Be a Shadow Co-Founder
Nivi: Do you think there’s an opportunity to build a brand investing at the pre-seed stage before—or simultaneous with—accelerators?
Naval: Accelerators give advice on how to start a company at scale. They don’t give you that much money, but they give you important know-how: how to put your company together, recruit and rev your idea; when it’s ready for investors; how to approach the first customers and measure customer growth; how to get your MVP out there.
Accelerators are training wheels until you’re ready to go raise money. An angel investor can do this—they just have to put in the time. And, actually, it’s the best place to play because the valuations at the seed stage are where Series A rounds used to be.
Be a shadow co-founder to create your own dealflow
The best way to get good valuations and dealflow is to create it yourself: Ally yourself with entrepreneurs and become their shadow business co-founder.
When technical entrepreneurs start out, they often give up half or two-thirds of their company to a seller, who helps put the company together and raises the money.
You can help founders put their companies together. You can put in the first bit of money. In return, you can might be able to get common equity or, at least, favorable investment terms. Later, you can help recruit a seller for 5% or 10% of the company, as opposed to 50%.
Nivi: If you’re investing at the pre-seed stage, you can back great teams, set the terms that you want and negotiate pro-rata rights.
Get valuable pro-rata rights by investing pre-seed
Naval: Pro-rata rights are the ability to invest in later rounds.
Let’s say you own 5% of a company through your original investment. Your pro-rata right gives you the right to provide 5% of the new capital in future rounds.
Even though you may already own a lot and may not care about the dilution, the cash-on-cash returns for later investments tend to be much better. You might be able to put $30 million in the pro rata, instead of your initial $3,000.
Once the company’s more proven, limited partners and big funds will fight for pro-rata rounds. They will pay you carry and management fees to invest in that pro rata. And you’re not waiting 10 years for liquidity on that investment. In later rounds, the company might be just two years away from liquidity.
So pro ratas can be quite valuable.They also keep you plugged into the company. You keep a closer relationship with the management team; they have to let you know what’s going on. And if there’s a down round or a washout round, your senior stock may protect some of your holdings.