Monzo Growth

How To Raise Investment

The old joke describes a lot of companies at the moment - “I’ll sell at a loss but make it up on volume.” Pilloried in the press, startups burn through vast sums of capital before spectacularly imploding.Let’s go back to 2012-13. The world was finally emerging from a punishing financial crisis, and low returns across most asset classes mean that a glut of capital was looking for a return. Leading tech companies were outperforming the rest of the stock market, and venture funding started to flow more freely as investors tried to find the next big thing. Loss-making companies finally had the capital to spend aggressively after a lean decade following the dot-com boom and bust.Uber took this to an extreme, weaponising cheap capital. It would expand aggressively into new cities, pay drivers cash incentives to sign up, and simultaneously subsidise the cost to riders. Every additional ride would lose Uber more and more money. This often continued for years in a given city. But it was part of a strategy - its business improved with scale and density - even if it took hundred of millions of dollars per city.<figure class="tmblr-full" data-orig-height="1024" data-orig-width="1024" data-orig-src="/media/img_1743235335204_BpfMqKzCUAAL7Xw.jpg:large"><img src="https://64.media.tumblr.com/0e7f5fcdb0245cc965025e30faa1e778/tumblr_inline_pa42n9OTkj1r5tr1m_500.jpg" data-orig-height="1024" data-orig-width="1024" data-orig-src="/media/img_1743235335204_BpfMqKzCUAAL7Xw.jpg:large" width="500" height="500" alt="image"></figure>As Uber got to scale in a city driver utilisation would increase. As a result, it could stop subsidising rides so heavily and margins would improve. In time, the city became profitable. To compete with Uber, other companies needed to raise huge war chests and go head-to-head in the same game of deep subsidies. It became an incredibly expensive war of attrition. In markets where a competitor was present, prices stayed lower for longer. Consumers got cheap travel funded by the venture capital industry. Whoever could raise the most capital could survive the longest and take the market. And Uber was great at raising capital. Their strategy largely worked in US and European markets, building a multi-billion dollar company.A new generation of entrepreneurs in 2014-2016 saw this playbook and drew the obvious conclusion. Growth to gain market-share mattered above all else. Negative unit economics could be fixed with scale. A generation of "on-demand” startups were launched; food delivery, laundry, home-cleaning, dog-walking, child-minding, hairdressing, massage. They heavily subsidised their service to acquire new users, believing that they’d turn things around once they got enough scale or density in a given city. Investors, following the “Uber playbook”, pumped in money. Companies raised eye-watering amounts of money on the back of growth metrics; skyrocketing weekly-active-user numbers and impressive viral co-efficients. But they had lacklustre revenues and unsustainable cost structures. It was a bloodbath - most companies failed when they couldn’t improve margins and investors finally pulled the plug on ever-growing losses. Some, though, succeeded in turning their business around. Instacart - most recently valued at $4.2bn - is a shining example.Now in 2018, what’s the lesson?Inevitably, investors are paying serious attention to "unit economics” - how much do you earn (or lose) from each extra "unit” (normally a customer) per year? How much does it cost you to acquire the customer? What’s the payback period? What’s the customer lifetime value? Business fundamentals matter again. Nevertheless, I think many new startups will continue to run successful negative-unit-economics strategies. I want to talk about a couple of examples where I think it makes sense.Perhaps the business is a marketplace that needs critical mass to be effective. Think about a traditional village market. Without vendors, no customers are going to show up. But serious vendors are not going to bother pitching their stall if they aren’t sure the customers will be there. So what does the village council do? Run a massive, free funfair to attract thousands of visitors from all the nearby villages. Then the merchants are sure to pay to set up stall. Alternatively, guarantee each merchant a minimum revenue amount to pitch their stall. As most marketplace models needs some kind of critical mass, focussing on growth first makes sense. Alternatively, companies can often dramatically reduce unit cost as they grow. Perhaps there are “economies of scale” - building an enormous factory will allow the company to produce products more cheaply than any competitor. Rather than trying to raise the money to build the factory up-front, companies will initially subsidise their product, selling below cost in order to stimulate demand and grow a massive customer base. They can then use this evidence of customer demand to raise capital to build a more efficient factory, eventually improving margin. Or, more simply, a company may believe it can use its massive scale to renegotiate with suppliers, improving margin over time.The advantage of these strategies is that you can figure out if there’s customer demand for your product without having to raise massive up-front investment. Customer demand is almost always the biggest problem for early-stage companies - a total lack of "product-market fit”.The problem with these growth-first strategies is that they’re capital intensive and very, very risky. You could simply be wrong about the savings you can achieve at scale. You might burn more cash than anticipated getting there. Perhaps a competitor also raises a lot of capital, and pushes the cost of customer acquisition even higher. Or perhaps there’s another financial crisis, and capital becomes scarce.But here’s the dilemma - if there two companies are competing for the same consumer market, the one that gets to scale first will generally win, provided it can continue to raise capital. If you’re going to take this approach, you’d better get really, really good at fundraising.

Unit Economics

Something has changed in the last few years which has made an increasing number of people want to join startups. It seemed to start around the time the Social Network movie came out - perhaps it’s just a coincidence, but part of me imagines a group of MBAs sitting around watching Justin Timberlake play Sean Parker, thinking that actually a billion dollars would be pretty cool.When choosing a startup to work at, people often overlook one of the most important factors, which is the size and stage&nbsp;of the company. I’d argue this is sometimes even more important than the industry or the idea itself. Bootstrapping, aka two people in a bedroomThe startup was recently formed, and the company might not even be legally incorporated yet. There’s no funding and no-one is taking any salary. You’re two, three or four people in a bedroom living on baked beans, working all hours of the day to get a working prototype to show to customers or investors. The only people using your website or app are a couple of sympathetic friends and your mum.Someone else tried to convince you to join a different startup a year earlier, but they had no funding and zero customers. They wanted you to work without a salary in return for 1% of equity, which sounded like a scam to you. You’re glad you picked this startup instead. You might not be getting any salary, but at least you’re joining as a co-founder with a double-digit equity stake. You jokingly talk with your cofounders about which island you’d each buy when you sell out for billions in a few years’ time.The product vision is vague and broad, but you’re working every day to try to validate it with customers. Anything is possible. The entire direction of the company might even be changing from week to week.Because nothing yet exists, you need to bring it to life with a combination of energy and raw self-belief. There’s little specialisation and no hierarchy; everyone does whatever needs to be done. It can be exhilarating.It can also be exhausting at times, lasting months or years before you find customer traction or funding. Seed-FundedNow the company has a working prototype, a few dozen regular users and £250k of seed funding. It’s enough to pay a handful of people low salaries. Since you’re too big to fit in a bedroom, you’re renting desks at a coworking space or scrounging them off a bigger startup.You cut a lot of corners, but seem to ship an incredible amount of code. People you don’t know personally start to use your product and it feels awesome. You’re working hard to spread the word, perhaps even starting to earn a little revenue from your first paying users. You join at this stage for 3% equity plus whatever basic salary you need to survive. You talk about which cities you’d buy houses in when the company sells.You might join as the first professional programmer or designer, but you’re still more-or-less on your own. When you join, your first job is to go to the Apple Store and buy yourself a laptop because no-one thought to order any equipment. There’s no “mentorship” from more experienced colleagues or even code-review, simply because the company is still too small. “Marketing” consists of one of the founders emailing your funding announcement to TechCrunch As an employee, you have a significant say in the direction of the company, although the business model might still shift substantially underneath you. Even if you’re not making the decisions, you hear about them immediately.There’s still a good chance that the company fails to find “product-market fit” and goes bankrupt without raising more money. Your mum tells you that you should have stuck with your well-paying job at Oracle.Series AThe company has raised £3m from a big-name VC and the team has grown to 10-15 people. You’ve got your own office with your logo on the door, or at least your own area in the coworking space.The investor makes you submit quarterly cashflow reports, so you start keeping accounts for the first time. This is done by whoever has Excel installed on their computer. The company eventually hires an office manager to ease the burden of administration on the founders. They set up a payroll provider and start doing peer reviews.You join the company to do a specific role, but you spend your first week or two figuring out what you should actually be working on. At least they remembered to buy you a laptop, a desk and a chair.There are 3 or 4 engineers in the team, so you start to do code-review and set up a continuous integration server. You lament all the technical debt that was accrued by those idiots who arrived before you, slowing down the pace of feature development.A new product direction for the company is decided in a meeting of the three founders; this is presented in an “all-hands” meeting of 12 employees. The company sets out a quarterly product roadmap, and you’re asked what you think should be prioritised. You pick the projects that most interest you.You’ll certainly be able to earn more money at a big company, but the salaries are enough to live comfortably on. You get 0.5% in stock options with a salary that’s 10-30% below market rate. But you reckon it’s worth the gamble - if the company sells, you’ll be able to buy a really nice house in London. Still, it feels a long way off.The marketing function is one full-time person who does everything from PR, paid advertising and social media. The founder no longer personally runs the company’s Twitter account. Your company regularly appears in the “ones to watch” articles in tech press.You’ve got thousands of paying customers, and you occasionally see people in public using your app, which feels fantastic. Your mum isn’t really sure what your company does, but she’s happy enough because you’re being paid a real salary.Series BThe company is now 2-3 years old and has just raised £10-20m. It’s using that money to grow the team, increasing headcount to 60 people.The founders got tired of the dingy office, so they splashed out on somewhere with lots of exposed brickwork and glass walls. Everyone is sitting on Herman Miller chairs. You find these chairs online and see they cost £1000 each.There are 3 or 4 people in finance and HR roles, and you’re presented with a company handbook when you join. You have a couple of days’ training, but you mostly figure it out along the way.Marketing now has three digital advertising people, and people specialising in PR, content and community management. You’ve got millions of paying customers in several countries, and your company is regularly featured in the business pages of the press. Engineering has been split into two or three separate teams, and they’re trying recruit graduating college students to fill the hiring pipeline for next year.You join in a very well-defined role, after the team manager recruited you. You meet founders during your interview, but they don’t always remember your name now you work here. The CEO sees a management coach every fortnight.A new product direction is debated at a board meeting, and senior management is informed by the CEO. Management let their teams know that changes are imminent. Most people are focussed on “repeatable processes” and scaling up. The company doesn’t seem to release new features very often, but the app is used by some of of your mum’s friends, which makes her very proud. Your salary is in line with what other companies are paying, and you get 0.05% stock options. You’ve already figured out which house you’d put a deposit on when the company sells. A sale seems inevitable at some stage.Series CYou’re joining a unicorn! After 5 years, the company has raised £100m at a £1bn valuation. There are some strange terms in the deal structure that you’ve never seen before, but the company’s HR department tells you that’s just “legal stuff”. When you join, you’re granted £50,000 of options, which you work out is one two-hundredth of a percent, or 0.005% of the company. Friends in other startups tell you to check what the investor’s liquidation preference is, but no-one at the company can seem tell you. They’re all too busy trying to guess when the IPO is going to be announced. You figure that any kind of payout is a nice bonus. The salary is pretty decent anyway.You join in the company’s newly opened Dublin office, part of a new drive by the company to internationalise. You’ve joined as one of 6 new Sales Associates focussing on European enterprise sales. There’s 4 week intensive induction training programme before you’re allowed to talk to any customers.The new office feels empty at first, but you’re surprised how quickly it fills up with new staff. You ask where the marketing department sit, but you’re told they’re in a different office.You see the CEO on the cover of Forbes, but you’ve never actually met him.Your mum is already using the app, although it’s starting to look a bit dated compared to some of the newer startups that are in TechCrunch.Business Insider reports that the company has fired the new VP of Product and is pursuing a new production direction. She had only arrived from Twitter 6 months earlier. An internal memo from HR a couple of days says that the company’s doing some minor internal restructuring.You see consultants in the meeting rooms, but you don’t know what they’re doing.A month later, you gather for a televised all-hands meeting, broadcast from the company’s HQ. The CEO delivers a short speech announcing that the company’s been acquired by Oracle, explaining how it will accelerate the company’s ability to deliver on its vision. He thanks everyone for being part of the company’s incredible journey. People in the audience are crying.HR follows up explaining that as part of the acquisition, some departments will be downsized. You’re told that your stock options are “underwater”. When you Google this, you &nbsp;find out that they’re worthless. You’ve got some friends in engineering who are being given Oracle stock as a “retention package”, but that doesn’t apply to anyone in sales. You wonder why you ever joined a startup in the first place. <a href="https://news.ycombinator.com/item?id=10900462">Discuss this post on Hacker News</a>

When To Join A Startup

I’ve been involved with 4 startups over the last 10 years or so, 3 as a co-founder. I’m a follower of <a href="http://paulgraham.com/articles.html">Paul Graham and the YC camp of startup wisdom</a>. There’s now a great deal of literature laying out the unbreakable rules for startups. Despite studying this literature, I’ve managed to break each of these rules, in some cases more than once. In every case, I have come to regret it.&nbsp;1. Choose your cofounders carefullyIf your startup is successful, you’ll spend the majority of your waking time with these people for the next 5 years. Invest the right amount of time getting to know each other. Ideally, you’ll have worked with these people for a few years at another company before you do your own thing.&nbsp;Your relationship will be like a marriage, but even more intense.Three co-founders feels like the right number. Try to find the most driven, effective people you know and convince them to join you. Unless there’s a really good reason, equity splits should be equal. If you don’t think your cofounders as effective or valuable as you, why are you starting a company with them?&nbsp;2. Written agreements from the startAn agreement doesn’t have to be complex, or necessarily involve lawyers. There are plenty of open-source co-founder agreements published by law firms. But you need to agree:&nbsp;a) Any money invested, either as equity or debt
 b) Equity split
 c) Salaries, included any deferred compensation&nbsp;In the simplest case, the agreement will be “no money invested, equal equity splits, zero salary”. But as soon as bills need paying, things get trickier. An investor friend recently told me that he makes a rule of telling founders, “I won’t ask you to trust me”. All deals go into writing immediately.&nbsp;3. All stock must be on a vesting scheduleVesting means that stock is earned over the lifetime of a person’s involvement at a company. A standard vesting schedule is “4 year vesting with a 1 year cliff”. This means, if I have 48 shares in a company, 12 of those become irrevocably mine (i.e. “vest”) on the first anniversary of my joining the company. The remaining 36 shares vest monthly over the remaining 3 years - 1 share per month.&nbsp;If I leave (or I’m fired) after 3 years, I walk away with 36 shares. The remaining 12 shares are taken back by the company.&nbsp;Vesting is a good thing for everyone. It ties people’s incentives to the long-term success of the company. I’ve heard founders even talking about 6 or 8 year vesting sometimes.&nbsp;If your co-founder says “just trust me”, see above. 4. Keep company money separateWhen your company needs to pay bills and you’ve not raised outside investment yet, be very clear who’s paying and under what terms. Is the money going to be repaid? When?&nbsp;As soon as you can, establish a separate company bank account. All cofounders ideally put the same amount of cash in, and bills get paid out from that account. Simple.&nbsp;If you’re putting in money as a stop-gap before an investment round and expect the money to be repaid, put this in writing. It should appear in your company’s balance sheet as a liability - “Director Loan”. You’ll also need to let investors know if you expect to use their investment to pay back loans.
 5. When you go out to raise investment, don’t over-optimise for valuation.PG stood up one Tuesday evening at Y Combinator with a memorable lesson. YC companies are competitive about everything. In each new batch, founders are told not to compete over who can raise at the highest valuation. And every batch, some founders ignore this advice. Airbnb, we were told, raised their seed round of $600k on a valuation of something like $3.5m - certainly nothing like the uncapped convertible notes we sometimes see at the moment. And the Airbnb founders are just fine with how they’re doing.&nbsp;You should spend a little time figuring out what price the market will offer. Choose the investors you think you could work with for next 5-10 years. Don’t spend time shopping the deal around to increase your valuation. Also, don’t pick crappy investors just because they offer a higher valuation.&nbsp;These rules are not negotiable!If you break them, you will end up in trouble.

Tom Blomfield

Monzo Growth

How To Raise Investment

Unit Economics

When To Join A Startup

Five Unbreakable Rules For Startups