20VC Craft Ventures’ David Sacks on How To Assess Founder Psychology, How To Accurately Evaluate CAC, Burn and Churn & What Makes The Very Best Startup Boards

In an insightful discussion on "20 Minutes VC" with Harry Stebbings, seasoned investor and former operator David Sacks of Craft Ventures delves into the intricacies of startup success and navigating economic downturns. Sacks, known for his strategic prowess and influential roles at PayPal, Yammer, and Zenefits, emphasizes the importance of innovation, capital efficiency, and understanding unit economics. He shares his perspective on the valuation adjustments in the venture landscape post-COVID, advocating for a focus on mission-critical services and the significance of maintaining robust customer acquisition strategies. Sacks also touches upon the delicate art of founder psychology, distinguishing between beneficial and detrimental "craziness," and the critical nature of swift, informed decision-making in leadership. Throughout the conversation, Sacks underscores the vitality of adaptability in both founders and investors to ensure long-term success and growth.

• David Sacks is a prominent Silicon Valley figure with a history of operating and investing in successful companies.
• He has a track record of building companies from the ground up, including PayPal, Genie.com, Yammer, and Zenefits.
• David transitioned from being an operator to an investor, founding Craft Ventures, an early-stage fund.
• Craft Ventures has an impressive portfolio with companies like Facebook, Tesla, SpaceX, Palantir, Affirm, Airbnb, Slack, and Bird.

"He is one of Silicon Valley's leading operators turned investors, with Navar avocado angelist calling him one of the world's best product strategists."

This quote highlights David Sacks' reputation as a top product strategist and his transition from an operator to an investor in Silicon Valley.

• David Sacks spent around 20 years founding and operating companies before moving into venture capital.
• He was the COO of PayPal during its formative years, a period known as the "PayPal Mafia."
• After founding and selling Genie.com and Yammer, and serving as CEO at Zenefits, he decided to take on a "player-coach" role in venture capital.
• Sacks chose to start a fund instead of continuing as an angel investor to write bigger checks, lead rounds, and build a team to support founders.

"Well, I was on the founder side for about 20 years, starting with PayPal in 1999. I was the original coo of PayPal during the so-called PayPal Mafia period."

This quote provides context on David Sacks' extensive experience as a founder and operator, which laid the foundation for his venture capital career.

• David Sacks believes that innovation continues during economic downturns, citing his experience with PayPal and Yammer, which were built during downturns.
• Downturns can make it easier to recruit talent and reduce competition from copycats.
• Fundraising becomes more challenging, but great companies can still be created.
• Sacks notes that Craft Ventures has continued to invest in deals post-COVID-19, valuing capital efficiency alongside growth.

"Innovation doesn't stop during a downturn. My own personal experience was that the two unicorn companies I was involved in creating were primarily built during downturns."

This quote emphasizes Sacks' belief that downturns can still yield successful companies, drawing from his personal experiences with PayPal and Yammer.

• Sacks observes a slowdown in the pace of venture capital investing due to greater uncertainty.
• He has witnessed a normalization in startup valuations, with SaaS startups returning to around ten times forward ARR from previously inflated valuations.
• Despite a challenging environment, Sacks asserts that Craft Ventures remains active in investing.

"I think we're already seeing price reductions during the frothy times."

This quote indicates that Sacks has noticed a decline in startup valuations, suggesting a shift towards more realistic pricing in venture capital deals.

• Sacks warns against startups losing money at the unit level, where the cost to provide a service exceeds what customers are willing to pay.
• Proper attribution of unit costs versus corporate expenses is crucial for startups to avoid gross margin problems.
• He acknowledges the challenges in assessing unit economics for startups with real-world components, like Bird, where future improvements need to be taken into account.

"What you want to avoid is a situation which the company is basically selling dollar bills for $0.90."

This quote underscores the importance of positive unit economics, where the revenue from selling a product or service must exceed the variable costs of producing it.

• Sacks agrees with Peter Thiel's sentiment that free and open distribution is a significant challenge for startups today.
• He differentiates between B2C and B2B companies, noting that B2C companies require viral growth due to low customer long-term value, while B2B companies can afford a sales-driven approach due to higher customer value and retention.

"You typically do need some sort of new platform or new distribution platform because consumer companies, they tend to have to grow virally to get to large numbers."

This quote reflects Sacks' view on the necessity for consumer startups to find innovative distribution methods to achieve significant growth without excessive customer acquisition costs.

• The difficulty in finding new consumer distribution platforms makes it challenging to justify the Customer Acquisition Cost (CAC) for new consumer companies.
• Without new platforms, the economics of spending on CAC do not work favorably.

And as a result of that, you can afford to spend money on CAC. It does pencil in a different way. So I would agree that in the absence of new consumer distribution platforms, it's very hard to get a CAC to pencil for a new consumer company.

The quote highlights the relationship between the availability of distribution platforms and the feasibility of spending on CAC for consumer companies. Without new platforms, the cost of acquiring customers is not easily justified.

• Economic downturns reveal which services are essential ("painkillers") versus non-essential ("vitamins").
• SaaS (Software as a Service) investments should focus on essential services, which become more evident during economic hardships.

Well, there's going to be air pockets ahead, so I think nobody is going to be immune from the economic downturn. What we're really going to see, I think, over the next several months is who is truly mission critical and who's not.

This quote emphasizes the expectation that the economic downturn will test the resilience of businesses, distinguishing between those that offer essential versus non-essential services.

• Startups may need to consider discounts or deferred payments for customers in industries hit hard by economic downturns.
• Offering discounts can build goodwill but must be done with caution due to increasing transparency and potential expectations from other customers.

I think that if the underlying customer is in a very hard hit industry and can make a case for some relief, I think it can make sense to basically invest in the goodwill of that relationship and not demand things like increase deal sizes and even may make sense to offer discounts or defer payments.

The quote suggests that startups may need to offer discounts or payment deferrals as a strategic investment in customer relationships, particularly for those in struggling industries.

• A common rule is not to spend more on acquiring a customer than the revenue expected in the first year.
• Another rule is that the long-term value (LTV) of a customer should be at least three times the CAC, though ideally higher to account for customer churn.

Well, there's a couple of pretty common rules of thumb around CAC. So one would be that you don't want to spend more than first year's revenue acquiring the customer, and I think that's a pretty good rule of thumb.

The quote outlines a widely accepted guideline for CAC, which is to keep the acquisition cost lower than the first year's revenue from the customer.

• Selling to startups is easier and can be a good market entry point, despite higher attrition rates compared to selling to enterprises.
• The trade-off between customer value and ease of sale determines the target market for companies.

But the flip side of that is that startups are so much easier to sell to, and so therefore they can provide a great entry point into the market for other startups which may find that the difficulty level of trying to sell to a Fortune 500 company is just too high.

This quote discusses the strategic advantage of selling to startups due to the lower difficulty level compared to targeting larger enterprises.

• Founders should separate CAC by channel to accurately assess the efficiency of each marketing channel.
• Blended CAC can be misleading and lead to overinvestment in less efficient channels.

You really want to separate your CAC by channel, because what happens is I guess a blended CAC would just be, you would report on your CAC across all channels.

The quote advises founders to report CAC for individual channels rather than using a blended metric, which can obscure the true performance of each channel.

• Logo churn is inevitable, but the goal is to have dollar expansion from remaining accounts exceed the churn.
• Focusing on negative churn or positive expansion on a cohort basis is key.

Logo churn is unavoidable all startups are going to have some logo churn. It's just impossible to avoid. But what you really want to see is that the expansion from the accounts that stay with you exceeds in dollar terms the churn from the customers that you're losing.

The quote explains that while losing some customers (logo churn) is unavoidable, successful companies ensure that revenue growth from existing customers outpaces the losses.

• A minimum of 100% retention on a revenue basis is necessary to avoid a "leaky bucket" in subscription businesses.
• Industry-leading companies can achieve up to 200% retention with effective land and expand strategies.

Well, I would say that good or not bad would start at 100%. Otherwise your bucket has some holes in it, and it's very hard to build a subscription business for the long term.

The quote sets a baseline for acceptable net negative churn, indicating that at least 100% retention is needed to sustain a subscription business.

• Growth during Covid-19 may be temporary or part of a larger trend.
• Companies benefiting from underlying trends accelerated by Covid-19 can be considered more sustainable investments.

Well, you need to ask the question whether the growth is sort of a flash in the pan or is part of some larger trend that's being accelerated and you're seeing both effects.

This quote suggests that investors should discern whether a company's growth during Covid-19 is temporary or indicative of a longer-term trend.

• Founders often possess traits of being visionary and aggressive, which can be seen as "crazy."
• Problems arise when founders lose perspective and become resistant to advice.

Founders need to be far more aggressive than what the average person might think. They need to have these traits of being visionary and pushing and being able to run through walls.

The quote discusses the positive aspects of what is often labeled as "crazy" behavior in founders, emphasizing the need for visionary and aggressive traits.

• Rapid deal processes make it challenging to thoroughly assess a founder's character.
• Founders largely choose their board members, who should be able to provide constructive feedback.

We always try to do reference checks on the founder to kind of understand the person, but you can't always tell in advance what's good crazy versus bad crazy.

This quote acknowledges the difficulty in assessing founder psychology due to the fast pace of deal-making and emphasizes the importance of reference checks.

• Founders, like Hollywood directors, seek creative freedom and control over their companies.
• VCs should aim to build trust with founders to provide support and constructive feedback.

Founders are the ones who choose their board members more so than the other way around. It's really up to founders to decide who their board members are going to be.

The quote reflects on the dynamic between founders and VCs, highlighting that founders have significant control over the composition of their board and the advice they receive.

• Founders should avoid an autocratic mentality and be open to advice to balance their perspective.
• Constructive relationships with VCs and board members are crucial for a healthy dynamic.
• The willingness to seek advice and be receptive to it is important for founders.

"But if it blinds the founder to seeking advice or seeking to balance their psychology or their perspective, I think that's dangerous."

This quote emphasizes the risk of a founder becoming too self-reliant or closed off to external input, which can be detrimental to their decision-making process and the company's health.

• Delivering tough advice is necessary but challenging, especially for those who are people pleasers.
• Founders must be open to receiving tough advice and actively solicit it.
• It is the responsibility of both the advice-giver and the founder to engage in a dialogue that includes difficult feedback.

"And so I think part of it is on you to deliver the tough love when it's called for."

David Sacks highlights the responsibility of the individual (in this case, Harry Stebbings) to provide necessary but challenging feedback when the situation calls for it.

• Board members should bring their unique strengths to the table, contributing to a well-rounded team.
• Different board members can offer various forms of support, including financial rigor, emotional support, or strategic advice.
• It is important for new board members to understand their strengths and how they can best contribute.

"And so everyone should bring their strengths. And I think for you it would just depend on bringing your strengths to the table and contributing that."

David Sacks advises Harry Stebbings to focus on his strengths when serving on a board, as this is how he can be most impactful.

• Playing to one's strengths is generally more effective than trying to compensate for weaknesses.
• Focusing on strengths can lead to greater differentiation and excellence.

"I'd be on the play to your strength side of it."

David Sacks advocates for concentrating on one's strengths rather than spending too much effort on trying to improve weaknesses.

• Burn multiple is defined as net burn divided by net new ARR.
• This metric helps to assess the cost of growth in terms of capital spent.
• The burn multiple can indicate whether a company is efficiently using its resources to grow.

"It's basically thinking about burn as a multiple of the growth that you're achieving in that month, quarter or year."

David Sacks introduces the concept of the burn multiple as a way to measure the efficiency of a company's growth relative to its expenditure.

• The burn multiple will vary depending on the stage of the company.
• A high burn multiple in the early stages may be acceptable due to necessary investments in R&D and sales.
• Over time, the burn multiple should improve, with the goal of approaching zero as the company moves towards profitability.

"But the burn multiple should be improving over time."

David Sacks explains that while a startup may have a high burn multiple initially, it should decrease as the company matures and becomes more efficient.

• A burn multiple of less than one is considered excellent.
• A burn multiple of more than three is a cause for concern and requires close scrutiny.
• These thresholds help investors assess whether a company is growing efficiently relative to its capital burn.

"If you're burning more than three times your net new ARR, I would define that as being suspect or bad."

David Sacks provides specific benchmarks for evaluating whether a company's burn rate is within a healthy range in relation to its growth.

• Keeping burn low is crucial when the market for a product is not yet established.
• Companies in emerging markets like AR/VR or crypto should be cautious with spending due to uncertainty.
• A low burn rate ensures longevity while waiting for the market to mature.

"The examples you gave are all examples of hot spaces that were heavily funded, and then the bottom kind of fell out because people realized that the demand wasn't quite there."

David Sacks discusses the importance of conservative spending in markets that are prone to hype but may not have sustainable demand.

• Aim for at least two years of runway due to potential economic disruptions.
• Having a significant runway mitigates the risk of being unable to fundraise during downturns.
• There is no such thing as too much runway, but it is essential to determine the minimum viable runway to ensure survival.

"I do think you want to have at least two years."

David Sacks recommends a minimum of two years of financial runway for startups to weather economic challenges effectively.

• Having a long runway, like ten years, may indicate overfunding.
• Companies should consider whether they can use additional funds to accelerate growth without being wasteful.
• If the market is not ready, it may be prudent to conserve cash until demand increases.

"I wouldn't just spend it willy nilly."

David Sacks warns against unnecessary spending, even when a company has an extensive runway, advocating for strategic use of funds.

• Founders often struggle more with transitioning from high spending to efficiency rather than the reverse.
• In times of economic hardship, founders need to learn to grow the company while maximizing the value of their capital.
• This transition requires a shift in mindset and the ability to make tough decisions.

"That's where I think founders have a lot of difficulty."

David Sacks acknowledges the challenge founders face when they need to switch from a growth-at-all-costs mentality to a more capital-efficient approach.

• Founders may need to adopt a wartime CEO mentality in challenging periods.
• Wartime CEOs are characterized by their willingness to make tough decisions and adapt quickly to changing circumstances.
• The current economic climate may necessitate a wartime approach for many founders.

"I think the short answer is yes, they do need to be wartime ceos."

David Sacks agrees with the notion that founders need to be prepared to take on a wartime CEO role, especially in the face of significant challenges like the COVID-19 pandemic.

• Companies experiencing a rapid increase in burn rate face existential threats.
• Wartime measures may be necessary to prevent the company from failing within months.
• CEOs need to make difficult decisions to ensure the survival of the company.

"Your burn multiple has become horrible. You've probably got some really tough decisions to make because you go from having an acceptable burn rate to one where the company's going to die in a number of months if you don't, you know, wartime measures are called for."

This quote emphasizes the urgency and severity of a situation where a company's burn rate has escalated to a point where immediate and drastic actions are needed to prevent failure.

• Quick and iterative decision-making is generally ideal for startups.
• Some decisions are existential and must be made correctly.
• Even with a high success rate in daily decisions, CEOs must focus on getting critical decisions right.

"I think it's largely true in the sense that quick, iterative decision making is the ideal way to run a startup. I would add one caveat to it, which is some decisions that you make, there'll be a few of them every year, are sort of existential. And those decisions you really have to get right."

This quote acknowledges the importance of rapid decision-making in startups while highlighting the necessity of carefully handling a few critical decisions that could determine the company's fate.

• The culture of celebrating failure is not endorsed.
• Founders should adopt a mindset where failure is not an option.
• Silicon Valley allows for failure without severe consequences, but founders should strive for success.

"Frankly, I hate it. I don't believe in celebrating failure."

The speaker expresses a strong dislike for celebrating failure, suggesting that it can lead to a complacent attitude towards the challenges of running a startup.

• It's essential to adapt quickly to new facts and situations.
• Legacy thinking and reluctance to face harsh realities can hinder effective decision-making.
• Adapting quickly without being tied to past plans or expectations is crucial.

"I think the most important thing is you do have to react to the new facts and to the new situation on the ground."

This quote stresses the importance of being responsive and flexible when faced with unexpected challenges or changes in circumstances.

• Time allocation between successful and struggling portfolio companies can be a dilemma.
• The speaker prioritizes being available for founders when they need help, regardless of the company's status.
• Reputation can be impacted by how VCs handle failures and successes.

"For me, I don't really think about it that much because I'm there for my founders whenever they need me."

The speaker indicates a commitment to supporting founders whenever they require assistance, suggesting that time allocation is not a significant concern.

• "Thucydides trap" is recommended for understanding the complexities of the US-China relationship.
• The book has become more relevant during the COVID-19 pandemic.

"I'd say most recently Thucydides trap, which has become even more relevant in light of COVID which describes some of the complexities involved in the US China relationship."

The speaker recommends a book that provides insights into the geopolitical dynamics between the US and China, especially pertinent in the context of global challenges like COVID-19.

• The speaker has had positive experiences with various board members.
• At Yammer, there was a harmonious board dynamic with notable members like Peter Thiel and Luke Nozick.
• It's difficult to single out one board member as the best or most memorable.

"And so you had all these really scary challenges."

This quote reflects on the challenges faced while being part of a startup board, emphasizing the importance of a supportive and cooperative board environment.

• The speaker disagrees with the mantra of doing things that don't scale.
• Startups should focus on finding scalable solutions as early as possible.
• Glorifying non-scalable practices can lead to a startup that ultimately doesn't scale.

"I strongly disagree with that mantra, and I think it's one of the chivales that gets startups in trouble."

The speaker criticizes the idea of focusing on non-scalable tactics, arguing that scalability is fundamental to the success of technology startups.

• Telling founders "no" when passing on an investment opportunity is challenging.
• Delivering bad news to founders is the least enjoyable part of the job.

"Probably just telling founders no. When we pass on a deal, sometimes you have a great founder and we'd love to support them, but for whatever reason, the idea or the business is just not one that we choose to invest in."

This quote conveys the difficulty of rejecting investment proposals, especially when the founders are capable and passionate.

• Outcomes of investments can be significantly larger than anticipated.
• Understanding the potential scale of startups is crucial for investors.

"Probably just that the outcomes are going to be ten x or bigger than you think."

The speaker reflects on past investment experiences, noting that the eventual success of companies like PayPal and Yammer exceeded initial expectations by a large margin.

• Silicon Valley has become a template for startups worldwide.
• Key elements of this template include employee ownership and risk-tolerant investment capital.
• The Silicon Valley way of doing business supports the best ideas and is spreading globally.

"Silicon Valley is no longer a place, it's a way of doing business."

This quote encapsulates the idea that the principles and practices associated with Silicon Valley have become a global model for entrepreneurship and innovation.

• Sourcegraph was chosen for investment due to its bottom-up adoption by developers.
• The company's SaaS tool for universal code search has shown promising enterprise potential.
• Bottom-up adoption is a strong indicator of a product's value and potential for success.

"The thing that gets me excited about it is the bottom of adoption by developers and companies."

The speaker expresses enthusiasm for Sourcegraph's business model, where the product's intrinsic value drives its adoption within organizations.