Becoming a Venture Capitalist
1 THE PITCH
Greylock Partners maintains not one but two offices in the San Francisco Bay Area. One is on Sand Hill Road, in Menlo Park, the Wall Street of venture capital and more or less in the middle of Silicon Valley. But these days the center of gravity in the tech world has shifted north to San Francisco, and Greylock, like most of the area’s top venture firms, now leases space in the city. Josh Elman, regarded widely as one of venture’s bright new stars, is working out of Greylock’s San Francisco offices on a sunny Wednesday in the fall of 2017. It’s there, in a factory-chic office in a part of town thick with start-ups and rival venture firms, that I join him for a lineup of meetings that includes a sit-down with the founder of a mobile-app start-up that’s been around for several years. “This is someone I’ve known a long time,” Elman tells me. “From before I was a VC.”
The ground rules of this interview dictate that I can’t
name the entrepreneur or his start-up. But there’s no stopping me from describing the man as an odd duck. I’ve sat in on my share of pitch meetings over the years. I’ve witnessed awkward mumblers who can’t make eye contact. In the late 1990s, at the peak of the dot-com madness, I tried not to visibly roll my eyes over the hubris of the MBAs descending on Silicon Valley with their charts and projections but not much else beyond a smooth, practiced delivery and the promise of “ubiquity” for whatever they were selling. But never had I come across an entrepreneur as buttoned-down bland as this one. His background was an interesting one that included a stint on Wall Street. He was older than the typical founder. Yet he didn’t seem to have the personality to lead a growing tech start-up.
The CEO claims that he isn’t at Greylock looking for money. “We’re not in fund-raising mode,” he says to me as we’re introducing ourselves to each other. As the founder tells it, he’s just one old colleague asking another for friendly advice as he preps himself to raise a large slug of money. The CEO takes a seat across a conference table from Elman and plugs in his laptop loaded with a multi-slide presentation that he thinks is worth at least $50 million. To his right sits a top executive from his company: a wiry man with
a shaved head, a deep résumé, and an intensity that suggests he would crash through a wall if that’s what it would take to win. “We literally were making changes in the car a few minutes ago,” the CEO tells Elman. He’s aiming for nonchalance, but it comes off as an obvious ploy to lower the stakes on a high-stakes meeting. He has no doubt been sweating this meeting—and every slide—for weeks.
Greylock is one of the country’s oldest venture firms and among the most highly regarded. It might be overstating things some to say that pitching Greylock (as a Newsweek contributor wrote in 2014) “is a bit like being a rookie pitcher stepping onto the mound at Yankee Stadium—with Babe Ruth walking up to the plate.” But there was no doubting the firm’s supremacy. I would speak to more than two dozen industry people for this book. Almost to a person, they listed Greylock as a top-five venture firm, if not top three. Greylock had been an early investor in both LinkedIn and Facebook, when $27.5 million bought nearly 6 percent of a company today worth more than $500 billion; and also the music-streaming service Pandora, which was worth $2.6 billion at the end of its first day as a publicly traded stock in 2011. Greylock Partners had also invested in Instagram, the thirteen-person start-up that Facebook
bought for $1 billion in 2012; Tumblr, the microblogging company that Yahoo purchased for $1.1 billion in 2013; Zipcar, which Avis paid $500 million for that same year; Dropbox (a digital storage service), valued at $12.7 billion when it went public in 2018; and also Medium (an online publisher) and Airbnb. Greylock had the economic means to provide the CEO with the money he needed to build out his idea and also the connections of Elman and his partners, along with the services of the eight full-time recruiters who work for Greylock and its in-house communications team if a start-up team needs help with its messaging. (A lot of the big firms provide these kinds of ancillary services, to increase the chances that the portfolio companies they fund are winners.) Quite simply, Elman could make his company.
This is not the CEO’s first time pitching Elman. That’s obvious a minute or two into the meeting. “I want to start by thanking you for calling BS on our numbers the last time we met,” the man says. Elman fills me in later. A year or two earlier, the CEO had offered revenue estimates based on the brightest assumptions—“and then basically he doubled everything.” But apparently Elman has a soft spot for the CEO. Or at least he sees potential in his company. The CEO had been struggling to find the right business model,
and Elman has been helping him find the right market for his app, even if he hasn’t been willing to invest yet. Now, several business models later, the CEO is certain the company is positioned where it needs to be. “We really appreciate all you’ve done to help us hone the business,” he says. A small smile appears briefly on his face but disappears immediately, as if someone has snapped shut the blinds.
“I’m just trying to be a blank slate here,” Elman says helpfully. The VC is of average height, with the chunky build of someone for whom exercise is largely speed walking between meetings. He has thinning hair and blue eyes behind a pair of stylish metal glasses. On this day, he’s dressed in a blue T-shirt under an untucked plaid shirt, jeans, and running shoes. He’s an upbeat, if fidgety, presence in the room, with a puppy-dog spirit, all nods and smiles. He almost leans into the presentation, as if primed to be delighted by whatever an entrepreneur might utter next.
Elman wants to fall in love. The CEO, however, is making it hard. An early slide boasts of the tens of millions of venture dollars his company has already raised. The smile dissolves from Elman’s face. His fingers absentmindedly find a pen and begin playing with it. The VC within seems almost offended that a founder is boasting of blowing all
that money in search of the right market. Elman lets another slide or two pass but then asks the CEO to go back. “You save that for the end,” he says of the amount of venture money raised already. Later, he is blunter: “He had burned through”—here he gives the exact number, but, suffice it to say, it was closer to $100 million than to zero. “And he’s putting that up at the top of his slide deck like a selling point?”
Every industry has its own vocabulary. The shorthand and jargon can sound like gibberish to an outsider, but they form a code that offers entry into that world. The CEO talks of “legacy systems” hobbled by “the premobile economic model” and “organic” versus “paid” growth, which has allowed them to pick up users without much in the way of customer “acquisition costs.” All of it is encouraging news for a mobile-app maker wanting to be on the smartphones of hundreds of millions of people around the globe. Millions have already downloaded the app, and, if most aren’t yet paying customers, the CEO shares some clever ideas for getting anxious parents and others to pay monthly for the premium services they’re selling.
He flashes a couple of slides showing the market share enjoyed by some of those “legacy” companies (big, established brands that are rarely tech savvy enough to offer
much in the way of competition). The numbers are tantalizingly large. The actual revenues they’ve already generated are similarly impressive: multimillion-dollar payments from third parties seeking access to the audience they are aggregating, with the promise of much more. The smile is back on Elman’s face.
“This is the first time in a meeting with you where I get the investment thesis,” Elman says. He does some quick math in his head and encourages the founder to be bolder in his pitch. “Play up that this is a ‘billion-dollar opportunity,’?” he suggests.
Elman is an observant, fast-thinking, fast-talking guy; he doesn’t seem to miss much. The CEO is more the opposite and slow to pick up on social cues. Dour and lacking emotion, he plods through a prepared presentation—which Elman continues to interrupt. “Go back a slide,” he tells the CEO. The revenue projections are on the screen again. “The big question is defensibility,” he says. “Couldn’t any number of big companies do exactly what you’re doing?” he asks and then lists several, including Google and Facebook. “How do we know you’re the only ones who can cash in on this honeypot?” Looking at me, Elman says, “That’s always the question.”
The CEO doesn’t attack the answer so much as brush it aside. But here his sidekick offers a far more convincing argument that gets Elman nodding and smiling happily.
The three of them talk about the company name: Do they need to change it? And, despite how much they’ve already spent establishing a brand, do they also need to change the company slogan? Elman shifts in his chair and starts fiddling with a paper clip. Another slide gets him talking about burn rate: the money a company spends on salaries and other costs each month. Prior to becoming a venture capitalist, Elman worked at Facebook and Twitter. He knows something about growing a tech company.
Elman points out that the CEO has been burning through less than $1 million a month. “If you ramped up your burn rate to closer to three million, no one would freak out,” he advises. From where I’m sitting, the message is unmistakably clear: Elman is telling his old colleague to mash his foot down hard on the gas pedal. But rather than pause to consider the VC’s comment, the CEO bats it down, saying dismissively, “I’m like a Depression baby when it comes to spending.”
Every venture deal gets reduced to what is called the “valuation”—the paper worth of a company—so that the
investors can figure out their ownership stakes. For example, a start-up is valued at $20 million (the “premoney” valuation) if the venture capitalists are spending $5 million to buy a 20 percent share in the company, or one-fifth of $25 million (the “postmoney valuation”). The CEO, perhaps feeling emboldened by Elman’s encouragement, offers, “I think it should be a $750 million valuation.” One of the legacy companies whose business he’s threatening has told him it wants to invest in the next round. But he’ll still need to find venture investors if he’s going to raise the kind of money he’s seeking.
Elman squirms in his seat. He pulls at his face and tugs at his clothes. It’s never easy to bring up what venture capitalists call a down round. The tech graveyard is crowded with companies that were valued at $400 million when they raised a C round (a third round of funding) but only $200 million (rather than, say, the $800 million valuation the founders had been counting on) on the D round. That dilutes the ownership rate of a company’s founders and initial investors—and also all those early employees who had been hired with the promise of owning a sliver of the company. Elman suggests the possibility of a down round, but the CEO shudders at the distasteful prospect of bursting the
bubble of all his hotshot programmers who are banking on a big payoff once the company hits it big.
“My engineers would mutiny if I even bring up a down round,” the CEO says, slamming shut the door on further conversation.
The rest of the meeting has Elman offering several more pieces of advice. “It’s time to pull together a narrative,” he tells the two men, by which he means they need to do a better job of presenting their story. He also suggests that they play up what he calls “engagement data”: stats that show how often and for how long customers use their service.
The art of being a venture capitalist means never saying no even if you rarely say yes. Greylock Partners met with several thousand entrepreneurs in 2016—and made sixteen investments that year. Yet what if the start-up that struck you as a dud in a first round—the A round—catches fire, and you and your partners want in on a B or C round? Or what about that entrepreneur’s next company? Elman offers only encouragement as we say our good-byes.
“This is great. I want to lean in and talk to the team,” he says, referring to others inside Greylock. “The last time we met,” he tells the CEO, “I was seventy-five percent sure
what you were proposing would work. Now I have a higher confidence range.”
On the way to the next meeting, Elman gives me the arguments against investing, starting with the CEO himself. “If we were to invest, we’d have to have a difficult conversation about whether he would be the CEO moving forward,” he says. The valuation was another possible deal killer—especially when the company’s founder had just told him that they would probably lose their best engineers if forced to accept a down round.
“But for argument’s sake,” he says—and then proceeds to outline the opposing views:
Yes, the company has blown through a lot of money in search of a working business model, but it still has multiple millions in the bank. More important, he adds, “They finally have a winning story to tell.” The company has been booking significant revenues, and all the numbers point in the right direction. “They’re no longer scratching and clawing the way they were,” he says. Maybe a fortyfold increase in revenues over the next eighteen months is on the giddy side of optimistic, but what if they grow twenty times? Elman does some quick calculations in his head and imagines a time in just a few years where, based on even
these more modest growth numbers, the company is generating $300 million or more in annual revenues.
A big smile flashes on his face. “Then,” he says, stopping to look at me, “it becomes interesting.” Maybe he’d help them grow into a giant business. More likely, though, he says, “they sell to Facebook because Facebook will realize they need it.” If they see the opportunity to book a few hundred million dollars a year in revenue, so would a Facebook or a Google.
The real question seems to be whether it would be worth the level of engagement that investing in the CEO’s venture would demand. The potential is there for a threefold or fivefold or maybe tenfold return on their investment (ROI). But this is hardly an Instagram, where Greylock took part in a B-round investment at the start of 2012 and several weeks later collected on its share of the winnings when the company sold to Facebook for $1 billion. “One problem with this business is that it’s the companies that aren’t working out take up an inordinate amount of your time,” Elman laments. “Those are the ones that sap your energy and your enthusiasm and your willingness to get into the next one.”
We’ve reached our destination, which ends the
conversation but also punctuates it. It’s a portfolio company in which Elman has invested millions of Greylock’s dollars. Yet in recent months, things haven’t been going as expected. “They’ve hit a plateau,” he says—a potentially fatal affliction to any venture-backed company.