High Growth Handbook

by Elad Gil

  As far as an entrepreneur’s concerned, more people vying to give them capital is good. More competition for something that they have to buy that’s normally expensive and painful is good.

  Fundamentally, venture capital is a bundle—it’s a bundle of advice, control, and money. The more options you have, the more you can unbundle those three things, and get the advice from the people you want and the money from the cheapest source of money, and leave the control behind. So I think it’s good.

  Now that said, a lot of these people who are newcomers—what are the downsides? The downsides are that these new types of investors are hot money, so they might not support you in a future round. They may not be smart money. What that means is not that they’re not going to add value, because almost nobody adds value as an investor in a later-stage company. It’s just that they might screw you up in a future round by not doing their pro-rata, by trying to veto something they shouldn’t. The way you solve that is by not giving them control in the first place, and not expecting more money out of them in the future.

  And then finally, money has karma too. You cannot take someone’s money without having a moral, ethical obligation to them. You can’t do it without committing your time. And you don’t want to get sued by them, because that makes you untouchable later on. So you do want to make sure that you have a good relationship with the people you’re getting the money from.

  Especially with a lot of these later-stage players, they tend to swap people out a lot more. Venture capitalists are very stable—they raise money in ten-year partnerships, they own and run their partnerships. It’s very unlikely that your venture investor is going to get switched out on you, and if they do it will probably be with somebody else who’s an experienced venture investor. But if you take money from a corporate investor and whoever is the head of corporate development gets sacked the next day, the company’s CEO’s brother comes in and might be a nightmare.

  If you give them a board seat or there’s a relationship person, you do want to have some control over who that person is. But I think more options are good, more choices are good.

  “Valuation is temporary.

  Control is forever.”

  —Naval Ravikant

  Elad: Yeah, I’ve seen good and bad situations—and this is from either my own company or companies I’m involved with. The bad has been that some of those sources of capital are a little bit jumpier. Some are not. Some are very stable and smart. But every once in a while you’ll have the random billionaire who’s never invested in tech and then freaks out. Or I should say their office freaks out, because the people who manage their money may or may not be savvy about tech.

  The positive for my startup has been working with people who come from finance backgrounds or from the New York network. And they’ve been amazingly helpful in a variety of ways. They’re very good strategic thinkers; they’re at the top of their game. But they also just have a different network from the traditional Silicon Valley group.

  Naval: Yeah, it used to be that you would go to a VC for their network. But most entrepreneurs these days are much better networked than they used to be, thanks to accelerators, thanks to blogs, thanks to just being savvier about it. Different investors can be good for bringing out-of-market networks.

  But exactly as you said, you want to interview your investors. And you really want to look for the subtle signals—I think people’s true motivations and behavior are revealed, not said. If somebody spends ten minutes telling you how honest they are, I can guarantee you that’s a dishonest person.

  You should reference-check the hell out of them, you spend time with them, and you see how they treat you during the negotiation process. If they’re relatively easy during the term sheet negotiation process, if they’re quick to respond, if they’re no hassle, if they say smart things, they’re probably going to be good people to work with. If they give you an exploding term sheet, if they’re difficult to work with, if they’re inflexible, intransigent, they’re going to be ten times worse once the money is in.

  By the way, that’s true of VCs too. You can learn everything you need to know about a VC during the term sheet process before the close. And don’t be afraid to call off the close if you’re getting negative signals. I’ve done it and I’ve never regretted it. The moment you know that you’re working with someone that you would not work with for the rest of your life, stop working with them right there. Save your time. Because you get married to investors, with almost no possibility of divorce. And your dating period with them ranges from a week to a year. A year if you’re really lucky, but it’s usually just a few weeks. So you really have to look for the subtle signals.

  This is actually where your early-stage investors can be super helpful, because they’ve seen it all. So you can use the nose that your early-stage investors have developed to help pick out later-stage investors. You do have to be a little careful, because early-stage investors can be brand obsessed—either they want to get a big markup, or they want to get a markup from Sequoia, so they’ll say or do whatever just to ingratiate themselves. But you will have somebody within your circle who has a good nose, has a high bar, and speaks truth. You’ll know it from the way they say it; they’ll say the unpopular thing. Get that person to make an assessment for you.

  Elad: I want to get back to your earlier point, about how companies today don’t need to be as large as they used to. How do you know when to stop hiring? Because there’s always that impulse, if you have the capital and you want to keep going.

  Naval: The nature of human beings is that you come into a company, you work like a dog, you work really hard, and then you get tired and hire someone to do your job. And it always takes two new hires to do your job. Just repeat that ad nauseam, and you end up with five thousand people sitting around at a web app company. And everyone from the outside is like, “What are all these people doing?” That’s a simple web app. Why do you need thousands of people to do it?

  Then, sure enough, the new CEO comes in and knows that they have to fire half these people, but they don’t know which half. That’s the dilemma that everybody faces, because they’re all politicking, so nobody knows who’s actually doing the work. And once you’re in that situation, you’re in trouble.

  So I think you should hire extremely slowly. Hire only after there’s a burning need for that person. I think you have to be ruthless about firing and trimming the ranks. And I know that’s not popular—I know people don’t like that model—but it’s worked well for me and for us. The founder just has to keep a very, very tight eye on waste. And there’s always waste.

  Elad: Do you think the granting of stock to people is an outdated model?

  Naval: I think it’s better than the other model, which was no stock. But I do believe it’s outdated. So we do six-year vests. Venture capital firms do ten-year vests. So I think in a rational model you would not only do longer vests, but you would also probably not have permanent issuances of value. Maybe you would have stock for the early people, because they’re creating scaffolding that then turns into a big company. But the older a company gets, the further along it gets, the more your grants should shift to profit sharing.

  Elad: I guess RSUs don’t quite capture what you’re saying.

  Naval: RSUs are basically a tax-efficient way to give out more compensation that’s somehow lightly tied to the overall performance of the company. If you’re a multi-thousand-person company, though, one person can’t affect performance that much. So I view it as a very diffuse kind of thing. When you look at true “eat what you can kill” kinds of businesses, where the human capital is really important—like go to Wall Street, where it’s kind of cutthroat—those are all bonus-based.

  Profit sharing can be very tax inefficient. AngelList is set up as an LLC, so for us it’s actually more efficient to do that because we only have one layer of taxation. But I just think that as companies get larger and larger, and get further and further along—you can hack it even be
fore you’re profitable—you can do revenue sharing. Or you can give very outsize grants. So you do small grants for everybody starting out, a standard grant that everybody gets. But then next year you either increase a person’s grant substantially or you let them go.

  “You cannot take someone’s money without having a moral, ethical obligation to them.”

  —Naval Ravikant

  Elad: It almost reminds me of McKinsey’s “up or out” model, where it’s a partnership and people either advance and get more and more pay or they’re out.

  Naval: Exactly. Peter Thiel put this well in Zero to One: how are you going to sell your 21st employee? Because you can’t give them enough stock that they own 5% of the company. So at that point you have to be on track to building a huge company. Or, I would argue, you can build a great company with a very small number of people, and you can incent them heavily.

  Right now is the lowest-risk time ever to be a founder. You can go into an accelerator and roll the dice, see where it goes. You can get some money, see where it goes. There’s very little risk to being a founder. But early employees are asked to take founder-level risk, because the companies often don’t have product/market fit, without getting founder-level equity.

  Elad: Well, I don’t think that they end up working as hard as founders, or dealing with the stress and the bad issues most employees never hear about.

  Naval: Absolutely true. But there used to be a very steep decline, where the founder would own 40% and the first employee would own like 0.15% or 0.25%. I think those days are ending.

  I think future companies, especially those that haven’t raised money yet or haven’t raised substantial capital or haven’t gotten product/market fit even loosely, when they’re hiring early employees, they’re really just hiring late founders. And so they should be giving 1, 2, 3, 4% of the company, instead of giving 0.1, 0.2, 0.3, 0.4%.

  The issue with hiring engineers into early-stage companies today is not that there’s a shortage of engineers, it’s that there’s a surplus of founders. And so you have to basically treat them more like founders, because there’s opportunity cost for these early engineers who could go start a company, join YC, whatever.

  Elad: Although I think that the one thing that people tend to both overestimate and underestimate is the risk associated with a startup. There’s a whole class of people that think startups are incredibly risky, and if they blow up your career is over—which is of course false. But on the flip side, too many people assume that 90% of startups have an exit of some sort. Which is also not true. Most startups completely fail. Their founders have lived on very low salaries, and they make nothing after that.

  Naval: And they’ve been so stressed beyond belief that they’ve lost their health and sacrificed their family.

  Elad: Yeah, they’re ten years older than they should be in some sense. And they haven’t made salary for three, four years.

  Naval: Yeah, actually the most successful class of people in Silicon Valley on a consistent basis are either the venture capitalists—because they get to be diversified, and at least used to control a scarce resource, although it’s currently not a scarce resource—or people who are very good at identifying companies that have just hit product/market fit. They have the background, expertise, and references that those companies really want them to help scale. And then those people go into the latest Dropbox, they go into the latest Airbnb.

  “The most successful class of people in Silicon Valley on a consistent basis are either the venture capitalists, or people who are very good at identifying companies that have just hit product/market fit. They have the background, expertise, and references that those companies really want to help them scale.”

  —Naval Ravikant

  Elad: It’s the people who were at Google, and then joined Facebook when it was a hundred people, and then joined Stripe when it was a hundred people.

  Naval: When Zuckerberg is just starting to scale his company and panics, he’s like, “I don’t know how to do this.” And he calls Jim Breyer. And Jim Breyer says, “Well, I have this really great head of product at this other company, and you need this person.” Those people tend to do the best risk-adjusted over a long period of time, other than the venture investors themselves.

  This interview has been edited for clarity and length.

  CHAPTER 9

  Mergers & acquisitions

  M&A: Buying other companies

  As your valuation increases, your stock may suddenly become a valuable currency with which to buy other companies. Many first-time CEOs or executive teams tend to shy away from acquisitions due to a lack of familiarity. If done right acquisitions can accelerate a company’s product and hiring plan, as well as enable key strategic or defensive moves against competitors.

  When I was at Twitter, the M&A team reported to me. I saw firsthand both the value of M&A as a strategic tool as well as the sheer number of startups that flounder and are looking for an acquirer (the failed startups no one ever talks about). While at Google, I was involved with the diligence, integration, or post-merger product management of a number of companies including Android (which became the well-known handset platform), Google Mobile Maps (originally a company called ZipDash), and the first Gmail client application (originally a company called Reqwireless).

  M&A was a powerful tool for both Google and Twitter to add new products and key people as well as make major strategic moves. Similarly, Facebook has stayed at the leading edge (and acquired major market share) via its acquisitions of companies such as WhatsApp and Instagram, but also less famous companies like Snaptu, which drove major adoption of Facebook as a mobile client to over a hundred million people in the low- and middle-income world.

  Most companies wait too long before making their first acquisition or are hesitant to use their stock as currency. Hopefully the information in this section will spark your M&A interest—and facilitate your ability to buy companies—early, rather than late, in your startup’s growth.

  When should you start to buy other companies?

  Each CEO and board needs to decide when the time is right. Strategic acquisitions may be necessary early in a company’s life. For example, when Twitter acquired Summize (which became Twitter Search), Twitter was just about 15 people in size and worth only around $100 million itself.

  By the time a given company is worth $1 billion or more, the CEO and board should start to think of M&A as a serious tool for accelerating the company’s progress and valuation. For example, at $1 billion market cap, a $10 million acquisition is just 1% of your startup’s equity. If the acquisition can increase your valuation by just 10%, then it is clearly ROI positive. By the time your company is worth $5 billion to $10 billion or more, M&A can become a central part of your overall company strategy.

  For revenue-generating companies, the potential value of an acquisition may be directly quantifiable. For example, when Twitter M&A worked for me, it was easier to assess the potential value of advertising-related acquisitions because of the direct revenue impact they would have. If Twitter could generate, say, $50 million more revenue than it had a year earlier, the potential dollar value of the acquisition was clear and therefore the range of prices we were willing to pay became a simple math problem.

  You can also translate revenue + margin into potential market cap. If your valuation (or your public market comparable) is at 10X earnings, then an extra $10 million in margin may equate to another $100 million in market cap for your own company. This sort of math allows the M&A team to present ROI-based arguments around ad-tech related acquisitions, and allows you to start prioritizing the purchases you want to make on the product side.

  three types of acquisitions

  For a high-growth company, acquisitions fundamentally boil down to one of three types: (1) team buy, (2) product buy, or (3) strategic buy. There is actually a fourth type of acquisition companies can make, often called a “synergistic” acquisition. Most high-growth technology companies do not do
“synergistic” buys—that is, those made for market share and cost-cutting reasons—like more mature companies do, so I will not discuss that type of acquisition here.

  Type of acquisition: Team buy, aka “acqui-hire”

  Valuation range: Anything from small signing bonus for the founders to $1M to $3M per engineering/product/design employee acquired.

  Reason for purchase: Increase pace of hiring. Hire key talent the company would not be able to otherwise acquire. In most cases, the product the purchased company was working on is discarded and the acquired team reassigned to a new area.

  Examples: Drop.io acquisition by Facebook was largely to acquire Sam Lessin.

  Type of acquisition: Product buy

  Valuation range: $5M to $500M. Most are in the range of several million to $100M in size.

  Reason for purchase: Fill a product hole or reposition an entire team to work on an area that is already in a company’s road map. Sometimes the original product survives as a stand-alone product, sometimes it is integrated with other products, and sometimes it is discarded in favor of a new, similar product to be launched by the acquiring company.

  Examples: ZipDash, acquired by Google and repositioned to form seed of Google Mobile Maps. Android purchase by Google. Acquisition of Summize by Twitter to create Twitter search.

  Type of acquisition: Strategic buy

  Valuation range: Up to $20B

  Reason for purchase: Purchase of a non-reproducible asset that has strategic value. For example, while Facebook could have launched a photo app, it could not reproduce the active and dynamic community using the Instagram social network.