Derek Norton — Watertower Ventures

Wednesday, May 25, 2022

We caught up with Derek Norton about Watertower ($100-500k checks with his partner Jeremy Milken), micro M&A, advantages(?) of a hard fundraise, media as IP, and how great we are here in LA 🙂



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Today’s guest is Derek Norton, founder and managing partner of WaterTower Ventures. Derek is a multiple time founder, investment banker and has been working in the L.A. startup ecosystem for over 20 years. Welcome, Derek. Thanks for having me. Let’s start with some of the basics about Watertower, your focus, check sites, etc. So focus is what we call the connected consumer.

So people building products, services, applications that are gonna be delivered through a connected device and enhance the life of that consumer all over the world. Right. We’re not just thinking about a specific type of consumer in terms of investment, geography. Obviously L.A., but the Bay Area, New York and Boston, we’re also very bullish on Utah as an opportunity as well for startups. Check size anywhere from 100,000 up to 500,000, average check sizes about 250.

And you have this is you and you have another partner, right? Yeah, I do.

So Jeremy Milkin was my partner in the first fund, kind of silently looked through every day.

We’ve been friends for 20 years, worked together.

I backed Jeremy back in 2000 and we have worked together on various opportunities since Jeremy’s my partner in our new fund Unto. And yes, we’re looking to do the same and kind of take the thesis, our original investment thesis and fund one the connected consumer and that’s built out into the evolving enterprise. So think about that consumerization of the enterprise and what’s going on there. That’s where Jeremy’s background is great.

Could you give us an example of a connected consumer investment of yours? Yeah.

So I think in one of its kind of stripes across the portfolio, but companies like wandering again where they’re they’re creating content, podcast content.

I’m super interested in wondering because they’re they’re the big they have all the top rated podcasts. They do. They tend to every every one of the wandering podcasts that come out seems to go right to number one across to all the different platforms. So they have they’ve kind of cracked the code on how to create great content.

But we also see, you know, companies like Mothership, which is enabling delivery personnel to pick up additional loads and make deliveries as a means by which these people can make additional capital, create more opportunities for themselves. And obviously, those things are delivered through a connected device. So it kind of strikes across both consumers as well as the enterprise. Okay.

And and you were. I was a water tower group. Right. And there’s Water Tower Group. Water Tower Ventures, my game that cracked.

Yeah. Not to confuse anyone, but I think, you know, a lot of people look, I ran a fund along with two other partners in nineteen ninety nine.

So these are the dot com days, an interesting period of time that went on after the dot com implosion and what took place subsequent to that we started advising companies myself and two of their partners and that was sort of the formation of Water Tower Group. And then that morphed into a full fledged investment bank. And so for the past 16 years, Water Tower Group has existed. It’s advised numerous companies on their capital formation, series A, series B, series C, capital raises and then a lot of M&A. And we kind of refer to it more as micro M&A. So sub $200 million sized transactions. Water Tower Ventures is obviously our venture fund and that’s what you’re mostly focused on. Definitely focused a lot there. So on M&A.

Can you just tell me what a normal role you’ll play? Like how like lessons you’ve learned from watching a lot of companies go through M&A, you know, tables, you’ve sat you in the room, you know, discussions, you’ve been in the room for any good stories or lessons learned.

There are lots of stories probably not appropriate for this public broadcast. But look, I think the main takeaway when you think about M&A, you can’t sell companies. Companies get bought. And I say that repeatedly when we’re talking with folks. But I think the role of an M&A banker is to take what has been inbound interest and turn that into additional interest. It’s very, very difficult when a company comes to you and says we want to sell, because the inevitable question is why would you be selling if it’s going so well? In some cases, it’s a it’s a distressed situation. And you broadcast that make that very, very clear. But, you know, make no mistake, companies are bought. They’re not sold.

And what is the banker do? So you say take the interest that is already there and sort of make it more concrete or something. You said something like that.

I think a banker is a couple of different roles. One is to help the management team stay focused on the business and what they’re supposed to be doing. Right. They’ve got a they’ve got a day job. Any time that management, the CEO, in some cases, sometimes the investors think that they’re the banker and running it, they realize what the you know, what a distraction and what a full time job.

This process becomes something you know, the one thing is, is to allow them to stay focused on their business while the banker takes up a lot of the, you know, in some cases heavy lista lifting, in many cases kind of the minutia that comes along with that process.

But it’s also, too, I think they make the process very efficient for the company and the management team to see the broader market, see those groups that maybe didn’t have inbound interest or see those groups they maybe didn’t have on their radar initially.

I’m curious if that’s informed, how you make your investment decisions or how you guide founders about their fundraising trajectories?

Short answer is yes. A lot of folks get caught up in the headline, they think they just constantly a company is being bought, being acquired.

You understand the real sort of the reality of how hard it is to raise money.

More importantly, how hard it is to actually achieve that exit. And that they happen very seldom and they happen very, very seldom where the founders and the investors have some sort of meaningful outcome from that. And how does one choose which sort of banker to work with? You are sort of a boutique investment banker.

Absolutely. And, you know, we sure we marketed, but most of it was inbound. Most of it was referrals.

It’s it’s chemistry. And I I think that if you’re if you’re going to hire a banker, you better realize one thing. You’re going to spend a lot of time with that person. You’re going to share multiple meals, you’re going to travel, you are going to talk one another off the ledge. You’re going to write an emotional roller coaster. You better really like this person. You better really trust the person.

I’m not going to name names, but actually went underwear shopping once with one of my bankers who was stuck in L.A. from his residence in New York.

Come on, name the name. No, I can’t do it. 

OK. So, so. And so that was I mean, to somebody that must mean how you got to know really the venture capitalists in L.A.. Because you’re helping them sell their companies.

Yeah. You know, you you my introduction to the venture world was overnight.

I went from being a founder to having sold one of my companies that I had started to all of a sudden becoming a venture capitalist and really knowing nothing about it. And it was almost overnight. This cannot, you know, takes us back to a time where Pete, I think most v._c._r.s were very technical. There was a lot of technical due diligence that was done on a company. It’s not like today. So that was kind of a critical component. And I happened to have that skill set from the prior company that I built. And, you know, I’ve had the pleasure of knowing a few of them for, you know, coming on 20 years. Rick Smith, Brian Garrett, these are guys who I sat in the room with, you know, regularly back then. And, you know, I’m I’m proud to call myself an LP in their fund and and a friend of theirs. And we continue to sit in the room together.

And how did you get that initial? Is there an interesting story of how overnight you went from being a founder to being a venture capitalist?

I wasn’t doing anything at. I used to post my this company and very bored and connected with somebody. And they they had just raised a significant fund. And we kind of hit it off and decided we were going to do that together. And the money was already in place back then. And so it was a it was really another startup situation. The fund was raised, but nothing else. So, you know, naming, branding, infrastructure and then trying to figure out what it is we were actually doing.

And was this with Jeremy? It was actually backed by by the Milkins.

And so they were the they were almost the sole LP in that fund, because I noticed when we interviewed Meredith, it must be Jeremy’s brother, Greg, who is has been deleted with March Capital, his cousin. Oh, OK. Got it.

Because there seemed to be a lot of people now in this space who are from that family. It’s a pretty big family.

He’s been around L.A. for a long time. We’re both. We’re both born and raised here in Los Angeles. And obviously, the name kind of speaks for itself. Great.

And just reminded me of your previous company.

First company was called Jefferys Technologies and second was called Digital Boardwalk. The third was called Water Tower Group.

It’s an interesting trajectory. I hear a lot about bankers turning into v._c._r.s. I don’t hear a lot about Reese. He’s turning into bankers. What? What?

It wasn’t really a choice. You know, it’s an exciting time.I would I would make visits up north and you drive up and down the one to one from San Jose to to San Francisco.

There was no traffic. There were no billboards. You could see through every building along the freeway there, really successful, let’s call them 90s.

Theses were out of business. We’re trying to raise a fund. Could not raise a fund.

I equated a lot of times with having been a dot com or Internet v.c back then was very similar to how Bitcoin was sort of characterized a year two years ago after it imploded. Very similar.

It was all sort of, you know, tricks and not real and vaporware.

And Amazon was, I think, a $2 or maybe less stock at the time.

One of the things you said earlier, though, was I think you said today it’s fashionable to be an entrepreneur, to start a company.

Well, I think we have a lot we have a have learned a lot of lessons from them. So I wouldn’t say it’s similar. But I do think the journey of being founder or starting a company, whether you raise capital, whether you bootstrap whatever whatever it is, it is an all encompassing journey that takes everything out of you. If you’re doing this because it sounds like a path to riches and success in a nice life, you’re in the wrong business for certain. But I guess it’s not it’s not a direct refutation, but I think there’s something exciting about the fact that a whole generation is growing up seeing entrepreneurship as a very sort of almost like a mainstream path to go down.

I think that’s always been the case. I think the press didn’t really pick up on it. And so I think it’s a bit in our DNA. And I think that as we see the opportunity here in L.A., that’s why we’re benefiting. That’s why this, if you will, startup ecosystem has happened. That’s why you have the venture community coming from up north, coming from New York, coming from Boston, coming from other regions to see this is because entrepreneurial ism is a part of our DNA.

Yeah, I guess it wasn’t media specific to L.A. so much as just I went to business school graduate in 2002 and no one was saying about going to a startup at the time.

And yet everybody nowadays is eager to be part of a startup. And I was trying to kind of push that. Is that a good thing or is it a bad thing?

Well, I think what’s a bad thing is when someone says I’m going to do a startup, they’re very sort of misinformed in terms of what that journey is going to look like.

So I think to your point, people look. There is a certain glamour that comes to it if it becomes a successful company and we see that played out. But the road to that success. Boy, it’s treacherous, right? 

You talk about water to our ventures is your fifth startup. What you know. As you know, we need a lot of passion, energy, drive to do a startup. What’s what drove you to to do another venture capital firm?

I had a friend of mine, real good friend for 20 plus years named Kevin Mayor, who’s at the Walt Disney Company. And we were having dinner one night with our wives. And he said, you need to reinvent yourself. He said, why don’t you raise a venture capital fund and and I’ll anchor you. And that sort of got the wheels turning. And I spent about six months sort of thinking about it and decided to do it and talk to a few other folks that I go to for counsel and advice. And they were supportive. And one of those one of those people was Jeremy Moken, my partner. And he sort of help me put together the summary terms and the idea and the concept. And I very much look at this as a business. I say that I’m not of D.C. I say that I run a venture capital fund. I’m building what will hopefully become an institutionalized venture capital fund that will be around for a long time with a plan of sort of bringing in a new generation and building something that’s of value.

Was there a hole in the market that you saw an opportunity that that water tower was trying to fill?

I’d say wasn’t as much a hole as it was an opportunity to do something.

What do you think about the current market and how does water tower fit in? 

We are and we will always be. First, institutional capital. Make no mistake, we have no vision or goal or desire to be anything other than that first check.

It’s interesting. I would have thought that if I had had desired to at some point get acquired, that you would be a great person to have as a as a that I’m on my side of the table, I guess.

Do you have any like rules of thumb or guidance on how someone could think about like, you know, do companies often get acquired for, you know, some multiple of their revenue that you can share? Anything like that?

There’s no consistency whatsoever. I think there is a perception around multiples. I think there’s well, there’s like of receptions where the perception is it’s five X.

Yeah. Yeah, I agree.

If I’m at 10 X eb even though it’s oh those guys are you know they got 30 X that it’s it’s all over the place.

Listen, a great M&A outcome is when the person that acquires you is someone that helps continue to make you successful. And that’s where it works the best. And we’ve seen it work well. We’ve seen it work not well and everything in between.

So do you think about exit when you’re making your investments? No. I think about. Can this company what they’re doing, the service, the product application? Does it have meaning to consumers or to, if you will, nodes on the network? Right.

It’s funny how trends change. When I was raising money last time I was a founder and for several companies before that, it was always necessary to put in your deck an exit slide. Now it’s kind of out of fashion, in fact. So out of fashion that some take it as a negative signal that you’re already thinking about exit before you start. You think there is a like an actual truth to that or is this just changing style?

No, no, I think that’s the truth. I don’t think anyone can think about an exit. And if they are thinking about an exit, it’s probably the wrong person to get in business with.It’s you can’t do it. You shouldn’t do it. And I’m not certain that we’d want to be in business with someone who is thinking that way.

Yeah, I’m just I guess I bet and I don’t have these decks. If you look at Amazon, eBay, Google, you know, any of those decks, I bet you they all had an exit slide. No idea. I would doubt it if Jeff Bezos had it access light other than to be there, but who knows?

Have you changed? So all sorts of conventional wisdom has changed. Do you think that’s how you approach Murray has changed in the course of your VEAZEY experience. Like here’s one like Dina still talks about like M&A now used to be usually more focused on tech acquirers. Now she’s seeing a lot more traditional industry come in for M&A. So Albertsons Target.

So I think, you know, some some folks look at it as we are going to build a fund and invest. And if we can have 100 million dollar exits, that creates the performance. And I think some people have been referenced that that was their game plan. Right.

I think McKinsey did a study, if I’m not mistaken. Ninety nine percent of M&A was less than hundred million dollars when you took account of the entirety of any company that had been sold across all industries. I would say that’s probably accurate given the experience that I’ve had in M&A. Tech M&A specifically and media M&A specifically is that there’s very few companies that get sold for multiple hundreds, let alone billions of dollars. Wow. Nine.

Nine percent. Do you see a phenomenon? I feel I’m not sure if that’s good thing. I think it’s pretty.

I think it’s it’s it’s a pretty well known fact.

I wonder if that includes all the small businesses that get sold, probably the dry cleaners into this and the that.

So I’m sure it’s some some sort of S.A.C. code that you would put in to figure out what those are.

You do see a lot of sort of this small exit where it’s really almost that acqua hire and it’s a little bit AT4 for the PR, if you will.

Sure. Yeah, absolutely. And I think, you know, nobody wants to have a failure. Nobody wants to say I wasn’t. And if you can say that insert big company name right in in the slide, it looks really good. And what doesn’t look good is now that didn’t work out so well.

How do you broadcast that? That’s what you are looking for. I mean, if that’s I mean, if you’re at that point, we like this. This can’t go on.

I’m not going to ask for a lot of money, but I want to save some face and get acquired by insert big company.

You know, look, I think this that’s not a banking assignment. But that’s the kind of situation where someone who you have worked for before, let’s say it’s an investor, let’s say it’s maybe a company, some like that where they say, look, I need a favor. Can you help us get to a number of groups? And we think it’s this group and let it be known that this group is available, this technology, this team is available, and you do it as a favor and correct me if I’m wrong, but you have a conference conference.

The flow conference were so not a new fund. Right. So we’re a startup and we’re trying to be scrappy and hustle as hard as you possibly can as as startups do. Right. We’re no different than the companies that we have the privilege of investing in. We see things the same way we think about the world, the same way we think about expenses with no management fee or anything on there the same way and all that. 

So yeah. So we’re launching our first conference. It’s going to be this year. It’s going to be May 7th taking place, obviously here in L.A.. And the premise of the conference really starts from a lot of how do we get back to this community, how to get back to Los Angeles.

It is a gathering of about 40 plus corporate decision makers across tech, media and Internet. And then what we’re trying to do is assemble in a very democratic way the 40, kind of 40 plus best, most promising venture backed companies that were born and raised in L.A.. Right. So I think just series A, series B kind of stage companies. The format is a speed dating format. I don’t mean to trivialize that, but the idea of how can we connect those companies with some of the best corporate’s out there. So think Google and Amazon, American Express, Verizons, the Walt Disney Company, WPP, even the NFL and maybe it is Albertsons, a different type of tech that will be there so that they can explore. Is this something that might be of interest and then from their carry on into further? Conversation.

How does one, if you’re the founder of a venture backed company. How do you considered for this?

So the venture funds that comprise are in the flow network are going to be nominating their two most promising L.A. based portfolio companies. And we’re going to assemble it that way. Tapping the day after the Milken conference. A lot of corporate will be in town for that event as well. Great. I’d love to go back and talk a little bit more about your portfolio and some of the things that we see are things like fantastic companies that have struggled to raise money. I was reading do you have any good stories from companies that maybe didn’t look like winners initially, but have, you know, risen up to be some your stars or struggled raise money? Well, you know, the portfolio is so young, right?

So we you know, we haven’t seen that. Certainly from the banking experience, we have been involved with numerous companies where it was just really difficult to raise money and who went on to have incredible outcomes and then other companies who had no problem raising money and went on to have not so incredible outcomes.

Are there any you can talk about from the banking? Well, especially the ones that have then had incredible outcomes. I think riot games had an incredible outcome and they’d struggled earlier. I didn’t. I don’t know its story. Yeah, I don’t think Brandon or Mark would be offended by, you know, they it took a lot to raise that round. And there’s a lot of no’s and there was one. Yes, a lot of sad knows it.

But I think that’s a good lesson, because I think as investors sometimes when you see the signal that a company has already had a lot of no’s.

It can make you more hesitant to say yes. I think it’s a it’s a huge industry trend, right. The minute you’ve said, oh, they they’re kind of shopped. They’ve been through. They met with everybody. No one bet. They already know and especially up north. This is really evident, I think, in the Bay Area and with Barry, these seasons, when someone’s kind of come through and people are past, it’s it’s just tough, right? You learn. You lose that sizzle and that kind of heat on an opportunity. But is that totally a wrong thing?

So I guess my my two counterpoints would be, one, if the founders can or the team can get tired and if they have been out there too long, like they can, they can the momentum can be self-fulfilling in some sense. And they can be, you know, eating ramen for too long. Yeah, sure.

Right. And then they give up that, you know, I think we’ve got a lot of founders where in again, couple words that are maybe overused today, but I do think they stand up and they’re true. It’s that grit and resilience. Right. At what point you then you are so grateful, thankful that you were able actually even raise some money that you are the right custodian of that capital. You’re thinking about everything and you’re working twice as hard. We’ve got a lot of I mean, Matt Coffin lower my bills. I think he’s very public that there were some like 140 no’s. Wow. He met with 140 investors. And then you obviously had a fabulous exit with the company.

Yeah. I guess to ask it more explicitly, do you think it’s correlation or causation? Do. Does does having a tough raise actually make it make you tougher and more likely to succeed?

When I put for fun won again, the data room, the materials, the approach, the vision was to build an institutionalized venture capital fund. That is the vision today. It was the vision when I first started thinking about this and we were putting together the investment track record and it was you know, it had striped across a couple of different funds and direct investments, investments as a result of the advisory business, lot of things.

And so we we had a data set of about 160 companies might have been a little bit more across. That is pretty decent, you know, period of time, about 16 years, 17 years, something like that.

So and I don’t know what happened, but we were in the room looking at the data and analyzing and someone said what were the hottest deals in that group? And we said, what’s a hot deal? And that was sort of, if you will, multiple term sheets, you know, VCP chasing it.

And so we ended up about 19. That was it out of that out of that that period of time and that number of companies and of the 19 and we won’t name names, but of the 1980s, those hot deals went out of business. Well, and the 19th was a bust basically return capital. And then we looked at the companies that are the hardest time and they were among some of the biggest exits, had had some of the biggest exits, including a public. Exit, and so I don’t know, David, how to answer that question, is it?

Maybe if it is causation, do you think it’s it’s that people are more careful with how they spend money?

Or Yes, I think so. Any other hypotheses? I think it’s a whole bunch.

I think it’s it’s going about that. I think it’s that idea. You’re never gonna be all to raise money again. So you better build a business as quick as you can. So I think we should get into like, you know, the more, you know, deep personal questions that were gonna pepper you with it.

But like, no, I wanna go back to wondering for one second. I want to go back there because this is a podcast. And I’m just curious about this space. 

So I’ve always loved the media space. You know, the traditional media space then is the media space became the digital media space. And then it was an investment focus and that was a banking focus. I think if you talk to people, they will say, you know, those guys do media and they’re the media guys.

The thesis for the fund and podcast was not so much, I would say, bucketing it into podcasts, but just think about audio. And again, back to that connected consumer.

Look, I’ve always thought of media probably differently than most venture capital is. Think about it. And that is I think of media as. And I think it is no different than a piece of enterprise software. If the nodes on that network aren’t using that software, then it’s not going to be successful. And just like if consumers aren’t consuming that content, it’s not going to be successful. So we’ve thought about it from that standpoint. And audio just seem like this this thing that was there and we’ve certainly seen that take off bigger than I ever thought it would in the past two and a half years. And in watching Spotify lean in now with all of their podcasts and listening to people talk about the different podcasts and then watching laundry take off. And yeah, we’ve we’ve been honored to be a part of that. And they’re having incredible success.

And I think they’ve kind of figured something out there that other big players that are being disruptive in the audio or podcast space.

So, you know, I think you look at the platforms that are there and then you look at the original content creation gimlets, obviously having great success. And I see wanderin’. They see themselves their media company, right in their podcasts that do garner an audience and do really resonate with people, then turn into other forms of media, television shows and movies and beyond that. And that’s the vision of the business.

I’ve been listening. I mean, I now listen to a podcast with like a real ear towards what makes them great. But I think it’s having great guests primarily.

So great. Moving on to the to the personal questions, they’re not really probing personal questions.

What do you like as a person? How would your friends describe you?

Oh, boy. You know, hopefully supportive, loyal and hopefully fun. What do you do for fun?

I travel a lot to stay with my family and sort of have a lot of wanderlust across all of us.

And so it’s it’s just always going on adventure. I love sports. I’m a runner. First cyclist, second surfer skier. Yeah. Just love adventure to garden. What a weird question.

I always told me this. I actually think I’m interested in the garden.

I mean, there is a lot of there’s not a lot of gardening going on.

But I am certainly aware of how the garden, by the way, if it had questions that were like tater tots or pie or no questions.

I know.

But are you acre pie, cake or pie? Apple pie. Thank you. Dessert. Apple pie. We’ll never turn it down, actually. Other personal questions from you, David. I am afraid to ask personal questions, right.

I think you you are friendly and loyal, and it’s it’s been great to know you over these years. And it’s a rare few that have been here throughout the the, you know, some of our darker days, not darker days, but quieter days.

Yeah, I think it’s sort of the formation days. Right.

And, you know, no one wanted to come. No one state and certainly no one wanted to move here. You sort of saw this stuff start to happen and some artists started to come here and then some other people started to come. And now it feels like, you know, you can’t talk to anybody who’s not like, I’m moving to L.A.. And that that’s that’s people in France. It’s people in Italy, people in London, people all over the world.

And so but it was a place that people kind of made fun of. Right, for a long time. And I call it the Michael Govan moment. And Michael Govan is the director of Lackomar. And when Michael took over as the director of Lackomar, I feel like there was this inflection point that sort of legitimized L.A. as a as a cultural place. He was bringing artists here and it was just felt like this something around that time that turned L.A. into a more legitimate place. And again, I think we didn’t get credit for what I said earlier, which is we are the creative capital of the world. There’s more content created here every day than anywhere else in the world. And now I think we’re benefiting from that. And I think that the startup ecosystem is benefiting from that creativity capitals coming here. I almost want to call it capital for the creative set, which I think Felix Capital in London uses on their as their moniker of things. I love and I love that. And I think it’s great.

Yeah, I’m a believer that startups develop their culture early and I think cities do, too. So it’s fun to jump in and get to know the culture. And you guys are all so lovey dovey friendly.

On that note, thank you so much for coming today. It’s been great to talk to you. It’s always a pleasure. Thanks for having me.  I don’t really know to call us a seed prissy super duper seed like we talk, you know, just be the right of the friends and family. Maybe sometimes the friends. I’d like that. Yeah, I like that goudey yourself as a branding thing. I like sort of being like, we’re not after friends and family. We want to be considered part of your. You want to definitely become considered friends and family.