For most of the twentieth century, entrepreneurship wasn’t seen as a career. It was more like a path followed by people who didn’t fit into one of the traditional professions open to them and could afford to do something different. Although some succeeded, being an entrepreneur was as much a curse—or maybe more of one—as an exciting opportunity. Even many initially successful entrepreneurs ended their careers in poverty or were forcibly removed from their creations. Now, though, conditions favor entrepreneurs. Barriers to entry are being reduced everywhere, thanks to the semiconductor revolution, the rise of globalization, and the influx of new talent into every industry and sector. Think about this: venture-backed companies now spend 44 percent of the entire R&D budget for American public companies.

As you’ll learn in this book, most venture firms invest money on behalf of larger institutional asset managers, like university endowments and retirement funds.

What that means is that the amount of resources our society currently invests in innovation is based on the percentage of assets that need to be invested according to this formula, rather than on the number of investable opportunities that exist. When too much money is chasing too few deals, there’s only one possible result: Because we have too few entrepreneurs, we can’t put enough money to work. Instead, it’s wasted on bidding up the prices of the few available assets rather than funding the kinds of organizations that are actually needed.

Possibly for the first time in history, we’re talent-constrained instead of capital-constrained.

According to a 2015 study by Ilya Strebulaev of Stanford University and Will Gornall of the University of British Columbia, 42 percent of all US company IPOs since 1974 were venture backed. Collectively, those venture-backed companies have invested $115 billion in research and development (R&D), accounting for 85 percent of all R&D spending, and created $4.3 trillion in market capitalization, which is 63 percent of the total market capitalization of public companies formed since 1974.

What I hope to lay out for founders is a better understanding of and appreciation for the interplay between VCs and founders in order to level the playing field. Information asymmetry should not pollute the foundation of a marriage that could last ten years or more.

Venture capitalists (VCs) were investing in new companies at an unprecedented pace relative to historical norms. About $36 billion went into new startups in 1999, which was approximately double what had been invested the prior year (although that’s now less than half of what was invested in 2017). Additionally, limited partners committed more than $100 billion of new capital to the venture capital industry in 2000, a record that hasn’t come close to being broken since! By comparison, limited partners committed about $33 billion in funding in 2017. Startups were also getting to an IPO faster than ever during the dot-com bubble. On average, it was taking companies about four years from founding to go public, which was a huge acceleration of the historical trend of taking six and a half to seven years to IPO. Today, that time period often exceeds ten years, for reasons we’ll get into later in this book. In addition to a record number of IPOs, the public markets were also exuberant. On March 10, 2000, the Nasdaq index, the barometer for technology stocks, peaked just above 5,000. More interesting, the price-to-earnings ratio (P/E ratio) of the companies listed in the Nasdaq index stood at 175.

I got the job as a business development manager at LoudCloud. This title was the euphemistic way of saying, “You were an investment banker in your previous job and might have some skills to add to the company, but we’re not quite sure yet exactly what those will be.”

We were privileged to have Bill on our board at LoudCloud, where he constantly reminded us in very simple terms of the critical role that cash plays in a startup’s life cycle: “It’s not about the money. It’s about the F-ing money.”

Beginning in the early 2000s, though, there were a few significant transformations in the startup ecosystem that would change things in the entrepreneurs’ favor. First, the amount of capital required to start a company began to decline;

The second material transformation in the startup ecosystem was the advent of an incubator known as Y Combinator

the import of YC, I believe, is that it has educated a whole range of entrepreneurs on the process of starting a company, of which raising capital from VCs is an integral part.

In addition, YC created true communities of entrepreneurs among which they could share their knowledge and views both on company building and on their experiences working with VC firms.

And that takes us to the founding of Andreessen Horowitz, started in 2009 by Marc Andreessen and Ben Horowitz. What Marc and Ben saw was this fundamental shift in the landscape that would no longer make access to capital alone a sufficient differentiator for VC firms. Rather, in their view, VCs would need to provide something more than simply capital, for that was becoming a commodity, and instead, in this post-2005 era of VC, firms would need to compete for the right to fund entrepreneurs by providing something more. What that “something more” would be was informed by their thinking around the nature of technology startup ventures. That is, tech startups are basically innovative product or service companies.

So, if we agree that VC is an asset class, why is it not a “good” one? Simply because the median returns are not worth the risk or the illiquidity that the average VC investor has to put up with. In fact, as recently as 2017, the median ten-year returns in VC were 160 basis points below those of Nasdaq.

If you look across the prior five years or so, US VC investments in portfolio companies tended to be around $60–$70 billion per year.

In 2017, US firms raised about $33 billion from investors.

the global buyout industry raised about $450 billion in 2017. The hedge fund industry manages north of $3 trillion. The US GDP is about $17 trillion.

Using the 1974 data cutoff, 42 percent of public companies are venture backed, representing 63 percent of total market capitalization. These companies account for 35 percent of total employment and 85 percent of total research and development spend. That’s pretty good for an industry that invests about 0.4 percent of the US GDP!

Many people are undoubtedly familiar with the concept of product-market fit. Popularized by Steve Blank and Eric Ries, product-market fit speaks to a product being so attractive to customers in the marketplace that they recognize the problem it was intended to solve and feel compelled to purchase the product. Consumer “delight” and repeat purchasing are the classic hallmarks of product-market fit. Airbnb has this, as do Instacart, Pinterest, Lyft, Facebook, and Instagram, among others. As consumers, we almost can’t imagine what we did before these products existed. Again, it is an organic pull on customers, resulting from the breakthrough nature of the product and its fitness to the market problem at which it is directed. The equivalent in founder evaluation for VCs is founder-market fit. As a corollary to the product-first company, founder-market fit speaks to the unique characteristics of this founding team to pursue the instant opportunity. Perhaps the founder has a unique educational background best suited to the opportunity.

Whatever the evidence, the fundamental question VCs are trying to answer is: Why back this founder against this problem set versus waiting to see who else may come along with a better organic understanding of the problem? Can I conceive of a team better equipped to address the market needs that might walk through our doors tomorrow? If the answer is no, then this is the team to back.

Buyout funds—Yale has a 15 percent allocation to buyout funds; recall that these are private equity funds that typically buy controlling ownership stakes in existing businesses and seek to increase their value over time by improving their financial operations. At 15 percent, Yale’s allocation to buyout funds well exceeds the 6 percent average among university endowments. Over the last twenty years, Yale’s buyout portfolio has returned about 14 percent annually. Venture capital—Yale has a 16 percent allocation to our good old venture capital category, again way in excess of the 5 percent average among other university endowments. And, boy, has this paid off for the Yale endowment; over the last twenty years, Yale’s venture capital portfolio has returned about 77 percent annually. No, that is not a typo—basically, that means that Yale has been doubling its money in venture capital every year for the last twenty years!

The step-down is typically reflected in a few ways, sometimes in concert with one another. In the first instance, the 2 percent fee often gets reduced by 50–100 basis points in the later years of the partnership. The second mechanism to reduce fees is to change the application of the fee against committed capital to apply the fee only to the cost of the investments remaining in the portfolio.

Here’s a quick example: If our hypothetical company raises a Series C financing at five dollars per share, the OPM says that all we know for certain is that anyone who holds Series C shares should value them at five dollars—simple enough. But if you own a Series B or a Series A share, the OPM says those are worth some fraction of five dollars—why?

One is called an “incentive stock option,” or ISO. In general, ISOs are the most favorable type of options. With an ISO, the employee does not have to pay taxes at the time of exercise on the difference between the exercise price of the option and the fair market value of the stock (though there are cases sometimes where the alternative minimum tax can come into play). This means that an employee can defer those taxes until she sells the underlying stock. If she chooses to hold the stock for one year from the exercise date (and at least two years from the date on which she was granted the option), the gains on the stock qualify for capital gains tax treatment, which is significantly lower than the tax rate on ordinary income.

“Non-qualified options,” or NQOs, are less favorable in that the employee must pay taxes at the time of exercise, regardless of whether she chooses to hold the stock longer term. And the amount of those taxes is calculated on the date of the exercise, so that if the stock price were to later fall in value, the employee would still owe taxes based on the historic, higher price of the stock.

When mutual funds get big, they are motivated to focus on large-cap, highly liquid stocks because they need to be able to put large amounts of money to work in individual stocks. Doing so in smaller capitalization stocks just doesn’t scale very well. As a result, mutual fund holdings tend to be concentrated in large-cap companies at the expense of small-cap ones.

Why startups stay private for longer

But, as a general rule of thumb, you should be able to credibly convince yourself (and your potential VC partners) that the market opportunity for your business is sufficiently large to be able to generate a profitable, high-growth, several-hundred-million-dollar-revenue business over a seven-to-ten-year period.

Employee expectations and sentiment matter a lot to a company’s development. Great employees who have lots of job opportunities want to work for great companies where they can achieve their personal growth goals. When a company is doing well in all respects—employee hiring and development, customer goals, product goals, financing goals—it’s easy to retain and motivate employees.

Law firms also tend to be important avenues into venture firms. As we talked about earlier, often the first stop along the entrepreneurial journey is at your lawyer’s office to form the company itself. Thus, as with seed and angel investors, lawyers are often upstream of the VCs and in a position to see opportunities at their most nascent state. Lawyers, too, are motivated to introduce their best startup clients to VCs, as more institutional funding for these clients means that they can become long-term business clients of the law firm.

Work w law firms!

If you can’t find a creative way to get to a VC, then, for example, how are you going to find a way to get to the senior executive at a potential customer prospect of yours? Your ability to find a warm introduction to a VC, while not a requirement, is often a screening heuristic that VCs use as a gauge on your grit, creativity, and determination, each of which might be an important characteristic of a successful founder.

But we failed to appreciate two things. The first was that Jack would realize that the best way to maximize success of the business was for him to become the CEO, something he effected a few short months after the Series A fund-raising. The second was that the star power that Jack possessed could provide the company unfair advantages in the marketplace. For example, Jack was so well-known that he was able to secure a spot on The Oprah Winfrey Show and use that as a way to tell his story to a broader audience; essentially, it was free marketing available only to someone with his brand appeal. He also was able to get directly to Jamie Dimon, CEO of J.P. Morgan, and convince Jamie to bundle the Square dongle with the J.P. Morgan credit card business in a way that generated tons of Square customers at very low cost.

No matter how great a product genius any founder may be, she can’t build a large business without employees and other business partners. So what makes you a natural-born leader, or a learned leader, that will cause people to quit their jobs and come work for you; cause customers to be willing to buy your products or services when there are many safer, established choices available to them; cause business development partners to want to help you sell your wares and penetrate new markets; and, of course, cause funding partners to want to provide you the capital to do all of the above? Maybe you’re a repeat entrepreneur and thus can point to having done all of the above before. But many entrepreneurs are doing so for the first time, so think about other leadership-like opportunities you’ve experienced before that might be good indicia of your ability to be a CEO-leader.

We talk a lot at Andreessen Horowitz about storytelling skills as a good indicator of potential success in an entrepreneur. And to be clear, we are using the word “story” in its purest sense; that is, the ability to captivate an audience (whether that audience is employees, customers, partners, financiers, etc.) and take them along for the proverbial ride. We are not talking about the negative connotation of storytelling, taking people on a proverbial ride because you’re hoodwinking them. True storytelling is a remarkable talent in so many endeavors, but particularly in a startup, where you have so little actual proof of success in the early years on which people can base their decision to join the company. Great CEOs find a way to paint a vision for the opportunity that simply makes people want to be a part of the company-building process.

Walk them through your thought process and demonstrate that you have strong beliefs, weakly held; that is, that you will adapt to the changing needs of the market but remain informed by your depth of product development experience.

One of the most amazing pivots of all time comes courtesy of Stewart Butterfield. Andreessen Horowitz invested in 2010 in a gaming company called Tiny Speck, run by a great entrepreneur by the name of Stewart Butterfield. Tiny Speck set out to build—and ultimately did build—a massively multiplayer online game called Speck. It was a great game in many respects, but Stewart later concluded that it couldn’t sustain itself as a long-term business. With a few months of cash remaining from our original investment, Stewart approached the board (Accel Partners was also an investor in the company and represented on the board) with an idea: in developing Speck, the company had built an internal communications and workflow tool that they found significantly increased the efficiency of their engineering development processes. Stewart wondered whether other organizations could also benefit from this product, so he sought permission from the board to “pivot” into this business with the remaining cash on the balance sheet. I’m happy that we were smart enough to say yes to Stewart’s request. That pivot is now Slack, an enterprise collaboration software company that is valued in the billions of dollars.

For example, if you are pitching a VC and she suggests that your go-to-market plans are all wrong and should instead be done differently from how you have pitched, the wrong reaction is to immediately abandon your plan. While that may ultimately be the right path to take, the fact that you could be so easily convinced in a meeting, where the VC has spent a total of one hour hearing about your business while you supposedly have spent nearly a lifetime doing so, would raise some serious questions about your preparedness and fitness to be a CEO. A thoughtful, engaged discussion on how you came to the conclusions that you did and a willingness to listen to the feedback and incorporate it into your thinking, as appropriate, would be a far better response than pivoting on the fly.

This means that no matter how many different classes of preferred stock may exist over the life of the company, they all vote together as a single group in determining whether a majority of them wants to voluntarily convert into common. This is important, particularly in the case where the company turns south after having raised many different rounds of capital, as the alternative to this definition could have been to give each individual series of preferred stock its own majority vote. In that case, if any one of the different classes of stock refused to go along with the conversion, the whole deal would grind to a halt.

The drag-along provision is intended to prevent minority investors from holding out on a deal to try to get a better deal for themselves. So what it says is that if each member of the board of directors, the majority of common stock, and the majority of Preferred stock all vote in favor of an acquisition, then any of the other 2 percent shareholders (recall this was our major investor definition) gets dragged along in favor of the deal.

Remember we talked earlier about incentive stock options (ISOs) and non-qualified stock options (NQOs). Among other things, a difference between the two is that taxes on the spread between the exercise price and fair market value of the stock are owed on NQOs at the time of exercise, whereas they can be deferred to the time of ultimate sale of the stock for ISOs. A critical element of ISOs, however, is that they must be exercised within ninety days of an employee’s termination from the company. So while the company’s decision to extend the option exercise period for employees has value to the employee by deferring the exercise costs of the option, it converts ISOs into NQOs and thus triggers the tax obligations.

What’s contemplated in our term sheet is what’s called a “double-trigger acceleration,” which is the more common version of acceleration. It means what it says—there are two triggers to the founder getting her acceleration. The first trigger is the acquisition itself, and the second trigger is the founder getting terminated by the acquirer other than for cause or good reason (these are defined terms that require pretty serious bad behavior, often conviction of a crime, on behalf of the founder). This way if the acquirer wants to retain the founder, it has that option without having to worry about her options automatically vesting.

The duty of care is a foundational responsibility of a board member. At its most basic level, the duty of care says that you need to be informed about what’s going on in the company to perform your basic role of maximizing value for the common shareholders.

So a preferred shareholder could in fact sue if she felt as though the contractual rights that she had negotiated for were being violated—i.e., she had a protective provision vote that the company ignored in undertaking a corporate action. But she could not sue (or, more correctly, she could sue but would lose) alleging that the directors violated their fiduciary duties to her, because in fact none are owed.

In fact, it’s even a bit more favorable than that to the board members. In legal terms, the board members are presumed to have done these things. This means that it is up to the plaintiff (the person who is challenging the board’s decision) to prove other-wise; she has the burden of proof to convince the court that the process was bad and thus led to a bad decision. This is a pretty high hurdle to jump and the reason why boards really want to stay within the protections of the BJR; it’s a good comfort blanket in which to wrap yourself.

A no-shop prohibits the company from taking your term sheet and showing it to others to induce them to potentially bid with better terms. A go-shop is exactly the opposite.

There are many ways to structure a MIP, but essentially think of the MIP as a mechanism by which the investors with liquidation preference agree to make some amount of the acquisition proceeds available first to defined employees in the company, before they take their liquidation preference. In general, the amount of a MIP ranges from 8 to 12 percent of the purchase price of the acquisition, and the beneficiaries of the MIP are agreed upon by the board. These beneficiaries are typically those employees who are most critical to getting the acquisition completed.

There is an exception to WARN liability under what is called the “faltering company exception.” This gives a company more latitude around the sixty-day WARN notice requirement if the company is actively pursuing financing for the business and believes that providing notice would significantly jeopardize the likelihood of being able to obtain that financing.

After this initial pricing dance, in the first thirty days post-IPO, the underwriters are allowed to stabilize the trading price of the stock. The primary mechanism by which they do this is through what’s called the “green shoe” (named after the first company, Green Shoe Manufacturing Company, for which this technique was deployed). The green shoe allows the underwriters to sell to the market up to an additional 15 percent of stock at the time of the IPO; essentially it oversells the IPO but retains the right to purchase those shares back within thirty days from the company at the IPO price. So if the stock price goes up, then the underwriter exercises the green shoe by buying the shares back and distributing them to the institutional investors to whom the overallotted shares were sold. If the stock price goes down below the original sale price, the underwriters can just go in the market and buy shares back at the lower market price and thus they do not end up exercising the green shoe.