Duncan Davidson, managing director at Bullpen Capital of Menlo Park, has been an entrepreneur and investor through several major technological "ages". He believes we are witnessing the end of one and the beginning of the next. He made a recent visit to Holland as part of a new teaching initiative organized by Tilburg University’s international law School. Jonathan Marks caught up with him to understand what’s changing in their profession.
Navigating the Era of the Unicorn
You may know that Aileen Lee, founder of Cowboy Ventures, coined the term unicorn to describe a billion-dollar startup company. Unicorns are not new, but they are certainly more plentiful. To understand why, I think it’s useful to examine what's changed since I did my two unicorns in the 1990's. Back then we had to raise between US$ 5-20 million just to get started. Then open source technologies came along, you only needed half a million. And when Amazon Web Services kicked in, start-up costs dropped to US$ 50K. It led to a huge growth in the number of startups. This has become the era of cheap.
So here's a lawyer angle to this. Companies raised a lot less money in early rounds and then the valuation skyrocketed up. So if you're a lawyer in one of these lean companies, here's what's changed in the human psychology.
Maybe a pivot is a good idea
If you raise a lot of money like we did in the 1990’s, you feel loathed to pivot. You need to prove that you can deliver against the business plan. If you raise a lot less, psychology says you are happy to change course if customer feedback tells you're taking the wrong path. You won't lose much. If you are a lawyer advising these young companies today, you should embrace these companies when they experiment and pivot. Many of the lawyers that advised me 15 years ago were adamant that I should stick to and live up to the business plan. It was truly terrible advice. Today you can take a small amount of money and with a good idea invade a mainline business; look at Uber or AirBnB.
Blocking rather than Building
”Most people on the outside perceive lawyers rather like beavers. They build dams, putting obstacles in the path of progress. But I believe there are two types of lawyers. Those who think they are just providing a service – and those who recognize that their profession is changing and use it as a vehicle to rise to new possibilities”.
“The brilliant lawyers working with the new breed of startups and scaleup companies understand the journey their clients are going through. There is a big difference between IP law and IP strategy. IP law is a service. You help others go through a process. IP strategy means sitting down with the founders working with them to achieve strategic goals as part of the team. That means you need to have a clear understanding of finance and you are entrepreneurial in your thinking to be able to navigate uncharted territory. For lawyers based in Europe, learn to understand how to communicate and engage across international cultures."
For example, just look at the work that needs to be done in Europe around legislation concerning crowdfunding. The new report Crowdfunding in Europe is a good start.
These days, Venture capital is divided into different types Bullpen Capital is part of a new category called seed investing now emerging in Silicon Valley.
Disrupting the traditional VC Funds
A whole new breed of funds has emerged. At the bubble peak in 2000 there were 1000 of what I would call traditional venture funds. By 2015, it had dropped to around 85. At the same time, the new breed of lean venture funds had grown to over 300. They have disrupted the market in the same way Uber has disrupted the taxi profession.
In the old world of ten years ago, funding was fat. So lawyers would send you a bill for US$ 50,000 for a traditional round of financing. In the new world, if you raise US$ 100,000, you're not going to give half of it to the lawyers. So the valuation cap was born, dreamed up by some clever people who saw the need for making it faster and much cheaper to do rounds.
The number of Series A and B rounds has shrunk dramatically. But the valuation of C seed rounds has exploded. Angels became VC seed funds. I think this a consequence of recent stock market corrections.
Understand the differences between Angels and VC’s
There are two main differences between angels and venture capitalists.
Angels behave differently than professional investors because they are investing their own money. They take it more seriously. When a venture person loses money they may be mad at the founders, but they don't go after you personally. Sometimes billionaires will do that! The other thing about angels is they do not have any institutional memory. So I saw deals coming up in 2010 that got angels funding but failed. In 2011 the same idea with a new set of angels that fails again. In 2012 history repeats itself for a third time. And what's strange is that maybe in 2014 the idea works and everyone assumes the angels are geniuses. In fact, no-one has really learned anything from the exercise.
I hasten to point out that some angels have an excellent reputation and if you take their money it is more likely that that VC's will follow suite. But you need to do your homework to understand who has the reputation and the domain knowledge in the field that you are in. The good ones are the gold standard for the Valley.
Venture people do have institutional memory. They do a lot of research to see if a company like this has been tried before. It may seem that because they invest other peoples' money they don't care really care about failure. Not true. Most of the limited partners force the venture's general partners to put a lot of their net worth into the fund. So it hurts when you lose. In general, that's good.
Risk Adversity is killing exponential innovation in some countries
I think a comparison between Australia and Silicon Valley is useful. I’ve done a lot of advisory work “down under” and I keep hearing it’s similar in Europe. If you are a board member of a company in Australia that goes under, you could be held personally liable. If you're a founder in Australia, everyone remembers and so failure is not an option. There is a huge stigma. And that makes the whole funding industry very conservative. They don't aim for a billion-dollar company – their goal is just to get a return on their investment.
In Silicon Valley, it is totally the opposite. Founders are not personally liable – so it's the investor that takes the risk. Failure is almost a badge of honor providing you do the right thing with the lessons learned. Remember that Steve Jobs got fired from his own company. In the wilderness, he learned a lot, so when he returned to Apple he was a much better CEO than if he hadn't faced failure. When someone comes to see us to pitch a company – and they failed in a prior one – we always ask them – what did you learn and what are you applying today? If they start blaming the VC or the angel, then it is clear they learned nothing and we politely ask them to leave.
What is the seed VC really looking for?
The new breed of seed VC’s are mixing entrepreneurial expertise from running a large high-tech enterprise with the customer experience that Millennials bring to the table. I still see too many founders from foreign countries who think that if they hang around San Francisco they’ll bump into someone who’ll fund their start-up idea. It’s a bit like aspiring actors who thought waiting tables in Hollywood would get them a starring role in a movie. Before you even think of getting on a plane, you need to understand the culture of doing business with a VC. For instance, if you want to engage with us, then be aware that I have two really big pet peeves.
1. No, I don’t want to see your demo.
These are the real questions I have for you:
- Who are you?
- Why have you decided to dedicate your life to this crazy new venture?
- Who else is involved?
- How much money have you raised? How much more do you need?
- How big can this really be?
Once I have answers to these questions and understand what you are all about, then I may want to see the demo. I don’t understand why some people try to convince founders that the product is all that matters. Nothing could be further from the truth. Early stage investing is all about the people involved and big markets.
Some people are personally offended that I don’t want to see their product demo. I understand that there is such pride in ownership, but recognize WHY I don’t want to see your demo.
I assume that your product is the best in its category. That seems like a crazy assumption, but it quickly gets us past features and to your thinking as to WHY you will win. HOW you will win? What’ s the go-to-market, what’s working and what’s not? Quite frankly most companies win or lose on this part of the discussion not the latest user interface innovation.
2. Please don’t tell me that raising money is a waste of time.
I often hear variations on the following during meetings with founders:
- “I need to get back to the office to work on new product features.”
- “Raising money is slowing the down the business and it’s a waste of my time.”
- “Raising money is taking my eye off the ball.”
If you are the CEO then one of the most important parts of your job is ensuring that the company has enough financial runway to not go bust. I believe it is probably the most important task you have. If you don’t feel that way, then perhaps you should be the VP of Product or the CTO. Why not hire a CEO who does care about raising the money? Please recognize that I am not insulted by the fact that you thinking raising money is a waste of your time. I’m more concerned that perhaps you’re not in this business for the right reasons!
We do understand your technology
Silicon Valley Venture partners have a deep understanding of tech domains. Even if they haven’t run a company with exactly the same kind of technology, they have been through the process of building a hardware technology company. They have a sixth sense in understanding whether a company has good product market fit – and they have a network which lives forever.
Let me prepare
Time is precious for everyone. In Dutch and US business cultures they are famous for coming straight to the point in meetings. Which is why I’m surprised some founders don’t want to send any information in advance, like the pitch deck. Don’t you want to engage with an informed audience? I promise I will read it in detail and the meeting will be a much more useful way to spend your time.
When the CEO doesn’t want to send anything before a meeting, I regard this attitude as a huge red flag. It says to me that there is something that is being hidden. Or that only when it’s read to me will it make any sense.
Don’t get me wrong. I want to learn about why you elected to change your life and start this company etc. But having it all be a surprise versus allowing me to prepare seems like a bad idea for everyone.
I’m curious what happens next.
In the 1990s Duncan Davidson founded Covad Communications, the digital subscriber line provider that hit a market value of US$9 billion after going public. He also ran Intertrust, which had a market cap of US8 billion at the time of its IPO. Duncan was managing director at VantagePoint Venture Partners for four years before joining Bullpen based on Sand Hill Road in Menlo Park, California.