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Protocol Pipeline
The inside story of the venture capital and startup world by Biz Carson.

Protocol Pipeline: Time to put down the 'hammer of equity'?

Bryce Roberts


Hello and welcome to Pipeline. I hope you don't spend all of your three-day weekend on Clubhouse, but please post your screen time notification and tag me on Twitter (@bizcarson) if you do. This week: Why you should probably mention COVID-19 in your pitch deck, blaming cows for outages, and the blunt hammer of equity.

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Overheard

  • Talk about a God complex. SoftBank's Masayoshi Son reportedly compared himself to Jesus Christ this week, arguing that he, too, is criticized and misunderstood. Son also showed off a slide depicting a"Valley of the Coronavirus," which had horses tumbling into a pit then emerging as unicorns with wings to "fly high" on the other side of the pandemic. No word on how Son plans to give companies those wings to get out of this, though, as the first Vision Fund is finally done investing.
  • Get ready for "Clubhouse but for X." Unsurprisingly, there's already dozens of ideas (and many existing companies) that want to re-create the audio-only community. Nothing like curing investor FOMO by pitching a derivative they can get in on.
  • "I still see some pitch decks that don't even mention COVID-19, and those that do think of it as like a footnote," Norwest Ventures partner Dr. Robert Mittendorf told Protocol. It's an eyebrow-raising move when pitching a healthtech VC who also works as an ER doctor during this crisis. "I think that speaks a bit to the acumen of the entrepreneur," he added.
  • Having unexplained internet outages? Blame the cows.

Biz on Biz

Not your parents' debt

For years, the trend has been to bundle venture debt rounds with traditional equity rounds in one big headline-grabbing number — a move that made sense, considering venture debt rounds are often made around the time of an equity fundraise. But that's changing: We're seeing companies such as Airbnb, Digital Ocean and Envoy openly talking about just raising venture debt.

  • Part of the hesitation around venture debt is a bad connotation with the word debt in general, says Larry Gadea, CEO of the workplace software startup Envoy, after securing $20 million in venture debt from TriplePoint Capital, and an extra $10 million in credit just for M&A opportunities. (He chatted with me as a never-ending Roller Coaster Tycoon scene looped on his Zoom background — the perfect allegory for how life has felt the last few months.)
  • "Don't think of it like your parents would say, 'Don't be in debt blah blah blah.' It's totally different when you have a company and when you have revenue," Gadea says. Venture debt isn't for everyone, but Gadea's company fits the profile venture debt lenders like: growing and revenue-generating. (It could also afford the hundreds of thousands of dollars in audit fees to get the deal through.)

Most companies seeking venture debt during COVID fall into one of two buckets, says Runway Growth Capital's David Spreng, a former VC and Midas List-er who has switched to the venture debt side.

  • One crop of startups needs rescue capital after their existing lenders panicked (although some are too late to save).
  • The second group includes strong companies that were on a path to profitability and IPO but suddenly find that path taking longer than planned. "That's where taking debt is a much better option than taking more dilution than you need to," he says.

This was the first time Gadea ever raised debt, but after talking with founders and other investors, he realized there was too much uncertainty — and too many down rounds — to go for a traditional venture round.

  • "This is not the time to be raising equity. People don't know how to value things, and investors are going to be like 'hey, might as well just do what the last guys did because that's easier,'" he says. Equity can be great as it's money that you never have to give back, but the problem is you're also giving away part of your company, Gadea says.
  • The combo of debt and a credit line gives Envoy flexibility and a chance to reassure customers that it's going to be around for a while. Plus, it can play a little offense and acquire other companies specifically with its M&A credit line.

Sadly, "founder financial literacy is probably at an all-time low," says Indie.vc founder Bryce Roberts. "We spend all of our energy educating them on equity and how to sell equity, and we don't spend any time educating them on all the other form factors of capital that are out there, despite that pool growing leaps and bounds."

  • But there's been an explosion in alternative capital sources alongside the growth of venture debt. Look at Shopify, Square and Brex, which all launched different financial tools and different lines of credit.
  • "In every other industry you see these things being used with kind of scalpel precision, and here you just kind of have the hammer of equity that we've used for the last decade or two," he says.
  • Still, as entrepreneurs see deals like those made by Envoy or Digital Ocean — which raised $100 million in debt, then followed it a few months later with a venture round — Roberts predicts that there could be a sea change in how founders pursue funding.

"Where you spend the money is how you should think about how you raise that capital," says Clearbanc's co-founder Michele Romanow.

  • The opportunity she saw was giving ecommerce startups the cash they need to pay for ads, and then make the money back (plus a little extra) through a revenue share agreement. "The arbitrage we saw in the market was people are using the most expensive capital, which is equity, to do something that is repeatable and scalable like buy Facebook and Google ads."
  • After deploying over $1 billion to 2,200 ecommerce companies last year, Clearbanc launched a new Runway program during the pandemic to help B2B companies cover sales commissions.

The key to nearly all of these alternative funding paths is to have a revenue-generating business that works. Clearbanc doesn't fund companies that can't show that their ad spend is returning money. Venture debt lenders like Spreng want to see revenue and growth, and not much risk.

  • "As we live in this post-WeWork world, or people start to have a deeper understanding and appreciation of positive cash flow of unit economics, they're going to be a lot more discerning about how they use equity versus how they use other instruments that can help them get there," Roberts predicts.
  • None of this will change the role venture plays in the ecosystem, he says. But instead of having it be the only path, he predicts there will be a new era — an "Enlightenment," where founders learn to explore their options.
  • "If you don't have that unicorn-shaped opportunity for equity to consolidate around, you're going to have to get creative," he says.

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Inside track

  • There are three sides to risk, says Collaborative Fund's Morgan Housel — a lesson he says he learned in a tragic way in Squaw Valley more than 20 years ago.
  • Houseparty may be having a moment, but it took a long road for it to get there. Founder Ben Rubin went down memory lane with NFX's James Currier on the inside story of the evolution from Life on Air to Meerkat to Houseparty.
  • It's easy to see which consumer apps are thriving during the pandemic, but the bigger question is what's actually going to stick around. Benchmark's Sarah Tavel published her framework for figuring that out, which involves rocks, sand and water.
  • The future of remote work came gradually, then suddenly: Automattic's Matt Mullenweg on the illusion that the office was ever about work.
  • "I've learned more about who people really are around me now in the last eight, nine weeks than in the last handful of years," says Airbnb's Brian Chesky. He spent two hours talking to startup guru Eric Ries about how Airbnb navigated the crisis, layoffs and how to design a company. Both parts are worth a listen, but here's the headlines of top lessons learned.

Need to know

  • Jio is still the hottest investment right now: The Indian telecom has now raised over $10 billion in the last month alone from Facebook, Silver Lake, Vista Equity, General Atlantic and now KKR.
  • It's all about remote work. Startups like Coinbase have joined big tech companies like Facebook, Shopify, Twitter and Square in announcing a remote-first workforce amid the crisis. What that means for employees salaries is still up for debate.
  • Microsoft developed a supercomputer for Sam Altman's OpenAI, in the latest sign that supercomputing is moving to the cloud.
  • Delivery companies are fighting city commission caps. Does anybody win?
  • This week in VC history: Yahoo bought Tumblr for $1.1 billion in 2013 — a big exit for NYC's tech scene — and promised "not to screw it up." Verizon, which now owns Yahoo, ended up selling Tumblr to Automattic last August for reportedly less than $3 million.
  • And your weekend reading: The infighting, sabotage and intrigue behind the scenes inside SoftBank.

Five questions for…

Canvas Ventures' Rebecca Lynn

What's one of your new quarantine habits?

Homeschooling! I am experiencing eighth grade, fourth grade and kindergarten all over again! I ended up really getting into it and wrote up a blog post called "Corona Curriculum." There are so many wonderful online resources, and they can learn anything — our kids are so lucky with everything at their fingertips for learning. We are doing painting, Python, pastries …

What's a pitching pet-peeve?

I like founders that are honest and direct — that is my style. My biggest pitching pet-peeve is distortion or "over spinning" of data. I put a big premium on honest, direct communication. If a founder is playing "hide the ball" during the pitch, or has to be asked three different ways for a simple metric, then this doesn't bode well for a long-term working relationship.

What was your first check?

Lending Club. I wrote a check for $7 million in Q1 of 2009, the depth of the last economic downturn. We came in on the series B at about $24 million pre, on a down round. Those really used to happen. At IPO, the company was valued at $8.5 billion. That was a pretty good first deal; it set the bar high.

What's one of the worst predictions you've ever made?

The worst prediction was telling Travis Kalanick, when he told me he was considering becoming the CEO of Uber, that he'd never win the battle against the taxi unions. That was a mistake.

What's one problem you wish an entrepreneur would solve?

Food logistics. Solve the issue of food rotting or having to be thrown away in one place while 1 in 10 kids in the U.S. are food insecure. Solve this. Please. Farmers don't want the food they worked so hard to grow to be thrown away, and childhood hunger is a problem we can solve in this country. It is more pressing than ever given the pandemic.

Thanks for reading this week's Protocol Pipeline. And happy birthday to my sister Meredith. If you like what you're reading, sign up here to get it in your inbox. Send story tips and Pipeline feedback to biz@protocol.com. Otherwise, stay safe, stay healthy and stay home. See you next week.

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