April 27, 2021
Ep. #77, Exploring Cloudflare Pages with Rita Kozlov
In episode 77 of JAMstack Radio, Brian speaks with Rita Kozlov of Cloudflare. They discuss how the success of Cloudflare Workers led to Clou...
In episode 18 of Venture Confidential, Aligned Partners’ Jodi Sherman Jahic stops by the Heavybit studio to discuss what kind of companies and portfolios she invests in and what capital efficiency should mean for startups.
About the Guests
Jodi Sherman Jahic is a managing partner for Aligned Partners, a VC firm that encourages its companies to stay as capital-efficient as possible throughout their lifecycle. She has previously been involved with SCG Investments, Voyager Capital, and worked with Battery Ventures as a Kauffman Fellow.
Peter Chapman: All right. Jodi, welcome to Venture Confidential.
Jodi Sherman Jahic: Glad to be here. Thanks for having me.
Peter: You've been doing venture for something like 20 years now.
Jodi: Getting close to 20 years now.
Peter: How did you get into it?
Jodi: Oh, I won the lottery. I got into it completely by accident. When I was in business school, I went to, of all things, the career management center to kind of be whiny and say, "What's a girl to do? All I care about is technology, and here I am at Kellogg in Chicago with no technology surrounding me."
The woman there listened to me, this is my first year of business school, and handed me an application to the Kauffman Fellows Program and said, "This is what you need to do."
I was fortunate enough to win the lottery and get a Kauffman fellowship, which landed me a venture fellowship in Boston at Battery Ventures. This was 1999.
Peter: That must have been a very exciting time to be in venture.
Jodi: Oh, it was a crazy time to be in venture. It was so interesting, though.
I'll tell you in great candor, the first year I spent with these brilliant, really accomplished investors at Battery, I was convinced I was going to be terrible at venture. And I realized I should just leave with my tail between my legs because I just did not understand how anybody was making these investments and eyeballs and dot coms.
Having come from an operating background as an entrepreneur, I just totally didn't get it. Of course, it turned out that I didn't get it because there may or may not have been anything to get and over time as the market corrected itself, some of my more fundamental skills came back into vogue.
Peter: I like that. When was your first bet?
Jodi: The first company that I invested in while I was at Battery in 1999 was a much too early, market-wise, investment in a mobile transactions company. I come from a wireless background and I was focused on wireless. I had done work in wireless data previously.
I invested in a company in Finland. Let's not make this simple. Right? Let's go, first venture investment, let's make it international. Let's have to figure out how to do exchangeable shares because of the lack of preferred stock structures in Europe and so on.
The company was a mobile money platform, basically. Not quite the mobile vaults that we see now, but keep in mind, this is almost 20 years ago. 3G networks were are just about to roll out. That was my first lesson in timing matters just as much as anything else. Because the timing was much too early.
Peter: I think I want to dive in to Aligned. And it's not because you don't have a juicy history that I'd love to explore, but you're doing something so specific with Aligned it's something that none of our guests are doing.
I'd like to hear from you, how is Aligned different from other venture capital firms?
Jodi: Aligned Partners, as the name implies, is really focused on founder-investor alignment. In fact, we're focused on multiple levels of alignment. We're trying to optimize outcomes for founders, for us the GPs, for our LPs, and in some ways even for the acquirers and owners of our companies, whether that would be the public or an acquirer.
The reason why we're focused on alignment is because I come from a family of entrepreneurs. Everybody in my family is an entrepreneur: my dad, my grandfather was, my uncles, my cousins, my brother, my husband.
I was part of three startups before going to the dark side, too. And a great disappointment for me when I came to venture. Because what I really thought I was doing when I took that Kauffman fellowship was finding a way to help entrepreneurs because it's just so damn hard.
Starting a company is, anyone who has done it will tell you that they know viscerally in their bones, is one of the hardest human endeavors there is.
It is so hard. It's so damn hard that by the time anyone has done it enough times to really master it, they're usually too old, too tired, too something to ever want to do it again.
I had really hoped that be being part of the venture ecosystem, I could see across many companies and help those heroic founders to make their lives a little bit easier, a little bit better. And the great disappointment was, for me, was not only was that not really necessarily going to be the case. It can be, but it doesn't always.
But also I learned that founders who take venture money at the median do worse on their equity than founders who never take venture money. It's crazy. 74.8% of founders who take venture money get not a dime for their equity.
This is just too hard a business to be doing. Why would anyone do it for that? Now, of course the averages come out differently. Right? Because there's some enormous outcomes, but the median is zero.
Peter: Our audience comes from a wide range of backgrounds. I'd love it if we explained to them how a founder with a successful exit can end up netting zero on that exit.
Jodi: Let's unpack that, because I think it's really important. Let's start at the very top.
I think many entrepreneurs and VCs alike understand and know that in a very successful venture portfolio, you would see one third of the companies go to zero, one third kind of be sideways, maybe be a 1x or a little bit more, and one third be where fund really makes its nut and let's be clear, this is a top performing, this is what the best funds look like.
A lesser-performing fund is going to be more biased towards the losses. I think the average founder is going to look at that and say, "A third of the time we go to zero, but two thirds of the times, the money comes back. So, I'm good."
The problem is that you have the stack of liquidation preferences that builds up in front of the founders. What that is is the preferred return that goes to investors, typically at least one times the money that went in. That gets to the investors before it ever touches the common shares and therefore the founders.
If you're not capital efficient and you raise a lot of money, more money than your company needs, what you find yourself in as a founder is liquidation-preference waterfall that yields nothing for the founders.
And again, this is not an uncommon occurrence. It happens almost three quarters of the time.
Peter: I'm going to play devils advocate here. These founders are really savvy. They've got great people giving advice. How do they end up backed into these corners where their liquidation charts are such that even decent exits end up yielding them nothing?
Jodi: I think some of it is rooted in the fundamental optimism of entrepreneurs in general, in Silicon Valley specifically. "You know what's really cool, a billion dollars," kind of feeling that roams around the haunted halls of Silicon Valley.
It's easy to get swept into that, but also once your company starts moving, it's easy to, inadvertently even, absorb too much capital. It's easy to say, "If a downturn comes, aren't I better off having more money rather than less? Don't the best companies raise the most money? My competitors raised $30 million. Don't I need to raise $30 million?"
That kind of cycle ends up building up to where the majority of companies, I think, end up overcapitalized. Or at a minimum end up capitalized to a place where they can make poor decisions, and do make poor decisions without really meaning to.
Peter: You said two things there that you've referenced in a couple of essays. One was the notion that in tough economic times, you're better off with a healthy amount of capital. And the other was that great companies raise a lot of money. You've written that both of those are actually not true.
Can you tell us a little bit about how capital efficiency increases options available to a founder?
Jodi: Absolutely. And I think the way you put that is very specific and good that what we do when we help a company stay capital-efficient is we increase their optionality. Let's talk about why, but also the how.
The how of capital efficiency. It is commonly believed that it's a great thing to have a stash of cash in case there's adverse market conditions. It's not necessarily true that you need the stash of cash. What you do need is for your runway to be long. One way yo make the runway long is to have cash. Another way to make the runway long is to not be burning very much.
Guess what? The not burning very much path has a lot more flexibility because it is human nature for burn rates to stay high when there's money available. It just is. That $10,000 conference? Let's just do it. You know, that extra expense here and there? It just happens.
Keeping the burn rate low is a more adversity-proof, a more resilient form of protecting a company against a downturn than having a big stash of capital.
Because that stash of capital inevitably goes away and the higher your burn rate is, no matter how large that stash of cash is, once you get to the end, if your burn rate is still high, you're in real trouble.
The only thing that survives is having a little burn, and that used to be how entrepreneurs ran their companies. You try to get to cash flow break-even or beyond.
There's a whole set of historical reasons why that doesn't necessarily come up as a top priority anymore, but I want to question the logic of moving away from "heading towards profitability" as a goal for entrepreneurs.
Peter: I recently spoke to Jocelyn Goldstein. In fact, she introduced you to me.
Jodi: She's awesome. She's a great investor.
Peter: Yeah, it was a fun interview. She has a very specific thesis. She invests in data network effects and like many venture capitalists, she's making plays in winner-take-all markets, wherein the first player to achieve a dominant network becomes really, really hard to dislodge.
We often hear this market used as an argument for really aggressive growth. You're in a market where there's only one winner and you need to get to that winning position as quickly as possible, so we're going to funnel a bunch of money to this business and help you achieve that dominance. How does this message resonate with capital efficiency? How do you navigate that argument?
Jodi: Sure. I think there are places where a winner-take-all mentality is the right way to go. Not every company can be capital efficient, but let's look at the winner-take-all approach because it's not wrong. There's accuracy to it.
When you're in a market where one dominant player is going to win and stay in the front, that's a great place to be. The question is how large does that market need to be?
When I look at companies, as I look for capital-efficient companies for Aligned Partners, what I look for is a high specificity of what problem they're trying to solve. I look for a bowling pin approach where the head pin is really, really specific.
What market niche are they approaching and what application are they serving them with? In other words, when you are a start-up, there's a lot of data that comes your way as you navigate the decision that you make in trying to, you know, position your company.
The smaller the number of variables, the easier it is to solve the equation. So I look for companies that have narrowed their variables down to something very specific.
For example, a company that I invested in in fund one, a healthcare IT company called SA Ignite, they, at the time that I invested in them, were solving one problem for one set of customers. And it was such a tight problem.
Now, this particular problem was meaningful use reporting of EHR systems for large ambulatory medical practices. I mean, if this doesn't sound wonky and specific, I don't know what does. So the market that they were going after with that initial product was really too small for a lot of VCs to be interested.
Peter: Yeah. Not a billion-dollar business.
Jodi: Not a billion-dollar business at that state. That total market was probably two- or three-hundred million if they completely saturated it, but nobody else was going to enter it either.
They did come to dominate that market and then that same set of customers needed the next stage of reporting. And the next stage of reporting. And we were able to build it up to where they are the dominant player in a very specific market, but nobody would yank them out.
Even if another product came in for free, and that's the real touch,
what if Google came out with a free product? Would your customers switch? If the answer is no, you've really come up with an important solution.
Peter: I want to take this back to the classic venture landscape that you laid out. A third of your investments fail, a third of your investments give you your money back, and a third of your investments are your money makers. I'm assuming that your breakdown looks different than the standard ratio.
Jodi: Our breakdown looks really, really different.
Peter: Yeah. What is your risk-in-return profile look like?
Jodi: In fund one, which part of how we invest is we invest in a very concentrated portfolio. So where many other firms of our size would invest in 50 or 100 companies in the size of fund that we have, fund one was about 30, fund two was 50, we tend to invest in seven or eight, maybe nine companies per fund.
So, that means a few things here. First of all, when we say aligned, I mean, we mean, aligned. I cannot afford to have a third of my companies go down. The founder of those companies can't really afford it either, but I'm not interested in sacrificing a couple companies for the good of the portfolio. I need everybody to win. And indeed, in fund one, about half the portfolio now has exited.
One, our smallest investment we cut off after the series A. That was about a million dollars, so about 4% of our capital, a little bit more. That was the only loss. Everybody else is either exited at a profit or funded to cash flow break-even or exit and beyond.
The founders can feel really differently about what we're doing, but we're not necessarily sacrificing cash-on-cash return in order to get there. We're still looking for and investing in companies that are going to return 10x to us.
The difference is, by staying capital efficient, we can achieve that 10x return at an acquisition price that is kind of in the market median and not 10 standard deviations off. Because I think this is kind of what's gone wrong with venture.
To come back to your question about how a portfolio is constructed and what the loss rates are, venture has always been known as a "hits business." And the reason why it's a hits business is because of these statistics that a small number of big wins have to cover all the losses.
But something has changed in the past 10 or so, maybe 15 years, with respect to what we mean by a hit. Fifteen or 20 years ago when I started investing, what we meant by a hit was two standard deviations out from the median. Now what we mean is 10 standard deviations out from the median.
Peter: Could we put numbers on these?
Jodi: Sure. If you look at KPMG's numbers or CBI's numbers or PitchBook's numbers, you can see that the average Venture exit is between 50 and 100 million dollars and has been for a decade. That's where it is. Those are the numbers.
Again, I can't get median numbers. I can only get average numbers from that, but still, it gives you a good sense. They're low enough that when somebody exits for $100 million, we should be congratulating and celebrating them.
But instead, a lot of the founders that come to me with their second or third or fourth or sixth venture backed company seeking funding, a lot of them have sold a company for $250 million and gotten a plaque and a really nice dinner, but not wealthy. They should be getting wealthy at $250 million. That's probably four standard deviations out already, maybe five at this point.
Peter: I want to just tie this altogether. I think what you're saying is that in the standard one-third/one-third/one-third portfolio construction, the fact that venture companies are taking losses on a third of their capital, or we should say on a third of their investments, might not be a third of their capital, forces them to aim for astronomically higher returns on the third that is going to do really well.
Jodi: That is absolutely correct.
Peter: And if you construct a portfolio that has less risk, you're no longer forced to pressure your small amount of winners to do really well. You can be happy with more moderate returns. Is that a fair summary?
Jodi: I think that is a fair summary and it's really born out of, partly just out of size of the funds. Because back in the '90s, fund sizes went up and they never came back down. Venture returns didn't change very much, but the fund sizes did a lot.
What you see in that just through the arithmetic on what it takes to return 3x on a given fund, and 3x is what LPs are expecting and should expect given the illiquidity of venture capital, what does it take to get to a 3x fund?
If you are a $500 million fund, which is not an especially large fund in this day and age, a properly constructed portfolio would probably have, say, 25 major investments in it at 20 million on average a piece.
Let's say you have 20% ownership at exit. This is really well-constructed portfolio if you can get it this even and have that high an ownership level, you're going to need something like between two and three hundred million dollars of exit value on average for every single company.
For every failure, you double the matching company in order to get to that number, let's call it $300 million. This is what motivates some of the energy and action around exits in venture.
That's why you sometimes hear venture capitalists say, "Well, if you can get to $200 million you can get to 500." We need to get to $500 million of exit value because that's how you make up for the craters and get to a 3x.
If you're a one and half billion dollar fund, the average exit value in a properly constructed portfolio where you're maintaining at least 20% ownership on exit, which is a very high number, the average exit value needs to be $750 million in order to get to 3x on the fund.
Peter: I'm smiling because that sounds a little crazy.
Jodi: It explains a lot of behavior, though, doesn't it?
Peter: You said something really interesting there. You said exit values haven't really increased over the past 10 years, but fund sizes have increased. And then you went on to imply that larger fund sizes encourage VCs to funnel more money into the same amount of investments.
Jodi: You have to, because there's only so much-- Well, there's two reasons. There's only so many portfolio companies you can manage as an investment fund, but also there's a statistical reason that if you have too many companies in a portfolio, the portfolio is going to regress to the mean.
In other words,
the big winners aren't going to have enough of an impact on the ultimate fund outcome to really make a difference. You'll end up in a very average place.
You do have to concentrate to some extent to remove that portfolio effect. You want a little bit of portfolio effect, but not too much.
Peter: I'm interested in how you got here because you worked for fairly traditional venture capital firms for the majority of your career. Where was the lightbulb moment for you?
Jodi: The aha moment came, I had invested personally in a company in the wireless base in 2000. I worked at Battery then. I had brought it to Battery this company, which came from an area that I knew really well, a part of wireless data that I understood and the company wanted to raise a million and a half dollars and that wasn't a fit for Battery, clearly.
"Why didn't the company want to raise $10 million?" they said. "Why didn't the company want to raise $10 million?" said every VC. So, I had permission to help make the investment on side and over time, I stayed with that company. I left Battery and joined Voyager Capital, but stayed alongside this company.
In 2007, we sold that company for about a 6 or 7x on the 2000 value. Now, keep in mind the investors, none of which were institutional, who invested in a start-up in 2000, would have been pleased to get their money back.
Jodi: But instead, we did really well. The reason why did really well, and I can say this with some certainty because we can play the movie on the alternate scenario, which would be basically everybody else who was venture-funded in 2000.
The reason why we did so well is because we didn't raise too much money.
If we had raised $10 million, we would have opened five field sale offices, we would have hired a bunch of people. The sales would not have materialized because that's just not how the world was working at that time. We would have had a cram-down around, we know exactly how it would play out because everybody else did it.
Instead, because the company had a limited amount of capital, we had to choose a very specific go-to market strategy. We had to choose exactly what problem we were going to solve and why and pursue that until the leads grew cold and pursue the next one and because they did that methodically and capital efficiently, we were able to get to a really nice outcome for everybody.
That was the aha moment. That hmm,
why did this company survive and thrive when nobody else did? It's because they didn't overcapitalize. They had more optionality at the end.
Peter: It goes back to your earlier theme about how when times get tough, having a low burn rate is way more advantageous than being overcapitalized and trying to force growth.
Jodi: That's right.
Peter: You said that Aligned Partners is founded on this principle of really getting everyone on the same page and you also said that one of the reasons founders often end up with exits but no fiscal reward is these liquidation tables, which can be really punitive to founders. How do you navigate this? Do you take common stock?
Jodi: No. No. Were traditional investors. We take preferred series A. Most of the companies that we work with will eventually raise a series B and that's usually it. Usually they're able to get all the way through their funding cycles with an A and a B.
Here's what that means from the founders perspective. We did a study last year on our fund one companies because, as I mentioned earlier, they're fully capitalized at this point. So they're mostly exit-ready or exited.
And we found this, that the average venture backed company, the founders and employees, owned 11% at exit and the average venture backed series B, the founders and employees owned 28% after the round. And the average Aligned Partners company, the founders and employees together owned 42%. So, the alignment works. It really works.
Peter: And that's simply because they're not raising for their rounds.
Jodi: It's because they've raised less capital. They haven't overcapitalized their company.
Peter: Tell me a little bit about how these companies feel different. I mean, I have a sense for them. They're capital efficient, they don't necessarily need to achieve an astronomically large exit. Is working with or for one of those companies a different experience than working for a traditional venture backed company?
Jodi: I would think so. I haven't worked for one of them, so it's hard for me to give you a real insider view, but I will tell you this, the founders are somewhat different than in traditional venture capital.
Part of being a good VC is knowing what you're good at and what you're not good at. What kinds of deals you're going to be able to win and really help be successful and which ones you're not.
I came to the conclusion pretty early on that the 23 year old in the hoodie who wants to be Zuck is not looking for me. I'm not going to win that deal.
The founders that I serve look really different than that. They tend to be pretty experienced and they tend to be deep domain experts in what they do.
Whether it's Bonnie Crater, who's the CEO of Full Circle Insights, who's been a CMO five times and really understands marketing software. Whether it's the folks at SA Ignite who have done healthcare IT over and over and over again.
But in all cases, they're people who have a little scar tissue in dealing with venture capital. They tend to not be newbies to the venture capital world. They ran a successful venture backed company, they ran a sideways venture backed company, but in all cases they got to see what's right and what's wrong about venture.
In most cases, they've been pretty successful and in most cases, they've said, I'm never going to raise money that way again. That way meaning overcapitalizing.
Peter: How do you find these companies?
Jodi: The vast majority are entrepreneur-to-entrepreneur referrals, because the entrepreneurs that get us, really get us and they tend to talk about us. I also get a lot of referrals from other VCs who know our thesis and know that if a company just isn't going to raise enough money to be interesting to them, that it might be interesting to me.
Peter: So, a VC might say, hey, seems like a promising market. It's not large enough for us to play, but Jodi, this is right up your alley.
Jodi: Potentially, yes. We get lots and lots of referrals that way. Still a lot of service providers, but its all referral based.
We don't, for example, create a thesis around Bitcoin and go find the hottest this or that. That's not how we do it. We are very focused on what I think of as the puzzle-piece approach. That
there's a shape and size and look to a company that fits us and when we find that puzzle piece, we can snap it into a larger puzzle that creates more value.
We know how to help them with their go-to-market strategy. We know how to help them with their financing strategy. We know how to help them with their hiring strategy. We can do all these things if they fit our puzzle pieces.
Peter: What are some of the ways that you plug into your portfolio?
Jodi: Certainly, expertise and go-to market strategy is something that any capital efficient company really needs. Because all of capital efficiency is hidden inside of go-to-market strategy. So we help them with that.
We help them really narrow down their target marketing, get the value propositions super tight, and figure out exactly what kind of channels and approaches they should take to market. I do a lot of work with that with my portfolio companies.
Peter: Could you walk me through a portfolio company that you've worked with in this way? I'd love to hear how you narrow down a go-to-market strategy and find a really capital-efficient approach.
Jodi: Let's go back to that company that I spoke of earlier in Chicago, SA Ignite and the healthcare IT space.
Jodi: When they went around looking for money for their series A, they had a really interesting product that helped providers, mostly doctors, figure out how their reimbursements were going to work with the Meaningful Use Program. It's not related to the ACA, it's a different government program, but it's a government program nevertheless and it's complicated enough that it's sort of like tax reporting.
When they went around to raise their series A, a lot of VCs noted that the database that they're building, and this was not news to the company, but the database that they were building could be very useful to sell that data to Pharma, to EHRs and other places.
So the vast majority of the VCs that they talked to wanted SA Ignite to give their product away for free in order to get to market as fast as possible, saturate the provider space, and then start selling access to their database.
The founder, I think very wisely said, A, "I don't know why I would stop charging for something that people are glad to pay for," and B, "People don't trust things that are free in healthcare. This is not a consumer play.
So when I worked with them on their go-to market strategy, I helped them to really tighten down who we're going after and why. They initially had a point of view that they could sell to all kinds of providers, whether it's hospitals or small practices and I helped work with them to figure out what kinds of practices they were going to have the easiest time landing.
And then segmented some of those practices into different kinds of practice areas, whether that's ENT or oncology because it turns out that when you're a startup, the best way to accelerate your sales process is to have really credible references that are very similar to the next customer.
You almost have to artificially create an echo chamber. And that's very uncomfortable for most entrepreneurs because it feels like turning away opportunity when you get that tight.
But if you can stay disciplined and really focus your strategy to where you're solving one tight problem to one set of people really, really well, the first sale is hard, the second sale is hard, the third sale is a little easier. By the time you've done 10 sales in that same market, you get to a default yes. It just changes things materially, but you can't do that if you sell to a diffuse set of customers.
It may be that you're selling exactly the same product, that the platform, the software you're selling is solving the exact same problem for the airline industry as it is for the toy industry. The problem is the purchaser in the airline industry doesn't believe that they have the same problems as the toy industry, and vice versa. So, the referencing doesn't do anything.
Peter: You've spent a bunch of time talking about how important specificity and focus is in this sort of approach. I want to say that when you're building a really capital-efficient sales process because you're not spending a lot of money on marketing overhead or on a huge sales force, you have to build a really referenced driven sales funnel. Is that fair?
Jodi: I think that is fair. I think everybody has to regardless of how large a sales force they've built, though.
Jodi: Let me tell you this about focus and capital efficiency. I eat the dog food. Aligned Partners is just as focused on sticking to the thing that we do better than anybody else and just killing that, as we expect our portfolio companies to be.
Peter: And that thing is capital efficient companies?
Jodi: We only invest in enterprise oriented, series A companies that plan to raise 10 million or less over multiple rounds.
Peter: Do you ever get to a point where a company says, "Jodi, I know we had this soft agreement that we wouldn't raise a series C, but boy would it be nice to have some additional cash right now and I would love to go back to the market."
Jodi: So, yes. All kinds of things happen. Life is long and startups are always venturing into the unknown. Sometimes we end up with a company, and this has certainly happened in the past, where they realize somewhere through their paces that they could be a billion dollar company, that they should be a billion dollar company.
And now we have an alignment problem. Because now we're going to go raise money from a really big fund with different incentives than Aligned Partners has.
There are ways to deal with this. If I were the founder, what I might want to see happen with my investors at that point is take the risk off the table for the early stage investors and maybe a little bit for the founders so that the late stage investors can really run with it and swing for the fences.
What does that mean? That means that, for example, maybe I sell my bases. We've done that once in a security company and ended up with a great outcome. Everybody made money. We made a little bit less money than we would have if we'd held onto every one of our shares, but we ended up with alignment all around and the founders were free to pursue their dreams without having to be shackled to some other approach to making money.
For the most part, our founders don't feel shackled. They feel quite the opposite. They feel like this gives them freedom to pursue a wide variety of exit outcomes and make money for everybody, including them.
Because I can't tell you how many times in the past I've seen companies get 200, 300 million dollar offers that would have been life changing to those founders and really would have made me, the series A investor, quite a bit of money as well.
But the larger funds wanted to see a billion dollars and so instead of selling for 300 million dollars, we ride up, we ride down, and we sell for 30 million dollars. I have seen that movie, I don't want to be a player in that movie, and I really don't want the founders to be a player in that movie.
Peter: We've heard a bunch about the sort of founders that you're looking for and I have a sense of how you work with those founders. I'd love to dive more into you as a board member. What is your relationship with these founders like?
Jodi: I'm very lucky because the fact of the alignment, the fact that I need the company to succeed as much as the founders do, helps a lot with trust. I think it's really hard for experienced founders to trust their VCs.
Most of them have been through the school of hard knocks and learned what you can say and what you can't say, but I've been fortunate both the alignment factor and I think just some of the working relationships have meant that we can get to a place where we're really open with each other.
I try to help the founders see that I'm not a customer, I'm a partner and I'm here to help. I'm a fan. So, there's the good, the bad, and the ugly. I already believe in the good, so let's go straight to the bad and the ugly and solve problems, but
a very important element of working with the companies, from my perspective, is being really clear about what hat I'm wearing at any given time.
There are three hats I wear with every portfolio company. There is the board member hat, in which I represent all shareholders. I'm designated to create good outcomes for all shareholders. There's the Aligned Partners investor, which is where I'm incented and required to maximize the value to Aligned Partners, and then there's my favorite hat, the founder-advisor hat, or what I think of as, "If you were my cousin, what would I tell you to do?"
And I try to be very, very clear with every company that I work with exactly what hat I'm wearing at any given time and being really clear about that really enhances trust I think.
Peter: What happens when the hats disagree?
Jodi: I'll be very specific about it. When I put on my Aligned Partners hat, "Here's what I would like to see." But as a board member, "Here's a decision I think we should make."
Peter: Interesting. Can you give me an example of a time when that happened?
Jodi: You know, it comes up a lot when we're dealing with new financing rounds and with exits. When we're dealing with new financing rounds, we really got to consider what is the best interest for all investors versus where I want to buy in it, for example, and makes it to which I want to get into it.
And being really clear about what this means for each different role helps a lot. Then the entrepreneurs can trust what I'm saying. You know, there are often competing demands as an investor and as a board member.
One way that comes up is in, for us series B, but for any investor later rounds, I'll have a company that is negotiating a series B investment, and to some extent, they want the price to be as high as possible and I want the price to be as low as possible.
But also to some extent I want the price to be as high as possible because then I get to write it up more and to some extent they want the post money to be as low as possible because then we create better alignment on the exit.
Keep in mind, if you raise money at a really high price, you better find a way to make a multiple out of that either in the next round or especially on the exit.
To some extent the company's better off with a lower post money value. So when we're negotiating through all of those different stances, it's really helpful to be able to say what I would advise you as my cousin verus what I would advise you as a board member in order to make all shareholders, including the common, as whole as possible and what's best for Aligned Partners.
I have never found it useful to hide that. I've always found it useful to put all the cards on the table and just be open about it. Everybody knows that there's an inherent conflict. Let's just talk it out.
Peter: Yeah. You've been doing this for almost two decades as we mentioned earlier. What keeps you at it?
Jodi: One thing that's so fun about venture specifically, but business generally is that it gets harder as you get better at it. You know, I've always wondered whether medicine, for example, gets harder as you get better at it. Maybe just start out incompetent and you end up really competent, but the problems don't change.
I don't know the answer. I'm not a doctor. No one in my family is either, so I don't know who to ask. But the problems get harder as you get better at this and I think that's really fun. Plus there's this endeavor of entrepreneurship being so difficult, so difficult.
Peter: I'd love to dive into that a little bit. How is your work now harder than it was when you first started as a venture capitalist?
Jodi: I think what I'm willing to take on is different and more challenging than what I was willing to take on even 10 years ago. First of all, it was really fun to take on the project of starting a whole new firm with it's own unique thesis and raising money against that.
The most delightful part of that is the culture and values of our firm are exactly what my partner or I say it is. I didn't inherit anything and any mistakes I made, all on me.
But I may as well make a declaration of what our values are because there's no need to default. We can make our firm whatever we want. That was a set of complex business challenges that I found really engaging and it was fun being a founder again too.
Peter: Was the conversation with LPs challenging given that you're going to market with a very unique model for venture?
Jodi: You know, something really funny happened with fund one. We started out going to a lot of large institutions, many of which knew either my partner, Susan Mason, or myself from a prior life.
We would go to them and show them exactly what our thesis is and they would always comment on how well thought out it is and how logical it is, how rational, how likely to make money it is and then they'd say, could you raise $150 million because we can't put less than $15 million in and we really can't take more than 10%.
Peter: This is the cascading problem of large checks.
Jodi: It's kind of fractal. Right? It has the same shape at every level of resolution. So, no we didn't want to raise $150 million though ironically, it would have been a lot easier than raising the $30 million that we wanted to keep the fund to.
Peter: Yeah. So, you ended up raising from smaller LPs?
Jodi: We had mid-sized endowments, we had some funds of funds, we had some family offices. It was pretty much 90 plus percent institutional and fund two is 95+ percent institutional, but yeah. We had to make sure that the scale of the investor matched our needs.
Peter: The venture now harder for you than it was when you started. You're taking on bigger and more complex problems. What's something you're trying to get better at as an investor?
Jodi: You know, 100% of this game is about the entrepreneur. I am always seeking to be a better coach to the entrepreneur. Whether it is having a deeper understand of the various areas of operations or bringing in the best experts to help with operations, my goal is to be the very best coach and so I'm always looking to improve on that front.
I feel like where I'm able to best help a company is the areas of both go-to-market strategy, but also decision navigation. All the really existential-feeling questions that a company, the decision they have to make when they're early. Every single one of those feels existential.
Helping them navigate that, helping them pull up a level and say, "Here's how this plays out," is what I love to do with the companies and what I feel I'm best at.
But I could get better at the operational side. I've just been away from operations for too long. So I would say that that's a drawback. But the deeper you get, the longer you get into this game. You get better at the venture piece but worse at the operational piece.
Peter: Are you at all tempted to spend some time on the other side?
Jodi: Oh, I was for a while. I think I got my founder fix by founding this firm.
Peter: That's a large endeavor.
Jodi: It was a lot of fun, though. Everybody had always told me how hard it is to raise a fund one and they weren't wrong. It's hard. It's character building, so to speak.
But I didn't know also how great it was going to be to have the firm be exactly what I said it is. That the decisions are exactly as I purport them to be. That the LPs, I have relationships with every single one of them. That's a real delight. I wasn't expecting that for some reason.
Peter: Jodi, this has been so fun. Thank you for joining me.
Jodi: Thank you for having me. This was great.
Peter: Where can our listeners find you?
Jodi: You can find us online at alignedvc.com and I'm on Twitter @jodij.
Peter: And you're looking for enterprise-focused, capital-efficient, third-time founders?
Jodi: At the series A stage.
Peter: Sounds good. Thank you.