a16z Podcast - a16z Podcast: Raising Money and Valuing Startups -- What Happens When Things Don't Go As Planned?

Episode Date: September 8, 2014

It’s a problem most entrepreneurs would love to face, a massive valuation offer from investors for the startup they’ve been killing themselves over. But what terms come along with that big number? In this segment a16z’s Scott Kupor is joined by two startup CEOs to pick apart the topic of valuations – serial entrepreneur Danny Shader, founder of PayNearMe, and Danielle Morrill, co-founder of Mattermark.

This is Scott Cooper, and I'm here with Danny Shader, CEO and founder of Paynearmy, and also Danielle Morrell, the CEO and founder of Mattermark. And thank you both for joining us today. What we thought we'd talk a little bit about is valuation trends, what's happening, and then in particular, kind of the idea of what are the pitfalls or what are the things you should be trying to solve for when you're raising money? And in some cases, is it worth stretching for valuation? Is it not worth stretching for valuation?

So we'll cover a bunch of topics, but I think we'll be. kind of start with that. So Danielle, maybe we'll be great is, you know, given kind of your business, obviously, where you guys are awash and kind of data and certainly are kind of the voice of what's actually happening in the, particularly the early stage venture capital world, you know, what are you seeing either valuation trend-wise or in terms of your conversations with entrepreneurs about how they're approaching valuation in this market? Yeah, well, I think there's a couple factors. One is that you can do more with money now than you used to be able to. So if you raise five or ten million dollars, that money can go a lot

further. I remember the first startup I worked on, we raised a pretty large venture round just to get servers. So even Amazon Web Services alone is just a huge impact. So you've got that side of the equation. And then I think you're also seeing these really massive rounds because what I'm seeing is really competitive deals where investors feel like there's not that many super unicorn potential startups. They want to pile into those. And so that drives up valuation just because the founders don't want to give up, you know, beyond a certain percentage of the company. So you kind of have those two different factors at play pushing valuations, I think, higher when it comes to the really competitive deals. But then I think the middle, my question

to this whole conversation is, isn't the middle pretty much still the same? Or has it really actually shifted the whole thing? Well, Daniel, I've got a question for you about that. One of the rumors you hear about some of these super high valuation deals is that they have a high headline number, but there's a lot of preferences or which is being preferred in others. And it seems like that has really negative implications for the new common shareholder employee who joined. which, you know, I'm old-fashioned, but that seems like that's not necessarily

an interest of the company long term. Yeah, I think that's right, at least. Certainly, you know, the ones we've seen, particularly where you start to get to either, you know, the hedge fund community or in some cases, you know, buyout firms who are now kind of doing these later stage private rounds. You definitely see more structured deals.

There's no question about that, right? You either see, you know, some type of ratchet or full ratchets or you see kind of various price resets. And, you know, I think the big question we don't know is obviously what will happen when and if those actually come to play, since we've all been lucky enough to kind of live through five years plus now of, you know, an incredible market.

Yeah, and I'm old enough been through the last time this, you know, the first time we saw one of these bubbles and it didn't end so pretty so. I was going to say, you can probably, you can probably give a perspective on that. So, you know, what happens for, you know, those entrepreneurs who haven't actually, you know, been privileged to live through the crash, you know, what happens? How do you think about the employees in this context? How do you think about down rounds, you know, what are the things that people ought to keep in the back of their mind as they think about stretching for evaluation?

I don't know that stretching for valuation is a great idea. Unless you have incredible certainty on your deal, right? And you absolutely know that there's going to be another round behind it at a higher valuation either because you're pressing about the overall capital markets or there's just, you have such insight into your own business that you just know it's exploding. Then you're setting yourself up potentially for a world of hurt if you overreach now and then you have to get money behind it because trips a ratchet in the current round. Right.

Well, frankly, just sends a psychological signal to the universe that you've lost momentum, particularly if you're in one of these high-flying momentum-based deals, that doesn't feel like goodness to me. My general philosophy, and maybe this is why I'm not super wealthy or something, but my general philosophy is there's plenty of money to go around if these things succeed. And so the number one objective is to make sure that you're always enough enough capital to keep going no matter what happens in front of you. Right. You know, Danielle, you mentioned this concept in your opening remarks about, number one, this kind of bifurcation between kind of small amount of money at the early stage and then these bigger rounds later stage and then you ask the question about the middle, which I want to come back to in a bit.

But on the later rounds, as you kind of talked to entrepreneurs, or at least as you kind of, you know, look at the data, do you get a sense that there is almost headline number envy or competition among entrepreneurs that you get this idea that, gee, so-and-so did a deal at $5 billion and now, you know, $5 billion. is now the new, you know, the new high water mark for how these things should go. Do you have a perspective on that? I mean, I think one of the really confusing things is when you're talking about those kinds of evaluations, there's always this question of like, what would the public market price these companies at? Because in the past, they probably would have gone public. So I think it's maybe less of comparing to other private companies and more saying,

well, this is basically an alternative to going public, so what do we really think that would look like, say we did it in five years? And I think you see a lot of those conversations. And so as you start, you think about the kind of investors in the deal later on. It's not just your VC investor. It's also people who are investment bankers who now don't have enough public deal flow or family offices or people who want to deploy really large amounts of money. And I think it's actually, what I'm saying is a lot of the pressure is coming from that side.

It's like, well, we don't want to deploy $30 million. We want to deploy $100 million because we don't have enough places to deploy its capital. And for founders, that's really weird because they're like, well, the advice they've been getting forever is take the money when you can get it. So I think that is a big factor. So that's interesting. So in some respects, which I totally agree with in terms of there's new money coming in, right? So we have definitely seen, to your point, you know, mutual funds, hedge funds, private equity guys, family offices. And are you saying, at least in some respects, that the valuation you think is being driven by those investors wanting to put larger amounts of capital to work and the entrepreneur and the other.

other end saying, look, there's only so much dilution I'm willing to take. And so we have this kind of natural, almost forcing function up in terms of round sizes. Yeah, I think it's a major factor. So a huge piece of this is I think there are a lot of new funds. So funds that maybe they've been around, but they haven't been investing in startups. And what they want is they want some logos on their website with legitimate, like, significant chunks of the company ownership where they can, you know, peg the value of the fund when they go to raise fund too on, hey, we got into Zinga, we got into Twitter, we got into Facebook,

book. I mean, you're in Andreessen Horowitz. I think you guys did this when you started your fund. And I think it's really smart, but I think now that that pattern seems to work, people are saying, well, I want to find these sure-bet companies. And in order to pay up enough to get a meaningful chunk of them, they've got to put a lot of money in. So I think that's another major factor. I mean, we had so many new funds are being started right now. So many new people are entering startup investing right now. It's not just on the angel side of things. Just what strikes me, it seems like there's a real flavor of the month dynamic, or maybe it's really flavor of the year dynamic to sectors that are hot and that are not hot.

And I wonder about people who, and you mentioned Zinga, for example, right? Things that you think are the name that you want on your website, whether or not that's going to be true, you know, when you actually need to go raise that fund and what the implications are for that across the valley as a whole. I mean, you know, I see some, in the world I live and I see in the payments world, I see valuations that I can't understand how they'll ever be an exit for a lot of these deals. And so my biggest fear, just as an entrepreneur, trying to run things rationally, is that some of those guys are going to crash and burn and drag the entire rational segment of the market down with them.

Right. Danny, you know, I want to go back to something you said, though, which is how do you get, how will there be exits from this, right? So it seems to me there's also some Rubicon you cross where at some point the valuation at which you raise is so high that now you've taken a whole segment of potential M&A buyers out of the market and you are at that point either wholly dependent upon being you know Bloomberg and having a private company for the rest of your life which can be a very you know profitable and fun thing when it works or probably doesn't fit very well with your

adventure and that's right probably the venture guys probably at some point would want to get their money out right or you really are almost you really are beholden now to the public markets at some point to actually create an exit do you do you think about that as a CEO that you know kind of have I you know reduce the number of options I have for an ultimate exit when you're when you're raising capital at these higher levels I don't I tend not to think about it that way, I just tend to think about sort of at what price would I come in on this if it were me to try to make sure that we're pricing in some, well, first of all, we don't set price. The market sets the price, right? But when people have proposed things that are

sort of too high, I've tried to signal bringing them down, which is a delicate balance. You may be the first CEO ever heard say that. Well, like I said, I'm old and I've been around And I've seen this, and badly, and, you know, if you're doing something as ambitious as we are, where you know that you're going to consume a reasonable amount of capital on the way there, you want to make sure you've got access to capital of the whole path, because at the end, the outcome's going to be great. And I've been fortunate to have good outcomes, but I've also consumed capital on the way to getting there. But you don't want to be in a place where, you know, the thing blows up, or frankly, you just have to stand in front of your employee base and explain to them why you're having to reprice all their options or, you know, revest them or do something like, like, that's not, that's no fun. Right. Yeah, that's interesting. So in sub respects, it's almost, you know, how much capital do we think we need to get to that exit or the goal we're trying to get to and then making sure you're kind of backing down and saying, look, if I take 50% of it now at this round, I know I still have 50% left to go and making sure that there's, they'll still be attractive investment opportunities for later people as they come in, as opposed to taking all the money off the table in the, you know, B round or the C round or whatever the case may be. that's right and I think another point is there have been companies in the valley that have sort of had a golden path all the way the one I always historically thought of was eBay maybe Facebook is the new example of that but every other major company I knew you know I've known whether or not it was Apple or Netscape or Sun or pick your favorite you know at whatever era most Google they all had these near death experiences yeah so unless you're unbelievably prescient and you and your model is right right, which they seldom are, that's a heck of a bet to make on knowing whether or not

you're going to need capital again or not in the future. And again, when these things work, they work so well that who really cares whether or not you're taking the last nickel off the table or not. And by the way, the other, just a subtle point, and I think it's important, you know, it's a, I wouldn't go so far as to say it's a sacred relationship, but it's a really important relationship that you have with your investors. And I think it's really important that that relationship is good

through good times or bad times. And nothing will set up that relationship if you be bad during bad times is if you overpromised when you were raised some money and then disappoint. Because now you've broken this bond of trust you need when you're, you know, weathering the inevitable storms are going to happen as you go along. So I don't know how you

get the top dollar unless you start weaving. Well, there's going to be a temptation to weave a tail. And I don't think that's necessarily long-term healthy either. So there's all these sort of reasons that come together that suggest being rational and open and not too greedy is wise. Daniel, you were trying to jump in there. Oh, I just wanted, speaking from the earlier stage perspective, I think a lot of things you guys are talking about, founders aren't always thinking about in the beginning. So, like building out a model for the long-term and thinking about all the money you're going to take in over the course of the company is something that,

I mean, we've done this now because we have revenues, so we've started to think about things like, how long do we run before we raise again and things like that? But early on, I think, you know, even maybe the first two major venture rounds, I'm not even sure how long-term founders are thinking. I'm not sure they are thinking how much capital they'll consume or about the relationship. I mean, I think that stuff starts out sounding like things we just say. Yeah. And then at some point, because I've definitely talked to founders who've got companies that are further alongwards.

They're still their first time, and they're saying, yeah, I thought that was just stuff people blogged about, and now I'm seeing it's true, and they're like raising their D, or their D round. So I always think there's this disconnect between the stuff we talk about and then, like, actually making sure you do it. I mean, maybe one of the downsides here is people are raising, and I'm one of these companies, raising these big seed rounds, so we don't have boards for a really long time. Right. Like, I don't have any board members.

So I go to my advisors, and I'm trying to work with them and think through a lot of these questions with them, but hopefully a board would help with that long-term thinking. So I wonder how much the breakdown of the early. stage piece actually really affects what's happening in a later stage with valuation. And what was your seed round, by the way? How large was it? Well, we're basically two seed rounds. So we've done, like, raised like a little over four million in total. Yeah. So, I mean, in my life, that was called an A and sometimes an A and so I'm basically calling on a weird A. So is the definition of a seed that it wasn't priced and

there was no board? Is that what? Yeah, it's very confusing to founders. I mean, I ask some people, should I just call this an A? Would that be more honest? And they say, well, it's not equity. And then you ask other people and I say, well, I mean, that's a lot of money. You're great. may. So what is it? I don't know. As far as I'm concerned, it's just we're not dead and we're going to keep growing. Well, I think it's really interesting. The point you raised about founders not necessarily think about this stuff, I would just say, you know, from the perspective of the deals that we see, I think almost to a fault, everybody historically underestimates how much capital they

will actually need to get to either next milestone or to an exit. You know, if I could, you know, if I had a dime for everybody who told us this was their last round of financing when they came in to pitch us, you know, we'd all be, you know, we'd all be out of this business and doing something else. But it is true. I think people either, they either assume that the business will work perfectly well, in which case they won't need money, or they certainly aren't considering the downside. And I think the challenge, particularly in this market, is even in the case where things are working well, you often then want to go raise more capital to go accelerate the growth, had an even faster pace, and to open new markets and do

new products. And so we tend to at least see almost everybody historically underestimate the amount of capital required to get to some ultimate outcome. Daniel, the other thing on the, maybe just to come back to one other point you mentioned, which was this idea that in some cases the round sizes at the later stage are growing, in part because the investors want to have some ownership that's meaningful in those companies.

There's another potential interpretation, which at least I see in some of our companies, which is there's an offensive reason to raise a lot of those valuations. And that is kind of a little bit to Danny's point, which is, look, if you're going to, if you're going to stretch for valuation, you better take as much money as you can possibly get at that valuation to give yourself way more running room than you ever think to kind of insulate yourself from macro changes that might kind of impact financing environment. Do you see that at all, or do you think that's part of kind of the calculus that people are thinking about?

Is that what you meant by offensive or did you mean like the Uber Lyft thing where like if you raise enough capital? Well, I think that's another. That's another version of, right. That's another version of offensive too. I almost think of it as kind of how do I, increase the margin of safety for myself by saying, okay, look, if I'm going to stretch, I know I have to do double what I thought I was going to do in order to be able to clear that hurdle for the next round. So one way to insulate against that is just take as much money as I can possibly get, given that, you know, the dilution is relatively nominal at these prices. Yeah, I mean, I think that's fairly accurate. I think in other pieces that

those late-stage deals with companies are like engines where you can put in money and you can get out money. So like Uber at this point, they probably have a pretty clear vision for markets they need to enter to grow. So if you're going to undertake the same effort to raise $100 million, why not raise $200 million, like not even just from the stretching perspective, but from the like, look, we have something that works here. It's like so often to have something that works.

Why wouldn't you put as much fuel into the engine as possible? Right. And the marginal cost, once you're already fundraising, right, the marginal cost of that extra dollar isn't really that high as long as you're willing to take whatever minimal dilution that that actually entails. What about, Danny, you know, you've probably seen, this, unfortunately, but how do you have the conversation with employees? So I can remember very clearly when we were at LoudCloud, and Ben, I think, talked about this story in his book, but

we raised money in early 2000. We raised at 700 pre, $120 million, so $820 post. And, you know, Ben and I were, of course, high-fiving ourselves and thought it was great because it was, you know, the market was starting to turn yet. It wasn't clear yet that we were going to Armageddon, but it certainly felt that way. And, you know, a few months earlier, companies that we, you know, were in our general space like, you know, Equinex or others raised at a billion dollars. And, you know, we had an all-hands meeting where Ben, you know, very triumphantly announced this financing. And it kind of felt like everybody breathed a huge, you know, side disappointment, basically,

that we hadn't cleared the billion dollar mark, right, that we had only gotten to 820. This was now, of course, you know, nine months after we found it the company. So I'm- You slack are you. Exactly. So I'm curious from your perspective, right, this concept sounds great, which is, gee, let's leave a little money on the table, even in the normal circumstance and not stretch for the last valuation, but how do you handle and how do you deal with kind of employee expectations around that and them saying, gee, my company may be doing, you know, less well than I thought

it did because they couldn't attain a valuation that, you know, other guys in the space are getting? Well, let's talk about the current company, Pena or Me, which is in a space that nobody's in processing electronic transactions with cash, right? There's like, nobody, right? And people don't understand it. Well, we sort of made a conscious decision that we would be sort of the tortoise and not the hair and that we wouldn't try to recruit people who were looking for the next hot

thing that we wanted people who valued what we were doing thought they could learn a lot thought it would be a high quality environment and that they could frankly last over the long run to the extent that we even do things like we don't have an office near a train station right intentionally like we're sort of self-screening for that so and everybody who interviews who say you know just to be very clear we could completely fail right and so once you've got the people on board who are on board because they like what you're doing. They think they're going to learn a lot. They like the people they're working with. They trust you. Then you've created a culture of trust that is inherently sustainable. That wouldn't work if we were in the

ride sharing business or some of these other just unbelievable spaces that have huge momentum where you've got to throw every inch of coal on the fire you can at once. But it's internally consistent. Our values are consistent with our financing structure, are consistent with our business model are consistent with the environment working by the way i happen to believe that you know at the outcome we end up with this incredibly profitable super defensible business and we'll probably have seen a bunch of fashionable waves you know that'll move through like oh i wish we were in the you know check-ins business or so you know all the things that have come along the way that have been hot and then weren't as we've moved along right uh daniel maybe this maybe you can address this one

which is kind of the other side of the employee issue is um is there a price at which you know you've now done a disservice in terms of being able to recruit new employees in because once you raise at you know 10 billion five billion with a three X right right and you know right you've got potentially right structured stuff right you've got liquidation preferences on top of that do you think employees particularly given how competitive the environment is around here employees kind of say gee i could go take you know stock at whatever price it's going to be based on the five billion dollar round or i'm way better off you know joining daniel where you know she's so much earlier and uh you know there's just such greater upside to the extent that the you know the business

turns out to work do you have a sense of how people are thinking of about that. Yeah, I mean, we have people who, you know, we're competing with other companies and they tell us what the offers they're looking at are like. So, you know, we run those numbers a lot. And as soon as we win those deals, sometimes we don't, I think it comes down to time horizon, so people who want a quick win, you know, going to a big company that, you know, looks great on the resume, people know what it is. It's got stock that might have liquidity soon. You know, if there's certain people, that's what they're looking for. Actually, you can find people that just hop from, you know, mid-stage startup to mid-stage startup as pretty much

a career tactic, which I think is pretty smart, actually. I was kind of on that path, I guess, before starting my own company. So I guess it's patted myself on the back there. But earlier stage, folks, you know, I think what they're thinking is they want a place where they can see their impact against the price end-to-end, so they want to, you know, come in now and they want to be here for five years, or at least they can imagine saying for five years. So it seems like it's a more personal preference. I just want to chime in, though, on one other piece of this, which is the idea that

like a 6,000-person company or whatever. I don't know how to gober is huge right now, but not that big yet. But everyone gets stock options is actually kind of odd at that stage. So I think that's another interesting Silicon Valley thing. Like that doesn't even have to work that way. There's like tons of other ways to incentivize people beyond stock options. Do you think, do you see anything? Do you think that's changing or no?

Are you seeing anything that's just like that change? Oh, no, I don't think it's changing, but maybe I'll change it. Because I just think that it's confusing because I think that doing the math on stock options is one of the things that I've had more awkward conversations about that. Either, you know, with employees in my current company, with people who have reported to me at Twilio, people just worrying about that, it's so confusing to them. And there's much more straightforward ways to incentivize people so that don't require all these external macro factors they can't affect.

So I just feel like it's almost like we've taken stock options and we've hyped them up more than we should have because then you do have this trust problem where if you do have to do something for the survival of the company. Now you're telling a couple thousand people, hey, we're sorry, we repriced this. I can't even imagine that you won't lose people from that ultimately. I mean, the no companies that have. What's different now in this environment versus Danny, particularly for you, kind of having raised money now across a couple different cycles?

Is there anything different you see either in terms of, you know, how investors are approaching some of these companies, how employees are thinking about, you know, options here, how, you know, people think about valuation. Is there, is there any kind of material differences, say, now between kind of the environment the way it was, you know, pre-bubble or in kind of, you know, the mid-2000s and that are new issues that we haven't seen before? I'll answer that question differently. And I can't figure out if it's different or I'm different because now I'm old when before

I wasn't. But the level of confidence and certainty that this is all going to work out great among the younger crowd, I think because they haven't seen what we've seen, really creates, and the fact that this, it's an order of magnitude, more capital being deployed, creates a generational gap in expectations and style to me that is profound and keep striking me. And to all the other old folks out there on the call who are listening to this, I mean, I don't think it means you have to start thinking like a different generation thinks, but I think it's worth knowing that we really view the world differently.

This ended so badly. And last time it was, you know, people who did early AMT exercises and literally went bankrupt. I don't think that happens this time. But there will be, I think this party ends and it will have an ugly end. And there will be people who have an expectation for what their lifestyle will be and have dialed in. a bunch of very important life decisions to that who are going to not be happy with what happens. But you can't, it's like, you know,

it's like telling stuff to my teenage daughter. It's a little bit fighting the last award. Yeah, you just got to live it. So that's what I perceive as different. Yeah. Danielle, do you have a perspective on that? Do you think entrepreneurs this time are either, to Danny's point,

either more or overly optimistic or just don't have an appreciation for kind of what things could look like if the market were to turn? Yeah, I mean, I think there's a ton of people who work on consumer products because they don't know anything about the world. So, like, I'm going to bash on the young people, and I guess I'm one of them. But I think what's different is there's some people who are really, like, getting into staff.

They went and they worked somewhere for, like, two or three years right out of college. They found the processes they had to deal with really crappy, and they're building solutions for that. And I feel like that is different. I feel like I worry mostly for my peers that choose to build consumer products because it is totally, like you said, you know, it's either going to be huge or it's going to be nothing. I guess this is, again, I can't tell if it's me or the market, but I'm running a SaaS company and I feel like recurring revenue and an understanding SaaS business that doesn't require like a really involved enterprise sales cycle.

Like, I don't put a suit on to sell $6,000 at your product. I think that's new. And I think there are a ton more opportunities that's kind of an unexplored space. I think the public market doesn't even know how to value it really. It's relatively new in the big scheme of things. So I wonder if that's something that's different that might be more lasting. I don't know if it is yet, but even, you know, taking lessons from that and applying them to consumer models might be interesting, too.

Good. All right, but let me see. Let me just try and wrap, since we're at a time here. Let me, just a couple takeaways, at least I think I heard in the conversation. You know, one is when you're thinking about valuation kind of deciding between, you know, how much do you want to stretch? It sounds like one of the biggest takeaways people need to be thinking more about is what does that next round look like?

What are the milestones I have to achieve to be able to get there? You know, how, you know, what could go wrong in the scenario where I might actually not have given myself enough wiggle room to get to that next up round of financing. Let me try to characterize it in a different way, which is the only thing that matters is the end. And so all these things that happen in the interim don't matter. So have a long planning horizon, and those will fall out of that, as will a bunch of things about how you deal with your employees and partners and everybody else.

Right. Good. All right. I think that's a great place to end it. Thank you, Danny. Thank you. You're at Danielle. And we're signing off.

Thanks. Thank you.