Am I Getting a Good Deal from a Venture Studio?

A conversation with a founder as they negotiated with a venture studio. (#88)

Recently, someone reached out to me (we’ll call her Sarah) to ask if I thought she was getting a good deal from a venture studio or not. We went back and forth extensively through Substack’s direct messaging (I do respond there!) and she also booked time with me on Intro (⬅️ you can too!)

Founders: I’ve written about how to pick a venture studio before. Every venture studio is different, which makes it tricky for founders to figure out.

How To Pick the Right Venture Studio

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There are lots of great responses and more coming in. I’ll synthesize and share the results in a couple weeks.

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Here is Sarah’s first detailed message to me (modified for privacy):

Honestly, as a founder, it's all about navigating the early allure of partnering with a venture studio—the excitement of not going it alone—but also being aware of the downstream implications of that relationship.

For example: I fear that giving 35% equity early on (plus having to pay a fee back to the studio out of future funding rounds) will deter future investors. The venture studio I'm considering is newly formed, they don't have a track record as a group even though they have impressive backgrounds individually, but their focus is in [specific industry vertical] which is my focus. Yet, they're asking 35% equity for time/resources, plus a payback of $25k/mo through MVP, plus no founder salary with no clear delineation of where their internal services end and external resources need to be brought in (which will be added to the fee of $25k/mo). Feels highly favorable to the studio. I'm not asking you to vet this, but my point is, it would be super helpful to see the EXACT terms of several example companies who went through the studio model, knowing full well that there are many different forms this could take. Examples are so helpful!

I shared a few Highline Beta examples, but I don’t know the exact details of other studios’ deal terms. She was familiar with Max Pog’s venture studio podcast series (where some share deal terms) and The Gallery (another venture studio podcast series), but there isn’t a ton of transparency. It’s complicated to understand if a deal is good or comparatively good with other studios.

Here was my response:

I totally get it. Tough to know if a deal is fair, especially with newer studios that don’t have a significant track record.

35% equity isn’t insane, although on the higher end, imo. But the “pay a fee back on future funding rounds” is definitely different / atypical and that’s not great.

It depends on what you get for the 35%.

Studios aren’t always clear on the precise services they offer. Founders may need different things depending on their own skillsets, who else they’re bringing to the table and the specific venture being built. Some studios are still figuring it out, while simultaneously figuring out how to make their business model work. This is why it’s important for founders to understand how venture studios make money:

Understanding Venture Studio Math

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Sarah followed up with more questions:

1. Is it your stance that, in exchange for 30-35% equity, the venture studio should:

   1. Cover all operational costs including: Product Development (design, engineering) and testing of the MVP or first version of the product.

   2. Founder Salary: A modest salary to ensure I can work full-time on the business.

   3. Marketing and Branding: Initial branding, website development, and go-to-market campaign.

2. Also curious if it's your stance that in addition to covering those operational costs, founder's salary, the studio should be investing money into the startup?

Here’s my response:

For 30-35% with zero invested into the company I think they have to assume the costs. Otherwise where would the founder get the capital?

If for 30-35% they invest money, that money could be used to fund development and other costs, and so the studio would need to put less resources against the startup.

Simply put, the more equity a studio takes, the more capital and services they should provide.

• If a studio provides less services, they should provide more capital.

• If a studio provides more services, they can provide less capital (as long as they’re not also charging the startup for those services).

Sarah then found out that the venture studio is not going to invest capital:

They're NOT putting in capital up front. They want to get the product in a place to raise seed capital in 3-4 months utilizing their internal resources, then Series A in 12-18 months.

They say they’ll provide a lot of stuff, including: marketing, operations and scaling support.

For marketing they’ll help with research & analysis, GTM, content, social media, PR and more.

For operations, they’ll help with back office stuff—finances, legal, compliance, recruiting, etc.

For scaling, they’ll continue to support GTM, sales/BD, partnerships and user acquisition.

They talked about development too, but it’s still not totally clear. I don’t think they’ll do any building, but maybe they’ll help with product strategy & management.This simply led to more questions. Venture studios need to be clearer on what they offer (and you’ll see the confusion throughout the rest of this post). Additionally, if a studio isn’t investing capital there’s a huge problem (I don’t even consider it a venture studio).

Here was my response:

• Do they have an expected target raise amount in 3-4 months? $1M? $2M? And when they say "utilizing their internal resources" they mean they'll help you fundraise?

• In my experience to get a Seed Raise done you need a product in-market with traction. Is that doable in 3-4 months? Also in my experience it can take UP TO 6 months to get a Seed Raise done, which means you'd have to start as soon as you start the company, but you'll have no product/etc. yet at all.

• Who pays to have the product built? Who actually builds it?

• What do you think they're going to MOSTLY provide? Operations support? Growth support? Do you know who they deploy, how much they work at it, etc.?

• Without them putting capital in I don't get how any of this works -- especially if there is a chargeback. The math just doesn't make sense to me.

The terms pre-seed, seed, etc. are never writ in stone. Instead, figure out the capital needed to hit the next major milestones. At Highline Beta we aim for startups to raise $1M as quickly as possible, and we think of that entire amount as the pre-seed. A seed round might happen when a startup leaves the venture studio, or later on as well. Ideally we want startup’s exiting the studio with a product and early traction, but that might not even be enough to raise a seed round (think: $2-$5M).

Sarah got more information from the studio and responded:

A few notes: Yes, targeted seed raise in 3 months. They haven't shared their target number. Yes, they'll help me fundraise with their network.

It always takes longer than hoped, so they're hoping to have a product to test in market by month 4, but really a "wizard of oz" version for that, then after raising money, build the full MVP. But, I see your point for a seed round. It seems they really need to be putting in a pre-seed round, or this isn't going to go anywhere.

They have one developer on staff, but he's not capable of a full build. He can stand up a wizard of oz scenario to test with a pilot group, but then we'd need to go externally for the full MVP build. They are claiming to have that resource on standby, but to your point, I'll ask who that is, and who pays for that.

They're going to mostly provide deep customer research, market validation, price testing, value prop testing, sales and seed pitch deck, GTM strategies, operating plan, financial modelling. Their networks are very deep, so they are opening up their entire network to the venture as well as it relates to customers and fund raising.

I'm not sharing all the good things they have going for them, namely their individual backgrounds and networks, and willingness to roll up their sleeves and DO the actual work with me, and for me. But I don't want to go in blind, so your candidness is beyond helpful.

A few key points from this:

1. Things often come back to money. Who pays for what? How? Etc. Studios need to be crystal clear on this otherwise it quickly gets awkward. The chargeback model (where a studio invests $100 and then requires $50 paid back for services) is common, but needs to be clear.

2. Sarah already has an idea for the startup. It’s partially validated through work she’s already done over the last few years. Some venture studios won’t do these types of deals, others will. They’re tricky because the founder is coming in with “their baby” and that can create tension with the studio. Founders with their own ideas (especially if they’ve worked on them in some capacity) always think they’re further along; the venture studio may disagree (even if they like the core idea). So the venture studio will propose that the idea/founder go through the “standard validation process” (i.e. take a few steps back before rushing into building an MVP), whereas the founder will push to move forward more quickly.

3. In this case it’s still not clear if the studio intends to ever invest. Perhaps they’ll invest at the seed stage—but if not, it’s going to be tough to build investor momentum (because every investor will wonder why they’re not investing). And if they are investing, the deal terms become very important, because the studio already owns a big chunk of the company.

Sarah decided to negotiate.

I’m not sure a lot of founders negotiate with venture studios, but I’ve had this experience. It’s completely fair. In the end both sides have to feel a bit of pain/tension and feel like there’s a potential win. Sarah went back and offered 10% equity (with a specific vesting schedule) because the studio is only investing time and not capital.

Sarah noted to me:

In reflecting on this for a few minutes, one thing I think is really fascinating is that for entrepreneurs, there’s a fine line between aggressively negotiating, and coming across as easy to work with, so much so that you feel the need to cede on some terms when you want to move on the idea quickly, land the partnership and start building. Amp this up a notch if you’re a woman tech founder (I hate playing the woman card, but some of that is straight up fact).

I completely agree. Venture studios are looking for founders that are coachable and flexible, but not wet noodles. Here’s a visual from “The Ideal Founder for Venture Studios”:

• A founder without an ego is doomed to fail.

• A founder without an ability to make decisions (at a high frequency and quickly) will fail.

• A founder that’s not coachable will fail.

Finding a balance between these things is tough.

Founders may find themselves intimidated by venture studios (or venture capitalists) especially if they’re a first time founder. The studio-founder relationship is a complicated one.

The venture studio responded to Sarah’s proposal and showed flexibility on a few points, but not all (for privacy reasons I’m not sharing their response). Specifically they refused to lower their equity stake in the company.

One of the interesting things that came out of the discussion is that the studio’s equity vests over time. I asked Sarah for more clarification and this is what she shared:

They earn equity over time as key milestones are hit. For example, when we’ve built a usable prototype and have a seed deck; or when the MVP is built & launched. They’ve defined certain milestones with terms such as “Problem Solution Fit Validated” and “Product Market Fit Identified”.

(Note: For confidentiality, I’m not included the exact vesting schedule and terms here.)

I understand why they include a vesting schedule (although there are no “expected timelines”), but it actually complicates things even further.

• What happens if the founder or studio decides not to continue at any stage? Can they break up? Who retains control?

• What happens if the founder or studio disagree on the specific milestones? “Problem-Solution Fit Validated” is a messy target. Product-Market Fit is even harder to define!

I haven’t heard of other venture studios vesting like this (and they confirmed it would be founder/common shares). I wouldn’t take this approach. It opens up more cans of worms. I pointed all of this out to Sarah, and she wrote back, “Ugh. How does one un-complicate this?”

The venture studio model is more complicated than accelerators or VCs, but when designing a venture studio think about how to make it as simple as possible. Venture studio operators need to be clear on what they offer and what they take. A variety of good and bad scenarios should be contemplated, because you’re getting into bed together and plan to be there awhile.

Are you looking to build a venture studio? Here’s a free Venture Studio Checklist that can help.

So what happened between Sarah and the Venture Studio?

In the end, they couldn’t strike a deal. The studio reached out and passed. Totally fair. Not every deal works out—everyone involved should expect that.

The studio’s explanation: Sarah has more conviction around the idea (and wants to move faster towards building an MVP) than they do. They would prefer to do more exploration and believe that’s a core value proposition of their studio (and why they ask for a 35% equity stake). My view: they’re both right. 😀

Sarah has a good idea of what she needs for the MVP because of the work she’s already done in the space. She already has early adopters that are interested in a product. She doesn’t have the skill or capital to build the MVP.

You could argue that Sarah should hire a dev shop and get the product built to her specifications (and maybe she’ll do that), but the appeal of a venture studio goes beyond simply building the product. There’s a tricky/fine line between a venture studio being a co-founder/partner and a service provider, especially when the studio accepts founders with their own ideas. I’ve lived this a few times.

Venture studios: You need to be very clear on what stage you recruit founders at. Do you take founders with their own ideas? What if they’ve incorporated? Or do you only incubate your own ideas and recruit the founders much later, when they’re really more operational CEOs? Or somewhere in the middle?

When to Recruit Founders into Your Venture Studio

From my perspective, there was never enough clarity on the deal.

The venture studio was negotiating smartly on a few key points, but wasn’t budging on the equity and wasn’t being super clear overall. This doesn’t totally surprise me. I’ve seen several new venture studios go to market with nebulous terms, especially when they’re trying to get their first few deals done. The studio is figuring things out, the founders are figuring things out and everyone is left uncertain and confused.

In the end, the only thing binding a studio and founders (beyond legal agreements) is trust. If trust is lost, the game is over. Everything will become insanely difficult. Venture studios are supposed to be co-founders—but you can’t win with co-founders you don’t trust. It won’t happen. So if you’re uncertain or a little queasy about a deal going in (as a studio or a founder) it’s a bad sign. By all means negotiate and feel like you gave some ground and won some ground (i.e. both sides lost and won a bit) but without genuine trust, you’re doomed.

5 Recommendations for Venture Studios

If you’re a venture studio (especially a new or soon-to-be-launched one), here are a few things to think about:

1. Venture studios need to build AND fund. If you’re not investing, you’re not a studio. If you’re not investing, you can expect founders to be a lot more concerned about the services being provided (i.e. What are you actually doing for them?) Startups can’t be built without some capital.

2. Be very clear on what services they provide. You need to define what you do and what you don’t do. Some of what you provide (i.e. domain expertise, startup building + funding experience, instincts, etc.) is hard to quantify. I don’t like reducing this to a menu of services that founders pick and choose from. But recognize that the more nebulous you are about the work you do, the more uncertain founders will be.

3. Chargeback models are OK, but it can be quickly seen as double dipping. In Sarah’s case, the studio wanted 35% equity and a fee (while not investing capital). Chargeback models are sensitive. Founders may feel like you’re overcharging or there’s a lack of transparency on what’s being done. The chargeback model may be a requirement (i.e. the founder has no choice). Design this part of your studio very carefully, because I think it has a huge impact on the quality of founders you attract and the quality of startups that get built.

4. The “proven validation methodology” is cool, but not a game winner. Every venture studio has a validation methodology designed to de-risk startup creation. I’m a believer. But at the same time there’s no amount of validation that you can do as a venture studio that guarantees success. The success or failure of a startup is almost entirely dependent on the quality of the founder. Five years after you’ve built a startup through your “proven validation methodology” that work is long forgotten. A studio’s unfair advantage is not its validation methodology, but its privileged access to stuff.

5. Keep things as simple as possible. Building startups is hard. It’s messy. Venture studios can over-complicate very quickly with myriad stage gates, funding triggers, target metrics to hit, etc. It’s worth thinking through these components and designing around them, but the simpler you make the model, the better. It’ll be easier for founders to understand (increasing the odds of attracting quality founders), and easier for you to manage. It’ll also help you with raising capital (for your studio and for your startups).

6. You need founders at least as much as they need you. Arrogant venture studios will screw themselves out of the best talent pools. This isn’t as true with VCs, because VCs are playing a more transactional game (despite all of their claims of “value add” most founders know it’s about the money). But founders will work very closely with a venture studio for 6-9+ months and if the relationship sours partway through it’s bad. Venture studios only win when the founders they work with also win.

3 Recommendations for Founders

1. Don’t join a venture studio unless you’re clear on the deal terms. If there’s a red flag in the deal terms or how a venture studio is engaging early on there’s a good chance that translates into how the venture studio operates once you’re working with them. Co-founders should be completely transparent.

2. Recognize that venture studios are NOT service providers. If you genuinely want someone to build your MVP (you know what you want built and that’s that), find the money to hire a dev shop and get it built. Don’t say you’re looking for a co-founder when what you really want is someone to do exactly what you say. Venture studios have to provide a service, but they’re not service providers, they’re meant to be partners.

3. Recognize that you’re trading some control for other things you need. You can’t have full control, do whatever you want, and get all the services + capital offered by a venture studio. In most cases, you’ll give a venture studio more equity than you would a VC/other investor. That’s part of the deal. You have to be comfortable with that and also recognize that you’re bringing on an active co-founder not a silent partner. The power dynamic with a venture studio is more balanced than it might be with straight-up investors (although investors have plenty of control mechanisms too).

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