Raising Money

Reflections on a startup journey (Chapter 3)

I founded AppSheet in Seattle in early 2012. The company was acquired by Google at the start of 2020 just before the pandemic took over our lives. This is #3 in a series of articles to capture some of my experiences. Here was article #2. Every startup journey is different, and my perspective is probably over-fitted to my unique situation. So please read with skepticism and treat these articles as opinions at best.

You need to raise money to run a startup. Here is a brief summary of AppSheet’s funding history.

Here were some things I learned.

• It is difficult to raise money.
• Raise only what you need and spend only what you must.
• The funding eco-system is structurally exploitative. Yet, the funding eco-system has principled and ethical people.
• Take money from the “right” investors.

Why do I suck at raising money?

One of our VCs (Greg Papadopoulos from NEA, a steadfast supporter who plays a key role in this tale) told me in late 2019 that I should be proud that we had run AppSheet on so little funding. He called it “sipping capital”. Although Greg meant it as a complement, I knew it was not out of choice. I was CEO, I was responsible for raising money, and I sucked at it. Over the years, we got turned down by more investors than I can remember. Unless you have pre-existing relationships and credibility with investors, I think it is just difficult to raise money. If you don’t struggle early, you will hit some stage later when the growth slows and you’ll struggle then. It’s just part of the deal. But in hindsight, what good fortune.

• We got good at spending money carefully. Just “sipping” it like precious water on Arrakis. And it made us focus on monetizing our product and that produced revenue as well. There’s nothing as nice as revenue to offset your burn rate.
• We always raised less than we wanted to raise. But that meant we gave away less of our stock at a low price. There is no such thing as cheap money. When I hear an entrepreneur say “We just took some more money because the terms were so good we couldn’t turn it down”, that makes no sense to me. $100 you raise today when your company is worth $5M is 10x more expensive than the same $100 you raise when your company is worth $50M.
• When someone invests in your company, it is a long-term relationship. Most people in the world may be fine acquaintances, but you don’t know enough about them to get into a long-term relationship. You want to be extremely careful who you take on as an investor at every stage. Unlike most other relationships, you cannot get out of a relationship with an investor. Our investors ended up being people who really believed in us, stuck with us, and helped us. They were “right” as principled people, they were “right” for us as advisors for our company, and they were “right” for as colleagues.

Now onto our story…

Pre-seed stage (2012 - 2014)

We were in this stage for two years because we pivoted multiple times. Usually, you’ll be trying to get angel/seed money soon after you start. As I noted before, investor money is incredibly expensive at this stage because you have to give up stock to get it. So I think it is a bad idea to do so when you are still ideating. You need some money to keep the company alive through this period though. At least for a software company, your primary expense is employee compensation. There’s a tiny number of employees (say less than five — in our case, just two). You have to compensate them with minimal salary and primarily stock. You are better off funding the expense yourself to the extent you can. Initially, I wrote a check to the company and then did it again.

I regularly put in time and energy meeting with a variety of investors, but unfruitfully. I thought I _had_ to raise money to prove the company was doing well and attract talent. There are some things at this stage that I learned to be skeptical of…

• “Fixers”: these are people who say they can help you raise money if you give them a cut or give them a retainer. Steer clear.
• “Angel groups” : every city has some kind of “alliance” or “band” or some such group of angel investors. Keiretsu. TiE. Maybe there are exceptions, but I found them all to be in the business of beating you down to low valuations that destroy your ability to build a valuable company. Do understand, if your valuation is too low, no good person is going to join your team because your stock is not worth much. And the next round will have a low valuation too. So you set up a long-term feedback loop that will kill your company on top of all the other challenges you have. Steer clear. If you ever actually see a band of real angels, it means you are probably dead already.
• “Incubators/Accelerators”: Accelerators are places that market the startup dream, but the reality is more murky. We participated in a Techstars class in 2013. In general, accelerators take anywhere from 5% to 10% of the company in exchange for some seed capital (usually $50K or less) plus “mentorship” and connection with investors. In my opinion, unless you are early in your career, desperate for a small amount of money, and have no ability to make connections on your own, avoid accelerators. Let’s assume they only took 5% (which is at the low end) and they gave you $50K for it (which is at the high end). So they valued your company at $1M total. That’s even worse than those low valuation “angels”. Yes, you will learn something from the 3 month program. But amazing people are generous with FREE advice for entrepreneurs. So if you start paying huge chunks of stock for advice, it better be insanely brilliant and transformative for your company. Legend has it that YC is something like that, but going to Techstars or any of the other accelerators doesn’t do that. You will struggle just as much as you otherwise would to get funding. And you just handed off enough stock to have hired your entire first set of critical talent. Was it really Techstars fault — no, they had well-intentioned people who tried to help us. It was my fault. I imagined they had some startup magic sauce but of course they did not.
• “Famous VCs”: every founder thinks it will be amazing to get Sequoia or Accel or <your favorite VC> to fund me. It will feel great in the moment, but it sets you up with a lot of risk. Let me explain. You’re a first-time entrepreneur and you’re at the pre-seed stage, nothing is proven yet. Anyone investing in it is betting on the founding team plus the broad idea space. It is easy for a big VC to write a $1M check to “take an option” on your company if they like it. Their terms and valuation will usually be decent. But actually, you should not take money from a big VC at this stage whatever the terms and valuation. I’ll explain this by analogy. This holiday break, our family bought four tickets for a Seahawks game in Seattle on Dec 26th. That morning, it snowed heavily and the roads were icy. So did we go for the game? You’ll realize it depends on how much we paid for the tickets. If we paid $10 per ticket, then we’d just say forget it and stay home. If we paid $100 per ticket, then we’d brave the roads and go. When the big VC writes you a $1M check from a $1B fund, they are just buying a $10 ticket to the game. When it comes time to “go to the game” (actually fund your next round with a bigger check), they may look at the weather forecast (your traction) and decide to stay home. Or they may decide to watch a basketball game (fund a competitor) on TV instead. If they do, your company is in serious trouble because nobody else will fund you. They’ll all want to know why the famous VC isn’t funding you anymore. This is the “signaling” problem. This happened to multiple entrepreneurs I know. So the rule is — big checks from big VCs, small checks from small VCs.

So who should you take money from at this stage?

• Individual angel investors: you want people who are investing their own money, not other people’s money. They must have high enough net worth that they can afford to lose their investment and not lose sleep over it (or blame you for it).
• Seed stage VCs: these are small VCs where you avoid the signaling risk. They explicitly do not lead subsequent rounds, so it avoids problems. But there’s a few things you should understand about small VCs. Despite their name and whatever they may say, VCs are risk averse and looking for sure bets. The smaller the fund size, the less risk they want to take. So they write small checks. But many VCs live by this formula that whatever check they write, they want to own at least 20% of your company. So recognize that when you go with a small VC, they have a limit on check size and that probably limits your valuation.

Once we had pivoted to the AppSheet idea in late 2013, I was sure we were onto a winning idea. We wanted to raise an “angel” round of $1M on a convertible note with a $5.5M cap. I talked with lots of the professional angel investors in Seattle and made relatively little progress. Then I decided to forgo my inhibitions and ask my professional “friends and family”. Basically, I put down a list of 50 people who I’d worked with at some point in the past, who were in the tech industry, and who I felt would have the net worth to make a $50K investment in our company. Some I knew very well. Some I hadn’t engaged with in a long time. I sent them all email. About 10 responded with interest. About 5 invested in the round. In the process, a couple of “adjacent” investors came in. Overall, this raised ~$500K, then I added a check of my own into the round and closed it. That gave us enough to hire a small team and ship the first version of the product.

Desperately seeking Series A (2015–2018)

This was a difficult period of four years when I kept trying to raise a priced Series A but never succeeded. The product kept doing well (metrics steadily up and to the right), but I think we were in a space associated with a lot of skepticism (“no-code” is now tied with “blockchain” in the hype hoopla, but back then, everyone was a skeptic).

In 2015, I decided to raise $1.5M on a convertible note. I got introduced to Greg at NEA. It was an awesome meeting. He was already sold on the idea of building apps from spreadsheets. He said NEA would invest $0.5M out of an early-stage program they had. So I had to just get the remaining $1M. I tried for months and couldn’t get anything. So Greg finally said — go focus on building the product, we’ll just fund you $1.5M. Also note, I didn’t know about or think about signalling risk. It could have hurt us badly. Just dumb luck I ended up with Greg/NEA and it didn’t.

By 2017, we’d made good progress, so we decided to aim for a $6M Series A raise. Greg and NEA were supportive and said they’d lead the round. They gave us a decent valuation and suggested we find a co-investor VC in Seattle. We made the mistake of trusting a large VC firm that first said they were not interested, then wanted back in, but then eventually said no in a last-minute way after we had turned down other interested parties. It was unexplainable and unprofessional. The optics were so bad at NEA that they felt burned and decided to pull back .We were down to very little in the bank. I talked with my wife about writing a personal check to make the next payroll. It was a grim time. Greg, despite I’m sure being mightily pissed, offered an extension of $1.5M with a new note. NEA could have just cut their losses but Greg knew we had been screwed over. He could very easily have required it to be at the original cap but he knew our metrics had grown significantly in the intervening two years. He gave us a higher cap for the new note.

This is just another example of power imbalance in funding eco-systems. Big firms generally care about their reputation, but still they occasionally do unprofessional things. One of the partners (a longtime friend) later came over and apologized, which was super nice of him. Yet the episode also showed the upside of having NEA, the “right” investors, on our side.

By the time we got to late 2018, we were making enough revenue that our burn rate was very low. So we faced a choice — should we try to raise a Series A, or just become a self-sustaining business. Consulting with NEA, we decided that either we raise from one of the top 20 VCs, or we go it alone. We tried a focused push with the top VCs, getting intros, having conversations, etc. This time it was somewhat enjoyable. Our numbers were good, we knew our stuff, our customers said good things about us. So we got reasonable conversations at a few big firms. But I think we’d been around too long, steady growth is good, but no hockey stick. Anyway, nothing came thru. I decided to hell with this fund-raising, we’ll grow breakeven with our revenue. We arranged to get a line of credit from Silicon Valley Bank (as a buffer), we worked with NEA to establish a valuation to convert all the outstanding notes into stock. We started to pull the trigger.

Series A (our only priced round)

But one last VC connection (to Shasta Ventures) had been delayed because of scheduling conflicts. In January 2019, I had a breakfast meeting with Ravi Mohan, and things went from there. They got really excited with what they saw. I’d keep finding ways to say “see, here’s what I believe, I understand it may not interest you, and that’s ok”, and they’d say “no, we are very interested, tell me more”. In an unexpected way, Shasta’s passion for AppSheet rekindled our belief in what our business could be. Shasta did a lot of diligence on our company and our numbers and on the people in our team. They were excited to lead the round. NEA after years of waiting patiently were happy to see the interest from someone else. We closed our Series A round.

As an aside, always maximize your valuation. At the seed stage, at the Series A stage, every stage. Good investors on the other side will tell you if they think it is too high. I’ve heard not-so-good investors peddle dire warnings about the perils of too high a valuation, and the “down round” that could follow. It’s very simple. You should never sell stock in your company without getting the maximum money you can get for it (from the “right” investors, of course). If you take anything less than that, you are cheating yourself and also all the other existing shareholders of the company (including all your team mates who hold stock).

There are a few things in the VC funding eco-system that are systemically exploitative.

• VC investors get preferred stock, not common stock (like the rest of the “common” people who work at the company). The preferred stock gets preferential treatment when the company is acquired (which is relevant if it is acquired at a price lower than the last priced round). In other words, VC investors are more likely to get their money back. The employees who put their sweat and blood into the company for years are treated as less important. Every VC does this. It is considered normal and is part of the system. But it feels obviously wrong to me.
• In some contracts, there are nasty additional clauses like aggressive liquidation preferences (eg: a VC could demand that they get 2X their money back before any of the common stock holders get anything). This stuff is total crap. I believe the best VCs don’t do this anymore. Shasta and NEA had no such terms.
• There’s a lot of legal work associated with a priced funding round. Our expensive company lawyers had to review and negotiate contract details with the expensive lawyers for the VCs. Now here’s the thing — — guess who pays for the VCs lawyers? Our company! Yes, you got that right. That is considered normal and part of the VC eco-system. It is done to discourage companies from negotiating the contracts. So out of the hard-earned money you just raised, you’ll write out $50K or more of combined legal fees. And if you don’t spend the money, the contracts may be detrimental to your company. This also feels wrong to me.

It seems to me that the funding systems date back to a time when money held all the power and dictated terms to powerless labor. But in today’s startup world, labor (the employees who do the innovation and the work) should be “preferred” and money is “common”.

The people I worked with at Shasta and NEA were principled and ethical. They wanted to participate in the company’s success and help it with their investment, and their engagement post investment. Not everyone is like that and the “norms” of the eco-system can enable bad behavior. Thankfully, at the seed stage, the standard SAFE contracts are leveling the playing field. That is yet to happen for the institutional rounds, but I hope it will soon.

Just some months after that, Google came knocking and we ended up being acquired. I’ll probably write a separate article about being ready for an acquisition and the various decisions to make.

Slow burn vs blitz scale

Our journey was clearly a slow burn. It was not intentional but that’s how it played out. I am pretty sure that AppSheet would have ended up a bigger company with more impact if I’d been able to raise more, spend more, grow the team faster, blitz scale, the whole thing the startup self-help books tell you to do. Maybe next time. I muddled through, got lucky along the way, but learned a lot in the process.

In the next article (Article 4), some thoughts about employee rewards.

“… There’s a silver dollar in the sky
Shining down on me.…”

— — Loius Armstrong. Sitting in the Sun (Countin’ my Money).