Category: Fundraising

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Feeding the LP Beast

feed, bird

My family and friends have always enjoyed local restaurants and never found that higher end culinary flair ever satisfied the beast within. Also, having been a swimmer in a prior lifetime, I also ate like a vacuum cleaner. Food was inhaled rather than chewed.

In 2015, my mentor brought me to my first fine dining experience. One with a Michelin star at that. It was a multi-course meal, filled with words I knew the definitions of, but the permutation of which left me perplexed. Palate cleanser. Salad forks and dinner forks. Kitchen tours. And more.

I remember one distinct course where they had served us clams with the shells attached in a bowl. And another ornate bowl after we de-shell. The messiest part of the dinner, to be fair. After we were all done, they cleaned the table and brought us a glass bowl of water. With slices of lemon and grapefruit, adorned with flower petals.

Thinking it was a complementary drink, I took a swig. It was akin to spa water. Cool, and rather refreshing. Contrary to the calming effect of the drink, I saw, out of the corner of my eye, our waiter run across the room faster than any Olympian. After zigs and zags between tables, he stopped abruptly at our table. Now the whole restaurant stared curiously at what would happen next. Between lengthy exhales, he said, “Sir, this bowl is for washing your hands.” Embarrassed, I apologized profusely. To which, he consoled me profusely back. He took the bowl to get us a new one.

As I looked over at my dining mate, he said, “Man, I’m glad you took that bullet for us. I would have done the same.”

Nowadays, especially if I’m in a fine dining establishment, I almost always ask, “How would you recommend us to eat this?”

Most fund managers start the meeting off, almost immediately with the pitch. Most founders do the same too. I was at a virtual conference last week, where I was matched with 8 GPs on a 15-minute speed date, 6 out of 8 jumped straight into, “Let me tell you about my fund.” I get the urgency, but the first meeting should always be an opportunity to get to know the person you are talking to. As Simon Sinek says, start with the why. Then the how. Then the what. Most flip the order when they’re in pitch mode. Hell, some may not ever get into the ‘why.’

Most LPs do not invest in venture full-time. In fact, it’s the asset class they know least well. And within their smallest bucket of allocation, aka venture, emerging managers are the smallest of the smallest bucket in their larger portfolio. So if amount of capital equated to depth of understanding, most LPs know bar none about venture. At least, compared to you, the GP, who is pitching. Some may think they know a lot. They may even want to invest directly in early-stage companies themselves. And while they may not admit it to you, a number of LPs think your job, as a venture capital GP, is easy.

You, I, and every investor who has spent meaningful time in venture and is not deluding themselves, know that this is the exact opposite of any easy job that anyone can do well. Do note, raising capital easily and deploying capital easily and supporting entrepreneurs easily are all different things.

Nevertheless, depending on the LP’s proficiency level, you need to remind them:

  1. On venture and its risks (why the asset class) — Compare the asset class to others. Buyout. Real estate. Credit. And so on. Set expectations explicitly. If you yourself are not capable of comparing and contrasting between the asset classes, you should learn about the others yourself.
  2. Why emerging managers (Big multi stage fund vs you the Fund I) — You are not Andreessen, GC, Redpoint, Emergence, IVP, Industry, you name it. Neither should you at a Fund I or II. The risks of betting on emerging managers is present. If an LP indexes the emerging manager venture asset class, they’ll be disappointed. The mean is great, but the median is horrible. At least, compared to other asset classes they could be investing in. Do not pitch them, “emerging managers are more likely to outperform.” Inform them of the real risks at play.
  3. Why vertical/industry — Many emerging funds are specialists. For good reason. Based on your past experience, you’re likely to have more scar tissue but also real learnings than in other industries you did not have exposure to. Just like the first two, set the stage. How does your industry compare to others?
  4. Why you — Why the strategy? Why do you have GP-thesis fit? Why have all your previous experiences culminated to this one point in time to start this fund? And is your interest in running a firm enduring? If not, it’s also okay, but be explicit about it.
  5. Why they loved you — This is for the venture-literate LP AND if they’ve previously invested in you. Now they’re deciding if they should re-up. Were you true to your word? Have you stayed focused enough that your bets are still largely uncorrelated to the other bets in the LP’s portfolio? Why are you as awesome, but ideally more awesome compared to the last time you’ve chatted?

In that order. Starting from (1) to (5). Do not skip (1), (2), and (3).

If you jump straight to (4), that LP will consume that information within their own biases. Something you may not be able to control. And that will either make a fool out of them. Or a fool out of you. Just like I was at my first fine dining meal.

No one wants to be a fool. Don’t give anyone a chance to be one.

Photo by Santiago Lacarta on Unsplash

Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!

The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.

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When is a Market too Small for VCs

small tea set, miniature

I was reading Chris Neumann’s latest post earlier this week, “Fundraising Sucks. Get Over It.” True to its name, it does. In all the ways possible. Especially if you’re an outsider. In it, there is a truism, among many others:

“If investors are repeatedly telling you that the market is too small or the opportunity isn’t big enough, what they might be saying is, ‘the market is too small for VCs,’ not that it’s a bad idea.”

Which reminded me of a post I wrote late last year. To which, I thought I’d elaborate on. As a founder, how do you know if a market is too small for a VC?

Or when a VC tells you, your market is too small, what do they mean?

Spoiler alert: What’s small for one may not be small for another. Let me elaborate.

If a fund has reserves — in other words, they write follow-on checks —, assume 50-60% dilution between entry to exit ownership. If they don’t, expect 75-80% dilution on their ownership. Of course, these may be on the higher end. Sometimes, there’s less dilution. You, the founder, need fewer rounds to get to profitability, or better yet, an exit.

Tactically, what that means is if a first-check only seed investor wants to invest in your company for 10%, by exit, they’ll have around 2%. Say they’re a $50M fund. Investors are always looking for fund returners, knowing that most of their investments will strike out and they’re really better on each company’s potential to be that one great, truly transformative company. And so… to return the fund or break even on the fund, you need to be at least a $2.5B company. In other words, 2% of $2.5B is $50M.

Of course, seed stage funds are usually underwritten to a 4-5X net. Roughly 5-6X gross return. Usually 50-70% of the returns come from one investment. So, to have a 5X gross on a $50M seed fund, they need to have a portfolio whose enterprise value is $12.5B. A single investment should exit between $6 and $9B, roughly.

So… if a VC cannot seeing you exiting for that amount, they’ll tell you your market is too small. Maybe it’s due to historical exits in your industry. Maybe it’s due to a lack of strategic acquirers who’d buy you at that price. Or maybe it’s that you’re too cash intensive that you need to raise more rounds to get to an exit that is meaningful. And in the process of which, take on a hefty preference stack. Fancy schmancy term for all those investors who collectively include a larger than 1X liquidation preference in their term sheet. Aka downside protection.

That said, let’s take another example. $50M seed fund, concentrated portfolio fund. They like to come in for 20% and will invest in at least 1-2 rounds after. By exit, they might dilute down to 10%. To return the fund, they only need a $500M exit. To 5X gross the fund, they’ll need only $2.5B of enterprise value. Half of which will come from a single company. Meaning instead of needing to be almost a decacorn at exit to impress the VC, you only need to be a unicorn. Still impressive, but let’s be real. Unicorn exits are easier to achieve than decacorn exits.

Next time, you’re about to have a VC pitch meeting, do your homework. And try not to spend too much time with investors who may give you the feedback of “your market is too small.”

Photo by Gabriella Clare Marino on Unsplash

Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!

The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.

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VC as an Asset vs Access Class

key, access

There are LPs who see VC as an asset class. And there are those who see it as an access class. Most GPs spend time with the former. Most emerging GPs try to spend time with the latter, just ’cause the former are out of their reach for multiple reasons. Chief of which is probably that the “asset-class” LPs typically write large checks, have small teams, and have little to no appetite for the risk in this asset class. Also given how much the industry is a black box, it’s hard to underwrite anything that puts their career at risk.

But most emerging GPs I talk to actually fail the latter, the “access-class” LPs, more often than not. Much of which is in understanding how to approach them.

In the world of business, there are customers and there are buyers. Someone who makes a one-time purchase, and rarely again is a buyer. It could be due lack of demand. Lack of availability. Or simply, they were bamboozled. Fool me once, shame on you. Fool me twice, shame on me. Most emerging LPs, whether individuals or family offices or even corporate venture arms, buy a product once. And unfortunately, what they were sold and what they bought ended up being two different things.

Relationships, in any industry, take time to nurture. It takes time to win trust. Those who trust easily can take trust away easily. Yet, most GPs talk to LPs for the first time when they start fundraising. With a fire under them. And a sense of urgency as the clock is ticking. And by function of that, attempt to force these LPs who see VC as an access class to make a transactional decision.

To help visualize the difference, this is how I typically like to frame it:

LPs who see VC as an…Asset classAccess class
When pitching them, it’s similar to which business functionMarketing
(Brand and outliers matter)		Sales
Turnover rate in portfolioLowHigh
Involvement“Lean back”
(Big picture)		“Lean in”
(In the trenches)
StrategyStrategy not to lose
(Play to stay rich)		Strategy to win
(Play to get rich)
Depth vs BreadthBreadth > DepthDepth > Breadth
Capital flows in the near futureSteady state
(VC exists and will keep our allocation at a steady state / set percentage annually. Any additional significant DPI generated here is re-allocated to other assets.)		Capital increase
(VC is interesting and likely to increase allocation to it in the impending future.)

For access-driven LPs, they typically transition to asset-driven after about 4 years. Subsequently churning from their “access” category, as they now have enough relationships and “experience” building a strategy around venture capital. Access-driven LPs typically churn through their portfolio quite frequently, with generational shifts and new regimes and interests.

Moreover, with access-driven LPs, the pitching process is often collaborative and there’s room for terms negotiation. More often than not, they have curiosities they’d like to satiate. Asset-driven LPs have you pitch them. When challenged, they are more defensive than they are curious.

Photo by Silas Köhler on Unsplash

Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!

The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.

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The 4 P’s to Evaluate GPs | Charlotte Zhang | Superclusters | S4E6

charlotte zhang

“Executional excellence can get you to being great at something – let’s call that top quartile – but it really is passion that distinguishes the best from great – top decile.” – Charlotte Zhang

As the director of investments, Charlotte Zhang oversees the selection of external investment managers at Inatai Foundation, conducts portfolio research, and helps to institutionalize processes, tools, and resources. Experienced in impact investing, she previously served as a senior associate at ICONIQ Capital and, before that, Medley Partners. Investing on behalf of foundations affiliated with family offices, her investments supported a variety of nonprofit work, from early childhood education to autism research. Charlotte was a founding partner of Seed Consulting Group, a California-based nonprofit that provides pro bono strategy consulting to environmental and public health organizations, and currently serves on the Women’s Association of Venture and Equity’s west coast steering committee and as a Project Pinklight panelist for Private Equity Women Investor Network. She is also on the advisory boards of MoDa Partners, a family office whose mission is to advance the economic and educational equity of women and girls, and 8090 Partners, a multifamily office consisting of families and entrepreneurs across diverse industries that is currently deploying an impact investment fund.

Charlotte earned a BS with honors in business administration from the University of California, Berkley. When not working, you can find her globetrotting (18 countries and counting), writing a Yelp review about the best bite in town, or cuddling up with a book and her two adorable cats.

You can find Charlotte on her LinkedIn here:
LinkedIn: https://www.linkedin.com/in/charlotterzhang/

And huge thanks to this episode’s sponsor, Alchemist Accelerator: https://alchemistaccelerator.com/superclusters

Listen to the episode on Apple Podcasts and Spotify. You can also watch the episode on YouTube here.

Brought to you by Alchemist Accelerator.

OUTLINE:

[00:00] Intro
[02:56] Charlotte’s humble beginnings
[07:02] Lessons as a pianist
[10:23] Lessons from swimming that piano didn’t teach
[14:52] How Charlotte became an LP
[17:44] Where are emerging managers looking for deal flow these days?
[21:23] Reasons as to why Inatai may pass on a fund
[24:35] The 4 P’s to Evaluate GPs
[29:26] How small is too small of a track record?
[34:42] How do you build a multi-billion dollar portfolio from scratch
[39:43] The minimum viable back office for an LP
[42:03] Underrated Bay Area restaurants
[47:01] Thank you to Alchemist Accelerator for sponsoring!
[48:02] If you learned something from this episode, it would mean a lot if you could share it with ONE friend!

SELECT LINKS FROM THIS EPISODE:

SELECT QUOTES FROM THIS EPISODE:

“Executional excellence can get you to being great at something – let’s call that top quartile – but it really is passion that distinguishes the best from great – top decile.” – Charlotte Zhang

“If you have enough capital chasing after an opportunity, alpha is just going to be degraded.” – Charlotte Zhang

Follow David Zhou for more Superclusters content:
For podcast show notes: https://cupofzhou.com/superclusters
Follow David Zhou’s blog: https://cupofzhou.com
Follow Superclusters on Twitter: https://twitter.com/SuperclustersLP
Follow Superclusters on TikTok: https://www.tiktok.com/@super.clusters
Follow Superclusters on Instagram: https://instagram.com/super.clusters

Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!

The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.

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The Most Common Rejection Email for Transformative Startups

The most common VC rejection by founders who end up building the world’s most transformative companies seems to be:

The market is too small.

Other variations:

  • Unfortunately, the size of the market didn’t make sense for our investment model.
  • The price of the round felt too expensive for our strategy. (An indirect assumption that the exit-to-entry multiple would be south of a 100X. In other words, there’s a cap on market size. Aka small market.)

There are plenty of public examples of founders (i.e. Airbnb, Instacart, Uber, Facebook/Meta, Shopify, eBay, Ford, NVIDIA, etc.) sharing their rejection emails from the first couple hundred VCs they’ve met. But also, I’ve been lucky enough to read a lot of the memos that GPs and partners have written in the decades past on their anti-portfolio.

Yep, that’s the blog post for today.

Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!

The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.

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Hypoxic Training

swimming, diving

Back when I was still swimming competitively, one of the drills our swim coach always had us do was a set of hypoxic drills. The two that left the most indelible marks were:

  1. 10 sets of 100 yards, broken down by 25 yards. Lap 1, breathe every 5 strokes. Lap 2, every 3 strokes. Lap 3, every 7 strokes. And Lap 4, every 9 strokes.
  2. 20 sets of 55 yards. You start with a flip turn into the wall. First 25 yards (Lap 1), no breaths allowed. Second 25 (Lap 2), you’re allowed to only take one breath.

Naturally, those drills usually left me the most exhausted. Not only did I find myself catching my breath, we also had to swim those on specific intervals, which left less than five seconds of rest at best, while swimming at 80% our max speed.

All that to say, it was a set of exercises that trained us to hold our breath. We had less oxygenated blood. Naturally, it was harder to exert our max strength and endurance. But it tested our ability to weather exhaustion.

Just like today.

Our venture ecosystem needs oxygen. The whole industry is holding their breath. For IPOs. like Stripe’s. Which may be unlikely to happen in the near future given Sequoia’s recent share acquisition. Software acquisitions have also hit an all-time low, leaving LPs starved for liquidity from the major private market exit paths.

Source: Tomasz Tunguz / Theory Ventures

And of the few “acquisitions” that are happening, they’re done to circumnavigate anti-trust laws. As Tomasz points out, “they hire the core team [in other words the founding team], license the technology, but the majority company continues to operate as a separate entity.” In addition, a number of companies also need to get re-priced in the market, having raised in 2020 and 2021 on over three-year runways. Which to their credit, was the common advice given by VCs during that era.

Election season does not make this Mexican standoff any less strenuous. How will it impact the global economy? And who’s the last to hold the bag with all these hot AI deals? We all know AI has low margins and requires and immense amount of compute to deliver the results that we expect, but how much longer will this need to go on?

Who knows?

At least until we get to breathe again. The consensus seems to be Q1 2025. But until we have oxygen again, this is the hypoxic training that our world will have to endure for the foreseeable future.

In the words of my coach, “focus on distance per stroke.” In other words, executional discipline. Do more with less.

Photo by NEOM on Unsplash

Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!

The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.

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Shoe Shopping

shoe

I went shoe shopping with my partner the past two weekends, and I’ll be the first to plead ignorance to the difference between the B and D suffix for shoe sizes. And even after two weekends, I’m still learning.

I’ve never looked much into shoes. Having spent much of my early life bathed in chlorine (so much that at one point, my hair was brown with blond tips. FYI, for those I’ve never met in person before, I sport naturally black hair.), I’ve spent more time choosing the right $300-400 swimsuit than what I’d wear on my two lower appendages the other eight hours of the day. All that to say, I’m ill-equipped to speak the language of sneakerheads and running shoe geeks.

But just as I’m still learning how shoe geeks around the world understand the finer nuances of heel to toe drop impacting ankle versus knee strain, most founders who haven’t spent the time understanding the nuances of VCs think all money is green. In fact, just last month, I spoke with a founder I randomly met at an event who said, “Money is money.”

And he’s not completely wrong. There is some truth to it. At the end of the day, as investors, we sell money. Moreover, most investors who promise to be helpful are not. As well-intentioned as they are at the time of investment, most fall short of being truly helpful. There are multiple studies that show that founders believe a huge majority of their investors are not helpful.

That said, one of my investor buddies said something quite interesting to me earlier this week. Many founders see investors as saviors not partners. A source of capital to save them when they’re near the gates of hell, but not while they’re building their stairway to heaven. All that to say, as someone who’s been an operator, now a “VC”, but also someone who invests in other VCs, here are some of the nuances I’ve really come to appreciate over the years that I overlooked when I first stepped into the world of entrepreneurship.

Consensus and conviction-driven decision making

Some firms are consensus-driven. Others are conviction-driven. The former requires majority or unanimous buy-in. The latter doesn’t. Neither is universally better than the other, but knowing how decisions are made is extremely helpful. Not only to know who else you need to convince on the team, but also to know how the firm will help you post-investment.

The former is usually a firm where carry is split equally among all partners, so all partners are theoretically incented to see every portfolio company succeed. So as a founder, if you want to rely on the expertise and network of the collective partnership, these are the firms you should pursue. The latter, the conviction-driven ones, are most helpful if you really want one specific partner’s experience. They’ll be the person who takes the board seat. Opportunistically, they may ask for 1-2 junior team members to also have board observer seats. The downside is when and if this partner leaves the firm, there may be a gaping hole in governance as well as interest in the continued success of your company. But otherwise, this will be the partner you will have on speed dial.

I shared a presentation I made recently on LinkedIn. Of which, I share that three kinds of friends in the world. When shit hits the fan at 3AM in the morning…

  1. There’s the friend you call. They see the call. And they go back to sleep.
  2. There’s the friend you call. They see the call. And begrudgingly pick up.
  3. And there’s the friend you call. And as they’re picking up the phone, they’ve got their pants on already and are running out the door with their keys.

Conviction-driven firms, where the partner that pounds the table for you will likely be on you board, or even if not, they’re going to be the third friend. At consensus-driven firms, and I’m clearly being reductive here, you’re more likely — not always — to have the reluctant one or sleepers.

Then it comes down to how the team is compensated. Not something most founders can find out or ask out, but how carry is distributed for each fund matters.

Disagreeableness

I’ve realized a lot of the best investors are quite disagreeable. They have their opinions and are quite vocal about them.

A lot of them quite often score incredibly low on investor review sites. Of course, some just score low on NPS purely because their assholes. But I want to caveat. Assholes are often disagreeable, but not all disagreeable people are assholes.

But it takes a lot of courage to have a contrarian viewpoint that one can back up. You don’t have to agree with it. But it matters. More often than not, these folks will also have negative references. For an LP evaluating VCs, that’s ok. Negative is always better than neutral references. The latter means you’re easily forgettable.

Regardless of whether you agree with these investors or not (equally, if not more true, in great founders), they make you stop and think. And that pause to think makes you a more well-rounded professional, and makes your own opinions more robust when you choose to adopt or not adopt said piece of advice.

There’s a great Steve Jobs line, which I think is quite applicable here. “Here’s to the crazy ones. The misfits. The rebels. The troublemakers. The round pegs in the square holes. The ones who see things differently. They’re not fond of rules. And they have no respect for the status quo. You can quote them, disagree with them, glorify or vilify them. About the only thing you can’t do is ignore them. Because they change things. They push the human race forward. And while some may see them as the crazy ones, we see genius. Because the people who are crazy enough to think they can change the world, are the ones who do.”

Great investors are troublemakers. In a good way.

P.S. To the three verified troublemakers I know who are reading this blogpost, can’t wait for your debut.

Small talk

Small talk was definitely one of those things I was rather dismissive of earlier in my career. Who da hell cares about the weather? Or what you did over the weekend?

But over the years, I realize some of the best investors are remarkably good at this. Not in the sense that they know how to ask great weather questions, but they learn how to build rapport early and quickly. And even better, they get a founder comfortable, honest, and candid about where they are at.

No one’s perfect. Every investor gets that. Most founders often pretend that they are. But a great investor is great at helping a founder realize they don’t have to be, and also get to understand a founder from a personal level. Not jumping straight into the pitch. Or give me your metrics. Or how much are you raising at how high of a valuation?

Radical candor

Borrowing this phrase from the amazing Kim Scott, the best investors are upfront with expectations. They don’t waste your time. Some even go as far as to share what their incentives are. And the harsh reality that they may be wrong many times before they’re right. They don’t beat around the bush. They don’t delay the inevitable. They’re great at ripping bandages off quickly, so they can prioritize their focus on other matters that require more attention. They have tough conversations early and synchronously. The last thing one can ever say about them is that they aren’t thoughtful. It seems remarkably simple, but most cannot do just that.

To be fair, it’s sometimes easier said than done. Even for myself, and I would not even dare to put myself in the category of great, I’ve been berated, gaslit, and shamed (haha!) for giving and attempting to give honest feedback to founders and investors. In fact, I was introed to a fund manager recently for the purpose of giving feedback. When I realized a couple red flags about her fund (namely her raising a $100M fund with no track record), I asked if she wanted feedback. To which, she replied with something to the effect that she only takes feedback from people who invest and that I didn’t deserve to give her feedback.

So I can see why some managers are averse to giving any.

Raising junior talent

I was reminded of this in my recent episode with Rick Zullo. And I noticed Rick is really good at giving credit and lifting up his team. In a soon-to-be-released episode, Eric Bahn from Hustle Fund does the same. I’ve asked him to speak at events before and he’s often referred one of his junior team members to the event. Not as a “I don’t want to do this, so someone else should”, but as a “I believe XX person will be a great future leader of this firm, and I believe others need to hear her insights.” And he’s been right every time.

Building an institutional firm takes more than one person. It takes a village. To build a legacy also requires more than one generation. I often see great investors taking less credit and giving a lot more to their team. Those often hidden from the limelight.

Discipline

Every great investor I know does something consistently every day. They set ground rules and while it’s less so for others, they hold themselves accountable to do so. Whether it’s a cup of coffee brewed from home every morning, or going to the gym on a daily basis or quality time with family or calling their significant other at a set time every day, I have yet to meet an investor who can’t keep to a promise they made to themselves consistently.

Venture capital is a long game, and it’s very possible for these multi-decade games, to be lucky at least once. Good investors, at some point, hit a unicorn. Great investors can discover many before others do. But any more than twice requires extreme discipline and the ability to say no to things that are good to make room for the great. And it’s so much harder than one might think.

And the simplest proxy to an investor’s ability to do so is their ability to fulfill promises to themselves when no one else is looking.

In closing

    At the end of the day, not all shoes are the same. Just like not all VCs are. But if all you need is to get from Point A to Point B, and you don’t care for what kind of support you get along the way, VCs, like shoes, may all be the same.

    Photo by Hunter Johnson on Unsplash

    Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!

    The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.

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    What Limited Capital Does to Founders and Investors

    pitch, presentation

    My friend invited me to a demo day earlier this week. Albeit, it was a bunch of summer interns presenting their project they’d been working on for the last two months. The few investors and I who sat on the judging panel were all admittedly quite surprised by the quality of pitches and products from students and hell, even within two months. In fact, these 10-11 interns have gotten much further in product development and customer discovery than most founders I’ve seen across the span of a year. Whether sampling bias or not, the latter is probably about 50%+ of what I see these days. And you’d think that AI would have sped up the product development cycle.

    But I digress.

    Simply put, I was impressed. So, in efforts to simulate actual pitches at demo days, I asked a team who had presented five features they’d been working on and gotten each to a working prototype. “If you had to kill three of the five features, which three would you kill?”

    To which, the “CEO” replied: “To be honest, all five are quite important. But if we had to kill a feature, it’d be the AI chatbot, but the rest of the four go hand-in-hand.”

    I pushed for a more discerning answer, but was met with a paraphrased version of the last answer. And of course, it left a little more to be desired. What I was looking for was something of more prescriptive specificity. For instance, “we’d focus on usage metrics, particularly with respect to retention cohorts and actions per session across all the features. And depending on what features seem to perform better than others, our plan is to focus 70% of engineering resources on the top feature, 20% on the second most popular feature, and 10% focused on either a permutation of the other three or spending time with our customers to see where they’re the most frustrated.” It may not need to be the “right” answer, but having a thought-out answer is helpful.

    After all, the original question boils down to the fact that most founders fail from indigestion not from starvation. Charles Hudson wrote this great piece last month, aptly named “The Last $250K.” In short, one of the most common behavioral changes he’s observed is when founders are down to their last $250K. And, three things stand out in particular:

    1. “The most important things to work on become incredibly clear.”
    2. “The data needed to validate the company’s hypothesis becomes much clearer.”
    3. “There are things that the company was doing that they stop doing because those things don’t really matter given the gravity of the situation.”

    It’s a quick read. And I highly recommend it. Much of which I personally agree with. Not sure if that’s usually the $250K mark, but my personal sample size is far smaller than Charles’. Constraints are the breeding grounds of creativity.

    What’s really interesting is that my first reaction to that blogpost was just like how the last 4-6 months of runway leads to deep focus, how do the last 4-6 months affect fund managers? And it’s not too far off.

    • Deployment speed slows. The simple reason is that they no longer feel the fire under their belly to deploy. Either because they’re close to their target portfolio size or they need to elongate the time horizon while they’re actively raising their next fund.
    • The quality bar for what gets funded goes up. Since your deal flow pipeline is likely not contracting, there’s a flight to quality. And quality more often than not, translates to traction, logos/brands, and founder’s prior experiences. While there are always outliers, I see many GPs take less risky bets that they would’ve otherwise.
    • GPs are actively planning for the next fund’s strategy. And actively synthesizing lessons learned. Or at least, with respect with how they pitch LPs. And if they’re an emerging manager, or a fund without clear wins in their last fund, the most important things also become painfully clear. They often focus on the 20% that drove 80% of fund returns.
    • GPs are spending a lot more time on portfolio support. Not only because graduation rates become a lot more important (for fund returns and narratives for prospective LPs), but also because references matter in diligence. And well, if you’re fundraising for your next fund, you can be damn well sure that a sophisticated LP is going to do anywhere between 10-50 reference checks. On-list and off-list. 20-30% of which with your portfolio companies.

    Thematically, focus. While there are other constraints that help improve a founder or a fund manager’s level of focus, limited runway (or capital to deploy) is a natural forcing function. The best ones I’ve seen often impose artificial constraints early on, before things get rough. Rules and codes of conduct. Things they promise themselves and the team never do. Aligning compensation behind performance. In other words, operational discipline.

    Naturally, it should be to no surprise that investors of any kind spend a lot of time on organizational discipline before they choose to invest.

    Photo by National Cancer Institute on Unsplash

    Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!

    The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.

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    The Power Law of Questions

    question, mark

    Recently I’ve been hearing a lot of power law this, power law that. And you guessed right, that’s VC and LP talk. Definitely not founder vocabulary. Simply, that 20% of inputs lead to 80% of outputs. For instance, 20% of investments yield 80% of the returns.

    Along a similar vein… what about questions? What 20% of questions lead to 80% of answers you need to make a decision? Or help you get 80% of the way to conviction in a deal?

    ‘Cause really, every question after those delivers only marginal and diminishing returns. And too much so, then you end up just wasting the founder’s or GP’s time. As the late Don Valentine once said, “[VC] is all about figuring out which questions are the right questions to ask, and since we don’t have a clue what the right answer is, we’re very interested in the process by which the entrepreneur get to the conclusion that he offers.”

    While I can’t speak for everyone, here are the questions that help me get to 80% conviction. For emerging GPs.

    I’m going to exclude “What is your fund strategy?” Because you should have either asked this at the beginning or found out before the meeting. This question informs if you should even take the meeting in the first place. Is it a fit for what you’re looking for or not? There, as one would expect, you’d be looking into fund size, vertical, portfolio size, and stage largely. Simple, but necessary. At least to not waste anyone’s time from the get go.

    Where are you at as a GP by Fund III? What does Fund I and II look like by Fund III?

    Discipline. In the first 4 years of a fund, you’re evaluated on nothing else except for the discipline and the prepared mind that you have going in. All the small and early DPI and TVPI mean close to nothing. And it’s far too early for a GP to fall into their respective quartile. In other words, Fund I is selling that promise. The prepared mind. Fund II is selling Fund I’s strategy and discipline. Fund III, you’re selling the returns on Fund I.

    Vision. Is this GP thinking about institutionalizing a firm versus just a fund? How are they thinking about creating processes and repeatability into their model? How do they think about succession and talent? And sometimes I go a few steps further. What does Fund V look like? And what does the steady state of your fund strategy look like?

    What value do you bring to your portfolio companies?

    This is going to help with reference calls and for you to fact check if an investor actually brings that kind of value to their portfolio companies. So, in effect, the question to portfolio companies would be: How has X investor helped you in your journey?

    On the flip side, even during those reference calls, I like asking: Would you take their check if they doubled their ownership? And for me to figure out how high can they take their ownership in a company before the check is no longer worth it. There are some investors who are phenomenal $250K pre-seed/seed checks for 2.5-5% ownership (other times less), but not worth their value for $2-3M checks for the same stages. To me, that’s indicative of where the market thinks GP-market fit is at.

    I also love the line of questioning that Eric Bahn once taught me. “How would you rate this GP on a scale of 1 to 10?” Oftentimes, founders will give them a rating of 6, 7, 8, or if you’re lucky 9. And the follow up question then becomes, “What would get this investor to a 10?” And that’s where meaty parts are.

    Of course, it’s important to do this exercise a few times, especially with the top performers in their portfolio to truly have a decent benchmark. And the ones that didn’t do so well. After all, our brand is made by our winners. And our reputation is made by those that didn’t.

    In the trifecta of sourcing, picking, and winning, this is how GPs win deals.

    How do you resolve conflict or disagreement in the partnership?

    This is really prescient in a partnership. Same as a co-foundership. If someone says, we never disagree, I’m running fast in the other direction. Everyone disagrees and has conflicts. Even twins and best friends do. If you don’t, you either have been sweeping things under the rug or one (or both or all) of you doesn’t care enough to give a shit. Because if you give a damn, you’re gonna have opinions. And not all humans have the same opinions. If everyone does, realistically, we only need one of you.

    Hell, Jaclyn Freeman Hester even goes a step further and asks, How would you fire your partner?

    Jaclyn on firing partners and team risk

    Personally I think that last question yields interesting results and thought exercises, but lower on my totem pole (or higher if you want to be culturally accurate) of questions I need answers to in the initial meetings.

    How are you finding companies? How are you building your pipeline?

    This is always a question I get to, but especially valuable, when I ask it to spinouts. Building a repeatable and scalable sourcing pipeline is one of the cruxes of being a great fund manager. But in the age when a lot of LPs are shifting their focus to spinouts from top-tier funds, it’s an important reminder that (a) not all spinouts are created equal, and (b) most often, I find spinouts who rely largely on their existing “brand” and “network” without being able to quantify the pillars of it and how it’s repeatable.

    For (a), a GP spinning out is evaluated differently than a partner or a junior investment member. A GP is one who manages the LP relationships, and knows intimately the value of what goes in an LPA, on top of her/his investing prowess. And the further you go down the food chain, the less visibility one gets of the end to end process. In many ways, the associates and analysts spinning out need the most help, but are also most willing to hustle.

    Which brings me to (b). Most spinouts rely on the infrastructure and brand of their previous firm, and once they’ve left, they lose that brand within a year’s time. Meaning if they don’t find a way or have an existing way to continue to build deal flow, oftentimes, they’ll be left with the leftovers on the venture table. This question, for me, gives me a sense of whether an investor is a lean-in investor or a lean-back investor. The devil’s in the details.

    What are the top 3 reasons I shouldn’t invest?

    This is a test to see how much self-awareness a founder/GP has. The most dangerous answer is saying “There are no reasons not to invest.” There are always reasons not to. The question is, are you aware of them? And can you prioritize which risks to de-risk first?

    In many ways, I think pitching a Fund I as illustrating the minimum viable assumption you need to get to the minimum viable product. And Fund II is getting to the minimum lovable strategy (by founders and other investors in the ecosystem). And with anything that is minimally viable, there are a bunch of holes in it.

    Another way to say the above is also, “If halfway through the fund we realize the fund isn’t working, what is the most likely reason why?”

    Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!

    The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.

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    Angels who are Useless to Founders

    angel. statue, broken

    This may very much be the hill I end up dying on as an angel. I also realize that the title of the blogpost itself is ionically charged. But it’s something I feel strongly about.

    Two caveats.

    One, this is going to be one of my more strongly worded blogposts. I don’t write many of these. It doesn’t give me joy to “call” people out. If you’re a reader to this blog for the more mild-mannered Cup of Zhou, I’ll see you next week. 🙂

    Let’s just say I’m writing this out of frustration after chatting with a founder who hit all the below red flags. But more importantly, frustration at myself for not recognizing the below a mile away when I took the meeting. And the opening 2 questions for that meeting was can you share what you do? and what do you invest in? Both of which are quite evident on my LinkedIn. Moreover the cold outreach came via LinkedIn.

    Two, I’m a small check angel. And this may not apply if you write north of a $100K angel check or a $250K LP check. You’re likely also excluded from this hill I’ll die on if you don’t have the network that would alert you on deals on a regular basis.

    That said, if you’re a small check investor like me AND you have a decent network, any founder who doesn’t know exactly why they want you on the cap table outside of money is probably not a founder worth your time.

    Why?

    1. To them, you’re just another check, and not THE check. Whatever wrapper they put on things, you’re dumb money to them. Now, it’s not about feeling self-important. In fact, don’t delude yourself on your importance. It’s about being valuable, outside of the money. The early stages of company-building are so crucial that you really need all hands rowing in the same direction. Any hands that are idle, or worse, rowing in the opposite direction, is a waste of time, attention and resources.
    2. They don’t know what they want. They don’t know the critical needs of the business. Is it talent? Is it getting to $1M ARR and developing a sales strategy? Is it scaling past product-market fit? Is it finding product-market fit? And because they don’t, they don’t know what they need help in. And any non-surgical answer, including terms relative to broad strokes, is a dud.
    3. And in many ways, because of the above reasons, you’re wasting your dollar. The best founders are surgical and intentional to a fault. They’re also some of the best salespeople in the world. And they will make you feel like you’re the most important person in the world (whether actually true or not, but sometimes, even that doesn’t really matter). Because if they can win you over, they have a great batting average of winning key customers over.

    FYI, also probably not worth your time if they:

    1. Say you specialize in XX industry is not enough. Anyone can guess that at a glance at your LinkedIn. Even more so, if you’ve made it explicit.
    2. Spend more time pitching to you than asking you questions to understand your values and what you’re interested in. They’re more interested in what comes out of their mouth than by how much reaches your ears.
    3. Say you’re valuable for intros you can make. LinkedIn doesn’t tell people the strength of your first degree connections. For better or worse, I’m connected with a lot of people. Product of me being a bit too liberal with inbound connections early on. But it doesn’t mean I know them all equally as well. In fact, intros for a founder as an investor are table stakes. You must either be best friends with key decision makers/customers or downstream investors, or it’s really not as useful. And that only comes out if the founder spends time getting to know you, as listed in the second point above.

    Ever since I added “Angel investor” to my LinkedIn profile, I’ve received a lot of noise. Quantity of deal flow went up by maybe 10-20 per week (and some weeks where I post something or get tagged in something that gets 5K+ impressions, that inbound deal flow from LinkedIn doubles if not more). But I’d say 95% of that are deals I would never invest in. Either since it’s out of scope, stage, check size, or just type of founder. Which at some point, when I remember to and I’m not typing this on my little 6×3 inch screen, I’ll have to redact that title, “Angel investor.”

    Deal flow has become easy. But easy doesn’t mean good. The truth is, I’d rather mean a lot to a few than a little to a lot people.

    And by the way, the same is true, if you’re a small check LP.

    At the end of the day, as a founder (or emerging GP), it’s about finding your early believers. Those who choose to stand by you not just because everything’s going up and to the right. But those who will stand by you when shit hits the fan.

    I was watching the latest episode of Hot Ones (yes, this is my guilty pleasure), where Sean is interviewing Will Smith, and Will shares that there are three kinds of friends in your life that you call at 3AM.

    1. One kind of friend looks at the phone and pretends to be asleep.
    2. A second kind of friend that picks up the phone that makes you feel bad for being in trouble.
    3. And the third kind is putting their pants on while they’re answering the phone.

    You want the third kind.

    It also harkens back to the same conversation Aakar, Ho, Vignesh, and I had two weeks ago. Believing comes from faith. And faith comes not just from where you are today, but where you will go. And that is established on Day 1.

    To get early believers, you have to show you care. You have to give (even if it means your time, attention, and/or enthusiasm/interest), before you get. That is as true for investors as it is for customers.

    Photo by Jon Tyson on Unsplash

    Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!

    The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.

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