Years of experience as a serial entrepreneur and investor have given Nick Grouf insights into fundraising from both perspectives. Grouf had the idea for his first company while earning his MBA from HBS. He co-founded, bootstrapped, and grew Firefly into a successful tech venture that Microsoft acquired. After founding, scaling, and leading billion-dollar exits for several tech-startups, Grouf co-founded Clementine Capital, a tech-based incubator that birthed one of the fastest-growing companies in the US. He then launched Alpha Edison, a successful investment firm. Sitting on both sides of the fundraising table, he’s witnessed common mistakes many entrepreneurs make. In an unabridged conversation with Shikhar Ghosh, he identifies why founders should think carefully about who they raise money from, and shares tips on what investors look for in founding teams, how founder-CEOs can better manage their boards, and how to terminate an employee with dignity. An unedited transcript follows the video.
Nick Grouf interviewed by Shikhar Ghosh on October 18, 2019, at Klarman Studios, Harvard Business School.
Nick Grouf Shares Insights on Fundraising & Scaling
SHIKHAR GHOSH: So just as a starting point could you give us just a little background of the arc of your career? Because you’ve pretty much done everything.
NICK GROUF: Well. So I started my first company when I was at Harvard Business School, a company called Firefly. We pioneered personalization on the Internet. So we invented collaborative filtering. If you go to Amazon it recommends books or Netflix recommends movies, that was our core tech. And then-
SHIKHAR GHOSH: My daughter use my Amazon account and now I get these ads for women’s underwear. Really embarrassing.
NICK GROUF: It used to be that you got ads for a lot more than just underwear if you recall. We wrote the privacy standards, the P2P privacy standards and Microsoft became very interested in stepped in and acquired the company. We moved the team out to Redmond, [Washington] and we built .NET which as you know is the platform on which Microsoft does everything online. And then had a chance to join Softbank as an entrepreneur in residence and started a second company there called PeoplePC which we took public for a little over a billion dollars and then merged with EarthLink. And then I had the opportunity to oversee all the technology for John Kerry’s presidential campaign which is really the first time the technology and the Internet played a central role in the presidential cycle. And after our loss there started another company called Spot Runner in the advertising space which we built and eventually sold.
NICK GROUF: And then I wanted to see if I could start more than one company at a time and so I bought a warehouse building out in Los Angeles and started both incubating my own ideas as well as the ideas of a small group of entrepreneurs who I really respected. And had a lot of success with that. And as I worked on it we did over a dozen. One of them became the fastest-growing company in the US. We bootstrapped it on $25,000, did $4 million of revenue year one, $40 million in year two, $120 million in year three. They were number one on the Inc, what is it the INC 5000 list or something like that. But what I realized was that we’re in a good economy, good economies don’t last forever and I was using my own capital. And that it was going to be hard to insulate these companies myself if there were a severe downturn and you and I have been through a couple of those already.
So a combination of that and really wanting to rethink the venture model led me to start a new company which is a venture capital firm but we try to think about the venture and investing and the sort of way that, traditionally, venture capitalists have tackled the issue in a different way. And so far so good.
SHIKHAR GHOSH: So what’s different about your model?
NICK GROUF: Well there are a couple of things. One of the things that’s happened with venture is it’s become very reactive. There’s been probably an order of magnitude increase in deals and it’s very easy to sit back, be passive, and let the deals come in. And the other thing is that venture capitalists do exactly the opposite of what we would tell any entrepreneur to do. Entrepreneurs go out, they find a challenge or a problem in the marketplace, they study it, they think about solutions, they identify what they believe is the best solution and then if they really have conviction they go out and build a business and raise capital. Venture capitalists do the opposite. They go, out raise capital, and then they sit in their office waiting for a great idea to come in. And the challenge is when the entrepreneur walks in the entrepreneur says “Well there’s this big problem” and the venture capitalist has to think “Well. Is there a problem. And if it is a problem is this the best solution. And if it is the best solution, is this the best company solving that problem?”
And usually, you only have a couple of weeks to make a final investment decision and so it leads to a lot of cognitive bias. And what we describe as type two errors which are errors where you looked at an opportunity, you missed it either because you passed, something more distracting came along, you didn’t understand it and it goes on to sort of outperform. And while the errors that we make when we actually invest and the company underperforms are painful; those errors where the company does 50-100 acts are obviously far more expensive. And what we found was that when we looked at the errors that we had made his investors and that the investors we most respect had made what we discovered was that the best investors, say the top ten or 20, they still are making type two errors on the rate of 90 plus percent. And the question was why are some of the very best investors in this category missing their very best opportunities. And so that’s one way that we’re different.
NICK GROUF: And then a second way is that we really believe that there’s an opportunity to be much more systematic and less of a mom and pop industry.
SHIKHAR GHOSH: How do you answer the first one?
NICK GROUF: The first one?
SHIKHAR GHOSH: The first thing where they’re making mistakes. So what do you do differently?
NICK GROUF: So what you have to do is proactively go out and study the market like entrepreneurs are. Look for problems in the market. Typically what sits behind those problems are not just customer pain or need but huge pools of pent up latency, typically latent demand, sometimes latent supply. The best companies are not companies that are stealing competitive shares from an incumbent here and there. They’re companies that are really unlocking this latency, creating new markets, and building extraordinary value. And oftentimes in those circumstances, it’s not winner take all but it’s often winner take most. If you look at the Air B&Bs or the Ubers all of these are very classic examples of that.
So instead of sitting back, develop a clear thesis, bring in lots of disparate intellectual skills to the firm, so we have behavioral scientists and data scientists and other social scientists who participate in this process with us. Identify the problem, map the ecosystem, go speak to all of the companies that are active in that space, and then select those that you think are best positioned to capitalize on the opportunity.
SHIKHAR GHOSH: You’ve been an entrepreneur right out of business school, you’ve built some really big companies. You’ve been an investor. You’ve been at SoftBank, a sort of huge investment fund. You started your own fund. You must have seen the entrepreneurial journey from many different lenses. And so if you look at sort of common mistakes or common things where people just sort of get it wrong where they could have gotten it right what are some that just come to mind?
NICK GROUF: Well, first of all, I should say that I’m a big believer that mistakes are good. It’s where we learn. We tend not to learn as much when things go well. But we do see a lot of mistakes and candidly I’ve made a lot of mistakes. I think that all of us have a responsibility to learn from them and try not to make them too many times and really try to share that knowledge with other people, particularly new younger entrepreneurs, so they can make their own mistakes instead of mistakes people like us have already made.
But in that context, we see a lot of stuff. And a couple of things that jump out at me. The first is that people really don’t spend enough time thinking about the business model. So understanding the very fundamental basics of who is the customer or are the customers. Because a lot of the models that we see today there are multiple levels of customers and participation. What are their incentives to participate? What is the economic value? What are the competitive dynamics? Particularly if you’re thinking about disrupting an industry, what are the consequences of that. How will players respond? I think oftentimes entrepreneurs believe that if they align closely with the existing players in the industry that will give them some sort of halo or protection. But the truth is that that usually is a destructive path and it prevents you from thinking independently about the best decisions for the strategy that you’re pursuing.
So really understanding fundamentally [the] business model and being able to communicate that whether that’s to your employees, to your customers, to your strategic partners, or to your investors. And we see people unable to do that quite a bit. And the extra work that it takes which is probably measured in days and weeks, certainly not months or years, to be very crisp and concise and think things through and identify the challenges allows you to avoid making the challenges when you’re now 10-20-50 million dollars into the opportunity and still have failed to think through what the consequences might be.
SHIKHAR GHOSH: Everyone says that VC is the first thing they look at particularly in a very early stage company is the quality of the team. You see lots and lots of teams coming to you and you must have something that says within the first I don’t know half an hour.
NICK GROUF: Yeah there a couple of things that we look at. We look at risk profile and tolerance for risk. And what we’re not looking for is a blind tolerance for risk. What we’re looking for is a thoughtful and pragmatic tolerance for risk. And there are a number of things that help you identify that but a lot of it has to do with how people think and think about sort of the consequence of the decisions that they’re typically faced with.
SHIKHAR GHOSH: Can you give me an example of that?
NICK GROUF: Oh God, there are so many examples of that. But if you look at… I’ll use a controversial example which is Travis at Uber. So part of the success of Uber was a philosophical decision to not ask for permission but ask for forgiveness. It ruffled a lot of feathers, it created a lot of trouble.
SHIKHAR GHOSH: Also created a whole industry.
NICK GROUF: And built an entire industry. Now in their case, I think they’ve done a very good job of it but there’s been a lot of cleanup that’s happened over the past year as Dara has come on board and taken on the reins to sort of take the company into a more mature stance as an organization. If you look at the business of scooters, electronic scooters. In California, they are everywhere littering the streets. They did not do as good a job so far at figuring out how to balance doing what they thought was right for the business and building the right relationships with the municipalities under whose jurisdiction they operate. And that’s created quite a bit of backlash recently. And so far I don’t think that they’ve done as successful a job of finding ways to work constructively, particularly the early movers like Bird as an example and Lime. And we’re investors in Bird so we know the company well. We’re very bullish about the prospects of the industry in general but there’s going to be a tremendous amount of tunneled eye and finding a way to balance maturity with a responsible pioneering spirit.
SHIKHAR GHOSH: A pioneering spirit.
NICK GROUF: Exactly. Is so important.
SHIKHAR GHOSH: If you think about the team itself and the composition of a team, what are you looking for in that? If you look at Team A and Team B and you say this one’s good, this one’s not. What are the ingredients of that?
NICK GROUF: Yeah, you’re looking for—obviously intelligence—but one of the things that I’ve learned is that raw intellectual horsepower is nowhere near as valuable as clarity of thought. And so what you’re really looking for is clarity. The ability to communicate that. The ability to take in disparate ideas, process them, process challenging questions, and do it in a way that’s not arrogant but that’s respectful of trying to find the truth. And it’s that intellectual integrity that we think is so important.
One of the ways we get at it is we ask people oftentimes what they’re most insecure about which is a funny question to ask in a fundraising circumstance or in a job interview. But what happens when you ask that question is that people are forced to decide if they’re going to present themselves as vulnerable in that moment. And what I found is that when you’re dealing with the early-stage companies or really if you’re in a big company and you make a mistake and you hide it, six months later it blows up and it’s really embarrassing. If you’re in a small company and you hide it, six months later it blows up and it can be fatal.
SHIKHAR GHOSH: Or six days later.
NICK GROUF: Anytime. And what you want on the team are people who are very introspective, understand their strengths and weaknesses, know where they have opportunities to grow and who are not afraid to ask for help, to raise their hand and say, “I screwed up. Somebody come help me.” Because the great thing about early-stage businesses there’s tremendous camaraderie and people will flood in to solve the problem and support the team. And what I found is that if people sit there and tell you “Well I really am not insecure about anything” it’s one of the clearest indicators that this is not somebody who’s gonna be a good cultural fit for an early-stage company.
NICK GROUF: A lot of people will use the metaphor of a foxhole and if you’re in the foxhole fighting it out, a grenade rolls in, you want the person with the best arm picking it up not the person who wants to prove that they have the best arm to throw that grenade out. And so going to the places where people are forced to be vulnerable and be vulnerable in a way that’s authentic tells you a lot about somebody’s character. We care a lot about teams where you have disparate skill sets, disparate levels of experience or insight and tremendous comfort with those differences. And one of the things that we often look for is we go to the core again of the business model and think about what are the critical skills that are going to be necessary to make this company successful and how are those going to be represented in members of the team.
And it’s an interesting exercise because I believe that entrepreneurs spend a lot of time thinking about the construction of that team. I wish they spent as much time thinking about the construction of their board because in many ways the talent that you’re looking for in the team that you need to create marketing expertise, that you need great product management expertise, you might need great expertise around international or finance, et cetera.
You want that reflected on your board as well. And all too often what you see on these early-stage boards are venture capitalists and friendly independent directors of venture capitalists and founders. And oftentimes that does not present enough diversity of thought and all too many times as we both know it doesn’t present enough diversity of life experience and perspective whether that be gender or ethnicity or background to really best position a company.
SHIKHAR GHOSH: So if you were advising a first-time founder who had an interesting idea, lots of interest from people to give capital and they were putting together a board or thinking about how to put that together what would you say?
NICK GROUF: I think it starts with where you take your money. And a lot of people think that taking the highest offer is the best idea. And I’m sure you talk about this a lot, but who the people are really matters. And if you’ve been through this as much as I have and you have what you learn very quickly is that great board members can be invaluable and bad board members can be extraordinarily destructive, not just useless but truly destructive. In taking the company in the wrong direction or focusing on areas that are just tangential to the real opportunity or having incentives or other interests that diverge from the core interests of the company and its shareholders.
SHIKHAR GHOSH: In the early stages one of the problems that founders face is that there’s this huge imbalance of information and most VCs who have funds are actually really good at marketing themselves. How can a founder actually tell what this board or this VC on their board is going to be like?
NICK GROUF: Yeah I think the most important thing you can do is go speak to other entrepreneurs and particularly speak to entrepreneurs whose companies did not succeed and find out how the investors behaved in circumstances where things are difficult. If you’ve ever had a challenge in your life you quickly are able to understand who your real friends are and who your real friends are not. And what you’re looking for are people who are going to lock arms with you when things get tough and you and I both know that companies at this stage face failure several times before they ultimately find success.
SHIKHAR GHOSH: Or failure.
NICK GROUF: Or failure. That’s right. And we believe in our firm. What we do is we aspire to earn the right to be the first call that an entrepreneur makes when something happens and it’s great when something good happens. But if we’re the last people called we’re fine. But when things get really difficult we want to get in there, roll up our sleeves and really help because it’s in those moments that there’s creative friction, when the business model is really refined, when some of the most important decisions are made. And we think that it’s our responsibility, not just to the entrepreneurs that we work with but to other shareholders in the company and to our limited partners who invest in our fund to really go in there and work. And we believe also that’s a great way to build a true brand and a great way to build deep relationships in the community that go beyond a single investment.
SHIKHAR GHOSH: Noam Wasserman has this paper that he’s published that say founders get replaced when things are going really badly. And a lot of founders get replaced when things are going really well. And that’s because the growth is going to be really high and there’s a question about whether the founder can take it to the next level if it’s growing at such a rate that there isn’t much time.
NICK GROUF: Sure.
SHIKHAR GHOSH: When you look at scaling and companies that are doing well and growing really fast and you’ve had a few of those. What are the things that really good founders do in order to manage that process since the company is going to need to be managed differently?
NICK GROUF: Sure. Yeah. I wrote a piece about this which I think we called something like 1000 Hats and it’s this idea that when you start a company you’re wearing a 1000 hats and your job is to sort of delegate that work and hand these hats off to other people as you scale and grow.
SHIKHAR GHOSH: That’s a great metaphor.
NICK GROUF: And one of the nice things about that story is that eventually you’re left with one hat and a lot of people think if they hand off that hat it’s a sign of failure. But the truth is that if you can hand that hat off and the company is successful that is a real sign of success. Now going to your question, what I’ve come to realize is that people tend to grow in a step function. So there’s this moment of growth and then a period of digestion of the knowledge, experience, et cetera and then a new moment of growth. Companies, their growth tends to map out a little more linearly.
NICK GROUF: And so you have circumstances where sometimes the company is growing faster than the people that are involved with the business. I think it’s a responsibility of everybody around a company to try to identify when that’s happening and have a candid conversation about it. What often happens is that the decision to maybe change leadership of the company is conflated with the decision of whether somebody should be with the company or not with the company. Founders I think have an extraordinarily important role inside a company at all times. I think most founding CEOs are better equipped to suffer through the challenges of a business and to really not only have the vision for the initial opportunity but all the derivative opportunities that tend to crest over that original vision when you have a truly extraordinary company.
SHIKHAR GHOSH: Yeah, they’re also the ones that almost provide the DNA for the company.
NICK GROUF: That’s right.
SHIKHAR GHOSH: They become the keepers of the culture in many ways.
NICK GROUF: But when I started my first company I was here at HBS. I was, I think, 25 years old and I went to sit down with Mitch Kapor. And Mitch at first didn’t think I was qualified and ultimately said “I think you can do this but you have one responsibility and that job is to know what you do not know and then surround yourself with people who really do have the knowledge that you’re missing.
And that knowledge can be manifest as experience or knowledge as we describe it or some other insight.” And I think that that’s the job of every entrepreneur. I think that’s the job of anyone who is operating in a business or other sort of organization in society. Know what you don’t know, recognize that, know when you’re playing to your strengths, know when you’re working on your weaknesses or development opportunities as some people like to say. And don’t be afraid of asking for help because no great company is built by a single individual and that is proven over and over again. And anybody who’s at the top of a company who is trying to cultivate a sense that that’s true is just not telling the truth.
SHIKHAR GHOSH: Last question. Founders, especially if a company is growing, have to hire a whole bunch of people and people say that your focus shifts from product to people. What process have you seen where founders select and hire really great people? Is there anything in your experience that stands out?
NICK GROUF: Well everybody talks about this but you can’t say it enough. Your job is to hire people who are better than you. Because you’re a founder you have a unique role and a unique opportunity. And if you’re lucky you get to hire people that are dramatically better than you and they’re coming on board because you have something that they don’t have which is vision, which is the courage to start the business.
Maybe it’s just the comfort with the risks that are associated with it. But they are looking for a partner and you are looking for a partner. And you can see this play out. A great example of that is Mark Zuckerberg making the decision to bring in Sheryl early on. That took tremendous courage. They’re very different personalities and people and they have an extraordinary-
SHIKHAR GHOSH: Or Sergei and Eric.
NICK GROUF: Exactly. Sergei and Larry and Eric. And with the understanding that one day Sergei and Larry would take the reins again which they ultimately did. That is a difficult thing to do. But I think that it is often directly correlated to success. And then the second thing is: build an organization for hiring, as well as sort of the process of investing in your human capital. And ultimately terminating people when you need to. Do it in a way that really respects the individual and is populated with people that are extraordinary at that skill.
Too often when people are terminated they’re not seen as potential ambassadors for the company as they leave. And the fact that they were not the right person for the role at the time is often confused with they shouldn’t leave with their dignity. And there are lots of ways to let people go in a way that their head is held high, that they continue to feel a part of the company that they were involved with building and the community that’s building that company and become extensions of that. And too often because of anxiety or just a lack of maturity in termination we let people go in a way that is not respectful.
SHIKHAR GHOSH: The valley is full of people who’ve been let go from other people then become incredibly successful. And the way they feel about you and about the organization that they left makes such a huge difference.
NICK GROUF: It reminds me, I know this is a little off subject but it reminds me of something which is, very few of us have only been in one romantic relationship. Romantic relationships often don’t succeed. And somebody once said to me that you do the most growing between those relationships. Really growing the understanding of who you are and who you want to be. I think a lot of that’s true professionally as well, that these in-between periods are really opportunities to take stock and think about who you are and who you want to be and tremendous growth happens there. And too often we don’t look at that as an opportunity when it happens. And it happens to everybody.