shots on goal. The more experiments you can run during this time, the more you can get closer to product market fit with the right market motions to position you well for a series A conversation. Things like shorter feedback loops, deep prioritization and the ability to abandon ideas quickly or examples of founder behaviors that can increase your iteration speed. Ultimately, Harris argues, the leaders and teams who can harness this will graduate and those who aren't able to make those adjustments will struggle far more. I think every founder does believe that they are able to make decisions quickly. But where have you seen that process break down and then impact the company and its trajectory as a result?

I read this and I was like, this has always been true. You know, we have our own internal review process after we make an investment. And at six months, the most important thing I evaluate companies on is product velocity. It's like, what have you done since you got the money? And I think in a pre world there was a sense of like, this is what good looks like. And it took into account that development cycles were longer and that you couldn't build as much and you probably had to hire people. So I would say the grading was more forgiving before. Even so, the companies that had Velocity always stood out. Now I would say we have the world's harshest graders in series A funds. I just saw it was like a podcast or some interview where someone's like, if you don't get to 10 million in ARR in three days, I'm paraphrasing that it's not good enough. And I'm like, wow. Like, that is both a very harsh bar. And there are companies I know that can clear it. Whether they clear it cleanly or not. That's a subject for another podcast. It's true. And I think people's expectation for what best in class Velocity looks like are probably 10x what they were before. And I don't know that every founder I talk to has absorbed that. Some of them are like, yeah, we're going really fast. We're getting a lot done. And I'm like, on an absolute basis that is true relative to market expectations, it is untrue. And this is one area where I think being in a dense builder area, whether that's San Francisco or New York, you just get a better sense of what best in class speed and execution look like. And I've met a bunch of teams where I've talked to the founders and they're like, we are working so hard. We are doing. We're nine nines and we're doing everything we can. And I'm like, yeah, but other people are doing the same thing you're doing. And I'm looking at the output and they're getting three times as much stuff done. And those companies are like, how? I'm like, I don't know. I don't work at those companies. All I can observe is the amount of time that you've both been given and the output on their end. You should go visit that company or you should come to San and people come. You know, we've been doing these field trips to our office where we bring companies in who are not building in the Bay Area, and they always are like this. The rate at which information propagates here is unprecedented. The rate at which we can fix problems when you get stuck is unprecedented because everybody here is working on the same thing. And they're like, those are the edges that I didn't realize I didn't have access to in my hometown. Which doesn't mean you need to move, but it means you need to periodically get an injection of that special magic.

And just come in temporarily to see what's the baseline, and then go back home and then really take a good look at what you guys are doing and say, am I making decisions as quickly as I possibly can, or is it just in my own bubble? I mean, we've talked a lot about how speed is not a moat. So how does this logic differ from your perspective, or is this a completely different.

No, I think they're related. Every time someone tells me speed is a mode, I'm like, I don't actually know what that means. I mean that, like, the most honest way. It's like, yes, building quickly.

Sarcastic joke that people are saying.

Yeah, it's like I took it as like, the shrug emoji of the moment. It's kind of like we've run out of good answers. It's not technology. It's not network effects. So I guess it's speed, for lack of a better answer. But I think people are so desperate to find a narrative. And so I think what ends up happening is if you're a Series A investor, you're like, I need to have some narrative that I can use to try to sort through all of these companies. And if you're just like, all right, I'm going to find the ones that are compounding revenue the fastest in the shortest period of time as a proxy for two things. The ability of the company to execute and customer interest in the product or service that the company is building. That's not a bad. It's not a bad proxy. I wouldn't say that's a bad way to invest. You run the risk of sometimes finding ephemeral things. I'd say the equivalent is if you invest in consumer companies and you're like, oh, wow, this company just got to a hundred thousand downloads really quickly. You're like, but what's day 90 retention going to look like? Well, I don't get to wait till day 90. I have to make a decision in the moment and you either believe that the product has legs or you don't.

Going on that line. I've met with so many different consumer AI companies right now that will say the same thing of I've gotten x thousands of downloads on our app in the first two months. I have this amount of engagement that's happening there and it maybe used to mean something when that felt like an outlier, but now that everyone is saying it, because I think everyone has kind of maybe unlocked the masterful way of to go, quote unquote viral in different social channels. I'm starting to struggle with just taking everyone for their word or wanting to ask further questions about how long people are spending the app, how often are they coming back, and also will they pay for it. It makes a difference in if it's a freemium. I love trying out different tools. I'll sign up for anything once. But the moment that you start wanting to charge me $20 a month, I wonder how long your community will stick.

Also, I think as an investor, I always have to remind myself that what works propagates through founder communities really quickly too. I mean, I felt like as soon as the Cluley thing happened, all these people were like, quick. We got to like clulify our marketing message. That worked for them. That was the moment. And we've seen this before ever. When the dollar Shave Club video came out, everyone's like, we got to get our founder to funny. I was like, that worked because no one had really done that. And the derivatives are almost never as interesting as the original.

One last question for you because I know how important it is for founders to be able to make decisions quickly and draw that analysis early on. Where have you seen founders struggle the most in this and kind of what have been their Achilles heel there, I think the hardest?

Well, there are many things that are hard about being a founder right now. I think one of the harder things is depending on when you go fundraise. The bar for excellence might have changed dramatically in a month or a quarter and you might have been racing toward a goal that was the right goal when you started the company. But now it just isn't enough. And it's much easier to have a sense of that as an investor because you're in market and you're constantly getting feedback than it is when you're a founder and you're like, hey, I'm heads down building and I saw a tweet that said that triple, triple, double, double was good enough and now I see another tweet that tells me that it isn't. What am I supposed to do? I'm like, I don't know. It's really hard. Grow as fast as you can, answer as many questions as you can and hope that it's enough.

That's like the double edged sword of popping your head up and looking around at other people. You want enough of it so that it motivates you, but then you don't want too much of it. Then it like drives all your decisions to try and imitate.

Totally. Totally.

Our final topic of the day was a brief mention of a recent Axios pro rata issue that shared news of Menlo adding details about secondaries to their term sheets. Secondaries have indeed become less stigmatized across venture, but if reports are true, Menlo is taking it a step further by outlining their liquidity intentions. Upfront concepts like telling founders that the fund will participate in secondaries when its position reaches a 10x cost basis and the founder is selling are examples of a more direct approach to the type of founder friendly secondary we've discussed on the podcast. I did like a historical look through basically all 53 episodes we've done, and we've been talking about secondaries on this podcast since maybe the first month. And that conversation has evolved so much since then. But in the beginning it felt like we were shouting into a void. So clearly there's been this consistent flow of support for the concept. And this reported piece is another data point. So of course this isn't also a direct report from Menlo, but wanted to ask you if you're surprised that we've arrived at this point in venture capital, that these are the the tools and levers that we're pulling now.

I think if you had told me this five years ago, I would have said you can't put that in a term sheet because every other venture firm will use that against you and they'll say why would you want to take money from someone who's going to sell their shares in your company? We're long term holders, we're not going anywhere and people would have used it against you and it would have probably have been successful. And I think it says a lot about where we are in the venture ecosystem. Whether or not this is true. I know there are firms who've adopted very similar policies. And so to me it says a couple of things. One, secondary liquidity is not only an emerging manager small fund issue, it is an industry level issue. And as I told an LP last week ago, it can't be only an emerging manager issue, because emerging managers don't have enough money for it to be a problem. The problem is the money that's locked up or tied up in the funds that have the most assets. And so to me, this is a signal that even large venture funds are thinking more critically about managing liquidity cycles. Second, I think one of the less well reported things that happened in 2020 and 2021 were just gigantic founder secondaries in businesses that didn't end up working out for investors and where founders took a ton of money off the table. Investors didn't have the same option. And founders were like, hey, I'm good. And investors were like, well, I'm still long this company. You're so motivated, right? Oh, yeah, yeah, I'm so motivated. I'm just motivated with $10 million in the bank. And I think a lot of investors now are saying like, hey, this doesn't feel right that we can have these situations where we're sitting on a position that has increased dramatically in value. I think it's really the. And condition in that Menlo statement, If it's up 10x and you're selling, how can you tell me I can't sell? Or we want to make it clear that our intention is if the position has grown a lot and you're selling that we want the right to participate too. And also, you know, I've seen situations where firms have come in, offered secondary liquidity only to founders as a way to buy positions in companies where it's a way to skirt. There's. There's a lot of reasons people have structured them this way. And I think a lot of investors are like, I don't want to be forced to stay long if the founder's taking a bit off the top. And I think when things like this come into the term sheet, it's kind of like pro rata. Everyone's like, oh, don't worry about pro rata. We'll give it to you. If you're a good. If you're a good actor and you're supportive, you got to earn your pro rata. Cool. But also I'd like it in writing because I want to be assured of it. And if I decide to be constructive and waive it or reduce it, I want that to be my choice. We're well past the stigma of secondary and now I think we're into the structurally, how do we start building this in to the relationship up front? And I think probably by this time next year, almost every term sheet will have some secondary language in it at the A and beyond about the that firm's intention.

So you think at this point secondaries are going to be more of a feature within venture and it's here to stay rather than like a blip that's future.

It's a feature. And look, I think also if you zoom out again, so much of the capital in our business is concentrated in the small number of firms and so much of the capital in that small number of firms is concentrated in a small number of companies. So if you're menlo when you're an Anthropic you're like suddenly a significant part of our not just our fund but maybe our firm AUM is tied up in a single security.

I mean this is going to be a completely different podcast. But I do wonder what's going to happen when all of the giant foundational LLM companies start buying up all the smaller companies and you roll up in a stock to stock purchase. So then everyone is now an owner in some sort of amount of share of Anthropic or OpenAI. How deep will the secondary market be at that point when everyone owns a little piece of it? I don't know.

There will certainly be more shares on offer. It's a lot easier to control price. But I also would say like for OpenAI and Anthropic, from everything I can tell, the demand to purchase shares in those companies are well in excess of what's available. And so it would take a lot of dilutive share issuance to change that. But I think what will be interesting is there will be some venture funds who get those shares in Anthropic or OpenAI through acquisition and immediately sell them. And there'll be some people who are like, hey, we're going to have a strategy here and we're going to hold some of these and it'll be interesting to see the differences in performance across funds based on those buy sell decisions when those shares end up in their lap.

Well, we are all out of time for today. Thank you Charles for stopping in. Thank you to our listeners for stopping through as well. Please like and subscribe and we'll talk with you all next week. Thank you. Bye bye.