#95 Code Cubitt: Coachability Is Critical
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This is what separates, you know, really good entrepreneurs from the rest of the pack is they have that vision. They have that crystal ball that they can see. And more importantly, they have the ability to articulate it and convince not only co-founders and employees to join, but also investors and customers to see that vision with them.

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This week I'm talking with venture capitalist Code Cubit of Mistral Venture Partners. Code's path to becoming a VC wasn't a straight line. He was kicked out of university not once, but twice. Since he's investing at the seed stage before a product market fit has been established, we're going to explore effective questions for evaluating founders, the decision-making process, common mistakes that companies make as they scale, and information curation. It's time to listen and learn. ♪

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You were kicked out of university not once, but twice. Can you? What a great starting point. Not my finest moment. Actually, it's a love story. So we'll start off our interview here with a love story. So it was a love story gone wrong. Third year university. My girlfriend of two years broke up with me. It was brutal to say the least.

And I spent an entire semester, fall semester, sort of working it out. And that meant ditching classes and exams and just generally doing poorly. So at the end of that semester, of course, if you don't succeed well enough, they ask you to take some time off, which they did. And I couldn't contemplate that. So I sent a letter saying, hey, can I have another chance? I'm really sorry I screwed up, but I think I've got my head on straight.

And they agreed and they said, okay, but you're on probation for the spring semester and, you know, hope you do better. Like academic probation. Academic probation, right. So I went back for the spring semester. I did not do better. It turned out I didn't have things locked in. And so they asked me to leave permanently.

The good news is the story has a happy ending. I did take a year off and the following spring I sent a letter and said, you know, this real world stuff is really hard with half a degree. I feel incomplete and can I please have another chance? And so they agreed. I'm grateful for that to this day. And the readmittance letter said, okay, you're on probation again. And by the way, this is your last comma last chance. So on the happy ending part,

I graduated with honors, top of my class. It was sort of a turnaround story. I had everything lined up and it was a good ending. What did you learn during that time off? Well, I think the biggest thing was that life is hard on your own and an academic degree and some schooling is a big help.

And I just sort of got over the issue of that particular girl and renewed my commitment to success and moving forward. I'm curious as to how you became a VC. What's the two second sort of, or two minute? It's a little longer than two seconds. Was it the two minute version from the end of university or maybe three minute version until now? Sure. I graduated university in the late 2000s.

96, I think, and immediately went to IBM. So I did an engineering degree in undergrad and IBM was sort of the pinnacle of what I thought the world could be. And so I accepted a job and

I spent two years at IBM and really didn't like any of it, partly because I was very junior and there was a lot of very senior skilled engineers there. So you ended up getting relegated to all the menial stuff. So on the heels of that, I moved from Toronto, Canada to Baltimore, Maryland. So I moved to the US to a startup called Sienna. And that afforded me a lot more opportunity as a startup to be a designer and build real world things and have my hand in it.

In that process, got an MBA. And in my MBA class, I met my first VC. I'd never even heard of the asset class, didn't know anything about finance before that. When I heard what venture capital was about, at the time, I fell in love immediately and decided that was it for me.

And so within weeks, I went back and happened to have a fortuitous meeting with the CEO of Sienna. And they ultimately hired me as an analyst in their new venture program. So I cut my teeth as an analyst. And then I moved to California where I came up through the ranks, associate principal partner at multiple firms and had a fairly successful start there.

I finished at Motorola Ventures. I was running their West Coast program in California, which was great because the business card got me into deals that I wouldn't have normally gotten into with my good looks and charm. And so, but Motorola canned the program effectively during the 08 crash. And so I ended up leaving.

And going to a startup that I had funded and joined them as the COO. And we grew that business for a couple of years and sold it successfully. And then I took a sabbatical and sailed around the world for a year and then moved to Canada to start a venture program of my own. So there's a couple of things I want to dive into. One, your undergrad was in physics, right? Yeah, engineering. Yeah.

And so what were you doing at CNN? Like, what was the original job there? So I was an RF engineer. So radio frequency designer, high frequency circuits, 10 gigabit optical links, sort of deep tech, hard stuff. Okay. And then in Silicon, like you went to become the COO of a company. How did that...

Talk to me about that experience a little bit. Yeah, it was interesting because I'm not a very good number two. You know, this is a personal thing. It's difficult for me. I question decisions constantly, whether they're mine or somebody else's. But even before university or while in university, I have started five of my own companies, two of them venture backed. So no stranger to, you know, being an entrepreneur, I guess you'd say, and creating things from from scratch.

And so as a COO, it was, you know, I call it the chief other officer. Right. So I cleaned up after the CEO who was a genius in his own right, but really difficult to work with. So basically he would make promises left and right and I would fulfill those promises as best I could.

And it was a good thing we sold when we did, otherwise it would have exploded. Having that perspective, having worked in that role and also your perspective now investing in teams of founders, how do you see that COO role? Yeah, it's critical, right? It's critical in a couple of ways. One, it's the operations person who fulfills on the CEO's vision and dreams and goal, but it's also the right hand person to the CEO, right? So it's the counterbalance of all that

enthusiasm and, and, uh, and drive. It's the level-headed sort of practical, pragmatic co-founder role in my view. A large part of your job now is evaluating founders. What, what are the tools, the questions you ask, the sort of like things that you look at in order to do that? Sure. I, you know, I think it's a bit cliche, but it all comes down to people, right? So my job really is to meet with people and get to know them and decide, you know, who I want to work with.

And so we've passed on good founders and we've passed on not so good founders. But at the core of it, it's, you know, does this person have a vision on the future that doesn't exist today that we want to play a role in? And it all starts with my first question with every interview is tell me about inception. So why do you want to do this so badly that you're willing to break through walls and spend years in the cold as an unknown at the shot for the shot of being a successful entrepreneur?

And the answer that you get back is really insightful, right? Is it a problem that they've experienced personally for a long time and just have to solve it? Or is it a job? Are they a wantrepreneur who found some technology and they want to exploit it? Oh, wait, a wantrepreneur? I'm diving into that term. I've never heard that before.

Yeah, I mean, you know, I think entrepreneurism in general is a fairly new phenomenon, ironically. So it used to be an entrepreneur was someone who was between jobs, if you think about it, 20, 30 years ago. And now it's a bona fide vocation, right? They teach it in university. That didn't happen before. But I think the sort of the cachet and persona of an entrepreneur is the Bill Gates, the Zuckerbergs of the world, these world changing, amazing, you know, genius types.

Bezos, another good example. And so it's become a very cool thing to be as an entrepreneur. But there's a difference between being an entrepreneur and being born an entrepreneur and sort of having that DNA deep inside. Go into that, though. Like, what is that? What's the difference?

Yeah, you know, I think some entrepreneurs just like, it's like a bohemian group or society that it's cool to be an entrepreneur and the underdog and they, you know, they feel oppressed by society and sort of fought against constantly versus the optimistic entrepreneur who sees the future a different way and, you know, eliminates all the barriers to getting there.

fundamentally different people. I have a friend who described being an entrepreneur as eating glass every day and then getting up the next day and wanting to do it all over again. It's probably true. You know, I say it's the hardest, most impossible job that you'll ever love. And it's the only opportunity that you can have as an individual in business to really create impact in the world. Otherwise, you're an employee, part of a big machine. And so it's the most exhilarating, you know, two miles an hour that you can ever go.

What are some of the other questions that you ask other than the story and the why? Like to get to the really the character of the people that you're investing with, to establish trust, to understand them?

You bring up trust, which is critical, right? So integrity, trust, rapport, all of those things are really integral to successful relationship. And at the core of all successes are talented people who are trustworthy, et cetera. So rather than pick personality or an entrepreneur from a series of interviews, what we do is we invest upside down. So we invest a small amount at the pre-seed stage and work very, very hard with our entrepreneurs to get to a series A.

And at the Series A, we invest significantly more than we did at the seed stage. And the reason I say that's upside down is that most firms will do one of two things, two other things. One is they develop deep conviction and knowledge around a space and they pick the best founders to prosecute that space. And the other strategy- At the seed level? At the seed or Series A, sure. Okay.

And the other strategy is what we call spray and pray. So that is, you know, a high volume of deals, small check sizes, and then you hope for the power law of venture economics to play their role. So our view is that it's nearly impossible to pick winners at the seed stage.

There's a lot of memory, I guess you'd say, and hard-won battles that help guide our decision. But at the end of the day, we are humble enough to know that it's impossible to pick unicorns consistently. So instead, what we do is we curate a portfolio of 15 to 20 companies at the seed stage, invest a small amount...

of capital, but invest a large amount of time in the ensuing year for the opportunity to get to know that founder, to build rapport, figure out if they're up for the task, and then even more importantly, figure out if the market deems them worthy and their product worthy to exist at all. So put a little bit of money up front, see what happens, and then you get the optionality on the series A.

That's the idea. That's right. So they, you know, ostensibly they invite us in because we don't necessarily have pro rata rights, which means we don't have the right to invest significant amounts. So you also have to be a good partner. And we have to earn it. That's exactly right. Now, the perverse part of that model is, of course, that we buy a very small chunk of a company at the seed stage as opposed to a regular VC who will buy 15, 20 percent of a company and have a more dominant influence.

Talk to me. You mentioned the power law of VC economics. Talk to me about that. What is that? Yeah, I mean, if you look at the share, I want to say failure, but I sort of hesitate to use that word. But the reality of venture is that at every subsequent financing, about half the deals fall off.

And so to become a unicorn is a one in a thousand proposition. And so the power law basically says that you need to find that one unicorn in your portfolio of 20 or 30 bets of each fund in order to have the kinds of returns that our LPs, our limited partners are expecting.

And so those numbers are very hard to find. And unless you're a, I'm going to call it a tier one firm who has a history of getting amazing deal flow from the best founders, it's really tough to live on the power law and expect to get a unicorn in every fund. So we have a slightly different model. Ours is, you know, especially in a...

a tier two market like Canada, if you will, as opposed to Silicon Valley, you know, there's less unicorns born here. So we are looking for the, the, the solid, but mid hundreds of millions of dollars exit as opposed to the billion dollar unicorns. You need a higher batting average in a way. We need a higher batting average. And is that because the inbound is different and sort of like the deal flow is different or just the nature of the, the economics is different?

I think it's a combination of all of those things. I think the Canadian market is still nascent. It's early and young. I wouldn't take anything away from the quality of founders that we have here and the quality of ideas, but the entire ecosystem is less mature and it's getting better day by day for sure. But you can't expect to, for a number of systemic reasons, you can't expect to find a unicorn every year in Canada.

What's in that ecosystem? What do you mean when you say ecosystem? Well, the ecosystem of entrepreneurism and innovation starts at the grassroots with a culture of risk-taking. So that's a key piece. And that's followed by education, universities that are doing cutting-edge research in things like artificial intelligence and distributed ledgers and so on.

And then you have to have a robust ecosystem of incubators and accelerators and early stage venture firms and angel groups to support them, those students as they come up. And then, of course, you need the other layers of financing to continue funding the best companies all the way through.

A lot of people would argue that you can't identify these things in the beginning and it's just through sort of randomness that some of them work out to these exits that generate the returns. But you make a living sort of

On the other side of that, can you riff on that for a second? Yeah, I think, you know, the numbers sort of show that venture-backed companies historically and statistically do better than non-venture-backed companies. And not to sort of blow our own horn, but VCs have a lot of experience in pattern matching and they simply have a lot of exposure to things that company founders don't have every day.

And so the idea of being a venture backable company in the first place is a different kind of category of company. And having a good syndicate of VCs around the table who can give you insight into customer behavior, trends in the industry, talent that you can attract, et cetera, and the credibility that goes along with being professionally funded gives an edge to those companies. So I...

I'm not going to say refute, but I believe that venture backed companies tend to do better than none. I'm fascinated by these patterns. What are sort of the patterns that you see that are precursors to failure in startups? Like, is there a way to change course? Is there you can see this in advance? Like, talk to me about what you see is why do the startups fail?

Sure. I mean, the number of reasons for failure probably far outweighs or far outnumbers the reasons for success, for sure. But, you know, there are certain patterns and it surprises me every day, actually, how very basic business fundamentals are lost on entrepreneurs as they're coming up. And I think

Things that I simply take for granted, having done this for 20 years, are still news to founders. For example, building a pro forma financial model that takes into consideration what I'm going to spend and how, what my expectations are for revenue in an honest, intellectually honest way, whether it's bottoms up or top down approach, being honest about what

where customers are going to come from, how you're going to talk to them, et cetera, et cetera, is not something that is natural instinct for a lot of entrepreneurs. So having a clear roadmap inside a business is fundamental. And too many companies start out with, you know, sort of grasping at straws and hoping for the best. And, you know, part of that naivety is important in building a company. But I think a solid structural plan is also critical.

Right.

Those are precursors to failure almost every time. There's some that sort of like come to mind as you were talking. I was like, oh, those are what about like there's idea failure. And then there's sort of like failures of the entrepreneur that might not be sort of like ego driven, but might be people driven. Right. Because often you start a company, I would presume, with friends or, you know, close people close to you. And then as you grow, you reach the ceiling of of capability of people.

yourself included, like as you try to scale. Talk to me about some of the problems you see as companies try to scale. And then getting rid of people, like how do you decide when to move on from somebody who's got you to where you are? - There's a lot packed in that question. Let me see if I can tease it apart.

You know, some common mistakes early on are expecting that you and your three co-founders who you've split the company up four ways, 25% each will scale. And it rarely does, right? So more often than not, one of those co-founders find something else to do. And now they're benefiting because they have 25% of the stock that's not vested.

So that's a simple mistake that we look for in capitalization tables before we invest. Following on that, there's the nepotism law, right? So rarely do husband-wife teams work out for a number of reasons, but not least of which, in our view anyway, let's say the wife is the CEO and the husband is the CTO or the CFO, their direct

reports are rarely going to, you know, not going to go to the CEO and complain about the CFO. So there's, there's obvious dynamics there. Those are, those are things that we have learned through hard knocks. And what happens there is you're getting insulated from information. Yeah, essentially. And there's agency issue, right? So what we're trying to do is minimize mistakes and, and thereby maximize opportunity. And so those common ones are minimizable and they're observable right out of the gate.

So do you avoid them or do you sort of like, is this one of the reasons that venture backed companies are more successful is because you bring these perspectives where you're like, okay, this won't work or this. Yeah, it's a good question. I think, I think we're probably subject to our own biases in our most recent deal, right? So to the extent that I've done 50 or 60 deals in my career, you know, there's been a lot of scars, a lot of learning, right? It's probably only 10 or 15% of those have exited in a, in a very positive way. And that's the reality of the economics. But,

But the other, call it 80%, who failed or did poorly, presented learnings and lectures that we've taken to heart, right? And so those are the rubrics that you apply. Now, it's not to say that we would never invest in a husband and wife team or four co-founders who decided to split the company four ways. Those are signals to us to really challenge the entrepreneurs to find out what they're really in it for. Do you think it's possible to have...

an even divide amongst co-founders like a 50 50 split or 25 25 25 i don't actually and so and the reason is that at the earliest stages you have to sort of forward look the cap table in other words i'm going to raise a seed and i'm going to get 20 percent dilution typically the series a another 20 to 30 percent dilution and so on and so forth

And so the question is, at the end of the day, when you're at Series C and you now own 5% or 6% of the company, or let's say 7% or 8%, is that enough to keep you motivated and knocking your head against the wall 18 hours a day and busting through all of the barriers that are presented to you? And it's a question mark. Having said that, if you own 50% or 60% of the company, then you are all in. And so it's that simple forward-looking five-year-ahead view that we bring to the table. Yeah.

Right. And do you sort of clean that up or do you avoid those situations? It depends. It depends on how coachable the entrepreneurs are. And I don't say that with any sort of arrogance, but a good entrepreneur is a good listener as well, right? They don't necessarily follow your advice because that's not necessarily a good thing, but they'll listen to ideas and perspectives and then they may right the ship. So I've been in situations where, you know, a husband and wife team,

They decide, yeah, you're probably right. And we're already feeling the strain at home. And so therefore, one of them is going to go off and she's going to continue to run the business as an example. But if they dig in their heels and say, you know, that's it's not going to be an issue. I guarantee it. I know this. We're different than everybody else. Then we probably walk away.

I'd love to hear you riff on the concept of coachability, because from one angle, as sort of the venture backer, there's a coachability angle to it. But I would imagine a lot of what goes into being coachable actually transcends itself into the company as well and makes for a better founder or a better operator.

Well, it does. And at its core, coachability is sort of a willingness to be introspective and a willingness to respect feedback, whether it's from the market, from your employees, from your customers, from your investing partners.

And so the entrepreneur who dismisses all of that and sort of their ego precedes their rationalness, they end up failing in my experience. And so coachability is critical. And you test that very quickly by challenging them in initial meetings and say, you know, I don't agree with that. That's the wrong approach. And just see how they react. And sometimes I'll be a little bit provocative just to test it. Yeah.

Is this pre or post investment or both? Pre and both. I mean, you certainly do your best pre, but, um, you know, once you invest money in a company, you have skin in the game, it's a different dynamic altogether. So what are the differences you see in the response? You challenge this, the CEO, you're trying to put money into the company. They want to raise money. Uh, you

You've probably seen a spectrum of different responses. Talk to me about some of them. I often say, and this is a bit tongue-in-cheek, but it's the entrepreneur's job to lie to me until I cut them a check. And it's my job to pick the best liar.

And so, you know, integrity notwithstanding, which is, of course, critical here. But when you challenge an entrepreneur with a tough question and you challenge their assumptions, you know, they can react in a myriad different ways. Right. So they can obviously be really defensive immediately and say, no, you don't understand. This is the way it is. Well, that's a pretty strong signal. The ones I like are, you know, contemplative and they'll sit back and go, you know, that's really interesting. Have you thought about it this way? And they'll contemplate it and maybe they shift decisions or maybe they don't.

I prefer the ones that take it in, consume it, and then dictate their own path, not necessarily mine. Because the fact is, you know, they're qualified to run their business. I'm not.

I'm qualified to advise and be a mentor, but I'm not qualified to run their business. Should the board, do you think, always agree with the founder? Not necessarily. I mean, there's board dynamics as a whole another subject. But, you know, I think it's a variety of perspectives. Board meetings in general are a venue for everybody to say what's on their mind and get educated and put it all on the table. And then hopefully the best decisions come out of that meeting. Not necessarily unanimous.

I'd love to hear like you're on the board of a lot of these companies. What's the difference between a bad board member, a good board member and an amazing board member? And I realize there's some flexibility to the role in terms of the company, but

What are the attributes that those different people bring to the table at different levels? I think what I'll maybe try and do is reframe the question to what is a board meeting for early stage companies? So we kind of bind it there. What we tell our entrepreneurs is that they're not really board meetings. They're a moment for you to get out of the weeds and riff with a bunch of sympathetic people.

aligned partners on where to take the business and out of a sort of day-to-day tactical decision-making mode into a strategic decision-making mode. So that, that has implications on both parties. So from the entrepreneur's perspective, there's a spectrum of, oh, I hate, I have to report to the board and I've got to spend three days crafting all these slides. And then I'm going to, I'm going to go in and they're going to tear it apart and

To the other extreme is I'm using internal documents that I'm using to run my business and that's what I'm presenting to the board. And I have I've thought about it and I have three or four key strategic questions that I want to discuss with the board and get their perspective and then come away with a slight adjustment or realignment of the business. That's the entrepreneur's perspective.

From a board member's perspective, I think you have to show up with some humility and empathy for what the entrepreneur is going through the other 160 or 180 hours before you met them last or after you met them last.

And so I generally think of early stage board meetings as really brainstorm meetings, not board meetings. The board meeting part, the formal part of the governance is five or 10 minutes, right? It's stock option allocation. It's, you know, strategy around syndicate investors, follow-ons and so on. But the vast majority of the meeting should be on the whiteboard talking about governance.

core strategic decisions for the company, which markets to go after next, who to hire, how quickly to spend the money, what's our fundraising strategy, deep, important questions like that. And how does the role of the board change as the company scales?

Yeah, I think at some level, later stage companies, it's a very different dynamic. So I'm on a bunch of, or I'm on at least a couple of formal, large, $100 million plus company boards. And it's a lot more formal. It's a little bit more nose in, fingers out. Actually, it's a lot more nose in, fingers out, to use that cliche. What does that mean? It means that you're observing and advising and reacting, but you're not managing. Right.

You're not necessarily creating dictums for the company to follow because the reality is that the company and their team are in the business, you know, two, three thousand hours a year as a board member. You know, it's several dozen hours a year. You're certainly not qualified. And if you are, you shouldn't be. You should be in the company. Right. You're not qualified to run that business. And so it's a different dynamic at that point. I think board meetings then are a lot more about governance later stage governance.

conflicts of interest, public market facing type dynamics that are very different than an early stage company. And how do you advise CEOs to pick board members at the early stage?

Yeah, I think of it as several tiers of advisors, right? So as an investor, we generally get the right to be a board member or an observer in their board. And that's really fundamentally so that we have information that we can report to our bosses, which are our limited partners. So that's contractual, right? So there's some board members that are filled by the investor base. And then there's usually one or two independents that we shoot as high as we can. We get experts from those industries that have a penchant for early stage companies and want to help out

We're all about finding the very best talent that's available. I have a friend who says that business plans aren't worth the paper they're printed on, but the process of creating the business plan is actually the value. And I'm wondering if there's something to the board meetings there too, where the entrepreneur is not necessarily the information that's being presented. It's the fact that they're focused and diving in on collecting that information, trying to figure out what it means, anticipating questions from the board members as a means to better understand the

the business without question i mean i couldn't have said it better myself you know the board meeting is a time to reflect it's a time to prepare for its accountability right we all know that the gym conundrum you only go to the gym because your coach is there and you don't want to show up late and that forces you to work out and become a better you so it's the same thing with board meetings so it's it's the preparation process um that is really where the value lies and in that that quiet contemplation that the ceo goes through that's out of the weeds out of the day-to-day

Walk me through your entire decision process from finding sort of possible companies to invest in all the way down to making the investment decision and writing the check. What are the gates that you have? What are the questions you're asking yourself? How are you evaluating not only the companies, but yourself in order to commit capital?

A bit more of a long-winded answer. The process for us can take anywhere from, I'm going to say, two months to a year. And actually, in multiple deals, it's several years for whatever reason. We're tracking companies. But it starts with that initial meeting. So we'll be introduced to a company through a reputable source, one of our limited partners, another VC, an accountant, a lawyer, et cetera. We'll have that meeting, and we'll decide –

whether we're interested at all right out of the gate. And so that comes from three things, three core questions. Do we like the team? Do we like the technology? And do we like the market? So we have a general rubric of what we invest in, which is enterprise software,

And we're looking at the intersection of technology and enterprise functions. So does it meet that market segment? Is it big enough? Is it growing? Is it interesting? And we'll be able to assess that fairly quickly. The technology itself takes a little bit more digging and probing, but we can figure that out whether there's enough to go forward in that first meeting. And then the team itself, you know, again, it's a relationship building exercise. It's multiple meetings over multiple days and a rapport gets built up.

Then if we agree that we want to move forward with the deal, we'll start doing diligence. So ideally, we're talking to customers. We're talking to personal references. We're getting to know the team even better, understanding the business model, challenging it, going through it, establishing all of those check marks. And then we'll have a conversation around valuation and structure and how much we're going to invest and what expectations are on both sides. And if everybody agrees on that, then we have an agreement in principle. So we'll draft a term sheet.

will react to the term sheet. Some negotiation happens back and forth there. And once that's done, we make sure that we have a full syndicate. We do definitive docs, which is the legal process.

And just for early stage entrepreneurs who are listening, you know, it's probably $20,000 or $30,000 on investor side and company side to prepare those docs. And then we have a closing. Checks are wired. And ideally, we have a 90-day, 180-day plan post-investment whereby we set up the KPIs that we want to track and that we agree with the company that that's what they're shooting for.

And then we move into the operational process. Are you cashing out entrepreneurs or anybody at this level? Or is it more you're just investing money into the company with a specific purpose in mind? Definitely not cashing out entrepreneurs at the seed stage. Right. And I think it's probably wrong to assume that you're going to get a secondary at the seed stage.

Every once in a while at a Series A or Series B, typically a Series B, and I think it's prudent for an entrepreneur to take some cash off the table. Generally, good entrepreneurs aren't necessarily cashed out millionaires. And so the stress that it puts on them and their family can be alleviated a little bit by taking a secondary at the Series B. But we want full alignment early on because we know how hard it is. We need everybody rowing in the same direction.

And how do you come up with a valuation? Like, where does that come from? Often, I mean, from an outsider's perspective, it seems like some of the valuations I see tossed around in the newspaper headlines are just, they seem outrageous based on the economics of the business. Completely arbitrary. Yeah, no, no, there's some rubric. So, you know, they're in SaaS based businesses because they're very data driven SaaS by software as a service. You know, there are, there are obvious statistics like the cost of acquisition of a customer, the CAC, the LRB,

Lifetime value, LTV, there's ratios, there's different dynamics that you can pull from other companies that are successful and you can apply them to your company. And then you can raise and lower. Generally, it's a price to sales multiple. You can raise and lower your multiple based on the dynamics, right? So if I have very high churn, you're going to get a lower multiple. If I have very high margin, let's say in the high 90s, you're going to get a higher multiple.

But at its core, it's a function of a couple of other things that are somewhat different. One is the investor syndicate needs to own enough to make it worth their while, right? So a lot of VCs will say, I need to own 20 or 30%. We won't get involved otherwise.

Angel investors may simply want to put dollars in and get reasonable ownership out. At the same time, the founding team needs to have enough equity to make it worth their while. And I think some VCs have it upside down where they say, well, we're going to own all this business, but then you've lost alignment of your founder. And if you lose your founding team, then you're in a lot of trouble. Similarly, employees, the option pool has to be sufficient and interesting enough to attract the right kind of talent.

So we think about all of those dynamics when we come up with a term sheet and the valuation so that we're best prepared for the long term. And are you specifying what the money is used for? Like at this point, I don't know. Right. Like have have companies proven the idea works at this point and now you're trying to turn the flywheel or it's like you're on the cusp of trying to prove it.

And then, you know, the series A would be more, okay, now we're going to like just turn this flywheel more and more and more. We've got the model working. Right. No, it's a great question. And it comes down in my mind to a business is a machine in a box.

And what you're looking to do is put money in one side of the box and have more money come out the other side of the box in a very simplistic way. At the seed stage where we play, rarely do we know we have product market fit. So it's a lot of customer exploration, a lot of talking to customers, some early customer trials, some indications that the product does what it says it's going to do.

And we explore that with our companies. Now, there's an overarching thesis around what they're doing and the utility function, which is a function of the value that you're providing to the customer. So we think a lot about the value proposition. In other words, if I give you this product for $100,000, does it save you a million dollars, rough economics, 10x, and therefore you're going to buy it?

So we have that thesis and we have some early customer exploration and customers that we can talk to. And that's the beginning of the relationship. So that's the seed stage. Going into the Series A, you have to have enough momentum and some early economic ratios, LTV to CAC, for example, to prove that there's a market for your product.

And so the Series A investors want to talk to a lot more customers and validate that this thing starts to scale. The Series A investment dollars is really around adding that scale, adding salespeople, refining that box that I mentioned, and understanding clearly the business economics, the unit economics of what you're selling, what your cost to acquire a customer is. And then at the Series B, it's all about scale. So we have a machine, we know it works, we pour gas in the tank, it's just going to go even faster.

That prompted a whole bunch of things while you were answering that. One, is there a problem with technical founders or a default, I guess, to over-invest in technology and under-invest in sales? Yeah, I've made this mistake so many times. You fall in love with technology. Yeah, I mean, you fall in love with technology as a focus group of one, which is mistake number one, right? So I'm a terrible focus group, for example, but I'm a technologist. So I love the gee whiz disruptive technology.

The problem is that the world may not. The world is a fickle place and doesn't necessarily think the way I do. A solid mistake that founders can make is relying on the better mousetrap to solve the day. So the better approach is to do a lot more customer exploration and find out where the real pain is in the market and customize your product to suit that. And I can tell you that

It's much easier as an engineer to build things with lots of bells and whistles and features than it is to go and talk to a customer because they're big and scary and they say no. But the opposite is actually the best path. Go talk to customers first and then solve their problem second. I might be making this up, but I remember when Microsoft was under the antitrust sort of microscope. And I think Bill Gates said something to the effect of the best technology doesn't win.

And that has always stuck with me. I don't even know if it was him that said it, but that line is sort of like stuck with me as I watch technical founders sort of start companies and then struggle on the sales and marketing side or struggle to sort of delegate that to somebody they trust.

Yeah, I mean, that problem is age old, right? The quintessential business school example is VHS versus Betamax, right? One was better technology. It was smaller, denser, et cetera, and it still failed. They were out-executed. And so no question that marketing and sales trump ideas and technology all day long. So let's come back a little bit to sort of idea and execution. You need both together, right? A great idea with poor execution goes nowhere. Great execution on a bad idea might be...

you know, a cash out for you at the same level or something. When you're evaluating the team, you're not just evaluating the founders or the, the sort of like that part of the business, you're evaluating the next level to the C level in the business. And how do you think about that? Like, how do you evaluate those people where they're not the founders and they work in the business and they're probably not professionals. So they haven't scaled.

Yeah, I think, you know, I'll answer it bottoms up. The balance of the team, the C-level team and the rest of the employees are evaluated on a matrix basis, right? So your CFO, do they have the credentials and experience that makes them suitable for that role? And that's the same for engineering, et cetera. Do they have the right tools that we think are necessary to get the business past this stage? Because it's not always necessarily the team that starts doesn't necessarily finish. In fact, that's most appropriate. Yeah.

But it really comes down to the narrative of the CEO. It really does. And it's their vision of the future that doesn't exist today that you want to buy into, that you want to fall in love with and get excited about and then play a role in. And so it really does always come back to that vision. How do you do that, though? Like, how do you predict the future before it happens? Most of us anchor to the present. If we're thinking about what the world's going to look like in five years, we sort of think about what it looks like today with this incremental progress, right?

And what you're trying to do is often know the world that we know today is not going to be incremental. There's going to be a zero to one sort of flip.

And we're trying to identify that flip in advance. And this is what separates, you know, really good entrepreneurs from the rest of the pack is they have that vision. They have that crystal ball that they can see. And more importantly, they have the ability to articulate it and convince not only co-founders and employees to join, but also investors and customers to see that vision with them. Talk to me about some of the mistakes that you've made. So what happens when you realize you've made a mistake?

Do you just immediately write the company off and don't invest in it? Like don't invest any time in it anymore? Do you dive in and try to solve that? I know you're huge on problem solving and troubleshooting. Sure. Like how do you handle that?

Yeah, there's a number of different models. I wouldn't necessarily say that ours is the best, but some VCs that I know, I won't name names, believe in cutting bait early. So they will invest in a company and if it's not tracking, they simply walk away, whether they sell their position or resign from the board and let the company fend for itself.

is their strategy. Our view is twofold. One is because we invest a small amount upfront, we have a structural sort of gate at the series A before we invest a significant amount of capital, we have a much more clean decision, thorough diligence process.

And that means that we can walk away from our early bets with minimal capital deployed and chalk it up to a learning experience. It's a lot easier to walk away from a couple hundred K than a 10 million or something. That's it. And so in our last fund, our cap was $500,000. And it's a very small percentage of the overall fund, call it 1% or 2% for each deal. And so you don't lose any sleep by walking away from those deals. And to be clear, we make those expectations super clear up front with the founder. So we say, look, we're not writing a bridge note

We're not following on unless we meet these milestones that the market basically decides whether you exist or not.

And they're comfortable with that. So that's the structural way that we do it. Having said that, there's always cases where a company is doing fairly well, not super gangbusters, but they're doing well enough to warrant a follow-on investment. And so now we're in it. And that's really where the hard questions happen. So then it starts to go sideways or the market speeds up and goes past them, et cetera. Our view is that we're partners with the entrepreneur through thick and thin. And so all the way to the end, we work very hard

even with the companies that aren't going to be gangbuster successes. And we think that the economics of that provide us with a 50 or 100% of AUM payback. And what I mean by that is, let's say you have a $100 million fund.

And you have a company that you've put $10 million in. And if you walk away, maybe you get two or three million back. But if you help them, maybe you get full 10 million back. So we think we can preserve probably half of the fund by putting in the extra time. Now, the trade-off, of course, is that it is extra time and it is a lot of energy. And so it's not for everybody. But part of our ethos is that we enjoy working with entrepreneurs. We want to roll up our sleeves. We have a lot of experience and we want to bring that to bear. So.

So the mistake at that level is sort of like self-explanatory, but what about the series A when you commit money at series A level and then you admit to yourself or the world's giving you feedback that you've got that wrong? How do you get that feedback at that level? Because now you have more capital committed, the sunk cost.

not only in financing, but time is real. It's the nature of the game, right? I mean, if you're afraid of failure, you shouldn't be a VC. That's for sure. This is probably the highest risk asset class in private equity that there is. And so by its very nature, half of your companies are going to fail. And if you're not comfortable with that, then it's probably not for you. And so the real question is, how do you deal with it when you start to see the ship going sideways?

And there's lots of tools for that. For a VC, we can advise the company or coach them to sell the business early, try and recover some capital. We can make a change at the CEO level on occasion. Not my favorite thing to do because I think it rarely turns out well. But there are things we can do to right the ship. And if all else fails and the company goes under, that's the nature of the game. You said you were conservative earlier.

And it's interesting that you just said, if you can't accept failure, you sort of like shouldn't be in this business. Can you talk to me a little bit about that? Have you always been comfortable with failure or is this like you forced yourself through this process or? I've always been comfortable with failure so long as that I face it with integrity and work hard to do the best I can. And then I am comfortable with it, I think.

You know, ironically, my personal portfolio is quite conservative. I have a lot of real estate investments and I do ETFs. You know, I don't day trade. I invest in my funds, of course, which is investing in myself. But outside of venture capital, I'm quite risk adverse, which is ironic.

We've had many conversations about sort of CEOs and their response. How many active CEOs do you have in all three funds now at this point? So we've invested in 29 companies in total in Mistral. And I want to think that there's about 20 left running. And so we've had a number of exits and failures, a couple of failures so far. And you're in contact with CEOs all the time. Talk to me about...

how you saw the transition between sort of February, March, April, the difference between CEOs who adapted right away and responded to that change and CEOs who sort of like denied what was happening and how the businesses sort of responded to those different cadences by the CEO, I guess.

Yeah, there's a question buried in there, which is, you know, what's the difference between a really good CEO and kind of a mediocre CEO? And in my view and experience, and actually even some research to back this up, that the most successful companies are highly correlated with timing, first of all. So are you in a bear market or a bull market? That's the number one correlation between success and failure in business.

Number two correlating success factor is the market that you're in. So if you're in healthcare, if you're in IT, if you're in primary industries, each have their cyclical time of success and failure.

So, again, that kind of comes back to timing, but as a sub industry, the third most correlated indicator of success is the CEO. But ironically, it's only about 40 percent correlated. And so the question is, you know, if you if you want to maximize that, because that's really the only thing that you can participate in actively is your CEO choices.

And so then the question is, you know, what makes a really good CEO versus a less good CEO? And I'll start by describing a B CEO, like a kind of a subpar CEO. That's the CEO who is terribly articulate, knowledgeable, experienced, credible, meets their numbers. Employees like them, investors like them, very, very compatible, very easy to get along with. And then you say to yourself, wow, that sounds like a really good CEO. What's the difference between that and an A CEO?

An ACEO is an executive who sees change coming, you know, six, nine, 12 months ahead of everybody else and has the ability to change course in the face of opposition from everybody else who is happy with the status quo.

And so, you know, that's a good rubric for thinking about COVID and March, right? So we went through this because we obviously have dozens of companies. We have dozens of experiences with different CEOs and how they dealt with the crisis. I'm happy to say that, you know, across the board, our companies are doing well, mostly because we invest in enterprise software. And so, again, the utility of what they provide provides value. Having said that, there is a difference between the reaction of different CEOs in that time. So-

You know, the best CEOs I can think of, I have one specific in mind. You know, we spoke in early March and he said, you know, I'm really worried about this COVID thing. Have you heard about it? I'm thinking about going remote with my employees. I bought a bunch of PPE gear and they have protocols in place. And I was I was dumbfounded. Right. You know, it was in my mind it was a non-event at that point.

I remember you laughing at me for stuck. And you were in you were in the you were in the correct camp. Absolutely. And, you know, within about two or three weeks before the well before the end of March, he was remote. That CEO, he was in a cabin, full Wi-Fi directing things on a fully remote team. And his view was, I simply can't get sick and I don't want to get anybody else sick. And so that's the action he took was very strong, drastic, but decisive action.

Drastic, decisive and correct in the end. And there was, it was a no regret move because worst case, you know, everybody comes back to the office, it's a non-event, but you know, should the worst come to pass, which it did, you know, it was the right decision. The opposite is a CEO who at the end of April said, do you think we should do something about this? Should we go remote?

And, you know, that's a time-lapse difference in the two CEOs. When you were talking about the difference between the A CEO and the B CEO, I'm thinking of this concept that Peter Kaufman gave me called advantageous divergence, which is you need, it's not enough to diverge from what everybody else is doing. You have to be correct. And in order to be correct, you have to have a strong opinion and go against the grain and against sort of like the sand of what everybody else is telling you to do. And, yeah,

as a strong founder, you can do that. Um, but you have to be correct. And if you're wrong, you're just one of those guys or girls who just, you know, uh, didn't listen to what everybody else was doing. And it's really easily explainable why you failed. Um, and then there's Keynes who basically said it's better to sort of succeed conventionally than, um, fail unconventionally. And there's a huge press or like pressure I would imagine on people, um,

Yeah, no, it's a really good point. And one of the problems with the thesis is there's a survivor bias, right? So the ones that did go against the grain and were successful can claim victory, right? There's lots of people who predicted 9-11 and they predicted, you know, the pandemic and they were right. But, you know, the 99% who, you know, say the sky is falling every day are wrong. And so I think it's really important to sort of not want to put up with that scrutiny.

So it's okay to be contrarian and thoughtful about being contrarian, but it doesn't necessarily always win the day. I had a friend who unfortunately had to lease some people off during this. And he shrunk his company from about 100 to 60 years.

And I remember talking to him and I was like, he was so upset. And I was like, how did you decide? Like, how do you make these choices on like who to lay off and who to keep? And is it functional? Is it level based? Is it seniority based? Like, how do you, is it what you need to keep the lights on? And he said, those are all really good ways to do it. But what I did was just ask myself who adapted to change.

And then I kept the people that adopted to change and let go of the people who didn't adopt. So he's like, who adopted to this new world and this new reality the quickest? They stayed and everybody else sort of unfolded.

unfortunately lost their jobs. But now he's like thriving. He's like, this is amazing. We're doing more with fewer people. He has a former admin. He's like leading a team of 12 people now. And I remember you talking about that. And I think what's important there though, is the fact that he realized that change was permanent and

And so the adaptation process around work from home was going to be permanent. Right. And that recognition drove some of those decisions as opposed to if it's temporary, then I'm going to go back to the status quo. So that's a visionary CEO. Well, I think he might have, I'm speaking for him at this point, but it's sort of like, I think he also thought, well, if we end up going back in three months, these people will be able to handle like going back because they can handle change. Right. Yeah.

And I think that's like an underrated thing that we ever look for in employees is like, how do you respond to change? And that comes back almost in a way to coachability, right? How adaptive are you to feedback? You're getting feedback that what you're doing may or may not be correct. You have to interpret that feedback and then you have to choose a path of action.

Well, I think it also speaks to, you know, a broader concept of diversity in general, right? So people who have lived tougher lives tend to be a little bit more flexible. So that's why in general, foreigners are better entrepreneurs, in my opinion. And I, you know, I don't want to overstate it, but

You know, they're willing to leave their country, their city, their place of growing up for new frontiers, maybe a new language, new culture. Certainly that alone is a strong indicator of their ability to adapt and thrive in an unknown world. That's a really interesting point, especially given the post-pandemic world where small businesses are probably going to be what brings the economy back to normalcy.

uh in full employment if you will and should that have an impact on immigration policies do you think

Well, I think it's certainly an opportunity. And I think there's a wave of diversity and inclusion that's happening that we'll all benefit from. And it's irreversible at this point. So I think, yeah, I think it bodes well for the future. I want to switch gears a little bit and talk about sort of misvalued assets. What do you think is the most undervalued asset in the world right now? The most undervalued asset in the world? Let me reframe the question to what I think is interesting as an investment area. Our view is that we invest in...

but not for technology's sake, technology that enables application of technology. So for example, AI, you know, a lot of people talk about AI being a sector. AI is not a sector. AI is math. AI is an algorithm that's enabled by very fast processors with new ways of thinking about how to analyze big sets of data and now smaller and smaller sets. But AI in and of itself is not that useful anymore.

But AI combined with a subject matter as a collision is really interesting. So we've invested, for example, in a company called Blue Jay Legal that does AI meets case law. So what they do is they apply artificial intelligence on all the historical cases around a particular question that were litigated.

And so they can predict with 95 plus percent accuracy the way that a judge will rule on a particular question given a certain set of... Not retrospectively, but in the future. In the future. So basically the software will ask you 10 questions that are salient that the AI figured out to ask. And if you answer yes or no, positive, negative, it will predict for you whether you will win or lose the case.

And the upshot of that is that the judiciary system can focus on cases that are 50-50, which really do need to be added to jurisprudence, as opposed to the frivolous cases where you clearly shouldn't win or you clearly should. So that's an application of AI in legal.

I think areas that we're quite excited about are where you have this collision between disparate areas of technology and knowledge. So we have another company that uses behavioral psychologists and AI and debt relief as a conglomerate, and they provide an incredible solution. But it's really adding multiple disciplines of technology and understanding and bringing that to a product. Are you guys invested in cryptocurrencies at all? What's your take on cryptocurrency?

We don't invest in cryptocurrencies, but we do invest in the underlying technology of cryptocurrencies, which is distributed ledgers, right? So in my view, this is a form of liquid trust that all parties can get behind. And if you think about business transactions at its most fundamental level, it's about trust. And as the world becomes a smaller place, trust is even more important. And so leveraging things like distributed ledgers, like blockchains, enables that to happen. Can you have trust with anonymous payments?

Yeah, you can. Because with a ledger that is trustable inherently, then both sides can believe in the math, so to speak. I don't know much about cryptocurrencies. It just strikes me as something where if you can move money around with anonymity...

It's probably not a good thing. I'm not saying it's not co-opted. And certainly cryptocurrencies is the first example of blockchain technology in action. I'm not necessarily sure that that'll win the day. There are plenty of other applications of ledgers like supply chain, like identity that are much more applicable. And because you can't mess with the underlying data without being found out,

inherent in that is a level of trust. You work with so many amazing people on a day-to-day basis. You get to introduce to a lot of people, you get exposed to a lot of different ideas, a lot of different values. What do you take home from that and try to teach your kids? Like, how have you applied the lessons that you've learned working with people and being a VC at home with your family?

you know, honestly, the, the, the best part of this job is interacting with people smarter than me, you know, and if I had to sum it up, I'd say my, my goal in life is to be the dumbest guy in the room. And, uh, and that, and,

And I'm not so dumb, so I'll declare that. But the point is entrepreneurs and innovators and change agents are the most interesting people that you'll ever meet. And so it's a privilege to get to work with them and alongside them and back them. You know, I think one of the key lessons I've learned is that, and that I try to pass on, is failure is okay. Failure is actually a feedback mechanism to allow you to improve. So I spent a lot of time

When I talk to people, I look for failure mechanisms that I can avoid. And the lesson I give my kids is if you do less talking and more listening, you can find out what the other person knows and you already know what you know. And so now you've doubled down on your knowledge base and you haven't necessarily given anything up.

Of course, conversation should be bidirectional. But the point is, learn from everybody around you and don't be afraid of failure because smarter people than you have failed a lot. That's a really good lesson. I used to play this game with my kids and they sort of like stuck with it, which is like you're a detective and everybody knows something that you don't know. And your job is to figure out what they know that you don't know and then learn it.

Oh, I love it. I do. I use that in networking. So I'll go into a room and I, and I, I know there's somebody in that room that I have to meet and my job is to find them and find out something interesting about them. And I, and I use it as a mission. It's great. I know you're a voracious consumer of audio books, podcasts, different information sources. Can you riff a little bit on how you curate the information sources that you're bringing into your brain and how you translate that into specific knowledge? Yeah, my, my sort of,

uh, goal with reading and consuming information is twofold. One is for my, my work, right? So I listened to a lot of podcasts and books, um, around startups, successes and failures, looking for clues on how companies can fail more than looking for success indicators. Um, and that just helps me in my, my day-to-day business. The other sort of, uh, half of the content that I consume is around, uh, two fundamental questions. One is, um,

understanding what the meaning of life is and to put it in broad perspective. So searching for what, what is happiness? What is truth? What is the point of it all? And by, by reading fundamentally biographies up and down the line from let's say Marcus Aurelius to, you know, Putin to, you know, even, even Trump's biographies written by third parties are interesting in that they give some inkling and some insight into what life is for them and why they're living it.

but I will say, and I'm quick to say it, I, I, I'm a terrible consumer and I have terrible retention. We've talked about this in the past. So I listen to high speed. I listen. It's like three X. It's like ridiculous. It is kind of crazy. How do you even hear anything? Truthfully, it's probably two X on average, but, um, for me, it's about, it's a volume game and it, maybe it shouldn't be, but I'm a little bit ADD. And so I, I don't like the middle sections of books. I'm only looking for four or five nuggets in a book. And the faster I can get to those, um,

the sooner I can get done and get onto the next one. I sort of feel like there's this ocean of knowledge out there and I've got to swim through as much as I possibly can. That's an interesting perspective. I think we sort of like disagree on how we consume information, which makes for interesting discussions. But I want to end sort of like on one of the things you just brought up, which is like, how would you answer that question? What is happiness?

Yeah. I, you know, I think my personal philosophy is there's, there's three levels of happiness. And, um, the first level is, is somewhat simplified by saying it's physical, right? So it's the, it's the five senses that we all have. So visual, auditory, et cetera. And I think

Most people live and with all due respect, I'd say most people live in the five senses world. So they consume food because it tastes good. You know, they they watch movies because it's stimulating. They listen to sound, you know, they enjoy good wine and trips and stuff like that. But they're all physical massages and so on.

I think the next level up is a little bit more interesting in that it's about learning, right? So the endorphin rush you get when you learn something you didn't know and it clicks and it helps form you. I find that as a key piece of happiness. So you're constantly in pursuit of that.

And ultimately, I think that philanthropy and giving and charity and teaching is the ultimate form. Right. So giving back what you've learned in life and making someone else's life richer and more poignant, meaningful is the ultimate happiness that you can get. And you have to look no further than donating to a charity. It's an endorphin rush every time you do it.

when you teach a young child to learn to read or something new, there's a huge endorphin rush. And I think if you focus your energy on those give back areas, you're about as happy as you can be. The best things in life are reserved for people who help other people succeed. I couldn't agree more. That's a great place to end this. Thank you so much, Cade. Thank you, Shane. Great time.

Hey, one more thing before we say goodbye. The Knowledge Project is produced by the team at Farnham Street. I want to make this the best podcast you've listened to, and I'd love to get your feedback. If you have comments, ideas for future shows or topics, or just feedback in general, you can email me at shane at fs.blog or follow me on Twitter at Shane A. Parrish. You can learn more about the show and find past episodes at fs.blog slash podcast.

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