One of our portfolio companies that we’ve been invested in for yearsrecently was acqui-hired. The foundersworked their asses off for years, it’s not the outcome anyone ever wants to see,and as investors frankly we failed our founders along the way. Here is what we learned:
Capitalization. The company was chronically undercapitalized, which meanswe just didn’t have the balance sheet to grow or withstand real shocks. To give you a sense of how undercapitalized,the company’s average cash balance for years was under ~$120k per month andnever eclipsed $200k. When you don’t havea balance sheet (low cash or general liquidity), things that a typical companycan withstand like a large customer loss or a poor executive hire becomecrises. A few things drove the undercapitalization:i) thecompany had small investors that could only write small checks, and thatincludes us. Our check now is up to $4mm,but at the time we invested, we were sub $1mm, and we were the largestinvestor; and ii) thecompany was based in the Midwest, which did it no favors. While the cost of labor is lower in the Midwest,the lack of proximity to large venture capital is a big problem. As a company we didn’t grow fast enough toattract capital from the coasts, so chronic undercapitalization was our state. When it’s time to raise, try and attract morecapital than you think you need. Try tolocate yourself in a venture capital hub (SF, Boston, NYC, Austin). Be stingy with the capital you do raise as ifyou wont be able to raise again.
Thelure of SMB. We served SMB’swho churned off a lot. As investors we didn’tpush the company hard enough to move away from this customer group. Because of undercapitalization, we wanted thequick cash that SMB customers provided, and didn’t appreciate the fact that servicingcustomers that churn inside of 2 years have a negative LTV in SaaS. While SMB’s might be the way you start tobuild your business, try to get to enterprise class customers as soon as youcan. Very few large companies have everbeen built off of SMB customers only.
Customerfocus. Once wefigured out that our best fit customer was actually large enterprises (theproduct was really robust), we didn’t push hard enough for the company to focuson that ICP. If you figure out your ICP,focus on them, and forsake all others. That’s a rule to live by.
VPof Sales. Wehired a VP of Sales way too soon and were supportive of the hire. This individual of course didn’t work out,and the cost of that executive hire combined with the time lost ended up beinga real blow. You should only hire a VPof Sales when you have 5 or more good account executives reporting to you, andit feels like all you do as a CEO is sales. By then, you’ll know what you need in a VP ofSales, you’ll know your customer very well, your AE’s can weigh in and makesure you hire the right candidate that they’ll mesh with, and should that VP ofSales fail, you’ll know how to step back into the sales leadership role whileyou source another candidate. Do nothire a VP of Sales to build out your sales team; hire a VP of Sales to manageyour sales team. There is a bigdifference.
Stateof Incorporation. We wereincorporated in a mid-western state that was extremely friendly toemployees. Some employees who we firedultimately knew this and inevitably sued us for frivolous bullshit (the VP ofSales sued us for age discrimination even though we’d hired him 8 monthsearlier when he was the same age!). Itcost a lot of time to fight and ultimately settle those cases, and we made a businessdecision every time to just pay them out. Know the labor laws in your state, and do not incorporate in a statewith labor laws that are overly friendly to employees. We probably wont invest in a companyincorporated in that state again.
Badacquirers. Two yearsago, we went down the path with one acquirer that ultimately didn’t workout. This acquirer was spearheaded by aguy that didn’t know what he was doing, was combative, and ultimately re-tradedus days before closing. The dealinevitably fell apart and we were saddled with a $100k+ legal bill, a bigdistraction, and time lost. If you’redealing with an acquirer who is at all shifty, acrimonious, or just gives you abad feeling, walk away early. We shouldhave killed the deal early on ourselves, but we wanted the outcome.
Productmisfire. We placeda few bets on products that ultimately didn’t work out. At the time we all thought these would begame-changing products, and they were costly and time consuming to build. When customers ultimately didn’t adopt thenew offerings, these ended up being big capital misallocations that we couldn’tafford. Our core product also sufferedbecause the smaller features customers wanted were delayed orde-prioritized. The lesson is if you’resmall and don’t have a large balance sheet, do not take big expensive shotswith the direction of the product. Bettingon game changing new products is allowed only when you can handle a misfire.
We loved the founders on this deal, and ‘we’re friends to the end’, so franklywe’ll probably never get over this outcome. They worked incredibly hard, took pay that was well below market, and werejust flat out good people. We learned alot from the ways we failed the company as their investor, and hopefully youwill as well.
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