20VC Upfront’s Mark Suster on COVID Redefining What A Great Company Looks Like and What Valuations Look Like, Why PayToPlay Is Back On The Table & Why We Will See The Death of Party Rounds

In this insightful conversation, Harry Stebbings interviews Mark Suster, Managing Partner at Upfront Ventures, exploring his journey from enterprise software CEO to a key figure in venture capital. Suster shares his philosophy of backing resilient founders with a "both sides of the table" approach, drawing on his operational experience to guide entrepreneurs through market cycles and negotiations. With the current economic downturn, he advises B2B and B2C companies on adapting to reduced spending and renegotiating contracts, emphasizing the importance of a strong investor-founder fit over party rounds. Suster also discusses the challenges of maintaining a disciplined reserve allocation and the significance of VC brand in winning competitive deals. Highlighting the role of VCs as people managers, he underscores the value of conviction in investment decisions and supporting founders through tough times.

• Harry Stebings introduces Mark Suster, managing partner at Upfront Ventures.
• Upfront Ventures is a leading venture firm in LA with a portfolio including Bird, Goat Maker Studios, and Ring.
• Mark Suster is a former founder and CEO of two successful enterprise software companies.
• He was also a VP of products at Salesforce.com after selling his company to them.
• Suster is the author of the industry blog "Both Sides of the Table."

"And I'm thrilled to welcome back to the hot seat Mark Souster, managing partner at Upfront Ventures, one of LA's leading and largest venture firms with a portfolio including the likes of Bird, Goat Maker Studios, and Ring, to name a few."

This quote introduces Mark Suster and highlights his current role and previous accomplishments, setting the stage for his insights on venture capital and entrepreneurship.

• Mark Suster entered venture capital after founding two tech startups in document collaboration.
• His startups were funded by the firm he later joined as a partner.
• Since 2007, he has been a partner at Upfront Ventures.

"But having been a two-time CEO, after I finished a period of time as VP of product@salesforce.com the firm that had funded both of my companies asked if I wanted to join as a partner."

This quote explains Mark Suster's transition from being an entrepreneur to becoming a venture capitalist, emphasizing his operational experience.

• Suster believes many investors lack real startup operating experience.
• His experience as a CEO provided him with insights into the challenges of negotiating terms with VCs and managing company growth and contraction.
• His blog, "Both Sides of the Table," reflects his experience from both the entrepreneur's and investor's perspectives.
• Suster values resilience and grit in entrepreneurs, traits he observed in successful peers.

"So now, as a venture capitalist, I feel like I can speak from the heart, from real experiences of hiring and firing and restructuring, of selling, of having to renegotiate contracts when I work with startup entrepreneurs."

The quote emphasizes the practical knowledge Suster gained from his time as a CEO, which he now applies to his role as a venture capitalist.

• Suster advises B2B founders to be aware that the full impact of the economic correction may not be immediately visible.
• In a booming market, innovation is rewarded, but in a contracting market, cost-cutting is prioritized.
• Companies may renegotiate contracts, even if the software is critical, leading to flat or reduced revenue.
• Suster encourages companies to reduce costs and prepare for the worst while hoping for the best.

"In a contracting market, people all across industry are paid to cut costs. Why aren't you canceling contracts? What are you renegotiating? What do we not really need?"

This quote highlights the shift in corporate priorities during economic downturns, with a focus on cost reduction over innovation.

• Suster advises accepting the new economic reality and being open to renegotiating contracts.
• He suggests seeking something in return, such as longer contract terms or executive sponsorships.
• Realpolitik is necessary to prevent losing contracts entirely.

"You're going to end up with a zero and you can't afford a zero with this customer and face the new reality."

This quote underscores the importance of pragmatic negotiation to maintain customer relationships and revenue in tough economic times.

• Suster believes that the quality of software contracts can vary widely.
• The term "shelfware" refers to software that is purchased but not fully utilized.
• Even successful software companies will likely see contract renegotiations and reductions.
• Companies need a plan for gracefully reducing contracts and adjusting their cost base.

"A lot of their customers are paying for the top of the line license, and they have way more licenses than their organization really needs because all the leverage was with the software company, was with the seller."

This quote reflects on the historical imbalance of power in software contracts, which may shift due to economic pressures.

• Suster believes that the definition of a great company and valuations will change.
• Companies may need to redefine growth expectations and focus on survival.
• Some companies may still experience rapid growth due to meeting a critical need at the right time.

"But the reality is most companies are going to have to cut back their expectations of growth."

This quote suggests a more conservative approach to growth for startups in the current economic climate, prioritizing survival over rapid expansion.## Economic Cycle Impact on B2C Landscape

• B2C companies with recurring sales may face immediate declines in purchasing.
• The full impact of economic contraction on consumer sentiment and spending has yet to be fully realized.
• The wealth effect from economics describes reduced spending as people feel less wealthy due to declines in stock market and retirement funds.
• With significant unemployment, spending is expected to decrease across almost all categories except essentials like groceries and pharma.

"When you feel less wealthy because your 401k goes down, your stockholding goes down, that people start spending less."

This quote highlights the wealth effect and its influence on consumer spending, especially during economic downturns where personal financial assets like 401k and stocks decrease in value.

• Founders should treat the current economic situation very seriously and adjust their cost base accordingly.
• Companies should aim to extend their Runway and gather evidence of success.
• Founders should continue conversations with VCs, even though securing funding may be more challenging.
• The economic environment is expected to be difficult, potentially the hardest of our lifetimes.

"Prepare for probably the hardest economic environment of any of our lifetimes."

Mark Suster emphasizes the severity of the current economic situation and the importance of founders being prepared for extreme challenges.

• The venture capital market is experiencing a decrease in the number of deals being done.
• The current active investment by some VCs may be an aberration or due to market timing.
• It is currently more difficult to finance companies, especially those in cash crises or needing significant repair.
• The difficulty in raising funds is expected to persist for the next several years.

"It's going to be harder to raise money across every phase of venture capital."

Mark Suster explains that the current climate is making it more challenging for startups to secure funding at all stages of growth.

• Despite the challenging environment, some VCs are still funding companies and submitting term sheets.
• Deals are getting done, particularly for promising companies with adjusted expectations.
• Communication with limited partners (LPs) remains crucial during high-volume investment periods.

"We funded a company today. We submitted the term sheet two weeks ago and I've never met the founder in person."

Mark Suster provides an example of how his firm continues to invest in companies despite not having traditional in-person meetings, indicating that some VCs are indeed open for business.

• Founders should be humble and prioritize a strong balance sheet over optimizing valuation.
• Companies with strong metrics and relevance to the current market may have more leverage in funding rounds.
• Founders should be aware of market prices and public market comparables when considering valuations.
• Holding on to artificially high prices can hinder a company's success.

"Understand that a strong balance sheet gets you through difficult times, that ultimately optimizing for a one over a zero is the single most important thing."

Mark Suster advises founders to focus on financial stability over maximizing valuation, especially during economic downturns.

• M&A prices are quick to fall during economic contractions due to a limited number of buyers and a surplus of sellers.
• Acquisitions are more likely to be driven by cost-cutting and efficiency rather than innovation.
• Buyers have increased leverage due to the limited options for privately held companies.

"The fastest thing to fall in a time like this is m a prices."

Mark Suster agrees with Jason Lemkin's observation that M&A prices decrease rapidly in challenging economic times.

• Public markets have liquidity and price signaling, allowing for immediate valuation adjustments.
• Private markets lack frequent pricing signals, making it difficult for companies to accept reduced valuations.
• Investors may resist valuation markdowns to avoid reporting losses to LPs.
• Coordinated acceptance of new valuations among founders and investors is necessary but challenging.

"You don't get to hold on to false hope that you're worth 800 million. If the market marks you down to 400 million, you're worth 400."

Mark Suster contrasts the immediate valuation adjustments in public markets with the difficulty of accepting new realities in private markets.

• Experienced VCs have methodical reserve planning to navigate economic cycles.
• Newer or smaller seed funds may struggle with reserve allocation during unprecedented times.
• Proper reserve planning is crucial for VCs to support their portfolio companies through economic downturns.

"We're incredibly methodical about how we do reserve planning."

Mark Suster shares how his firm's experience and methodical approach to reserve planning positions them to manage the current economic challenges effectively.## Reserve Policy and Financing Challenges

• The difficulty for smaller funds that haven't considered reserve policy and relied on SPVs.
• Impact of a tougher environment for raising SPVs on both winning and struggling companies.
• The risk of dilution or losing equity stakes when not participating in funding rounds.

"For example, if you didn't have to think about reserve policy and you wrote a bunch of checks, and your strategy was to raise SPVs... SPVs are much harder to raise now, and so your ability to protect not just your winners, but also your companies that are struggling... it's going to be much harder."

This quote highlights the challenges faced by smaller funds that haven't previously needed to focus on reserve policies. The difficulty in raising SPVs in the current environment can jeopardize their ability to support their portfolio companies effectively.

• The resurgence of "pay to play" provisions in investment terms.
• The conditions leading to pay to play, such as down rounds and lack of external lead support.
• The desire to avoid free riders in investment scenarios.

"Pay to play is on the table. I think any deal that is being recut from a high price to a low price... the last thing you want is a free rider."

Mark Suster explains that "pay to play" provisions are now common, particularly in situations where deals are being renegotiated at lower valuations and external lead support is absent, to prevent investors who don't contribute from benefiting at the expense of those who do.

• The strategy of dividing fund capital between initial investments and reserves.
• The importance of pacing and discipline in reserve planning.
• The concept of "recycling" capital from exits back into the fund.
• The risks of not planning adequately for reserve allocations.

"So what we've always done is break down our funds in terms of the dollars that we're going to write into first checks, and then we model out how many we're going to do at the seed stage, the A stage and the B stage, and what reserve dollars we historically have put into each of those categories."

Mark Suster outlines the methodical approach to reserve planning, which involves allocating specific portions of the fund to initial checks and reserves, and pacing investments according to historical data.

• The variance in recycling rates among different funds.
• The calculation of needed reserves based on historical data and investment stages.
• The potential pitfalls of overallocating dollars to maintain equity positions.

"But as you may know, for reserve planning, that requires you to do something called recycling... you could theoretically have to pull from management fees and stop paying any fees to yourself in order to fund your reserves."

Mark Suster discusses the practice of recycling capital to fund reserves and the potential consequences of inadequate planning, which could lead to using management fees to cover reserve commitments.

• The correlation between investment pace and economic cycles.
• The benefits of time-based diversity in investment portfolios.
• The potential for a "graveyard" of funds that have deployed capital too quickly without sufficient reserves.

"The nice thing about being over a longer period of time is if you invest over three years versus 18 months, you're more likely to pick up a different phase of the economic cycle."

Mark Suster emphasizes the advantage of spreading investments over a longer period to capture different economic conditions and technological shifts, reducing the risk associated with rapid deployment of funds.

• The historical occurrence of LP defaults during economic downturns.
• The severe penalties for LP defaults and the alternative of selling in a secondary market.
• The impact of economic situations on LP commitments to future funds.

"LP defaults have always existed in a period of huge economic correction, but I think they tend to be pretty mild... Also, if you want to be a long term LP and you're in economic trouble, if you resort to a default, that's a reputational risk."

Mark Suster addresses the likelihood of LP defaults in challenging economic times, noting that while defaults do occur, the consequences and alternatives often lead LPs to seek other solutions.

• The primary role of a VC as a talent manager and people identifier.
• The importance of complementing a founder's strengths and weaknesses with a strong team.
• The significance of supporting founders in building successful companies.

"Fundamentally, we're people managers... The most consequential decision you make after the first check is figuring out the strengths and weaknesses of the founder and then working with him or her to figure out how to build a team that complements them."

Mark Suster explains that the most critical role of a VC is to manage and identify talent, emphasizing the need to support founders in assembling teams that will lead to the company's success.

• The concept of "naive optimism" and its role in a founder's success.
• The challenge of overcoming past experiences that may lead to skepticism.
• The importance of betting on ambitious ideas and making bold investment decisions.

"What I think of is, one of the things it takes to be super successful as a founder is what I call naive optimism... And I've been proven wrong several times on that."

Mark Suster reflects on the necessity of maintaining an optimistic outlook when investing in new ideas, despite past experiences that may suggest otherwise.

• The preference for conviction over consensus in investment decisions.
• The responsibility of the individual partner to own their investment decisions and outcomes.
• The encouragement of productive dissent to identify outlier investments.

"We actually actively use the term that we're looking for conviction over consensus... I'm looking for someone who really believes, and they're going to own that belief."

Mark Suster describes the firm's approach to investment decisions, prioritizing strong personal conviction and accountability over group consensus, fostering an environment where dissent can lead to successful outlier investments.## Investment Decision Process

• Upfront Ventures prefers to have at least a second person supporting the main investment partner.
• They have eight full-time investment partners.
• A typical investment for them is a $3 to $5 million check for 20% ownership.
• They are open to dissenting opinions among partners and believe heated conversations are healthy for the decision-making process.
• A deal is greenlighted unless there's strong opposition from one or two partners.

"I usually prefer at least a second as supporting them. But if it's down the fairway, and down the fairway for us, let's call it a three to $5 million check for 20% ownership. If it's down the fairway and you have high conviction, and there's not one or two partners laying on the track saying, we just absolutely cannot do this deal, we'll greenlight it."

This quote explains Upfront Ventures' general preference for investment decisions, highlighting their typical investment size and the importance of consensus among partners.

• Mark Suster believes the trend of VC firms taking 20% ownership in companies will increase, not decrease.
• He emphasizes the importance of product market fit, founder market fit, and founder upfront fit.
• Upfront Ventures looks for founders who desire a supportive VC through good and bad times.
• He predicts that "party rounds" with multiple small investors will perform poorly in the coming years due to a lack of conviction and coordination among investors.

"Yes. In fact, I think it'll go up from 20%, not down."

Mark Suster disagrees with the idea that the trend of obtaining 20% ownership is over, instead suggesting it will increase.

• Mark Suster recommends three books: "The Accidental Superpower," "The Absent Superpower," and "Disunited Nations."
• These books provide predictions about geopolitical events and their implications for business.
• "Disunited Nations" specifically discusses the breakdown of international cooperation and supply chains.
• He finds these books data-rich and ahead of their time in terms of predictions.

"And disunited nations couldn't have predicted the pandemic, but they exactly predicted what was going to happen in a global breakdown of countries working together, of isolationism and breakdown of supply chains, of things like food and oil."

Mark Suster highlights "Disunited Nations" for its accurate predictions about geopolitical breakdowns and impacts on global supply chains.

• Rory O'Driscoll from Scale Ventures is highlighted for his effectiveness as a board member.
• Qualities appreciated in a board member include: doing the work, having a strong yet flexible point of view, bringing humor, and genuinely caring.
• Great board members are proactive, engage in detail-oriented work, and are thoughtful about company challenges.

"I love working with Rory because, number one, I like people who do the work and many VCs don't do the work."

Mark Suster appreciates Rory O'Driscoll for his dedication and hands-on approach as a board member.

• The current environment is difficult for VCs and even more challenging for entrepreneurs.
• VCs face the task of supporting founders who are dealing with significant disruptions in their businesses and personal lives.
• Mark Suster tries to be present and offer advice, recognizing that many VCs might not engage as deeply with their portfolio companies during tough times.

"It's hard because we're dealing with so many founders who have bet so much of their lives on their company and their futures and just looking at the disruption and the pain going on in their companies, in their families, having to let employees go..."

This quote reflects on the hardships faced by founders and the role of VCs in providing support during challenging times.

• The VC brand is considered critical in winning deals and attracting founders.
• A strong brand helps VCs stand out when founders have multiple funding options.
• Brand encompasses perceived value-add, behavior in good and bad times, and the ability to provide resources and connections.

"And brand really plays into that. They have to perceive that you're going to be value add."

Mark Suster emphasizes the importance of VC brand in influencing founders' perceptions and choices.

• Mark Suster shares two lessons learned over his career: the value of giving founders space to solve problems and the benefits of not engaging in conflict.
• He now believes in allowing founders time to reach their own conclusions.
• He has learned to hold strong opinions without letting disagreements affect his peace of mind.

"And now I realize there's some value in stepping back and giving a founder time and letting them come to their own conclusion..."

Mark Suster discusses the importance of allowing founders the space to work through issues independently.

• Solve is a company that blends video games with short-form true crime videos.
• The company has shown promising results in test markets and has a popular show on Snapchat.
• Mark Suster is excited about Solve's innovative approach to gaming and storytelling.

"What they do is they produce video games... you get dragged into the story and solving the crimes and playing games as you go."

This quote describes Solve's unique gaming experience, which combines video storytelling with interactive crime-solving games.