Heidi Roizen: The point is to understand the terms and understand how they impact not only your return but the motivations of everyone else around the table. When you set up a situation where someone is going to make three times their money no matter what and they’re going to be the first money out, and then another person who’s only going to make money if you sell the company for $200 million, you are talking about two people who have dramatically different ideas about what you should do strategically.
That, to me, is a very divisive thing. I’ve been a VC now for 16 years, but I was an entrepreneur for 14 years before that. I raised two rounds of venture. I’ve lived this. Even though I understand why VCs negotiate for these terms, when you do these things and trade a high valuation for these other stuff, you’re going to create a divisive underlying shareholder base. That’s going to come around to hurt you unless everything goes super well. I’ve been on 40 boards in my life so far. Very rarely does everything go perfectly.
Sramana Mitra: That’s the problem of this unicorn thing of raising too much money. One is, you’re betting on a low probability scenario for success. Two is, you’re introducing levels of compilations that you yourself have a hard time understanding. I think successful entrepreneurship, or successful anything actually, is not taking un-calculated risks.
Calculated risks are good. Success comes from mitigating risks that you don’t have a lot of control over. The higher probability of success is in the $100 exit scenario which means that you have to do a company without burning more than $20 million to be able to make any money at all.
Heidi Roizen: Even $100 million success is unlikely. This is another thing I’ve explained to entrepreneurs. If you raise $2 million and it’s a reasonable valuation, even if you sell your company for $20 million, that is a life-changing experience. For most people if you walk away with $5 million, that’s a lot.
Just process that for a minute. If you have raised $15 million and you sell your company for $25 million, you don’t make anything. When people do this where they raise a bunch of money and they say, “It’s my safety net”, they create this debt that needs to get repaid. They also create a barrier to new people coming in. You just create these structures that don’t work. I understand. Entrepreneurs will say, “I need the money.” I also will put a disclaimer in here. There are certain types of companies that are disruptive and capital intensive.
Some of them take hundreds of millions of dollars of investment before you get to the first customer. In the downturn, you don’t say, “Let’s cut to profitability. Instead of building a rocket to get to orbit, why don’t we just get to Lodi with something.” That doesn’t work. Tesla is another one. Sometimes you have to take a leap of faith and raise lots of money. My favorite form of financing is customers buying your product. It’s validating and non-dilutive.
If you, as an early-stage startup, can figure out how to get somebody to pay you for what you’re doing, that is golden. That is absolutely the best money that you can use to build your business. I would encourage entrepreneurs to really think about that as opposed to going out and raising funding. Can you get your business started by someone who’s going to value what you do and is going to pay you for doing it without taking that equity dilution?
Sramana Mitra: This is the mantra in One Million by One Million. Our definition is entrepreneurship equals customers, revenues, and profits. Financing and exit are optional.
Heidi Roizen: That’s right.
Sramana Mitra: One point you made which I think is an excellent point and is a perfect summary of what you discussed today. Investors are portfolio managers. You are not.
Heidi Roizen: At DFJ, I’m responsible for eight companies. There are eight companies that I am a Board Director of. I try as hard as I can for those companies. I show up and I’m responsive, but I have eight. I’m making decisions even among those eight. Especially in a fund that’s closed, a million into one company is a million that’s not going into another company.
We’re portfolio managers. We’re looking across the field and we’re saying, “Who’s got the best chance of returning this money?” You, as the entrepreneur, have 100% of your eggs in one basket. I think it’s important to remember that your outcome matters to you more than your outcome matters to your investors usually who have multiple bets and who are going to be judged by their performance across the whole portfolio and not just across your deals.
I show up and work as hard as I can but then in the background, I and my partners have a hundred companies each of which have limited funding. We have to make decisions on who gets the limited resources. We’re portfolio managers at the end of the day.
Sramana Mitra: This has been fantastic. Thank you for your time.