Episode 466: Casey Aylward on Venture Capital for Software Investing

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Casey Aylward, Principal at Costanoa Ventures, discusses venture capital for software investing with a focus on early stage. Host Kanchan Shringi spoke with Casey on the key questions an entrepreneur may have when starting to think about obtaining VC funding and what the VC firms look for. They also talk about what it is like working at a VC firm, how VC firms are structured and touch upon how VC’s make the early stage investment decisions.

This episode sponsored by NetApp.

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SE Radio 00:00:00 This is software engineering radio, the podcast for professional developers on the web@sc-radio.net. Se radio is brought to you by the computer society. I is your belief software magazine online at computer.org/software.

Kanchan Shringi 00:00:16 Hello, welcome to software engineering radio. This is your host Kanchan Shringi. Our guest today is Casey Alwood. Casey is a principal at Costanoa ventures and early stage we see from in today’s episode, we will explore questions. An entrepreneur may have when starting to think about updating VC funding and what VC firms look for before Costanoa. Casey was a software engineer at Pinterest. Casey is now focused on sourcing, evaluating and investing in the next generation of enterprise software companies. She has invested in companies like Kyle Cyril and stack Hawk. Welcome Casey, really looking forward to our conversation today.

Casey Aylward 00:01:00 Same here. Thanks so much for having me on conscience

Kanchan Shringi 00:01:03 Before we start. I like to point listeners to three related episodes. The first is 3 7 3 Joel Spolsky on startups growth and valuation episode 4, 4 8, which is Matt Albertville on starting your own software company. And for the last one, I don’t have an episode number yet, but it’s a role in Savage on getting a quiet Casey, let’s jump into it, but the very, very basic question. What is venture capital and what is private equity?

Casey Aylward 00:01:34 Sure. So venture capital is a form of private equity and a type of financing that investors provide to startup companies and small businesses that are believed to have very high growth potential. So they’re similar in that they both want to see the value of the equity that they purchase increase over time, but there are some pretty key differences with the types of companies that they invest in. So I’d say both in terms of the company’s life cycle and how fast the business is growing. Uh, some pretty key differences with how much capital they put to work, and then also with how much of the company they’d likely own after the transaction. So I’m a venture capitalist I’m investing in early stage companies. And in some cases, these are pre-product two person teams with no revenue. And in some cases they’re a little bit further along.

Casey Aylward 00:02:30 As I mentioned, we hope that these companies are growing pretty quickly and we’d hope to own about 20% of the companies. So founders would very much be in control of the board and also own a majority of the company’s shares in private equity or PE the companies are going to be much later staged, potentially not growing super fast or distressed, but they’ll definitely have significant revenue. And so a PE firm will come in and buy a controlling stake at the company and usually make pretty big changes to it. So maybe replacing the management team or sort of infamously cutting lots of roles from the company and by correcting these, you know, quote-unquote inefficiencies, they hope that the company will get back on track and growing more quickly.

Kanchan Shringi 00:03:21 Okay. So my key takeaway was when should capital more early stage private equity is probably at a much later stage, but even with early stage, can you talk about angel investors versus seed investors? And we see, as you say, you’re an early stage VC, but how do you compare to angel and seed investors?

Casey Aylward 00:03:42 So there are a handful of differences between angels and VCs. I’d say the big ones are where the capital’s coming from when each one might invest in a company’s life cycle, probably the check sizes they’re writing and then potentially some of the corporate responsibilities. So angel investors are investing personal capital into companies, whereas of venture capitalists, VC is investing institutional capital on behalf of their limited partners. So think something like a university endowment, a large pension fund or high net worth individuals. So to take an example, maybe of a very early stage security company that was just founded to get the initial product built, the founder might raise a 200 K friends and family round and obviously include, you know, mom and dad, but also some other angel investors as well, who might be senior operators or technical experts in the security space. And the check size is going to vary a lot.

Casey Aylward 00:04:50 It can be anywhere from, you know, single digit thousands up to maybe a hundred K. So then, you know, the security company with that initial capital begins to grow. They start monetizing and that they want to go out and raise a $2 million seed round six months later. And unless you have very rich friends, you’re going to have to go and talk to a venture fund that invests in seed companies. So a VC might offer to invest a good portion of the round. You know, let’s say $1.8 million of the 2 million that remaining 200 K of the allocation might go to angels or maybe another smaller fund, but they’re going to be a much smaller portion of the round. Overall, the VC will also probably go and create a board seat with this round of financing. So there will be some governance component that emerges out of the financing.

Kanchan Shringi 00:05:46 So Angelice, burstow we see is institutional with other related structure. That’s right. You talked about rich friends. What about crowdfunding? You know, there’s a lot of emergence of crowdfunding today. Does that, can that take the place of rich friends?

Casey Aylward 00:06:04 Sadly, we all can’t have rich friends. I’d say, you know, crowdfunding is very interesting. Previously companies were only able to raise capital from accredited investors. So, you know, that’s what we’re talking about with rich friends, these higher earning or wealthy individuals that all started to change in 2012, the jobs act passed, and this changed something called title three, which really enabled what we think of as crowdfunding today. And title three is also referred to as regulation CF, if you want to go and learn more about it, but essentially what this did was allow early stage companies to raise up to $5 million from any individual. So not just institutions or accredited investors. So at a high level, crowdsourcing is generally good for the industry. It allows people who are not accredited more fair access to private investment opportunities. And as we all know, there are a lot of gains happening in the early stage private markets.

Casey Aylward 00:07:13 So even though it is a risky asset class, the sec decided to not limit access to it. In my opinion, I’d say crowdfunding, isn’t right for every type of business. I think it’s probably better suited for consumer products, maybe a physical good, where you can spread the word via the crowdfunding campaign and your customers can become your investors. So to speak where it’s not great is really for enterprise businesses because you have to disclose a ton of information to the public. And so if you’re building an enterprise software product and have competitors, that’s probably not the most advisable thing.

Kanchan Shringi 00:07:53 Okay. So I think that’s sets the stage. At least for me, I can understand the difference between angel and institutional funding. A little bit of a crowdfunding too. I’d like to focus for the next few minutes, maybe several minutes, thinking through the point of view of someone who is maybe three or four years out of grad school and has an idea. If I am that person, how do I go about executing my idea? Should I raise money right away? If not, how do I know when the time is right as someone who may not know much about this, can you give us some advice? Can you give me some advice? Sure.

Casey Aylward 00:08:32 So raising venture capital isn’t right for every business, because once you raise outside capital, you have a level of responsibility to produce a return on that money. So you sort of have that extra layer of accountability and venture businesses in a lot of ways are valued off the growth rate of the business. And so if you don’t think that what you’re building will be a high growth opportunity or that’s not achievable, then it’s probably not the best option. So there are plenty of things you can do though, before raising capital, of course you should be having lots of conversations with potential customers and folks in the industry, maybe validating some wireframes you built to get early product feedback. And, you know, depending on what your specific skill set is possibly co-founder dating. If you’re looking for someone to really balance out the skills of the founding team.

Casey Aylward 00:09:29 And so I’d say ahead of making that decision of whether or not to raise VC money, it’s common for founders to bootstrap with their own money. So to keep bootstrapping, though, you have to have customers paying you pretty quickly to remain a viable business. And that’s going to be hard to do. If the product is just built and maintained by one person, you’ll probably need some capital to go and hire engineers or maybe someone to service your customers. So one option, and I’ve seen this done in a handful of companies, but some businesses might start out more in a professional services, capacity solving a very specific problem and then sort of productize from there. And so that’s one way I’ve seen a handful of successful bootstrapped businesses get off the ground.

Kanchan Shringi 00:10:19 So it’s sounds like it might be a good day to bootstrap with their own money. When you start wanting to grow, you want to make the team larger, you explore, we see funding. So I did that and I have a choice. Now I have a few different investors that I want to approach. What should I look for? You know, what value can a VC bring to the table other than capital?

Casey Aylward 00:10:43 So when you pick your first early stage and faster, it is important to remember that this person could legitimately be on your board for 10 years. So it’s definitely an important decision and not something to go and rush into. So I think beyond capital, I’d want to know if I trust the person, do I respect their opinions? Do I think we’re capable of having intellectually honest, maybe even challenging conversations together. And so for founders, you know, I’d really reference the VC talk to founders that they’ve worked with, where things went well, but also where things really maybe didn’t go well. And I think you can learn a lot from those conversations. Also as more capital has come into the early stage markets in recent years, it’s definitely been forcing VCs to redefine their value, to remain competitive in the market. And so early stage partners and firms are becoming more specialized in their investment sector, focus areas, you know, 10, 15 years ago, there were plenty of generalist funds and partners. And now we see funds that are highly specialized at the early stages. You know, there’s a fund called heavy bet for example, which is focused on working exclusively with developer tools companies. And so firms are continuing to build out these sort of value added portfolio programs to support founders, depending on what space they’re in. As an example, Costanoa has senior partners in sales, marketing, and talent recruitment, and they do nothing but work full time with our early stage enterprise portfolio.

Kanchan Shringi 00:12:24 Oh, so it sounds like, you know, there is this concept of building trust and long-term because you are going to be working with the investor for quite some time. And there are firms that are specializing in areas as well. So, you know, I decided who I want to approach, what should I be prepared with? You did hint at some of this in your bootstrapping discussion, but you know, we know of many companies in the late nineties, I got funding based on the idea alone. What would your advice be for the entrepreneur today? How far along this idea, you know, really should be in the implementation before approaching a VC.

Casey Aylward 00:13:05 So I’d say every interaction with an investor, you know, whether it’s a formal pitch or maybe just a friendly catch-up meeting with someone, you know, pretty well, it’s an opportunity really to test your story. And so while fundraising and investor relations are not the most important part of building a company, it’s still an incredibly important piece of it. And can definitely give your company a real advantage over its competitors. So more tactically, I think at a very minimum, if you’re just starting to think about raising and are having casual conversations with a VC, I really recommend writing a one pager. This is not something you need to share externally, but it’ll just help kind of distill your thinking on how you’re defining the problem and the opportunity that you’re tackling. You don’t really need to have customers or revenue, but you need to have done significant customer discovery.

Casey Aylward 00:14:06 I’d say if you’re actively trying to raise capital, but it is definitely my strong preference to have a deck and a plan. You know, even if you don’t have a product yet, and you haven’t hired really anyone else on the team, I do like to see the high level plan that includes, you know, the hiring ramp, product milestones and sort of the projected customer traction. And to me, you know, the reason I love to see it, even if the company is really early, as it just shows that you’re thinking strategically and can kind of tie those basic business pieces and blocks together, which is obviously an important trait in a founder and CEO.

Kanchan Shringi 00:14:44 So have a deck and a pager, a deck related to the business plan and a one pager on idea. You must have seen many of these pitches, what makes a good pitch?

Casey Aylward 00:14:57 So I’d say all good pitches come with a ton of practice, no matter how experienced the CEO is, there are a few things that founders can do in a pitch that I really like personally, the first thing is proactively addressing the risks in the business instead of sort of hiding them away. For example, if your product or company is very blatantly competing with another large player in the market, but you never bring it up once and hours of conversation, I just don’t think that’s very realistic. So I like to see those be addressed proactively. The second thing I like to see is having the founders share what kind of key metrics they’re tracking internally, whether that’s on the product side or on the customer side, I really like the quote you make, what you measure. And so sharing the handful of those handful of top level company goals that you care about.

Casey Aylward 00:15:53 It gives me a better sense of what’s important in the business. The third thing I like to see is sharing learning moments. I really like when founders talk about how they’ve gotten to where they are today, and of course no startup journey is linear. So having the humility to share mistakes and more on the experiments, you’ve run paints a more realistic picture of what it would actually be like to work together. And then the last thing is, you know, less about style, but of course it’s always exciting to have a recent burst of momentum. So maybe you’ve just closed a really large enterprise contract. You’ve hired a key exac or you just announced a product feature, but it’s kinda nice to see those tangible milestones as well.

Kanchan Shringi 00:16:43 Sounds good. So share learning metrics. And of course, you know, a recent success is also in which certainly energizes everyone

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Kanchan Shringi 00:17:20 So, you know, we had a good pitch. We, you know, we want to work together. Now I understand that a multiple phases of funding I’ve heard of a, B and C rounds. Can you talk about that?

Casey Aylward 00:17:32 Sure. So each round from seed to see, I’d say is underwriting a different kind of risk. And each round is we see companies raise more money at higher valuations is really to recognize the continued growth and progress from the last. So most seed investors would say very basically that they’re betting on the founding team and that the market is a good one to play on. And I generally do agree with that. I’d say seed rounds today are kind of a wide range, but in between one and $5 billion usually falls somewhere in the middle. That series a, a company will have some revenue the market right now, you know, as we’ve sort of alluded to is valuing companies ahead of traditional benchmarks. But when I think of what a traditional series a was like, and maybe this was two, three years ago, the company would maybe have about a million dollars in annual recurring revenue, you know, ideally added in the prior 12 months and the science of kind of an early talented team and maybe some initial signals that they’re getting ready to build out some scalable processes on the sales and marketing side and a series a and this market is a little bit bigger, but it might be between eight and $15 million.

Casey Aylward 00:18:54 When you go and raise a series B, I’d say the bet is really on whether or not the company is ready to scale. So the company will probably have between three and $10 million in annual recurring revenue. And later stage investors will want to put more capital to work. So they might be investing close to $30 million in the round and then series C investors come in. And they’re usually betting on the continued scale and typically proof that the market is big enough for the company to continue to run. So of course those rounds are even larger than the series B and even higher evaluations.

Kanchan Shringi 00:19:34 So how much money would I need? And you know, how long can I keep getting funding before my company really needs to be self-sustaining or, you know, I think you’re talk about series B was up to 30 million. So how much money should an entrepreneur typically have to raise?

Casey Aylward 00:19:52 Right? So we typically recommend that founders raised about two years of capital with each round. If you want to raise a little bit more and the terms are good, that it may make sense to raise a little bit more capital and give your company a bit of buffer, I’d say, on these specific amount to raise some products like an enterprise grade security product may just take a little bit more time to build because of all the product requirements that it may entail. So, you know, you might see a seed round for that type of product, closer to the $5 billion amount that I stated earlier, but maybe for a more simple products that you can launch quickly, you might raise one to $2 million.

Kanchan Shringi 00:20:36 So two years capital with each round, is there some advice there which related to also how much equity you need to give away? How do you balance, you know, how much money you raised was is how much equity you might have to give away?

Casey Aylward 00:20:52 So I’d say the average early stage round in aggregate has the founding team taking between 20 and 30% dilution on the financing. If the team is more experienced or maybe you’ve had some fast traction, you can get closer to that 20% dilution mark, I’d say it’s hard to take less dilution than this because most leading funds are going to be ownership centric. And 20% is really seen as that line that most major funds are trying to get across in the early stages.

Kanchan Shringi 00:21:25 Then by the time the company has gone public, or, you know, has been taken over how much of that equity is gone or distributed, I should say to maybe to the early stage employees or to the investors.

Casey Aylward 00:21:41 So the answer to that depends on how much capital the company has raised privately, and also what the terms were on each round. I’ll also add too, if you have multiple co-founders, that will have a pretty significant effect on how much you might own as an individual, by the time your company goes public. I think it’s most common for the founders to own between 10 and 20% of the company at the time of the IPO. That can be one founder, or it can be a group of three or four co-founders, but again, this can vary pretty significantly. So I’ll give an example when Snapchat, when public, the two co-founders Evan Spiegel and Robert Murphy owned a combined 37% of the company on the other end, when Lyft went public, the two co-founders jointly owned about 6% of the business together. And it’s important to remember two IPOs are a diluted financing event. So you are raising money and diluting yourself in that process.

Kanchan Shringi 00:22:50 I heard about safe notes, other different from giving up equity.

Casey Aylward 00:22:55 So safes have become pretty popular in early stage companies, safe stands for simple agreement for future equity. And it’s a type of financial instrument that Y Combinator popularized in the early 2000 tens. As you can tell from the expanded definition, it’s an agreement for future equity. So it’s actually neither debt nor equity safes in today’s world. When we talk about them are typically being referred to as post money safes, which is actually a little bit different from how they initially started when they first came out, founders like safes, because they don’t really have all these governance components that equity rounds have. And so they really keep the legal diligence and the legal fees and all of that to a minimum. And so you can close your round out pretty quickly sometimes, honestly, in a matter of days, and with the governance component, as I mentioned, there’s not going to be an official board created for the company or anything like that. So all in all, they are a very founder-friendly instrument and we’re in a founder friendly environment. So we do see a lot of them at the early stages,

Kanchan Shringi 00:24:13 A slightly different track now, but, you know, continuing on our journey as an entrepreneur, how should I be thinking upon getting all the return off on my hard work? Do I really have to wait until the IPO or acquisition are, is there a payoff as navigating through all the stages of funding?

Casey Aylward 00:24:34 So it is pretty challenging to get significant liquidity or pay off before an IPO or a good acquisition. You know, the trade off of course, is a smaller near term salary for the potentially huge value of your equity over time before an IPO or acquisition happens, though, there are a handful of ways that some founders can see pay off, but they traditionally come with hitting business milestones or, you know, raising another financing round. So to start with executive compensation does increase over time, but it’s usually tied to company performance and financings. Another thing some founders can do is to sell a small percentage of their holdings, usually at incremental Browns. So investors might allow a founder to sell something like up to 10 or 15% of their shares at the series B or C. And since it does take a longer time for companies to go public these days, you know, it’s close to 10 years, founders may value having some cash today to do something like buy a house or send their kids to college. For example, investors definitely do prefer that the amounts sold to be a little less, since we do want that alignment with the founder, and we do want them invested equity wise. We do recognize though it can be pretty meaningful to founders to take a little bit of capital off the table with success before an IPO or an acquisition though.

Kanchan Shringi 00:26:10 So just summarizing our conversation over the last several minutes as an entrepreneur, I should be careful about the pitch. I would start with a C drowned and the goal would be typically to make sure I have about two years of funding as I move through the BNC rounds at the IPO stage, are they as the company progresses. And when I come to the IPO stage, I would expect that the co-founders typically have up to somewhere between 20 and 30% of the equity in the company. It could be lesser as well. Is that a fair summary?

Casey Aylward 00:26:45 Yes. I think that’s a fair summary.

Kanchan Shringi 00:26:48 So that said, um, a couple of more questions here. What common mistakes would you see a first-time entrepreneur make that would make this journey not as straightforward as we have painted the picture here.

Casey Aylward 00:27:01 So I have a few that come to mind. The first thing is not picking the right co-founder. So if you have two co-founders, you want to make sure that that atomic team can both sell and build. And I think one without the other is going to put you out of disadvantage. And so you want to make sure you bring on a balanced skillset when you’re getting started. There are some exceptions, but I’d say for technical products, I do like to see that balance in the founding team

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Kanchan Shringi 00:28:21 So the calc co-founders important and then expanding to the team you mentioned on your website that early stage investing is really, really about the team and the people. What do you mean by that? You know, what else do you look for in the people and the teams? Yeah,

Casey Aylward 00:28:36 I’d say all of my investments are fundamentally about on the founder or co-founders. And I looked for a handful of key things. The first one is really the ability to hire and recruit great talent. So this is always surprising to first-time founders, but they probably spend up to 50% of their time recruiting in the first year. So if you’re spending that much of your time doing something, hopefully it’s, you know, highly leveraged time. The second thing I like to see is really the sense of urgency and sort of an obsession with the product. So again, building a high growth company, it’s not for everyone and you do pretty much have to be a little bit crazier, obsessed to want to do it. So, you know, do you light up with positive customer feedback? Do you show up, you know, a week later after our first meeting with a ton of notes from all your customer interviews or new wire frames, I love to see that passion and, you know, level of excitement and commitment to the problem.

Casey Aylward 00:29:41 And then the third and final thing I say is to really have a growth mindset. So as a seed stage company, you can’t just say, all right, that’s it. I think we solve the problem here. The product is usually a really narrow slice of functionality. And once you start working with customers, you’ve started to earn the right to actually hear them give you real feedback. And so it’s important to really keep your ear to the ground and listen to what they’re saying and then build the right next thing. So hearing not just what you want to hear, but is a really important trait that I look for in early stage leaders.

Kanchan Shringi 00:30:22 Thanks for that, Casey. I think that rolls into my next question and next segment, which is about working at a startup. So if I am looking to join an early stage company as an engineer, how do I decide if it’s worth it, given that so many companies don’t actually make it? So some of the insights that you shared about looking at the company from a VC angle may apply here, but you know, somebody that’s looking for a job may not have all that kind of information. So what would you advise that, you know, somebody that looking for a job at a early stage company, figure it out.

Casey Aylward 00:30:57 The truth is, you know, early stage companies, aren’t for everyone and that’s fine, but I do think that everyone can benefit from trying it once. It’s good to know what you want to get out of the experience before joining the company, you know, do you want to become an engineering manager? Do you want to work in a customer facing function and get more hands on experience with customers? You know, there are certain goals that you can set up for yourself so that you come out of the experience. Having learned something new, the people that I know working at startups, typically name, I guess, two things that really drew them to the opportunity. The first thing is the team. And the second thing is usually having an impact. So startups are a really high velocity learning environment and at a startup, you know, if you need to build something or do something, it won’t happen.

Casey Aylward 00:31:54 If you don’t do it at a big company, there might be a dozen other people who can do your job. So some people love that level of responsibility and some people really don’t like it. I’ve also seen startups be a great career accelerator. So especially if the startup is growing quickly and on a good trajectory, and you’re at that company early, you really have the trust of the leadership team. And so you can really quickly grow into leadership roles that otherwise might have taken three times as long climbing up the corporate ladder, so to speak at a much more established company. And then the final thing I’ll say is if you are potentially interested in starting a company, but don’t yet quite feel ready to do that, being in a startup environment is probably the next best thing to prepare you for that. So it’s good to test it out and see if you enjoy that sort of environment.

Kanchan Shringi 00:32:51 Thanks, Casey. I think a lot of that may have come from your experience at Pinterest as well. Is that right?

Casey Aylward 00:32:58 Yeah, that’s right. I worked at Pinterest and then I also worked at a seed stage company called URX. That was a YC company back in the day. And I think that working at a startup early in your career is a great move as an engineer. It can be a really awesome learning experience either way, because you’re going to get to build something usually from scratch in general too. I think early stage technical hires tend to be actually a little bit more senior in their career. And so if you’re joining a startup as a more junior engineer, you’re going to get to work really closely with these senior level ICS. And that doesn’t always happen at big companies at big companies, I’d say there are really standard development processes and it’s rare to actually get to build something from scratch when you’re in a startup. You know, every developer in the early days is a decision maker and your work really has outsized effects on, you know, how things grow over time. So what languages you pick the tooling and standards that you set up, all of those are actually really critical decisions. And so again, if you’re thinking about working at a startup, definitely go in with an idea of what you want to get out of it. But I think as an engineer, it’s great because you’ll get to actually build things,

Kanchan Shringi 00:34:22 Right. So put on multiple hats and build, so switch gears now, and let’s talk about, uh, the VC firm itself. So you made the transition from a software engineer to, we see, so is working at a VC firm and interesting and attractive career part in itself from what you’ve seen so far,

Casey Aylward 00:34:43 It is, I’m obviously biased, but I think it’s also one of the only finance jobs where you can probably wear a t-shirt to work. So that’s pretty important. I think, you know, in seriousness, there’s no other job where you have to be learning constantly this much. And I definitely value that. I think besides maybe starting your own company, this might come in second for just how much constant education you have to be doing. In addition, you know, the exposure you get to really talented founders executives and other industry experts is unparalleled. And so that’s, you know, a thing that you can get addicted to pretty easily from a macro perspective, there is definitely more value growing in private companies today. You know, anecdotally, a lot of investment bankers are trying to move into tech since they see this and the lifestyle is better. So it feels like there is just so much opportunity at the early stages. And as a VC, you’re getting to work alongside and are compensated alongside a company’s success.

Kanchan Shringi 00:35:54 So how was your experience when making the transition, you know, what did you have to learn? What did you have to maybe unlearn and how did you acquire business acumen?

Casey Aylward 00:36:05 So I think working at a startup, I actually did get a lot of exposure to some of the business aspects. You know, I had early exposure to our customers, their feedback, what the key metrics were inside of the business. And so I think I learned a lot through osmosis, just being on such a small team when it came to my role as an investor. You’re right. I did have to learn some of those business fundamentals, but I do think again, they’re learnable and something you can pick up on the job. And quite frankly, in early stage investing today, there isn’t too much financial data. It happens to be quite theoretical or maybe high level, you know, at series a that starts to change. But at the end of the day, you’re looking at a financial model and really asking high level questions. Like what are the key assumptions or risks here that we’re underwriting in the business. I’d also say when you invest in a company and see it grow over the course of a number of years, you know, over many board meetings, over regular meetings with the founders and the key executives that additional increase in complexity feels really natural. And so again, you get to learn a lot on the job and because I’m working with, you know, almost up to 10 early stage companies, that means I get to learn things pretty quickly

Kanchan Shringi 00:37:28 Going on the job is of course helpful, but starting at an early stage company was also helpful. It sounds like,

Casey Aylward 00:37:34 Yes, that’s right. I think the empathy that I have for early stage founders is someone who has been inside a very early stage business. That piece of it, I definitely value having, but a lot, I’ve just had to learn on the job.

Kanchan Shringi 00:37:49 How is a VC company structured,

Casey Aylward 00:37:52 It’s complex, but a VC firm typically has an operating company. That’s an LLC or limited liability company. And this is the company that operates our business, pays the rent and salaries and other expenses for the capital that we’re actually investing into companies. You know, that’s coming out of a fund and each fund is a unique, limited partnership. And so the capital for that limited partnership is coming from, you know, what we call LPs or limited partners. And so LPs for us are things like pension funds or university endowments. And I’ll note that those LPs do not have investment discretion over the capital. It’s actually the general partners of the limited partnership that will make the investment decisions. Every fund is a unique, limited partnership. So every fund will have its own unique cohort of investment companies within it. And once a fund is fully deployed and the next fund is raised, the investment team then starts investing out of that next fund, which will have its own separate cohort of companies.

Kanchan Shringi 00:39:07 So my summary for that would be that as you had mentioned, very early on the venture capital firm is an institutional investor. So within the venture capital firm, there are multiple funds that raise money and as each of them mature than they used to then for the invest in early stage software companies.

Casey Aylward 00:39:27 Yep. That’s

Kanchan Shringi 00:39:28 Right. So you’ve been at Costanoa now for several years. So I’d like to ask you a little bit more questions on how you’re measured. So as an investor, how are you measured and what do you plan for as you know, you, a certain number of investments would be a hit. So how do you measure that probability and how do you make sure that you’re successful?

Casey Aylward 00:39:51 So of course, when we invest in a company, you know, we want to believe that it has a major, major outcome at the end of it. I’d say though, in early stage venture, you know, looking at it from the fund level, realistically, what ends up happening is unfortunately more than half of your companies are going to fail or not reaching outcome. And this is of course, you know, an early stage venture. I’m not talking about much later stage companies here. So I think it’s fair to say, and this is a little bit of anecdata, but I’d say less than 10% of the companies in a portfolio are going to go and produce the vast majority of returns. So maybe 10% is producing 90 plus percent of the returns of the fund on a more formal basis. You know, there are a couple of metrics that we use in the industry to measure performance. The most important one is called DPI, and that stands for distribution to paid in. And basically it measures what you have distributed back and capital to your LPs. So if you have a a hundred million dollar fund, you want to return, let’s say $400 million or more in capital back to your investors.

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Kanchan Shringi 00:41:39 Okay. Your process really is ensuring that you are investing says that you have a certain percentage of return for the folks that are actually investing in the funds for the VC itself.

Casey Aylward 00:41:51 Yeah, that’s right. What

Kanchan Shringi 00:41:53 Does a successful exit look like for an early stage investor in a company?

Casey Aylward 00:42:00 So a successful exit for an early stage investor will depend a good amount on the size of the fund. And so, you know, it’s not just about getting a company to IPO or a high priced acquisition. What also really matters is how much ownership the venture fund actually has in that company. So typically you want material ownership, I’d say between 10 and 20% of the business, you know, the more, the better to return a fund that is maybe a hundred million dollars, you’re going to need at least 1 billion or, you know, a multi-billion dollar outcome to return that fund where you own a material percentage of the company. But if you’re a 400 to $500 million early stage fund, you’re definitely going to need to have a couple of multi-billion dollar outcomes to produce good returns for your investors. Okay.

Kanchan Shringi 00:42:56 So let’s talk about your investment philosophy when it comes to selecting ideas, you know, what is it about the idea of technology that you look for?

Casey Aylward 00:43:07 So I’d say, you know, team and founder market fit really do determine the bulk of why I would invest at an early stage company, you know, good ideas, people see them, they end up getting copied and you might have a headstart of a year or something like that. But ultimately it’s just going to really depend on your ability to build and execute quickly. You know, that being said, there are definitely a handful of things that I look for with an idea or a certain piece of technology. And those probably fall into three categories. You know, the first thing is I’m looking for a scoped and defined and user value. I’d say, especially with technical products, you know, you can’t go in and say, you’re going to have this problem in the future as an organization, you really have to solve an individual’s problem today. So that’s a big one, especially in technical products for me, the second one is the adoption paradigm and how much time it takes for an ad user to see value.

Casey Aylward 00:44:16 So the way I ask about this typically is I’ll ask what does your onboarding flow look like? And so I’m trying to get a sense if the product is complex or simple, what it looks like when you deploy it. And this very basically tells me a couple of things about what the go to market motion might look like for the business in the early days. And then I’d say the last thing I look at and care about, especially again with technical products is the ecosystem of tools and the developer community around it. Of course, as we know, developers have things they fall in love with and want to use. And usually, you know, that toolkit that they’re using all those tools are compatible with each other. So you can’t come in and reinvent the wheel and have them relearn everything. So I’d say typically the ecosystems around these tools, especially if they’re open source or maybe language specific aligning with those communities early on is a pretty powerful thing. So I definitely look for that in early technical products that I’m backing.

Kanchan Shringi 00:45:25 Okay. So fit within the ecosystems, solve a real immediate problem and have a simpler onboarding. Those are the three takeaways

Casey Aylward 00:45:35 That’s right. I think developers can be lazy sometimes. And if you can’t show a developer, something that excites them within, you know, 15 minutes to an hour, it’s going to be pretty challenging to get them to come back later and try the product

Kanchan Shringi 00:45:52 Key trends. Are you bullish on maybe right now?

Casey Aylward 00:45:56 So there are a couple of key trends going on in cloud data infrastructure that I’m excited about. You know, as we know, there’s a ton of activity in the open source ecosystem, and I’m seeing a lot of compatible tools emerging at every part of the data stack. And what’s great here is that you can really pick the best in class tool for your specific use case and sort of stack them all up together. So one area that’s exciting, at least I think is exciting is around projects that are helping to bring data lakes up to par with some of the benefits that something like a cloud data warehouse might provide. So at the data management level, I think there are a handful of emerging projects that are helping give data lakes. Some of the core data management features like change capture data, encryption, and caching and adjusting.

Casey Aylward 00:46:51 A lot of these are solved in a cloud data warehouse, like a snowflake or a big query, but haven’t really been solved for data lakes yet. So I think there’s going to be some big developments in that area in the next few years. The second trend is around developer authorization. I’d say with the recent massive acquisition of auth zero by Okta for $6.5 billion, which was announced, I think in March of this year, it’s clear that developer authentication is a solved problem. I’d say that authorization though, which is, you know, the act of specifying access rights and privileges to resources. It’s still in the very early days, you know, especially for application developers, we’re seeing a lot of pain points around this specific problem. And I think there’s potential for a pretty big company to be built here.

Kanchan Shringi 00:47:46 We’ll put some links around what you mentioned, especially Octa. I think that is relevant to our discussion today. Thank you for that. As we start to wind down, I’d like to ask you on a lighter note, if you’ve seen this one, does the series Silicon valley represent a real estate experience of a startup? Have you seen it?

Casey Aylward 00:48:08 So of course I’ve seen it. The show in my opinion is way too real. What I do think it does a good job of is showing that sort of rollercoaster that happens in early stage startups. You know, Richard, it feels like, is always battling with someone, whether it’s his investors or the CEO of Hooli. And usually, you know, those relationships are not as intaglio cystic or antagonistic at all, but I think the show does a good job of showing that the startup journey is definitely not just a linear path. I do think the personas are obviously pretty exaggerated, but in some cases they can be pretty spot on

Kanchan Shringi 00:48:49 And they probably do illustrate your advice on having a good co-founder and a good initial team.

Casey Aylward 00:48:56 That’s right.

Kanchan Shringi 00:48:58 Is there anything that we missed today that you’d like to cover?

Casey Aylward 00:49:02 Well, I really enjoyed our conversation. Thank you so much for having me on this content. And you know, if anyone in your audience thinking about starting a company or wants to work with one, you know, I’d love to meet them. And if you’re interested in that, please do feel free to reach out to me directly. The other thing I’ll say is that it is a great time to start a company right now. It’s a very founder friendly environment and there’s just a ton of activity. And so, you know, if you’re waiting for that sign, I’ll say, this is your side.

Kanchan Shringi 00:49:36 Especially if you have a solution for authorization. Exactly. So how can people contact you if they want to?

Casey Aylward 00:49:44 So I’m pretty accessible. The best way to get in touch is via email. I’m justCasey@costanoavc.com. I’m also active on Twitter. And so if you want to shoot me a DM on Twitter, that’s another good way to get in touch. We’ll

Kanchan Shringi 00:49:59 Put your Twitter handle in the show notes.

Casey Aylward 00:50:02 Great. Thank you.

Kanchan Shringi 00:50:04 Thanks so much, Casey. This is awesome. I learned a lot. I hope our listeners did too. This is Kunshan stringy for suffrage ding radio. Thanks for listening.

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