JOSH KOPELMAN IS A partner at First Round Capital, a seed-stage venture firm. Before becoming a venture capitalist, he was an entrepreneur, founding three companies in succession. He formed his first company, Infonautics, when he was still attending college at the Wharton School of the University of Pennsylvania. The company went public on the Nasdaq in 1996. In July 1999, Kopelman formed Half.com, which allowed people to buy and sell used books, music, and DVDs online. eBay acquired Half.com in July 2000. Kopelman then founded TurnTide, an anti-spam business that was later acquired by Symantec. Kopelman’s “three-for-three” record of accomplishment is rarely seen in the startup business world. First Round focuses on helping seed-stage startups as its name implies. Kopelman is unusual in that he is primarily based out of Philadelphia, rather than Silicon Valley. He has also been an early investor in firms like LinkedIn and Uber.
1. “We’re seed-stage investors—and like to invest in the ‘first round’—so we’d rather meet with an entrepreneur earlier than later. (Caveat being that an entrepreneur should have selected an idea they want to pursue—and be willing to pursue it full time).”
First Round has adopted what has become known as a platform approach to investing, which involves providing more resources and operational support to businesses in the portfolio than was traditionally the case. Kopelman is saying that when a venture capitalist is trying to add platform value, it is easier to work with someone who does not already make problematic business decisions. In other words, it is easier to train people in the right approach than to change patterns that have already been established. The cynic might say this is because valuations are lower for the “first-dollar-in” venture capitalist. The noncynic would reply that the probability of success goes up when a business has a great start since a strong start helps retire risk and uncertainty. What is a cynic? A cynic is a person who, when they smell flowers, starts looking for a coffin.
On the last point made by Kopelman in the parentheses, it is surprising how often I talk to people who think they can get professional venture capital backing while working only part time. The best venture capitalists want the entrepreneurs they back to be “all in,” pursuing the business opportunity full time. In this regard, missionaries are easier to spot since they are obsessed with the business and the customer’s problem and want to go at it all the time. Mercenaries are more inclined to hedge their commitments.
2. “The typical founder spends their time either picking an idea, starting a company (hunting for product-market fit), or scaling a company (growing). Most founders spend less than 5 percent of their time on idea selection, yet I believe that ‘the pick’ accounts for more than 50 percent of startup success/failure. Observation 1: Many founders rush the pick. If you’re spending the next five to ten years of your life doing something, pick your idea wisely. Observation 2: In my experience, serial entrepreneurs are more likely to rush the pick due to high self-confidence and easy access to money.”
Kopelman sets out a clear taxonomy with “pick,” “start,” and “scale” categories. Each stage has its challenges. Many venture investors believe the best ideas seem half-crazy since that degree of “craziness” increases the probability that there is sufficient undiscovered convexity to generate a grand-slam financial outcome. Financially backing ideas that are fully crazy, however, is unwise. Some things that seem nuts are nuts. As with the final bed selected by Goldilocks, “half-nuts” is most often “just right” in terms of the convexity a venture capitalist desires.
3. “Starting a company is lonely. Every day you wake up, and there are more unanswered questions and more decisions to make. Find a community of like-minded people because together, you’re able to answer these questions far more effectively than individually.”
You’ll benefit from having a confidant to work through doubts with and together determine the 90 percent of advice from investors and customers you should ignore.
There is nothing quite like having a conversation with someone you trust to help you think things through. That process is a lot like writing down your ideas in that you can discover things you had not yet thought through and also generate new ideas. Having trustworthy and wise colleagues around you is particularly valuable since there are no formulas for success. If there were recipes for success, everyone would be rich.
4. “We see a ton of consumer companies who say, ‘We’ll just make it viral.’ It’s hard to achieve virality. If there were a virality button, if there were virality dust, then no one would spend a dollar on advertising. Viral is not easy. It’s hard, and it has to be built into your product. The best viral apps are built around viral mechanisms. The same thing applies to the community. Building a community isn’t easy. You can’t sprinkle community dust on it.”
Selling anything is hard. The importance of actually asking for the order and generating cash from a sale is something best appreciated by successfully doing so. Salespeople are highly compensated for a good reason. Selling is not only a real skill but a scarce skill. A business with an offering that has a low cost of sale has usually created a process that enables the customer to self-educate and communicate the value of the products to others. The best way to get people to talk to their friends is to have a treasured product that naturally creates incentives to invite others to try it. In other words, the fastest growing and most profitable businesses acquire many of their customers “organically,” without advertising. Great products, positive word of mouth, and a natural inclination for customers to invite others to use the product drive sales at such businesses. In contrast, businesses that must sell their wares with huge advertising budgets are losing their edge.
5. “Every business plan is wrong. The moment an entrepreneur hits ‘save’ or ‘print’ the plan is out of date. Things change.”
I’ve always said that I’d much rather bet on an entrepreneur who can adapt to change rather than an entrepreneur who is convinced that they have the ability to predict the future. But adapting to change is hard. How do you maintain flexibility yet still preserve a goal-oriented culture?
The old saying that “planning is essential, but plans are not” is attributed to a range of famous people. The quote has many variations, but the central point is always identical. Mike Tyson’s version is “Everybody has a plan until they get punched in the mouth.” The Jeff Bezos version is “Any business plan won’t survive its first encounter with reality. Reality will always be different. It will never be the plan.” The ability of a company to adapt is essential.
6. “You should target eighteen to twenty-four months of runway post-series seed. The best time to raise follow-on capital is when you don’t need it, and two years of runway gives you the best chance to land in that situation.”
Never run out of cash. Ever. A business can recover from lots of bad situations, but an absence of capital is nearly always fatal for equity holders and at least very painful for debtors. Having a margin of safety on cash is a wise idea for that reason. Raising money before you need it is also wise since at that point you still have leverage in negotiating with investors. Having the option to dial down spending to deal with the inability to generate new cash does not mean a business should not be aggressive. Instead, it means that the firm has an option if things turn sour. A business should always be careful in managing its cash, but this is more important at some times than others since venture capital is a cyclical business. For example, in February 2016, First Round put out a memo to its portfolio businesses that said,
During the meeting, there was a conversation about the rapidly changing funding landscape. And one of the company’s (bullish) later-stage investors warned the founder that the company should no longer rely on raising additional follow-on financing, saying, “We need to act like we’re Mark Watney in The Martian. We can’t assume we will get a shipment of new potatoes to save us.”
7. “I don’t think a lot of people have been entrepreneurial about venture capital.”
Venture capital is itself a business, and it is only natural that new approaches will be developed as more entrepreneurs like Kopelman get involved. There are aspects of the venture business that are unlikely to change (e.g., buying underpriced convexity) and some aspects that are likely to change (e.g., how venture capitalists interact with entrepreneurs). We have already seen different approaches to governance, investing-stage focus, and entrepreneur support. More experiments and modifications to venture capital are likely.
8. “Get to know entrepreneurs and who’s best equipped to ‘fill in cells,’ seeking out the market and customer data they need to de-risk their business. Look for the ‘heat-seeking missiles’ that aim at a target, but continuously scan the environment and adjust course as they separate signal from noise.”
Many things must be figured out and invented as a new business is created and grown to significant scale. In accomplishing these tasks, there is no manual for success. There are no formulas. Kopelman is saying that there is a premium on inventiveness, good judgment, and knowing what is important. The best entrepreneurs know when and how to adapt in an ever-changing world.
Retiring risk is something a great entrepreneur does every day.
9. “Start off with smaller checks than you expect to write and view them as tuition.”
The venture capital business takes time to learn. Any new venture capitalist will make mistakes, especially at first. While those mistakes will have a monetary cost, Kopelman believes that making them is a necessary and valuable way to learn (i.e., it is like tuition). There is no way to learn to be a good venture capitalist without making mistakes. Good judgment comes from experience, which often comes from bad judgment. If you are not aware of your mistakes, you will not learn.
10. “Your business may not fit venture return profiles, and yet it still may be big for you! Or perhaps venture capitalists are just not into the team (which they’ll never tell you!).”
Choose bigger ideas. Ideas that, in the success case, have massive scale and the impact can be significant. Chances are you won’t succeed but, if you do, the prize is worth playing for.
Not every business should raise venture capital. Sometimes it is far better for an entrepreneur to bootstrap a business. It’s perfectly fine and in fact normal not to have venture capital backing when starting a business. Most businesses do not need and should not raise venture capital since not every business has the potential to generate a grand-slam financial return.
11. “We bust our ass to try to get lucky.”
What Kopelman is saying humorously is that hustle, skill, and hard work can pay big dividends. Some people will call that luck, but the reality is that success is the outcome of hard work. If you can hustle, work hard, and apply skills to alter the probability of success, the change being created by those actions is not luck, but rather skill.
12. “A company’s outcome should drive VC returns. When VCs’ required returns drive company’s outcomes, it’s a recipe for trouble.”
Take a $400 million venture fund. To get a 20 percent return in six years, they need to triple the fund—or return $1.2 billion. Add in fees/carry, and you now have to return $1.5 billion. Assuming that the fund owns 20 percent of their portfolio companies on exit, they need to create $7.5 billion of market value. So assume that one VC invested in Skype, Myspace, and YouTube in the same fund—they would be just halfway to their goal. Seriously? A decade ago, any one of those deals would have been (and should have been) a fund maker! As a result of this new math, VCs end up super-focused on the long bets (or moonshots) and frequently remove optionality for midtier exits. It is because of the challenges of “VC math” that First Round Capital chose to raise a relatively small fund—allowing us to continue to make initial investments that average $600,000. I understand the importance of aligning one’s time and capital to the upside opportunity and recognize that there is some minimum threshold of ownership that is required for a VC to commit the time and attention to an opportunity. Does it make sense for an investor to spend the time and join the board of a company in which they only own a 2 percent stake? Probably not. However, the difference between 25 percent and 20 percent ownership—or even the difference between 20 percent and 10 percent—should not prevent a VC from investing in a promising opportunity.
The interests of a startup business and its investors are not always fully aligned. The best venture capitalists put the interests of the business first, and they do not get involved in businesses where they cannot do that. This is easy to say but sometimes tricky to do in practice. On this issue and others, an entrepreneur’s best source of information is other entrepreneurs. Entrepreneurs should do due diligence on their potential investors since the relationship will last for many years.