Retool founder David Hsu says most of startup fundraising is about “ego and optics.” “That’s not a costless game,” he argues, for what it means for employee shares.
When Retool CEO David Hsu set out recently to raise fresh funding for his low-code software startup, he took an unusual risk: leave as much money on the table as possible.
Let other tech companies seek billion-dollar mega-deals or dazzling valuations, Hsu argued. Retool would deliberately come in under market – and raise as small a sum as its founder could manage. “Most people are conditioned to think higher valuations are great, and huge amounts of money raised are really good,” Hsu says. “But a lower valuation and lower dilution is substantially better for employees.”
So in putting together Retool’s latest funding round, Hsu went against the startup world’s typical order of operations. A year after raising a $50 million Series B funding round led by Sequoia, Hsu turned back to a group of his earliest individual investors – Color Genomics cofounder Elad Gil, Stripe cofounders John and Patrick Collison and former GitHub CEO Nat Friedman – to lead a smaller $20 million Series C, alongside Sequoia and growth fund Bond. The new funding values San Francisco-based Retool at $1.85 billion, not including the new capital, double its previous mark.
It’s easy for a company to claim to be undervalued; Retool’s CEO insists that when he says his startup could’ve raised at double or triple the price tag in any of its funding rounds, the company’s growth numbers back it up. Retool operates in the app-building space, but for internal business tools, turning code into building blocks for engineers to quickly assemble, from components handling passwords to images and sales logs. A graduate of startup accelerator Y Combinator in 2017, Retool reached several million dollars in revenue while still just four people, Hsu says; Retool’s revenue is now in the mid-eight figures (tens of millions) and it’s at least currently cash-flow positive, a source with knowledge of its finances adds. Customer today include Coinbase, NBC, Peloton and Volvo.
“How we build software really hasn’t changed very much in the past 20 or 30 years. You sit down in front of a computer and you write code,” Hsu says. “We think that there could be a substantially faster way of building software with much higher levels of control.”
Mostly bootstrapping the business from a beach in Hawaii was briefly tempting, but Hsu and co. raised their first funding in the spring of 2019, then a $25 million Series A led by Sequoia in early 2020 and the Series B led by the firm that October. Retool’s hardly touched that money, Hsu says.
A look at the Retool office in San Francisco; the startup currently has more than 130 employees.
After that, Hsu’s thesis on lean fundraising solidified. He was bothered by the idea that employees who joined tech companies in the weeks after they reached a $5 billion or $10 billion valuation faced far less financial upside than those who joined in the weeks before. Pursuing a different model of smaller, stepped funding rounds every six to nine months, Hsu calculated that the typical engineer would save one million dollars in exercising their stock options; executives could save up to $10 million.
“You talk to candidates these days, and I think a lot are worried about valuations being pretty high and having already missed the boat,” Hsu says. “Team is what got us here, which is why we feel a sense of duty to get the team a great strike price on their options.”
Raising small rounds like this Series C regularly, Retool projects to give up an additional 3% dilution on top of its current 6% in order to reach a $5 billion valuation. That compares favorably to cloud data company Snowflake, which gave up 60% of its equity in dilution by the time it reached a $3.6 billion valuation; API company Twilio, which was diluted 37% at IPO, and work messenger Slack, which was diluted 36%, according to data from PitchBook.
The startup’s investors say the new approach could help keep the company disciplined in its spending and able to win talent battles with similarly sized, higher valued peers. “In a world of abundant calories, the healthy person is a disciplined person,” says Friedman, the former GitHub and Xamarin CEO. “I think it’s in the enlightened self-interest of the company to optimize for acquiring the best talent and over-compensating them.”
Outside Retool’s supporters circle, other venture capitalists note that raising small rounds and banking on fast-following with more could prove risky if the current abundant capital cycle shifts. Some entrepreneurs, like Slack’s Stewart Butterfield, have historically argued it’s best to raise as much as one can when the money is cheap. But at VC firm Renegade Partners, cofounder and managing director Roseanne Wincek says she sees executives passing on job opportunities at startup unicorns because they feel the companies have already realized too much of their upside. She also notes that at public companies like Uber, a divide between millionaire, high-equity early employees and more recent hires can create cultural challenges.
“It’s smart to think about employee equity and outcomes as part of the calculus of a round,” Wincek says. “You never want to game a system, and you could probably get too cute and try to be overly precise. But the idea of raising money while thinking about all the shareholders, it’s the right thing to do.”
Retool’s CEO says its internal tools, designed for engineers using databases, don’t compete closely with fellow startup unicorn Airtable, which takes a more spreadsheet-based approach.
There may prove a limited number of startups, however, that can follow Retool’s example, at least to Hsu’s level of zeal. Startups outside of the Bay Area and disconnected from Y Combinator or Sequoia’s powerful networks might struggle to tap the same deep-pocketed angel investors like Stripe’s Collison brothers willing to co-lead rounds for smaller equity stakes than would fit the fund models of traditional venture firms. Startups burning cash faster, or in an arms race with a close competitor with venture backing, may not have the luxury to turn dollars down. “No doubt about it, Retool has earned the right,” says Sequoia’s Bryan Schreier. “It’s not a strategy that every company could employ.”
At Retool, Hsu says he hopes more startups follow suit, but sees the most natural fits as capital-efficient businesses in the software-as-a-service category. But he’s hopeful that at the least, he can help start a conversation about funding rounds that trade costly consequences for impressive optics: “I think a lot of companies are doing these larger, flashier rounds to impress upon the world that, ‘look, my company is doing incredibly well.’”
Swimming against the big-valuation narrative is a “risky proposition,” Retool’s CEO admits. But he’s happy to serve as its experiment. “We are going to try to convince people,” Hsu says. “It’s going to take a while, but we’ll try our best.”
Correction: This story previously misidentified one of the investors in Retool’s Series C.
Source by www.forbes.com