How Entrepreneurs Can Think Like a VC, with Jim Franklin

Hey everybody, welcome to this Founder Institute webinar. My name is Jonathan Gritchen. I'm a co-founder of the Founder Institute, and, uh, I would imagine that you're coming here today because we have a pretty cool topic. All right. And for about the last 20 minutes or so, uh, me and Jim have been talking about this topic because there's a lot of places where this trips up a lot of entrepreneurs, and that is sort of this difference in mindsets and I don't necessarily wanna say values, but concepts in the day-to-day business of being a venture capital investor, even an angel investor to a little bit of a lesser degree, and a startup founder, right? Both of those parties need each other, but they think in very different ways. And since it's the entrepreneur in most cases that is courting the VC, the entrepreneur needs to understand that mindset in order to create a successful relationship and raise money. So before we get started, just really quick about the Founder Institute, we are the world's largest pre-seed startup accelerator. So what that means is that we operate earlier than seed accelerators like a Techstars or a Y Combinator or something like that. We work with solo founders, we work with teams that are pre-traction, pre-funding, and we help you get to that point. We help you do that through a structured process and also access to mentorship. Every single step of the way as you build your company. We are enrolling in more chapters now than we ever been enrolling in our history, including the Colorado chapter where Jim and I are currently tuning in from. So you can check us out at fi.co/join or see all of the chapters enrolling at fi.co/enrolling. Okay, so end of shameless plug. We got, now have 354 people, which is great. And to be honest, I've really been looking forward to this discussion because I know Jim Franklin, who I'll allow to introduce himself in a second, but Jim is one of the OG, the old guard of the Founder Institute. He helped us launch the Founder Institute back, I think it was 2010, 2011. I may be a little bit off on that. And he Clearly, if you wanna talk to somebody who has experience on both sides of the table, who really understands how venture capital works, not only as a VC, as an angel investor, now as a professor or a teacher at UC Boulder, but also as the CEO of major companies, board member of major companies, advisor of a lot of startups, and investor of a lot of startups as well, this is the guy to talk to. So, hey Jim, hopefully that was a warm, a warm introduction.

Yes, thank you. It's great to be working with the Founders Institute. I think that when the topic is about venture capital, it's most important, remember, the founders are the center of the ecosystem. And having founders, especially fundable founders, which is what I think is the output of Founders Institute, you take people who wanna be founders and take them through a process that then become fundable founders can join a team and go through an accelerator and raise money and go create the success stories of tomorrow. So you have all the things I've done, but the most thing I'm proud of is having started a company and been a founder is very, very exciting. Yeah.

And again, Jim has seen everything from every angle, okay, with regards to this space. So please don't be shy. I'm seeing California, Waterloo, Milan, South Africa, Abidjan, Munich, Zurich, Orange County, South Africa again. So please, I, we love having these international audiences. You have access right now to somebody who is one of the global experts in this space and has a very nice background in Boulder, Colorado, which is a beautiful city. And I'm totally biased about that. But, uh, really quick. So Some of the topics that we're gonna talk about today, all right? So for the people in the crowd that wanna put some questions, so we're gonna first go through a little bit of kind of VC 101, all right? To talk about how, who VCs report to, how they make money, because we really want to get you into that mindset of how a VC works. Like they wake up in the morning, what do they care about? They go to work, what do they do, et cetera. As part of that, we're also gonna talk about the VC mindset, some of the ways that they evaluate companies, and negotiating deals and, and maybe some other concepts after that. But please, at any time, throw your questions into the chat. We have a member of the FI team in there who's going to be feeding those questions to us, and we'll be sure to pepper those up. Okay, so I guess we're ready to get started. So, Jen, um, as I've said a couple times now, you've been on both sides of the table in, in multiple ways, and now you are actually teaching some up-and-coming people that wanna be VCs, wanna start funds, et cetera, on some of the basic concepts of, you know, what it means to be a VC. Like, do you wanna give us maybe a little bit of a breakdown? Like, how do they make their money? Where are they getting their money from?

You bet. VCs are much like you as founders in a sense that they have to go pitch investors to raise money to put into a fund. And then they need you, the founders, right, to make investments to go return a multiple of that back to their investors. So I think of them as really as a middleman between limited partners on the one side, they're putting money in, and, you know, the founders on the other side where they have to put the money out. And so they're just sort of caught in this healthy tension, if you will, between those two forces. So this is the basic economics. If they were to go raise $100 million from investors and put that into a fund, And then that fund goes to entrepreneurs and it grows. And if it will return $100 million, all of that first $100 million goes back to the limited partners. If it returns more than $100 million, sort of, you know, the profits above the money put in, that money is split 80/20, with 20% going to the VCs and 80% going to limited partners. And the limited partners generally wanna get something like a 2 or 3x their money, from this asset class. And along the way, the VCs have to pay themselves because they're not independently wealthy generally to start. And so they need salaries and overhead and associates and things like that. So they get 2% of the capital committed along the way to run the fund. And these funds generally last for 10 years. They'll invest maybe the first 3 or 4 years and then do follow-ons. And so that 2% of that $100 million fund, that we get $2 million to help to run that fund. Now, many venture funds are much smaller. They might only be $5 million as a first fund, and those VCs tend to have day jobs of some sort. Some, in fact, are running startups, and then they will start a little, you know, $1 million or $5 million fund, and they'll get no fees other than just paying the lawyers and accountants to do the the regulatory aspects of this. So, I think to get that mindset of that, they're like you, they have people to answer to, they have limited partners who, different types of limited partners have different sorts of expectations, but they've got to do a lot of reporting back to them. They need to write memos on, you know, your deal. They can't just be like, oh, you know, Jonathan's got this great thing, let's give him money. And they've got to go back to their partnerships and sort of follow their process to make sure they're checking the boxes and doing pretty proper due diligence because they have to answer to their limited partners. That's what it's called, the 2 and 20 model, about how venture people make money.

Right. And just to fill in the gap here a little bit, like, so the LPs normally are what types of organizations and what type of money are they managing? Just to give a little bit more flavor to the equation here.

Typically, the limited partners that write the big checks into the VCs are insurance companies, pension funds, your state retirement fund, and others, you know, very, very large portfolios. And one of the things you might not realize is that our whole industry really depends on sort of how these LPs allocate their capital, because the vast majority of their capital is in publicly traded stocks and bonds. And then they have this tiny little slice called alternative investments. Within alternative investments, there's lots of little subclasses of which venture capital is just one. But, you know, how many, you know, fractions of a percent, you know, go to VC from these giant funds determines whether our industry has $20 billion flowing into venture capital funds a year or $80 billion flowing in. And believe me, if you're out pitching VCs, it makes a huge difference if they are having $80 billion coming to their funds or only $20 billion. Up until COVID, we've been at more than that $60 to $80 billion per year range. So these have been the good times, where in the years sort of post-Great Recession, it was more like $20 billion going into the funds. And then way back in the 2000 peak, it was $100 billion. And so, trough. So you get a sense that there's a lot of money in venture firms right now. So they're feeling flush because the LPs have been allocating a relatively large percentage into venture capital. That changes over time. So as you go through your career and pitch at different times, it's good to know if you're pitching in a, you know, a thin market where there's only $20 billion of new capital available or $80 billion. So it's— I get it's always hard, but it is, you know, it's just that much harder. It could be 4x harder if you're in a tighter tighter market. So the type of LP matters a lot, and I don't think this gets enough attention. So the classic LP is this big institution, but there are other kinds of LPs. For instance, there are funds of funds. So Foundry Group here in Boulder had some very successful funds that invested in startups that became big companies. And so when they raised a number of those funds, they raised another fund whose only goal is to invest in other venture capital funds. To invest in first-time managers. So if you wanna go start a $25 million fund, you could go to Foundry's next fund and say, "Hey, you know, back me." And they would be like the lead investor putting in a $5 or $8 million commitment to help you start to build your funding round for your venture firm.

Right.

Almost exactly like how you do it as a startup. Other LPs are corporates. I'm on the board of a company that's only raised venture money from a venture fund that's backed by one corporation, and they have a completely different mindset and goals about that investment. And sure, economics are important, but they're clearly secondary. They are much more interested in the business and its technology, its platform, and how it's being applied to solve their larger corporate interests. And having two investors each put in about $5 million, is a very interesting way to capitalize your business. We can get like $10 million and you don't have any traditional VCs on your board that have these LP dynamics and the 2 to 3x return and all that, but you have a different set of goals and you need to understand those might also conflict with other things. So I think knowing your LPs is very important because it helps you really understand that particular investor's mindset. Having large institutional funds from the West Coast here in the US gives you one set of sort of, they focus on growth and that's what really makes them go. If you have LPs who are based in the upper Midwest, you know, around Chicago or Minneapolis, they might be more concerned about your burn rates and your pathway to profitability. And it makes it very challenging for you as the founder to speak out of both sides of your mouth about, we're gonna grow and be awesome, but we're not gonna spend too much. And there's a healthy tension there. And then finally, there are some, you know, very wealthy individuals, you know, the billion or multi-billion dollar class of people who are maybe former tech entrepreneurs, people like yourselves, who've gone and, you know, created the next Shopify or Twilio or Pinterest, Uber, companies like that. And then they create family offices and foundations, which have funds that invest in other technology startups, and they have got a different frame of reference because they're not really interested in returns. They have multi-generational lifetime wealth already. They're more interested in, I don't know, better words, just mojo, right? It's like, are you doing something cool and interesting in the startup community? And they can have very, very deep pockets to back you and help you scale rather than having, you know, their goal being, hey, I need to have a good return in this fund so I can go raise the next fund. And as I mentioned, those funds are 10 years old with about a 3 to 4 year investment period. So they need some returns in those first few years to help, because they'll be out pitching their, their second fund in that second, third year, say, oh, look at those good investments we made in the first 1 or 2 years. And again, just like you, you're pitching a lot of future performance when they're out raising that second fund. So I would have some empathy and some sympathy for your VCs. Don't put them on a pedestal and think, oh, these people are writing checks out of their own checkbook. That's different. You know, angels do that, and that's another topic for another day. I'm a big fan of VCs. I like VCs. I know some people have had a lot of conflict with VCs. I think the important thing is to make sure you understand the rules of the game and then don't complain. If you signed up to play a game and if you didn't know the rules or you changed your mind and you don't wanna play that game anymore. But when you take money from a VC, understand their limited partners, what their definition of a win is. And the classic conflict is that you get an offer to sell for $100 million and that is super great for the founders. It can be life-changing money for founders, but for the investors, it's not enough of a win for them to go raise their next fund and then to put it to curricular. And so that's where a lot of the conflict comes in, but there are some ways in these current markets to avoid that with secondary offerings. It's kind of a long topic, but you can sell part, maybe up to 25 to 30% of your founder stock in a later round, say a Series B. So you can take some money off the table, you know, $1 million or more in your personal checking account. And that helps you sort of calibrate, you know, that longer view. You're willing to, you know, keep growing that business past $100 million exit, get to $1 billion or $4 billion or whatever the right number is. And we could talk about how to calculate that right number if you'd like to do that, Jonathan.

Yeah, let's, I mean, there's so many concepts. So there was just so much of a knowledge dump that just went on. So for anyone else, we are going to be sharing out the video of this, believe me, you want to dissect a lot of the things that Jim just said, because that was a lot of insider knowledge on how a lot of these deals get done. All right. But I want to hone in on a couple of things pretty quickly. Right. So just as a summary, Jim was explaining that VCs have— they're middlemen, right? And your words, not mine, by the way. But no, but they are, they are the middlemen for people that are managing massive amounts of money, whether it's pension funds and university endowments, that kind of stuff. And they don't have the time to drill into individual investments like startups and things like that.

Right.

So they essentially outsource this to middlemen. They give them a good amount of money and they want them to produce a certain amount of return. Right. So you should have some empathy for what the VCs need to do, because that's what they're doing on a day-to-day basis. They're trying to make sure that they're providing a good return that beats the stock market, right? And other areas where this LP could invest their money. And they're helping them do that. And it's usually by a certain thesis, right, Jim? And that thesis, we see this a lot too, where it should be pretty simple, but, you know, don't— people are going to have a thesis and that's the same way that they attract their LPs to invest money in their fund is the same way you as a startup will have a thesis about how the world's gonna work and that's how you attract money to your company.

Jonathan, I would love to disagree with you. Okay, go for it. I'm a thesis skeptic. So I know in general, yes, you have a thesis and you tell your LPs this, but when I see a thesis or thesai on a website of a VC, you know, that we invest in these 4 buckets and you go pitch them and they say, well, you're not in one of our buckets. I think they use those as a polite no. And I'll tell you what, every investor's thesis is this. We invest in fast-growing, high-margin recurring revenue, right? If you have fast-growing, high-margin recurring revenue, that's our thesis. And what I've seen is that the thesis, you know, bend to fit the facts. It's not like the facts fit the thesis. And so, you know, with SendGrid, my last company where I was CEO, it was growing so fast with recurring high margin revenue, it fit everyone's thesis. Okay, we're suddenly in the email infrastructure business. Oh, that's your thesis. And you'll notice that these, the thesis are written with some pretty soft language in there. So if they wanna make it work, they'll fit it in, right? If you're high margin recurring scaling revenue. So I think that I would take that with a grain of salt as we say here.

You're 100% right. And I think that—

If you get that objection, say, oh, you don't fit in one of our buckets, just know you're getting the stated objection, not the real objection. And it's very hard, I think it's human sometimes to give people that direct feedback. Like, wow, we think maybe you're not the right team, you know, to execute in this market, or hey, we think you're a great team, but you're not in, we don't buy your market thesis, right? That's just not what we wanna do. Those can be hard conversations to have with people, but they just say like, oh, not in our thesis. And that's part of your job is to qualify the VC to make sure that, the check size, the geography, whether they lead or not, the sector, you know, all that should be your homework. It's easy now to understand what people invest in. So clearly there are some things like if you're medical devices versus software internet, but if you're in generally the right, the right area, sometimes that thesis might just be a polite no.

Right. So I think they want to align by thesis. That may give you a bit of a better chance of it. If they find something that's a win that really convinces them, they're going to go for that anyway. Right. And that's mostly because of the economics. Right. Do you want to talk a little bit about like the power law concepts? Right. If they want to return money to their LPs, which is their function, right, that's what they do. Like they have to find winners.

Yeah, right. So this is a, uh, one of the people reached out to me prior to this and asked this question of like, how can they, you know, lose 7 out of 10, right? Shouldn't these managers get fired? It's like, no, right? It's not, uh, losing 7 of 10 is not the issue. It's finding that one that makes all the difference. And this is the concept of outliers, and it's not 10x, uh, you know, it might be 50x or more. And so that's that power law, is that one thing will make all the difference. For the last 10-ish years, I've also been a limited partner. I sold a company and you put some money back in the ecosystem by being a limited partner. And I put some money into a small David Cohen's First Angel Fund here in Boulder, which had SendGrid in it as a seed company, had Twilio in it as a seed company, and had Uber in it as a seed company.

That's a decent return.

That's the best angel fund in the history of the world. But just the uber return on that paid for all of my other investing. And so the small fraction of the small fraction of it, just because it got to be so large, it was about a 4,000x return on the seed. And so that's the kind of leverage you're looking for. And so if you're that investor, it's gonna call it the beta, it's just that sense of variance. And simply your pitch is you're trying to convince that investor why your business will be the outlier in their fund that will return their whole fund at least once. Remember, we started with basic economics. If you just return the whole fund, the VC makes zero.

Yeah.

And their other investments have to make money so for them to make money. So if you can return a multiple of the fund, then that's fantastic. I was a part of a company that raised a very small amount of money, say $100,000 from one investor. And that investor ended up owning a decent amount of the company. And then when we sold it, they got $6.7 million back. So turning $100,000 into $6.7 million is a 67x return. But what's interesting is that that $100,000 came out of a fund. There's only $1.6 million in total. So the $6.7 million was about 4x the entire fund. So if you can return 4x the fund, that investor will love you forever because the first 1x goes back to one of their partners and that 3x gets split that 80/20. They got a big take-home pay. Now, of course, there's always more to the story. It took 15 years to do it. So the IRR wasn't fantastic, but, you know, it was still like 25% or something. But getting those big multiples and looking for that leverage, do some quick math. And this might, might have to review this on the recording, but I call it VC napkin math. And there's really sort of two versions of it, but I'll start with the, when I first joined SendGrid as the CEO, my first week on the job, if not the second day, was I wanted to understand the cap table and how much each investor owned and how big their fund was. Is if I divide their fund size by how much they own, then I can calculate how much we need to sell for to return the entire fund. And we had 6 investors at that point. And so I came up with 6 different numbers, and it varied between $200 million and $600 million. So that told me, as the, you know, as the CEO of the company, if we could— if we sell for over $600 million, all of the investors will be thrilled because they'll get the entire fund returned, and hopefully, hopefully more. And if we sell for $100 million, nobody's happy, right? And so it's super important for you to understand your cap table and how much each person owns relative to their fund size. And no one really talks about that, but that's just a good thing to have in the back of your mind. So, quick story. One time I was pitching an investor, and you think it's about the market and the team and all this stuff. I swear to God, he got a pen and a sheet of paper And he just started asking me a few questions. And he said, "How much money you're raising?" I said, "Million bucks or whatever." He said, "How much of the company will I own if I give you that million bucks?" I'm like, "20%, 30%." And then he's like, "Okay, how many more rounds do you need to grow the business?" "Probably 2 more rounds." "Okay, that'll be so much dilution about, you know, cut your position, say by a third, with some pro rata, so we can do some follow-on." And he goes, "How much do you think it'll sell for?" I'll say $100 million. He's like, "All right, so if I end up having 20% at the exit on $100 million, I'll get $20 million back. And if I put $1 million in and I get $20 million back and my fund is $20 million, you know, that squares, that works for me." And while that's an extremely crude example, because we didn't talk about the mission or the people or the why or the product or the— we didn't talk about any of that. Fundamentally, in every conversation, that math is going on in that investor's head. At some level. And even if they're talking about, you know, all these other things, about we love founders and we love the market and your thesis and your traction and your CAC and all that stuff, it's like, how much do they own when they buy it? How much do they own when they sell it? What's that, you know, why is someone going to pay that much for it and when? And if I were to ask you, if you were to send me your pitch deck and I were to flip through your 25 slides, which should really be 15, How many of your 25 slides talk about how much you're asking for, how much do they own, how many rounds you're gonna do, how much you're gonna sell for, to whom, when, and why, right? It's like, I bet there's 2 slides out of 25 that even begin to approach those questions. But that's the sort of underlying math that they're thinking, does this make sense for my fund?

Right, 'cause the people that they're getting the money from, and I'm talking about startups now, have to report to other people. Right. And those people, like, there's a reason why they have VCs, right, making these smaller investments or a little bit smaller than they want to deal with on a day-to-day basis is they create the separation. Right. So just know, yes, as you said, I think that's a really good way to put it, Jim. Like a lot of VCs are very, very supportive. Okay. Like we're not at all like bashing VCs here, but you just look in any kind of system. There's rules to the system and the rules to their system is that they need to create outsized returns. So just to give people an idea of the math, if somebody is running a $100 million fund and they're putting $10 million into each business, 10 businesses, how many— and this was a question, who's the question from? So this is a question from Sai. Right. Like, so they're assuming how many businesses are going to fail, how many businesses are going to do okay, and how many businesses are actually going to create the return for the fund so that they can raise another fund. Right.

Yeah. So the rough math is a third fail outright, another third or so return, you know, 0.6 or 0.8 or 1.1, something like that. And so then you have just, you know, a couple of deals out of 10 that will be a material return. And so, you know, then you get the 2s and 3s. We had a company sell recently, a portfolio where LPs in, and we were supportive of the founder for selling. It was like a 3.2x in 2 or 3 years. And so you're like, oh, that's, that's nice. But, but like, that was like, that was like the winner, right, in this fund. It's like, you want to see that keep going. So it's 30x and not 3x. But for the founder, they made life-changing money. It was really good. For their personal and professional development. And it's like, oh, that's okay. But if you start, if you sell your winners off, things that could be 10 or more, or 20 or more, 30 or more, at 3, it's like, how does that fund, you know, then you got to go down your list and like, how, what is this one going to, you know, you just, you just can't add up enough, you know, 2s and 3s or 1.8s or 1.2s to get to a whole portfolio return. So I think just because we have 10 fingers, we tend to think, think in lots of 10. We'll say, oh, 1 in 10 is 10x and that works. It's like, that's not enough. You talk about the power law or exponential curve, it's gotta be way bigger than 10. And so that, that, that's where you look at, you know, 50 to 100x to really kind of make that fund and make that return. And that's why you need probably more than 10 deals, probably need at least, you know, 20 to 25 deals. But as a venture capitalist, that's some of their hardest decisions. Is you have raised a certain amount of money. It's like how many shots on goal do you take, you know, versus, you know, owning a material percentage? And you can see, you know, widely different approaches from, you know, 500 startups, let's just, you know, buy the whole market and do no follow-ons, versus we're gonna do, you know, big checks. Like, yeah, $10 million out of $100 million fund would be an enormous check, probably more like, you know, $3 to $5 million, you know, per company. So you get, you know, 20, 25 shots on goal with some, with some follow-on. And then other people are very algorithmic in their approach. Right Side Capital just crunches a lot of numbers and says, hey, well, if you're willing to take 3 money pre and we'll give you $100 grand and no follow-on, sign up. And if they're just trying to index a certain class of businesses, but you see them a lot of cap tables on Crunchbase when you see companies actually, oh, Crunchbase, those guys are in the seed round because they had a formula for it, but they're never in on the later stuff. So there's different approaches and it's, I've done some math on that, I was looking at starting a fund, and about how you do, like how you do follow-ons. And it seems like 2/3 of follow-on decisions are economically poor, that you're throwing good money after bad, but you're supporting founders and there's other reasons to do it. And then the 1/3 of decisions that are economically positive are so positive, they offset the 2/3 losses. And so economically, you're basically neutral, that the wins and losses of the follow-ons You might, you know, make 2 out of 3 bad decisions, but the 1/3 makes up for the other 2/3. And you wanna support your investments because it's just the psychology of subsequent rounds. If the early investors don't re-up, it makes it super hard for the founder to go out and do a follow-on financing without that internal support.

[Speaker] Right, so you touched upon a couple of different concepts there, right? So first of all, just to make it clear on the power law for everybody, right? So what Jim was saying, Let's say you had a fund that you were going to invest in 10 companies. You're not investing in 10 companies to create a 2x or 3x return. You're investing in all of those companies with the potential that they can go like 50x, right? And they're essentially just bets. And you know that 80% of them are probably going to— well, maybe— I mean, there's like what you said about 2 maybe, will create outsized returns. There's a couple in the middle that may like even out, and then there's a couple that'll just be a wash, right? But the decision to invest in every single one of those companies is with the idea that they're going to create the outsized return.

Right? I think an important element to all this is like, think about your time as your most important asset, whether you're on the founder side or the investor side, and where does your time go? And if you were to map your time to that sort of distribution of 10, companies, you know, you probably don't spend too much on absolute zeros, right? Because they sometimes write them quickly and you're okay. And those that go super well, you know, that you're very fortunate to have that, and that's time well spent. But that sort of middle group around the, you know, 0.6 to 1.2 returns, I would argue, is a big time suck for both parties. And, you know, many years of your investable life if you're an investor, or many years of your operating life, get sort of sucked into something that fundamentally isn't working. And you are then in the term sheet mechanics around, oh, what kind of liquidation preference is it, and can we do a set-aside, and all this stuff. And that's a lot of thrashing around for something that really doesn't make any difference to the investor, because that's not going to, you know, get them that outside return. It's sort of, you just, you're spending time there because it's, there's a lot of emotion tied up into that. But I think that we would all be better served if we actually killed things quicker. So as founders or as investors, we just said, look, we signed up, we made a bet, we tried again, we tried again, we even tried it again. And you get that third or fourth try, you say, let's, let's just quit doing this. And whatever the outcome is, whether it's zero or 0.2, or just like, just wind it up and free up that human capital on both sides. So the founders, get into something that has tailwinds. Now that we're in, you know, pandemic land, or hopefully post-pandemic land at some point, you know, just seems we've— it's radically shifted. Go back to, you know, 2000, right? The world shifted back there in spring of 2000, and we didn't realize it for about 3 years. And so '01, '02, '03, on the investor side, they were licking their wounds, not making new investments, but reserving their capital to prop up all their 2000-era companies. I think in hindsight, that was dumb, right? They should have killed off the 2000-era companies and invested in Google and Facebook and the rise of social, right? There's always a new thing happening, right? And, you know, 10 years ago was cloud, right? And so if you were in '07, '08, and you're like, oh, my portfolio just crashed, I'm gonna put my money into shoring up my pre-'08 companies, bad idea, right? Because you're gonna sit there through '08, '09, 2010, 2011, you know, sort of living in the last world where you've wasted your time and your money. Where if you'd have said, look, cut our losses, let's just all be adults, and let's take this capital and figure out what is new, right? And that's when, you know, Pinterest and Uber and, you know, SendGrid and Twilio— the whole rise of the cloud happened in '09, 2010. That's the— 2009 was David Cohen's fund that invested in Twilio and SendGrid and Uber and a few other unicorns in there. And it was so much about the function of the time and the market that you are in. And so now that we're in this pandemic, it seems like I keep hearing like, oh, it's, you know, a great time to start a company because we're in a down market. It's like, not yet, because we still have too much hangover. You know, the VCs have lots of money and salaries are still very high throughout the ecosystem, which makes it very expensive. You need to go raise more money. And so I think, you know, a fund Made a commitment to a Techstars 2021 investment fund, which will invest in '21, '22, '23. Those years seem like they could be very good years for starting companies and doing investing, more like the 2009, 2010, where you've gotta kinda let this system play through for a couple years. And now, I think we're just at the beginning of the next phase, but we haven't really digested all the pain yet to sort of wash out the businesses that didn't work, from the last incarnation of our ecosystem and think about, you know, what is working and think of all the new pain points that we're living in, trying to do Zoom and Facebook Live and working from home and all of these things. So, yeah, repositioning your portfolio if you're an investor or rethinking your whole business or just shutting it down and moving on to something that is much better positioned for the next 10 years rather than the last 10 years.

Yeah, and most— the way that I like to phrase it to a lot of other entrepreneurs is that, you know, there's the forest from the trees, right? The individual entrepreneurs that are running their business, they like to look at things like efficiencies. How do I squeeze more money out of this thing? Or how do I make— solve this problem, right? But the investors are always going to think about growing the forest, right? Because they need to get those outsized returns. And especially in times like these, there's a lot of, you know, to use that analogy, a lot of forests that are gonna be grown, right? A lot of markets that are going to be expanded either just through, you know, COVID and this new reality that we live in and just the needs of consumers, but also, you know, if a business can actually expand a market, that's like music to a VC's ears, right?

Yes, I think there are some ways, and even the very earliest stages to get a sense for like how big something can be. We made an investment in a company called Section.io, and they fundamentally change how the internet works and how applications run on the internet. And so if they're successful, you're like, I don't know how big that'll be, they'll just be in the super large category, versus a company that's just, you know, changing, you know, one small part of one particular market. It's like, well, you know, that market's this big, and it's like, you know, just the beta, the sort of upside on that is, is maybe, it's just very limited. And so trying to find, if you have an application, you kind of take it down to the platform and say, oh, we're not just changing, think of like Slack, if Slack just worked for development teams, probably nice business, right? A lot of development teams, make it more efficient, but if you can use Slack to make all teams more efficient, right? It's like, oh, you're changing the way the world works, like, and communicates at work. Like that's, you know, that's giant. And having, you know, in your storytelling, that sense of what that very, you know, that big and now new market is with the changing environment is where I think you get people's interest, you know, very, very early. I think there's just misconceptions around, you know, CAC and revenue and all this stuff in early-stage pitching. And again, I think that's just VCs saying a polite no, like, "Oh, come back when you have another customer, come back when you have more revenue, come back when you have $100K of ARR," whatever that is. It's like, that's not the real objection. But it's— there's something else going on where they just, you know, aren't buying your team or your market or your approach or something. But there's plenty of companies that in the early stage, it's about that storytelling and saying that one miracle, right? If, you know, we've built this platform, if we can get it adopted, we'll be like Cloudflare or Akamai or something, you know, Fastly, MuleSoft, like boom, something's gonna be, you know, billions and billions of dollars.

I love that term, the one miracle, right? Because it's— I see a lot of businesses where it's like, okay, yeah, it'll take It might take one miracle to get there, but when it takes three, you know, then it, you know, miracles happen, but maybe not three in short succession, right?

Yeah. A common situation is in marketplace businesses. A lot of people pitching, we've got a marketplace, there's some supply and demand side. I always like to ask like, well, which one is the easy side? Which one is the hard side? And if someone says, oh, they're both easy, I don't believe it, right? The world doesn't work that way. That's what, this stuff's hard. And if they say they're both hard, that's kind of the two miracle problems. Like we haven't really figured this out or this. You say, oh, well, my co-founder has some magic on the supply side, so we can sign up the supply. We're just not sure if people are gonna buy it, right? And so that's what the miracle you have to believe, right? Is that we build it, they will come, right? And in this marketplace or vice versa. And I think that's where that good pitch, like, oh, okay, you've got some secret sauce on demand side, you can aggregate an audience, terrific. Can you make the technology work, right? Oh, okay, well, that's their bet then, right? It's like, can we actually get this thing Can we get this thing going?

Makes sense. All right, so for the last, uh, the last, uh, 10-15 minutes here, we're going to talk about evaluating pitches, okay? And I know there's been a lot of questions that have come in on this, and I know, Jim, you, you have some, some passionate, uh, you know, responses to some of these things. Now, you know, we, we've touched upon a couple of different things here, right? I think at least in my opinion, a lot of founders look at like a pitch as just like a way to sell investors, right? It's like, how do I do this? But it really is like this narrative, right? As you said, it's like, it's a narrative of here's where the world's going. I only need this miracle to happen for us to become huge, right? Versus like 3 or 4 or 5. So some of these questions like how, What are you looking at, you know, in the— what are the first criteria that you think of when you're looking at a pitch deck from a founder?

There's a lot in that simple question.

Maybe it's not so simple.

How it came to you. And so I can think of deals we've actually done, sort of like, you know, other investors we know say, hey, you know, Here's, you know, the— here's this situation, you know, are you interested? You take a meeting and we do, and it's like, okay, uh, and I have a thesis, and my thesis is with direct angel investing, uh, my wife and I only directly angel invest in people we've been through some battle with, so people we know well. And it's more like philanthropy, it's like we're voting for people, and it's not really about all the markets and stuff. And if it's on the more economic side of LPs or angel investing, like Oh, we really expect an economic return from this, then we're not leads. And we've done some direct angel investing with people that we haven't done battle with. And so I don't even follow my own thesis, right? So that's maybe why I'm a thesis skeptic, 'cause I don't follow my own. It's like, well, why did we sort of break our rules? And it's like, you have a founder ends up in Boulder, so there's that local effect, then through Techstars in New York, Amsterdam, and Boulder, we like that global, like being global citizens. And so that's what I really enjoy this call is, and you wanna structure your gap so that there's just a need to fill. So whether it's your whole round and you're talking to an investor that can write a $5 million check, well, you'd better be asking for $5 million, right? And so they said, "Oh, the round's mostly full," right? The whole soft circle concept. You know, I know it's just psychology, but it really works, right? To say, "Oh, we just need to fill this gap." I'm like, "Oh, that's my check size. I can fill that gap." And then you feel like you're being useful and part of it. And then our thesis, right, around SendGrid and doing developer tools and cloud infrastructure, that's what this company does. And so like, it just kind of checked all the boxes. And we could really, we thought the economics sort of made sense. And we wanted to be part of this investor group and just sort of like paying dues to a club, sort of periodically, you gotta keep throwing checks in to the pot. And that's sort of how that one came together. Another one, the desert edge computing was, they moved from Australia to Boulder. Anyway, well, that was a big commitment because they wanted to scale their company here. And so we like put together a group of angel investors to kind of do their first $800,000. Took about 2 weeks. And they worked for probably 6 months flying back and forth to kind of tee everybody up. They ended up going through Techstars and we had a, you know, just a good group of people that wanted to acknowledge that, hey, they had that big beta, right? That could be huge like a Cloudflare if their thing worked. A great technical founder and a great business founder. So team had been together, they were sort of, I'll say, mature adults, right, in their 40s or something like that, late 30s. And, you know, the hustler-hacker dynamic I think is important, whether you cover sort of both of those bases. And it had—

I think— sorry to interrupt, but I think you touched upon an interesting concept there, right? So you and your wife, you guys angel invest, right? You mentioned. And when you angel invest, it's less about the thesis and more about, okay, this is like what we are passionate about. These are the people that we believe in. Right. But then when it goes a level more, which generally means more money and you get into the institutional funding and the VC funding and that kind of stuff, then it's going to focus a lot more on thesis and then the 10x stuff. Is that correct?

Yeah. Or the 50x stuff. Really, the 50x. What would be a meaningful outcome? Doubling and tripling is like, eh, you know, again, it's just part of being an ecosystem. It's information value about being an LP and seeing what's happening, but just like specifically on a pitch deck, right? It's like the, I think the biggest thing, that sense of beta or outliers, like, you know, how big can this be? How do you get big fast? Back when I started work with you at FI, that was my, I think every mentor, and I think you should all be mentors in your own ecosystem, you should have your own, theme. And for me, it was always, how do you get big fast? Because if you get big fast, that solves all your problems. You'll raise money, you can hire people, it'll be chaotic, but at least you'll make an impact and there'll be a difference. But then once you get a deck and start going through things, some things we listen for are like, who's the hero of your story? And so when we listen to a story, it's like, who's the hero of the story? So with SendGrid, right, we're sending mail. Is it, you know, is it, uh, is the hero of the story, you know, Pinterest, or is it Very clear was the developer, because we were founded by developers, by, you know, cloud developers. And cloud developers have certain problems, and one of which was they couldn't get mail to their application users from the Amazon cloud. It just wouldn't work. And so they created a relay system to end-run that and solve that problem. And so we did other things to try and solve other cloud developer pain points rather than do sort of other things in email. It wasn't about the email, it was about— right, developer was the hero of our story, not the marketer. So we didn't create a a marketing system because we didn't give a shit about marketers, right? No one in the company had any marketing DNA. It was all startup developer focused. And so being clear on that, even as a— as your whole deck should have one voice, or if you have 3 founders, which I think is the right number to have in a team, you know, do they agree on, oh yeah, we really care about, you know, this person? These are the people they benefit, but at the end of the day, this is the particular, uh, you know, thing is our why, right? Why do we care about this business? And for sure as heck, I didn't care about sending email, but I care a lot about startups and developers and making developers' lives easier, which is that thesis. The other thing we look for a lot is what bank do you rob? So if you're clear on who the hero of your story is, sometimes you'll hear things and you're like, where's the money in this deal, right? There's gotta be a river of money flowing around somewhere, and how do you sort of intercept that So it turns into, you know, revenue on your income statement. And that's not always obvious to people. And that's why you, you know, you gotta, you literally sell to banks, right? They've got money, pharmaceutical companies, energy companies, you know, institutions like that. I was part of a security software company and we sold to school districts. Well, school districts are lousy customers because their revenue comes from taxes, which can go up or down depending on property values, and their costs are high and fixed, you know, unionized salaries to teachers and things. And so there's almost zero discretionary dollars. And so if you have a good solution for a real pain, and you don't charge too much, like, why don't they buy it? Because they have no money. There's no money between their fixed cost and their revenue, or it's very, very tight to try and get that versus selling to, you know, Exxon or P&G or Conoco or whatever, these other companies that have money available to go solve to go solve problems. So there's just some of the things you get the hero right, uh, understanding that, uh, economic model. And probably the other big thing is just alignment. Too often we see like, we're gonna do this huge thing with 20 people and a million bucks and profitable. You say, well, wait a minute, that makes no sense. So you need to align your vision. How big is the dent you're going to put in the world? Your people, you know, the you and what army, and your resources, how much money you're going to raise, you know, over time. Almost no one can answer that question. You know, what is the lifetime financing needs of your business? That's when you have a financial model with the big J-curve that says, oh, we're gonna raise $1 million to start, and then $5 million, and then $15 million, and then $50 million. And having a curve that shows that in your executive summary even before the pitch deck, so you get a sense for, oh, we'll be at $50 million revenue in 5 years, and we'll be losing $15 million a year. And we just see decks all the time that show we'll be profitable in 3 years and we're gonna grow super fast. It's like, no, you just under-modeled your expenses then.

So I think most people copy and paste that online, the hockey stick, 3 years, yeah.

That same executive summary, numbs table to raise money for 2 different companies about 3 years apart. And I literally just changed the years across the top. Because it's the same curve for pitching in a particular market. You know, here it was just, yeah, there's a, part of it was by design is that we were just trying to find an opportunity that we could solve with 50 people in 5 years with $5 million. Because in Boulder, it's pretty easy to raise $5 million, not so easy to raise 50. And you can hire 50 people pretty easily. And you have a CEO and VPs and people who do stuff. Uh, it's just a, it's a kind of a small, you know, tight squad of people that can go do a certain thing. So, but then you need to scope the scope of your business. They cannot be giant. And so we were looking at sort of where there were large messy problems and finding just one kink in that chain. If we can pull that straight and fix that one problem, uh, and be very focused on that, then we'd just be, we'd be known as the way to do that one thing. Then the big players in that ecosystem say, oh, "You figured out how to solve that one thing. Thank you very much." And then they could, you know, buy that company for, you know, $50 to $150 million, and it worked for the investors, it worked for the employees, founders, et cetera. So how aligning your, your mission and your people and your money so that they're generally in the right ballpark is a, uh, is a key thing.

That is, I took so many notes here and, You touched upon a couple different points there, so I want to get into a few of those. And any last-minute questions, please throw them in the chat. Thank you so much, Jim. Uh, you— everybody who has been registered to this event will get a video afterwards, so don't worry about that because he's just been spitting fire this entire time. Um, so the first thing, you just getting into the HERO concept, right? It's— well, there are a couple things. It was HERO, where are you getting your revenue from, How are you gonna get future money? Such a big thing that most founders don't think about. They think, oh, I'm only gonna need one round. No, you're gonna need multiple. And then sort of aligning the design of the business to find this one big thing. But to the hero analogy, it sort of boils down to the basic story of the business, right? Because I thought SendGrid was a perfect example of that. And any passerby would look at SendGrid and say, oh, they're an email business, right? But you guys basically were able to boil that down and say, no, we're not an email business. Yes, the first application of our business does go to email, but really we're solving something that's very complex for developers, right? And that not only is really fundamentally what you do, and we use SendGrid, by the way, at Founder Institute, But, you know, it also was your way to sort of, you know, it's a much bigger market, right? It's not just about email, it's about all of these different components that a developer has to do.

Yeah, and so we created a SendGrid Labs group in Rhode Island and we had 12 guys basically running techstars-type projects to solve other pain points for developers. They weren't building, you know, different flavors of email, we're building applications on top of email. We want ecosystem partners to go do that because that's not, you know, not our why or our business.

Right. Yeah, it's the why. You're— it's sort of the classic, what is it, the Ford? We don't, you know, faster horses or cars kind of thing, right? It's like— yeah, it's not just— it's not just about— so try to think a little bit bigger in your business when you're pitching VCs as well. And because that will just— it opens up. That's how you can grow a market. Right.

I think our biggest asset wasn't on our balance sheet, and that asset was we had 200,000 developers trusting with their infrastructure. Yep.

You solved one problem for them so you could solve several more.

What else can we sell to them, right? And that's what else— because they bought it, we didn't sell it. So what else would they want to buy from us in the way that we were engaging with them through developer relations and free trials and self-onboarding and radical support? So with that model, what other things sort of fit in there so that it was sort of frictionless process. And of course, that was, that was very hard to find. Something that when you have one act that goes, you know, very big, then it's like, what else can flow in there and be meaningful is challenging, right? Some other things we look for on, on when looking at pitch decks is like the 10-to-1, you know, your difference needs to be 10-to-1. I think that's a common, uh, pitch point, which is important. Also headlines. When you have your 15 slides Instead of saying the market and the mission and the team and all that, those are, those are just empty words. But instead, think of it as like an article, and you want the headline. What is the headline about the market, right? What is the headline about the team? You know, proven, you know, ex-Google founder start this, right? Like, oh, that's a good team headline, right? Market headline, you know, accessible, large, you know, expanding market, you know, with the big graph. And so if I were to print off your 15 slides and only show, you know, just hold them up so I can only see the very top words. Those 15 headlines should basically be your argument on why this is a good stock to own. Remember, you're selling stock, not the product. Another common problem is people will sit there and say why this is a good product to use. Or I saw a deck last week and his call to action at the end was download and try the product, you know, now. I'm like, this is not a product pitch. I love Techstars, but they call it Demo Day. You're demoing a product? You know, that's just an accident of history and it's called that, right? It should be pitch day, right? Like we're selling stock today day, right? Not future day or something. Yeah, right. Why is this a good stock down? And maybe just one other sort of concept that I think people get wrong a lot is how to talk about breakeven. Many founders will say, oh, and we can be breakeven in 3 years, or we'll take your money and we can be breakeven. And breakeven's a fine thing. But it's not a venture thing. And if the way you only bring it up in a venture context is as an off-ramp, and this would be maybe after your pitch meeting, right? In a subsequent second, third, fourth meeting, and sort of what does breakeven look like? I had this come up once the night before closing. They said, we need your plan B. What if this is the last capital you ever get? How would you run the business cash flow neutral? And I was like, oh man. And so I just went home and typed up a different business plan for our business that was, you know, focused one product, one market, market, you know, inside sales channel, you know, just something a lot tighter than, oh, we're gonna go do multiple products, multiple markets, multiple channels. And they just threw it in a drawer, but they wanted to know, again, Midwestern LPs, they wanted to know that, you know, is there a plan B that is an off-ramp? And you can have off-ramps like, oh, we'll go sell to, you know, one of our major investors or something if they're strategic, or what are some of these off-ramps along the way if things don't go as planned? But that's the only context to talk about breakeven. Otherwise, talk about how you're gonna radically change how something's done, which generates billions of dollars of market cap and hundreds of millions of dollars in revenue.

Right. And I just— just to wrap things up, we got a minute or two left here, Jim. Like, I'm sure that there's a lot of people that are in the crowd today, they're thinking about their business, so they're just like, it's not right for me, right? Like, this is not my vision for the business. And that's fine, right? I mean, I'm sure you see a lot of pitches that, like, do you Do you tell a lot of, you know, you're a pretty active angel investor, right? Like, do you tell a lot of business like, hey, this is just not a venture kind of thing?

I should do that more often. But yes, absolutely. I think what I do tell people is whether you want to just self-fund, raise money from friends and family, angel investing, local VCs, you know, international VCs, all fine, right? No judging. They're all different. As a community, I don't think we honor the sort of bootstrapped and companies that are, you know, doing $5 or $10 million and you own it with a couple founders, that's fantastic and greatly underappreciated. But there's no milestone of fundraising or whatnot where you're like, oh, you know, let's, you know, clap for these people. And it's like, and so I think that we probably underappreciate that and the hard work of having a cash flow positive business. So I always sort of close any kind of a session with, you know, congratulations on your progress. Progress and just say like, you know, it's your business. You know, I have a lot of opinions or whatever, just an investor or operator. It's like, it's your business. You know what you're doing better than I do. Congratulations on your progress. A lot of ways to be happy and successful. And it doesn't have to be by taking OPM, other people's money, and the trade-offs and consequences that come with that.

Right. Yeah. And it's, you know, it's right for certain businesses and it's not right for others. If you can see yourself taking over, providing a 100x investment in what, 5 years, 5 to 10 years, right? 10. Yeah. Then it makes sense. If not, then you should probably— because raising funding takes a lot of time. All right. It becomes essentially a full-time job for the CEO and a good amount of time to the CFO and some other key people for a long period of time. So, you know, you could also allocate those resources to just generating more revenue or coming up with other ways to raise finance. Okay, well, Jim, thank you so much. Um, for, for anybody, honestly, I don't know if Jim wants you to reach out to him, but you could find Jim online. He, he really is— he's the OG of the Founder Institute Colorado, was one of the first people that helped us launch this back in the day, former CEO of SendGrid, pretty prolific. He's on a ton of boards, like, he really I'm really happy that we did this today, Jim, because you've seen this from every single angle now throughout your career— founder, investor, board member, advisor. You know, you've seen every single thing. So, and I know we're getting a lot of praise here in the, uh, in the audience as well. So for everybody that's been attending, you'll get a video in a couple days. Jim, thank you so much, man. This is super helpful.

Thank you.

All right.