This Week in Startups - ANGEL: Insight's Deven Parekh on venture tourists, cleaning cap tables & winning investments | E1679

Episode Date: February 15, 2023

Deven Parekh of Insight Partners joins Jason to discuss navigating markets during the dot com era and the pandemic. (1:50) Then they discuss "venture tourists" and cleaning up cap tables before wrapping up with a look back at some of Deven's winning investments. (20:04) (0:00) Jason kicks off the show (1:50) Experiencing the dot com burst (10:14) LinkedIn Jobs - Go to https://linkedIn.com/angel and post your first job for free. (11:36) Comparing Web 3.0 and the dot com era + navigating the markets during the pandemic (18:40) Cast.ai - Get a free cloud cost audit with a personal consultation at https://cast.ai/twist (20:04) Venture Tourists (29:30) Unfavorable preference stacks (37:07) Acquire.com - Sign up for FREE at https://try.acquire.com/twist (38:32) Cleaning a cap table (47:57) Looking back at Deven’s investments FOLLOW Deven: https://twitter.com/djparekh FOLLOW Jason: https://linktr.ee/calacanis FOLLOW Molly: https://twitter.com/mollywood

Okay, today we're back with an amazing episode of Angel. This is one of the best episodes we've ever done of this podcast. Devin Perret is here from Insight. Devin started his career as an analyst at Blackstone in 1991 when I was still at Fordham at college at night and I was doing Cyber Surfer Magazine, writing about DVDs, and then he moved to Berenson and Co. But in 2000, he joined Insight. He's been there for 22 years.

He's seen three cycles. the dot-com bust, the great financial crisis, right? Remember that? And now this boom bust. In that time, he's made over 140 investments. And these are in big companies. We had an amazing conversation. He is one of the most thoughtful, fascinating guys in our industry, a great capital

allocator. And he takes to work seriously, right? And that's what I'm trying to do here with this series, is find the people who've been there for three, some cases, four of these boom bus cycles, and who are incredibly hardworking and who roll up their sleeves during hard times and do the work. This is going to be an amazing show. Get your pen and paper out. Stick with us. This week in startups is brought to you by LinkedIn Jobs. A business is only as strong as its people and every hire matters. Go to LinkedIn.com slash Angel and post your first job

for free. Terms and conditions apply. Cast AI. Cast AI automates cloud cost reduction with clients saving an average of over 60%. Twist listeners can get a cloud cost audit with a personal consultation free of charge. Visit cast.AI slash twist to get started and Acquire.com. Whether you want to sell a solo project or a booming startup with hundreds of employees, Acquire.com has the tools, experience, and most importantly, engaged buyers to help you achieve your acquisition goals. Sign up for free at try.acquire.com slash twist.

All right, everybody, welcome back to the show. you know, we're sitting here in 2023 wondering, how is this third boom bus cycle that many of us have lived through from the internet to the great recession, Web 2.0 and now, whatever we're going to wind up calling this a speculative asset recession is what I'm calling it speculative asset bubble. There are so many lessons between these three bubbles, and we're all trying to figure it out,

especially startups, angel investors, people who listen to this program. and we thought we would try to find people who are old enough to have lived through three of these bubbles and hopefully have either been building companies as founders or investing in them or some combination of that. And my friend Devin Perreck from Insight Venture Partners. It's Inside Venture Partners, right, Devin? Actually, Insight Partners now.

It used to be Inside Ventureners. Got it. Okay. So we tightened the name up. We got one word out. It's much more, much tighter. It's good to see you. You joined Insight back in 2000.

with impeccable timing. Was it right before the bubble burst or right as it burst that you took the job? It was right before it burst. I joined literally January of 2000. It felt like the, you know, I think lots of people thought that they were going to retire by the middle of 2000 because their funds were all going to make five and ten times their money. And it was amazing how quickly things changed. from our, I think we had our annual meeting,

my first annual meeting, which I was just listening to, it didn't say it was early 2000, I think February and March. And from that six months later, it was a totally different world. Yeah. It was quite a, it was quite a time to join. I didn't actually get the, well, you could say the fun, but I didn't get to actually do the deployment in 1999. When I got there, we actually had deployed a lot of,

a lot of capital and had a portfolio and the portfolio looked great like everybody's portfolio looked. But then, of course, the market changes a lot. So the market changes dramatically. Stocks that are publicly traded in the internet space started losing 90, 95, 99% of their value, $100 stocks became penny stocks. It was in some ways, very similar to what we've just experienced in the past year. How did you and your partners at the firm, approach this cataclysmic event and what was the work you had to do. And then let's talk about how that relates to the work that we're all going to have to do here during this 2023 year of, I think, cleanup and resetting of the market.

Sure. I mean, look, I mean, we're going to hit all three over the course of the next hour. And I think they're all different. And remember, the 99 one, it started really much more just with tax. back. And then 9-11 happened. And, of course, it affected the broader economy. But it started with tech. In fact, I just pulled up some of the stats. If you looked at January of 2000 to December of 2002, you know, S&P, the peak to trough down 40, Dow down 27, but NASDAQ and software down 70, right? Wow.

So, I mean, it was a good reminder just pulling up the statistics of like how. And then when a big China, of that really happened, the broader market actually held up pretty well until 9-11, and then you had an impact on the broader economy. I think, you know, look, the biggest distinction between the 99-2000 period and today was a few things. One, you had a lot less companies who actually had a business model, right? You had a lot, a lot less companies where even product market fit or the underlying economic model didn't really necessarily work. That's one. Two, companies were not as well capitalized as the companies were today. And we'll come to that.

And so, for me, it was at the time, it felt like a miserable experience. But when I look back on it, it was probably one of the most important experiences to kind of go through. Because we had a, also keep in mind, that cycle, Jason, you'll remember, really lasted a long time. is a multi-year kind of period. It also had those two phases, correct? You just mentioned we had the dot-com burst, 70% goes out of the market, and then the Black Swan of Black Swan events of our lifetime, 9-11, who could have ever imagined that the largest attack on American soil

would happen just on a crazy, beautiful September afternoon? tragically in New York, and I was in New York, and I remember seeing the exact conference room, I was sitting when it happened. But I think the challenge that you had back then is that really you had to what you had to go do, look, it's always when things are good, we're all just cheerleaders. I mean, if we're being honest. But when things get tough, you really got to peel the onion back and see what you have. And what you generally find when you peel the onion back is maybe you have a little less than you thought. And in the 99, 2000 time period, you probably had a lot less than you thought. And so really, while you were taking costs out, lots of times the companies

have very little revenue. And so you could take costs out and reduce burn. But until you can actually create a business, it doesn't really help you other than reduce your period of cash out. So oftentimes, you're just trying to find a home, you know, for these companies, and try to find a reasonable place for them to go. Now, we were fortunate, I think that we were in Fund 3 at the time. We're right now, we're investing on a Fund 12. And we from the beginning had done both kind of growth equity and some buyouts. And so we actually had this portfolio that ended up being ballast in a time when a lot of these business models that ended up

not really kind of working out in a bunch of those deals, it's still doing a lot of work. But, you know, we managed to claw our way back to basically a one-x on that fund. And I think there's a lot of, I mean, I look back on that time and I feel like I, well, it wasn't, it was a worst performing fund, obviously. It's not, I look back on that time as being really important. And I think it's been really helpful for me as we went through 2008 and then, today. What was the LP reaction when you put your head down, you work for years to just claw your way back, to give back every LP, you gave us, you know, a dollar, here's your dollar back.

That was years of work to just return one X. Maybe talk a little bit about how they felt about it, because I would think they would be highly respectful of the seriousness of which you return that capital. No, I think they were because if you looked at kind of what happened to, you know, NASDAQ over that of time, you know, it was down 50%. And so to be able to kind of get to 1X and of course, you can't, you know, you can't eat relative returns and you can't eat, I mean, 1X doesn't give you kind of a lot to do with. It's also says that in a really unprecedentedly bad case, if you're able to kind of get capital back, it actually gives people some comfort around what the downside is. And the interesting thing is keep in mind,

And I don't think this is just true of insights. I don't want to make this about insight. But keep in mind that at the time, the amount of penetration in the portfolio of recurring revenue models, close to zero, we had some, but relative to 2008 and certainly relative today. So we didn't even have the downside protection from the business model standpoint back in 2000, by and large, that we have today. And so that I actually think, you know, when we get to talking about today, kind of says that

I feel like even better that we've got some real recurring revenue businesses that gives us nice stability. If you want to crush it this year, you're not going to do it alone. Remember what I always say. Nobody gets there alone. It's always a team. And you need to fill your team with the hardest working, the most dogged, and of course the most qualified team members you can find. How do you going to find those people?

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Again, the call to action is so generous for my friends at LinkedIn. LinkedIn.com slash angel. LinkedIn.com slash A-N-G-E-L to post your job for free terms and conditions do apply. Let's get to work, people. In a way, it's a very interesting point that I think people have to understand. During that dot-com era, people were trying a lot of new business models. They were trying to even just get a website up and running and let people log into it. It was really about laying the tracks and figuring out how to, you know, get these to just simply function, let alone come up with a business model.

There was no subscription model. It was, you know, a time when if you actually, when the tide went out, you're saying, you To fill back the onion, there is no business model there. So now you're just trying to find a place, you know, can Microsoft or Google or somebody buy this company? Actually, Google wasn't really in the game back then. Google wasn't in the game. But if you looked at the software businesses back then, with some exceptions, you know, a lot of them were perpetual license companies, right? And in an economic downturn, the perpetual license business gets impacted by far the most, right?

That's much easier. If your cable company came to you once a year in January and said, hey, do you want to pay for your cable, or do you want to pay for your Netflix, you might have a different view than when it's auto charge on your credit card. And so I think it's what I would just say is that I think sometimes people underestimate, they look at these three things and they say, oh, like, NASDAQ was down by this much or that much, and that's the way they compare. But I think what that misses oftentimes is how much evolution there's been in the underlying

business models over that period of time. Yeah. I mean, it's almost, I think it's analogous to crypto maybe. If you look at dot-com companies and crypto companies, the dot-com companies were just trying to figure out, like, is there a product here? A lot of the crypto companies are just trying to figure out, like, how do I even deliver a product, let alone have a business model other than selling tokens to reflect back to. And I think the challenge just on that kind of thing, I mean, the challenge that I think the, you know, the crypto market is what they're trying to show is if you go back to 1999 and you say, okay, a lot of people say the analogy for crypto today might be 1999, right? just the 1999 of kind of that market. And what I often say is, look, but what you had in 1999,

and I'll use an example of a company that we were not investors in, like say Pets.com, I picked that one because obviously people joke about it. There's a by the company called Chewy, which has kind of got after the same market in a much more an interesting way. But if you were a user of Pets.com, you know, it was a better user experience, right? Pet food showed up at your home, maybe at a discount. Now, the economic model made no sense. The shipping cost and free shipping and all.

all of that didn't make sense. But as a consumer, you actually felt like you got a new way to buy things. It was a good experience, an uneconomic experience, but a good experience. Chewy figured out how to make it economic. I think the question, first example, Web 3 is how many Web 3 companies actually can make the argument that it's a better experience, even if the underlying economic model is not yet proven, right? And I think that's the question that, you know, that market's going to have to answer. All right. So let's fast forward to today.

Interestingly, you gave us that little snapshot of the markets, how the, you know, the S&P and, you know, wasn't as impacted as the NASDAQ. You look at today's numbers, S&P down 22 percent, mega cap, tech, down around 20 percent. But the growth stocks, you know, those have been down 50 to 80 percent. You're Palatians. We have a comp set for, yeah. We have a comp set for just SaaS companies that we use for our valuation. that's down 54%, right?

Where the Dow Jones is down nine just to take the really large big deal. Right? So it's really, of course, we have to, even this market, I feel like there's two segments of it, right? Because there's a COVID and then kind of this kind of post-COVID period. So we talked about how there's got two segments of that 99 period, different. But even here, right? I remember in March when COVID hit getting on the phone with our investors and basically kind of making a few predictions.

One was we don't think we're going to deploy a lot of capital the next two years or at least the next year. In fairness, I think I said the next year because we didn't know how long COVID would last. You know, we expect liquidity to be very constrained. And, you know, we expect the operating performance of our portfolio to be pretty challenged because the economy was shutting down. Right. And it's amazing, I was 0 for three, right? I was about to say, wow, you missed each one. Yeah, like you don't hire me as a predictor.

And so, because COVID had these impacts on spend that I don't think any of us really anticipated, right? Now, the interesting thing is I was wrong on those predictions, but I think what we ended up, what we also ended up as a market being wrong on sometimes is we took some of those behavioral changes and kind of extrapolated them out into the future, right? And again, I'm going to use an example company. I'm not an, we're not investors in, but Peloton, right? I think we got to the mindset that, oh, it's great to work out at home. I guess everyone's going to work out at home all the time.

Or it's great to have Zoom so people are never going to get together again. Turns out that actually people like to interact in person, turns out that people actually like going to gym because it's social. And so I think that a lot of these behavioral e-commerce, obviously people went to e-commerce and we said, oh, this is structural now. It's just a portion of the population that's not going to go back to stores. Well, it turns out that people actually like going to stores. So some of these behavioral changes that we were wrong, that demand was going to go down really quickly.

And then, of course, you had the backdrop of a massive government stimulus. And we kind of have to talk about that, both as it relates to, you know, fiscal policy, but also as it relates to monetary policy. Because you started with, I think you said, speculative. asset bubble or something like that, you can't underestimate the impact that the rate environment that we've been living in has had the magnitude of the fiscal policy that's gone into the system that's had it. Anyway, we hit a lot of topics there, but there are kind of two elements of this current period. Yeah, we've learned something, I think, from that pandemic, which is, you know,

when you're trying to figure out what the impact is going to be, the complete absolute shutdown created a bunch of pandemic businesses. Do those behaviors stick with us or are they transient behaviors? You know, you're going to find out. Seems like remote work. Yeah, we're still going to have a larger number of remote work folks. So yeah, real estate, commercial real estate is going to be impacted for some extended period of time. But yeah, going to the gym, I think people still like going to the gym and socializing. So Peloton, yeah, maybe got a little overheated. And then this wild card, what happens when you drop just a large amount of money and you airdrop money on every citizen, and they have access to Robin Hood, Coinbase, FDX, whatever it is,

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You also get this weird behavior of people coming into your business, and you do a lot of like series B, series C investing, I think, since you have large funds. You had a bunch of, let's call them venture tourists. You had a bunch of people playing the role of late stage venture capitalist. Tell me about how that impacted your business when we'll mention specific names here. But some people come in and say, hey, what Devin does is super easy. We're going to just take what Devin does and other late stage folks and we're just going to copy it.

We're going to give 20% more money than they do. We're not going to rewire a board seat or governance. And we're just going to drop 50 million into, you know, whatever, a company or two a week. for a year at the top of the market. Take us into that moment where the venture tour showed up and then started competing with you. And let's face it,

beating you on terms in many cases. And founders are like, well, if they're going to just airdrop us, $50 million, $100 million at a crazy valuation, we're taking it. Talk about that moment in time and then what it's left,

you know, because it's left to kind of a whole. So first of what I'd say, I think we have lots of really good competitors that we respect. You know, some of them are kind of traditional venture capital funds,

some are more crossover funds. There's some public investors who've been doing private investing for a long time. But I think what is true is over this relatively short period of time, you had a flurry of new funds that kind of came into this market, did not consistently have been in the market. And I think that a few things happen. One, and I think we all felt it, I'm sure Jason, you felt it as an angel investor as well, right? I think the number of times where it was like, hey, we need to do a Zoom on Saturday. because somebody's going to drop a term sheet on Sunday, and if we don't drop a term sheet Sunday morning,

that we got into that kind of cycle. But I go back to one thing. I want to make a COVID point, which I think is really important, which is that, you know, if you look at it in retrospect, I think COVID reduced friction too much, right? I think there's a point in time where we all appreciated not having to get on planes, not having to go to board meetings in person. and all these things that become a drag when you have a, you know, you have a big portfolio,

whether that be an angel portfolio or a series hit portfolio or growth portfolio. But that reduction and friction made it too easy to do deals as well, right? And so that actually partially enabled new entrance to come into the market, because now with a pretty small team, you can actually talk to lots of companies and significantly reduce cycle time of an investment. And I think that, you know, that had that certainly had some positive impacts, but also had a lot of negative impacts, right? And I think the thing that everybody goes to always is diligence, right?

Oh, like diligence. But I think I don't, I have this one of the things, when we're talking to investors, I say, is if you take a, pick five deals that we did over 20, one, 2021 and 22, or pick one a quarter and pick one from each quarter of each year and then tear off the cover page and then compare them. And I want you to put them in order of when they happened because of course the ones that happened in 21 must have, you know, thinner diligence packages and we didn't do cost. You won't find it, right? Like our process stayed consistent. Now what it required us to do was significantly increased the size of the firm, right?

So we tripled during COVID as a firm. We added our operational team now, when I say operational team, I'm talking by the team that helps due diligence on portfolio, but also kind of works with the portfolio companies post investment is the largest team at the firm, right? And if you go back to 2007 or 2008, it was probably one-eighth the size that it is today, right? So why is that important? One, I think it allowed us to, at a time when there was a lot of deals, still kind of do the work that we're used to doing. But I think a more important thing, and this is where I think the biggest difference is going to be, particularly for firms that didn't really build out their team. Because right now, what companies need is they need help.

When I say, help doesn't always mean that you need 10 people there. But this is when kind of the rubber meets the road. We all talk about value ad and we all talk about customer introductions. But right now, lots of entrepreneurs, a lot of companies are struggling. And this is what I need help on rethinking their business model or rethinking their cost structure. And I think that the firms like us, but there's others who have significantly invested in their operating teams to help proportional to their portfolio. So if you look at our professionals per portfolio company, the ratio has gone down, even though our portfolio size has gone up dramatically. Because we knew that as our portfolio size went up, we still wanted to make sure that we were able to do the things that we said we would do.

And I think that's the biggest investment we made. Jason, does that mean that if we paid too much for our company in 2021, that's going to change that? It doesn't, right? And we should come to valuations. But what I feel like the risk in the market right now is you have a lot of firms out there with really large portfolios where they don't have sufficient kind of headcount to really, really work with the companies. And you go back to 1999 and we talked about like getting that one X back, well, that took a lot

of work. It took a lot of time working with the companies, making changes. So I think that we're, we kind of made the investments to kind of deal with that. But I do think that reduction in friction, we don't have, you know, you have lots of times you show up to a board meeting, you haven't met them, you realize, oh, wow, Jason's a lot taller than I thought. Or it's a lot shorter than that first board meeting feeling sometimes. But I think it reminded you all.

So, wow, I didn't really get to build enough of a relationship with this person. And when, you know, when there's problems, you need to be able to draw on that relationship capital. And so we're as much time as we can right now with companies. This is critically important. You said earlier, hey, when things are going to be able to. going up and to the right. People are cheerleaders. Investors are cheerleaders. Everybody's high-fiving. Now all of a sudden, you know, somebody flipped the car over three times. It's on

the side of the road. You know, people are injured. Man, we got to get this car back on the road somehow. I mean, this is, and the number of months of runway could be challenged. And some of the venture tourists, they didn't take board seats. And like you're saying, they had a five-person team that was doing a deal a week. They didn't have an operations team. They've never run a company. And what I'm hearing from multiple folks, because we invest early, series A, C rounds, even before that, first money in, I have founders who are like, these people are not returning calls. These people are MIA. These people are no longer at the firms. So you had somebody who put 50 million into your company, didn't take a board seat, outbid everybody. Now they own five or

10 percent of the company, and they're no longer at that firm. They've gone and started a new firm, because all the investments they made were at the top of the market and they said, you know what, there's no carry to be had here. I might as well start from zero. So this has led to, I guess, the old school firms, folks like us, are going to have to roll up our sleeves and clean up the mess for everybody. Yeah, look, and I think that's what we get paid to do. Right.

I think it's, you know, I mean, you get paid to do that as an angel and we get paid to do that the place that we play. But I think, you know, look, we've been around now for 27 years, right? And I think the way, and I hope as a firm, we're around for another 27 years. And I think that you often are going to get really judged by what happens when things are tough. It's easy to get judged when things are good. Look, the flip side is I always say, look, we're probably never as smart as we look when things are good and we're never as dumb as we look when things are bad. But I do think that this is a time.

And look, the hard thing, I mean, we obviously have a lot of people we've hired. Many of them have not been through the last two cycles. And, you know, one of the things that I want to try to remind them is how valuable 1999 was for me. Yeah. Like that it didn't feel good during the period. And I actually think this will probably be shorter than that 1999 period. But the skills you learn in times like this are so valuable. Right.

We can all high fives when companies are going public. It's not that hard. It's way harder to be able to have to figure out, oh, wow, we don't really totally have a product market fit or, hey, our cost structure really makes no sense relative to kind of our business opportunity and we got to figure that out and kind of being there in the trenches with the team. And I think, look, we're not perfect. And I'm sure there are places that they're founders who don't feel like we've invested enough

time. But I think if you generally were to call our companies, you know, we're there for them. and we're we're we're we're we're we're we're kind of doing what we said what we do what's going to happen to the companies that raised that valuations a hundred times revenue 50 times revenue we saw some SaaS companies do that so they're they had 20 million in revenue somebody came along gave them a 1.5 billion dollar valuation they raised 150 million they were spending too much money now they're not growing they're flat maybe some people their product didn't have great product market fit it had okay product market fit so some

people are canceling or, you know, so let's just say they're going to be flat year over year. And now the market's valuing them at 10 times top line or five times top line. I think there's two categories, right? I think there's companies where, you know, where we can objectively look at it today and say, we were paying prevailing prices in 2021, whatever that price was. And that price is too high based on where markets are today. But the company is still growing at 80%. And we have a lot of those, right?

Now, is the price still too high? Yes. But you know, the amazing thing about compounding is, you know, 80%. You get fast. You get big quickly. Now, we were doing deals in 21. We were assuming multiple contraction at exit of 50%. Right.

Now, multiples contracted 70%. Now, do I think that they will stay at 70%? I personally don't. That's a personal opinion. But, you know, the market overreacted up. I think it overreacted down. This data is three or four weeks old, so post the activist in Salesforce, it might not be correct.

But directionally, you know, a month ago, Honeywell, which is a 33% gross margin, was trading a higher revenue multiple in Salesforce, which is an 80% gross margin. Okay. We can do a lot of analysis, but I think we can both probably say that doesn't make sense. Now, you could say maybe Honeywell is overvalued and Salesforce is fairly valued. That's possible. But I think that when you're seeing with these go privates, as an example,

is like a recognition that these companies have the potential to be significantly more profitable. And if you believe that the companies can be significantly more profitable, the revenue multiples have kind of overreacted to the downside. Now, I'm not of the view. You'll still be with people who will sometimes say, can't wait for things to get back to where they were. I'm like, well, that was probably the anomaly. And we're probably closer to normal today. And so, but when you assume, you know, a 50% multiple contraction, the key. thing ends up being not the price you paid, but whether your growth underwriting was right.

So where our growth underwriting was right, what I'll say is we'll do, if we pay too higher price, we won't do what we thought, right, because multiples have come down, but we can do okay. Yeah. Now, where we were wrong, where we're wrong, and we thought it was going to grow at 80, and we paid a price based on 80, it's growing 10. Well, that's a problem. And there, I think probably the more.

relevant data point is going to be what's the preference stack. Oh, boy. And right, what's the preference stack? And are you able to, are you able to deal that maybe gets people their money back or maybe gets people some fraction of their money back? I think the risk when those businesses is just play it out, you can, I mean, and particularly if they're still burning, is, you know, you're just probably having value erode. So I think, I do think that you have to take a realistic view.

of what is the long-term growth rate. And this is the triage you're doing internally. You're saying, hey, let's look at the portfolio. Hey, this group, they're growing slow, massive overhang with the preference stack. The outcome here, it can't catch up to that valuation. Therefore, and the preference stock is so high. And we got to think about how this management team is going to have any kind of an exit. Because if the overhang is a quarter million dollars on some of these companies,

and the company's worth a hundred, you know, how do the management teams, maybe you could explain to the audience, how the management team, you know, gets motivated. How do you keep them in the game? If the common is behind $250 million in preference, that's what's been invested.

Companies only worth $100. Now you've got a management team that owns 50% of the common and the employees. And the common is essentially worthless because if it was to get sold, it would sell between $100,250 million. To a fair point, look, I think a lot of us live this, you've lived it too in 99,000, to a lesser extent in 2008, 2009.

So before I get to answer that question, I'll make more of their point, which is I do believe that there's going to be a very interesting opportunity, which is that you're going to have a lot of these venture funds that are going to need to get liquidity, right, because they want to raise their next fund. They're not necessarily going to get the valuation they've wanted when they sell. But some of these companies, look, a 20% growth company with 80% gross margin, it's not a bad company. It's just not worth the multiple that you thought it was worth. But they can actually be pretty interesting businesses if you run them with more of a private equity mindset, right?

So I do believe that you're going to see kind of call buyouts get done with some of these companies where they're kind of interesting, slower growth platforms where you can do roll-ups in kind of a market, right? We've done some of this. We haven't done it yet with the current class of companies, but I think you're going to see that. So I think you're going to see some types of exits we didn't necessarily see in 2007, 2008, or 99 in 2000. I'm a new class of exits. They're kind of a little bit more private equity driven. But to answer your question, look, I think we've all been to that movie,

and I think that the thing that we have to do is we certainly, you know, we all have the benefit of having a portfolio. A founder typically doesn't have a portfolio. I mean, they might have some personal investments, but by and large, they have a portfolio of one. We have a portfolio of, you know, hundreds. And so I think the only way that you can expect, you can't expect people to work for free because the biggest thing a founder has is their time, right?

And at some point, if the preference stack is in a way where they can never make any money, well, their incentive is to go start something else. Yeah, clean cap table. Clean cap table. So I think that what generally ends up happening, I don't think we're through this yet, Jason. I think we're early still in the kind of restructuring of these cap tables. So I think a lot more to come. But I think we're going to create management teams will end up with getting carveouts in some of these companies

where they're going to have to participate in the exit from dollar one and not after the pref stack. So the carve out for people who don't know is when, hey, the board says, you know what, the management team, we know there's a big preference stack. If this company gets sold, we're going to earmark 20% of the sale price. if it's 100, if it's 300, to go to the management and to go to employees, knowing that maybe the common's not going to participate. So at least you know, in a short sale, we're all steering in the right direction, correct? That's kind of how this would go.

Yeah, correct. And because you need to be above incentives. Look, there's no indenture servitude. You can't expect people to work for free. And one of the beauties of the American capitalist system is you can fail and start over again. And so expecting a founder to stick around just because they need to. to or should is probably not kind of realistic after a period of time. So I think that like it happened in the past, it'll happen again. And there will be some of these cap tables that will need to get

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Get more information at try. Attacquire.com slash twist. That's try. dot acquire.com slash twist. Take the audience through a recap and how mechanically that works from any of the three errors when we saw, hey, this company is got something, but it maybe doesn't equal what we thought last year. And there's a management team that wants to keep going,

but the existing investors don't want to put another dollar in. They're done. And they own 30, 40% of the company. And then there's just new group of investors who want to come in. How does a mechanical recap work? And how do people take that, you know, which is, let's just call what it is, bitter medicine.

It's hard to take the medicine. But you take the medicine, sometimes you at least get some kind of a save. What people mechanically, through how these dialogues happen. Because people are going to face them this year. Yeah. So one thing I'd say is,

look, one of the, look, one of the advantages of being one of, we're often the largest cap, you know, balance sheet around the table, you know,

on these deals. And one of the things I try to do with the companies I'm involved in early, particularly if you sense that there's going to be a capital need, is to say, look, like our advice would be that we really need to reduce the cost structure here, create a lot of runway so that if we need to raise,

that we minimize the amount of money that we need to raise, because we're basically going to want everyone to participate pro rata. You know, we might have more of the ability to participate pro rata because we're a bigger fund. But we're saying it now, let's try to reduce the number so that we can all do that. Because if everybody participates parata, then you don't really need to do a cram down because everybody's ownership kind of stays the same. So that's phase one. Hey, here's a realistic discussion.

We're going to put 10 million more into this business. You own 10 percent. I own 20 percent. I put in two. You put in one. And we go from there. I think it's, I start with that because I think it's really important that those conversations

start happening now, right? Where it gets, where it's not good is when that conversation happens like, oh, I'm going to miss payroll next week. We need to have this conversation. And it just never works out. out very well. Because every organization needs to get internal buy-in if they're kind of going to continue to support a company, particularly one that might be trouble. So start those conversations early would be my strong advice. And then what generally happens is some set of, but what's

the issue? The issue is everyone has problems in their portfolio, right? Anybody who says they doesn't have problems are probably not being totally upfront. And so everybody's going to have to triage to some degree, right? Everyone has to have to make tough decisions and say, well, these are the ones I feel great about and maybe these are ones I feel less great about. And you kind of want to smoke that out early to figure out who's going to play. And then you get to that point where the company actually needs the money, and that's where the rubber meets the road. And let's just take, let's use basic math, but let's just say that there's companies raised, you know, $25 million.

and the investor's own, you know, I'm just going to, for simple math, half the company, you know, and it's three different, three or four different investors. Now, let's just say that one investor ends up basically taking the entire round. Well, there's a few things they're probably going to do. One is they're going to say, well, I want to convert all the old preferred to common because I want to have a clean preference stack. And one of the reasons to have a clean preference stack to be clear, because I know founders listen to this as well, it's actually good for founders.

I mean, yes, the second part of what I'm not going to say affects founders as well, but clean balance sheets are generally good, right? It's not great to have really complicated multiple preference stacks when markets are challenged. So I would just say to management when you, the founders, when you hear this like, oh, we want to convert all preference, like that's not bad for you. Like, that's good. That's not, they got fight. Clean cap table makes the next person coming in to invest look at it and go, oh, clean cap table, I can engage this.

I've heard back channel from a lot of investors. I love the company. I love the founder. It's such a mess. I don't want to be involved in uncomfortable discussions around the preference stack. I don't want to make people feel bad. And it's sort of like somebody who's selling their home and they want to get $10 million for it because that's what they heard it's worth two years ago.

And now the market isn't there for it. And they just, they won't take, they won't accept it. The reality. So I think that getting to that clean preference stack, I think it is a, Getting to a clean cap table, I think, is good. Then the conversation is, okay, well, nobody else is going to participate, but me, me being not necessarily insight, whoever that person is, whoever that is one of those things. Well, then they're probably going to say, look, guys, like the pre-money is whatever I want it to be.

And I'm going to kind of take the majority of the company. And look, if somebody wants to be really aggressive, they can say the pre-money is zero and I own the whole company. They can say it's half or a third of what it was. it doesn't really matter. They're going to own a lot more than they were going to own before. Now, a smart person who does that is then going to go to the management team and say, I'm going to re-incent you and we're going to create a new pool.

So, yes, you got diluted massively by my investing in the company, but we've cleaned up the cap table. I'm going to give you a new incentive. Yep. And now let's go try to create as much value as we can. And it's, look, the beauty and danger of private investing is, People can have very different views. Jason can think this thing, Devon is the next whatever.

And I might think, oh, I think I hate the business model. And one of us will end up being right. So either I was right to not write to check or you were right to write to check, but that's okay. We have different views and we took our actions based on that. I think that one of the things I would caution against with founders and directing this more founders, don't get emotional about this. This is kind of, I know.

know it's emotional, but at the end of the day, once you get through it, I think it's cleaner for you as a founder or CEO if you're going to stay in that business. And then the last piece of advice I give is, and I can't tell you that we've never done this, but generally when we've done it, it's because nobody else and the founders wanted us to do something with structure, but you're better off just doing a price round. And the company was worth X, and now it's worth 0.5x, it's just better to say it's worth 0.5 And, you know, we're in this market right now where companies have got so much capital on their balance sheet that they raised in 21. They don't have any incentives to change price.

And if they don't need the money, that's totally fine. But if you need the money, trying to do a flat round with multiple liquidation preferences, I just heard about a deal yesterday, like, you know, 3x liquidation preference. it's not that's not a flat round. And anybody who looks at the deal next time is going to look at that and say, you know what, that's not a flat round. I want a 3x liquidation preference too. And you're going to end up with more and more complexity in that cap table. So sorry for a long answer, Jason, but that.

It's a very important answer. And there's a lot of mechanics here. And founders are going to have to, sadly, you know, sharpen their pencils and understand this. The good news, I should want to. out is that the founders and the management team will always be taken care of by investors, new investors and previous investors, anybody in between, whatever combination it winds up being, because you need great management and they need to be incentive properly. So that's one thing that will never change.

Yeah, and look, and the only thing I say to founders is, look, I know it sometimes feels like in these conversations, there's like the VCs, like, kind of paper shuffling their way to, like, more ownership and all that. But, look, this isn't great for. investors either, right? We're all having to reset our valuations. We're probably going to make a less return on that investment by doing that. But we all, I think all kind of high quality investors do feel a responsibility to their companies to try to do the right thing. I'm not going to not say everybody, but the vast majority of people that I deal with investors that we're in, they all want to kind

of try to do the right thing. But emotion does get in the way. Yeah. You know, the thing I'm seeing is Even in, I had one or two instances where people were being a bit predatory, you know, unrealistic terms. I just said, these feel predatory and these are bad for your reputation. Can we come up with something that's clean? And it was just really encouraging to hear you sort of reinforce that for people who are listening, for people who might be in those deals that I'm sort of sub-tweeting now is keep it clean, keep it simple, so we can grow the company. I'll be the first to admit that we have some deals where there is structure. the reason that their structure is because there's a desire to kind of keep valuation

kind of where it is, right? And, you know, generally probably your investors already marked it down, right? So what's what's the art, there's an artificiality to it all that, you know, I just think you have to be mindful of. All right. Let's look at a couple of portfolio companies as we wrap here. You did the series A in one of my favorite companies, com. Maybe talk a little bit about finding that company and just how extraordinary it was to find a company that had raised so little money and had gotten to, you know, such incredible revenue revenue.

You know, one of the, uh, one of the kind of the amazing things about, um, kind of insight and, you know, our, our kind of calling efforts and program is that we just, uh, we, we, we, we, we see a lot of these companies that have kind of bootstrapped themselves. It's harder to find those these days. you know but but you know com was kind of a great you know example of a company and you know what what i liked about it was that it well you know it always happens that there's always some personal interest that gets you know that engages somebody and you know i i had started to try meditating um and full disclosure i was trying it on headspace at the time right and

I her you know one of one of the members of the team who sourced the deal came to me and said hey what do you think he was at the time

probably almost a little probably a little bit of trepidation to like raise a meditation company and I was like sure no that seems really it seems really interesting let's let's get on the phone with them and of course you're an investor

so you know the company and you know the numbers they had tremendous momentum and they did it with a really small team and they were really good marketers and they've really built this brand initially on very small dollars. Subsequent to that, you know, obviously we invested. And, you know, since then, a number of other people have, you know, have come into that investment. And we've actually

done, as I think you also know, like an acquisition or two, to really kind of broaden what we're doing. Because the challenge that they had that had space and others had is kind of what we talked about earlier, right? The meditation definitely had a COVID tailwind. Yeah. We all had more time. So, okay, I'll meditate. And a lot of anxiety. We all had a lot of stress and anxiety. So like, okay, I'll meditate. Now, look, we probably all have stress and anxiety today, too, for a different reason.

Yeah. All the reasons we're talking about today. But, you know, we have less time. Like, we're trying to get back to the office. People are traveling more. And so they had to keep thinking about how do I, how do they reinvent? And as you know, they, you know, they probably do more of their usage around sleep today than it is about meditation. and, you know, we're kind of expanding into kind of mental health and these other areas.

So it's been a, it's been a super fascinating journey. Yeah, yeah, great, great company and just amazing how capital efficient they are. You know, we put $378,000 in when it was a $4 or $5 million company. And then the next thing we know, series A, when you did it at $250. Yeah, yeah. It was like, you know, many years in between that. It was like, how did you do all this? It was like, well, we had revenue.

Oh, really? You built up of revenue. It's a unique differentiated thing. Pretty miraculous when you see that because it does inspire you. Distro Kid, my good friend Phil Kaplan, he has, he's another bootstrapper. This is an incredible entrepreneur. Not only bootstrap with like really high margins, right? Really high margin.

Talk about Distro Kid, how you found that and just the nature of the business. One of our associates, Bradford, who is also really into music, you know, came to me. And he said, hey, I think this company is really interesting. You kind of walk me through. And by the way, when he first came to him, I was like, district kid, Bradford, it sounds like a company that's like a $500,000 of revenue. This can't be like a big company. He's like, no, no, no, we didn't have the numbers at the time.

And he's like, no, I'm pretty sure it's bigger than that. And then I call my son, who's in college, but he's really into music and he DJs and makes music. And I'm like, what do you think this company district kid? He's like, oh, we started talking to me about. different products in the space. And I'm like, okay, so like, it seems like there's really a product here. And at the time, they, so they had bootstrapped, and prior to us, had raised some private equity capital, right? So they had brought in a, they had brought in an investor.

They didn't need the money and the company was making a lot of money. But they had started getting a bunch of inbound interest from strategics and kind of other parties. and so they said, hey, we'd like to look at it. And so the timing ended up being great because they were thinking about doing something. We started kind of cold calling them. And you know, Philip. So like, he's like a product machine. I mean, you're doing a Zoom call with him and he's like coding while he's talking to you.

I mean, it reminds me of common that way about Alex and Michael, who are just such product-driven founders. focus. Yeah. Obsession. The interesting thing about that is that, and that's, well, so the good news in that is he spent so much time on product that we just think there's lots of other things that we can do with the company, right?

And there's so much more functionality to add. The price has always been the same. But, you know, if we add more functionality, there's some competitors out there that charge a lot more for less. And so I think we're just in, even though the companies are pretty big, profitable company, I think we're still in like very early innings of the district at opportunity. You, I don't know if you're still on the board of WeWork. But you're still on the board of We Work.

Well, we came in, keep in mind as part of the recap, really. Yeah, perfect. We came in as part of the recap when they kind of effectively took it public using a SPAC. And so, yeah, I am still on the board. And, you know, Sundee, who's the CEO is, you know, I think one of the best real estate executives out there. So take us through that. This is a recap. We talked about that earlier.

And this is like hard work. You've got this high flyer. You got a mercurial CEO who gets a lot of attention. Good and bad. I have to give, you know, the credit around the hard work. And I'll, because I'm on the board, I won't talk specifics. about the company. But look, a lot of the hard work for the SPAC transaction was in fairness done by the soft bank team and the existing management team. We came in and did diligence

as part of and said, look, the only way this makes sense for us is if it's kind of a relatively clean cap table. But they, I think, to their credit, recognize that they needed to do that and to give the company a path to raise capital and to then create future liquidity for, I'm sorry, create a way to get liquidity for stock bank and other shareholders over time. So, you know, in that case, some of that credit has to go to the existing shareholders who were kind of willing to really think about how to do this in a way that made sense for new investors. And that goes back to what we said. I think it's a responsibility if you're an existing shareholder to really be to think about what are the things that you can do

to try to make sure that you're making it possible for somebody to come into that deal. Let's talk for a minute as we wrap here. We were having a little preamble before we started recording about being an Indian American and the ascension of the Indian American CEO in Silicon Valley and so many venture capitalists, the extraordinary success of this group in Silicon Valley.

What was it like 20 years ago? And then, you know, what do you think of just what you've actually seen within the Americans running some of the great companies? And my dad came here as an immigrant. He had a scholarship to go to Berkeley. And he had not a penny to his name. And he lived on somebody's sofa for the first few months that he was here, you know, paying whatever he could afford to pay. and it gave me the ability to be successful enough to be able to put me through college and give me the opportunity to do this.

And the thing that I worry about most, I'll start with that, is that if you look at the CEOs of the major tech companies, you look at Google, you look at Adobe, you look at Microsoft, we can keep going. They're all Indian immigrants. And by the way, I don't, not suggest there are other immigrants who are extremely important. And yet many of those are my dad, if you're trying to come to this country today, might not be able to come here. This is something that needs to be fixed. This needs to be fixed.

And what was disappointing, you know, watching the State of the Union, I don't want to make it a political comment. I'll just make that when there was discussion at the State of the Union, you know, when there was discussion at the State of the Union. union about immigration, only half of the group, half stood up. And this, to me, seems like such a no-brainer, regardless of your political affiliation, whether you're pro-company creation, you're pro-capitalism, I don't care really what it is you believe. I have a hard time believing that there's a scenario in which making sure that the next generation of Sundar's the next generation, my dad, and the next generation, come to this. country. You know, my, you know, my sister is getting married this July and we couldn't get a

visa for her fiance's mom to come here for the wedding, right? What is going on in this country? This country was built by immigrants and this specific group has created so much value. We have to be able to separate immigration from recruitment of elite talent. We need to recruit. We see this on the front lines. We need more entrepreneurs. We need more companies. We want to invest more money. We need to recruit the smartest, most ambitious people in the world. If they're coming from India, let's open the floodgates. Let's recruit the best people, wherever they're coming from. Remember they're coming from. And one of the things that's interesting is during COVID, we did actually make some investments in India. And one of my observations was, for the first time, you saw people come to the U.S.,

get educated, you know, whether it is Wharton, Harvard Business School. So we give them the most elite education possible. Unbelievable. And then they basically go back. Get kicked out. They get kicked out. Whether they get kicked out or don't feel welcome, it doesn't really matter. My view is, again, whether this be, you know, you know, Indian immigrants or Korean immigrants, it doesn't really matter to me. Like, we should, the welcome match should be at. We should be hugging these people that want to come to this country. 100%. And so to me, look, I feel like I've been incredibly fortunate. I feel like I've been very lucky. and I feel like the Indian diaspora has had a huge impact, not just obviously in technology, but in other areas as well.

And so, and I think this country, I think overall, for all these years, it was very welcoming. My dad would have said that he thought that the country was incredibly welcoming of him. And for him, it's been a disappointment to feel like we've lost that as a country. We're regressing. And what got us to this point? What created this amount of winning? Yeah. Was recruiting and being the place where the most talented people, most ambitious people wanted to come.

Let's bring that back. Let's not forget what got us here. If we lose, this is, you know, this is the place everybody in the world, I think, still wants to be. Yeah. But we're at risk of losing that. And if we lose that, we lose a lot, not just in technology, in my opinion. But in a lot of things, culture, lots of areas. And so, one, I always say, like, I'm very lucky to have had a father who came here and kind of gave me the ability to be in this position.

And, you know, my only hope is that as a society, we can come together irrespective of our political differences and agree that being a melting pot is what makes America special. and let's make sure we stick with that. Yeah. I think on that note, Devin, great job on the pod. So great to catch up with your continued success. And we'll see you all next time on this weekend startups. Bye-bye.