Fundraising While Controlling Your Own Destiny with Airbase’s CEO Thejo Kote

Hello everyone. My name is Hayley. I'm a partner at First Round Capital and I'd like to introduce you to Tejo Kote. He's a two-time founder. He's an angel investor and he's currently CEO of Airbase, which is the number one spend management platform for mid-market businesses. Welcome, Teja.

Thank you, Haley. So Haley is a partner at First Round Capital. She joined in 2016. First Round is a very early investor in a bunch of awesome companies like Uber and Square and Roblox. And Haley is also a founder herself. Before she joined First Round, she built and scaled an e-commerce company called Birchbox. Right. And so what we thought we could do today was hopefully bring our collective experience with founding companies and investing, not just about fundraising, but more importantly, you know, this notion of how you can control your own destiny and the lessons we have learned about that.

Yes. And we're going to— we're going to do some real talk here. So let's get started. Vijay, what does the title of this talk mean to you? What is controlling your own destiny as a founder?

Yeah. So, look, my definition of controlling my own destiny is pretty simple. If I can't continue building a business without having to depend on external investors giving me money. And I'm probably not controlling my own destiny. Right. And so, you know, that doesn't mean that you have to bootstrap and you not raise venture capital. That absolutely makes sense if the characteristics of the business support a venture capital model. Right. But ultimately, it comes down to how you execute on a day-to-day basis and can you continue building the business especially in an environment where external capital might not be readily available like the one we're in right now.

All right. Well, I like that definition. Given the two businesses that you've started, do you have any lessons learned or tactics that you can share about controlling your destiny?

Yeah, so Airbase is my second venture-funded company. I wasn't, you know, that smart about controlling my own destiny the first time around, and I have the gray hair to show for it. You know, time will tell, but I'd like to think I'm doing it a little better. This time around. So my definition of how I look at controlling your own destiny is along two dimensions, right? So I think of it as the long-term habits and discipline that, that you have to bring to execution on the one hand, and also the short-term optimization when it comes to control terms and things like that. When you raise a round of funding, when you think about the long-term habits, what do I mean by that? It comes down to things like being capital efficient and being extremely mindful about bond and understanding the difference between fixed bond and variable bond and how you can turn down variable bond very quickly if you have to. And also not expecting that capital will always be available in 12, 18, 24 months, you know, when you want to kind of go for that next round of funding because it might not, again, in an environment like this. And so if you do that well, then You are controlling your own destiny, and those kinds of habits are actually also more attractive to investors. And I'd love to hear your thoughts on that, because if you show those good long-term habits and discipline, you're probably going to be more successful, right? And you're also going to give yourself more negotiating leverage when you are actually fundraising. And that's kind of been my experience, you know, at a high level. And so But the short-term optimization of control terms also matter. If you think about the impact that it has on the life of the company for the next 5 to 10 years as you're building that company. So it's not that that's not important, but in my view, the thing that ultimately gives you more negotiating leverage is, you know, if you show that the right habits from a long-term perspective. So I'd love to hear your thoughts about the short-term, those control terms. What does that even mean at the end of the day when you're negotiating a term sheet, when you're thinking about it, how do you think about control terms? And also, what do investors particularly care about? There are lots of them, right? So lots of those control terms. So how do you think about that?

Yeah. So now we're getting at a very different type of control, right? You were talking about controlling your own destiny. Do you even need to raise? Can you walk away in a negotiation because you don't need to take subpar terms? But let's say you find the right investor, you've chosen to take an equity investment. There's certain things that investors will ask for when they invest millions of dollars into your business. And they fall into a few different categories. Um, first is board structure. An investor will ask for either a board seat or board observer rights. That is very typical. The second category is shareholder agreements. So rights that the shareholders have. And the last is investor approvals. And these should be over only the big decisions. Things like if you're gonna raise over a certain amount of debt, then investors should have approvals. If you're going to do a next fundraise, that the investors can approve those term sheets. Or if you're going to sell the business, investors will need to approve that. And you might think, ah, this sounds onerous or annoying. But it actually creates a good level of controls and checks and balances that could be in your favor as a founder. Let's say that you're in a fundraise and you get a term sheet that's not great. You can turn around to that investor and say, "Look, my board or my existing investors won't take that." And the investors can sort of, sort of bad cop in that situation and clean up that term sheet for you. Or in a sale, you could say, "My investors won't accept offer below X amount. So having investors with certain control rights can be really healthy and help to optimize the long-term value of the business.

All right. So as you're thinking about those control terms, as you— your first round typically tends to invest in the first round very early, right? And so you find yourself in this position of working with founders as you're raising subsequent rounds of funding. So you're the advisor sitting across the table helping founders think this through. As you're thinking about control terms in particular, are there any watchouts, something you're typically advising them to avoid? Yeah.

So, look, I think there's a standard set of what's fair in market, and most good investors won't ask for anything that's out of bounds. If you're wondering, is this fair? Is this market? Get a good venture lawyer. Someone who does a lot of deals will be able to tell you what's typical. Or you can refer to the National Venture Capital Association, the NVCA. Has on their website a standard set of docs. So you can refer there. But here's a set of watchouts that I talk about with my founders. There shouldn't be investors asking for unnecessary day-to-day operational approvals. Yes, they should approve the sale of the business, but it shouldn't be over little expenses. It shouldn't be over every contract that you sign. That should be avoided. The next is different class votes. So if a new investor comes in asking for different rights or different approvals than your existing investors, that gets onerous, complicated. It means different investors have different incentives. Avoid that as well. And then what's called a ROFO, or right of first offer. Investors should want to maximize the value of the business in long term. And if someone has a right of first offer on a fundraise, that means they might have incentives to actually limit the valuation next time around. And similar with, with strategic investors, they might have different incentives. It's okay to work with strategic investors. I know Tejo has some strategic investors, but be careful in terms of they shouldn't have a ROFR, a right of first refusal, and they shouldn't have any non-competes. You don't want to hamstring the business in terms of maximizing that final exit value.

Yeah. So the conversation about strategic investors can itself be a long one. Like what I will probably say here is try to avoid giving strategic investors significant control over the business board seats and all that kind of stuff. You're probably signing up for a world of pain, right? So, but also let's talk a little bit about the tradeoff between control and dilution, right? So in my experience, if you're typically trying to maximize valuation, minimize dilution, you're also giving away more control, right? So how does that play out in practice?

Yeah, so I invest at the seed stage and it's usually clean, easy terms. The business often is just getting started, but you start to see this as companies raise later stage rounds or growth rounds when if they're trying to maximize just the headline valuation, trying to get that unicorn tag, there might be tradeoffs that investors ask for in exchange for that higher post-money valuation. You could start to see things like multiple board seats instead of single board seats. And then you can see ways that they're like minimizing the downside in terms of other terms like 2x or greater liquidation preference, things like accruing interest on their investment, full ratchets, anti-dilution. There's like this whole alphabet soup of different ways that investors can make sure they get their money back more and first. On the downside. The good thing is in the last couple of years this has been very rare. It's been a very founder-friendly market. There's been competitive rounds and I've seen basically exclusively clean term sheets. But it's important to watch out, especially given the environment that we're now in, that if you're just going to strive for the biggest valuation, there may be some things that you have to pay for in terms of control terms. How do you think about it, Fayejo? And what would you tell founders in the audience?

Yeah, look, you know, you're right that it's always attractive as a founder to chase the highest valuation and to not dilute yourself as much. But in my experience, you know, optimizing for valuation is usually the wrong thing to ultimately optimize for. Right. And the way I've always thought about fundraising and what I try to optimize for is it's actually— it comes down to basic math. You know, the question I ask myself is if I'm going to raise another round of funding in, say, 18 to 24 months and I am going to make a conservative assumption about the revenue multiple that that future investor is going to give me, what is the amount by which I need to grow revenue from where I am today, even in that conservative situation, to get a healthy up round, right? So where the valuation of that next round is greater than the round that I'm raising in now. That's the math you have to try and work out, right? So let me try and illustrate that with an example. Say you're doing $10 million in ARR and, you know, we're in a market environment that is willing to give you 30x multiple for your business. And so the post-money valuation that you raise that in the current round is $300 million right now. What might happen 18 months from now 2 years from now, and we're seeing that play out right now, is that that multiple may not be 30x anymore. It might have come down to 15x. The question you want to ask yourself is, hey, between this round and the next round, I would like to double the value of the company. I would like to double that valuation. How do you get that? So how do you end up at a $600 million valuation in that next round? You have to increase your revenue from $10 million to $40 million. Now, to double the valuation, you have to quadruple the revenue scale, right? And so the key question that ultimately comes down to is, am I raising enough cash now? And at the end of this round, once I close it, am I going to have enough cash in the bank to get from 10 to 40? What's it going to take? What's the go-to-market investment? What is the R&D investment? What might the competitive situation be like? So there are all of these elements you have to kind of keep in mind, and otherwise you're going to put yourself in a difficult spot. And when it really comes down to it, if the trade-off is between maximizing valuation and on the other hand leaving some value on the table, because this, it's not a science, right? So when you're trying to make these calls and make these decisions, there isn't hard data. You can't look up a table and kind of make that call at the end of the day. You have to make that trade-off. Do I kind of try to eke out every kind of dollar I can get from a valuation perspective or is it okay for me to leave some value on the table? How do you think about that trade-off? And my approach has always been, hey, it's okay, leave some value on the table, because the flip side of it is way more painful, right? So if you get stuck with a valuation that is really, really high, then the downstream impact of that is really bad in a variety of ways. It is not just bad for you as a founder, for the investors, for the employees too, right? And you typically then— so start to fall into this trap of trying to maintain that valuation, not have the bad news of taking a down round, and you end up, you know, signing up for all the bad terms that you were talking about, which you will have to live with for multiple years. So on and on and on. Right. So there are multiple layers of challenges that you end up signing up for.

And I think the math that you just described is exactly the math that an investor is doing as well, saying, are they raising enough? Such that they can reach the right level of revenue so they can double their valuation with a lower multiple next time around. So if you're doing that math as a founder and it matches the math of the investor, it's much easier that you find a fit in terms of valuation and getting the term sheets.

Exactly. No, but in very frothy markets like the last 18 months, you know, there is not a lot of discipline on every side. Founders tend to push for higher valuation, investors tend to give it to you and everybody suffers downstream. And, and that's kind of been my lesson. The hardest thing to do is to stay disciplined in a frothy market. Right. So one more thing I'd love to kind of now dive into is, you know, the founder investor dynamic. We talked about some of that when the founder and investor are on the opposite sides of the table before a round of funding has happened. Let's talk a little bit about how that changes and evolves once investors get on the same side of the table.

Yep. So once the term sheet signs, the money is wired, all incentives should be aligned. But I think there's one thing that founders need to think about in terms of what might actually be different incentives between founders and investors. And that's the fact that founders are betting on one company being successful while investors have a portfolio. The truth of the matter is that we're diversified. We have dozens of companies in each fund. And so there's this fundamental challenge of where do you set that growth versus profitability spot on the— on that spectrum? Do you want to go long and reject the lower acquisition offer? Investors on the margin are always going to be willing to take a little bit more risk than founders are. And I think it's a founder's job to understand that, to listen to the broad perspective that investors have, the great best practices, ways we can see around corners, give you market data. But you also have to stick up what's right for you and the common shareholders when you're less diversified than investors are. How have you thought about it?

Yeah. So, you know, we talk about negotiating leverage, we talk about control and all of those things. You know, from my perspective as a founder, the thing that ultimately matters that I'm trying to optimize for after a round of funding is closed, it's a long relationship. There is no divorce between a founder and an investor. You are stuck at the hip on that journey for 10 years, however long it takes, right? So you really want to have a good, productive, frictionless experience with your investing partners, your board, and the folks who kind of are stakeholders in the business, because there's nothing more stressful as a founder than to have like a contentious relationship with your board and investors. That's the thing that you want to avoid at all costs. And you know, the thing about controlling your own destiny is that if things are going well and you are actually doing that, then there is no contention, there is no friction, right? It's just a fact of, you know, life that when everything is going great, everybody is friendly, you know, people like each other. But it's when you're going through challenging times that the friction starts and the contention starts, and you want to avoid that, right? Like, that's the hardest thing to deal with as a founder. That's another reason why being so thoughtful and disciplined about controlling your own destiny is important. And in my experience, you also probably want to sit down and have these conversations with your investor before you raise the round of funding, right? Because you might, as a founder, have a certain approach to how you want to kind of control your own destiny. Hailey talked about how investors have a portfolio. You have all your eggs in one basket as a founder. Right? And so you want to make sure that you might be okay with the ultimate exit and value creation event taking 2 more years, and the investor may not, right? An investor may really want growth at all costs, you know, dump money into it, grow faster. But you might not want that as an— as an— as a founder. So you have to have those conversations. You have to make sure that you're on the same page. You don't want to find out that you're not on the same page after the term sheet is signed, the round is done, the money money's in the bank. Okay, that's not a good place to be in. Right. And so that's kind of why I've kind of always approached the process of relationship building as one that starts even before you sign the term sheet, when you're getting to know the investor.

Right.

And so, you know, I know we're running out of time. So what do you think are some of the key takeaways that, that everybody should walk away with based on what we've been talking about?

Yes, I think we covered a few things. First, that long-term behaviors are important to instill in your company sooner. Doing the right things with capital efficiency, being able to walk away from a bad term sheet gives you more leverage in a funding round. Related, careful stewardship of capital helps you maintain control. And lastly, what you just mentioned, set expectations with your investors before they invest so they know that where you want to set that growth versus profitability tradeoff is what they want as well. What would you add, Vijay?

All right. So I guess I'll wrap up by saying controlling your own destiny and being disciplined is hard, right? It's, it's easy to say, very hard to do. And building a business is hard, right? It's a slog that can last for many, many years. And I have not yet met a founder who enjoys the fundraising process. Right. The universal opinion, if a lot of you are going through that process, is thinking, oh my God, this sucks. You're right, right? And, you know, even people have done it for a very long time think that it sucks. But the thing that makes it easy, the thing that gives you the negotiating leverage, is to control your own destiny. So everything that you can do to put yourself in that position, you know, your future self will bless you, right? So the, the mental health benefits, the sanity benefits, and, and just the enjoyment of the journey is just that much greater when you put in the work and the effort to try and control your own destiny.

All right, fantastic. Well, on that note, we will wrap up. Thank you, everyone. Hopefully you learned a few things, and thanks for listening.

Thank you. And so if you're around Airbase, the booth is over there. We'd love to see you. Thank you.