Sramana Mitra: We see cap notes a lot in Silicon Valley, but if you go outside of Silicon Valley, people are still using equity vary aggressively. We, very often, see terribly diluted deals at very early stages.
Don Hutchinson: That is the historic nature of equity investment. The issue you’re talking about is before notes became accepted here. It was a couple of years’ process. Earlier, it was all equity here as well. You didn’t go through as many rounds before jumping to an A. If you got seed, you went to an A. There might be some bridge but the bridge usually came from the incumbents. That usually was discounted notes to the A. The clearest way is to gain traction quickly.
Sramana Mitra: We’ve been saying this. Get traction before you raise money.
Don Hutchinson: Don’t have five raises before you go for an A. Raise an appropriate amount of money. It all circles back to what are you selling. Do you have something of interest? The market reaction to what you are doing is something that you have to pay attention to. Things may take a while to develop. If you look at Salesforce, their early years were not robust from a sales standpoint. The idea of leasing software as opposed to buying it at the enterprise level was so resonant. If you don’t find traction, you have to ask yourself why.
Sramana Mitra: Why are you doing this? Is this a business at all? Especially, this whole eyeball economy. We get a lot of eyeballs and traffic. Then what? Where’s the monetization?
Don Hutchinson: Is there a business here and what kind of a business? There are many, many more businesses that never take the venture capital to go on building fabulous businesses. If you look at the landscape, over 90% of these businesses don’t even know what venture is. They just built a business. You have to ask yourself a question too. Is this a business that’s suitable for venture investment? If it is, it’s almost a requirement that the business has exceptional growth.
If you can’t forge that growth, then maybe it’s a more traditional style business. Maybe it’s a lifestyle business. Maybe, it’s not a business. These are questions we have to ask ourselves early on. We have to accept what the game is. If I want to be good at basketball, I don’t get to change the rules of the game. I have to, within those rules, be good.
Sramana Mitra: Create a strategy that fits your business as opposed to trying to force a square peg in a round hole.
Don Hutchinson: We’re not going to change venture at any point in time. It’s a financial exercise. You’re unlikely to change it. Subsequent investors have a great deal of latitude, depending on the competitiveness of the deal, to impose terms on prior investors. If I’m doing Series A or Series B and I really like these founders, the truth is, I could care less about the prior investors.
If I’m concerned about the fraction of equity the founders have, then I increase what they get which comes out of the guys that are already in the deal. A fair number of investors seem not to recognize the dependency that they agree to, implicitly, on terms of subsequent investors. If in a subsequent round, you only have one viable prospect who’s willing to invest, then that new investor, within reason, can impose some pretty harsh terms for themselves and the founders. They’ll take it out of the equity of the current investors.