20vc — Gili Raanan: Why Margins Don't Matter for Early-Stage Startups

And I'm not as you know I'm focused solely on cyber security. So I know very little about about other domains that you probably know way more than than I do. But cyber security is is is is probably an interesting enough market to talk about and it's sizable enough market to to talk about.

The flow of new players into cyber security is quite steady for the past I would say 20 years. You're looking at around 350 to 400 new teams that get funded every year across US, Israel and and a little bit in Europe. Unfortunately you know it should be more I guess and hope it would get a bigger number over the time over time but that you know that number that's that's the 100% of of the cyber security universe.

So think about it like the past decade there were about 4,000 new cyber security startups. And in the next decade there'll be probably four to five maybe thousand cyber security startups in a world. That's that's a large number. And over the past few years the entry price as you rightfully mentioned is going up is going up for for many of those uh for many of those startups.

If you look at the outgoing stream, you know, you look at exit prices or even the likelihood of a cyber security company to become a unicorn. Do you have any idea? Take Israel which is probably 40% of the market. So we have to to multiply the Israeli number by two and a half to get the global number. Do you have any guess what's the number of companies that became unicorns in cyber security last year 2025?

Two. 2024? One. So we go it's two or one till 2022. The only year which was an outlier which was an exception was 2021. 2021 there were like seven companies that turned unicorn but that changed the mindset of investors.

In a way it doesn't matter. It is what it is. That's those are the stats. We can argue about the reasons and the drivers and we are probably be going to be wrong because we have all kind of biases. But the fact is that out of around 150 new companies in cyber security in Israel, the likelihood you'll hit a successful company is still one to 1%. It's one out of 150, maybe two out of 150.

And the prices, the entry prices where you buy stock at the seed stage is going significantly higher means that the market is not balanced. It means that a lot of that cash that's flowing into the market would be wasted and it means that you have to be — not just as a limited partner — as a founder you have to pick your financing partners more wisely because the numbers and the probabilities are not working in your favor. They're working against you and it's just getting worse and worse over time.

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If you had to bet, I'm going to bet that brands go to zero. Really? When you can make things that are as good or better and you can make them in a cheaper, faster, better way, people want that abundance more than they want an affiliation to a brand.

I'm not sure what's the right answer because I don't think that we have seen enough of healthy profitable AI businesses to really you know drive back the important vital signs for a healthy AI company. Who knows? I can tell you for sure that the vital signs for a healthy cyber security company involves high healthy gross margins.

So my instincts are that you know gross margins matter. Now are they important? How much I discuss, how often I discuss gross margins with my early stage companies? Never. Why? Because part part of the journey and part of our job as investors is to really help the founders realize what challenges, what problems they need to tackle right now, this year, let's say, versus challenges and problems that they would tackle in 2027 and 2028.

So if you have, if I would be lucky enough and you become a founder of a young cyber security company in the Cyberstarts portfolio, I would tell you: gross margins are important. Let's talk about it in 2029 and let's build the foundations of healthy business. Assuming that we would get to deal with gross margins. Now that's true for cyber security. It may not be the truth for AI businesses. As I said, I don't think that we as an industry have enough track record and history with that. But I think that I suspect that gross margins would continue to be important.

I believe first of all I believe that trajectory, velocity, growth rates are the most important indicators for a healthy business. And I think that part of our job is to look at that growth and try to sense whether it's been engineered or it's being organically achieved. And there are ways to engineer growth. But whenever you see a company that's a business that's growing very very fast, it's a good company.

That's the best predictor for for a company that does well. And over time, I learned that whenever a business is getting to a point it's growing super fast year over year, it becomes part of their DNA. So it would not slow down just because just because you know averages and things like that. There need to be a significant external event to slow them down. So if a company grows fast, it would continue to grow fast. It's part of the DNA.

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Fund sizes have ballooned. I mean now we have 10 — we both love your Sequoias and your Andreessens and we have 10 billion funds. I mean Andreessen I know it's combined so it's a little bit misleading but you know David George has six to seven billion pool. It's a lot of money. Do you think the mega funds will be able to return venture-like economics in this generation of venture given what we just discussed?

We should admit that we are looking at a massive opportunity ahead of us. So it's not criticism of the opportunity. The opportunity is here. It's real. And you know the investment in innovation is justified. And those companies, especially those companies that are growing very very fast, they need a lot of cash — more cash than before.

And you know I don't think that cloud or AI would at least in next few years would not change that materially. And it takes a lot of money to build large companies. So yes I I encourage founders to raise a lot of money if they like to continue and build significant companies. So you can you can correlate fund sizes to that.

My concern is around entry prices and whether that would limit innovation at some point in time because disappointment would show up.

I'm never worried about that. Never worried about that. Why? Because it takes a lot of money to really build those companies. And if we don't need the cash this year, we need it next year. So I'm not worried about that.

The contrary example of engineering growth: if you're taking good money and your magic number is horrible and you know, for every dollar you spent on sales and marketing, you generate 10 cents in new ARR, you're in a horrible business. But if your yield, if you've built a product that fits what the market needs — product market fit — you've got a team, a go to market team that executes in a decent way, decent plus way, your yield would be significantly higher.

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I think about secondaries first of all in a context of retaining talent. That's I think the most important consideration I have in mind when I think about secondary. Because it doesn't just take a lot of cash to build important companies and specifically important cyber security companies in our case. It takes longer time.

And with the current market you typically grant employees stock for four maybe five years and yes you can do some refill and new allocation but typically those are fractions of of the original allocation because the company is bigger, there are more employees, it's in a different stage.

So you get to situations where your best employees, your most important employees, your best engineers, your best product managers, your best salespeople are already fully fully vested and structurally you are unable to allocate them equally large or equally tempting grants. And you actually force them out of the company.

For those employees, assuming they are not — they were not born super wealthy — that equity they are lucky enough, they are happy enough to be part of a company that is doing extremely well. They're fully vested. Now most of the wealth of their family is actually attached to that one company. So it's actually very very logical for them to consider diversification exactly as we diversify our portfolio by going and joining another team and hoping to build a diversified portfolio.

Now the antidote for that market built-in weakness is the secondary. So that's the reason by the way that at Cyberstarts we created a vehicle we call it employee liquidity fund which is focused not just on a one-off type of secondary deals but creating a program, a recurring program with our portfolio company where we provide liquidity to their employees every year.

And what we do is that we underwrite a tender offer every year. So the employee of that company knows that they are getting liquidity. The very same type of liquidity they would get in a public market, they would get it in a private company. And that would help our portfolio companies retain talent.

We just announced that we are doing our first — we've done our first type of secondary program with Sierra. I think that we are buying probably not mention the exact number but it's many many millions of dollars from a few hundred employees of Sierra.

Look, it's not a secret that you know we at Cyberstarts we have sold secondary shares at companies like Whiz early on. By the way, I regret I sold every single share at Whiz. I regret it because you know if I sold it right now I would make — I would show better performance for my limited partners. But at the time it looks like the right thing and the responsible thing for us to do and we did it.

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Price is an important consideration and whenever I see an inflated price seed deal where essentially it's a bet on a team, I get more more skeptic. Now whether I turn it down or not, it depends on many other factors.

Do you ever have a cyber company in Israel where their seed round is announced and you're like, I didn't see that? Maybe once or twice over the past eight years. But there are deals that I'm telling myself, okay, I should have done it. That was a mistake.

Which one most resonates? It really doesn't matter. And I probably regret — I probably don't regret the right one and I regret the wrong ones. But you know, one thing I learned about the business is that I focus on my on the deals I've done and the teams I've partnered with. That's where I put my focus and energy.

You can't cover everything and you can't get everything. You are not going to win every battle. And if you are stressed about winning every battle — I need to be in every important AI company — I can predict that you are not going to be in every important AI company. I need to be in every important cyber security company — you are not going to be in every cyber security company over time.

So I focus on my portfolio companies and I try to do the best with the teams that put their faith in Cyberstarts and work with us.

Have you lost a deal in the last 5 years? Yes. Who did you lose to? Some amazing other amazing investors. Is there anything else you could have done? Absolutely. There are always things you can — if I look at the Cyberstarts business we are improving it all the time.

And I'm telling our my partners all the time: we are always as good as our next investment. Why it really doesn't matter? Because if all our investments would be amazing and we've lost one or two companies, that doesn't matter. So again, everything leads me to the conclusion that let's focus on our own thing. We typically get what we want to get. We can always improve. I'm very very happy with the progress.

You have an amazing partnership and you have great people in your team. What would you advise me on how to build a great venture partnership with incredible dynamics, relationships between partners? What should I know that you've learned?

You do that typically because you think, okay, this is what worked for me. Now, here's a new partner. Let's map the gaps between the way he or she performs and that recipe and let's bridge the gap.

My view on that is that I would let each team member play on their relative strengths and would not require them to focus on improving their weaknesses, but actually play more more often and stronger on their relative advantages.

Because on their weaknesses at the best case they can be as good as the market. But on the things that are exceptional they are creating real advantage, real beta, you know, some real greatness. And that leaves Cyberstarts with a team of people that really enjoy working with each other. But each of us is operating in a different way. And we respect that.

The decade I spent with Sequoia Capital was formational, you know, period for me. And it wasn't easy period. I couldn't do what I'm doing today without learning from Doug Leone and Michael Moritz and Jim Goetz and Pat Grady. It wasn't easy. You know, as I told you it took me a long time to mature as investor and it's hard. It's crazy hard.

You show up to the office every day, you're surrounded by super achievers who are building amazing companies and you look yourself in a mirror and said: okay I'm the shittiest investor in this room. There are I don't know 10 guys around me. I'm the worst. And the next day I'm still the shittiest investor. And you go like that every day. It's really hard. It's really hard. You have really bad days sometimes. It takes a lot of grit and determination to keep going and believe that you're going to figure it out.

What was your hardest day as an investor? When the first company I invested in shut down. I had to shut it down. That was super hard. That was because it's a very public failure. It's a failure that you cannot cover. It's a failure that you have to deal with.

What motivates you more, the thrill of winning or the fear of losing? Thrill of winning.

What are you most excited about when you look forward to the next 10 years? Working with my team and growing amazing investors that can keep on making impact on cyber security.