The Startup Solution

Over 20 years ago, Heidi Roizen became the subject of a Harvard Business School case that is still one of the most popular cases taught at business schools around the world today. This episode is a culmination of Heidi's best answers and actionable advice from two decades of being asked about the best ways to build one's network — or, as Heidi likes to put it, how to build a relationship-driven life, as opposed to one that's transaction-driven.

More Information: https://threshold.vc/podcast/the-case-for-a-relationship-driven-life

Further Reading:

• Here's another take on my favorite sentence in a negotiation: What problem are you trying to solve? https://www.tumblr.com/heidiroizen/92662870040/the-magic-question-that-turns-transactions-into?source=share
• Funny enough, First Round Capital covered me and my advice about relationship-driven living and more here: https://review.firstround.com/8-rare-gems-from-heidi-roizen-on-building-a-fulfilling-life-and-career/
• And, if you want to actually read the Harvard Business School case, you can find it here: https://www.hbs.edu/faculty/Pages/item.aspx?num=26880

In Season 3 Episode 8 of The Startup Solution, Heidi covered "How to Think About Venture Capital" and explained the VC business model. She now wants to dive into the topic of dilution - that is, how to think about the tradeoff between what you give up and what you get when it comes to your startup's equity.

For more information: https://www.threshold.vc/podcast/how-to-think-about-dilution

To determine if you should pursue VC dollars to fund your company, you first need to understand how the venture capital model works. Heidi covers the type of businesses and growth potential required for a VC to make an investment, along with the high risk involved in venture capital and an explanation of the power law.

More Information: https://threshold.vc/podcast/how-to-think-about-venture-capital

Further Reading:

I promised a lot of additional reading – so here goes.

First off, understanding the VC power law is fundamental to understanding the VC business model. Here's a post about it: https://x.com/speechu/status/1083921878786310144

And a whole book abot it: https://www.amazon.com/Power-Law-Venture-Capital-Disruption/dp/0241356520

The topic of whether venture capital is the right way to fund your business is critically important. Here's a post by VC Erik Berg that nicely captures many of the key points to consider: https://abergseyeview.com/is-venture-capital-funding-right-for-my-busines Here's a fantastic article by the New York Times about why some entrepreneurs didn't take VC: https://www.nytimes.com/2019/01/11/technology/start-ups-rejecting-venture-capital.html

And here's a post by entrepreneur Anthony Collias about the pros and cons of taking that venture investment given his experience as an entrepreneur: https://blog.joinodin.com/p/vc-steroids

A bit dramatic, but the gist of it isn't wrong – The warning label that should come with VC money: https://hackernoon.com/the-warning-label-that-should-come-with-venture-capital-9432500b7195

And for those of you who like stats:

• Here are some interesting stats on startup financing from Fundera: https://www.fundera.com/resources/startup-funding-statistics
• A great infographic by Entreprener on where startup financing comes from: https://www.entrepreneur.com/money-finance/where-startup-funding-really-comes-from-infographic/230011
• And venture investing data from Crunchbas: https://news.crunchbase.com/venture/global-funding-data-analysis-ai-eoy-2023/
• And more data from the National Venture Capital Association: https://nvca.org/wp-content/uploads/2024/05/2024-NVCA-Yearbook.pdf

As for startup failure rate, there's this piece from Harvard Law School: https://corpgov.law.harvard.edu/2023/09/29/startup-failure/

Here's the story about the Wordle creator and his sale to the New York Times: https://corpgov.law.harvard.edu/2023/09/29/startup-failure/

The Benchmark/eBay story is summarized here: https://medium.com/venture-capital-research/8-vc-insights-from-the-genesis-of-benchmark-capital-8915d4fe6f39

And last but not least, my Alec Baldwin quote comes from this famous scene in Glengarry Glen Ross: https://www.youtube.com/watch?v=Q4PE2hSqVnk

A person with a big online presence is calling out Athena for the seed investment she received from a big corporation that appears to be in opposition with Athena's company's mission. Heidi points out why founders need to know as much as they can about potential investors before they take their money to avoid being blindsided by an association that may lead to reputational fallout.

More Information: https://www.threshold.vc/podcast/the-case-of-the-compromised-capital

Further Reading:

• Spot on to the topic in this podcast, Should Climate Tech Startups Accept Money From Big Oil?: https://sifted.eu/articles/climate-tech-startups-big-oil-gas
• An article about tainted donors, though topics also relevant to tainted investors, Tainted Money and Tainted Donors: A Growing Crisis: https://johnsoncenter.org/blog/tainted-money-and-tainted-donors-a-growing-crisis
• Business Insider's take on the topic: https://www.businessinsider.com/startups-silicon-valley-jeffrey-epstein-problem-2019-8
• An article highlighting increasing concern about taking money from Chinese investors due to geopolitical clouds on the horizon: https://www.wired.com/story/chinese-venture-capital-silicon-valley-party-over
• Here's the apology statement from Joi Ito, former director of MIT's Media Lab, about taking money from Jeffrey Epstein: https://www.media.mit.edu/posts/my-apology-regarding-jeffrey-epstein/
• Interesting Quora thread on "Catch and Kill" startup M&A: https://www.quora.com/Why-do-big-companies-acquire-and-then-kill-promising-startups

Rudy, a founder in fund-raising mode, received a verbal term sheet. A what? Heidi informs Rudy that there is no such thing as a verbal term sheet and flags all the other issues with the investor's offer. In this episode, Heidi resets Rudy's expectations of what is involved in the fund-raising process, including the time it will take to properly diligence investors.

More information: https://www.threshold.vc/podcast/the-case-of-the-verbal-term-sheet

Further Reading:

• Here's a great piece about whether Term Sheets are legally binding, and what happens to your reputation if you renege on one.
• Term sheets are typically non-binding in that neither side is obligated to close the deal. But what is usually binding is confidentiality and exclusivity: https://www.jdsupra.com/legalnews/are-term-sheets-really-nonbinding-1765649/
• Y Combinator has a great piece on seed fundraising, which goes into detail about debt versus equity here: https://www.ycombinator.com/library/4A-a-guide-to-seed-fundraising
• Here's a good post on SAFEs versus convertible notes: https://blog.hubspot.com/sales/safe-vs-convertible-note
• And, finally, seed-stage investor Chris Neumann on how to diligence a VC: https://chrisneumann.com/archives/how-to-diligence-a-vc

Simone is a founder in a challenging situation. The only financing she can raise comes with a catch – she needs to do a recap. Heidi reviews how Simone landed in this position, what a recap entails, and the best path forward for the company and investors.

More information: https://www.threshold.vc/podcast/the-case-of-the-radical-recap

Further Reading:

• This is an excellent four-part series for entrepreneurs that explains how to navigate down rounds and recaps by Eric Ashman, highly recommended! https://www.linkedin.com/pulse/navigating-funding-roadblocks-intro-down-rounds-recaps-eric-ashman
• A great summary of the legal pitfalls and best practices for a cram down financing from the law firm Gibson, Dunn & Crutcher: https://www.gibsondunn.com/wp-content/uploads/documents/publications/Weirick-Wortmann-Stephens-Barinsky-DownRoundFinancings.pdf
• From the great Bill Gurley of Benchmark, a comprehensive tome about recaps and other forms of "the party is over" financings. He wrote it in 2016, but it is just as relevant today: https://abovethecrowd.com/2016/04/21/on-the-road-to-recap
• Here's an interesting take from Joanne Wilson, an early-stage angel investor, on a recap of a seed company, with additional commentary by Brad Feld, my old partner and dear friend. It covers the danger of too many note financings and also talks about the people/reputation/relationship aspects of recapping a seed stage deal: https://gothamgal.com/2015/07/recapping-a-round
• And here's another interesting take from my fellow Stanford Lecturer and amazing entrepreneur Steve Blank about why recaps/cram downs are a bad idea. I don't 100% agree with him, but I think his position is excellent food for thought: https://steveblank.com/2022/04/26/cram-down-a-test-of-character-for-vcs-and-founders

What do you do when you want to exercise your startup's stock options but need to borrow money to do so? Do you take an interest-free loan from your company? Heidi counsels her former student Aisha on why that may sound like a great offer, but the devil is in the details. It's likely that a loan could lead to painful financial consequences later. More Information: https://www.threshold.vc/podcast/the-case-of-the-dubious-debt

Further Reading:

Here it is, straight from the IRS, what capital gains are and the rate at which they are taxed: https://www.irs.gov/taxtopics/tc409

And also, straight from the IRS, how they look at forgiven loans as ordinary income: https://www.irs.gov/taxtopics/tc431

And here's a comprehensive Forbes article on using debt to exercise options: https://www.forbes.com/sites/brucebrumberg/2021/09/20/financing-stock-option-exercises-in-private-companies-insights-from-a-top-financial-advisor/?sh=5f1fe75f2446

Many founders, like Alyssa, worry that a 409a valuation is considered a true market-based assessment of a company's overall worth or potential. It is not. Heidi points out factors that influence a 409a valuation along with what is not reflected, namely, leadership, team quality, and disruptive potential.

More information: https://www.threshold.vc/podcast/the-case-of-the-409a-freak-out

Further Reading:

• Carta provides a pretty comprehensive discussion of 409a's here: https://rb.gy/z4vsky
• While we all think of 409a's in the context of getting a valuation for common shares, it stems from The Internal Revenue Code, section 409a. A little 'fun' (if you think of the Enron bankruptcy as fun) history here: https://www.equityeffect.com/blog/irc-409a-overview-409a-valuations-explained/

An independent director can play a crucial role in mitigating conflicts of interest among board members while also providing valuable input. Heidi explains what an independent director does and why it's important for a founder to include one on their board.

More information: https://www.threshold.vc/podcast/the-case-for-the-independent-director

Further Reading:

• Every entrepreneur who raises capital should understand how preference structures work and the inherent pitfalls this creates in corporate governance. Excellent article on the topic here: https://thevcfactory.com/liquidation-preference-conflicts-venture-capital
• Fortune recently published an interesting piece on director independence. While it is mostly aimed at public companies, there are good considerations for private companies too: https://fortune.com/2023/10/16/modern-board-directors-independence
• PwC issued this handy guidebook to the whys and hows of adding independent directors to private boards, which you can find here: https://www.pwc.com/us/en/services/governance-insights-center/pwc-why-private-company-boards-need-outside-directors-v2.pdf
• A solid checklist from Underscore.vc for bringing on an independent director here: https://underscore.vc/startupsecrets/add-an-independent-director-to-your-board
• And finally, when you're ready to actually look for that great independent director, theBoardlist (https://www.theboardlist.com) can be a great resource for you, as can Bolster (https://bolster.com).

Chester, an early-stage entrepreneur, wants to put terms in place so he can never be fired by his board. Like many founders, he saw what went down with Sam Altman at OpenAI and wants to know what he can do to avoid a similar situation from ever happening to him. Heidi explains why boards are set up the way they are and reassures him that a board and accountability are good for an entrepreneur and their company.

More information: https://www.threshold.vc/podcast/the-case-of-the-infallible-founder