20VC Why Convertible Notes Are Ridiculous, Why Party Rounds Are Bad For Both Founder and Investor & Why ProRata Rights Are A Mess with David Waxman, Founding Partner @ TenOneTen Ventures

In this episode of "20 Minutes VC," host Harry Stebbings interviews David Waxman, founding partner at TenOneTen Ventures, to delve into the intricacies of venture capital and the burgeoning tech ecosystem in LA. Waxman shares insights from his transition from a successful three-time founder to a VC, emphasizing the importance of market size, founder vision, and the challenges of deal structures like convertible notes and party rounds. He also discusses the significance of financial planning over accounting for startups and the necessity for founders to conduct due diligence on potential investors. Waxman's latest investment in Velocity, a company analyzing human motion through phone sensors, exemplifies his commitment to innovative tech beyond the traditional media focus of LA. Throughout, Stebbings highlights various products and services, including the new 20 minutes VC app, Raiden travel gear, and the Simba hybrid mattress.

• Harry Stebings hosts the podcast 20 minutes VC.
• He can be found on Snapchat at hstebings with two B's.
• The podcast now features a new app for easier access to episodes and content.
• The app allows tagging of episodes, finding resources, and providing feedback.
• Jason Humphreys is thanked for his work on the app.
• The app is available on the App Store by searching "20 VC."

"This is the 20 minutes VC with me, Harry Stebings and you can find me on Snapchat at hstebings with two B's." "The 20 minutes VC now has a fantastic app."

The quotes introduce the podcast and its host, as well as the new app that enhances listener engagement with the podcast.

• David Waxman is a founding partner at TenOneTen Ventures.
• TenOneTen Ventures is a prominent new venture fund in the LA tech scene.
• The fund's portfolio includes successful exits to major companies like Facebook, Google, and Amazon.
• Companies in the portfolio include ecommerce unicorn Wish and airspace services platform Airmap.
• David has a history of successful startups, including Firefly and People PC, with exits to Microsoft and Earthlink respectively.
• Saul Klein at LocalGlobe is thanked for introducing David to the show.

"I'm thrilled to welcome David Waxman, founding partner at ten 110 Ventures, one of the leading new venture funds in the rising tide of LA tech." "Their portfolio companies have enjoyed exits from the likes of Facebook, Google, Amazon, Cisco, Airbnb, and include companies like ecommerce, Pioneer and Unicorn Wish, and the world's leading airspace services platform, Airmap."

These quotes highlight David Waxman's role and the success of TenOneTen Ventures within the tech industry, emphasizing the significant exits and notable companies in their portfolio.

• David describes his transition from being a founder to becoming a venture capitalist.
• He used to focus intensely on his startups, limiting his social interactions.
• After his last startup, he became more active in the LA tech community.
• David enjoyed participating in hackathons, meetups, and became an angel investor and advisor.
• He compares the transition to going from being a parent to a grandparent, caring deeply but with less emotional charge.

"I'd go into ultra focus mode for several years when I was doing a startup and I basically wouldn't talk to anybody outside of my immediate family and my colleagues." "You care so deeply about the companies, but everything is a little less emotionally charged."

David reflects on his intense focus during his time as a startup founder and how becoming a VC allowed him to care about companies with a healthier emotional distance.

• David emphasizes the importance of perspective and not being too operationally involved as an investor.
• He acknowledges the control founders have and his role in providing guidance.
• David is careful to consider when to step in and when to allow the founders to lead.

"You have influence, but you don't have control. It's right, it's not your baby." "I can't operate every single company in the portfolio, and I only know so much."

These quotes underscore David's philosophy as a venture capitalist, focusing on influence rather than control and understanding the limits of his role.

• David discusses the transition to investing professionally and learning about the craft of venture capital.
• He initially started investing informally with his partner Gil Albaz and later raised a fund in 2014.
• David learned about LPs, portfolio construction, and brand development as a VC firm.
• The venture capital industry is described as both subjective and objective, with a focus on delivering returns.

"I've learned a whole lot about how much of a craft it really is." "It's a weird industry because it's super subjective and it's super objective."

The quotes reveal David's insights into venture capital as an industry that requires a balance of subjective judgment and objective performance metrics.

• Harry Stebings endorses the Raiden suitcase for its convenience and durability, offering a discount code and Uber credit for purchases.
• He also recommends the Simba mattress for its advanced features and comfort.
• Harry shares his personal use of both products on Snapchat.

"It fits on every plane. My favorite for this, of course, being the carryon." "It's the most advanced mattress in the world."

These quotes provide personal recommendations from Harry Stebings, showcasing his positive experiences with the Raiden suitcase and Simba mattress.### VC as a Craft

• VC approaches vary widely, indicating it's more of an art than a science.
• There's a stark contrast between highly concentrated VC strategies and those with broader portfolios.
• Different methods aim to achieve similar returns but through varying paths.

"I've spoken to so many smart people, I know a lot of vcs and a lot of really great vcs, and everybody has their own slightly or sometimes extremely different take on how to do that. And that makes me think that it's a craft."

The quote explains that the diversity of approaches among VCs suggests that venture capital is a nuanced craft rather than a formulaic process. Each VC's unique method contributes to the artistry of the field.

• Evaluating opportunities in VC often revolves around Total Addressable Market (TAM).
• The concept of TAM can be misleading, as it's difficult to predict the true market potential of disruptive companies.
• Early investors in companies like Uber didn't foresee the full scale of market transformation.
• Founders should focus on a smaller market they can win and then expand.
• VCs should understand a founder's true ambitions and potential for "world domination."

"But it's really, really hard to get the magnitude right. I doubt that if you went back to any of the investors who looked at Uber. I doubt any of them imagined that it could be bigger than the black car industry, and maybe a few imagine that it could be big as the taxi industry."

This quote emphasizes the challenge of accurately gauging a company's market potential, as exemplified by the underestimation of Uber's growth by early investors. It highlights the unpredictability of market disruption and the importance of vision in evaluating VC opportunities.

• The discussion is planned to delve into the importance of data in creating a competitive advantage for VCs.
• The specifics of this discussion are not included in the provided transcript.

"And then I'd love to move into a deeper discussion on the role and moat created by data."

This quote sets the stage for a future discussion about how data can create a defensible competitive edge in the VC industry, although the details of this conversation are not covered in the transcript segment provided.

• VCs get excited by founders who can articulate growing market trends.
• Companies like Joy Mode exemplify innovation by challenging traditional ownership models.
• Founders should be able to connect their business to broader societal shifts and trends.

"I believe it's a big swing, what Joy mode is doing, but if they win, they're really taking on the very idea of ownership, and there's nothing big than that."

The quote illustrates the potential for startups to revolutionize established concepts, like ownership, by aligning with cultural trends. It underscores the importance of a founder's ability to articulate and tap into these shifts for VC interest.

• Equity rounds are generally preferred over convertible notes for larger funding amounts.
• Convertible notes leave many terms undefined, which can lead to complications later on.
• Clear deal structures and agreements are crucial for both founders and investors.

"But when you get into a multimillion dollar round, I think that convertible notes make absolutely no sense at all."

This quote expresses a strong stance against using convertible notes for significant funding rounds due to the ambiguity they can create in key terms of the deal.

• Party rounds lack a clear lead investor, which can be problematic during company challenges.
• Strong leadership among investor groups is essential, especially when a company faces difficulties.

"But when the company encounters challenges, sometimes an investor group really needs a lead because they need leadership."

The quote highlights the importance of having a lead investor to provide guidance and take charge during challenging times, which party rounds typically lack.

• Prorata rights have become problematic in recent deals.
• The specifics of these issues are not detailed in the transcript provided.

"There's something that I've noticed lately that's become kind of a mess, and it's probably worth a whole different podcast, which is that prorata rights have become kind of a mess."

This quote points out that prorata rights are currently causing complications in VC deals, suggesting the need for further discussion and potential reform.## Founder-Investor Dynamics

• Founders face a challenging situation balancing early investors' rights and new investors' ownership demands.
• New investors often require minimum ownership thresholds, putting founders in difficult positions.
• Founders must navigate the potential of either disadvantaging early investors, rejecting ideal A round investors, or accepting more dilution than necessary.

"Here founders are put in this terrible situation of trying to do right by their early investors and respect all of the contractual rights that they signed up for, and new investors demanding minimum ownership thresholds."

This quote highlights the dilemma founders face when trying to honor early investors' rights while meeting new investors' demands for ownership stakes.

• Ownership thresholds for investors have become stricter compared to the past.
• New layers of professional investors have emerged, such as pre-seed, seed, and post-seed investors, all expecting to follow on.
• Prorata rights are increasingly seen as a separate asset class, leading early investors to hold on to them longer.

"One is that these ownership thresholds are stricter than they used to be...and then the problem is compounded because you have all these new layers of professional investors..."

This quote explains how the investment landscape has evolved, with more investor types and stricter ownership requirements complicating fundraising for founders.

• Founders should carefully consider prorata rights when distributing them to early investors.
• Adjusting the major investor threshold can limit the number of investors with contractual prorata rights.
• Founders can negotiate with A round investors who demand high ownership percentages.

"One is think through the pro rata rights as you're giving them out early...people who invest less than the threshold often don't get prorata rights, and people invest more than it do get prorata rights."

This quote suggests that founders can manage investor expectations and contractual obligations by setting and adjusting the major investor threshold.

• Founders may underestimate their leverage when negotiating with prestigious VC firms.
• Investors who are genuinely interested in a startup are unlikely to walk away over a small percentage difference.
• Founders should prioritize maintaining good relationships with all investors for the company's future.

"It always shocks me, but founders are rightfully, they want to get through the process...but I think that they underestimate the power of the situation that they're in..."

The speaker indicates that founders have more negotiating power with investors than they might realize, especially when the investor is very interested in the company.

• Limited Partners (LPs) often desire co-investment opportunities, particularly family offices and high net worth individuals.
• Founders should have a say in whether LPs can directly invest in their company.
• It is crucial for founders to vet LP co-investors thoroughly to ensure they align with the company's vision and culture.

"Nearly every lp I talk to wants them...They want us around for a reason. They don't necessarily know our lps and they don't know whether they're going to be good investors or difficult investors."

This quote emphasizes the importance of founders being comfortable with LPs as potential direct investors in their companies, given that they have established relationships with the VCs, not necessarily the LPs.

• Founders should conduct due diligence on potential investors, similar to the scrutiny they face from investors.
• It's essential to understand an investor's behavior in both successful ventures and challenging times.
• The relationship with an investor is long-term and difficult to dissolve, making thorough vetting critical.

"It's important for founders to know what they're dealing with when they get into that situation...before you get into a divorceless marriage, it's probably worth doing your homework."

The speaker advises founders to perform due diligence on investors to understand their track record and behavior, as the investor-founder relationship is enduring and binding.

• There is a growing conversation about the role of secondary markets for early-stage investors.
• Secondary markets may become more necessary due to constraints in IPO and M&A markets.
• Founders and investors should consider the right timing and circumstances for utilizing secondary markets.

"I haven't thought about that. Maybe as much as Samil. We haven't gotten to the point in any of our companies where I would want to sell our stake prior to an exit."

The speaker acknowledges the potential importance of secondary markets but has not yet found the need to engage with them personally, suggesting a cautious approach to selling stakes before an exit.## Favorite Book Recommendation

• David Waxman does not have a single favorite book, as he reads and loves many.
• He recommends "The Last Lion," a three-volume biography of Winston Churchill.
• The book covers Churchill's life from Victorian England to the presidency of John F. Kennedy.
• Churchill's impact on history and his personal flaws are highlighted.
• The biography also provides a perspective on the historical changes during Churchill's lifetime.

"The Last Lion, especially because you're English. It's a three-volume biography of Winston Churchill and he's an amazing man. He had real flaws, but without him we'd probably be having this interview in german, or more likely as a jewish person, I probably wouldn't be here at all."

This quote explains the significance of Winston Churchill as a historical figure and why "The Last Lion" is a recommended read, especially for an English person. It highlights Churchill's impact on world history and his personal complexities.

• David Waxman tries to be aware of cognitive biases that affect venture capital (VC), such as loss aversion.
• He understands the financial equivalence of a loss and a high gain, despite their emotional differences.
• Waxman notes that the best VCs have higher loss ratios because they take more risks.
• He is concerned about his own fund's low loss ratio and the potential lack of risk-taking.

"A one x loss is the same as the difference between, say, a twelve x or a 13 x gain. Emotionally they feel completely different, but financially they're the same."

This quote clarifies the concept of loss aversion in VC and the importance of understanding the financial reality over emotional responses. It highlights the necessity for VCs to take calculated risks to achieve higher returns.

• David Waxman believes that a real tech ecosystem is being built in Los Angeles (LA).
• LA is known for Hollywood, fashion, and media, which contributes to the success of companies like Snapchat and Tinder.
• There is a legacy of hard tech in LA, with aerospace being revitalized by companies like SpaceX.
• The growth of VR in LA is supported by the talent from visual effects studios and academic institutions.
• LA's tech ecosystem is becoming richer and more diverse, attracting talent and new residents.

"There's a real tech ecosystem being built. There's so much going on here right now."

This quote emphasizes the burgeoning tech ecosystem in Los Angeles, which encompasses a variety of industries beyond the traditional media and entertainment sectors.

• David Waxman reads "Strictly VC" for venture capital news.
• He uses Nuzzel to get recommendations from his network.
• Waxman listens to podcasts but does not have other daily reading habits.

"I read strictly VC pretty regularly just to sort of get the news and I'm a nuzzle user, so I get a lot of recommendations from my network."

This quote reveals David Waxman's sources for staying informed about venture capital news and trends, highlighting his preference for curated content from his network.

• David Waxman sees finance and accounting as distinct disciplines.
• Finance is forward-looking and crucial for startups to model and guide their future.
• Accounting is backward-looking, ensuring that money is accounted for properly.
• While accounting is essential, finance plays a more significant role in business planning.

"Finance and accounting are totally different disciplines. Finance is completely prospective... Accounting is retrospective."

This quote explains the fundamental differences between finance and accounting, emphasizing the prospective nature of finance in contrast to the retrospective function of accounting.

• CEOs must always be aware of their company's cash zero day.
• They should also know their monthly burn rate and projected revenue for the next month.

"You need to know at any moment, a CEO needs to know her cash zero day monthly burn and projected revenue for the following month."

This quote stresses the critical financial awareness a CEO must maintain to manage a company's cash flow effectively.

• David Waxman's recent investment is in a company called Velocity.
• Velocity has created a catalog of human motion, which can be detected through phone sensors.
• The technology can distinguish between various activities and contexts, which is valuable for mobile advertising and app personalization.

"Velocity has created a huge catalog of human motion... They can tell based on the motion sensors of your phone what you're doing at the time."

This quote describes the innovative technology developed by Velocity and its potential applications in enhancing mobile user experiences through context-aware services.