20VC Venture Capital Is One Hell Of A Drug, What VCs Expect From Founders Once They Have Raised & Why Customers Validate Your Business Not Venture Capital with Eric Paley, Managing Partner @ Founder Collective

In this episode of the 20 Minute VC, host Harry Stebbings interviews Eric Paley, managing partner at Founder Collective, discussing the impact of venture capital on startups and the concept of efficient entrepreneurship. Eric, a former entrepreneur and co-founder of Brontes Technologies, shares insights from his transition to venture capital, emphasizing customer validation over capital validation, and the dangers of overcapitalization. He also highlights the importance of founder ownership and control, warning against the dependency on venture capital that may arise from aggressive funding and valuations. Eric and Harry discuss the challenges in the VC ecosystem, such as the trend towards larger funds and the pressure on startups to achieve unrealistic growth expectations. They advocate for a more stage-specific focus among funds and a balanced approach to growth, where capital is used to accelerate proven aspects of a business rather than to force growth.

• Harry Stebbings hosts the 20 Minute VC podcast and runs a blog on ventures, startups, and guest reviews.
• Eric Paley is the managing partner at Founder Collective, a successful seed fund.
• Eric's background includes co-founding Brontes Technologies and making angel investments before establishing Founder Collective with David Frankel.

"Welcome back to the 20 minutes VC with your host Harry Stebbings at h stepbings on Snapchat. And you can find my written thoughts on our new blog on all things ventures, startups and the review of guests on the show. And you can find that on the incredibly named Mojitovc.com."

This quote introduces Harry Stebbings, the host of the podcast, and mentions his blog where he shares his insights on various topics related to venture capital, startups, and his podcast guests.

"Eric is the managing partner at Founder Collective, one of the world's most successful seed funds, with investments in the likes of Uber, Pillpack, Makerbot and BuzzFeed."

Harry introduces Eric Paley and highlights his role at Founder Collective, a seed fund known for its successful investments.

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The quote explains the functionality and accessibility of Headspace, an app for meditation and mental health, which is also a sponsor.

• Eric was an entrepreneur before entering venture capital, starting a company during the dot-com boom and co-founding Brontes Technologies.
• Brontes Technologies was an innovative product in dentistry involving 3D scanning and was later acquired by 3M.
• After the acquisition, Eric and his partners began angel investing, which led to the creation of Founder Collective.

"Sure. So I was twice an entrepreneur, started a company in New York during the.com boom, and then went to business school, and during business school, teamed up with Micah Rosenblum to start a company with him and two folks out of MIT called Bronte's technologies."

Eric recounts his entrepreneurial background and the founding of Brontes Technologies, setting the stage for his transition into venture capital.

"Ultimately, we sold that company to three m in 2006. So it's starting to be quite a long time ago. I stayed there until the end of 2008. And in that period, from 2006 to 2008, Mike and I joined Dave Frankel, along with another classmate, Chris Dixon, and all started doing a whole bunch of angel investing together. And that work ultimately became founder collective."

This quote outlines the journey from selling Brontes Technologies to the formation of Founder Collective, highlighting the shift from entrepreneurship to angel investing and venture capital.

• Venture capital should not be seen as the primary validation for a business; customer validation is more important.
• While venture capital can be helpful, it can also lead to false validation and potentially unwise investments.
• Venture capital is valuable for scaling successful aspects of a business, but it should not be considered the greatest bottleneck for founders.

"Well, I think for a lot of founders, at the beginning, there's probably too much emphasis on venture capital validating their business. Ultimately, your customers validate your business, venture capital doesn't."

Eric emphasizes that customer validation is crucial for a business, not the acquisition of venture capital, which can sometimes lead to a false sense of success.

"It very rarely really is your greatest bottleneck, but many founders believe it is. Ultimately, though, as you're trying to accelerate success and prove more and more out and scale the things that are working, it is very helpful to have venture capital."

The quote addresses the misconception among founders that capital is their biggest bottleneck, while also acknowledging the role of venture capital in scaling a business.## Over-Capitalization Perils

• Over-capitalization can be a high-class problem for entrepreneurs, where they have the choice of how much to raise.
• The venture ecosystem has a lot of money, leading to entrepreneurs focusing on maximizing capital and aggressive valuations.
• Aggressive valuations and excess capital come with downsides that are under-discussed.
• Founder Collective promotes efficient entrepreneurship for more founder ownership, control, and reduced risk.

"For most entrepreneurs, just raising capital, getting into the point where they can accelerate their business to some degree, is so hard that I think what I'm mostly talking about today is high class problems for most entrepreneurs."

This quote highlights the difficulty most entrepreneurs face in raising capital and suggests that over-capitalization is a problem that affects a smaller, more successful subset of entrepreneurs.

"But those other elements, the aggressive valuations and lots of capital, come with lots of downsides that not enough people are talking about right now."

Eric Paley emphasizes the negative consequences of aggressive valuations and excessive capital, which are often overlooked in the entrepreneurial discourse.

• Efficient entrepreneurship involves using capital to accelerate proven aspects of the business, not just to find what works.
• VCs can offer too much capital, leading to increased burn rates and unjustified pressures based on VC willingness instead of market validation.
• This creates a dependency on venture capital, limiting exit options and creating unsustainable burn rates.

"It's using capital to accelerate those things that are working, as opposed to using capital to find things that work."

Eric Paley defines efficient entrepreneurship as the strategic use of capital to bolster successful aspects of a business rather than experimenting to find success.

"Venture capital is a hell of a drug. It is sort of a drug dependency, because now you have a burn rate that's not necessarily well justified by the evidence that the market is telling you about your company."

Eric Paley likens venture capital to a drug that can create a dependency, leading to spending (burn rates) that are not supported by actual market demand or success.

• The transition from a manageable burn rate to an unsustainable one is not clear-cut.
• Making cuts in a business is painful and not easily done, especially with fixed costs like office space and supplier contracts.
• Entrepreneurs often wait too long to address high burn rates, usually when running low on capital, which is dangerous.

"And when you're burning ahead of what the business is proving, most people don't start addressing that until they start running low on capital."

Eric Paley warns that entrepreneurs often fail to address high burn rates until they are nearly out of capital, which can be too late and lead to painful business cuts.

• A longer runway is healthier for founders and can be achieved with more capital.
• However, the pressure to meet lofty expectations can lead founders to make poor investments and mask underlying business problems.
• Even well-capitalized companies do not necessarily perform better, as shown by a study of tech IPOs over five years.

"Yeah, I think the healthiest thing that founders could do with more capital is drive a longer Runway."

Eric Paley advises that a longer financial runway is beneficial for founders, allowing them more time to develop their businesses without immediate pressure to raise additional funds at higher valuations.

"The second piece we put out in TechCrunch, I did with Joe Flaherty on my team, we looked at what happens with lots of capital, well capitalized companies, when everything goes really incredibly well."

Eric Paley discusses a study conducted with Joe Flaherty, examining the impact of capital on successful companies, which found no correlation between the amount of capital raised and success in IPOs.## Venture Capital Expectations on Valuation Upticks

• Venture-backed startups are expected to grow rapidly; they are seen as potential "rocket ships."
• A rough rule of thumb for valuation upticks is tripling every two years, though some argue for doubling every year.
• If a startup is not tripling its valuation in two years, it may not meet the expectations set upon it.
• Both VCs and founders contribute to setting high expectations due to negotiations over capital and valuation.
• Founders often focus on the benefit of more capital at a higher price without considering the associated risks.

"You should at least be tripling every two years, some people would argue should be doubling every year, which would mean forex in two years."

This quote emphasizes the rapid growth expected from venture-backed startups, with a specific target for valuation increases over time.

"Actually, the expectations come as a result of a tough negotiation where not just vcs, but founders typically want more capital and higher prices."

This quote highlights that both VCs and founders play a role in setting high expectations through the negotiation process.

• The billion-dollar exit requirement is partly mythological but has influenced VC expectations.
• Over 200 companies are considered unicorns, but many may not justify their valuations.
• Venture funds have grown, leading to larger exits being necessary for significant impact on the fund.
• A venture capitalist typically aims to own 20% of a company, making a billion-dollar exit only marginally impactful for a billion-dollar fund.
• Entrepreneurs need to be aware of the size of the investing fund and the associated risk tolerance.

"Any exit that isn't at least equivalent to the size of the fund is not really material to a fund."

This quote outlines the perspective that an exit needs to be at least as large as the fund itself to be considered significant for the fund's success.

"You need five of those just to return your fund. You need 15 of those to get to a three x return, which most limited partners would be looking for."

This quote provides insight into the scale of successful exits required to meet the expectations of limited partners in venture funds.

• There is a distinction between genuine ambition and bravado among founders.
• The "go big or go home" mentality is not a requirement for building a successful company.
• Rational decisions about selling a business are based on the founder's vision of future value and potential inflection points.
• A founder's decision to reject acquisition offers is often grounded in a clear understanding of the company's growth trajectory, not irrational bravado.

"I think it's bravado, not ambition, right? I've never believed that go big or go home is a requirement to building a big company."

This quote differentiates between the concepts of bravado and true ambition in the context of startup growth and decision-making.

"And why would he sell if he could see that much more upside?"

This quote suggests that rational founders base their decisions on their understanding of the company's potential, not on arbitrary growth targets.

• Mega funds like Andreessen, Greylock, and NEA have emerged, focusing on growth stage investing.
• These funds write large eight-figure checks and aim for strong returns, contributing to the extended private IPO period.
• The overfunding of unicorn-class companies is a concern, but wise investment choices can lead to success for these mega funds.

"I think for them to do really well, they need to do a lot of growth stage investing, right, where they're writing meaningful eight figure checks, large eight figure checks, into companies, and seeing strong return on those companies."

This quote explains the strategy mega funds employ to achieve success, highlighting their focus on growth stage investing and significant funding rounds.## Venture Capital Ecosystem Challenges

• Continuously finding new ways to add value in a saturated market with increasing venture shops and co-investors.
• The importance of differentiating and providing unique contributions to portfolio companies.

I think continuously finding new and interesting ways to make sure we're adding value in an ecosystem where there are more and more venture shops, and in fact co investors finding good ways to add value to companies.

This quote emphasizes the challenge that venture capital firms face in maintaining their relevance and competitive edge by consistently finding innovative ways to support their portfolio companies in a crowded market.

• Advocating for more funds to specialize in specific stages of a company's life rather than being lifecycle funds.
• Encouraging entrepreneurs to focus on efficient company building and retaining more ownership due to intelligent growth strategies.
• Suggesting that capital should not be viewed as the primary solution to all business challenges.

I would love to see more funds focus on specific stage instead of being lifecycle funds. ... more entrepreneurs focusing on efficiently building companies, frankly owning more of their companies in the end because of how intelligently they built them, and not thinking that capital is the solution to many of their problems.

The quote captures the speaker's desire for a shift in the venture capital ecosystem where funds are more specialized, and entrepreneurs prioritize efficient growth and maintaining equity, rather than relying heavily on capital infusion.

• Acknowledging the high failure rate of startups and the perception of bridge rounds as delays to the inevitable.
• Recognizing that while many bridge rounds may not lead to success, they can also provide necessary time for some startups to evolve into successful companies.

Look, at the end of the day, most startups fail. So it's easy to look at the companies that need bridge rounds and say they're often piers, not bridges. We have seen many examples of bridges that became great companies.

This quote reflects the realistic view of the high-risk nature of startups and the dual nature of bridge rounds, which can either be a path to failure or a crucial step towards success.

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• The investment was made due to Crayon's innovative approach, strong team, and a supportive syndicate led by Founder Collective and Baseline.

Yeah, we just announced an investment in a company called Crayon, which is a SaaS platform for competitive intelligence... Crayon does this with machine learning and helps understand trend lines over time, how positioning is changing for your competitors, how pricing is changing, how their management structure is changing, how active their marketing efforts are.

The quote explains the reasons behind the investment in Crayon, highlighting its unique value proposition in the competitive intelligence space and the potential it has to transform how companies track and respond to competitors.

• Eric offers personal support and mentorship to Harry, which is highly valued.
• The relationship underscores the importance of guidance and support within the VC community.

What a top man Eric is, and what many do not know is that Eric has been of great support and mentorship to me personally as I progress.

This quote expresses personal appreciation for the mentorship provided by Eric, illustrating the significance of mentor-mentee relationships in professional development within the venture capital sector.

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These quotes serve as endorsements for Headspace and Luma, highlighting their benefits and the personal impact they have had on Harry's life, suggesting their utility for listeners seeking meditation tools and home wifi solutions.