About Ali: Partner at CoVenture fund
- He looks at new asset classes that can be hard to value.
- Alternative financing like asset-backed loans (loans against fruit inventory, app for fast-food chain which allows them to clock employees in and out and allow them to pay employees whenever they wanted for a slight pay haircut)
- Fee structures depend on the dispersion of manager skill.
Coventure recognized many seed companies never get to Series A
- Fail to build the planned software to get to market. So Covenutures helps them.
- Software types who don’t understand the industry they are building a solution for
- Don’t understand the team they need
How does CoVenture fit into this?
The lesson is that the capital was easier to find than the people who can execute so :
- Giving young businesses guidance and connecting them to the personnel they need is very valuable.
- Having a service which serves common needs to many prospective startups is how to scale this idea.
Thoughts on cost of capital
- If one VC fund can convince its LPs to accept 1/2 the going return because it has the clout to get the best deals that’s another way of saying it has a lower cost of capital. Sequoia can offer lower rates of return because they are less risky than an upstart fund
- These relative differences in costs of capital sustain significant advantages.
- A fund may offer a startup cheap financing in exchange for warrants (similar to a convert). This is a bad strategy b/c the performance of the instruments is inversely correlated. If the company takes off and does well, the warrants will perform but a larger fund with a low cost of capital like Blackrock or Apollo will refinance the debt piece for cheaper. In the case where the debt is not refinanced the warrants will be worthless.
Conundrums for seed funds
- They are expected to “stick to their knitting” and be contrarian. This is practically impossible since being contrarian requires you to exit the seed company in a year or so to a Series A fund which is by definition consensus.
- Any seed fund of quality naturally wants to raise more money but will find itself capacity constrained so it will drift towards Series A deals which are outside their expertise
- Pre-seed round is about trying to methodically uncover if you are creating customer value. Revenue can be falsely equated to customer value. For example, you can spend money marketing which will lead to more revenue but this is not the relevant KPI (“key performance indicator”) to test the hypothesis that you are increasing customer value. The seed round is then about trying to find out if the improvements to KPI can scale.
- Important to have a strong understanding of the role of the round you are in
- Judgment vs Empathy at the core of a solution
- Empathy reflects a true understanding of the practical trade-offs that lie within a business problem.
- Judgment is typically what an arrogant or ignorant outsider looking at the problem prescribes when crafting the solution
- Technology has made starting companies cheap but scaling is more expensive.
- Trade-off when raising capital: balancing getting off to a fast start to acquire customers and scale versus discipline and overleverage.
A link to another post with takeaways from this podcast: https://thewaiterspad.com/2018/01/24/ali-hamed/