Duncan Davidson (Bullpen Capital): In Silicon Valley failure is a feature, not a bug.
04 Feb, 2022
David Gardner is General Partner at Cofounders Capital. He is a serial entrepreneur, writer, adviser, and early-stage fund manager with over thirty years of experience in creating and building software technology companies. He was the founder or co-founder of seven companies including PeopleClick and Report2Web. He served as the Executive VP and Thought Leader for Compuware, a Fortune 1000 Corporation. He is author of a popular book on entrepreneurship called The StartUp Hats. Among other firsts, David is credited with founding and launching the first software-as-a-service venture in North Carolina.
I’ve never planned to be an entrepreneur. I studied philosophy. I often say that the best thing higher education did for me is that it left me with absolutely no marketable skills, so I was kind of forced to figure out how to pay back student loans and just make money. I begin doing what I could. I built a computer for myself because I couldn’t afford to buy one. Then a friend asked me to build one, another one, and then that turned into programming and networking and putting in complete solutions – inventory control solutions, sales solutions, etc. That lead me eventually to shaving the hardware side and doing just software, where margins were better. I built a service-based company with a couple of hundred developers. I ended up creating 6 more SaaS product stirrups.
I drifted toward investments because I started doing angel investments, mentoring companies. Again, most things weren’t conscious decisions on my part. After I cashed out of a few of my own ventures I found myself some time, realized that I want to get back, help some local entrepreneurs. I found that when I was working with them and talking about marketing strategies, looking at the data, maybe pivoting based on that data rather than on the original plan, I could tell whether an entrepreneur was going to be successful. If they have this ability to pivot when necessary, if they implemented things we were talking about during our meetings, if they were eager for the next steps, if there was no patience here and they wanted things to be done as quickly as they could, their chances were much higher. And I thought that this free mentoring I was doing could be an investment strategy. The thing is when you’re talking to a mentor, you’re more open and talk about what’s not working more freely. When you’re an investor, you just get the investor pitch where everything is figured out, there’s the plan, there is no risk here, there is no unknown here. When you’re a mentor, you’re like a doctor, you know what’s not working first. I think it turned well with my angel investments that turned into a VC fund as people wanted to invest with me and move forward.
Because I run a venture fund, I’m not able to invest in software companies personally due to the conflict of interests, and I have to invest in other things that I don’t know much about. It’s risky. One of the really interesting investments was a company called Undercover Colors. Basically, those guys have been trying to invent a nail polish that could be a test for date rape drugs. A woman wearing this could steer her drink and see instantly on the back of the nail whether or not there is some ketamine or other date rape drug in there. Ultimately that did not work as fingernail polish and became a little medallion that sticks on the back of your phone, so you still steer drink with your finger and take the drop of the stuff with the same results. That actually did work, although it takes a longer time. I thought it was a very interesting technology.
Deal inflow has not been a problem for us ever, because we are in North Carolina, and NC doesn’t have a lot of early-stage capital. And the reason I’ve started the fund is that I wanted entrepreneurs to have more of a chance. It’s just a target-rich environment, they don’t have the money here they have in West Coast areas, even in cities like Austin or Atlanta. I don’t think I’ve ever seen a competitor’s term sheet – I would love to see one! It would mean we’re growing, getting more funding sources here. We have a great ecosystem here, in NC, grant programs, I run 3 accelerator programs – completely free, we don’t charge equity, but we just don’t have a lot of early-stage VC funds.
I am in, probably, 50 companies right now between my fund and my portfolio. I have 2 funds, they have 60-70 companies each. We’re starting the third fund. There are about 25 companies in my personal portfolio. That’s the problem with investing that you have to protect your investment for many years, dealing with many issues. That’s the thing many angel investors don’t understand: writing a check is an easy part – it’s all the work that comes after that is really tough. You may have to change direction trying to raise more money, sometimes you have to swap the management team – it takes a lot of work to make money.
Like any VC, I like industries that I understand, so my joke answer is anywhere I’ve started and sold a company, which is Healthcare IT, FinTech, EdTech, some InsuTech right now, some Infrastructure. We don’t do Security, Cryptocurrency. We do some Manufacturing Automation. Any B2B workflow automation is our sweet spot. We are not trying to find the next Facebook – we’re looking for real quantifiable ROI, when a reasonable enterprise businessperson can say, “Wow, I pay only x for this product, and my return on that is going to be 3x!” This is a no-brainer. It doesn’t have to be some kind of supersophisticated sexy AI software, it just has to provide some strong business case, something we can write a white paper on.
A lot of money can be made in A round in Paperless Currency, but I don’t ever have a company in that space and I don’t understand all the nuances of it and I’m afraid of government regulations in the space and what could happen. We do some GovTech, though, – it’s not hard to get efficiency when it’s related to government. We want to be a value-added investor and we tell entrepreneurs, “If all you get is money for part of your equity, you didn’t do well. Always get more than money. You want someone who’s going to be an advisor or mentor, who is going to help with your management team, help you with recruiting, with strategy help you with your pitch deck, someone who can introduce you to potential customers, a great board advisor. Get someone who can help.” Always get more than just money.
Very early. We’ve never met anything too early for us. Half of our investments are pre-revenue. We have no issue with this and all our diligence will just be going out to see an entrepreneur and a couple of the first customers.
We consider seed and Series A stages. Sometimes we participate in Series B to protect our pro-rata. But we get all our equity early on when it’s less expensive. That actually makes us a good partner because we drive the highest valuation we can get in later rounds and that puts us very closely aligned with our founders. Early-stage funds are not that big: my first one was only $12M and the second one was $31M. We tend to invest around $1M dollars or so in the seed round and then we reserve a couple of millions for follow-ups.
Fund 1 was just North Carolina. Fund 2 is NC-centric. We are branching out of NC. We have deals in New York and Atlanta, but we are very hands-on investors, we like our companies to be close, so we can utilize our network – we have a lot of tools and people, advisors, technical people that we move around. We don’t want to get too far away from NC, we wouldn’t do a deal in California or out of the country. However, I will say this thesis has been challenged recently with so many companies working completely remotely that it’s hard to say where a company is actually from. We have a lot of companies that are completely virtual, each rounder is in a different state.
A lot of our companies don’t have many numbers. Later stage guys want to see numbers, analyses, and agonize around financials. Early-stage guys smell the numbers because we know they are wrong. It’s more about the forecast. You base it on certain assumptions and if they are true, business works. Unfortunately, the models are sensitive to certain assumptions and not to others. Which numbers are the most impactful to the model – sale cycle, margin? What’s going to create your costs and sales? If your margin times a lifetime value of a customer is greater than your CAC, you have a business. Our due diligence is not so much looking at historical financials (despite we interview customers), it’s more about do we believe that forecast and how can we de-risk those assumptions that the forecast is based on. And even if there’s no revenue, but we feel good about that forecast and the assumptions, we consider our investment. If those numbers are really to prove new comparing to other industries, we evaluate a company lower, because it’s riskier.
We’ve done deals in less than 30 days and more than 90 days. Most of it at entrepreneurs’ side. We give them a due diligence packet – spreadsheets with checkboxes of what we want to do – interview their employees, talk to customers, we want to spend time with them in the model, go on sales calls with them – a whole bunch of stuff in there. If the entrepreneur is really motivated, we can do it very quickly. If they don’t, it can take 2-3 months.
It is all about an entrepreneur. A bad idea but a great entrepreneur will bring you more money than the other way around. In the first 2 minutes, I need to understand what are they doing, what’s the value. We have a joke that if we don’t understand something in the first 2 minutes, we won’t invest, because it’s not articulated well enough, and it’s all about being a great communicator. They need to be able to communicate what they are going to do, why, and who’s going to buy it. If they are not able to talk this way, they are never going to convince people to come work with a risky startup or get customers or convince the next investors. We want to know are they smart, articulate, efficient with their time. If you don’t have all that, nothing else really matters.
Everything else! Do I believe this person? Are they convincing or are they sugarcoating things? It’s ok for them to say “I don’t know,” because that’s honest. We’re going to be partners, we’re working together, and if they won’t be successful, it will be as much my fault as theirs. I want to have a good partner, who shares information with us, not just gives us good news. We are looking at the dynamic within the team. Is it balanced? If it’s not, will they let us bring another founder? Are they coachable? Sometimes I look for something to object to (even if I like it) just to see how they handle my objection. Those are all parts to look at – even before we look at the business.
I think, Woz. You’re always looking for someone who isn’t like you to balance you.
Yes, we had solo entrepreneurs. In that case, they have to know what they know and what they don’t. In that case, we will probably want to get a team together before we write a check to know people we invest in. I want to work with people who have equity, not hire-ups. I’m sorry for this “yes, if” answer: unfortunately, that is the answer most of the time.
Dishonesty. If we don’t have clear communication, if someone’s holding information, if we find out something that an entrepreneur should have been told us, that’s a big red flag. We got to be able to trust one another. One VCs told me that the first thing he asks himself every board meeting is does he believe what he talks about. Entrepreneurs never stop selling! This is the thing we have in our manual: Stop selling! You’ve got us, you’ve got our money, let us help you. That’s a dealbreaker for me. A lack of coachability: if we don’t have influence, we might as well buy stock. I can go to Vegas and play if they let me arrange the cards! But if I have no influence on a coachable entrepreneur, I’m just alone in this ride. I don’t want that. I want a deal where I can be impactful and help move this investment toward a faster and bigger exit.
Well, I’d like to say that we continue to be mentors, but actually, we play a lot of roles. I’ve been the counselor, the psychologist, the bookkeeper, and sometimes for younger entrepreneurs I’ve been even their parents. It’s whatever they need. We have guys that are good at something and not good at other things. The skillset that they need changes as the business grows. I’ve invested in a brewery just so I can take entrepreneurs out for beers to talk. We have to be tough sometimes and hold their feet to the fire, making them fix problems and reach their goals in time. But out of the board meetings we try to be their friends. At the end of every meeting, I always ask what is the single thing that I can do to help you – to recruit, to make an introduction to the healthcare system, to help you get other venture money. This is what I trained my team to always ask.
In all practices, the biggest thing is building a solution before you know what the problem is. You think you understand a problem and you spend a lot of time and money building software to fix it, then you talk to customers and discover that that’s not a problem or the problem is in other areas, so you end up pivoting and writing a bunch more software messing with timelines. The biggest issue is thinking you know stuff when you really don’t know. I always suggest not to write any software and don’t quit job or start spending money until you talk to customers and know very very well what they need and how much time and money they save using your solution. The one thing you can’t come back from is the lack of a market. Make sure that you have a market and it is a sizable market.
Whatever we can get. If we don’t see a potential for every deal to return at least half of our fund, it’s not a deal we want to do. When we discover that something isn’t that good as it seemed, maybe, we thought it was a must-have but it’s turning to be a nice-to-have or the selling cycle is longer than we anticipated, we will find potential buyers and sell this technology. We were very good in this so far: of all my companies only one was a complete loss for us. With all the others we were able to break even or make a low return. We do ok with the downside.
The right answer is “Is there enough money to keep founders incentivized and is there enough money to accomplish the plan and is there enough equity left over for entrepreneurs to have a big upside and stay excited about working in that venture?” You’ve got to strike that balance. We try to not do an early-stage equity stake in less than 20% equity ownership, and we may put in more money sometimes to get that 20%. However, there are some ventures that don’t need that much money. The truth is, whatever we get – 1% or 20% – we have to do the exact same amount of work that goes on for years and we don’t get paid for that. We want to make sure that we have a significant upside if we’re going to do all the same work regardless of the amount of equity we get.
Yes. I think everyone has skipped things and wishes they had gotten in on it. I will say that at the time we made the call it was the right decision based on the information we had. There was a team that we passed on because a team wasn’t clicking, it wasn’t working, they weren’t willing to let us bringing anyone to help them, and it was the right decision for us to walk away. They figured out their issues, brought a successful CEO, and are a killer now, but at the time we made that decision, it was right. Venture capital is a very humbling business, you make mistakes all the time. Entrepreneurs think we have all the money, but we do way more selling in fundraising than they ever did, we have to sell every single LP to keep them happy. We kissed a lot more but any entrepreneur does. It’s not right that they have to come in and jump through hoops for us; with everyone who walks through our door we pray, “Please, let it be the one!” We want to give them money. I’ve been at both sides of this – there’s plenty of misery in both sides of that equation.
I don’t know. I can do both. At this stage of my life, I like being an investor more because I’m involved in more strategy discussions, acquisition discussions, fundraising, in higher-level strategic instructions. When you run your own company, you’re doing a lot of mundane stuff that just has to be done. I still do some of that, but spend more time doing the more fun parts of business now than I did before. Of course, without that experience, I wasn’t able to do what I do now.
Yes and no. We have a couple of companies in Healthcare that was selling to the hospital system, the hospital system was not buying the last year. They were busy. That moved a lot of our stuff back. Our funs is older now, so our last deals are going to be a little more later-stage deals than we typically would do. We don’t want to do very very early-stage investing in a company that may take 6-7-8 years to exit when we’re already 6 years into our fund and are going to make the last couple of investments. COVID set us back. Also, we are more open to doing deals outside of North Carolina, because we are just so comfortable. We have been effective with our companies. In fact, we’re looking at a deal in Florida right now which is way further we ever thought. We’ve gotten very comfortable working virtually. That’s another thing we will do more, especially in our next fund.
Both! We have a company in food and groceries delivery, and COVID was a huge blessing for it. We have other companies that basically were shut down for a year. Anytime when there is a big change in markets there are going to be winners and losers.
I get 15-20 pitch decks a day, so we get educated a lot by entrepreneurs. The information that they bring us, the diligence our interns and partners do – we learn a lot. As fund management, we get the typical sources – local media, Crunchbase, Pitchbook, I take the local news feeds, we’re reading whitepapers and things related to our trade to see where valuations are, how things are coming and going. We follow tax code and VC feeds, like NVCA, because tax exemption is huge for early-stage investing. We’re involved in some initiatives in North Carolina for credits for early-stage and angel investors – it is good for the startup economy. Anything that touches our business or the industry – you always feel amazingly underinformed.
If you measure by success… Obviously, Google has been massively successful. Amazon has been massively successful. Amazon, although they are B2C, they are also B2B as a marketplace. All Google revenue comes from B2B, but they have a B2C component like some of our companies. There are a lot of the big hardware companies that have B2B offerings that are pretty amazing. The list of hugely successful B2B companies is so long – you can pick anyone.
You can read every month about a company that raised hundreds of millions of dollars and went under. We are an early-stage fund, I don’t pay much attention to those mega-funding rounds and billion dollars exits – it’s not where we live. We are not homerunners – we are basemen.
Maybe, we can compare it to poker, because you’re looking at what you have – that’s a given. There’s something that is given and you know it, but you don’t know what other people have. You’re making some assumptions, you running probabilities, and make educated guesses – that’s probably the best analogy to venture capital.
Accomplish your mission, don’t run out of money, and take care of your team.