Generated Transcript

[00:00:15] David Hornik
Hello and welcome to Venture Cast. I’m David Hornik from August Capital.

[00:00:19] Howard Hartenbaum
And I’m Howard Hartenbaum, also from August Capital.

[00:00:23] David Hornik
I was thinking yet again of a theme song for Venture Cast, but I didn’t. I didn’t really arrive at one.

[00:00:30] Howard Hartenbaum
But if we, if we start using one, don’t we have to pay royalties to them for using it?

[00:00:34] David Hornik
Well, it depends on what. It depends on whether we write it. Then we just own the rights.

[00:00:37] Howard Hartenbaum
Then we can join you doing this.

[00:00:39] David Hornik
Yeah, I just thought I’d make one like, you know, Venture Cast.

[00:00:43] Howard Hartenbaum
You could do it on the, on the base.

[00:00:47] David Hornik
I could do it on my new. I just got a new new keyboard. On Mass Drop, I just got a new keyboard. There’s like this whole electronic section and all these fanatics talking about it. And so I replaced my very boring controller keyboard that sits next to my desk with. With something way cooler. Now I have to figure out how to use it, which is always the problem. I’ll tell you, it has changed unbelievably since I was the. You know, the first synthesizers I bought, they were all self contained. It was like a keyboard. It sat in one case, you plugged it into an amplifier and whatever sounds it had, it had. And now of course that’s completely not what it is. You plug it into your computer. Your computer has an infinite amount of power and sounds and then you can manipulate the crap out of them. The only problem is there’s always some new software package associated with it that you have to figure out, oh, how do I define these keys, how to define these pads and whatever. So, so if you come in here and you’re like hey David, I have a question about venture capital. And you see me like looking confused and frustrated, it’s because I’m trying to figure out how to use my new keyboard.

[00:01:48] Howard Hartenbaum
I’ve come into the office early 7:15 or 7:30 some days and I’ll hear out coming out of your office that you practice in the bass. It’s usually when you’re pissed about something.

[00:01:59] David Hornik
That is true.

[00:02:02] Howard Hartenbaum
Once even you were pissed at me.

[00:02:05] David Hornik
What song was I playing?

[00:02:08] Howard Hartenbaum
Pretty much.

[00:02:12] David Hornik
No, it is a good. I’m glad that I have a bass in my office now because it is a good like release. It’s like oh, you know, I opportunity to. To do something that isn’t email.

[00:02:23] Howard Hartenbaum
And my guess is that your family won’t allow you to play the bass at home. And that’s why you have a bass in the office. I have a ukulele in my office. But it’s a ukulele that you gave me. Well, you’ve never heard me play that.

[00:02:34] David Hornik
I just want you to be able to relax. No, my, my. We have kind of an outdoor play room that has a bunch of basses and stuff. So I do play, but I find that when I’m home, I actually have even less time. Like if you’re here in the office and you have a 20 minute break, you know, you could fill it or whatever, but just as well might go play some bass. Right. And so it’s. Whereas once I get home, they’re like a million home things to do. And it’s unlikely that one of those includes playing bass.

[00:03:01] Howard Hartenbaum
Yeah.

[00:03:02] David Hornik
But anyway. So how have you been, Howard?

[00:03:07] Howard Hartenbaum
You know, it’s always an exciting time. Just. I guess we’ll report it the next time. Just agreed to invest in a new company where we have received our first term sheet. Did I tell you about how it went down with the company? I went to them and I wanted to work with them. And I’d gotten to know the founder for about two years and he wasn’t raising money yet. And he still had like, I don’t know, eight or nine months of Runway in the bank and his burn rate was modest. And I went up to his office and I told him before I went up, I said, I would like to bring you a term sheet. And he said, I’m not raising money. And I said, but I would bring one anyway. And he’s like, okay. And I went up to his office and I took a piece of paper out of my thing. I like to deliver it in person because I just think it’s the right thing to do. And, you know, I like to see their face when you hand them the term sheet.

[00:04:00] David Hornik
It’s like when you asked your wife to marry you. You wanted to be there in person to see her reaction, see how it was going to go.

[00:04:06] Howard Hartenbaum
I did that on the phone because if the answer was no, I just wanted to hang up.

[00:04:11] David Hornik
Click. I’m sorry. Oh, I can’t hear you. I’m sorry.

[00:04:13] Howard Hartenbaum
So I handed the CEO and his two co founders. Were there a term sheet. And I said, you know, it’s all basically common terms, you know, plain vanilla upside. If the company goes down, the only request we have is that we have one ex liquidation preference and that’s it.

[00:04:29] David Hornik
Which is totally what we do. Like we’re not a we get rich on terms kind of firm where we help you be successful and everybody gets rich kind of.

[00:04:39] Howard Hartenbaum
Yeah. And it wasn’t an Exploding term sheet, which means many term sheets. They say you have to make a decision by Friday at 5pm this was just a piece of paper and I gave it to him and he said, but what’s the price? And I actually hadn’t filled that part out yet. It said, august Capital will invest blank million dollars to buy 20% of the company at blank valuation with blank option pool. And I gave it to him and I said, you know what, why don’t you just fill this out? I’ll leave day or two from now after you guys have had time to do some research and reference calls and talk to your friends. Just write down what you think is fair and it’ll probably be lower than you want and higher than I want, but we can agree on it and you just give it to me and if I think it is fair, I will not negotiate it. I will just sign it. And two days later he called me up and he said, you know, I was going to say 100 million free just as a starting point just to mess with you. But anyway, he came and he put a price, which I think is way more than the company is worth today. And he thought it was less than the company is worth today. And I did not negotiate it with him. I just said, let’s start off on the right foot and I sign the document and we are closing next week.

[00:06:03] David Hornik
You know, I just. As you know, I’m doing a deal right now where we had a similar thing where the company is great. I’m excited about the company was sitting down with the founder. He at this point had six term sheets. And I said, what? So what’s the deal? What’s the deal you want to do that would get this done? Like, I understand you have a bunch of options or whatever. If you, if all things being equal, you would like to work with me and August Capital, then what’s the deal? And he said, yes, all things being equal, I would like to work with you. And in fact, it doesn’t even have to be equal, but I’d like the deal to be X. And I said, okay. And he looked at me and said like, well, what are you talking about? I said, okay, I’ll do that deal. He was like. He said, you know, you are. You guys are weird. You don’t behave like the rest of the venture business. That’s, you know, this is supposed to be a negotiation. I said, nope, this is not a negotiation. That’s a perfectly reasonable deal. As how would you say, oh, it’s more expensive than we had planned. And more than we would like. On the other hand, I think that this is going to be a great company. Let’s go build a company instead of wasting time with this.

[00:07:08] Howard Hartenbaum
Or instead of starting off already having a negotiation. Yeah, why not just shake hands?

[00:07:13] David Hornik
And he said, okay. And then we spent an hour walking around chatting about the business and then I put home and he was sort of like, well, that was easy, you know. So anyway, so you’re saying that. What do you mean, you got another term sheet, so.

[00:07:29] Howard Hartenbaum
No, no, no, we got a term sheet. I look at it as if actually he filled it, he wrote the term sheet and gave it to us. And then I accepted it.

[00:07:37] David Hornik
I thought what you were going to say is, and meanwhile, he just got seven unsolicited term sheets or something.

[00:07:42] Howard Hartenbaum
No, no, he wasn’t raising money. And he said, you know what this is? He named the price. And I said, yes, and it was totally fair. So he had no need to go out and get seven other term sheets. Yeah, which was, which was great. But. But back to like, you know, getting engaged to your wife, I mean, this is sort of like marriage. You’re hooking up with somebody for five or 10 years. Sort of like marriage and ebates.

[00:08:04] David Hornik
14.

[00:08:05] Howard Hartenbaum
14. And my marriage is 22 and yours is 20.

[00:08:07] David Hornik
I’ve been on the, I’ve been on splunk board for 11. I’ve been on the Nomas board for 10.

[00:08:12] Howard Hartenbaum
I mean, can you imagine if getting engaged to be married was like a term sheet negotiation?

[00:08:18] David Hornik
Well, this is.

[00:08:18] Howard Hartenbaum
Will you marry me? I don’t know. How much money are you going to give me? Under what circumstances? And if things go bad, let’s negotiate the downside protections.

[00:08:28] David Hornik
I, I should probably not mention names, but I know a very famous entrepreneur who has a. A long set of agreements with his wife that were pre. Negotiated as part of the engagement process. Literally was like, here’s how we’re going to treat, you know, children and religion and vacation and work and all the, you know, like it was a. I.

[00:08:51] Howard Hartenbaum
Could see the benefit of that. Not that it needs to be a document, but that it’s a discussion of how people feel about specific topics. I can say the biggest challenge my wife and I had was before we got married, I said I wanted to have five children. And after she had the second child, I said, great, we got to get going. We got three more to go. And she said, what do you mean? And I said, we talked about this, wanted five. She said, no, I thought you were kidding. So this friend of yours who’s negotiated all that stuff like you put it down in paper when she’s. It’s pretty clear. Five kids.

[00:09:25] David Hornik
Yeah, I mean I had four but that was not clear going in. That was not part of the pre negotiation. It was like well I guess should we have another? And then after the four time passed and once they were all out of diapers it was like well now that’s that. Like I’m not going back to that.

[00:09:43] Howard Hartenbaum
Not me. I would like more kids. Kids are fun.

[00:09:45] David Hornik
Kids are good. Well you particular like you’re right on the what. How old’s your youngest now?

[00:09:50] Howard Hartenbaum
She’ll be. She just finished junior year.

[00:09:52] David Hornik
Oh my God. So you’re about to be an empty nester.

[00:09:55] Howard Hartenbaum
See ya.

[00:09:59] David Hornik
We’ve been talking about having a sabbatical program here at August Capital.

[00:10:02] Howard Hartenbaum
Eric, nix that.

[00:10:03] David Hornik
And it’s out. But you’ll be the only one who could actually take advantage of it.

[00:10:09] Howard Hartenbaum
But you know I would do two weeks and I would be bored.

[00:10:11] David Hornik
Yeah, that’s what all of us would be. That’s the problem is I think the.

[00:10:13] Howard Hartenbaum
Truth will be is after my second kid goes away to college I’ll probably work even more because like what else will you do?

[00:10:20] David Hornik
I I was just talking with a very a young VC new a year and a half into one of one of our friends on Sandhill Road firms and he yesterday and we’re walking, he’s like, you know I can only say this among other VCs but this job is hard and he was an entrepreneur before. He’s like I thought entrepreneurship was hard but oh my God, this is so hard. And my companies aren’t doing as well as I’d hoped and holy crap. And it’s like I know well when.

[00:10:51] Howard Hartenbaum
You’Re at an operator and you’re at a company one you’re only dealing with one set of problems and there’s things you can do to try and fix those problems. But when you’re a VC with 10 portfolio companies at any moment of time, half or more are having problems. So it’s compounded and there’s nothing you can do to fix them. So it’s very challenging.

[00:11:08] David Hornik
Yeah. Yeah.

[00:11:09] Howard Hartenbaum
Let’s talk mattresses.

[00:11:10] David Hornik
Oh my God. Your favorite.

[00:11:12] Howard Hartenbaum
Do you mind?

[00:11:12] David Hornik
No, not at all. I know you’re obsessed with.

[00:11:15] Howard Hartenbaum
So I have this habit of I get obsessed with one topic for a few months and I learn everything I can about that topic and I research it and I draw my own crazy conclusions on it. There’s a lot of different areas. Like I know a lot about car breaks, and I know a lot about sprinkler systems, and I know a lot about keys and locks. This thing now it’s mattresses.

[00:11:37] David Hornik
I mean, actually, unlike my esoteric things like, oh, no, you know, minimalism in music, you’d be like, yeah, whatever.

[00:11:44] Howard Hartenbaum
Minimalism in music.

[00:11:45] David Hornik
You turn it off, I’ll fix your sprinkler.

[00:11:47] Howard Hartenbaum
You know, so let me tell you, my, my. Here’s my high level theory of mattresses. So mattresses as a business, so are totally screwed. I needed a new mattress for my house, and I walked into a mattress store. Well, so first it started where somebody said, hey, have you heard about that company Casper? And I said, no, what’s Casper? And they say, it’s a mattress you buy in a box. It comes in the mail, you cut it open, and it’s a foam mattress and it inflates. And I said, oh, I did that when I lived in Europe. I bought these water latex mattresses for my kids. And they came in this little tiny roll and you cut the plastic and they inflate like 80 times their size. And they’re really awesome mattresses. So apparently what happened, I think the Tempur Pedic patent or something went out. And so competition has popped up and Tempur Pedic didn’t grab enough market share while they had the chance. And so faster operators like Casper and another one, Tuft and Needle, and there’s a whole slew of them now, started shipping mattresses by mail in boxes so they don’t have to fund staff in stores. They don’t have to have stores with inventory and huge floor where people come in and flop around on mattresses. And they sell one per day. Anyway, so I bought. I was looking into Casper and then I. And I saw on one blog somebody saying, well, if you like firmer ones, get a Tuft and needle because it’s more firm. And I wanted more firm. And so I went and Tuft and Needle was cheaper. And it was on Amazon. It had 900 or 890 reviews that were five star. And I’m like a mattress that people like. I figured I gotta get one of those. So I bought one. A few days later, it came to my house. I cut the bag open.

[00:13:21] David Hornik
So how big is the box? Like, when it shows up, is it like.

[00:13:24] Howard Hartenbaum
It’s like two feet by. Two feet by whatever, you know, four feet high or three feet high and weighs about 75 pounds for a queen. It’s heavy.

[00:13:32] David Hornik
Heavy, but pretty. But pretty comfortable.

[00:13:33] Howard Hartenbaum
Totally manageable for UPS to die Comes.

[00:13:35] David Hornik
And drops it, and you can move it wherever you want to get.

[00:13:39] Howard Hartenbaum
Bring it in my room. I open the box, I cut the. You cut the plastic open, and the thing just expands like. It’s like those kids toys you put in water, and they’re like a pill, and they just. And you’re just like, holy crap. And it was hands down the most comfortable mattress I’ve ever slept on. It was only 600 bucks. It’s just awesome. It’s firm, but it’s soft, and it’s.

[00:13:59] David Hornik
Anyway, we are not investors in tough.

[00:14:01] Howard Hartenbaum
We’re not investors. I just think it’s the most awesome thing in the world. So then we have another room in the house, and my wife wanted to get a different mattress for that room because she. Whatever. Wanted a different thing. So I looked on Yelp, and I found three mattress stores that were rated highly. And the first one I walk into is in Palo Alto. And there’s a guy there, and all Yelp review say, armando, he’s the best guy. He’s awesome. And I talked to Armando for three minutes, and he starts off, and he tells me his dad founded the shop 40 whatever years ago, and he’s been working there for 31 years. And he was very nice and helpful. And before he finished talking, and he said, and those stupid mattresses that come in boxes in the mail. And I said to him, oh, I’m thinking to myself right here. This is the clue that the mattress industry is screwed. When the first time you walk into the store and the guy who’s been running a shop for 40 years tells you his first sentence, he’s worried about mattresses that come in the mail. That’s like, AT&T saying Skype, it’ll never work. I said to him, you might want to try one and think about how you can change your business as a result. So, anyway, we flopped around in mattresses there. We went to another shop, and we flopped around in mattresses there. We went to another shop and flopped around in mattresses there. And by then, I couldn’t tell them apart. They’re all the same. So I just picked one and bought it, and it got delivered to my house, and it’s too hard.

[00:15:17] David Hornik
In a giant truck.

[00:15:18] Howard Hartenbaum
In a giant truck. It took a week and a half to get there. I can’t move it on my own. It’s so heavy, and it was too hard. I’m uncomfortable on it. I called the mattress company Heirloom, and I asked, I need to talk to your person who’s an expert on all the mattresses you sell. Oh, you want to talk to Linda? And I get Linda on the phone. She’s worked there 10 years, she knows everything. She said, what happened? I said, well, I bought this mattress and I thought it looked more, you know, it was a little bit like this, but frankly, it felt like I slept on the top of Half Dome last night. She goes, well, which one did you buy? And I read the receipt for her and she goes, oh, yeah, you bought the one that we call the Rock. You said, well, I was like, well, I called it out and I did. I called the retailer, I paid them a 15% restocking fee plus an $80 pickup. And I’m done with that mattress and I’m buying. I just ordered another tuft and needle.

[00:16:09] David Hornik
Seriously?

[00:16:10] Howard Hartenbaum
Seriously.

[00:16:10] David Hornik
Did you just said to your wife, I understand that this is a problem, it will finish smelling like whatever, but.

[00:16:17] Howard Hartenbaum
I bought another one.

[00:16:18] David Hornik
And what did you go have to say? Like, she just said, oh, fine, or.

[00:16:24] Howard Hartenbaum
Well, no, I, you know, I butted her up for a few days by basically complaining every 20 minutes. She just doesn’t want to hear me complain anymore.

[00:16:30] David Hornik
That’s not really buttering her up as.

[00:16:32] Howard Hartenbaum
Much as, like, I bought her a.

[00:16:33] David Hornik
Handbag, pestering her into submission.

[00:16:37] Howard Hartenbaum
Anyway, the mattress industry. And we read that somebody funded Casper big time money. And as crazy as the whole thing sounds, based on the one data point of the 40 year old mattress shop in Palo Alto, the guy telling me that he hates these mattresses that come in the mail in boxes, I think the mattress industry is screwed.

[00:16:55] David Hornik
See, this is the thing, like, you know all these industries where people think, oh, tech doesn’t matter or innovation doesn’t matter, what’s the disruption? Doesn’t matter. We funded a sock company we’re now investors in Stance Socks. Are you wearing stands? Of course, we’re both wearing.

[00:17:13] Howard Hartenbaum
They manufacture socks with 200 needles, concurrently sewing the socks on a mold, which.

[00:17:21] David Hornik
Is cool, it turns out. Actually we had this conversation because they come into pitch. The CEO is an amazing guy, comes into pitch, but like, ah, what’s the technology involved? And then you find out that he’s an expert in the technology of socks and he’s actually manufacturing better socks. They’re better, they’re more comfortable, they’re whatever. They also happen to be really cool looking and they’re sort of disrupting what otherwise was a boring old, not very innovative business. And I, and I think, I hope is going to be a big, interesting business.

[00:17:50] Howard Hartenbaum
And every entrepreneur that pitches August Capital goes home with a nice Pair of socks.

[00:17:55] David Hornik
Here’s some socks.

[00:17:56] Howard Hartenbaum
In fact, I had an entrepreneur come in yesterday who wanted to pitch again. At the end of the pitch, he said to me, can I get some more socks? He came back for more socks. And so I said to him, well, yeah, you can get a few pair. And he said, can I have five pairs? And I said, no, five pair is. If we fund you, I’ll let you have two pair today.

[00:18:14] David Hornik
Well, I didn’t know this was like a part of the ongoing negotiation.

[00:18:17] Howard Hartenbaum
But we can put that in socks.

[00:18:20] David Hornik
Yeah, we will also give you socks.

[00:18:22] Howard Hartenbaum
We’ll fill your sock drawer.

[00:18:23] David Hornik
Yeah, they are good socks.

[00:18:25] Howard Hartenbaum
You should try that.

[00:18:26] David Hornik
I have a lot of socks.

[00:18:27] Howard Hartenbaum
Send them a bag of socks. Seriously.

[00:18:33] David Hornik
We’re currently in negotiation with an entrepreneur and Howard believes that perhaps sending socks would be. Effort.

[00:18:39] Howard Hartenbaum
Couldn’t hurt.

[00:18:40] David Hornik
And I just got a bottle of wine. I could send over some wine. I mean all these things. But in the end if it worked, that’d be. So it would be a contra indicator. It’d be a negative indicator because no one should make this decision based on socks. You should make the decision based on who is going to help. Who are you going to want to work with for the next 10 years, who is good when. When you have a board meeting go oh David or oh, Howard.

[00:19:06] Howard Hartenbaum
Not, you know, but I totally agree with you. But.001% of it is that the guys people just like to deal with a little bit of flair or excitement or being pampered or. I was talking to what’s her name, the girl runs Shophers down in la. Wonderful Jacqueline, I think her name is. Floodgate had funded her and she said she was really sick a few weeks ago and she is talking to a vc. I don’t know if it was Greylock or some other nice firm. And she said like she got off the call and two hours later some matzo ball soup showed up on her.

[00:19:37] David Hornik
Doorstep and she was just like being like nice. I mean, yeah, I suppose some people could do it strategically, but I agree with you. Ultimately I’d rather work with people who are good people and like when you don’t feel well, they send you matzo ball soup. Unless you don’t like matzo ball soup, which would be criminal because matzo ball soup is delicious.

[00:19:55] Howard Hartenbaum
Yeah. Good matzo ball soup. Have you.

[00:19:57] David Hornik
Is there good matzo ball? So we end up going to Max’s because my daughter loves matzo ball soup. Pretty mediocre.

[00:20:02] Howard Hartenbaum
Is that the one that’s at Stafford Shopping Center?

[00:20:04] David Hornik
Shopping center. Do you Know of any other place?

[00:20:06] Howard Hartenbaum
No. My mom lives in Mountain View so.

[00:20:10] David Hornik
I should just call her because my mom lives in Cambridge and that’s not helping me a whole lot. We’ve talked about nothing so far.

[00:20:18] Howard Hartenbaum
Yeah, that’s good.

[00:20:19] David Hornik
Pretty much. What do you want to talk about? You want to talk about a couple companies pitching us and why don’t we talk about all.

[00:20:25] Howard Hartenbaum
Yeah, why don’t we talk about all these structure and deals and all the unicorns and high prices and stuff like that? Because everything isn’t always as it seems.

[00:20:35] David Hornik
Yeah. I just gave a talk to one of our investors, right. Rlp and it was a fund of funds and therefore these fund of funds have other investors and they have their own conferences where they tell their investors how they’re doing. So I went down to sort of represent venture as like hey, I’m a venture capitalist and I’m investing your money. And the fund of funds did a presentation talking about how venture was doing and they had a whole thing about unicorns. Oh, here are the unicorns. And by the way, once again a shout out to Aileen Lee who invented this term unicorn that has is just completely pervasive now. Pernicious even. But, but you know, they’re talking about him. Then I have this debate with at the conference where I say like, you know what? I think there are two types of unicorns. There are, there are real unicorns and then they’re pretend unicorns.

[00:21:27] Howard Hartenbaum
Fantasy. Fantasy unicorns.

[00:21:29] David Hornik
Fantasy unicorns. One is realized gain. A company has gone public at more than a billion dollars, has sold for a billion dollars or more. You know, those are real, live tangible billion dollar businesses. And then there are these companies that get funded at a billion dollars and you say oh well it’s a unicorn.

[00:21:51] Howard Hartenbaum
Well, some of them will be.

[00:21:52] David Hornik
They may be unicorns.

[00:21:54] Howard Hartenbaum
I the Ubers of the world.

[00:21:55] David Hornik
Knowledge it is extraordinarily unlikely that Uber is not ultimately worth many billions of dollars. But there’s some of these companies. Look at fab was a unicorn supposedly, right. Funded out of valuation and went out of business.

[00:22:10] Howard Hartenbaum
Like Living Social.

[00:22:12] David Hornik
Living Social is, was one of the unicorns listed on this thing. I don’t know what it’s worth now. Right. So there are. So to be clear, realized gains are, are the real McCoy and before that there are financings. And the thing that is perfectly clear to us is that these financings aren’t just like oh, simple financing here what we talked about earlier, this 1x preference, very simple, no terms that get in the way.

[00:22:39] Howard Hartenbaum
Downside ratchets yeah, warrant issuance and time based triggers and all sorts of stuff.

[00:22:44] David Hornik
So maybe we should describe those for.

[00:22:46] Howard Hartenbaum
You a little bit.

[00:22:47] David Hornik
So those of you don’t know. Some of the things that you can do in a financing is set the terms of the stock you’re buying so that it changes based on the value of the company or the time of the company or the timing. So the first one is the value. There’s a thing called a ratchet and the ratchet says, hey, I’m going to give you a 2 billion dollar valuation, but if the company is worth less than that, it will be as if our financing got done at that valuation plus extra usually or yeah, worse than that. So let’s say I’m gonna make your company worth 2 billion, but if you don’t get public at $2 billion, then we’re gonna treat it like it was a billion dollar business. And we have seen multiples of these. In fact, when, when Chegg went public, their last investors got a bunch more shares because they had one of these terms in and it went public at meaningfully less than the price of their last round. The other one is a timing thing which says, hey, if you don’t get public at a price at this price we’re paying now by such and such a date, we’re going to get more shares every month that you have failed to achieve this goal. And that was Box. Box’s last financing said get public by X date or you’re going to start issuing us a lot of your company. They literally had to get public by that date. They did manage to get public, but again not at the price that was anticipated, etc. So, so people may be paying a billion, 2 billion, 7 billion, 15 billion. What’s the latest? Spotify just did around 8 billion, I think. 8 billion Pinterest has done around or not? WhatsApp has done an. I mean, not WhatsApp, Snapchat. Snapchat just, I mean it’s just these valuations are mind bogglingly large and by the way, higher than the average IPO price over the last decade. Right. So we’re talking about private valuations that are meaningfully higher than the, than the public company valuations that are actually creating realized gain. So this is dumb. What’s your take on it, Howard? I mean, is it just that people are being short sighted?

[00:25:02] Howard Hartenbaum
I think it’s, I think they’re not being short sighted, they’re just being overly optimistic. And when you imagine everything is going to go right and you don’t really plan for what happens if things go wrong? If things go right, then it was a good choice. But if things go wrong, it’s significantly more painful than a more cautious approach. For example, people perceive having a billion dollar valuation and being a unicorn is a really great thing from a recruiting perspective, from a press perspective. And if the company continues to do great and becomes worth more in the future, then it doesn’t really matter. But in many cases companies have problems or the markets change and the IPO window closes down or whatever.

[00:25:46] David Hornik
That’s going to be a big one. In fact, this has been the slowest IPO year in years. We think it’s a great robust market.

[00:25:53] Howard Hartenbaum
But it turns out actually not fewer.

[00:25:55] David Hornik
Venture backed companies have gone public this year than in many years recently.

[00:26:01] Howard Hartenbaum
Yep. And so it’s sort of like you can’t, you know, people, soldiers run off into battle with a gun, facing towards the enemy, thinking I might get shot but I’m going to do my job. And then when they get shot and their leg gets blown off and later they’re like, oh, this is a lot worse than I thought it would be. It’s kind of similar with all the terms you can have on a. No, I’m not, don’t get me wrong, like a soldier who loses his leg on behalf of our country. Infinite respect. I’m just talking about the psychology. You don’t know how bad something is until the thing actually happens to you.

[00:26:37] David Hornik
And therefore you don’t take appropriate account of that negative outcome.

[00:26:41] Howard Hartenbaum
Correct. And so you have a company that could have raised at a 500 million valuation in straight preferred. No, termed equity, or they raised at a billion valuation with all sorts of ratchets. If the company struggles a little bit or a lot, either way, the lower valuation was much better, typically for the founders and the employees and all the investors. But if everything goes great, then the high valuation was better. But more often than not companies struggle before they exit. And so I think entrepreneurs are just being a little bit overly optimistic sometimes and the pain and suffering isn’t something as bad as they perceive it will be. And then it’s really a lot worse than they thought it be.

[00:27:22] David Hornik
Would I have a super interesting company that’s out raising money right now and we had this conversation and everyone in the room is 100% on board with clean terms at whatever the price of that term. Right. Whatever that is. Like if it turns out that that’s a 700 million dollar deal or a 900 million dollar deal and if it’s a 700 million dollar clean deal and a 1.1 billion dollar not clean deal. It is the 700 million dollar deal. And by the way, if you do the math, take a spreadsheet and do the math, because it’s not like you’re raising $400 million in these instances. So let’s say you’re raising $50 million. The difference between a 700 million dollar valuation and a billion dollar valuation. Raising $50 million is not that large. The amount of additional dilution is not that large versus the real challenge of not of the downside when you don’t hit it. Right.

[00:28:19] Howard Hartenbaum
Yeah. So many of the unicorns and the terms that they have, those investors have only upside. They have no downside unless the company is a zero.

[00:28:29] David Hornik
That’s right.

[00:28:30] Howard Hartenbaum
They even have things like they’re putting money in a billion, but you’re guaranteeing them a minimum 10 or 15% return every year no matter what. And if you end up raising money at a 500 million valuation, then they get a whole bunch more like it is no lose for those guys in those financings. And if things go down, basically the company and the founders are the ones who get bled the most.

[00:28:53] David Hornik
Yeah.

[00:28:54] Howard Hartenbaum
But they would continue to do it because people are optimists.

[00:28:57] David Hornik
So it’s funny, this entrepreneur who’s out raising money said that he would rather raise money at a $999 million valuation than a billion because he said, I don’t want to be a fucking uniform. I love that. Like, forget it.

[00:29:15] Howard Hartenbaum
But, but the reality is his business is only worth 80 million.

[00:29:17] David Hornik
Yeah, yeah, exactly. You wish. Yeah, no, his business is worth a lot. I appreciate, I appreciate that. That I know, frankly, if it does end up being worth more than a billion dollars, I think we should create a T shirt with him riding a unicorn because that would be so great.

[00:29:35] Howard Hartenbaum
What will he be sitting on?

[00:29:39] David Hornik
Yes. Oh, man. Well, anyway, all right, so terms, terms matter. Terminology matters, you know. So one of the things that makes me crazy and it actually makes you crazier than it makes me, is that we get pitched by businesses all the time and they use these terms like, oh, these terms of art. Right. Where they’re supposed to mean a particular thing. And yet they always have a different meaning. Right? So in particular, I’m thinking of this idea that many of the companies we’re pitched on these days are talking about, what is the cost of acquisition? We call it cac. Right. What is the cost of. To acquire a customer? And they say, oh yeah, yeah, our CAC is $40 or whatever. And when you and so and, and, and the LTV, the lifetime value of our customer is 100 or whatever. And therefore it’s a good deal. Like, look how well we’re doing. It’s 40 to 100 or 40 to 400 or whatever it is.

[00:30:28] Howard Hartenbaum
We see businesses go out, go under all the time with metrics like that.

[00:30:32] David Hornik
Those kinds of metrics say, okay, so how is that possible? Because it turns out that not all CAC is created equal. Not all LTV is created equal. So why don’t you literally, when we see one of these pitches now, particularly around their CAC and they say our blended cac, which is blah, we say Howard because Howard hates the idea of a blended cac. So why don’t you give just for those entrepreneurs who are thinking you might pitch us. Here is Howard’s rant. It is 100% appropriate, 100% accurate. That is bullshit. So please share what you think is appropriate to be in CAC and what is not, or at least what should be separated out so that we understand what your business’s economics actually are.

[00:31:15] Howard Hartenbaum
Yeah, and the reason it matters is if you don’t really understand CAC and you raise a bunch of money and then you spend that money to acquire customers, if you don’t understand cac, you will quite likely waste all of that money and burn through it and you will have sold off a bunch of equity to get it. You will have great top line numbers, but you will have a shitty business. And what I mean by that is CAC isn’t the amount of money that you spend to acquire customers and then divide that by the number of new customers that you have coming in the door. That is not what CAC is. CAC is money that you spend that you can attribute to a specific customer or a specific class of customers and leave out all of those customers that you can’t attribute to anything. So some businesses have a lot of word of mouth or a lot of virality or a lot of organic results that bring in customers. And then those businesses spend some money in order to acquire more customers. So if you, you know, half of the customers are coming in for free and half of the customers are a result of paying money. If you spend $100,000 and you get $50,000, sorry, you spend $100,000, you get 50,000 paid customers coming in the door, then the math on that is $2 customer acquisition cost for those paid customers. But what people typically do is they take the total number of customers, which is the free ones and the paid ones, and they say we got 100,000 customers, 50 paid, 50 free, and we only spent 100,000 bucks. So the CAC was a buck. And so therefore, if you, Mr. Venture Capitalist, give me $10 million, I can spend 8 million of it on customer acquisition and I will get 8 million customers. That’s actually not true. You only get 4 million customers.

[00:33:06] David Hornik
Well, and now. So just to be clear, if it turned out that your free customers scaled with your paid customers, then that would be true. It just that those things don’t go hand in hand.

[00:33:18] Howard Hartenbaum
Sometimes they do, but they’re very hard to measure.

[00:33:20] David Hornik
It’s very hard to measure. Usually you have a certain amount of organic traffic and then you use money to goose the other number, which you can control. And so therefore you can accelerate the paid one, but you really will have a hard time accelerated the free one.

[00:33:36] Howard Hartenbaum
Yeah.

[00:33:36] David Hornik
And so that ratio will dramatically change the second you go to spend a bunch more money. And this is the part that makes us crazy because it’s like, look, we know where and we know that when you go from buying 10,000 customers to buying 100,000 customers, that the cost goes up.

[00:33:54] Howard Hartenbaum
Most entrepreneurs assume that the cost goes down because they get more efficient at acquiring customers. But actually what happens is the first bucket of customers are the easy ones to get and the next bucket are more difficult and the next bucket are even more so. The cost of acquiring an incremental customer goes up overall time, not down over time. And the other issue that you have to consider is everybody’s always worried about LTV or LTV to CAC ratio. And they say, I spend $10 to acquire a customer and I’m going to make $80 from them. So that’s an eight times LTV to CAC ratio. But they leave time out of the equation. So if it’s going to take 60 years to make that $80.

[00:34:36] David Hornik
So again, LTV is lifetime value.

[00:34:39] Howard Hartenbaum
So yeah, I think actually the most important thing is not CAC or ltv. It’s payback period. And if you have a long payback period, that means you spend money to acquire a customer. And now that money is gone, and how long is it going to take before you recoup that money back in the bank? And if that is in it within a few months, that’s pretty good because then that money is gone, but you get it back quickly. But if that’s a year or 14 months later and you’re growing, your business will consume a lot, a lot of money in order to grow, which may be okay as long as you really understand your customers. But you will consume a lot of money, which means you have to raise a lot of equity, raise a lot of cash, you have to sell off a lot of equity and you could end up with a business with a great LTV to CAC ratio. That’s a shitty investment. And you don’t make much money at as an entrepreneur because you had to sell off the business.

[00:35:32] David Hornik
Yeah, either it takes so much money to get to scale that you can’t raise it and therefore it flattens because it’s taking three years to make back the money. And so you’ll basically be flat for three years before you can start reinvesting or it goes out of business. Like, forget it, you know, it just you, you have no capacity to grow your business. So.

[00:35:55] Howard Hartenbaum
So an ideal transactional business pitch is we acquire X number of customers, 72% or whatever the number is, is organic through word of mouth or search result or viral. What remaining is paid. And here are the channels we are paying for and how they are performing. And when we acquire a customer at this paid amount, we get paid back on that investment within a certain time frame, which is usually 6 months or less or 3 months or less or something in that time frame. And then after we’ve been paid back, we continue to get paid from that customer over time because it’s a subscription business or a repeat purchase business or whatever it is. And ideally the engagement is pretty high so you don’t have to reacquire the same customers over and over and over again.

[00:36:44] David Hornik
And great entrepreneurs can tell you here’s paid customers, here’s free customers, here’s how they behave the same or differently, and here’s how they’re therefore how their value is different. And then here’s how we’re going to scale the marketing channels and what we think will where we have the opportunity to go from 10,000 customers to 100,000 customers a month or whatever.

[00:37:06] Howard Hartenbaum
So to give a simple example, Zulily acquired customers via affiliate marketing through blogs. And what their pitch was. It costs $4 to get a consumer to register with Zulily and give an email address. And in the first month, one out of four of those consumers would make a first purchase. So the customer acquisition cost of that converted customer was $16. The first purchase dollar amount was roughly $65 at a 27% margin. So if you do, I’m guessing on the numbers but relatively close if you do the math, the company has a $16 CAC and they get that back in gross margin in the first month. And so the payback period is very quickly and then the customer purchases again after 60 days and then purchase again after 90 days.

[00:38:00] David Hornik
Purchase after that is great.

[00:38:03] Howard Hartenbaum
So they paid back their acquisition cost very quickly. And the ltv, the lifetime value is getting longer and longer over time. And when they would make estimates that their lifetime value would be two years or three years at six purchases per year, that number actually got better and better. Meaning people kept around longer and were purchasing more but they didn’t give ridiculous like well we think people will be buying baby clothes from us for 12.

[00:38:29] David Hornik
Years when we now have 12 year olds.

[00:38:32] Howard Hartenbaum
We now have 12 year olds.

[00:38:33] David Hornik
So this is our other, you know, pet peeve which is LTV is the lifetime value of the customer. And if you are a two year old company and you’re projecting three year lifetime values, you know it’s made up, right? You can’t have had a single lifetime customer at three years if you’ve only been around for two years. And so it is important to recognize that a lot of this is projected lifetime value right here. And, and look at statistical. So you can say here’s what happens with our customers. You know, 90% disappear after the first nine months. The remaining seem to flatten from months nine to you know, 12 or month in the months nine to 16 or wherever you are. And therefore, you know, the predicted lifetime value we will estimate is a 3 year value, but could be bigger. But estimating 10 year lifetime values, 9 year lifetime values, whatever is just such absurd fiction. It doesn’t do anyone any good to calculate the value of their business.

[00:39:40] Howard Hartenbaum
How many, what percentage of consumer transactional businesses on the web are still alive after 10 years?

[00:39:46] David Hornik
Yeah, exactly. I bet you it’s astonishingly small. I mean we could, we could practically do the math. I mean look at, look at all the businesses that we’ve seen.

[00:39:55] Howard Hartenbaum
Yeah, Fab was protecting 10 prevent projecting 10 year LTV.

[00:39:59] David Hornik
Yeah, exactly. I mean what’s, and what’s left? You know like we have Google’s left, ebay’s left and Amazon’s left and Yahoo’s left, although limping a little bit. And you know, I mean there just aren’t that many multi decade kinds of businesses. So even if you acquired customers. But Yahoo, like Yahoo is a great example. The Yahoo Mail lifetime value of Yahoo mail customers is astonishing. I mean, you know, there’s customers who have been around easily for more than a decade and have been extraordinarily valuable. But if you’d come in and pitched us on that business today, okay, well, what’s the realistic time frame that we’re going to measure against? And again, to your point, who cares Compared to what is the realistic cost of acquisition and then the realistic lifetime value against which it is useful for building this business. Right?

[00:40:49] Howard Hartenbaum
Yeah, but you know, we don’t mind if you don’t have the measured data. We prefer it. But as long as when you give a presentation, you talk, because we see so many presentations, we have a sense for what customer acquisition costs and what channels work and we have a sense for that. So as long as you say you’re a startup company, you say, here’s what we think it will be, as long as you’re being reasonable, folks like us will still invest.

[00:41:13] David Hornik
If there’s an opportunity for saying, here’s what we know, here’s what we don’t know, what we don’t know, here’s what we predict is the answer to the thing we don’t know. And the reason we predict it is because of a set of facts.

[00:41:26] Howard Hartenbaum
And the answer isn’t 10 year LTV.

[00:41:28] David Hornik
Yeah, and let’s be clear. And you could say like, oh, there’s some possibility that the lifetime value of a customer extends over a decade, but we’re not measuring that because that, that’s meaningless. Then we say, oh good, you speak our language. What’s a rational period of time to measure a cap to LTV ratio against?

[00:41:46] Howard Hartenbaum
And if the meeting goes really well at the end of the meeting, then you just simply give us a term sheet and if we think it’s fair, we will just cite it and we’ll be off to business together.

[00:41:58] David Hornik
Exactly. We have a President Howard’s ready to do business that way. You might just want to send us your term sheet.

[00:42:05] Howard Hartenbaum
Yes, it’s send it with your executive staff, HowardGustCap.com or Hornickust.com just send us your term sheets. But frankly speaking, back to that point, we do have entrepreneurs who sometimes send us stuff that looks kind of interesting. And they say things like, and we’re raising $30 million for 20% of the company. And these are companies that haven’t even incorporated yet and they have no product. You are better off to not send a. You can say how much money you’re raising, but it’s generally not a good idea to say what the price will be on the company. Because if you’re too high, it’s crazy. And if you’re too low, then you just shot yourself in the foot. It is lose, lose for the entrepreneur to say what your valuation should be.

[00:42:51] David Hornik
Yeah, It’s a terrible idea.

[00:42:54] Howard Hartenbaum
Unless you’re sending me a term sheet.

[00:42:56] David Hornik
This has been a very. I feel like we’ve just given lots of bad ideas today. This has been a. The these are bad ideas show. Do we have any other bad ideas? I mean.

[00:43:03] Howard Hartenbaum
Oh, I got a long list. Oh, doing Venture Cast after I drink a cup of coffee.

[00:43:11] David Hornik
That’s right. No more Venture Cast after. After the coffee. No more Venture Cast after. We’ve been pitched on businesses where we. Where we’re annoyed by their LTV to CAC Miss ratio. Yeah, I think we should call it there.

[00:43:24] Howard Hartenbaum
I feel like it’s been a long one.

[00:43:26] David Hornik
I feel like, you know, we’ve been very technical in this venturecast. We promised to talk more about our children, our wives and our mothers in the future.

[00:43:34] Howard Hartenbaum
You know, let’s do a pitch for MileIQ. We are not investors in that company, but I just moved MileIQ to my home screen on my iPhone. And it is a simple application that costs $60 for a piece of software.

[00:43:47] David Hornik
Which is very high for an app.

[00:43:49] Howard Hartenbaum
And it allows me to swipe to the left after I’ve done a personal drive and swipe to the right backup.

[00:43:55] David Hornik
You gotta back up and explain. So the tax laws in America say if you’re driving your car to and from work, you may not write that off. That’s a normal cost of work. But if you are driving your car anywhere else and you are not being reimbursed by your business for that drive, then you can write it off as a business expense. And it’s charged at, what, cents a mile?

[00:44:18] Howard Hartenbaum
A little over 50 cents.

[00:44:20] David Hornik
So a little bit more than 50 cents a mile you can deduct from your taxes for that drive. So now there’s an app that allows you to.

[00:44:28] Howard Hartenbaum
It’s basically Tinder for driving. And you swipe one way or the other, and it automatically tracks it for you. And at the end of the year, you push a button, you get a report, you hand it to your accountant. And for me, I will save several thousand dollars on my taxes by simply spending 60 bucks on an app and swiping left and swiping right.

[00:44:47] David Hornik
I literally just did this. I’m onto it because of Howard. Howard is. Howard will find these things. I’m quite excited. I’ve. So just yesterday, I had a. I had multiple meetings up in the city. So I drove up to the city, I had my meetings, I drove back from the city. And this morning, while I was waiting at the post office, I said, I declared those both business. Business trips and it’s tens of dollars in tax write off for that for seconds worth of time. It’s a really, it’s just a very clever of use of location awareness and technology to create a simple. And by the by the way, one of the challenges of writing off this kind of behavior of activity is you have to keep a very clear log and it’s really hard to demonstrate that you truly did it. This app is a hundred percent verifiable. Like, you know, the only thing in question is whether you were on a business trip or not. But you know, Monday through Wednesday through Friday, Monday through Wednesday, there’s the VC job Monday through Friday, you know, when we’re heading to the city or to a board meeting or whatever, it’s very clear this is a business trip and it should be taxable.

[00:45:53] Howard Hartenbaum
And you can set the app to just ignore weekends.

[00:45:56] David Hornik
I should do that. I didn’t know that.

[00:45:57] Howard Hartenbaum
And then when you get to Monday, there’s nothing from the weekend suggests I’m.

[00:46:00] David Hornik
Never meeting with anyone on the weekend. So it’s worth. This is a time to value question. Like, you know, you’ll save a lot of time because the. You’ll have relatively few weekend meetings.

[00:46:09] Howard Hartenbaum
I have relatively few, but when I do, I just turn that function off.

[00:46:13] David Hornik
All right, there you go.

[00:46:14] Howard Hartenbaum
Anyway, we’re doing a shout out to Mileiq. Buy it on the App Store.

[00:46:18] David Hornik
Yeah, we enjoy. We’re believers in Mileiq. Keep up the, keep up the good work. Mileiq and others who are working on little apps like that that will make them a lot of money are probably not vendor scale businesses or they may be, but we’re pretty psyched to be using them. A little bit of positivity to end.

[00:46:35] Howard Hartenbaum
The show and a little bit of marketing for Bialikey.

[00:46:38] David Hornik
There you go. I am David Hornik from August Capital.

[00:46:42] Howard Hartenbaum
And Howard Hardenbaum, also from August Capital.

[00:46:44] David Hornik
And this has been Venture Cast.