A Bad Investor is Worse Than No Investor

Sean Weisbrot: What is so mesmerizing for you about putting together a deal?

Scott Kelly: I think the thing that's most mesmerizing is finding a company that is unknown to the investor community. Helping them structure their pitch deck, their deal room, their presentation, and then putting 'em in front of the right investor who is not only gonna just provide them capital, but provide them access, advice, coaching, and other things. And I think that's the thing that I. It is probably most mesmerizing to me is the art of finding the right partner. 'cause that's essentially everything, especially when you're an early stage startup.

Sean Weisbrot: I attempted to do this kind of a business in the past in the blockchain industry. It was very successful for me for fundraising and helping them with the support outside of the blockchain industry. I found it to be far more difficult to do. And the vast majority of startups fail. So are you specifically looking for companies that you know have a higher chance of success, or are you just raising because they've come to you and you believe there's a chance? What are you looking for?

Scott Kelly: Yeah, I'm somewhat selective in the companies I work for. 'cause the reality is they've gotta have a solid founder team. The reality it's hard work. So they gotta have the tenacity to be able to hear no, a lot, be able to pivot often. , So I really look at the founders of the company, the people who are starting it, and who they are, what their background is. Because until you have product market fit, until you have revenue and sales, you're really relying on that founder. So that's almost exclusively what I look at first. and that really can help determine the success. Now you're right. the vast majority of startups fail. the vast majority of entrepreneurs don't raise capital. and honestly, there's a lot of opportunities for companies to be successful without raising a single dollar capital. And we don't necessarily raise capital for everybody. There are some companies that just need help with go to market. Need to generate sales. I tell people all the time that the best non-dilutive capital you can get is when you go out and sell your product and service. And so in many cases, we help them go to scale, and either delay or avoid, the fundraising portion of it.

Sean Weisbrot: That was my goal with my tech company was I, self-funded for as long as I could, because the goal was let's get this thing out there. Let's get revenue, and when we go to raise money, it's because we don't need it. And that didn't happen. And the, startup died. we did raise money, but the startup did die, unfortunately, because we didn't get all of the money that we were promised. And because I. Didn't know what I didn't know. So there was a lot of different things there. I'm curious for someone who. Wants to start a company that could raise money in the future? Is the most important thing that they need to know before they even make the decision to start that company?

Scott Kelly: They need to know they have a market and a customer base for their product or service. I find, I tell entrepreneurs all the time. you've gotta find a problem that has enough people that need to solve that problem, and you need to do some testing of whether or not your service or product can solve that problem for 'em in a more efficient fashion, whether that be faster or, less expensive, or whatever the case may be. I think, a lot of entrepreneurs don't do the research. As whether or not they have what's called, product market fit, or, and I think that's almost entirely, true with the vast majority of unsuccessful founders. they, they believe the wrong cooking, before they find other people that are interested in, and taking advantage of it.

Sean Weisbrot: I've heard this and I'd like to know what you think about it. The difference between a startup founder who raises money and a bootstrap founder is that the bootstrap founder typically has probably been in the industry and has seen a problem and understands that, that their solution will solve the problem, and therefore they just have to go and get the customers and. The startup founder who raises money is someone who doesn't know the industry, thinks that they've got an idea that could solve a problem and raises money to figure out if that works or not.

Scott Kelly: I think that's partially true. I think, in either case, the entrepreneur needs to solve a viable problem. But in the first case, when you mention someone who's bootstrapped, they may be bootstrapped because they don't have a network of investors to go after. They don't live in, Northern California and you can go to, an a, a business school. so they are in some cases are bootstrapping outta necessity. But in other cases, they're bootstrapping because they, like you mentioned, they do understand the business. They've been in the business for a while. we have an entrepreneur that we're working with now that, was in the construction business, been very successful in the construction business, is now building a, an AI model for the construction business. And he is totally self-funded up to this point. it's not to say he's not going to raise capital, at some point, but he at least knows the industry. He has some potential customers he could put in front of it, and I think that's the primary difference. fundraising gets a, Gets probably too much press in all honesty. everyone talks about the company that raised capital, but not a lot of people talk about the people that bootstrapped the business to a successful exit. And I think sometimes entrepreneurs get caught up with the goal of raising capital versus the goal of building a successful business.

Sean Weisbrot: And that's something that I tell people who come to me and say, I wanna raise money for a business. And I'm like, are you sure? Do you, actually need this money? so my degree is in psychology and so I look at everything from a lens of, psychology when I do anything. And so when I'm having conversations with these entrepreneurs, my thought process is, have you actually thought about the kind of lifestyle that you wanna have? Because I went through this, I had a bootstrap business that did eight figures, and then I used some of the profit to bootstrap. until I raised money for the tech company that failed and never launched, never had a single dollar of revenue. And I realized during the process of becoming of trying to become a tech CEO, that it wasn't actually the life I wanted. I didn't wanna have a multi-billion dollar company that was publicly listed, like I didn't want to have millions upon millions of dollars raised by investors. I didn't want to potentially be so successful that I lost my anonymity and had to hire security guards to keep my family safe. That just wasn't the kind of person I was, that wasn't life I wanted, I didn't wanna have tens of thousands of employees to manage. I was really happy with that consulting business that did eight figures. And so after that business failed, I went back to. Doing that. obviously the industries have changed, so it's not exactly the same business, but essentially I went back to the old model that I was running where it was me and some contractors and very lean. and so I push very heavily on people who say, I have an idea. My first question is, yeah, but have you thought about how that idea is going to impact your life? And, is that gonna vibe?

Scott Kelly: Yeah, I agree a hundred percent. in a lot of cases you gotta determine. make a decision between the, quantity of your life or the quality of your life. And being an entrepreneur, running a startup is a full-time job, and it's a multiple full-time job. You are spending 80 hours, you are hearing nothing but rejection from investors, from partners, from, clients and customers. So I think it's a grind and, you have to be wired a certain way in order to go without a paycheck, live on that ramen budget while you're growing something, whether it's bootstrapped or whether you bring on investors, because, essentially when you are bringing on some early investors, many of them want you to continue to be eating on a ramen budget, until they get paid. so I think, I would agree with that. You really have to really look inside yourself. To whether or not you want to go through what could be a very long, difficult process with, quite frankly, the odds against you.

Sean Weisbrot: So one of my closest friends has bootstrapped a SaaS business for the last 14 years, and they're on track to do 10 million for the first time ever this year after acquiring, another business. We've had conversations over the years. I've known him for nearly 30 years. We've had conversations over the years about should I raise, should I not raise? 'cause he looks at some of his competitors and they've raised 20 million or a hundred million. And I say to him the same thing. Like right now you own a hundred percent. His brother and him own the business. So you own half of the business. You have complete say over what's going on in the business. The only reason that you would raise money right now? Is because you have a massive expansion strategy that either includes moving into new geographical markets because their ba, their business is, serving hotel companies. And so they're mostly focused in the US and they've done a little bit of expansion into Europe. So if they raised, let's say 20, 50, a hundred million dollars, it would be to enter new markets basically, or to acquire some other competitors that maybe they can get access to their customer base. So it'd be a very focused raise and. but when you do those things, you lose some semblance of control, including if there's now suddenly $20 million of profit in the business, that money isn't yours anymore. You can't do with it what you want. But when you own a hundred percent of the company and you have 20 million in cash sitting in the bank, you could put all of that in your pocket if you wanted to. Yep. And so we, he's flip flopped back and forth over the years with this idea of should I raise, but never, should I sell?

Scott Kelly: You can look at several examples out there. several years ago, MailChimp, the email marketing company, had two founders that owned 98% of the company didn't raise a single dollar and sold it, and so they kept 98% of the sales proceeds. And as opposed to give it to an investor. And on the flip side, I believe it was FanDuel that raised literally hundreds of millions of venture capital dollars. and when they got sold, the founders got little or nothing in the transaction because of preference items, liquidity preference items that the investors had. And, they got diluted to the point where they were no longer the owners of the business. They were the employees of the business. So I think you do have to look really hard. About the path, and I think entrepreneurs have to understand it too, is that, venture capital isn't the, for everybody. Equity investments isn't the only option. you can look at debt, you can look at other forms of financing. we have many early stage companies that use grant financing, to get to where they are. so I think you, you have to be, you have to go into that with your eyes wide open.

Sean Weisbrot: Yeah, I think Europe is pretty good about grants. I have friends in France that raised I think a million euros from the French government in order to start the business a long time ago. I. there's a lot of opportunity for, as you said, different kinds of funding, and I think there's not enough resources out there for founders to know more about how to access those things. there was a guy I invested in Canada who. He didn't have a good credit score 'cause he had a problem with debt previously and he had paid off the debt, but the, his credit score was still low and so he couldn't get a loan from the bank. He couldn't get a small business association loan and so he had to turn to someone like me to, give him a loan. And then I, we converted the loan into equity and, There. I think there's so many people that struggle to get access to that kind of money.

Scott Kelly: I agree. I think there, those aren't enough resources out there. we've done webinars and we have partners that, provide access to grants and a non dilutive financing, ta, RED, tax credits, our way to get some of that development money back. There's a lot of resources that you can help, fund to grow your business. But like I mentioned in the beginning, the best way to raise capital is go out and sell.

Sean Weisbrot: For sure. So I want to focus more on m and a, so you know, acqui acquisition, because that's, I think those are more exciting than these earlier stage fundraisings. So I've spoken to people who run PE firms. I've spoken to VC investors, I've spoken to angel investors, I've spoken to business owners that have sold. Everybody loves this idea of selling a business or acquiring a business. Why is it such a sexy thing?

Scott Kelly: I think it's sexy from a couple of standpoints. One, it is a way to accelerate your growth much faster. You can add new product lines that you didn't have previously going to new markets. Whether different industry markets or geographic markets. So it provides that opportunity. And and the reality is the hope is when you do a transaction that, one plus one equals three to five, not two. And I think that's the sexy part of it, is be able to grow faster. the reality is you can, grind it out and grow your business or you can buy revenue, I spent many years working with companies that they did just that. Many years ago, we had a company that was in the analog, wireless space. when digital came out, what they did is they bought all the analog bandwidth around the country through acquisition. they acquired close to $300 million in revenue, none internally, all by acquisition, and then subsequently sold them on, sold the business to a very large private equity firm at a significant profit. I, think that's the sexy part of it, is that you see. the, the speed of how you can grow and obviously you've gotta make sure you put together a good deal. 'cause all comes down to terms, and, you need to make sure that you, if you're going to get into bed with another company, that you get along with them or you have a way for them, or they understand, what's gonna happen post acquisition.

Sean Weisbrot: So what are the failures you've seen post-acquisition, if any?

Scott Kelly: I think a lot of it comes down to, poor founder fit. there's been many transactions where it's not necessarily an acquisition, it's more of a merger. And then you have cultural differences, business plan differences with the founders of both companies. I think the reality is a lot of times it happens where there's not proper due diligence. I think sometimes if you're buying assets of a company, you need to make sure those assets are what they say they are, that they're generating the revenue and the value that you paid for it. And I think many times you'll find deals that get unwound because of those two issues. And, then honestly it's comes down to, the financing and the terms of the deal. You want to, that's where the art comes in is, paying not too much, and getting, proper value.

Sean Weisbrot: So you hit on something really interesting that I've been thinking a lot about the last few weeks, which is the due diligence for, an acquisition. I'll tell you after we record why it's been so fascinating for me, but I've been thinking about this a lot because I know for a fact that when I was raising for my tech company, I felt like all of the investors I was talking to did basically no due diligence on me and gave me the money. Based on my personality and that they believed in my ability to do it. Unfortunately, I lost their money. I feel awful about it, but I did. Everything in my power to put together the most robust DD that I could put. You were talking about data rooms. I did my best because I'm a responsible person, I'm representing a company, I'm representing myself. I'm trying to raise a million dollars for my business. I wanna make sure that you have everything you have, but I felt like they didn't ask me questions that I would be asking me if I was gonna be giving me money, and so I see that. There's maybe the vast majority of these acquirers or these investors, they don't have operational experiences, and so they don't know what to ask. Or maybe they just don't care. I don't know. what do you see that's like allowing these DDs to fail?

Scott Kelly: I think it's a, common, and you, what everyone has to understand is you have to look at it from the. The, general partners standpoint of, a venture capital firm, okay? Most venture capital firms get compensated on what's called a two and 20. Okay? They get a two perc, they get this management fee on the heavy assets that they deploy. So they are motivated to deploy assets. Okay? And, honestly, they're, motivated to maximize profits for them and their limited partners. and I think there's been a lot of changes over the course of the last couple years, and even more so you hear a lot over the next, last six months is that venture capital is changing, that the old model is not necessarily working as, as well. The, model of investing in 10 startups knowing eight could fail. Hoping the other two give you the proper rate of return, and there's a lot of PAC mentality, especially with the large, name brand venture capital firms. it's, years ago when I was teaching at the university, there was this old, thing that came out about, McDonald's spending a half a million dollars about where to put a McDonald's. Burger King waited for the McDonald's to go up and put within a two mile radius. And I think in some cases that is, you've got that fomo, with a lot of venture capital firms. And, I, we work with a lot of, newer funds and newer firms and, they get a better, return because they do that due diligence. But you're right. Honestly, I'm gonna be on a call a little later today with one of our portfolio companies and a venture capital firm, and we're talking to their analyst who is a year outta college. and that's what, so that, so you, have to understand, VC firms and even angel investors have to work at scale. they have to get through a lot of companies fast. Find those companies are going to invest in. And, the reality is you, it's FOMO more than anything else out there with the major VC firms in my opinion.

Sean Weisbrot: So what I'm hearing is they're not doing proper DD so that they can get into the deal as fast as possible, faster than anyone else, and, or they just want to keep more of the money for their own salaries, so they don't wanna spend it on DD.

Scott Kelly: I wouldn't necessarily make that as a general statement for all Venture California. There's 3,200 VCs in the US and the vast majority of the capital goes into a couple of dozen of them, in a handful of markets. but I think what's happening now is that you see trends. when I was running my company's internet. You could put ".com" on a lightbulb and people would give you money. and it, we're not too far away from that in ai. and so I think there is part, that's part of it. and honestly I think it's incumbent upon the entrepreneurs to do some due diligence on their investors. As much as the investors are doing due diligence on them, they should be asked, they should be talking to other portfolio companies to see what more they got besides the check. they, need to do their homework. As I tell a lot of entrepreneurs, a bad investor is worse than no investor. And you've gotta be really, you gotta do your diligence on the investor side as much as the, the investors may or may not do diligence, due diligence on you.

Sean Weisbrot: So if there was a service to help these, VC firms, do you think that would be valuable? That they would be willing to pay for an external partner to take care of that.

Scott Kelly: They do, and they have. Yeah. You'll find a lot of the larger, venture capital firms and even smaller, mid-size, firms, will hire a consulting firm or an outsourced, due diligence service. I think that's, that's a more efficient way to get it done. I, there's several companies that you know, that I know of that. I've used outsource and other, contractors to, do, perform certain parts of it. at the end of the day, the general partner has the ability to make the decision. but the, in order to make proper decisions, you gotta scale a lot and look at a lot of companies. And sometimes, the general partner can't necessarily be on hundreds of phone calls a month, in order to find those one or two gyms. So there's obviously several ways too. divvy up that, those needs.

Sean Weisbrot: Do you think this audit is, or this due diligence is more important for these early stage startups with VCs or with companies that are being acquired really for the acquirer?

Scott Kelly: I think it's important for both and probably for different reasons. If you're an early stage startup and you're a new founder, they're going to spend more time doing due diligence. That, and you need to be prepared for that. if you're a founder of a startup that's had several successful exits and have had several successful races. The due diligence might be, more of a personal due diligence or a conversation versus a full on audit of, their books and everything else. and on the MEA side, they, it's really gonna be about assessing the quality of the assets and the price you're paying for it. you, that those are factors you, you are gonna be very, important in an m and a transactions.

Sean Weisbrot: I've spoken with a few, PE firms as I mentioned previously, and they seem to be in consensus at their size where they're doing eight figure transactions, but they haven't really done too many yet. maybe three, four, or five, but that they still struggle with the ability to audit and to do due diligence on the companies that they're acquiring.

Scott Kelly: I would tend to agree that keep in mind you're dealing, especially if you're dealing with a private company, you have to. Rely on the acquirer, the acquire to, have good books, have good legal counsel, be able to account for their assets. in the public markets it's a little bit easier because, public companies have to report on a quarterly basis, the market will say what the value is of the company. so I think when you're trying to value assets, and you're, and like startup investing, you're making an assumption. That the acquisition or the investment is going to be additive to the company and added additive at a level that's gonna provide a good return in a reasonable amount of time. so it, it's a challenge and it's, there's some science to it, but there's some art to it also. Of all of the types of people that you work with, who are your favorite? Wow. My favorite ones are honestly the ones that don't need to raise the money. But may raise money, they've been able to build a business on their own to have grit. in the early mid nineties, I left my h bigger job as an investment banker and just ran, start, started my own business, with a partner of mine. And they were fortunate to have an exit, four years later. but the reality is I didn't raise a dime of capital. I just sold. and I think those are the entrepreneurs I like. 'cause at the end of the day, I think sales has become a lost start. everyone relies on social media or paid ads or some type of model where someone's not on a phone call or not in a room with somebody asking them to give them a check. those are the people that I like to work with. 'cause if they can, ask those kind of questions. If they can ask almost any kind of question that's necessary to succeed.

Sean Weisbrot: Fair. This is something that I've come to learn as well from interviewing people because when I started the podcast five years ago was when I was in the early days of the startup, and so I went into it with this mindset of I'm gonna be talking to people that have. Dozens or hundreds of employees for the purposes of building a waiting list for our product. And what I came to realize was that the vast majority of the people that I was interviewing, they all came to me like yourself saying, Hey, I heard about your podcast. I'd love to, be a guest. What do you think? And then we talked and I realized that the vast majority of people coming to me have never raised a single dollar. And they're running seven, eight, some even nine figure brands. Yep. A hundred percent of them said, I love my life. Things are good because at that stage, they've been able to remove themselves slightly or completely from the daily operations of the business, and yet they can still decide how much money they take home. They could decide to skip work a day and go to the beach with their family. They can spend their days however they want. But the founders that I've spoken to who've raised money from VCs in the even a million dollar range, but I've interviewed people that have raised up to 80 million so far, and every single one of them are miserably stressed and every day is a grind. And so as I was building that business, the more and more I spoke to these founders that hadn't raised the money, the more I was like, ah, I made a mistake. I made a mistake.

Scott Kelly: I own 100% of my company and, I call 100% of the shots. because I, learned that lesson the hard way, running a public company, being responsible for shareholders, and, the government and regulators and lawyers and accountants. That wasn't a lifestyle I wanted. And, I tell, I, every entrepreneur I talk to, I ask them many of the questions you asked is that, What does your end look like? And if you get to that end, are you gonna be happy? because that really motivates and dictates a lot of the decisions entrepreneurs make. I think you have to start with the end in mind first. and I think the reality is if your end in mind is to have a, a lifestyle business or a business, give to your family or a business that provides you the, income and the freedom that you want, don't go raise capital. If you're looking to, be on Bloomberg and the Wall Street Journal and and you'd be famous for raising millions or billions of dollars. understand there's a lot of pluses to that, but there are a lot of negatives that come along with it.

Sean Weisbrot: Would you say that's the most important thing you've learned so far, or is there something even more important?

Scott Kelly: I think the most important thing for me is that, I'm 61. I've been in all sides of the transaction I've made and lost hundreds of millions of dollars in my career. So I don't have the fear of loss because I've lost and overcome. but for me, it's about having, enjoying my life. I've had two offers to sell my business, and I've turned it down 'cause I enjoy what I do. When the time comes, I'll make that decision. but I get to make that decision. If I have investors that own a, large stake, and God forbid, a majority stake, they'll, make the decision of whether I stay or go. and I prefer to, have the freedom call my own shots.