It's Not Just What You Say, It's How You Say It

The average VC meets dozens of new founders each week. That means dozens of conversations with incredible founders sharing their visions for the future. While most founders focus on talking about their product and market (after all, market matters most to VCs), the investor on the other end of the call is often focused on something different: you.

Over the years, I’ve heard thousands of founders tell me about their market hypothesis, product, technology, team and long-term ambitions. But the reality is, I already knew most of what they were going to tell me from reading their pitch deck.

In our first meeting, I’m focused less on what a founder says and more concerned with how they say it.

Last week, I shared my story of pitching legendary investor Brad Feld and what I learned from that experience. Here are some of the things that I’m watching for in a first conversation:

Founder-Market Fit

We talk a lot about product-market fit, but founder-market fit is arguably more important to investors in the early stages of a company.

As a VC, I want to understand why you chose this particular problem. Of all the things that you could devote your life to, what started you down a path that will potentially lead to you spending the next 7-10 years (or more) on this?

Ultimately, VCs are looking for a passion that goes beyond just numbers. Far too many founders I meet have thoughtful business plans and product roadmaps, but can’t articulate in a convincing way why they’re doing this instead of any number of other things (beyond money). As a former founder, I know how hard things get and how lonely and exhausting the CEO journey is. I need to have conviction that 5 years down the road, when things get tough, early employees (and potentially cofounders) move on and the level of competition has you feeling like you’re like a back alley knife fight, you’re still going to push ahead because this problem matters so much to you.

The Road Ahead

The founders and companies that attract the most investor attention are, paradoxically, the ones that need our help the least.

VCs are in the business of generating a return for our LPs, which means we’re going to be far more interested in a company whose success seems like an inevitability than one that needs a lot of help. In my experience, this is best reflected in the level of confidence with which a founder talks about the road ahead:

• Do you know exactly what the market wants and/or have a plan to figure it out?

• Do you know where your competitors are weak and how to exploit those weaknesses?

• Do you understand how purchase decisions are made in your market and have GTM (go-to-market) ideas that make sense and are realistic to execute?

• If you’re in a regulated industry, do you know the exact steps necessary to gain approval and how long each step will take?

• Do you know who you need to hire over the next 18 - 24 months and have a plan for finding those people?

• Do you know what your blindspots are as a founding team and have a plan to solve for them?

• Do you know what milestones you need to achieve in order to unlock subsequent rounds of funding?

I don’t expect founders to have answers to every single one of these questions (especially first-time founders), but I am looking for founders to come armed with a solid plan of what they’re going to do tomorrow, next week and next month.

I’m looking for founders who have supreme conviction in what they’re doing and what it’s going to take to succeed — and that they’re going to succeed with or without my help (though, hopefully, I can help a bit 😉).

Hungry Yet Humble

In my experience, the most successful founders exhibit both the extreme conviction I referred to above and a level of humility that enables them to learn from others and incorporate new information as it becomes available. It’s what I refer to as “hungry yet humble.”

When I speak with a founder for the first time, I specifically ask questions to understand how they incorporate new information:

• If I challenge an assertion you made, do you respond in a thoughtful way or brush off my concerns?

• If I point out contradictions or limitations in your approach, do you engage in a discussion or retreat to defensiveness?

• If I offer a suggestion based on my past experience, do you take note of it, blindly accept it or immediately reject it?

I’m looking for founders who are willing to engage in thoughtful discourse and are capable of evolving their view of the world. You shouldn’t blindly accept everything I say, nor should you become defensive when I ask a pointed question or offer constructive criticism (and you definitely shouldn’t become argumentative). New information will come at you from all manner of sources and it’s essential that you be able to thoughtfully incorporate it into your model of the world.

Team Cohesion

Another thing I’m watching when I meet founders for the first time is how they interact with one another. Are you generally respectful and play to each others strengths? Or do you contradict, interrupt or one-up each other?

Over the years, I’ve seen it all. Cofounders correcting each other, disagreeing with each others’ answers or responding with snipes and micro-aggressions. I even watched two founders get into a full-on argument with each other while all but forgetting that I was in the room.

Once again, I’m not expecting you to be perfect. Fundraising can be incredibly stressful and you’re going to disagree. But I need to believe that you generally like and respect each other and can work together successfully for many years.

No Assholes

This last perspective isn’t shared by every VC (if it were, certain companies would never have had a single investor). I have zero interest in investing in or working with assholes. When Stanford professor Robert Sutton wrote his bestselling book in 2007, I loved it.

But as a VC, I’m in the business of generating a return for my LPs, so my feelings alone aren’t enough.

From a pure returns perspective, I believe that in today’s age of hyper-connectivity and social media, generational companies can no longer be built by people who exhibit or tolerate bad behavior. While there are still some well-known companies led by prominent jerks, I believe that the age of the asshole CEO is nearing its end and that investing in such founders today will lead to poor returns over the long run.

Companies led by assholes almost always self-implode. We’ve seen it over and over again. It will only happen more.

To be clear, this doesn’t mean that everyone should love you or that you should behave like a pushover. It does mean that you’re a generally good person who treats other people with respect. If you can’t do that, you’re going to have a tough time recruiting and retaining people. So, if I get a sense the first time we meet that you’re a jerk, we’re probably not going to spend much more time together.

Some behaviors that will immediately land you in my bad books:

• Rude or disrespectful behavior (to anyone)

• Being dismissive or talking down to a junior member of our team

• Interrupting, cutting off or otherwise disrespecting female members of our team

• Argumentative or combative behavior

• Racist, sexist, or otherwise inappropriate comments

The Moment of Truth

It was early 2012. My cofounder and I were huddled around a laptop nervously pitching yet another investor (that’s right folks, remote pitches existed long before Covid). But this wasn’t just any VC. Staring back at us from the screen was Brad Feld, cofounder of Foundry Group and TechStars.

It was the early days of DataHero and we were trying to raise our Pre-Seed round. Our vision was to create the world’s first cloud-native business intelligence platform. We believed that the shift to software-as-a-service would lead to massive demand for analytics solutions capable of unlocking insights across those services. Key to achieving this goal was the ability to identify and standardize data regardless of where it came from. To prove out our concept, we had created a prototype that could take any CSV file and automatically identify and normalize the data it contained.

Of course, it was the early days, so our prototype had lots of bugs.

DataHero 0.8 — aka why DataHero’s first hire was a designer

Brad Feld was the “final boss” in our quest to secure a term sheet from Foundry Group. We had already spoken with his three partners, Ryan, Seth and Jason, each of whom had given us a thumbs up. So there we sat, dutifully answering Brad’s questions before transitioning into a demo.

Brad’s eyes lit up as we showed him our prototype, importing a variety of CSV files that were automatically turned into beautiful charts. He then jumped into more questions,

“Can your system really take any CSV data and understand it?”

“Yes!” replied my cofounder and head of product, sharing more about how the underlying technology worked.

“Does the data need to be in a specific format?”

“No,” replied my cofounder, “DataHero can figure it out automatically!”

At that point, I started to get nervous. Brad was asking what were starting to feel like leading questions and my cofounder was getting caught up in the excitement.

“So…you can literally take any CSV file and load it into DataHero right now…?”

Before I could kick my cofounder under the table, he excitedly blurted out “Yes!!” as I watched a mischievous smirk pass across Brad’s face.

“I just emailed you a CSV export from my Withings scale. Can we try it?”

Actual photos of Brad Feld on a startup pitch call

Cue the record scratch.

At that point, we faced a choice: do we try loading Brad’s file, knowing that there was a high likelihood something would go wrong (seriously…our prototype had a lot of bugs), or do we back pedal and try to escape the corner that we’d painted ourselves into?

We took one look at each other and, without saying a word, answered, “absolutely!”

I then found the CSV file in my email, loaded it into DataHero and…

…it completely broke.

We desperately looked through the errors in front of us and figured out pretty quickly what went wrong. We told Brad that we knew what the issue was and asked if we could email him the results later that day. He agreed.

We got off the call frustrated and deflated.

We figured that we’d just blown our chances with Foundry, but nonetheless got to work fixing the bug in our prototype. A couple of hours later, we sent Brad a PDF with the charts that DataHero had generated from his data.

The next morning, we received an email from Ryan McIntyre with a term sheet to lead our Pre-Seed round.

---

A few weeks later, we went to Boulder and met Brad in person for the first time. I asked him about our experience and what made him decide to invest in us.

“The way you answered,” he responded, matter-of-factly.

“Look, I knew it would probably break,” Brad continued. “I didn’t care if it worked or not, I cared about how you answered. I would have invested even if your response was ‘we’ll send it to you the next day.’”

“The fact that you were willing to try it live — right then and there — told me that you guys believed it would work. That you believed in what you were pitching me. The way you responded told me everything I needed to know about you guys.”

Over the years, I’ve learned an incredible amount from Brad and his partners at Foundry, but this lesson always stuck out:

When the moment of truth arrives, how you respond matters as much as what you say.

Why Don't VCs Give Feedback?

One of the most frustrating experiences for startup founders is to have multiple calls with a potential investor, dutifully answering follow-up questions from the VC and their team over the course of several weeks, only to hear…nothing.

“Cricket's the name. Jiminy Cricket.”

Unfortunately, it’s an all-too-common experience. While there are some fantastic investors who make a point of providing very detailed feedback when they pass on a company, they represent the exception rather than the rule. Many VCs pass with what feels like comically generic reasons (“you’re too early for us”), while entirely too many simply ghost founders.

Why do VCs act like this? Why don’t they have the decency to at least say “no” when they decide that they’re not interested? Or provide more than a single sentence when they pass after 5 meetings and 10 phone calls?

As a founder, I had far more of these frustrating experiences than I’d care to remember. I never understood why an investor wouldn’t “close-the-loop” or be willing to share their honest feedback with me.

Now that I’m on the other side of the table, I understand some of the reasons why many VCs don’t give feedback. While I’m not going to try to justify all of these, here are some insights to help you better understand what’s going on in the mind of many investors and a few strategies you can use to try to pry a bit more feedback out from them.

Let’s start with some specific situations that investors regularly encounter.

The Rebuttal

Many founders find it difficult to listen to live investor feedback without offering a rebuttal. Especially if they think that the investor is wrong.

It’s human nature to want to correct people and defend yourself. Especially when you’re trying to sell. I’ve run virtual fundraising bootcamps for 5 years and the only way we’ve been able to get founders to actually listen to investor feedback is to mute them immediately after they’re done pitching. And those are situations where the only goal is to get feedback!

From the perspective of the investor, it’s kind of like dating. If you’ve made up your mind that there isn’t going to be a second date, having to defend and justify your reasons for not wanting another date can be exhausting. Which is why so many people don’t bother.

The Argument

It’s one thing to offer a well-meaning rebuttal, but it can escalate — many founders actually argue with investors when they pass.

The unfortunate reality is that, despite craving closure, many people don’t react well to critical feedback. I’ve seen everything from profanity-laden emails to lengthy twitter threads to outright screaming sessions in response to well-meaning, thoughtful feedback. While it might be easy to dismiss these as extreme outliers, they happen more often than you might think.

The Badmouthing

At this point, you might think that having a founder scream and insult you is the #1 reason why VCs don’t give feedback. But you’d be wrong. Worse than having someone insult you is when a founder reacts to critical feedback by “shooting the messenger” and privately badmouthing you to other founders.

In other words, there’s a non-zero chance that as a “thank you” for providing honest feedback, you will lose access to a future deal.

And this isn’t just a theoretical risk…

It’s Not Me, It’s You

Things get dicier when the reason why an investor is passing is the founder.

Even if an investor likes everything about the business, if there are concerns about the founder / founding team, VCs won’t invest. Here are some of the dynamics that raise concerns for potential investors about the founding team:

• Warning signs of friction between the cofounders

• Inappropriate language/behavior during calls

• Poor/problematic reference calls

• Challenges articulating the problem (even if the solution works, can the founder sell it / sell the vision to potential customers/employees/future investors?)

• Lack of mental flexibility (not open to engaging in discussion/debate about the company / product / thesis)

Suffice to say, if some founders get defensive when offered constructive feedback on their business, you can imagine how well that goes over when it’s about them as individuals…

Despite all of this, there remain many investors (myself included) who strive to give detailed feedback to each and every founder we meet.

How To Get Better Feedback

Now that you understand a bit more about what’s going on in the mind of a VC, how can you increase the likelihood that you walk away from a “pass” with helpful feedback?

1. Preempt Fears of a Rebuttal

If an investor begins to tell you that they’re passing, immediately eliminating concerns over a rebuttal can be very helpful in extracting feedback.

[VC] At this point, I don’t think this is going to be a fit for us…

[Founder] Before you go any further, is there anything I can say at this point that would change your mind?

[VC] <Usually caught a bit off guard> No.

[Founder] In that case, would you be willing to share your thought process and allow me to ask a few questions about that to better understand?

Simply telegraphing that you don’t intend to argue with them can alleviate an investor’s worries about your reaction and effectively lower their defenses when it comes to offering genuine feedback.

2. Ask About Your Weaknesses

Proactively asking about your weaknesses is a great signal to investors about your coachability and openness to feedback. If they end up passing, it increases the likelihood that they’ll provide more detailed feedback.

3. Don’t Defend Yourself

The moment an investor tells you that they’re passing and begins to convey their reasoning, you have a decision to make: will you try to change their mind / offer a rebuttal or will you listen to the feedback? It’s very difficult to do both.

In my experience, once an investor has made the decision to communicate a pass, they’ve made up their mind. Absent a complete misunderstanding of your business, it’s unlikely that anything you say will change that. So if you really want to learn from the feedback, it’s essential that you listen.

Sometimes, it can take a few seconds to switch contexts and get out of selling mode. I find that leveraging a prop can help buy you a few seconds to transition into the right mindset:

[VC] At this point, I don’t think this is going to be a fit for us…

[Founder] Before you go any further, do you mind if I get out my laptop/notepad so I can take notes on your feedback?

[VC] Absolutely.

4. Ask for Feedback

If a VC sends you a pass email with a generic (or non-existent) reason, don’t be afraid to ask for feedback:

Dear [VC],

Thank you for closing the loop with regards to our conversation. Would you be willing to share a few additional details about your reasons (either by email or on a quick 5-min call)? Any feedback you would be willing to share would be massively helpful as I go forth on my founder journey.

Same thing goes for the situation where a VC ghosts you:

Dear [VC],

Given that I haven’t heard from you in the past 2 weeks, I’m presuming that you’ve made the decision that [company] is not a fit for [VC]. I completely respect your decision and would love to learn from it. Would you be willing to share a few details about your reasons for passing (either by email or on a quick 5-min call)? Any feedback you would be willing to share would be massively helpful as I go forth on my founder journey.

5. Don’t Get Angry

Above all else, resist the urge to get angry / take it personal (even if the reasons for passing seem stupid). At the end of the day, the vast majority of conversations you have with VCs will not lead to an investment. But they can lead to learnings.

Each pass is an opportunity to create a data point. The more data points you have, the more obvious patterns become. If you hear the same reason over-and-over again (even if you don’t agree with it), you can learn and do something about it.

Why Market Matters Most to VCs

A lot of things can go wrong for a startup. In fact, the vast majority of startups ultimately fail. They fail because they didn’t find product-market fit, got beat by a competitor, were pre-empted by newer, better technology or were unable to figure out an effective go-to-market strategy. They also fail for all sorts of human reasons: cofounder breakups, bad hires, culture issues and the simple, heartbreaking realities of life.

As both a VC and former founder, I understand this all too well. And that understanding is fundamental to the decisions that I make as an investor.

It Starts with the Power Law

You’ve undoubtedly heard or read about the significance of power law distributions (aka “power law”) to venture investing, but most people don’t appreciate how fundamental a role the concept plays in the investment decisions that VCs make.

It’s long been understood that venture returns are best described by a statistical distribution known as power law, in which a small number of investments are responsible for the majority of the returns. (You may also have heard this referred to as the “Pareto principle” aka “the 80/20 rule”. Pareto distributions are, in fact, a type of power law distribution.)

My far more educated brother-from-another-mother, Jerry Neumann, once wrote a deep dive into the economic theory behind power law distributions in venture investing. If you want to go really deep on the topic, read this.

In 2014, Correlation Ventures released a landmark study of 21,640 VC investments that took place over the course of 9 years and the returns generated by their investors:

The study empirically confirmed that the returns of venture-backed startups indeed follow a power law distribution — although the distribution was far more skewed than many investors previously believed. What the chart above shows is that nearly 90% of all venture investments result in returns that are inconsequential to the majority of VCs. That might seem like an exaggeration (for most people, a 1 - 5x return-on-investment is pretty good), but if you’re an early-stage VC, it is indeed the case.

Seth Levine of Foundry Group wrote a great post shortly after Correlation’s study came out that explained why. In his post, Seth described the returns of a hypothetical $100M fund and noted that if the fund failed to invest in at least one company that returned more than 5x, it would ultimately fail to generate a positive return for its investors (i.e. it would lose investors money).

Going further, for a $100M VC fund to generate a positive (but not great) return for its investors, it typically must invest in at least one company that returns 10x or more. But here’s the thing: the target return for top-performing VC funds is 3x. For that to happen, a $100M fund must invest in at least one company that returns 50x or more!

So what does it takes for an early-stage VC to generate such a return? Let’s look at an example.

Evolution of an Early-Stage Investment

At Panache Ventures, we invest exclusively in Pre-Seed and Seed stage startups (conveniently for this post, out of a $100M fund that precisely matches Seth’s example).

Let’s assume that Panache invests $1M into a Seed stage startup at a $10M post-money valuation. Once that round has completed, Panache owns $1M / $10M = 10% of the company.

Our hypothetical company is doing quite well and 18 months later the founders raise a Series A. Assuming that Panache invests our pro rata (which we typically do in companies that are executing well), then we will remain with 10% ownership of the company following that round. Let’s assume that the pro rata investment for Panache is a further $1M, thus bringing the total investment by Panache to $2M.

Like most early-stage funds, Panache Ventures typically does not invest after the Series A, so our ownership in the company will dilute with each subsequent round. If we assume that each round dilutes the company by 20% (a reasonable assumption for a solidly-growing company), our ownership will evolve as follows:

• After Series B: 8%

• After Series C: 6.4%

• After Series D: 5.12%

• After Series E: 4.10%

(In reality, Panache’s ownership will almost certainly be lower than the above amounts, as this example doesn’t take into account non-finance dilution, such as when the size of the employee stock option pool needs to be increased, or other common situations where overall dilution increases.)

Like founders, early-stage investors see their ownership slowly but surely diluted over time

Let’s assume that our hypothetical company continues to grow and ultimately has a successful exit after the Series D (at which point Panache owns 5.12% of the company). Here are the returns to Panache based on various exit scenarios:

• $100M Exit: $5.12M (2.56x ROI, based on a $2M total investment)

• $250M Exit: $12.8M (6.4x ROI)

• $500M Exit: $25.6M (12.8x ROI)

• $1B Exit: $51.2M (25.6x ROI)

• $2B Exit: $102.4M (51.2x ROI)

• $5B Exit: $256.0M (128x ROI)

(Note that these scenarios are again overly-simplistic, in that they do not take into account multiple share classes, investor preferences and other terms and dynamics that typically come into play when an exit occurs.)

If we look through the above scenarios, we can see that our hypothetical company needs to exit for at least $250M in order for Panache’s return to exceed 5x. For the return to be 50x — enough for Panache to “return the fund” (i.e. generate a 1x ROI for Panache’s $100M fund) — the exit must be at least $2B.

This is why VCs are so focused on unicorns.

Isn’t This Post Supposed to be About Markets?

Given that the title of this post is “Why Market Matters Most to VCs,” you’re probably wondering why I haven’t talked about markets yet.

Because we needed to walk through the details of power law math in order to understand the significance of the following fact:

The vast majority of markets aren’t large enough to support companies that can credibly generate a $2B+ exit.

The uncomfortable truth is that a lot of effort is spent on companies where, even if everything goes right, the economic outcome simply isn’t big enough for investors. This doesn’t mean that those ideas aren’t important or worthy of pursuit. It does mean that the majority of startup ideas are fundamentally not a fit for VCs.

And, ultimately, it’s because of the size of the market that they’re going after.

Marc Andreesen of a16z noted this back in 2007 in a famous — though somewhat controversial at the time — post he wrote titled The Only Thing that Matters. In considering the variables of team, product and market, Marc noted that “in a terrible market, you can have the best product in the world and an absolutely killer team, and it doesn’t matter.” At the end of the day, if the market isn’t large enough to credibly support multiple multi-billion dollar companies, then it doesn’t matter how good the team or product are, the outcome will never be big enough to generate a return that is meaningful to VC investors.

In practice, this manifests in the fact that VCs spend effort analyzing the market potential for each-and-every startup they consider investing in as part of their diligence. At Panache, our analysts work to not only understand the target market as described by the founders, but also adjacent markets (so that we have a sense of what is possible if the company expands beyond and/or pivots into a different market). This analysis provides the foundation for a key part of our investment thesis: a set of calculations that describes various exit scenarios for the company, based on target and adjacent market sizes and historical exit multiples.

Our goal: to build confidence that, if everything goes right, the resulting return will be sufficient to “return the fund.”

If this sounds like an incredible amount of work for an early-stage investment, rest assured that top VCs are really good at it. In our case, we can go from first meeting to term sheet in less than a week, with a comprehensive market analysis and exit scenario map having been created in the background.

That said, the outcome of our analysis plays a key role in whether or not we invest in a startup. If, at the end of the day, there isn’t a version of the future where a company can generate a 50x return on our investment, then we will not invest. No matter how good the team is. No matter how cool the product is.

Because to VCs, market matters most.

Don't Forget the Big Picture

Last week, I had the privilege to attend Capital Camp, a 3-day investor conference held in Columbia, Missouri.

If you’ve never been to Columbia, you’re not alone - it’s a town with a population of about 125,000 smack dab in the middle of the American Midwest. Columbia is probably best known as the home of the University of Missouri (aka “Mizzou”), but it’s also home to a unique private equity fund called Permanent Equity, the hosts of Capital Camp.

Columbia, Missouri was not on any of my American geography tests growing up in Canada…

Permanent Equity invests in “private companies deliberately built for long-term success…with 30-year funds.” It goes without saying that any group of people who would have the audacity to create a PE firm that invests in 30-year fund cycles think about the world in a different way, which is part of why I was so excited to attend Capital Camp. The thing is, other than having a number like-minded investors telling me for the past few years that I “have to go to Capital Camp,” I really didn’t know what to expect.

What I got was a 3-day reminder of why many of us do what we do: to make the world a better place for our children and our communities.

Opening night (photo courtesy of Kirby Winfield)

While Capital Camp is an investor conference insofar as all of the attendees are investors, it’s not a conference about investing. Yes, there were talks on interest rates, emerging markets and M&A. But there were also panels on developing audiences, strengthening marriages and reinvigorating communities. Moreover, the entire 3-day event was curated specifically to facilitate building genuine connections through small group activities (many of which involved food).

Here are some of my takeaways from this year’s Capital Camp:

Tech Really is a Bubble

While I saw a number of familiar faces at Capital Camp, I would guess that fewer than 25% of the attendees were tech investors. To my sincere delight, I met incredible investors who were every bit as deep into areas that I know nothing about as I am into tech. Some owned brick-and-mortar businesses while others were focused on creating financially self-sustaining models for reducing global poverty and homelessness. Over the course of three days, I spent almost no time talking about tech investing, other than when answering questions from my fellow “campers” about how our industry works (it was quite entertaining to see the looks of confusion on the faces of so many investors when I shared that my job is primarily to invest in businesses that have no business plan 🤣).

AI Will Change Everything…Maybe

One of the most talked-about sessions was from Kanyi Maqubela of Kindred Ventures, who gave a riveting overview of the history of AI and shared his thoughts on where things might be headed. On the one hand, it was apparent to everyone in the room that the rise of AI will have a monumental impact on everyone. On the other hand, many of the investors I spoke to afterwards reacted with bemusement to the thought that AI could threaten their businesses (“I promise you, AI is not going to stick its arm into a dirty pipe to remove a jammed sock from a washing machine.”). Overall, the feelings around AI were a mix of excitement, trepidation and ambivalence - which is probably the right balance.

Investor-Philosopher Kanyi Maqubela

Food Builds Connection

At the start of Capital Camp, the hosts — Brent Beshore and Patrick O’Shaughnessy — playfully joked that one thought of Capital Camp as an investor conference with great food, while the other looked at it as a food and wine event with a bunch of investors. That perspective was the foundation for many of the conference’s activities: small-format demonstrations and hands-on tutorials for groups of 10 - 30 investors. Each session was intentionally designed to be informative and entertaining, while facilitating conversations and connections between the attendees. As someone who loves to cook and host food-related events, I came away with a ton of ideas for future Panache events (along with a full belly and many new friends).

What Matters is People

Whether it was the founders of Marsh Collective sharing stories from their 30-year marriage and their mission to revitalize small towns across America or David Steward and Jim Kavanaugh of World Wide Technology inspiring the audience with lessons from building the largest black-owned company in America, the focus throughout Capital Camp was on the people. The employees, communities and families without whom nothing is possible. At a conference attended by some of the most successful investors in the world, the humility, groundedness and feeling of genuine care for people in each and every conversation was amazing and served as a poignant reminder of what really matters.

Not a bad place to hold a conference

While I never expected to attend an investor conference in Columbia, MO (heck, until recently, I never even knew such a place existed), I am beyond grateful to have escaped my VC bubble for 3 days in the American Midwest. It’s easy to get caught up in the hype of our industry, which makes it all the more important that we step out of our bubble from time-to-time to reflect on the big picture.

The Power of In-Person

For the better part of the past three years, there’s been a debate about the importance of working in-person. At the height of Covid, many voices were proclaiming that the office was dead and remote-only was the future of work. Today, many are arguing (just as loudly) that real companies need to be in-person, all-the-time.

I personally think that the reality is somewhere in the middle. At the end of the day, many connections can only be made in-person and the best companies — remote, hybrid or traditional — need to prioritize making that happen with some amount of regularity. That’s why twice each year, the entire team at Panache Ventures gets together for a week of in-person strategy meetings, team-building activities and connectivity building.

Panache Ventures team dinner!

Last week, the Panache Ventures team from across Canada descended on New York for our semi-annual team retreat. We plan our retreats months in advance, in order to make the most of our time together. Our agendas aren’t all that different from what a startup retreat might look like, and typically include the following:

• Weekly activities that are normally done remotely (e.g. our weekly investment committee meeting)

• In-person training sessions (new expense tracking system! 🎉)

• Educational sessions (e.g. fireside chats with other VCs and subject-matter experts)

• Team dinners and fun activities

We even did a VC “hackathon”, working in small teams on prototypes that we can develop to further support the founders we invest in (stay tuned 👀).

“Team Red” hard at work

But these team retreats aren’t just about getting our team together. We believe that it’s important for Canadian VCs to get out of Canada, so we intentionally hold our semi-annual retreats in leading U.S. ecosystems — one each year in San Francisco, and another elsewhere in the U.S. Taking our entire team – from partner to junior analyst – to the leading U.S. startup hubs immerses everyone in the competitive energy of the world’s biggest tech ecosystems while enabling them to build connections with investors, founders, and ecosystem players across the U.S.

On this trip, NYC-based angel investor Jerry Neumann (aka my brother-from-another-mother), shared lessons and learnings from his upcoming book, Founder vs. Investor, while our friends at First Mark Capital hosted us at Data Driven NYC, their quarterly showcase of leading companies and practitioners of data, machine learning and AI in New York City.

Data Driven NYC, hosted by First Mark’s Matt Turck

Each time we hold a team retreat, we also take the opportunity to host an event for local VCs and angel investors to talk about the opportunities in Canada and all of the great things Canadian startups are doing. In New York, we held an investor-only event at Rise by Barclays, the city’s preeminent fintech hub, in partnership with BMO, Telus Ventures, Fasken and the Government of Canada.

The Consul General of Canada in New York, Tom Clark, speaks to a packed house about Canada’s role in the emergence of AI

At the end of the day, there’s simply no replacement for being together, in-person. Whether you’re a small startup or a high-growth company, prioritizing bringing your entire team together in an intentional way can deliver countless long-term benefits, while providing opportunities to promote your brand and strategic priorities.

Thanks New York! Next up, San Francisco in September ☀️.

Stop with the Fake FOMO

FOMO — the source of and solution to many a founder’s fundraising woes. Over the years, countless stories have been written about founders using FOMO to catalyze a fundraising process to stratospheric heights. What too many founders misunderstand is that FOMO only works when applied to a well-run fundraising process. It’s not a replacement for actual investor interest.

And it’s not something you can fake.

Here are 5 mistakes founders make when pushing fake FOMO:

1. Pushing FOMO Too Early

Pushing FOMO too early in a fundraising process is like asking someone out on a date and prefixing it with “by the way, three other people are already considering proposing to me.” Even if it’s true, it’s gross.

Here are some of the ways I’ve seen this play out:

FOMO Before the First Date

You secure a warm introduction to an investor. The next step is to schedule an initial call. Unfortunately, some founders can’t resist the urge to throw in a bit of FOMO in that very first interaction. Here’s one I saw recently:

Great to connect. Here’s my calendly to book a time that works for you. Our round is moving quickly, with a good number of funds in due diligence right now. I'd be happy to discuss more over a conversation.

I’m sure this founder thought that they were adding a subtle bit of urgency to the interaction. Instead, the reaction was an unnecessary eye roll.

FOMO During the First Date

I recently had a first call with a founder who I had heard good things about. At the end of our introduction, I asked if he had any questions for me (reminder: this is the opportunity for you to ask an investor how their process works, what next steps are and gauge their initial reaction). Instead of asking me any questions, he proceeded to state that his process was going incredibly fast, he felt that he had shared everything necessary in order for me to make an investment decision, and he expected to receive a term sheet from me by the end of the week.

The Ticking Timebomb

Another common tactic used to push fake FOMO is the “ticking timebomb”. In this approach, founders send successive emails urging investors that time is almost up. While investors genuinely want to be updated if a round is progressing quickly, it’s easy to go overboard (particularly if the progress isn’t real).

I recently received a series of cold emails from a founder who wanted to pitch me (yes, I read cold emails!). This particular founder combined FOMO “before the first date” with a ticking timebomb, but couldn’t keep his numbers straight:

March 3:

Our funding round is almost full (~80%). Therefore, we strongly recommend strategic investors to get in now, or the opportunity won’t be there.

March 18:

I'd love to have Panache in our investment round but the window is closing as we are beyond 70% of the round and current investors are increasing the size of their participation.

The “No Time for Questions” Approach

A tactic that was common in the heyday of 2020-21 was for founders to limit the number of responses they would provide to investor diligence requests. When a fundraising round is legitimately competitive, this can make a lot of sense. But it only works in truly hot deals.

I’ve seen many founders who clearly read about this approach online, but failed to understand that in most cases it doesn’t work. Why? Because most VCs won’t make an investment until they get all of their questions answered.

One company I met last year tried to do this. The first meeting got me interested, so I asked to schedule a follow-up meeting to dig into a couple of topics that were important to me. Instead of agreeing to another meeting, the founder sent me this email:

We're no longer taking meetings really, just closing the loop with a few folks from last week. Back to building + looking for a first customer. Is there something I can answer for you over email?

Instead of continuing to dig in, I sent them this response:

In that case, I’ll pass.

Good luck!

This particular company completely failed to raise their round, in large part because they tried this tactic with every VC they spoke to and 100% of investors disengaged.

2. Not Understanding How VCs Make Decisions

When you project FOMO too early in the process, you’re highlighting to investors that you don’t understand how they make decisions.

Every VC has a process that they follow internally when making investment decisions. While most firms have the ability to accelerate that process, no good investor will skip steps in their diligence process. Understanding where a given investor is in their process and what steps remain is critical to knowing whether or not FOMO will help or hurt you.

If you signal too early that you’re close to the finish line, investors who are near the beginning of their process will simply opt out, for fear of not having enough time to complete their process (they would rather use their time and resources towards a deal they’re likely to win). That’s why it’s so important to ask every investor in your first meeting how they make decisions and what needs to be true in order for them to reach conviction.

3. Using Hyperbole Instead of Hard Numbers

Another dead giveaway of fake FOMO is when founders use subjective hyperbole instead of hard numbers. It’s the same effect as when a pitch deck says “we’re growing fast!” but doesn’t show any graphs or metrics.

The first example above, in which the founder pushed FOMO before the first date, captures this:

Our round is moving quickly, with a good number of funds in due diligence right now.

Even if it’s true, the lack of concrete numbers raises doubts. Sharing hard numbers without adjectives or exaggerations is far more effective than the most eloquent hyperbole:

• We’re in week 2 of our fundraising process and are in second meetings with a dozen firms.

• 7 firms are already in our data room.

• We’re currently in 3rd and 4th meetings with a handful of firms.

• We have received 3 term sheets and are entertaining additional offers until 5pm on Friday.

• We are currently raising our pre-seed round via SAFE ($6M valuation cap and 20% discount). So far, $500K has been committed and I am looking to raise another $250K.

Each of these statements implies urgency by the very nature of their facts, without resorting to artificially pushing urgency through over-the-top language.

4. Trying to predict the future

Many founders feel the need to over-explain things. A common example of this in fundraising occurs when founders want to signal that term sheets are close, but try to predict the future instead of sticking to the facts:

We’re expecting term sheets by…

or

We’re almost at term sheets.

Here’s the thing: you either have a term sheet or you don’t. The moment you try to predict when a term sheet might land, you open yourself up to the collapse of your entire fundraising process if one doesn’t materialize.

Unless you’re near-certain, avoid the urge to say “we’re hoping for term sheets by Friday” and stick to the facts. If you tell an investor that “we’re in 3rd and 4th meetings with multiple firms,” “we’re nearing the end of our process,” etc., I promise that they know what that means. 

5. Not Reading the Room

Today’s fundraising environment is not what it was two years ago. VCs aren’t in a rush (even when it comes to generative AI). Moreover, we generally know the pace at which our peers are moving. If you try to project a level of FOMO that doesn’t match what we know to be happening in the industry, you’re likely to fail.

The sky is falling!

How to do it right

Arjun Dev Arora is a former founder and VC who advises startups around the world on effective fundraising. According to Arjun, effective FOMO is created by tactfully letting investors know how the round is progressing. You want to let investors know what’s happening without being over-the-top. This means:

• Being honest and truthful. FOMO is built on a foundation of fact.

• Being concrete. Use hard numbers and dates instead of subjective hyperbole.

• Being subtle. Lead investors down the path but trust that they’ll reach the right conclusion.

Remember, investors receive hundreds of emails from founders each month. I promise that it’s glaringly obvious when founders try to push fake FOMO. You might think you’re being smart, but the VC on the other end is likely rolling their eyes.

And deleting your email.

10 Books Every Founder Should Read

It seems like every blog has a top-10 list of books that founders absolutely, positively must read. So why should I be any different? 😂

All jokes aside, I’ve found that many book lists for founders over-index on biographies of “famous” founders and investors. While reading about Steve Job, Jeff Besos, Ben Horowitz or Elon Musk can provide plenty of motivation, your mileage as a reader definitely varies.

So I’ve put together a list of books that, I believe, are valuable for all founders to read, regardless of your personality, approach or experience. The book list below includes three categories:

• Understanding the Market and Opportunity

• How to “Startup”

• Founder Mental Health

Without further ado, here are 10 books (and one bonus book) that all founders should read:

Understanding the Market and Opportunity

1. Crossing the Chasm

Let’s start with one of the most foundational startup books ever: Crossing the Chasm. Originally published in 1991, Crossing the Chasm was one of the first mainstream business books to focus on the different stages of technology product adoption. The book is based on the technology adoption lifecycle, a model that describes the adoption or acceptance of a new product or innovation by different segments of the market. Its particular focus is on the “chasm” that exists between early adopters of a new innovation and the majority of the market. While the original edition of Crossing the Chasm is more than 30 years old, its framework is as relevant today as when it was first published.

2. The Innovators Dilemma

The Innovator’s Dilemma is another classic business book that every founder should read. First published in 1997, the book focuses on why incumbent companies consistently struggle to adapt to distributive technologies. Through a detailed study of multiple industries across several decades, Christensen unpacks the structural factors that prevent incumbents from reacting to disruption. For any founder who’s ever been asked “What if Google builds this?” (or who wants to better understand how their ‘David’ can conquer ‘Goliath’), this book is a must-read.

3. The Mom Test

When I teach entrepreneurship at the Beedie School of Business, The Mom Test is required reading for all students. This is by far the best book I’ve read when it comes to learning how to validate market opportunities when most people aren’t inclined to give you honest feedback. The book goes into detail about all of the ways people “lie” to you about your idea and strategies for getting effective market and product feedback.

How to “Startup”

4. The Lean Startup

Very few people can claim to have started a genuine movement, but Eric' Ries did just that with The Lean Startup. The basis of The Lean Startup is both simple and powerful: startups should iterate rapidly in order to make progress while course correcting early. Prior to the lean startup movement, software development typically followed a “waterfall model”, which involved significant design work up front and an implicit assumption that you could “think” your way through product design. In contrast, The Lean Startup emphasized repetitive cycles of learning, building and measuring results.

While most founders today implement some form of lean startup methodology in their companies, if you haven’t read the foundation within The Lean Startup, it’s worth the time.

5. The Cold Start Problem

Founders often hear about “network effects” when reseaching startups or talking to investors, but how do you actually create them? Andrew Chen is a General Partner at a16z and, prior to that, led rider growth at Uber. His book focuses on the “cold start problem” - aka how do you bootstrap the network effects necessary for two-sided marketplaces and other similar businesses to succeed. Through case studies including Uber, Tinder, Dropbox, Zoom and Airbnb, The Cold Start Problem presents a framework for testing and building network effects in a focused, iterative way.

While The Cold Startup is targeted at founders of two-sided marketplaces and other startups with network effects, the structured way in which Andrew presents his approach to go-to-market makes this a worthwhile read for every founder.

6. Venture Deals

Historically, the power and information dynamics between founders and investors has always been in favor of VCs. Brad Feld and Jason Mendelson, two of the co-founders of Foundry Group, sought to change that when they published Venture Deals in 2012 (sadly, the book came out 6 months after DataHero raised its Pre-Seed round from Foundry Group, so I didn’t have the benefit of this tome). The book’s subtitle, Be Smarter than your Lawyer and Venture Capitalist, is a tongue-in-cheek nod to both Brad and Jason’s roles as VCs and Jason’s status as a former lawyer.

Venture Deals provides an introduction to many of the key terms that appear in startup investment agreements and walks readers through the significance of each term, what the implications are and why investors ask for them. A particularly helpful aspect of the book is that it includes founder call outs throughout, in order to provide perspectives from actual founders.

7. Startup Communities / The Startup Community Way

2012 was a busy year for Brad Feld as an author, as he also published the book Startup Communities that year. The book talks about how to build entrepreneurial ecosystems, using the town of Boulder, CO as an example (Brad and his cofounders relocated to Boulder to form Foundry Group. He also co-founded Techstars there). 10 years later, Brad teamed up with Ian Hathaway to publish The Startup Community Way, a follow-up book that looked back on the lessons of Startup Communities while overlaying the experience of Boulder with those of emerging ecosystems around the world.

While Startup Communities and The Startup Community Way are both ostensibly targeted at stakeholders in emerging startup ecosystems, these books can be incredibly helpful for founders to better understand the resources available to them, particularly if they’re based in smaller or emerging tech hubs.

Founder Mental Health

8. Reboot

Jerry Colonna is a former VC-turned-executive coach, who for many years has run transformational founder and executive bootcamps. His 2019 book, Reboot, is equal parts a leadership book, a compilation of case studies and a shockingly vulnerable autobiography that looks back at Jerry’s own childhood and his struggles with mental health. While this is very much a book about leadership, the degree to which it focuses on the impact that our childhood experiences have on our ability to lead makes it stick out from the thousands of cookie-cutter management books that are published each year.

9. Lost and Founder

I’ve written previously about my friend Rand Fishkin’s book, Lost and Founder, in discussing founder mental health. Unlike most founder autobiographies, this one hits hard. Rand opens up about the rise and fall of both his company and his status within it, while unpacking countless aspects of the founder experience that are far more common than the “up-and-to-the-right” narrative that the media would have you believe. I highly recommend this book for any founder starting (or thinking about starting) an entrepreneurial journey.

10. Quit

Former professional poker player and current advisor-to-founders, Annie Duke, published an excellent study on the importance of quitting late last year, appropriately called Quit. I previously wrote a detailed review of this book (go read it now!). Suffice to say, I think that this is an incredibly important book and one that all founders should read.

Bonus: Coming Soon

11. Founder vs Investor

This September, renowned angel investor Jerry Neumann and former founder Elizabeth Zalman are publishing a new book called Founder vs. Investor: The Honest Truth About Venture Capital from Startup to IPO. The book covers a litany of topics related to the founder-investor relationship, which as any founder (or investor) can tell you is rife with conflicting motivations. I was lucky enough to read some early drafts and this looks to be an important addition to founder libraries.

The book will be released on Sept. 12, 2023 and can be pre-ordered on Amazon.

Making Sense of Accelerator Terms

Accelerator season is upon us!

Last week, I was in Montreal for the launch of FounderFuel, which is making a return to Montreal after a 4-year hiatus. We’re also only a few weeks away from the start of YC’s S23 batch and the launch of many other summer accelerators. As founders around the world contemplate joining accelerators and incubators, the inevitable question comes up: is it worth it?

The Basics

In general, accelerators “cost” between 5-10% of a company’s equity. In exchange, founders receive the benefits of the program, along with a nominal investment.

Here are some example terms from well-known accelerators:

• Y-Combinator: USD $125K for 7%

• Techstars: USD $120K for 6%

• 500 Startups: USD $112.5K for 6% ($150K - $37.5K “Program Fee”)

• Entrepreneur First (UK): £80K + ~£6K/founder stipend for 10%

• FounderFuel (Canada): CAD $120K for ~8%

• Alchemist (Enterprise Software): USD $25K for 5%

• HAX (Hardware): USD $150K for 14%

The Fine Print

I won’t go into the details of each and every permutation of accelerator fine print (I would have to write a series of novels in order to do so). Suffice to say, there are many nuances to the terms offered by accelerators around the world. While the terms aren’t generally meant to be misleading, it’s incredibly important that you understand the fine print before you sign on.

Covering an entire topic is hard

Here are a few examples of accelerator fine print:

Y Combinator

Y Combinator makes an initial investment of USD $125K for 7% of the company, but they also have the right to an additional USD $375K investment on “Most-Favored Nation” terms. This means that they have the right to invest an additional USD $375K at the best SAFE terms that occur between the time you start the program and your next equity round. On the one hand, this ensures that you have $375K already committed to your next round. On the other hand, depending on how your post-YC fundraising goes, they could end up owning a lot more than 7% of your company.

500 Startups

500 Startups advertises a USD $150K investment, but subtracts from that a USD $37.5K “Program Fee”. This type of clawback is a fairly common (and relatively benign) practice amongst accelerators. It’s simply a means for them to transfer money from their investment fund to their balance sheet in order to fund operations (i.e. pay the salaries of all of the people who run the accelerator). Bottom line: they’re actually giving you USD $112.5K as opposed to $150K.

Entrepreneur First

Entrepreneur First focuses on helping train individuals to become entrepreneurs. The program starts by offering individuals a £2K/month stipend to participate in the program. If, at the end of the program, you end up founding a company, they have the right to invest £80K for 10%. The thing is, they have no obligation to do so. So, even if you do found a company during the program, you might end up finishing with £80K in the bank and EF owning 10% of your company. Or you might end up with a shiny new company that you (and your cofounders) own 100% of, but no money in the bank.

FounderFuel

FounderFuel invests CAD $120K, but does so in two parts:

1. CAD $20K for 5% of the company in common shares

2. CAD $100K on a SAFE with a CAD $3.5M valuation cap and a 20% discount

Assuming that you raise your next round at or above a valuation of CAD $3.5M, FounderFuel will own ~7.9% of your company. However, if your next round occurs below the cap, then the 20% discount comes into play and they could end up with a higher ownership percentage.

The Investment

The #1 thing that most founders get hung up on when comparing accelerators is the investment amount.

The thing is: that’s not actually the main benefit.

When you join an accelerator, you’re committing to spending 3 - 6 months of your life in the program. That’s a huge time commitment when you’re a founder. Not only that, you’re giving up 5 - 10% of your company for that privilege.

The investment amount? It’s actually a rounding error in the big picture.

Now, don’t get me wrong — $100K or $200K is a significant amount of money when you’re an early-stage founder. But it’s honestly not a large amount of money to raise if you’re running a high-velocity fundraising process. In fact, the investment amount was never meant to be the primary focus.

The financial investment from accelerators was originally meant to serve two purposes:

1. To provide you with operational capital while you’re in the accelerator

2. To provide a mechanism for the accelerator to obtain equity without tax implications

Funding as Operational Capital

When Y Combinator, 500 Startups and Techstars were founded, each of them realized that for their programs to succeed, they needed to provide founders with operational capital to keep the lights on while they were participating in the program. The concept was similar to scholarships for university: if you don’t have to worry about paying the bills (i.e. getting a part-time job), then you can better focus on the educational content of the program.

If you look at accelerators and incubators around the world, you’ll find that the amount of capital invested typically equates to 4 - 6 months of runway for a company of 3 - 5 people. This is absolutely by design (and why accelerators in cities with lower costs typically invest far less than those based in major tech ecosystems).

Funding as a Means to Transfer Equity

It may surprise you to learn that U.S. tax law contributed significantly to the precedent set by the original startup accelerators when they provided companies with funding in exchange for equity. In the U.S., there is no way for a startup to simply “give” an accelerator equity without a taxable event occurring. Absent an exchange of cash-for-equity, accelerators would have pay taxes on the receipt of equity and both the startup and the accelerator would need to jump through hoops in order to ensure that the calculations were correct (e.g. 409A valuations). Mistakes could lead to lots of problems down the road, including a degree of outcome variability for the accelerators that simply wasn’t worth it.

Exchanging funding for equity results in a clean, simple transaction for both sides.

Do Accelerator Valuations Matter?

In short: no.

Many founders worry that they could be setting a precedent for future funding rounds if the valuation implied by an accelerator’s terms is too low. In reality, no investor takes into account accelerator valuations when thinking about a company (if an investor ever tries to use this as a negotiation point, you should run the other way).

It’s also quite common for startups to join accelerators with implied terms that are lower than the terms that they have already raised on. Generally, this isn’t an issue — although if your early investors have “Most-Favored Nation” terms, then you’ll need to go back to them and negotiate an exemption before signing onto the accelerator (something that any good investor will generally agree to).

How Do You Decide?

When I was a founder, I never participated in an accelerator (although Brad Feld and David Cohen, two of the cofounders of Techstars, were investors in DataHero through their respective funds), so I can’t speak from personal experience as a founder.

However, my first role in VC was at 500 Startups, where I helped to run the firm’s flagship San Francisco accelerator. After that, I helped launch and operate accelerators on five continents and founded one (San Francisco-based Commonwealth Ventures). In short, I believe that the right accelerator can have a massive positive impact for many first-time founders. But you have to choose carefully.

Where’s Chris?

After seeing the inside of so many accelerators, my perspective is simple: if the money wasn’t part of the equation, would you trade X% of equity to participate in the program?

Like any important decision, you need to do your research. What companies have gone through the program and what outcomes did they achieve? What do the founders who participated in the accelerator have to say about it? What areas do you need help in and does the program focus on those?

If the answer is yes, then it’s probably a good deal, regardless of how much the accelerator invests. If the answer is no, then — absent a desperate need for funding — you probably shouldn’t do it.

It really is that simple.

How to Make the Most of Mentors

I spend a lot of time mentoring founders. I would guess that I've easily spent 2,500+ hours mentoring founders over the years through my role as a VC, programs like Creative Destruction Lab and Barclays Global Connect and just generally trying to be helpful. And I’m far from alone.

One of the things that makes the startup world so special is that the vast majority of people genuinely enjoy helping others. Most of us sincerely want to see founders succeed. As a result, it's easier than you might expect for resourceful entrepreneurs to get face time with experienced founders, investors and subject matter experts.

Unfortunately, I've found that many founders don't know how to make the most of these opportunities.

Here are 5 common mistakes founders make when meeting with mentors:

1. Not Preparing

Founders spend countless hours preparing for pitches and fundraising meetings, but many are shockingly unprepared when they meet with mentors whose insights could potentially change the trajectory of their startup.

If you’ve taken the initiative to ask a mentor to speak with you and are allocating 30 minutes or more of your incredibly limited time to the meeting, why wouldn’t you research their background and experience and come prepared with a list of specific questions/topics to discuss?

2. Talking Too Much

One of the most common mistakes I see founders make during mentorship meetings is they spend way too much time talking. They’re so used to being in “sales” mode that they don’t know how to turn it off.

From a founder’s perspective, the goal of a mentorship meeting should be to extract as many insights as possible from the mentor in the time you have with them. If you spend 10 or 15 minutes out of a 30-minute call sharing your entire company and life’s story with them, then you leave only 15 minutes to get actual value from the meeting.

Of course, this relates to being prepared. If you’re not asking the mentor for product advice, then you don’t need to give them the full breakdown on what the product is and how it works. If you’re not speaking to them about founder dynamics, then it doesn’t matter who your cofounders are or how you met. And so on.

3. Not Controlling the Meeting

Another corollary of being unprepared is that many founders allow mentorship meetings to be pulled into random directions based on the natural flow of the conversation. This can sometimes be good, but in many cases you eat into your limited time with the mentor by discussing unrelated topics that pop into your head, are outside of the mentor’s area of expertise and/or could easily be answered by Googling.

Mentorship meetings are conversations, so there needs to be a certain degree of organic flow, but it’s up to you to focus and refocus the conversation towards the issues that are most important to you.

I promise, the mentor won’t be offended.

4. Late / Bad Location / Poor Connection

I can’t tell you how many mentorship calls I’ve had where the founder dials in late or from a bad location with questionable WiFi.

Mentorship meetings might not be your top priority, but if you’ve gone through the effort to secure a meeting with a mentor, why on earth wouldn’t you plan the call at a time and location that ensures an optimal outcome?

Two things typically result from this:

1. Founders don’t get the most out of the mentor’s time (“can you hear me now..?”)

2. The mentor tends to leave the meeting with a poor impression of the founder

The latter might not matter in the long run, but if you’re hoping that the mentor might help you on an ongoing basis or make introductions in the future, first impressions matter.

5. Doing Exactly What the Mentor Says

pinball / ˈpɪn.bɑːl / verb. - to move abruptly from one place to another

A common mistake that first-time founders make is to leave a mentorship meeting and do exactly what the mentor said that they should.

A few weeks later, they speak with another mentor, who contradicts the first one. The second mentor was incredibly compelling, so they change directions completely and do exactly what the second mentor advised.

And so on.

One of the biggest challenges for founders is learning how to reconcile strongly-voiced, contradictory opinions from experienced mentors. Learning to filter advice through the lens of understanding the mentor’s lived experience is crucial to not being reactive.

In Search of Alpha

If you’ve spent any time reading “VC Twitter” or been in the company of a group of VCs for more than 5 minutes, you’ve probably seen or heard reference to the concept of “finding alpha”. But what is “alpha” and where do you find it?

Alpha is one of the key metrics used to evaluate the performance of an investment portfolio. It measures a portfolio manager’s ability to outperform a market index, when adjusted for risk. An alpha of 1.0 means that the investment outperformed its benchmark index by 1%.

Of course, most VCs aren’t actually thinking about rigorous financial benchmarking when they’re talking about alpha.

When VCs talk about “finding alpha,” they’re loosely referring to the strategies they use to (a) win deals and (b) increase the likelihood that the startups they invest in succeed.

Hunting vs. Farming

The “hunter / farmer” sales model is one that’s been around for decades and captures these two key aspects of venture capital. In this methodology, “hunters” are salespeople who seek out and win new customers, while “farmers” cultivate relationships and generate returns from existing customers.

In venture capital, “hunting” refers to going out and winning new deals (investing in new companies) while “farming” refers to increasing the likelihood that a company will succeed through post-investment support and services.

Hunting Alpha

It goes without saying that VCs must first-and-foremost invest in startups. But what does alpha refer to in this context?

When VCs think about generating returns through hunting, they’re referring to two things:

1. Being able to invest in the best companies they can (winning deals)

2. Being able to invest at the best price they can (maximizing the potential return on an investment)

In both cases, investors can increase their chances of success by identifying and investing in startups early. Stated differently, when VCs are talking about “hunting alpha”, what they’re really referring to is avoiding competition.

For any given startup, one of the primary drivers of valuation is the level of competition amongst investors. This is why high-velocity fundraising is typically the best approach for early-stage startups. Investors, however, want to minimize competition. Not only does competition reduce the likelihood that a firm will win a deal (point 1 above), but if it does, the price will likely be higher (point 2 above).

Within VC firms, “deal sourcing” refers to the activities that the VC performs in order to identify new startups. Like any organization that performs sales and marketing, deal sourcing for VCs is a combination of “inbound” and “outbound” activities.

Inbound activities focus on increasing the likelihood that founders will reach out to the firm when they fundraise. These include traditional marketing activities like public speaking, newsletters and blogging (like the post you’re reading right now 😉).

Outbound activities try to proactively identify startups before they fundraise, in order to give the VC an opportunity to engage with the founders early. If you’ve ever received cold emails from VCs asking to meet, this is what I’m talking about.

For early-stage VCs, outbound activities focus on identifying both startups that might be of interest and individuals who might become founders.

In the US, most startups incorporate as Delaware C-Corps. The Delaware Division of Corporations has a public database of all registered companies and many VCs have built bots that monitor that registry for new companies that might be of interest. LinkedIn is another source of potential leads for VCs. If you’ve ever changed your status to “Starting Something New” or “Cofounder at Stealth”, VCs around the world immediately know.

Many VCs also have outbound activities that are designed to systematically leverage their networks to identify potential investments. Scout programs, in which VC firms empower founders and others in their network to make small investments on their behalf, are an example of this. The original scout program was created by Sequoia more than 10 years ago and led to early investments in Uber and Stripe.

Farming Alpha

In venture capital, “farming” refers to all of the ways VCs try to increase the likelihood that the startups they invest in succeed. Historically, this started and ended with the investing partner. After making a new investment, the lead partner might regularly meet with the founders to give them advice, sit on their board to provide fiduciary oversight, make introductions, etc. But that was about it.

In the early 2000s, VC firms started to build internal capabilities to perform some of the key but non-core functions startups required. The premise was that by helping founders not “get distracted” by non-core activities, they could increase the velocity of the startup and the likelihood that it would succeed.

After DataHero closed its Pre-Seed round in 2012, my cofounder and I easily spent two months on non-core activities, ranging from setting up bank accounts and accounting systems to building recruiting and onboarding infrastructure to generating legal agreements.

First Round Capital was one of the first firms to do this at scale, providing the startups it invested in with accounting and other services needed to “stand up” a company. Today, many VCs employ subject matter experts (such as internal recruiters, design partners and even decision support partners) that their portfolio companies can leverage. a16z famously employs more operating partners than it does investing partners.

At Panache Ventures, one of the ways we generate farming alpha is through Panache Academy, our San Francisco-based accelerator. Panache Academy delivers programs exclusive to our portfolio companies, such as our quarterly fundraising bootcamp. We believe (and have the data to show) that participating in the Panache Academy fundraising bootcamp materially increases the likelihood that our portfolio companies will succeed in raising follow-on capital, the valuation at which they raise follow-on capital, and the quality of the VC firms from which they raise follow-on capital (all of which increase the likelihood that those companies will succeed).

In fact, the entire accelerator model is based on a farming-centric approach to generating returns. Prominent accelerators like Y Combinator, Techstars and 500 Startups all have models built on investing in a large numbers of very early startups and surrounding them with the expertise needed to help them get to product-market fit.

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The level of competition amongst VCs has never been higher. At the same time, outbound activities are becoming commoditized, greatly diminishing the potential for hunting alpha.

As we look ahead to the next decade of venture, I believe that the importance of investor value-add — farming — will only magnify in importance. Even in the current downturn, founders are firmly in the drivers seat when it comes to choosing who to allow on their cap table. Providing more than just capital is now table stakes for VCs and where the next decade of alpha is like to come from.

Why Do Pre-Seed Investors Ask for Side Letters?

I was recently asked by a founder to explain why early-stage VCs ask for side letters when investing using SAFEs. “Isn’t the point of a SAFE that it’s a standard agreement?”

Let’s dive in, starting with a bit of history…

The History of SAFEs

The SAFE (“Simple Agreement for Future Equity) was introduced by Y Combinator in 2013. Prior to that, startups raised funds using one of two methods:

1. Equity (Priced) Rounds

2. Convertible Notes

Priced rounds have the advantage of certainty of terms, but require a lot more detail than might be appropriate for a startup that has not yet achieved product-market fit. Convertible notes “kick the can down the road” in terms of valuation and terms, however, they are a form of debt (which comes with its own risks and drawbacks).

When we raised DataHero’s USD $1M Pre-Seed round in 2012, the SAFE did not yet exist. We executed a full equity agreement that cost ~USD $35K in legal fees.

The goal of the SAFE was simple: to standardize the fundraising documents for early-stage startups in a way that reduced overall costs and complexity, provide clarity for both sides around scenarios that were likely to occur, and avoid the pitfalls of debt.

When we raised DataHero’s Pre-Seed round, we had the benefit of an incredibly founder-friendly lead VC in Foundry Group, so our documents were “clean” and straightforward. Unfortunately, many startups don’t have that luxury. It wasn’t uncommon in those days to see small Pre-Seed rounds done with shareholder agreements filled with predatory terms.

Actual footage of a startup founder trying to avoid predatory investor terms

In addition to limiting the cost and complexity of small rounds, a major (positive) side-effect of the widespread adoption of the SAFE is that the prevalence of damaging and predatory terms in early funding rounds has been significantly reduced (at least, in North America).

The Limitation of SAFEs

The primary focus of the original SAFE was to simplify angel rounds (YC’s stated goal when it introduced the SAFE was to replace convertible notes, as opposed to VC-led equity rounds). Over time, however, investors across the board saw the benefits of this simplified approach for small funding rounds and many Pre-Seed VCs began to adopt the SAFE as their preferred agreement.

Today, Panache Ventures invests exclusively using SAFEs, unless a non-SAFE round has already occurred and/or we are co-investing with a firm that insists on an equity round.

This development was great for startups, as it made it faster, easier and cheaper to raise from Pre-Seed VCs. However, the simplicity of the SAFE was in part due to the removal of clauses that, while not particularly important to angel investors, matter a lot to VCs. As more and more VCs adopted the SAFE for smaller rounds, they needed to find a way to “add back in” key clauses without losing the spirit of the SAFE’s simplicity.

The point of the SAFE was to be a standard legal agreement that could be used without changing anything other than the cap, discount and signees. In order to maintain the standard SAFE template, another mechanism was needed to codify the additional clauses required by VCs. The result was the SAFE “side letter”.

VCs and Founders Adding and Removing Legal Clauses

What is a Side Letter?

A side letter is an amendment to a legal agreement that has the same force as the underlying contract but only impacts the signees to the side letter. Using a side letter along with a SAFE allows additional terms/provisions to be added that apply to the relationship between the VC and the startup without changing the SAFE itself or impacting other investors.

What Clauses Do VCs Put in SAFE Side Letters?

There are three clauses that are commonly found in SAFE side letters:

1. Information Rights

Information Rights grant the investor the right to receive certain types of information (typically, quarterly and/or annual financial reports) on an ongoing basis.

VCs need access to financial information in order to fulfil their fiduciary duties, however, the standard SAFE does not include any such rights (which makes sense, since founders generally would not want to provide detailed, highly-confidential financial information to each and every angel investor).

2. Pro Rata Rights

Pro Rata rights grant the investor the right to invest an additional amount at the next round in order to maintain their ownership percentage.

Angel investors rarely ask for this, as most would not be able to afford to invest in subsequent rounds. For VCs, however, the ability to maintain their ownership percentage as the company makes progress is key to generating a return for their investors. This right is standard in priced rounds but does not exist in the SAFE.

3. Major Investor Rights

Major Investor rights relate to the rights that the investor receives after the SAFE is converted into equity.

Each time an equity round occurs, investors receive a class designation (e.g. “SAFE Investors”, “Seed Investors”, “Seed-2 Investors”, “Series A Investors”, etc.). These designations are used throughout the shareholder agreement to define the rights, privileges and preferences of each class of shares. Class rights are shared by every investor in the class, regardless of how much (or how little) they invested.

A VC who invests $10M in a Series A round will receive the same class rights as an angel investor who contributes $10K as part of that round.

In addition to the shared class rights, shareholder agreements include a set of rights that are reserved for investors (typically VCs) whose shareholdings exceed a minimum threshold (referred to as the “Major Investor threshold”). The most common Major Investor rights relate to actions that cannot be performed without the approval of the Major Investors, including:

1. Acquisitions, Mergers and IPOs (i.e. a startup cannot do any of these without the approval of the Major Investors)

2. Diluting the rights and protections of the Major Investors (i.e. the rights of the Major Investors cannot be negatively altered in subsequent rounds without that investor’s approval).

Pre-Seed investors without the protections of Major Investor status can be wiped out by subsequent investors without any recourse

The standard SAFE does not include any reference to Major Investors, so it is common for side letters to include language that grants the investor “Major Investor” status — however that is subsequently defined — when the SAFE is converted into equity.

Why Have I Never Heard of This?

One Canadian founder I spoke to recently about SAFE side letters shared that he had asked an American founder friend about the topic and that founder’s response was, “I’ve never heard of such requests. It must be a Canadian VC thing.”

That perspective couldn’t be further from the truth.

In reality, there’s an entire generation of founders (in both Canada and the US) who never encountered SAFE side letters. Because for a period of time, they disappeared.

A few years after the original SAFE was introduced and VCs began to adopt it (along with the use of side letters), the economy started heating up. From 2017 onwards, there was an explosion of new funds and new types of funds. At the same time, large multi-stage funds began investing earlier and earlier. Early-stage rounds became more competitive and dedicated Pre-Seed funds found themselves unable to negotiate the rights that they needed. Given the choice between investing without a side letter and losing out on an investment altogether, many of them invested without protections (and against their long-term best interests).

As a result, the majority of founders who raised a SAFE round — particularly in the U.S. — between 2017 and 2021 were never introduced to side letters as a condition of VC investment. Now that the economy has recalibrated, we’re back to a landscape where early-stage funds (in both Canada and the U.S.) are insisting on these rights as a condition of their investment.

Side Letters are Here to Stay

As a Pre-Seed VC, I’m obviously biased when it comes to this topic. The rights contained in SAFE side letters are important to me as an investor and to my ability to generate a return for my LPs. Alongside angel investors, Pre-Seed VCs take the first big investor risk into a company. We’re also the most at-risk when it comes to later-stage investors eliminating our rights down-the-road.

That said, side letters are by no means a silver bullet. Elizabeth Yin recently wrote an excellent thread detailing some of the situations in which the protections of side letters can be nullified by later-stage investors:

Elizabeth makes the point (one which I agree with) that side letters are but one aspect of a relationship that early-stage investors must work hard to cultivate before, during and after an investment is made. At the end of the day, venture capital is a customer service business and we need to earn the right to continue to invest in the startups we back.

Ultimately, our goal as early-stage VCs is to support the founders we invest in all the way to the finish line, while ensuring that we can generate a return for our investors should you win. SAFE side letters are one tool that helps us to do so.

Founders Never Forget

It’s been nearly 15 years since I cofounded DataHero, while at a bed-and-breakfast in Tuscany (a story for another day). All these year later, certain memories are seared into my being:

There was the tense, late night conversation in a dark parking lot in Palo Alto as we debated the equity split between the founders. The excitement of our first day in a “real office” (in reality, a handful of unused desks that we rented from AOL). The anxiety and uncertainty of turning down the first term sheet we received because we felt the terms were unfair. And the thrill of seeing the first dollar of revenue hit our bank account (deposited via check, because we hadn’t yet implemented online payments).

More than anything else, I remember how we were treated by investors. To this day, I viscerally remember each and every investor encounter I had. All founders do.

Some of the investors who helped me the most were ones who, for a variety of reasons, never ended up on our cap table. There was Josh Kopelman, who spent hours with me over the course of several months thinking through the market opportunity for cloud-based BI and what applications could be “venture scale”. Or Doug Leone, who brought together members of the Sequoia team to work through the thought exercise of whether or not a SaaS business model could be applied to enterprise data software (it had never been tried before). There were folks like Kent Goldman, Mike Dauber, Aaref Hilaly, Stephanie Palmeri, Villi Iltchev and Karan Mehandru, each of whom spent time with me long before we raised a dollar of funding and shared their thoughts on go-to-market, the early landscape of SaaS providers and other aspects big and small of an entirely new approach to data analytics.

None of these VCs remember our interactions nearly as vividly as I do. In fact, some don’t remember them at all (I’ve asked!). But I remember each of these investors, their generosity of time, and the fact that they showed up focused, open-minded and genuine. And sure, they were each undoubtedly hoping for an investment down the road. But even after that ship had sailed, every single one of them continued to make themselves available. They genuinely wanted us to succeed.

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And then there were the others…

There was [redacted], who couldn’t be bothered to look up from his phone when we pitched him. Or [redacted], who scheduled a meeting with me to “catch up”, showed up 15 minutes late and then asked arrogantly who I was and why were we meeting. There was [redacted], [redacted], and [redacted], each of whom declared — in their own snide, condescending way — that what we were doing would never work (while clearly having neither prepared for the meeting nor listened to what we were saying). And, of course, [redacted], who over the course of an hour asked pointed, incredibly well-informed questions, only to admit at the end of our meeting that he had already made an unannounced investment into a competitor.

Every meeting that I had with a VC informed not only my perspective of that individual, but of the firm they worked for. It informed the likelihood that I re-engaged with their firm for subsequent rounds. It informed what I told other founders when they asked about my experiences fundraising.

A decade later, those experiences — both good and bad — informed how I chose to enter the world of venture capital.

Most significantly, they informed the way that I try to show up for the founders each and every day.

My partner, Pat Lor, frequently reminds the team at Panache of the importance of bringing our full selves to every interaction we have with founders. Whether it’s a pitch meeting, a panel, or a chance encounter on the sidelines of a conference, every conversation we have with a founder leaves a lasting impression that reflects not only on ourselves, but on the firm as a whole.

Pat is adamant that the entire Panache team needs to come correct every time we interact with founders. No matter when, where or why.

He too remembers each and every one of his investor encounters.

Pat (center) on a recent panel at Creative Destruction Lab

Recently, I was reminded that not every investor shares this view.

A few weeks back, I had the privilege of joining a virtual investor panel. For the founders participating in the Zoom call, this was an important moment. They were eager to listen to what we had to say and came prepared with thoughtful, pointed questions. The moderator led a wide-ranging and engaging discussion amongst the VCs.

Well…almost all of the VCs.

Within a few minutes, it became glaringly obvious that one of the panelists wasn’t bringing his full and focused self to the session. Beyond his obviously bored facial expressions, this particular investor’s dual-monitor setup gave away his propensity to multitask, as he visibly turned his head away from the camera every time he finished speaking. He was clearly a big important person who had big important things to do.

I began watching the faces of the founders on the call. Each person was eager, engaged and smiling, except when this particular investor spoke. Each time he chimed in (often with a rambling comment that belied the fact that he only a half-heard the question), their smiles almost uniformly turned to frowns. Their body language became closed. Their feelings were clear: this VC — this person — doesn’t respect me.

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My point in writing this post is not to call out another investor. Nor am I trying to stand on a soapbox and pretend like I’m perfect.

I’m writing this post as a reminder to myself and to other investors of the importance of showing up. We are incredibly privileged to do what we do, and we owe it to founders to bring our full and focused selves to every encounter. Every founder we meet is trying to create something out of nothing. To use their time, energy and resources to quite literally change the world.

That deserves our respect and our attention.

I also write this for founders as a reminder that you have the real power. Founders can build businesses without investors. Without founders? Investors are nothing. You have agency over who you choose to work with. Use it.

As an investor, I try my best to always bring my full, focused self whenever I meet founders. I hope that you’ll hold me accountable for that — if you ever meet me and feel that I wasn't fully present, please let me know.

Because I was once a founder. And I know that founders never forget.

“People will forget what you said, people will forget what you did, but people will never forget how you made them feel.”

- Maya Angelou

Why Silicon Valley VCs Want You to Be a Delaware C-Corp

One topic that frequently comes up for Canadian founders raising from U.S. VCs is the location of their startup’s incorporation.

“Are you a Delaware C-Corp?”

What exactly is a Delaware C-Corp and why do Silicon Valley VCs care so much about where your company is incorporated?

What is a Delaware C-Corp?

Let’s start with the basics. A C Corporation (or C-Corp) is the most common corporate structure in the U.S. It’s a legal entity in which the owners (or shareholders) are taxed separately from the company itself. In Canada, the equivalent is a Canadian-Controlled Private Corporation (or CCPC).

In the U.S., just like in Canada, the choice of state/province in which you incorporate has both legal and tax implications. Delaware is the preferred state of incorporation for most businesses because the state has more than 200 years of business-friendly legal precedents. The high volume of corporate disputes that the Delaware Court of Chancery has processed has resulted in judicial outcomes that are overwhelmingly predictable. In addition, the court has a history of protecting the rights of founders and board members to make business decisions without risking personal liability.

Delaware does not require that a company be physically based there in order to incorporate in the state. You are only required to have a Registered Agent (a Delaware-based intermediary who receives and forwards legal documents and correspondence from the Delaware Division of Corporations to you).

When I was a founder, the companies that I raised VC capital for (or considered raising external capital for) were all Delaware C-Corps.

What About Companies Outside of the U.S.?

Right now, you might be thinking “all of this sounds great, but my company is based in Canada — who cares?”

In this case, it helps to think about things from the perspective of a (U.S.-based) investor.

If your company is incorporated in Delaware, then investors (and potential investors) don’t have to spend brainpower thinking about potential tax or legal implications resulting from where your company is domiciled. On the other hand, if your company is incorporated outside of the U.S., then there are real implications for them as investors. And these aren’t just theoretical:

The U.S. government is very serious about keeping track of foreign investments made by U.S.-based firms. When an American VC invests in a Canadian company, it’s very likely that they will have to file additional paperwork about that investment each-and-every year. So in addition to the potential legal risk (or, at least, uncertainty) they incur by investing in a Canadian-domiciled company, doing so all but ensures that they will be doing extra paperwork as a result every year.

And nobody likes paperwork (even VCs).

Beyond paperwork, it’s helpful to empathize with the degree of uncertainty that potential investors might feel about investing internationally.

As the saying goes, you don’t know what you don’t know. So while it’s easy to say that “great companies can be based anywhere,” a typical investor has likely never given much thought to the tax and legal implications of investing in startups based in other countries. Your average Silicon Valley VC has no clue how Canadian taxes or laws work. Nor do they have any particular inclination to learn.

That doesn’t mean that they don’t want to invest in your company (they wouldn’t be talking to you if that was the case).

What it means is that figuring out whether or not they can invest in an Ontario-, Quebec- or BC-domiciled company may not be worth the effort to them if it’s unlikely that they’ll invest in another one anytime soon.

QSBS

Another consideration for some investors is QSBS (“Qualified Small Business Stock”). It’s a U.S. tax scheme that lets certain early investors reduce their capital gains taxes. I won’t dig into the details of QSBS or how it works, other than to say that for accelerators and early investors, it can provide a significant enough impact for them to insist on investments being domiciled in the U.S.

QSBS is generally not a consideration for Series A or later investors.

What Are Your Options?

As a Canadian founder, there are many reasons to want your company to remain domiciled in Canada. Many grant programs are only available to CCPCs while others, like SR&D, have material differences depending on whether or not the company is domiciled in Canada. Plenty of Canadian founders simply want their company to be Canadian (and that’s awesome!).

So what are your options if you’re looking to raise from Silicon Valley VCs but want to remain a Canadian-domiciled company?

1. Know Your Numbers

As part of your preparation for fundraising, figure out the exact costs of losing your status as a CCPC. Would you see a reduction in SR&D credits? Would you lose access to other relevant grants or government-sponsored opportunities?

A number of companies I’ve invested in have responded to requests by Silicon Valley VCs to reincorporate as a Delaware C-Corp by calmly stating:

“We aren’t willing to do that because it would cost us $Xm/year in government grants.”

U.S. investors rarely think about grants and tax breaks as part of their investment decision, so coming prepared with meaningful numbers can be very impactful.

2. Know Your Emotions

If remaining a Canadian-domiciled company is important to you for non-financial reasons, that’s equally as significant. But you need to think in advance about how to convey that to potential investors.

Too many founders don’t think through how to explain their convictions and instead ramble unprepared and off-the-cuff about how it’s “important to them.”

Americans are some of the most patriotic people on earth, so they will often be very receptive to founders who express sincere conviction around this. But it can’t be ad libbed.

3. Know Your Line

Bottom line: is this a deal-breaker for you?

Understanding the answer to that simple question before you talk to VCs is incredibly important (and will likely influence whether or not you get the result you want). Are you willing to walk away from an investor to remain a CCPC or is this a position that you’re willing to give up for the “right” VC?

Because it may be a deal-breaker for them.

At the end of the day, you should expect the majority of U.S. VCs to ask you to reincorporate as a Delaware C-Corp. It’s not a red flag and it’s not something they’re doing for spurious reasons — investing in Delaware C-Corps is simply easier, cheaper and and more predictable for Silicon Valley VCs.

That said, in my experience, the vast majority of US VCs are willing and able to invest in Canadian-domiciled companies. I’ve personally co-invested with many of the best Silicon Valley VCs in companies that chose to remain CCPCs.

At the end of the day, if it’s important to you to remain a Canadian-domiciled company, then come prepared. Explaining with conviction (ideally backed up by numbers) why you intend to remain a CCPC is the most effective way to get the result you want.

How to Make Your Startup Antifragile

In the aftermath of the shocking collapse of SVB, a plethora of posts have been written with recommendations for how startups should react. Many have, understandably, focused on ways to add redundancy to banking and financial infrastructure.

If you take a step back, this experience should serve as a broader reminder of the importance of building companies that are antifragile.

But what does it mean for a company to be “antifragile” and how can you make your startup antifragile?

What Does It Mean to be Antifragile?

The term antifragile was introduced 10 years ago by Nassim Nicholas Taleb, a professor and former hedge fund manager (who in a previous book coined the term “black swan event” to refer to the disproportionate role of high-profile, hard-to-predict events):

Some things benefit from shocks; they thrive and grow when exposed to volatility, randomness, disorder, and stressors and love adventure. Yet in spite of the ubiquity of the phenomenon, there is no word for the exact opposite of fragile. Let us call it antifragile. Antifragility is beyond resilience or robustness. The resilient resists shocks and stays the same; the antifragile gets better.

Nassim proposed three types of companies, each defined by how they react to stress: “Fragile” companies wither and collapse when stress is introduced. “Resilient” companies act like reeds: they bend but do not break when stress is introduced, returning to their original form once the stressor is removed. “Antifragile” companies grow stronger as a result of stress. Like muscle development through strength training, stress still challenges the system in the short term, but when the stressor is removed, the company becomes stronger as a result.

While the concept of antifragility is relatively new for companies, its application to software development predates Nassim’s book by at least a decade. My first exposure to the these concepts took place 10 years prior, when I was a graduate student at Stanford University. My advisor, Armando Fox, was part of the “Recovery-Oriented Computing” (ROC) project, a joint effort between Stanford University and U.C. Berkeley to develop reliable distributing computing and internet infrastructure.

The foundation of recovering-oriented computing was a simple concept: instead of trying to enumerate all of the ways that software could fail and trying to author it in such as way as to prevent bad things from ever happening, engineers should create software under the assumption that bad things can happen at any time and instead focus on reducing recovery time. (For those readers old enough to remember when you could remove the battery from a cell phone, this is how mobile software was designed: engineers had to presume that a user could take out the battery at any time, and the software had to be able to recover no matter what.)

Remember This?

The concepts originated in the ROC project helped move software design from fragile to resilient. The next step — towards antifragility — came in the form of software innovations intended to promote learning and adaptability of systems. For example, in 2011, Netflix created a tool called “Chaos Monkey” that randomly disabled servers and networks in its production infrastructure in order to test resiliency and drive improvement:

Imagine a monkey entering a 'data center', these 'farms' of servers that host all the critical functions of our online activities. The monkey randomly rips cables, destroys devices and returns everything that passes by the hand [i.e. flings excrement]. The challenge for IT managers is to design the information system they are responsible for so that it can work despite these monkeys, which no one ever knows when they arrive and what they will destroy.

It’s All About Options

Antifragile systems don’t try to predict future events. Rather, they are designed to react quickly and effectively to shocks of unknown or unexpected origin.

Just as recovery-oriented software is built on the assumption that bad things can happen at any time, antifragile companies expect shocks to occur. What makes them antifragile is how they deal with them.

The foundation of antifragile systems is options — courses of action that are prepared in advance, such that they can be put into action if and when a shock occurs. By preparing options in advance and independent of specific events, you don’t have to scramble when something unexpected occurs.

Scott Fenstermaker noted one example of an antifragile company that should be familiar to all startup founders: VC firms.

What does a VC company do? It buys a certain ownership percentage of a range of companies and mixes them together into a portfolio. These investments have a limited downside: the up-front cost of ownership. Therefore a VC company always knows what its maximum financial loss would be.

But every once in a while, they get a unicorn in their portfolio, a company that takes off to a far greater degree than the other members of the cohort.

Notice also that the VC didn’t have to predict which companies in the portfolio would be the ones to take off. This is key. Antifragile propositions don’t require specific predictions about the future.

VCs are not fragile to a deviation from expectation because they don’t care which company in their portfolio takes off. They just have to be correct on average. Every startup investment is simply an option that they can choose to exercise.

VCs don’t need to think in advance about which companies will fail, or what will cause their failure (although this information definitely benefits them when making investment decisions). By building a company that is predicated on options, VCs are able to continue moving forward when shocks to one or more portfolio companies occurs.

Making Your Startup Antifragile

As great as it sounds for a startup to get stronger when unexpected events occur, I don’t actually think that’s a realistic goal for most companies (it certainly isn’t the case for VC firms). Rather, I think the goal in making antifragile startups should be to minimize the risk and distraction when unexpected events occur, such that the company can continue to make progress while its competitors are panicking and reacting.

If we think about the recent collapse of SVB, every company fell into one of three buckets:

1. SVB was your only bank

2. SVB was one of multiple banks

3. You did not bank with SVB

If you were in category (1), then you likely lost a week (or more) of productivity dealing with the situation. If you were in (3), then you likely lost little or no time. Of course, founders with U.S. bank accounts couldn't reasonably have predicted which bank would collapse, so whether you were in (1) or (3) came down to luck. That means from a resiliency standpoint, (2) was actually the best case scenario. In this case, there would have been some distraction (trying to move money out), but no panicking (since short-term cashflow wouldn’t be a risk). In parallel, the company would have continued to make progress.

Of course, you would only ever have implemented (2) if you believed that there was a specific risk that a bank in the U.S. would fail. Until a few weeks ago, no reasonable founder believed that, or even thought about it.

So what is reasonable?

If we go back to the concept of recovery-oriented computing, the solution is definitely not to try to enumerate all of the exact things that could go wrong in the future. Trying to think through every possible shock that could happen and attempting to design resiliency around each and every one is a losing proposition.

Instead, founders should think about the broad categories of shocks that are possible and design around those. While the exact stressor might not be predictable, it’s possible to design resiliency around themes. For example:

• An employee suddenly becoming unavailable (due to a family emergency, injury/illness, unexpectedly quitting, etc.)

• A major technical issue (breach, hack, extended downtime, etc.)

• A cash flow issue (large customers not paying, investor or grant money not coming through on time, fraud or other criminal activity, a major bank failing,…)

While this does require some enumeration of risks, in reality it’s focused on understanding the core components of the business and designing options for unexpected failures in each of those components.

Having redundancy across the team provides options when an employee is unavailable, without having to design around each specific employee or scenario. Building redundant software and infrastructure (and systems around that software and infrastructure) provides options when there’s a technical issue, without having to enumerate every possible thing that can go wrong. And so on.

At a higher level, you can design crisis management processes so that everyone knows who to go to when a shock occurs. Thinking about and designing (even at a high level) responses to technical, legal, PR and finance crises can provide a huge advantage if and when such a shock occurs.

Of course, all of this comes at a cost. Each option you create for your company requires an investment of time and resources. The return comes over the long-term as and when shocks do occur. As a founder, one of the best things you can do is to build your organization such that it is resilient to the types of unexpected shocks that are reasonably likely to occur.

As Louis Pasteur famously said, “Chance favors the prepared company mind.”

A Humbling Moment for Tech

Friday’s shocking collapse of Silicon Valley bank reverberated across the tech sector throughout this past weekend as nervous founders, investors and bankers awaited the U.S. government’s response. While the actions taken by the Fed look to have stabilized things in the short term, amongst the chaos and drama of the weekend, one thing became clear:

American’s really don’t like Silicon Valley.

While the tech industry was frantically trying to get money out of SVB and making backup plans and backup backup plans (along with a lot of tweeting and doomscrolling), the rest of America showed little sympathy. Following Sunday’s announcement of a rescue plan by the Fed, both sides of the political spectrum went into overdrive with derision and blame for the “tech elite”.

From the Left

From the Right

For Canadians (or anyone else in tech outside of America), it can be hard to understand the degree to which the U.S. tech sector is detached from the rest of the country. It’s even harder to understand the level of contempt that Middle America has for Silicon Valley, particularly when the rest of the world very much idolizes it.

To understand this dynamic, we need to go back to the turn of the century…

A Chip on the Shoulder

One of the historically common characteristics of people in tech is that many of them have a sizeable chip on their shoulder. They were often the nerdy kids in school, marginalized or bullied for being different (I was definitely not the “cool kid” growing up). In the late-90s and well into the 2000s, that shared experience and “us against them” mentality brought together many of the people who migrated to Silicon Valley.

When I moved to Palo Alto in 2002 (to do a Master’s Degree in Computer Science, no less) I was amazed to be surrounded by people like me. Smart, quirky, driven individuals who often didn’t fit in. But in Silicon Valley, the nerds were the majority. In those days, you were as likely to run into friends at the local electronics superstore as you were over beers at the Nut House.

I can’t begin to tell you how many hours I spent here ✨

For nearly a decade after that, Silicon Valley remained deeply uncool. There weren’t any celebrity-filled tech parties or private members clubs, just tens of thousands of quirky people from around the world coming together to build things. But that all started to change after the 2008 financial crisis. As the economy flourished and the world became more dependent on technology, money poured in at an unprecedented rate and Silicon Valley reaped the rewards.

Unfortunately, many people in tech haven’t fully accepted that they’re now at the top of the mountain. Far too many billionaire founders and influential VCs continue to act as if they’re the underdogs. They genuinely believe that they are still David fighting against Goliath. But with the the average salary of a mediocre engineer at a big tech company exceeding $250K, while the median salary for Americans is barely above $50,000, it’s long past time for us to stop and read the room.

Unfortunately, many in Silicon Valley haven’t.

It’s true that people in tech work crazy hours. In fact, they’re some of the hardest working people I know. Alex Iskold (above) has spent a good portion of the last year raising money for his native Ukraine, in addition to running 2048 Ventures and supporting hundreds of founders around the world.

But let’s be honest, a big part of the “sacrifice” people make in startupland is in pursuit of the pot of gold at the end of the proverbial rainbow. That doesn’t make it any less work, but it’s a hell of a lot less risky to join a venture-backed startup than to put your entire life’s savings into starting a traditional small business.

When I joined Aster Data as the company’s first employee in 2005, I took a big risk. But I also knew that if things didn’t work out, I could walk across the street to Google, Apple or a host of other companies and get an incredibly well-paying job in a matter of weeks. The worst case scenario was never going to be that bad. That is the absolute definition of privilege.

The fact of the matter is people in tech are elite. And if you ask most of Middle America, we’re completely out-of-touch.

The Silicon Valley Bubble

If you’ve only visited the Bay Area for brief periods of time, it’s hard to grasp just how much of a bubble it really is.

And how hard it can be to escape.

Jim Carrey knew a thing or two about living in a bubble

Over the years, the mantras popular with startups have encouraged an explosion of companies designed to service other startups. We build things for ourselves and champion “dog fooding” of our products. We invent and reinvent solutions to problems that only people in tech have, while turning a blind eye to the challenges of the rest of the world. (I won’t even begin to talk about all of the self-reinforcement that’s driven by the lack of representation across founders and funders.) These companies have absolutely moved the world forward in incredible ways — and in doing so, created enormous amounts of wealth — but for the average person, the benefits often seem isolated and far away.

To be clear, there are many people in Silicon Valley who are aware of these problems. People who’ve taken everything they’ve learned (and earned) and are using it to bridge the considerable social, cultural and economic gaps between Silicon Valley and the rest of America. But many more are emerging from last weekend’s rollercoaster to the slow realization that the rest of America doesn’t see them as the heroes we often imagine ourselves to be.

What About Canada?

If you’re in tech in Canada, all of this may very well sound foreign. Broadly speaking, our country is far more collaborative across industries and geographies. In general, Canadians are supportive and proud of our tech industry. Why is America so different?

There are two significant factors that have contributed to considerably different relationships between our respective tech industries and the rest of the country:

1. The U.S. tech industry is overwhelmingly concentrated in Northern California, whereas Canada’s is far more geographically distributed.

2. Canada’s system of equalization payments serves to ensure that the economic gap between the provinces never gets to big.

Canadians often lament our equalization system, but by ensuring that our entire country benefits when any one province “strikes gold,” we constantly reinforce our social fabric. “A rising tide lifts all boats.”

Canadians overwhelmingly see a growing tech sector as benefiting the entire country.

In the U.S., the situation is quite different. While the tech industry has seen an explosion of success over the past decade (along with unprecedented wealth creation), the rest of the country saw little or no benefit. To the contrary, during that same period of time, much of America suffered through crippling layoffs, a devastating opioid crisis, and increasing poverty.

Americans outside of tech see a growing tech sector as benefiting only the “tech elite”. And they’re not entirely wrong.

In the 80s, Wall Street was the target of Middle America’s ire. Today, Silicon Valley is the bad guy.

So What’s The Takeaway From All Of This?

While the majority of the media’s attention over the past few days has (rightly) been concentrated on analyzing the lead-up to SVB’s collapse and the Fed’s subsequent reaction, a growing subplot is focused on how the rest of America perceives Silicon Valley’s near-disaster.

For many in tech, the disdain and derision that Middle America has demonstrated towards the tech sector has been surprising or even shocking to witness. When we look back at this week’s events, they may prove to be an important wakeup call that helps refocus Silicon Valley on the challenges that exist outside of the Bay Area.

For those of us in Canada, there are plenty of lessons to take away. The reaction of Middle America to the challenges of Silicon Valley should serve as a reminder to all of us that we are part of a broader ecosystem and must remember that we are very much in positions of privilege.

Tech can change the world. We just have to remember to pay attention to it.

I'm a Canadian Founder. What Does SVB Mean for Me?

Unless you’ve been living under a rock for the last 48 hours, you woke up this morning to the shocking news that Silicon Valley Bank had collapsed.

For anyone unfamiliar with SVB, it’s a commercial bank that, for the past 40 years, has been laser-focused on the tech industry. It’s the 14th-largest bank in the United States and the preferred bank of VCs and VC-backed companies across the country (my last startup, DataHero, originally banked with SVB). It’s also one of the main providers of venture debt to tech startups, an offering it recently brought to Canada.

I’m not going to write about why we’re in this situation. Nor do I intend to posit on what the future may bring for SVB. There are people far smarter than I to educate you about the former, and thousands of instant experts on Twitter to spread rumours and mansplain to you the latter.

Instead, I want to focus on one simple question: what does this mean for Canadian founders who don’t have a banking relationship with SVB?

And what, if anything, should they do about it?

What Does this Mean for Canadian Founders?

Since SVB was taken over by regulators this morning, I’ve seen the full range of instant reactions about what this means for Canada, from “this could be catastrophic” to “nothing has changed and this won’t impact us”. My perspective is things are likely to land in the middle.

In general, I’m a “hope for the best, plan for the worst” kind of guy. I don’t think that the sky is falling just yet, but I also believe that it would be naive for Canadian founders to put their heads in the sand and assume this won’t impact them in any way.

There are a few key facts to understand:

1. As of this morning, all withdrawals from SVB accounts have been halted. That means any company whose money is deposited at SVB is unable to access it for any reason.

2. The FDIC (the US government organization that insures bank deposits) only insures up to $250K in deposits for a given customer. For an individual, this is a big amount. But for a startup that’s raised millions (or tens of millions) of dollars, it’s a drop-in-the-bucket.

3. The FDIC has indicated that SVB customers will have access to $250K of their deposits on Monday.

Looming overhead is next Wednesday, March 15th. For most companies, that’s their next payroll date (in fact, most companies would have had their payroll withdrawn today in order to pay on the 15th).

Put all of these together and it means that there is a real risk that a significant number of U.S. tech companies — particularly those with large head counts — will not be able to make their next payroll. It also means that any wire payments (to vendors, partners, conferences, etc.) may not be processed in time.

There are at least three areas where Canadian startups may experience short-term impact as a result of this:

1. Customers

For companies with U.S. customers, there may be a short-term impact on cash flow:

• B2B customers that bank at SVB may not be able to pay you.

• Even if they do have the cash, they may choose to delay payment in order to preserve that cash for payroll and more urgent services.

• If your customers are individuals who work at impacted companies, they may proactively downgrade or withhold payment until they get clarity on their payroll situation.

2. Vendors / Partners

For companies who leverage U.S.-based vendors, partners, etc., there may be an interruption of service. For example, several major payroll processors use SVB to process transactions. Until they’re able to transfer their services to a new bank, those vendors aren’t able to run payroll (even for companies who themselves don’t bank with SVB).

3. Prospects / Pipeline

If you’re trying to sell to any companies that banks with SVB, expect a slowdown in that part of your pipeline. Even if your prospects have their short-term cash positions figured out, employees are likely to be distracted and whatever you’re selling them isn’t likely to be top of mind in the short-term.

What Should Canadian Founders Do?

If you have exposure to US tech companies through any of these categories, you should spend a few minutes to understand the magnitude of your risk:

• If you have a large U.S. customer base (particularly tech startups), take a look at your cash flow and understand what the worst case scenario is. If a meaningful percentage of those customers miss or delay a payment, will it cause problems for you?

• If you rely on U.S. vendors / partners who are likely to bank with SVB, are there any potential risks?

• What happens if prospects you’re aiming to close by the end of Q1 (i.e. the end of this month) slip into the next quarter or off of your pipeline entirely as a result of this?

To be clear, I’m not saying that you should panic over any of these. It’s entirely possible that by Monday, a resolution will have taken place and/or we may have significant clarity into the road ahead, but it’s good hygiene as a founder to go through the thought exercise.

Be Canadian

Above all else, this is a time to be Canadian. And what’s more Canadian than showing empathy?

If you have U.S. customers that are likely to bank with SVB, consider sending them a note offering to delay payment if they need it.

If you have founder friends in the U.S., send them a message to check in with them and ask if you can help.

If you’re working with sales prospects that are likely to bank with SVB, offer to reschedule any meetings next week.

This is an incredibly stressful time for a lot of startup founders and their employees. And it could have happened to any of us.

When to Walk Away

Right now, many founders are facing difficult decisions.

In the aftermath of the 2020-21 bull market, countless startups are nearing the end of their runway. Some will make it. Many more will not. And then there are the companies languishing in the middle. They have revenue, but not product-market fit. They are growing, but not fast enough. Some employees have decided to move on. So have some customers. They can potentially extend their runway, but at what cost?

Over the past few months, I’ve spoken with a number of founders trying to decide what they should do next. Every investor I know has. And I expect to have many more of these difficult conversations in the near future. For founders caught between a clear win and an obvious loss, with the added pressures of investor expectations and employee responsibility weighing heavily on their shoulders, the path forward is as clear as molasses.

It’s a struggle I’m deeply familiar with. Because I’ve been there.

Which is why I was curious to read Annie Duke’s latest book, Quit: The Power of Knowing When to Walk Away. For readers unfamiliar with Annie, she was a professional poker player during the heyday of the World Series of Poker in the late 90s and early-2000s. After retiring from poker, she became a speaker, consultant and author and has written a number of books on decision science. Last year, Annie joined First Round Capital as a "Special Partner” focused on coaching founders through difficult decisions.

In her latest book, Annie discusses both the power of quitting and the social, societal and psychological barriers to doing so. In particular, she talks a lot about the two-sided nature of “grit”.

Persistence is not always the best decision, certainly not absent context. And context changes.

That’s the funny thing about grit. While grit can get you to stick to hard things that are worthwhile, grit can also get you to stick to hard things that are no longer worthwhile.

What makes the book so powerful for founders is the way it combines deep insights into the psychology, emotions and economics of quitting with real-life startup examples (including from Canadian founders Stewart Butterfield and Andrew Wilkinson).

Here are a few of my key takeaways from Quit:

Loss Aversion and Sunk Costs

While most founders understand (at least conceptually) the notion of sunk costs, loss aversion is an equally important concept. Loss aversion is a cognitive bias that causes humans to feel the pain of a loss more acutely than the pleasure of an equivalent gain:

One of the key findings of prospect theory, a theory at the core of behavioral economics, is loss aversion. Simply put, the negative emotional impact of a loss is greater than the positive emotional impact of an equivalent gain.

Loss aversion makes us not want to stop something we have already started.

The combination of loss aversion and sunk costs creates a powerful foe for founders who are considering quitting. Instead of clearly and rationally analyzing whether or not it makes sense to continue on, founders who’ve been grinding it out for years often struggle to separate the decision of what to do moving forward from the blood, sweat and tears that they’ve already put into their startup.

When we quit, we fear two things: that we’ve failed, and that we’ve wasted our time, effort or money.

Founder Identity

When you add founder identity into the mix, it gets even harder for startup founders to walk away.

When your identity is what you do, then what you do becomes hard to abandon, because it means quitting who you are.

First-time founders, in particular, often struggle to separate their identity from that of their startup. What started off as a statement of pride “I’m Chris, Founder of X”, can over time become an albatross that holds them back. Founders who have embraced grittiness as a core part of their identity (picture of all the founders you know who’ve been quoting The Hard Thing about Hard Things ad nauseum for the past few years), this effect can be orders of magnitude stronger.

Founders, who are gritty by nature, all too often continue to grind it out until the bitter end.

Duty to Investors

When it comes to quitting, most investors think the opposite of what founders assume. The reality is that no investor wants founders to work themselves into the ground when there is no longer a clear path to success. Investors are looking for a return-on-investment, not a martyr. Yet many founders believe this.

One of the most common ways that founders push back [on quitting] is by claiming that they have a duty to the investors to give it everything they have.

To prove this point, Annie points to one of Silicon Valley’s most successful angel investors, Ron Conway. Most people know Ron as the founder of SV Angel and as an investor in countless unicorns. What few realize is that he is also one of the startup world’s most skilled “quitting coaches”. According to Conway,

There is no honor in spending every last bit of investor money pursuing an endeavor that’s failing. Returning capital to investors is the responsible choice under those circumstances and demonstrates the ability to make the hard decision when it’s the right thing to do. It shows an understanding of expected value and the ability to respond to new information and changing circumstances with flexibility rather than rigidity.

Contrary to most founders’ beliefs, returning capital increases the chances that those investors will want to work with them again.

Duty to Employees

If you ask founders what holds them back from shutting down a business, responsibility to their employees is often at the top of their list. The idea that the people who took a chance on them will be out of work can be hard to stomach, leading them to continue on with the status quo.

This is another “trap” the adds founder ego into the mix. While it’s absolutely noble to want to take care of your employees, if it were really true that nobody on your team would be able to get another job, then you must have a pretty awful team. The reality is that each employee at a startup has made (and continues to make) economic decisions that take into account the potential future value of equity/options in considering their opportunity cost.

The problem? When founders of failing startups continue to sell their team on the future success of the company, they’re providing those employees with false information with which to make those decisions.

Just as investors don’t want to see founders trapped in something that’s failing, founders shouldn’t want that for their employees.

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While reading Quit (which I highly recommend for both founders and investors), I found myself replaying some of the conversations I’ve had recently with founders debating the future of their companies. A few of those founders made the difficult decision to shut things down. Many are pushing ahead. As a VC, I obviously want to see every company I invest in succeed, but I know that will never happen. So while it’s hard not to admire the grit of those founders determined to give it their all, it’s difficult for me as a former founder to watch some of them continue down a path that I know has little-to-no chance of success.

If you’re a founder reading this, I hope you win. But please know that it’s okay to quit. To quit something that’s no longer worth pursuing isn’t a failure, it’s a success.

When the world tells you to quit, it is, of course, possible you might see something the world doesn’t see, causing you to rightly persist even when others would abandon the cause. But when the world is screaming at the top of its lungs for you to quit and you refuse to listen, grit can become folly.

Too often, we refuse to listen.

To Create More Canadian VCs, We Need More Canadian LPs

Starting a new VC firm is hard. On average, it takes 18 – 24 months for an emerging manager (the term for a first-time VC fund manager) to raise a new fund.

San Francisco VC Monique Woodard spent more than two years raising the recently-announced debut fund for Cake Ventures

In Canada, starting a new VC firm is near-impossible.

Just as first-time founders in Canada often struggle to find angel investors and Pre-Seed VCs willing to take a chance on their startup, emerging managers in Canada struggle to find investors willing to take a chance on their VC firm.

Why? Because Canada doesn’t have enough risk-taking LPs.

How VCs Raise Funds

When startup founders raise their initial capital, they look to friends-and-family, angel investors and Pre-Seed VCs as potential investors. Emerging managers do the same thing: they target friends-and-family, high net worth individuals and family offices, and institutional investors that focus on emerging funds.

In the US, firms like Cendana Capital have built incredibly successful “fund-of-fund” businesses that focus on emerging managers. They effectively act as “Pre-Seed investors” for VC firms. Cake Ventures, a new VC focused on investing in opportunities created as the result of demographic change, recently closed a debut fund that boasts a number of such investors, including Cendana Capital, Foundry Group, Pivotal Ventures, Plexo Capital and Screendoor.

In Canada, there isn’t a single institutional investor dedicated to investing in emerging managers.

That’s not to say that their aren’t any institutional investors in Canada that have invested in emerging funds. However, those “emerging funds” have traditionally been large funds founded by experienced VCs with lengthy track records — safe bets — rather than $10-20M funds launched by up-and-coming investors.

As a result, when a Canadian investor wants to start a new VC firm, they generally take the same approach Canadian startup founders do: they look for angel investors to fill the gap. Unfortunately, in Canada there aren’t enough VC “angel investors”.

By some estimates, there are more than 1 million accredited investors in Canada (individuals and organizations that are eligible to invest in VC firms). Fewer than 5,000 have ever invested in a Canadian VC.

In other words, Canada doesn’t have any dedicated “Pre-Seed” LPs and we don’t have enough “Angel” LPs.

Actual footage of a Canadian founder hearing that it’s hard for new VCs to raise money

Why Does This Even Matter?

Why does Canada need more VCs?

In my opinion, the biggest challenge with Canadian early-stage funding today isn’t the lack of capital (despite how vocal I am that we don’t have enough of it), it’s the lack of capital allocators. Canada simply doesn’t have enough people and firms making investment decisions.

As investor Sylvain Carle recently noted, “While we need more generalist [VCs], we need many many more specialists.” Whether they be experts in climate tech, deep tech or the things that Gen Z likes that I’m way too old to understand, Canada needs more investors whose unique interests and backgrounds align with the startups being founded here.

This is also hugely important from the standpoint of diversity and inclusion. Like every country, Canada needs more investors from diverse backgrounds with a seat at the VC table. We know that underrepresented founders aren’t seeing enough investment dollars and we know that VCs from diverse backgrounds are more likely to invest in diverse founders.

One way to change this is to hire more diverse investors into existing funds (something that’s already starting to happen), but that’s a slow process.

If we really want to pour rocket fuel on Canadian tech, we need to make it easier for the next generation of Canadian investors to start their own funds.

Easier Said Than Done

Over the years, a variety of government-backed initiatives have been launched to bolster the Canadian VC ecosystem. Many of these have had an immensely-positive impact on the funding landscape. Unfortunately, only a handful included the creation of new VC firms as part of their mandate (the Government of Quebec’s Seed Fund Competition being the most recent).

The challenge with relying on government-backed programs to fund emerging managers is that they typically aim to deploy amounts of capital that are too large to be absorbed by a $10-20M emerging fund. In addition, their diligence expectations are frequently at odds with what an emerging manager is capable of. (Any Canadian founder who’s been asked for 5 years of financial plans for a pre-product friends-and-family round knows what I’m talking about).

The result? We see repeated cycles of government programs that funnel money into a relatively small number of established firms without driving expansion of the investor landscape.

Setting Canada up for Success

So how can we meaningfully accelerate the creation of new Canadian VCs if the top-down approach isn’t working?

Here are 5 ways Canadian tech leaders can help:

1. Investor Education

We have amazing angel groups across Canada that are dedicated to helping high net worth individuals learn how to invest in startups, but nothing equivalent for learning how to invest in VC funds. In fact, most angel investors have never even had the opportunity to invest in a VC fund. So investor education is the first step.

We also need to better support family offices that are looking to expand into the venture capital asset class. These investors are capable of investing millions of dollars into organizations that align with their professional and philanthropic missions, but many don’t know where to start when it comes to VC.

2. Emerging Manager Diligence Programs

A second function performed by angel groups is to centralize diligence into startups. A similar function could be performed for VC investments. What would it look like to create a program to “certify” emerging managers (or at least standardize their investment materials) to make it easier for angel investors and family offices to invest? (And, no, I’m not talking about the 58-page ILPA Due Diligence Questionnaire.)

3. Government Matching Programs

Rather than a heavy, top-down investment approach, could Canada or the provinces ever support a lightweight “matching” program for emerging managers? e.g. Any emerging fund that raises at least $5M and fulfils reasonable / stage-appropriate governance requirements automatically receives matching (which could, in effect, act as the fund anchor).

4. Emerging Manager Fund-of-Funds

What about the creation of a private “fund-of-funds” for emerging managers in Canada?  As a country, Canada will likely never create more than a handful of high-potential emerging funds each year, but I suspect there might be demand amongst investors for a “Cendana of Canada”.

10 new funds/year @ $1M/fund is only $50M over 5 years…

5. Emerging Manager Scholarships

Most people assume that by the time someone decides to start a VC firm, they’re independently wealthy and can afford to take two years off to fundraise. In reality, virtually no emerging managers have that priviledge.

Instead, most work side gigs as advisors, consultants or EIRs/Venture Partners/Scouts at larger firms to pay the bills.

Imagine a program where promising emerging managers received two-year scholarships along with mentoring, legal grants (to actually form the fund) and other support to launch a new VC.

If we want to accelerate early-stage investment across Canada, we need to make it easier for promising investors from a variety of backgrounds to launch new funds. And that starts with minting new LPs who are willing to take risks.

Let’s come together and make it happen.

Why Aren't There More VCs in My City?

Last week, I attended a gathering of 70 civic and business leaders from Vancouver hosted by the Frontier Collective, an organization dedicated to advancing Vancouver’s standing on the global tech stage. One of the questions that came up was whether Vancouver needs more “home grown” venture capital in order to reach its full potential.

I’m very vocal about the fact that Canada is severely lacking in early-stage venture capital. Whether we like to admit it or not, much of Canada’s recent successes in tech are due to angel investors across the country stepping up to fill the gap in risk-taking institutional capital. Toronto’s size — now firmly the third largest startup ecosystem in North America — provides enough gravitational pull to US VCs to further augment the local sources of capital, but it’s still not enough.

Yet despite that, I don’t believe that we will see a sudden explosion of home grown venture capital firms in Vancouver or any other mid-sized city. Nor should we want one.

Here’s why.

Supply and Demand

A typical VC invests in less than 1% of the startups they meet. Last year, the team at Panache spoke with more than 3,000 founders across Canada. We invested in 16 companies.

What does this mean for an ecosystem?

Assume that a typical VC aims to make 10 investments per year. If each firm invests in 1% of the startups they meet, then the startup ecosystem they operate in needs to reliably generate at least 1,000 new startups per year for every VC*.

This means that for a mid-sized city like Vancouver to support 10 power law VCs investing locally, it would need to produce more than 10,000 new startups per year.

It has only about 2,000 startups in total.

* This simple model doesn’t take into account competition amongst investors, sector focus, startups coming from outside of the region to fundraise, etc., but you get the point.

What Happens if There Aren’t Enough Startups?

If a VC firm is based in an ecosystem that doesn’t produce enough startups to satisfy their investment thesis, then they have only two choices:

1. Invest Outside of their Local Ecosystem

2. Adjust their Investment Thesis

Invest Outside of their Local Ecosystem

For power law VCs, the solution to not finding enough startups locally is to look elsewhere. This is what the top early-stage VCs in Canada do. Vancouver-based Version One has made investments in Toronto, San Francisco and New York. Golden Ventures from Toronto has made investments in Vancouver, Boston and Los Angeles. Montreal-based Inovia invests across North America.

(While Panache Ventures is Montreal-based, we consider our “local” ecosystem to be the entire country, which is why we have partners on-the-ground in Vancouver, Calgary, Toronto and Montreal.)

Adjust the Investment Thesis

Regional VCs – investors whose thesis restricts them to investing in a local city, province or region – have a different approach. They focus on delivering a return to their investors based entirely within their local ecosystem. While this might sound amazing (more money for the local ecosystem!), the reality is that outside of Toronto, no ecosystem in Canada generates enough new startups to support power law investing regionally.

The result? Investors who focus their diligence on revenue, sales cycles and short-to-medium term business plans instead of long-term potential, much to the frustration of founders.

Why does this happen? Because regional VCs need to ensure that they generate a return regardless of the quality of startups they meet. If a given VC’s thesis requires making 10 investments per year but the region only generates 2 venture-quality startups that match their thesis, then the fund must find 8 additional “safe bets” to round out their portfolio. These companies are unlikely to generate billion-dollar outcomes but could reliably return 2, 5 or 10x to their investors.

The Paradox of Numbers

If Canada doesn’t produce enough startups each year to support more locally-focused power law VCs, why am I so adamant that their aren’t enough early-stage VCs? Why does it feel like their aren’t enough VCs?

Because not every startup is a match for every VC.

The reality is that most startups are only a fit for 10 or 20% of the VC firms they meet. If a firm like Version One or Golden Ventures could find enough startups that matched their thesis locally, they wouldn’t have to search beyond Canada. But they don’t.

So how can Canada support more VCs if it can’t support more VCs? The solution depends on your perspective.

How Can Ecosystems Fill the Gap?

Cities and local ecosystems can fill the funding gap in two ways:

1. Help create more local VCs

   Wait…didn’t you just say that the solution isn’t more local VC firms…?

   While a city like Vancouver isn’t large enough to support power law VC firms focused exclusively on local investments, helping anchor new funds with a broader investment thesis will almost certainly result in more local investments. In other words, having more VCs based in a city — even if they don’t invest exclusively in that city — can have a massive impact on the local ecosystem.

   Why doesn’t this happen?

   In the US, there are numerous institutional investors that invest in emerging managers (the term for new VCs launching their first or second fund). In Canada, we have zero. That makes it incredibly difficult to launch new funds, even for investors with lengthy track records.

2. Help attract VCs from elsewhere

   Investors from New York and Boston regularly travel to Toronto in search of deals. In Vancouver, we’re seeing increased interest from Pre-Seed VCs based in Seattle and Portland, with the occasional San Francisco VC heading north.

   Unfortunately, cities themselves tend to struggle to attract the right types of investors.

(There is, actually, a third option: loudly and repeatedly profess that your city is just “one big exit” away from minting a bunch of super-angels who will magically fill the local funding gap. I don’t recommend that strategy.)

How Panache is Helping Fill the Gap

Panache’s national investment thesis ensures that we meet enough incredible, ambitious Canadian founders each year to achieve our investment goals. However, we feel the VC gap in a different way.

After we commit to investing in a company, we often have to help the founders seek out other investors to fill the round. For example, we might invest $500K into a $750K round or $1M into a $1.5M round. Sometimes we can find other Canadian investors to join us, but often we encounter the same challenges that founders do. There just aren’t enough like-minded VCs in Canada.

Last year, we embarked on an ambitious plan to build a North America-wide co-investor network, starting with a September event where we hosted more than 150 VCs in the heart of San Francisco.

This year, the team from Panache will be in Seattle, Portland, San Francisco, Los Angeles, Miami, Austin, New York, Atlanta, Washington DC, Boulder, Boston and Columbia, MO (iykyk) to champion the Canadian ecosystem and help bring more investors and investment dollars to the Great White North.

We’d love nothing more than to see more home-grown early-stage VCs. And I think it’s going to eventually happen.

But in the meantime, we’re going to go find some.