DtSR Episode 720 - Finance Masterclass for Cyber (Part 1)

TL;DR: This week's pod features a Masterclass on finance for Cyber folks, led by Patrick Dennis, where we ask all kinds of questions and go from idea to the pre-growth stage of a company. What's next? Check out part 2 coming next.

Guest: Patrick Dennis

Description

A splashy funding announcement can feel like proof you’re winning, but it can also be the moment the clock gets louder. We sit down with returning guest Patrick Dennis, a multi-time [cybersecurity] CEO and operator who “swims in these waters,” to translate the funding ecosystem into plain English and remove the mystique from venture money without dumbing it down. If you’ve ever wondered why a Series D gets celebrated, what that really signals, and what it costs later, this conversation is for you.

We walk step-by-step through the early-to-late funding path: angel investors and seed rounds, venture capital at Series A and B, growth equity, and how private equity can show up as companies scale. Along the way, we tackle the words people throw around at conferences as if they’re obvious: valuation, dilution, burn rate, cap table, down rounds, and liquidity. Patrick breaks down why valuation is largely “on paper” until an exit, why investor timelines often point to a three-to-seven-year window, and why the higher you push the price, the smaller your list of realistic buyers becomes. We also talk about the “markup” incentive system that can quietly trap teams into needing a bigger round or a bigger exit than the market will support.

Then we bring it back to operating reality: how the zero-interest-rate [ZIRP] era trained cybersecurity companies to spend aggressively, and what changes when money is no longer cheap. We close with the human part founders underestimate most: taking money means giving up control and choosing a partner, and “hands-off” becomes “hands-on” fast when performance slips. Subscribe for part two, share this with a founder or operator in your circle, and leave a review with the funding question you want answered next.

YouTube video: https://youtube.com/live/zbDNnbHKEaU

Transcript

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Welcome And Why This Matters

SPEAKER_05 0:51

Hello, hello, good morning, good afternoon, and good evening. Welcome down the security rabbit hole to another edition of your favorite cybersecurity podcast, the Down the Security Rabbit Hole podcast. This is Raf. I've got James over here, and that way is Jim. And that guy right there, right, that guy. Returning guest, Patrick Dennis. How are you, Patrick?

SPEAKER_06 1:17

Doing good. It's good to see everybody. Thanks for having me back. So far, I've remained employed. Raf has always invited me in an attempt to get me fired. So far, I've been successfully. Although I feel like we're going to go into the topics that might make me unemployable again. So thanks again, Raf, for the invitation. It's really nice of you. What a good friend.

SPEAKER_05 1:38

Listen, I I I've had I've I had a whole bunch of these conversations uh at Black Hat about getting funded and VCs and PE's and and valuations and stuff. And I've always been like interested and followed all this, but I think this whole thing started with, you know, I saw a bunch of these announcements at Black Hat, and I've always wondered like, you're on your Series D funding round, and you're super excited about the next 50 million you've taken on. And I've always wondered, like, that feels like you're celebrating the wrong thing. And and so naturally I go to the person that lives and breathes this stuff, and then you wrote a blog post and an article, and I said, Hey, let's go do let's go do a two-parter on the podcast and just talk through this and like a one-on-one for people that are uh that are curious. And so, uh, Professor Dennis, welcome, uh, welcome to the show. Well, I feel like I should get you a jacket with like the pat the patches on the elbows.

SPEAKER_06 2:36

Well, I I did, I almost played a joke on you guys, and I have one time I went to a disco party and I have a cheetah jumpsuit. And I I felt like given the fact we were gonna dive down the venture money rabbit hole, we it was maybe necessitated the cheetah jumpsuit. But today I will be Patrick.

SPEAKER_05 2:56

I would be offended if you don't do that for part two of this episode.

SPEAKER_06 2:59

Okay, so for part two, the cheetah jumpsuit's in.

SPEAKER_05 3:02

Oh my god. You guys hear to hear people. This is this is this is now a must-watch for part two. All right, listen, I'm I'm gonna people know who you are. Uh if not, give them a quick taste.

SPEAKER_06 3:13

Yeah, my name's Patrick Dennis. Been lucky enough to be a CEO a few times now. Mainly do cyber security and some comm software. A lot of times, if you're a CEO and you do something in one segment, you can't go back to it right away. So you have to sort of have two domains. I think I got brought on today. I've exited, I exited guidance software to open text, I exited Venify to CyberArc. I concurrently bought and sold aspect software and mobile systems and made a company called Elvaria with a about a $1.3 billion raise. Been the chairman of the board of a company called Ripcord for the last eight years that's backed by Google, Kleiner, Lux, and Icon. And so, yeah, so I sort of swim in these waters. And so I think, I think, Raph, what you wanted to do was try to demystify some of the space for the audience. And since you guys have been nice enough to demystify things for me over the years, I will try to return the favor as best I can. Although, if there was any water murkier than cyber, it may be finance.

SPEAKER_05 4:18

So uh that's why we're talking. This is why we're talking. This is, I feel like this is gonna be for me. Uh, I'm glad we're recording this because I'm I'm probably gonna listen to us a couple times. I feel like I need to absorb this. You know, sometimes you gotta listen to it twice, three times they actually absorb something. So let me start this.

Why Founders Raise Money

SPEAKER_05 4:37

How do explain to us? Because there's private equity, venture capital, some other things in there. Talk to me how these these how and why people go just kind of at the on the surface, right? And then we'll dive in. Why people go to to get funded, to get funded at different stages.

SPEAKER_06 4:57

Well, so I guess let's start at the beginning. If we all start a business, let's just use the four of us. If we start a business today and and we had a product, and let's say we wanted to go sell it, right? And maybe, you know, Raf, you are the service person, and maybe James is the product person, and Jim does the back office, and I run sales. Uh, probably by Wednesday of that week, if the product is any good, we're all going to look at each other and say we need to hire another person. And so, you know, the real reason people go get funding, get funding, is they draw the conclusion they can't scale the business as quickly as they want to with their own resources. You know, that's particularly true if it's a founder's first time doing something, very rarely do they have enough money to go kind of sometimes you will hear self-fund. And so if you can't self-fund it, you wind up having to go off and and and take out some money so that you can go try to scale the business. I I don't think of it as being that dissimilar. Most finance equivalency I can kind of draw to your personal life. You know, if your company is a big investment as an individual, that's sort of like you going to get your mortgage. Most of us can't afford to buy the house that we want out of the gate. And so we can put together some money for a down payment. We need to go take some money out for us to actually buy the home, and then we're going to pay that money back over time. So, you know, I guess before we get into the dark art of all this, we should explain like why does it exist in the first place? It's very difficult to compete and scale a business on the back of your own resources if you're a founder, even if you're co-founders, and so oftentimes you need to go get money. And your upfront choices are really do you want to go raise debt? Uh most people don't have a business that can raise debt. We can talk about that if it's interesting out of the gate. So they go and they try to find somebody that is as interested in the business as they are and believes in the business, and that's how they quote get funded. That's sort of how it all begins.

Angels Venture Growth Equity Explained

SPEAKER_05 6:58

Okay. So uh there's I've heard terms angel investors, seed funds, institutional uh venture capital, then there's private equity further down the line. Like what what's the what's the difference between those and like when is when do you when should you be hearing or using each of these things?

SPEAKER_06 7:17

Yeah, so they sort of loosely tie to when you hear people talk about rounds of funding. So sometimes you'll hear about like a series A or a B or a C. You know, these days, uh in the old days you didn't really go much beyond C and D. These days, you know, there there's E F G H I J, right, whatever. So, so think of each of those people as having a type of expertise. So angel investors make, I mean, I'm gonna way oversimplify. So listen, somebody in the comments is gonna hate me for whatever I say today. So I get it, haters. All right, we're gonna try to keep this at a cursory level for everybody. You want to come at me in the DMs, come at me. All right. Come boy. So let's go, let's go with the easy one. So angel investors generally make smaller bets on very speculative companies. So you could think of that as, again, it would be sort of the four of us start a company sort of phase. We sort of have a product, maybe we don't even have it ready to quite ship yet. We probably are pre-revenue, we might not have a customer. You know, that's sort of when you're like, okay, but we need some funding. You're looking for an angel investor to come in and make a really early investment in a company. You know, that could be a check that's as small as $25,000, $50,000, $75,000. It might be a check that's $200,000, $250,000. So relatively small amounts of money. Typically, the reason they do it is they wind up with a reasonable percentage of the company in exchange for that. You also tend to see in angel rounds, you'll sometimes hear people say, like, it's a friends and family round. It's not unusual for the angel round to be done by people that are in the circle of the founder or founders versus professional, what I will call, like in air quotes, professional firm-based investors. So that's sort of the angel round. After that, you're probably headed into venture. And I'm gonna, again, oversimplify. If I named all the venture firms I know, some of them are sort of like invest in bigger things, some of them in smaller things. So there's diversity inside of venture, but broadly speaking, venture sort of comes next. They're gonna write a slightly bigger check depending on the series that they're coming in. And most of them sort of focus in certain series. So you'll find like some venture firms primarily do A rounds or B rounds, right? Typically, the asset is a little less speculative. By now, there's a product, and they probably are thinking about like, how are we gonna take it to market? Those people get involved because they're writing checks that are gonna return, if things work out, really big outcomes. So typically, I know this has been on your mind, those are the kind of people that go in understanding they're gonna make, you know, quite literally a hundred bets, and maybe one, one or two are gonna work. After venture, you get into a round typically called growth. Those growth rounds, sometimes growth equity comes from venture-backed firms, sometimes it comes from private equity-backed firms. If we went and we looked at all the firms inside of them, they have different disciplines. So I'm just gonna call that growth equity, although very few firms call themselves growth equity firms. That's typically where the fund comes from after venture. And by that time, somebody's had product market fit, they're looking to scale it. A lot of that funding tends to go to go to market and tends to come when people think that they can actually scale the business. And then once we get past those phases, we can talk about sort of like what comes next. But typically, success is sort of the fork in the road after that. So Angel Invest, we kind of bootstrap a company, all right. It has some relative success. We get some venture people interested in it. We go off, we prove product market fit, we get a few customers. Now we actually need to scale the business more quickly with you know, perhaps salespeople and go to market. We're gonna go get some growth equity that probably comes from either the venture community or a growth equity fund inside of private equity. That's sort of the beginning.

SPEAKER_00 11:27

Where does like Shark Tank fit into that? Because I'm sure a lot of people know what Shark Tank is. Like, is that is that like venture or is that because those people sometimes have something, sometimes don't?

SPEAKER_06 11:39

They that's sort of a funny thing. So, like that show in and of itself is not representative of either of those two camps. They really are more like what you would expect somebody to do for an angel round. You know, typically when you hear those pitches, those folks are going there saying, like, hey, we have an idea, but we need some capital to get it going. And oftentimes, you know, when you when you watch that show, or listen, I watch Shark Tank when I'm on the road and it's two o'clock in the morning and I can't quite get to bed yet, and I turn on CMBC because it's always channel 16 in a Marriott. All right, that's usually the show that's on. Most of those people haven't had some wild success, and so they need some money to get started. So it's a good example for that reason. So I I would think of them as, you know, a little bit more like Angel, although in that show's case, there's some really smart people there. So they're bringing some skills to the table. Usually in angel investing, you don't necessarily get skills. By the time you get to venture, it's a firm. So you're gonna get some that's making an investment in the company, but they probably also can bring you some skills and experience that maybe you that you don't have yourself or the management team doesn't have to be.

SPEAKER_00 12:48

Yeah, so so often in like Angel, you're not you're not getting the expertise. Like they show, like, oh, I've got all these connections into this, I can get you into retail, I can get you into that. Angel's probably not getting that. It's like, hey, I know somebody that is interested in this and they're willing to pony up some stuff.

SPEAKER_06 13:04

Probably not. Like, for instance, I know a few people that would call themselves angel investors who have worked in big tech, they have made call it tens of millions of dollars in their careers. They're willing to put some of that at risk in something that's an alternative to the stock market or whatever they do. They're not necessarily super professional. That's kind of the entry-level part of Angel. There are some sophisticated angel investors as well. But you know, you get the full gamut. You get some people that are sort of like playing around with what they think is house money and their personal lives, and you get some people that are professional. Typically, they're not bringing a firm to bear that has a ton of skills, though. Which differs a lot when you get to venture. When you get to venture, and certainly when you get to private equity, those people are gonna bring experts to the table to help scale a company.

Valuation Is Only Paper Until Exit

SPEAKER_05 13:58

So the thing that I've always been interested in is you you have and you go from I have an idea, I've got a minimally viable product. Like my buddy and I built this in the basement. I think it's gonna work. I tried it in a demo, it's running on my laptop. All right, but I I need to go buy a bunch of computer, I need to go buy a bunch of stuff, and I don't have the cash for it, right? You go, Angel, you build the thing, you go, all right, I've I can talk to a CISO friend, they're willing to try it. They're like, oh, cool, this is gonna work. We tried it. Now you're like, okay, now I need actual money to go like hire people to professionally build this thing. How the hell do you know how much money to ask for and how much of your business to give away, right? Because that's the trade-off, is you get money and in exchange you give away future profit, right? Or future revenue in the business.

SPEAKER_06 14:51

Yeah. Well, I mean, what you're really giving away is ownership. So this is really an important thing. This is actually this it is worse. This is and and and this is sort of the important point. You know, one thing that doesn't equate in my mortgage example is let's just say you want to go buy a boat and people take out home equity line of credit to go buy a boat, something like that, right? Well, what the banker doesn't do is show up and like show up and sort of sit down in your home office and occupy it, right? Like you didn't give away a portion of your house to get the home equity line of credit. When you go into these phases, what you really are doing is you're exchanging, you're selling a percentage of your business for the cash that's gonna come in the door with the belief that you're gonna go use that cash to make your business worth even more money. And and therefore, let's just say you gave away 20% of the company, you know, the money that you got is gonna vastly improve the quality of the company, and therefore you're going to make it worth more than the 20% that you just gave away. So, yeah, it's very expensive. You know, by now, if folks haven't read the part the a little bit that I wrote for you on venture, you know, that explains this markup culture thing that I talked about a little bit, where there's this weird incentive system where, you know, for a venture capital fund, a big mark, a big print, a big valuation has some reasons why it's really attractive to them. And on the founder side, what typically happens is, you know, you're just if you get a really big valuation, you're actually giving away a smaller portion of your company for the same amount of money. And so if you didn't know anything, you'd go, well, why wouldn't you do that? Well, yeah, there's a butt in this, isn't there? Well, there is because what you're really signing up for is you're sort of you're loosely guaranteeing the future performance of the company. And so, you know, it's the same reason why you are thoughtful when you go out and you take a mortgage. You think about what you're earning today. Maybe you buy up the house a little bit. Um, you know, we've all been through the phase where you know you have kids and stuff and you're looking at somebody and saying, We need a bigger house. You might have to buy something that's a little beyond your means those days, but you're gonna work harder and you're gonna do better, right? Right. You know, that said, I don't think you show up at the bank earlier in your career on the cusp of having children and say, Well, I'm gonna go buy a five million dollar house. Right. So, like, yeah, this you have to use some some good judgment because ultimately having a really, really high valuation and then just burning those dollars only puts you in a really difficult spot later. And, you know, we've seen that that happens time and time again, and it creates a bunch of problems structurally and getting another round of funding. And I'm happy to explain what why, but in most basic terms, once a valuation gets set, very rarely do people want it to come down. So if somebody puts an amount of money in at a billion-dollar valuation, you almost need the next amount of money to come in at a billion and a half or two billion. You it's very hard to do what in the industry is called a down round, which would be you're taking more money into the business, but the valuation's coming down. And you're seeing that now because so many people raised so much money on these crazy valuations that they're not exiting the companies at those values, and now they still need more money to run the business. Nobody's gonna put money into the business at those high valuations, and that's what's causing the pressure in the system, you know, that I think is probably causing this discussion right now. You and I could have had this discussion two years ago, three years ago, four years ago. We're having it now because the pressure in the system is starting to show up because of these large valuations and the fact companies haven't exited for that amount of money.

SPEAKER_05 18:57

So so we've said we you've used you've used valuation a couple times, right? Like the tell me what explain in like really high level and go like one layer below. What is a valuation? Like, what does that actually mean?

SPEAKER_06 19:14

So again, let's use the house example. Who moved in their house the longest ago? Anybody move has anybody been in their house like 10 years?

SPEAKER_00 19:23

Five years. Okay.

SPEAKER_06 19:26

So my guess is the house is probably worth more now than it was when you bought it, right? So the valuation, Raf, would be like if if we had guessed what that house value is going to be 10 years in the future, okay, okay, that would have been the valuation. We would have said, oh, we expect it to be worth, you know, X number of dollars. Right now, no, no, no.

SPEAKER_05 19:49

How far do you go? But how far in the future do you go? Is it like a year? Is it five years, or is it like at some point?

SPEAKER_06 19:57

That's a really good question. It gets the answer can be a little complicated. So I'm gonna make this. This is definitely gonna get me hate in the comments. Really, when they think it's gonna exit. Okay. That's the real answer. Okay, okay. And and the reason I say that is because in order for any of what we just talked about to turn into real money, you have to exit a company and then somebody's gonna write you a check. Okay. So the valuation is all on paper until somebody buys it. Okay. And so the answer to your question varies a little bit based upon where the company is in its life and when the when specifically the investor andor the founders andor the management team think they're gonna exit the company. Does that make sense?

SPEAKER_05 20:50

Yeah, yeah, yeah. Okay. So at the time of the whatever the next uh event, right? The sale or the trend next transition point.

SPEAKER_06 20:58

That that that's right. Now, now I will answer your question more generically. For most people, that answer is something like five years. Okay. Okay. Plus or minus two. Most things are somewhere between like three, five, and seven years is sort of when an event has to happen.

SPEAKER_00 21:21

Is that due to how long people actually think it's gonna take to get there, or people don't want to wait that long to cash out? All right.

SPEAKER_06 21:30

Definitely going into the dark art now. Oh, okay. You're gonna hate this answer. All right. So we're now gonna put push pause on the company for a second. We're gonna go run an investment firm. All right. So if we ran an investment firm, what we would do is we would raise the money that eventually I am going to give to you guys, all right? For the company we just talked about. So let's just pretend I raised $500 million to pay. Pick a number. All right. Well, the way an investment firm would talk to people about getting that $500 million is hey, all you rich people that are going to contribute money to my fund, if you make a $500 million investment, I'm going to return two to three times your money. Okay. Now that might sound great. What is the natural question for that person to ask? When? When? Right? So, you know, the answer, James, to your question is in these funds, most of them exist for four or five years to seven years. And you have to start to show some. First of all, when you raise a fund, you have to go deploy it. So you have to find stuff to go invest in. Then ultimately you have to go get the money back from these companies that you invested. And most of your investors don't want to wait forever and a day. So that five to seven year window tends to be a pretty important window.

unknown 23:01

Okay.

SPEAKER_00 23:02

Like putting your money into a CD, it feels like a little bit here. Just much riskier, right?

SPEAKER_06 23:07

Well, yes, but it also probably is going to give you way more money in return. Right. And that's the whole, that's how you get into this game, right? So the reality is if we all went off, and this is sort of a weird time in the world, which we're not going to dive down this today because it's too complicated. But the reality is for most of most of the time that we've been working, if you put basic money into these very, you know, these very basic things, CDs, bonds, like you left it in your checking account, you're going to earn two, three percent, something like that, four percent maybe. You know, so the notion of doubling your money certainly wasn't gonna happen. You needed to go find something else to do that. Now, at some stage, if you have enough money, you could say, okay, well, I've got enough money to be comfortable. In order for me to do something great, I'd actually have to double this. So, you know, if you think about the range of ways people invest, very wealthy people typically are willing to take on some additional risk because honestly, they need more absolute dollars for it to make a dent in their life. So, yeah, you're right. The whole periods are longer. So a couple of parameters here kind of describe the kind of people that invest in these things. They need to have enough money that they don't need that cash right away, right? Because you're gonna give it to me and then I'm gonna give it to you guys, and you're gonna go build a company. And then two, you sort of have to have enough money that you know the money has to sort of double or triple, or it's not really gonna make a dent in the broader scheme of things. Does that make sense?

unknown 24:36

Yeah.

SPEAKER_05 24:37

So big piles of cash.

Dilution Math And The Buyer Problem

SPEAKER_03 24:39

What I was gonna ask you a question about like the this sort of after the first round and getting the second and third rounds, right? And let's assume the valuation goes up. Is there a point where so I assume let's say we have our company now, we've given you 50% because you gave us a bunch of money, right? Yep. And we valued it at a million dollars. So you gave us, you know, half a million and the math works out. Now we need more money. You're not willing to dump in more, right? Let's say you're the angel, okay? But we need more money. But now the company's valued at say two million dollars. So effectively, your half a million became a million from a valuation, right? Now we have a million. Now we go, we go generate more funds. So we go to a second sort of round or first round outside of angel. We only have an option now of using our half to sell it unless you agree to give it some of yours. So we're continuing to dilute our ownership at that point, aren't we?

SPEAKER_06 25:34

Let's pick up on your D word. That's a really important word. And you just sort of walked everybody through something that's important. What Jim just described is the process of dilution. And what that means in plain English is if your ownership percentage in a company is 100% on the first day, and over time you're taking these rounds, the portion of that company that is owned by several different people, you know, the number of people tends to go up. You'll hear that described as the cap table getting big. All right. And typically every individual that's in the cap table is getting diluted. Now, this is one asterisk that I do think is worth mentioning. We're not gonna, we're not gonna go down this path too far, other than to say, Jim, there's a notion of people going in what's called prorata, which allows them to maintain a percentage over time. So there's mechanics to get through those things, but principally you're correct. Over time, what you're doing is you're diluting your percentage.

SPEAKER_00 26:31

Is that diluting all percentages, though? Like if you're the initial 20% to get it going, we go to round two, we sell another 20%. Is that coming out of the owner, or does the person they put in the initial 20% are they getting diluted as well?

SPEAKER_06 26:48

They'll get diluted unless they put in more money.

SPEAKER_03 26:52

So the idea though is your lesser percentage equates to technically more because the valuation technology presumably has gone up.

SPEAKER_06 27:00

And that is why everybody, and that's why everybody wants the values to go up.

SPEAKER_03 27:04

Okay. And then how does that make sense?

SPEAKER_06 27:07

Does that make sense why?

SPEAKER_03 27:08

Yeah. Yeah.

SPEAKER_06 27:09

Yeah.

unknown 27:10

Okay.

SPEAKER_06 27:10

Yeah. Because if you took so just use use really easy math, okay. If you raised 20 20 million dollars, means I'm gonna give you guys 20 million bucks, right? At a 200 million dollar valuation, that means you give up 10% of the company. At a hundred million dollar valuation, that same $20 million, same $20 million that you're getting in the company is worth 20% of the company, right? So that is part of why there's this wicked incentive system that says you want to ratchet up, you know, you want to ratchet up these values. Okay, so this is a really good time to make this point. What is what is the principal problem with that uh vis-a-vis what James brought up to brought up a minute ago? I have to be able to sell it at that value. Yeah. Right. So where I get where I start to think it gets pretty cringy is when you start to see these valuations that are really big. And then I'm just gonna make it, I'm gonna again try to oversimplify this for everybody. You know, I'm sure all of us started off in starter homes, and you know, there's been some lucky people here. You know, it gets a little harder to sell these houses to people because there's fewer people that can pay for nicer houses, right?

SPEAKER_05 28:32

Yeah.

SPEAKER_06 28:32

Which, you know, great example is how many times do you see uh movie stars or athletes when they finally sell their mansion in Florida, you know, for 45 million dollars, and there's like one buyer, right? It's hard to sell a 45 million dollar house that a basketball guy had, right? Yeah, so yeah, what's tricky is these valuations get ratcheted while you get to a place where you have to say to yourself, like, okay, Jim, who's gonna buy it? Right? And that I think is the part that not a lot of people think about, but is really, really important. So as the values start to climb, you know, and and and James's point, you need to sell it, you have to ask yourself a real question, like, who can I sell it to for this amount of money? And and now in cyber, let's pick some easy examples. If you want to sell a company for two, three, four, five billion dollars, who can you sell a company to for five billion dollars these days? Palo Cisco, Palo, Cisco, Google, okay, we're at four so far.

SPEAKER_04 29:40

Probably a couple more, but that number gets really small real fast.

SPEAKER_06 29:44

It gets thin, right? And and by the way, how many times have you guys heard people when you're at these conferences throw around five billion dollar valuations? Like it's not a big deal. All the time. All the time. I'll tell you, like there's a bunch of recently. Yeah, recently, right? And and so, yeah, I get it. Everybody can pull out the example of whiz. How many whizes have we had in the last five years? Ooh. I can name one, Wiz. One, right? You know? So so that's sort of let's back up. So we started a company, we needed money to scale the company, we didn't want to dilute ourselves, so we took we took a really high valuation to get the very amount of money that we needed. We can come back to why we figured out how we never really answered that question and how we figured out what money we needed, but we took this really high valuation, then we burned another key word that you guys hear. We burned. We didn't, we didn't make as much money as we were spending. So we burned the money that got invested. Now we need to go get another round, so we got another big valuation for that amount of money. Now all of a sudden, James is on our doorstep and he's like, hey guys, I need some magic word, liquidity, which means I need to sell. All right, and we're all looking at each other going, okay, where do we sell this three billion dollar company? And we have a list of four. Does that make sense? How this gets sticky quick?

SPEAKER_05 31:05

Yeah. I so that's the so let's let's let's touch on that one because I have a feeling this is gonna this is gonna be another one of those ugly things. Is like, how do you figure out how much you need? Like, because you know, I think the naive perception is let's go like, oh man, I'm gonna go raise 50 million dollars. That's gonna make me rich. It's like, no, that I don't that's not that's not the part that makes you wealthy, right? That's not the part that earns you money. That that that's just debt.

SPEAKER_06 31:34

Yeah, it's just you know, you're just taking money for a promise in the future that you're gonna give that money back at a multiple, right? So so maybe this is a good time to just introduce this idea. You know, Raf, you and I have worked together before, so you you have seen me do this and you've seen that it's occasionally not popular. Probably vis-a-vis the people in cyber. I'm one of those guys that's pretty thrifty when it comes to spending. And, you know, I take a I've taken some heat about that before in companies that I've worked for, like, why is he so cheap? And and the answer is because I sort of assume every dollar that we spend, if we're an air quotes burning, okay, needs to get me like five or ten dollars back, or ultimately I'm not doing my job for you guys in this example, right? And so when somebody's like, hey, I want to have the sales guys go on a club trip to you know, wherever, to loom, and it's the single most expensive place in the whole world. I'm like, okay, well, could we do the club trip in Montana? All right, if we were gonna go to, you know, pick your favorite. Well, we're not gonna pick on RSA, but we'll pick your favorite conference. Pick your favorite conference, they're all expensive.

SPEAKER_05 32:48

You know, a lot of those booths, just the booth, are a couple hundred grand, you know, maybe the entry point dollars is is what I heard this year for the the big one. Like, are you kidding me?

SPEAKER_06 33:00

I I mean, we used to pay, you know, you've worked at companies with me where we've paid $250,000 for a booth. Yeah, right. So you you start to ask yourself, like, do I need the $250,000 booth? Do I need to be at this conference? Do I need to be at all the conferences? Okay, how many salespeople do I need? Do I need a hundred or do I need 10? Do they all need SEs? Do I need a one-to-one ratio? Or can it, you know, they're all the right questions to ask. And and so what I would just tell you is like, as an industry, this industry almost never calculates what it actually needs. This industry, because raising money has been so easy, has not been particularly good at raising the amount of money that you need to spend it on the stuff that you need. Yeah, this industry is sort of a raise blindly and assume there's another raise kind of industry.

Burn Rate In The Free Money Era

SPEAKER_05 33:53

So this is the this is the conversation we we had a while back, and that is I think we had on a different podcast, actually. Like there was a time when raising money was easy, right? It was money was cheap, interest rates were low, like you could get you could get you know a bunch of money for a smaller, you know, smaller percentage of the company, valuations were all exorbitant, and then money got expensive. And like it feels like all of these companies, right around that time, needed to go get more money because they were burning like crazy because money was cheap. And then suddenly you're you're like this huge value, your two billion dollar valuation, you're about to run and and miss payroll, and you're like, hey, I'd like a three billion dollar valuation to raise money, and somebody looks at you and goes, Yeah, you're like a $750 million company.

SPEAKER_06 34:48

And then what? Yeah, that's 100% right. So that period of time that you're referring to, you know, you often on the on the prior prior times you've had me on, you've heard me refer to that as ZERP, the zero interest rate policy, which we had in place for a long time. And again, I'm gonna oversimplify this, but if money costs you zero, okay, and I go hire a salesperson and they sell even one thing, okay, and it's actually worth just the same amount of money that we took out to hire the salesperson, we're even. If they happen to sell two things, okay, we're better off. So when the money is free, you actually, as long as you have some growth, okay, it almost didn't make any sense not to keep trying to grow. Right. Then when the money gets really expensive, the question is, and this it it brings up a few, one of them is was the business model that you just built efficient enough for you to continue to grow without that level of spend? And that's what really broke down in cyber. Most of these businesses couldn't achieve 20, 30, 40% growth rates efficiently. And that's when you saw, you know, like recently uh industries had a little bit of a hard time there. And I think people sometimes are trying to figure out why. That has a lot to do with the why.

SPEAKER_05 36:12

Yeah. I think that efficiency, right? Because it was, you know, it started it the evidence was in the booth sizes, the evidence is was in like how much money they're spending on uh, you know, private concerts for for their for random strangers or for potential customers, or you know, you know, race car things and sponsorships and all kinds of crazy things. And suddenly, you know, like but there's different stages of the business. Like, you know, I think at the beginning you're just trying to make sure that you have something that works, and then you got to get the name out, you got to get people to notice that you're there. Yep. That's right. But at some point, like I but I feel like a lot of companies that, and maybe I'm wrong, Patrick. Correct me here, but like I think that's where a lot of companies got stuck. They never got to that, like, okay, people know us. Now we need to get serious about what we're doing. Because that burn rate, when you're when you're trying to quote get the name out, it it can it is often very, very crazy high. But at some point, you're like, all right, we we the the market knows us, now it's time to go sell. And that that's a different level of spending, right?

Series C And The Pre IPO Story

SPEAKER_06 37:22

It it is. So if we kind of go back, we've touched on this, you're you're now entering the you're sort of entering C and D round funding now, just to kind of try to tie this back for everybody. So if we kind of go all the way back, we got angels, they get us started. Okay. Sometimes you'll hear that called seed stage, by the way. We probably don't think I said that earlier. I probably should have. All right. Then you get to A. A funding is usually sort of validating product market fit. That's sort of what is happening right then. You start to scale a business model. B is typically where you're growing the team and you're trying to actually acquire some more customers, usually bigger customers. So that's sort of like an expansion round. Now you're talking about C and sort of beyond. Once you start to go into C, people start to talk about like aggressive scale, hyper growth, international expansion, we're gonna do acquisitions. Typically, is also when you hear people say, like, we're pre-IPO.

unknown 38:23

Yeah.

SPEAKER_02 38:23

Okay.

SPEAKER_06 38:24

All right. So let's maybe just spend 10 seconds on that because I think it's a good time to make this point. So back to we raised a bunch of money and we found four places to exit the company, right? Because it was worth three to five billion. All right. What what one did what what option did we not throw out there that could raise three to five billion? We could go public. Go public, yeah. Right. So also in the cards in these phases is somebody considering going public. So typically, if we've kind of gone angel, you know, pre seed angel A, B, C, D, valuations up, right? You know, now we're like, okay, we got to go again to James's earlier thing, we got to find liquidity. Okay, we want to go sell the business. Okay, there's four buyers, nobody's gonna buy it. The next thing you start to hear people talk about is, hey, we're pre-IPO. Because that's the other way you could picture creating enough value to sort of pay the investors and the employees. Does that make sense how that creeps into the conversation? Yeah.

SPEAKER_03 39:30

It is a whole other conversation now.

SPEAKER_05 39:32

Yeah, I and I've and I've been a part of companies that have been pre-IPO for like years.

SPEAKER_06 39:37

Yeah. Well, I mean, you got to keep the plate. Like, my joke is, you know, in the old days, actually, Jim and I might be the only two old enough for this. Do you remember like when they used to spin the plates at the circus gym? You didn't want the plates to fall? I mean, you know, you gotta keep you got to keep the plates spinning. So if the company's not gonna have an exit, you got you know, difficult guy like uh James on your doorstep saying, I want liquidity, what do you have to say to him? You gotta say, Don't worry, James, your investment's okay. This thing's pre-IPO, we're gonna get IPO'd, you're gonna get your money back. So, you know, you need a you need a story. So it makes sense why people do that.

SPEAKER_05 40:13

So we one more thing before we before we say, you know, this this epic this segment's done, and then we'll we'll come back for part two

Giving Up Control And Picking Partners

SPEAKER_05 40:21

in the next episode. But I want to talk about because it's we we're talking about giving up control of the company, right? I want to dive a little bit more into that because it's not just it in your example, like the investor gets to take a room in your house, but the investor also gets to tell you like if you're gonna go take that money out for a boat, they get to go shopping with you, right? They get they get a say in which boat you buy, they get to say in in how how high you turn up your heat in the winter and your AC up in the summer.

SPEAKER_06 40:46

Yep. No, that's right. So now it's interesting. So if you've ever been through these processes, at some stage, the person that you are talking to about raising the money is going to talk about how hands-on they are.

SPEAKER_02 41:04

Yeah.

SPEAKER_06 41:04

And some people say, hey, listen, we're hands-off and they mean it. Some people say they're hands-on and they mean it. In my experience, everybody is hands-on when something's going wrong. So, you know, no matter what gets said to you up front, there is no such thing as passive money when things are off the rails. Okay. Now, you can get left alone, all right, if things are going really, really well. But, you know, that doesn't mean, and I think people have like the wrong view of this. If you're going to take somebody's money in a private company context, it's no different than a public company in the sense that in a public company, you owe reporting to the shareholders in the street and all that sort of stuff. You know, you you actually owe your private investors the same thing. So, yes, you're giving up control. The distinction that I think is important is, you know, when I ran a public company, I had a bunch of shareholders. There were like maybe three or five that had big positions, but it was still three or five. You know, most of the time, what we're talking about here, there's one or two, you know, venture capital firms or private equity firms involved in a deal. So you really have like one shareholder. And so the amount of influence that they can exert can be quite high. Right. So, you know, oftentimes those things are described a little bit more like a marriage. And I think that's probably true because you both got into it together and you know, they're gonna want to have an opinion. They're going to have an opinion and they're gonna want you to take it seriously. That tends to be the place where founder friction starts to show up first.

SPEAKER_03 42:40

But that's why picking, you know, that you go into business with and who you're still part of your company with is you want to make sure you have great connections that your vision in many ways is shared. Because we're saying it in almost, I won't say a negative way, but like you said earlier, bringing skills to the company, you know, they can they may seem like them blocking or getting in the way or showing up and you know looking through your stuff. They may be helping to find you opportunities to build efficiencies, build, you know, go to market faster, you know, get rid of some waste that you've collected.

SPEAKER_06 43:12

That that's true. Somebody in the comments, you know, when I posted the one article, brought up, you know, the right venture capital firm can bring credibility to your company, you know. And I record when we did, you know, Google Client or Locks Icon, you know, those are like real firms, they'll bring some credibility to your company. And, you know, so like a lot of times this industry does get a bad bad rap. And I get it, finance people do a lot of silly things that get the that earn them the bad rap. But the reality is a bunch of these companies wouldn't exist without the backing of venture capital and the investment that people made. And there's a lot of great people that are in these places. And so maybe the way to like take Jim's point and make it hyper actionable is like if you're in a decision-making capacity on these kind of topics, I would worry less about the firm that you're working with, and I would worry more about the person at the firm that you're working with. Like if that person believes in what you're doing and does have a shared vision, all the things Jim just said, it's a great list. Like you want to work with that person. They happen to be at a firm. You know, I do think sometimes people get a little too focused on the name on the outside of the building. When the reality is your experience with, you know, any of those places I just listed is going to be because you deal with RAF at Pleiner or, you know, you deal with Jim at Icon or whatever. And you want to make sure the partner that you pick is somebody that you can work with as best you can.

SPEAKER_05 44:40

That's a good place to end it because this this is this conversation is just getting rolling. Come back for the next one on the next episode. We'll talk about what happens down the road, what happens when you miss that that exit window and all the fun stuff. Because we're all about touching that third rail, right, Patrick?

SPEAKER_06 44:57

I have a feeling this one was this one was good and educational and like pretty tame because so far in this conversation everything has gone for the most part well. I sort of feel like in part two, we have to do the part of like, you know, when uh when reality hits, what happens next?

SPEAKER_05 45:13

What when when that uh when that when that uh what's the uh what's that gif of the reporter that's standing there, a huge wave comes by and the giant mackerel just slaps her across the face.

SPEAKER_06 45:22

Yeah, and or or the the one where you want to be Homer that's fading into the bush, right? Yes, that one. Homer fading into the bushes.

SPEAKER_05 45:29

All right, guys, come back for the next

Part Two Teaser And Listener Questions

SPEAKER_05 45:32

episode. Patrick, thank you so much for doing this. We're gonna give it some thoughts. We're gonna come back for part two. Jim James, awesome having you guys on board. And uh, this is obviously the conversation, you know, uh to ask questions and less less the hate mail, but you know, questions, concerns, comments. And this will go up on LinkedIn in in the uh down the security rabbit hole podcast group, and I'm sure Patrick will have it a link to it as well and everybody else. So let's let's uh let's ask the questions that are on your mind. What did we forget? What did we not talk about? Where do you want to take this with? And then uh we'll take some of that and and and have the next conversation. We'll see you guys another time, another place on another down the security rabbit hole podcast for what did this thing before.