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  Copyright © 2019 by Scott Kupor

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  ISBN: 9780593083581 (hardcover)

  ISBN: 9780593083598 (ebook)

  While the author has made every effort to provide accurate telephone numbers, Internet addresses, and other contact information at the time of publication, neither the publisher nor the author assumes any responsibility for errors, or for changes that occur after publication. Further, the publisher does not have any control over and does not assume any responsibility for author or third-party websites or their content.

  Cover design: Karl Spurzem

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  To all the women in my life—Laura, Ashlee, Alexa, and Amanda—who put up with my silly antics, yet remind me every day of how lucky I am to enjoy their love

  CONTENTS

  Title Page

  Copyright

  Dedication

  Foreword by Eric Ries

  Introduction

  1. Born in the Bubble

  2. So Really, What Is Venture Capital?

  3. How Do Early-Stage VCs Decide Where to Invest?

  4. What Are LPs and Why Should You Care?

  5. The “Limited” Edition: How LPs Team Up with VCs

  6. Forming Your Startup

  7. Raising Money from a VC

  8. The Art of the Pitch

  9. The Alphabet Soup of Term Sheets: Part One (Economics)

  10. The Alphabet Soup of Term Sheets: Part Two (Governance)

  11. The Deal Dilemma: Which Deal Is Better?

  12. Board Members and the Good Housekeeping Seal of Approval

  13. In Trados We Trust

  14. Difficult Financings: When Bad Things Happen to Good People

  15. Exit Stage Left (The Good Kind)

  Conclusion: The World Is Flat

  Appendix: Sample Term Sheet

  Acknowledgments

  Notes

  Index

  About the Author

  FOREWORD

  Scott Kupor’s Secrets of Sand Hill Road: Venture Capital and How to Get It is motivated by the desire to democratize opportunity. It demystifies venture capital, laying out how this crucial part of the startup ecosystem works for anyone who picks it up. It examines the VC startup life cycle from every angle, including how VCs decide where to invest, how to pitch, and all the many, many legal and financial details and players involved in forming and growing a startup. (Its exposition of the term sheet alone makes it worth far more than its cover price, and I wish I’d had it available to me when I was first looking for startup funding.) It understands that hard decisions sometimes have to be made and that deals can be confusing, and ends with a look at the IPO process. All of this information is presented as a means of reframing the relationship between startups and their investors as a true partnership, rather than an uneasy alliance. Scott has seen the process from both sides of the table, as a startup executive and as an investor, and he’s distilled his experiences and his perspective into an accessible, straightforward guide. Its purpose is to help build on the progress that’s already been made in taking entrepreneurship from a career path open to the few and the privileged, to one that’s open to anyone with an idea and the will to see it to fruition. This is the most urgent obligation of the startup movement as a whole, as we work to help build a more equitable society, but it also has huge implications for the continuing economic success and survival of our country, where new businesses account for almost all net new job creation and nearly 20 percent of gross job creation overall. Leaders like Scott are moving us all closer to fulfilling that obligation.

  For most of the twentieth century, entrepreneurship wasn’t seen as a career. It was more like a path followed by people who didn’t fit into one of the traditional professions open to them and could afford to do something different. Although some succeeded, being an entrepreneur was as much a curse—or maybe more of one—as an exciting opportunity. Even many initially successful entrepreneurs ended their careers in poverty or were forcibly removed from their creations. Now, though, conditions favor entrepreneurs. Barriers to entry are being reduced everywhere, thanks to the semiconductor revolution, the rise of globalization, and the influx of new talent into every industry and sector. Think about this: venture-backed companies now spend 44 percent of the entire R&D budget for American public companies. The 665 public companies that are VC-backed make up a fifth of the total market capitalization of public companies. They employ four million people. Those are significant numbers, but I believe this is just the beginning. The startup movement can—and must—grow to have a much larger impact. When we pour so much money into such a limited range of companies, we can’t effectively tackle the challenges we face. That’s why one of my favorite things about this book is the way it so clearly parses out the incentives and systems behind venture capital. This will help all entrepreneurs navigate the maze of venture investors and decipher their behavior. The system works the way it does for a reason, and now that reason is comprehensible.

  But there are other, larger lessons to glean as well. As you’ll learn in this book, most venture firms invest money on behalf of larger institutional asset managers, like university endowments and retirement funds. Most of these asset managers use a formula to determine how much money to allocate to different types of investments, including the high-risk, highly-illiquid sector of venture. (This approach to portfolio construction was pioneered by David Swensen at Yale, whose methods have been widely adopted, as you’ll read about in chapter 2). What that means is that the amount of resources our society currently invests in innovation is based on the percentage of assets that need to be invested according to this formula, rather than on the number of investable opportunities that exist. When too much money is chasing too few deals, there’s only one possible result: Because we have too few entrepreneurs, we can’t put enough money to work. Instead, it’s wasted on bidding up the prices of the few available assets rather than funding the kinds of organizations that are actually needed. The problem is even more pressing when you consider it from a diversity point of view. Not only are there not enough startups, but the ones that do exist aren’t nearly wide-ranging enough to build the kinds of companies our present and future call for. Possibly for the first time in history, we’re talent-constrained instead of capital-constrained. Scott’s book is an important step in making the opportunity to build a venture-scale business available to everyone so we can change that. The information about how to seek out and secure funding shouldn’t be limited to an elite club. Every startup is about a single idea, but taken together, all startups have a common purpose as well: to shape a better world for all of us. And a better world is one in which everyone is represented and served well by the companies and systems we create.

  That’s why Secrets of Sand Hill Road is so valuable, and so timely. It’s for people interested in venture capital, of course, but it’s also for anyone who cares about the ability of the US to remain competitive, create new jobs, and continue on the path of economic growth. Those people include policy makers, academics, government officials in the US and elsewhere, civic leaders in startup hubs around the count
ry and globe—who are already helping to democratize startups geographically—and people who work in corporate innovation (who can look to the VC world for inspiration on how to fund and grow projects within their organizations). Finally, Secrets of Sand Hill Road is for all the entrepreneurs who might not see themselves as a part of Silicon Valley—everyone who might not be considering trying to start a company based on their crazy concept, but really should be thinking about it. Given the chance, any one of those ideas could well become a reality that changes the way we live, and those are ideas we need to support. I believe Scott’s book is destined to change the equation when it comes to who gets funded. It’s leading us into a fairer, more robust future, and I can’t think of a wiser person to take us there.

  Eric Ries, author of The Lean Startup and The Startup Way

  Introduction

  I am writing this book from my office on Sand Hill Road, the hallowed Silicon Valley street that holds as much promise for entrepreneurs as Hollywood Boulevard does for actors, Wall Street does for investment bankers, and Music Row does for country music artists. And, as with most of the storied streets, it’s not much to write home about—Sand Hill Road is a drab collection of modest, low-rise office buildings, upstaged by its much more famous neighbor, Stanford University.

  But I’m not writing it from on high. This is no sermon, no stone tablet passed down. This book isn’t intended to be the venture capital (VC) bible. There are far too many important nuances in the field, with lots of different firms that invest at different stages, under different investment theses, with different portfolio constructions, and different return expectations. Not to mention different personalities.

  And that’s just on the venture capitalist side of things. More importantly, no two entrepreneurs are the same. The innovative, often world-changing companies they create always come with a unique set of opportunities, challenges, and conditions to be navigated.

  I also fully acknowledge the personal biases I bring to the table. The first is my experience, hard-won, on the startup side of things via my years at LoudCloud and then Opsware. The other bias has been personally developed, on the VC side, in my role as managing partner at Andreessen Horowitz, or a16z, where I have been since the firm started in 2009. This means I’ve had the opportunity to see VC from multiple vantage points.

  And, in fact, my hope is to help us stop thinking divisively in terms of one side or the other, one side versus the other. Entrepreneurs and VCs are not on opposing sides, the way one soccer team tries to crush another in the World Cup. Rather, we are partners, and once we agree to work together (and even if we don’t), we are on the same side. What we share is a desire to create benign businesses, see them have an impact on and improve the world, and together realize some financial benefit along the way.

  The story of venture capital is really a subset of the story of entrepreneurship. As venture capitalists, we raise investment funds from a broad range of limited partners (LPs), such as endowments, foundations, pension plans, family offices, and fund of funds. The capital raised from LPs is then invested in great entrepreneurs with breakthrough ideas.

  Venture capitalists invest anywhere from the very early stage, where the startup is little more than an idea and a couple of people, to growth-stage startups, where there is some decent revenue coming in and the focus is on effectively scaling the business. Generally, a company leaves the venture ecosystem one of three ways: via an initial public offering (IPO), a merger or acquisition, or bankruptcy and a wind down.

  There is often a misconception that venture capitalists are like other investment fund managers in that they find promising investments and write checks. But writing the check is simply the beginning of our engagement; the hard work begins when we engage with startups to help entrepreneurs turn their ideas into successful companies.

  For example, at Andreessen Horowitz, we often work with our companies to help them identify talented employees and executives to bring into the company or to identify existing companies that can serve as live customer test sites for their products. The reality is that those who are successful in our field do not just pick winners. We work actively with our investments to help them throughout the company-building life cycle over a long period of time. We often support our portfolio companies with multiple investment rounds generally spanning five to ten years, or longer. We serve on the boards of many of our portfolio companies, provide strategic advice, open our contact lists, and generally do whatever we can to help our companies succeed.

  All that being said, VCs are only as good as the entrepreneurs in whom they have the privilege to invest. And nobody should confuse the tireless heavy lifting that the entrepreneurs and their teams do to build a successful business with the investing activity of a VC. Simply put, entrepreneurs build businesses; VCs don’t. Great VCs help in any way they can along the company-building path, but it is the entrepreneurs and their teams who tread that path every day and make the difference between success and failure. And while all VCs hope that each of our companies succeeds against huge risks and grows into a successful business, the reality is that the majority fail.

  Entrepreneurship is inherently a risky endeavor, but it is absolutely essential to the American economy. Successful venture-backed companies have had an outsize positive impact on the US economy. According to a 2015 study by Ilya Strebulaev of Stanford University and Will Gornall of the University of British Columbia, 42 percent of all US company IPOs since 1974 were venture backed. Collectively, those venture-backed companies have invested $115 billion in research and development (R&D), accounting for 85 percent of all R&D spending, and created $4.3 trillion in market capitalization, which is 63 percent of the total market capitalization of public companies formed since 1974. Furthermore, specific to the impact on the American workforce, a 2010 study from the Kauffman Foundation found that young startups, most venture backed, were responsible for almost all of the twenty-five million net jobs created since 1977.

  What does all this mean? Simple. We need you. We need your ideas and your guts. We need your companies and your commitment to growth.

  What I want to do most with this book is help entrepreneurs. Access to capital is critically important to the success of a startup, and at one time or another you have to (or will) consider whether or not your business can and should raise VC. I hope this book helps to democratize access to the information about what makes the venture business tick—to the benefit of you, the entrepreneur.

  The decision to raise capital from a venture firm is a huge one, and should not be undertaken without a full consideration of the benefits and risks of this source of capital. For example, is your business even appropriate in the first instance to raise venture financing? Is the market size big enough that the business at scale has the prospect of being a home run, and thus moving the needle for a venture capitalist in terms of her overall fund returns? How can you better understand the economic incentives of the VC industry in order to determine whether you are in fact looking for capital in all the right (or wrong) places?

  If you choose to raise venture money, how do you think about the appropriate balance of economic and governance terms with your VC financier? What trade-offs are you willing to make, and what are the downstream implications of those decisions, particularly if you need to raise subsequent capital when the business develops at a different pace than you expect? And how will you and the board work effectively to achieve the long-term goals of the business?

  It’s an unfair truth that VCs get a lot of at bats, lots of chances to invest in a home-run company, while most entrepreneurs get to step up to the plate only a few times. Or to mix my sports metaphors, you get only a few real shots on goal in your lifetime while we VCs get several. Because of this imbalance, specifically regarding investment decisions, information asymmetry can come into play (often at the expense of the founder). The VCs are repeat players and thus have the benefit of lots of years of develo
ping their understanding of the various mechanics (especially when negotiating term sheets), whereas founders have been through the process only a handful of times, at most. What I hope to lay out for founders is a better understanding of and appreciation for the interplay between VCs and founders in order to level the playing field. Information asymmetry should not pollute the foundation of a marriage that could last ten years or more.

  Does that timeline surprise you? That you are likely entering into a (minimum) ten-year marriage of sorts with your venture partners? It’s longer now than ever before, yet for too long there has been a lack of transparency into the inner workings of that partnership.

  That is why I want to give you, a founder, some insider information, secrets, and advice so that you can best navigate your way through your interactions with venture capital firms, from the initial pitch session all the way through to an IPO or acquisition.

  I’ve now had the opportunity to see VC from both perspectives—as a member of a startup and now as the managing partner for Andreessen Horowitz. While my seat has changed—and certain elements of the venture business have evolved—the fundamentals remain the same: VCs seek investment opportunities with asymmetric upside payoff potential (and capped downside—after all, you can only lose the money you invest), and entrepreneurs who are funded by VCs seek to build industry-changing and valuable stand-alone companies. And every so often when these incentives align, magic happens.

  Entrepreneurs need to understand their own goals and objectives and see whether they align with those of the funding sources they want to tap. To determine that calculus, entrepreneurs would be wise to understand how the VC business works, what makes VCs tick, and what ultimately motivates (and constrains) them. After all, we are each motivated by the incentive structures that our industries engender; understanding those is in many ways a key part of the entrepreneurial journey.