This past week, one particular graphic stood out. Endeavor shared some research they’ve been working on for a bit on the common themes in unicorn founders. And the below graphic is what came out of that.
For any VC out there, the above may be interesting to compare to your own deal flow and portfolio. For any founders out there reading the piece, and while this is a loaded term that comes with a lot of baggage, the above is where you might see a lot of investors regress to pattern recognition. So if you don’t look like a founder that’s illustrated above, be sure to address the implicit elephant in the room early on in your pitch. The best way to do so is through metrics. The second best way is to share leading indicators of grit and market / problem obsession.
While the study itself is fascinating, and I highly recommend you taking a deeper dive into it, one particular portion is worth underscoring. “Another difference between the emerging market and US founders is how fast they grow their companies. Founders in emerging markets achieved unicorn status for their companies in an average of five and a half years, while US founders took more than six years.”
Why is that noteworthy?
So I will preface that this is completely anecdotal. I’ve seen about two dozen or so emerging market funds myself, and have chatted with about the same number of LPs who have invested in emerging market funds. And the statisticians out there may say that isn’t statistically significant. So take what I’m about to say next with a grain of salt.
In the decks I’ve seen and the conversations I’ve had, I’ve noticed something else. That funds investing in the US and Western European markets tend to have an expected deployment period of 3-4 years. I’ll caveat that this period in practice may differ from the pitch. But nevertheless the model holds. LPs in US-oriented funds often expect 6-8 years before any exits or liquidation events happen. Which is why so many LPs say it takes a fund an average of 6-8 years to settle into its quartile. (And, here’s another example.)
And it is because of that, GPs are incentivized to deploy their last net new check before year 4, and for others year 3. ‘Cause compounding takes time.
But on the flip side, I’ve seen emerging market funds err on the side of longer deployment periods. Usually 4-5 years. At least in the pitch. In my very, very basic diligence, aka asking lawyer friends who help funds set up in emerging markets, that seems to corroborate with their experience.
Reading the tea leaves
So I don’t know how much of this deployment period pitch is intentional by design, or accidental. The latter in the sense, that at least in Asian and SEA markets, professionals tend to be more conservative than in the US. So longer deployment periods help investors proceed with caution. In fairness, some investors are more intentional than others. But the logic seems to hold. If it takes less time for exits to materialize in emerging markets, for the same 10-year fund, one can afford to deploy their last net new check later.
All this to say, Endeavor’s piece was quite thought-provoking for an LP, just as much it’s been for a VC or founder.
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.
This past weekend, I ended rewatching a classic and one of my favorite Eddie Murphy movies, A Thousand Words. Eddie, who plays Jack McCall, a literary agent, is someone who will say anything to get what he wants. And the plot of the movie effectively revolves around him trying to sign his next author and the after effects of doing so.
At one point, Dr. Sinja, the author he’s trying to sign, tells Jack, after he exclaims that he tells his wife he loves her “all the time”, “Words? More words, Jack. You tell her, like meaningless leaves that fly off a dying tree?
“Words.
“Can’t you show her that you love her? Make peace. Show them that you love them. And be truthful.”
One of my favorite people in the world, my friend who I met by way of mutual friend introduction, also happens to be one of the more well-traveled people I know. While it’s not my intention to embarrass her by writing this blogpost, she’s someone I’m deeply grateful for — my pen pal.
Every time we text, we send these long passages to each other. Paragraphs long. It doesn’t happen super often, every 2-3 months or so. And at times, we go six months without texting each other. But what makes her awesome aren’t our virtual letters, while I do really enjoy writing and reading them. What makes her awesome is that every time we meet in-person, she brings me gifts from abroad.
And she did so, ever since the day we first met, and I, in a passing remark, mentioned I didn’t travel often. And because of my work, my school, the need for me to be close to take care of family, I’ve stayed in the cocoon of the Bay Area my whole life. As such, I really do enjoy when friends tell me in detail of their travels beyond the horizons. But she took it a step further, where she would:
Buy gifts, snacks and souvenirs from abroad to bring back
Mail me postcards from every trip, sharing the smells, sights, sounds, and feels of her surroundings as she writes them
And of course, bring me back tales from her adventures when we meet in person.
They’re small things. But despite being small, they mean a lot to me.
I’m luckier now to be able to travel more. And just like my pen pal brings back treasures when she travels, I do so for her now too.
And of course, this extends beyond friendships. The fundamentals for any relationship (friendship, romantic, customer, investor, or some other business relationship) are fulfilling promises. Too often, I meet folks, who like Jack McCall say more than they can deliver. Most times unintentionally. A large part due to society’s expectations to be nice.
I’ll give an example. How often do we hear “How can I help?” at the end of a conversation? If you’re anyone who has something that others want — connections, capital, or advice — the ones on the receiving end probably wish to pay you back in some way. But most people ask that, and when they get an answer back, they take it in like the passing wind. Personally, I’d rather people who can’t deliver on that not ask that question than ask and not deliver (if there is something the other could use help on).
To go beyond just a normal relationship means you need to deliver the unexpected — beyond the initial promise. That requires you to actually spend time caring. And when you do, actions will naturally follow words or perform independent of words.
#unfiltered is a series where I share my raw thoughts and unfiltered commentary about anything and everything. It’s not designed to go down smoothly like the best cup of cappuccino you’ve ever had (although here‘s where I found mine), more like the lonely coffee bean still struggling to find its identity (which also may one day find its way into a more thesis-driven blogpost). Who knows? The possibilities are endless.
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.
The other day, I had a super insightful conversation with one of my awesome teammates here at Alchemist Accelerator about access and exposure. The difference between accelerators and emerging early-stage managers.
I’ll preface that for investors, particularly emerging managers, the three things you need to win are sourcing, picking, winning. And to be a GP, you need at least two of the above three. But for the purpose of this blogpost, I’m only focusing on sourcing.
I’ll also preface with the fact that I may be biased. I started in venture at SkyDeck, an accelerator. Additionally, I advise at a bunch of studios, incubators and accelerators. Moreover, I worked at On Deck when we launched our accelerator. And now, I’m here at Alchemist Accelerator.
I truly love early-stage programs. The earlier the better.
Instacart’s recent IPO is a clear example of venture returns compared to the public market equivalent as a function of stage. The earlier you invest, the more alpha you generate to your most liquid comparable.
It’s the difference between a market maker and a market taker. A price maker and a price taker.
Though admittedly, one day, this too may become saturated, just like how venture capital went from 50-60 funds in ’07 and ’08 to now over 4000 in 2023. Do fact check me on exact numbers, but I believe I’m directionally accurate.
Let me give a more concrete example. Harvard is a phenomenal institution. And there’s a Wikipedia page full of breakout Harvard alums. But as an LP, if 50% of your managers, despite having different theses, all have half their portfolio as Harvard alums, then you as the LP are overexposed to the same underlying asset. The same is true for Stanford. Or seed or Series A funds investing in YC founders. All great institutions, but you’re not getting your buck’s worth of diversification.
The only caveat here is if you’re not looking for diversification. After all, the best performing fund would be the fund that invested a 100% of their fund in Google at the seed round. AND holding it till today. Realistically, they will have had to distribute on IPO.
The question is are you a fisher? Or are you a digger? One requires a fishing rod; the other a shovel. The latter requires more work, but you’re more likely to be the first to gold. Like Eniac was for mobile. Or Lux to deep tech.
So how do you know you’re fishing in someone else’s pond?
Easy. Your deal flow includes someone’s else’s brand. Whether that’s Sequoia or YC or SBIR. It’s not your own. You don’t own that pipeline. A lot of people have access to it. It’s no longer about proprietary deal flow, but about proprietary access to deals to borrow a framing from the amazing Beezer.
If your deal flow pipeline looks something like the graph below, you probably don’t have a sourcing advantage.
Now that’s not to say there aren’t a lot of nonobvious companies coming out of YC or these startup accelerators. Airbnb, Sendbird, Twitch (the last of which Ravi who I work with here at Alchemist happened to be one of the first institutional investor for, so have heard some of these stories), and more were all non-obvious coming out of YC. And have also seen the same for companies coming out of Techstars, 500, and Alchemist, where I call home now. But that’s a picking advantage, not a sourcing one.
The flip side is, how do you know you’re excavating your own pond?
I’ll preface by saying having your own Slack or Discord “community” is not enough. Or having your own podcast.
I put community in quotes simply because having XXX members in a large group chat isn’t indicative that their presence is really there. Is their seat warm or cold?
I love using a stadium analogy. Imagine you sold a couple thousand season tickets to a team. You can name whatever sport it is. Football (yes, the rough American kind). Soccer. Basketball. Baseball. You name it. But despite all the tickets you sell, a solid percentage of your seats each game is empty. Can you really say that your team has fans? All you did was sell a couple of cold seats.
You can make the same analogy with likes or comments on Instagram. Which seems to be a problem these days, when an influencer with a couple thousand likes per post starts hosting their fan meetups, only to realize they rented out an empty hall. In case, you’re wondering for the IG example, it’s due to bots.
All that said, I like to think about excavation in the lens of competition for attention. Everyone only has 24 hours in a day. 7 days in a week. 365 days in a year. And as someone who is expecting any level of engagement from others, you are fighting for attention with every other product, person, and habit out there.
Perks of being a consumer investor, I think about this a lot. But in the same way, having an unfair sourcing advantage is the same.
Is the greatest source of your deals tuning into you at least four of the seven calendar days in a week? Or if you have a professional audience (i.e. only product people, or only execs), are they engaging at least 3 workdays per week or 8 workdays per month? Are they spending more time reading/listening/engaging with you than with their best friend?
If you have a community, do you have solid product-market fit? Is your daily active to monthly active over 50%? You don’t need a massive audience, but for the people who are primary sources of your deal flow, are you top of mind? As Andrew Chensays, at that point, “it’s part of a daily habit.”
Is it easy for them to share your content, what you’re doing, who you are with others? Does sharing you or your content generate dopamine and social capital for them? Do you embody something aspirational? Is your viral coefficient greater than 0.5? Even better if it’s 1, then you’re ready to go viral.
And do people stick around? Do the seats stay warm? Is your community self-propagating? Is your content evergreen? Or do you produce content at a voracious pace that it doesn’t have to be? Do you live rent free in people’s brain?
And once you do invest, are you the weapon in the arsenal of choice? For instance, 65% of Signalfire’s portfolio use their platform weekly to learn and get advice. But more on the winning side in a future essay.
In closing
To truly have a sourcing advantage, you need to be building your own platform that is impressionable and regularly take mind space from the founder audience. But if you don’t, that’s okay. You just need to be really good at picking and winning.
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.
In one of the recent All-In podcast episodes, Bill Gurley shared that both VCs and LPs aren’t marking down their portfolios. For GPs, inflated numbers helps you raise the next fund. For LPs, they’re given their “bonus on paper marks. So, they don’t have an incentive to dial around to their GPs and say, ‘Get their marks right.’ ‘Cause it’s actually going to reflect poorly on them if they were to roll those up.”
The last few years, enterprise value has been largely based on multiple expansion. The truth is we’re not going to see much of it in the incoming years. Even AI that’s exploding right now will see a contraction of their multiples in due time.
Companies that should not be in business today will see their ultimatum too in the next few years. Hunter Walk recently wrote “they’re 2017-2021’s normal failures clustered into current times.”
So, while some GPs do pre-emptively mark down their portfolio by 25-30% — we’re seeing this behavior more so in pre-seed and seed funds — the only people in this whole dance that are incented to mark down portfolios are new LPs trying to figure out if they want to commit to a new fund.
And while the advice applies to newer VCs, the same is true for experienced investors. Of course, most investors aim to be in the upper right-hand corner, but that’s really, really hard. In truth, most notable investors fall in two cohorts: marketers and tastemakers.
Marketers:
Share a high volume of deal flow,
Lower quality opportunities,
Have relatively low conviction on each deal compared to their counterparts, the tastemakers,
Have comparatively diversified portfolios,
And could have adverse effects on branding and positioning in the market.
Tastemakers, on the other hand:
Share a lower volume of deals,
Usually higher quality opportunities,
Higher conviction per deal,
Have comparatively more concentrated portfolios.
And the downside may simply be the fact that their volume may not warrant raising a fund around, and might be better off as an opportunistic investor.
And speaking of concentrated versus diversified, the interesting thing, as Samir Kaji shared on his recent podcast episode, is that “at 85 companies [in the portfolio], you had over 90% chance of getting a 2X. But a very low chance at getting anything above a 3X. And with smaller portfolio sizes [between 15-25 companies], there was much higher variance — both on the top and bottom. Higher chance that you perform worse than the median. But a much higher chance of being in the top quartile and even beyond that, in the top decile.”
It’s also so hard to tell what high quality companies look like before the liquidation event. Naturally, high quality funds are even harder to tell before the fund term. It’s ’cause of that that a few LPs and I wrote the post last week on early DPI. But I digress. At the end of the day, many, for better or worse, use valuation and markups as a proxy for quality.
But really, the last week’s valuation in this week’s market environment. Rather than chasing an arbitrary number, a lot more LPs when evaluating net new fund investments, and GPs making net new startup investments, care about the quality of the businesses they invest in. It’s not about the unicorns; it’s about the centaurs. The $100M annualized revenue businesses.
Samir Kaji’s words in 2022 ring true then as they do today. “Mark-downs of prior vintages are starting to occur but will take some time given valuation and reporting lags.” We’re still seeing many who have yet to go back to market. As many say, the flat round is the new up round. But until folks go back to market, there are many who won’t jump the gun in writing down their portfolio. But they are cautioning themselves, so that hopefully they won’t make the same mistakes again. The goalposts have changed.
I’m reminded of Henry McCance’s words channeled through Chris Douvos. “When an asset class works well, capital is expensive and time is cheap. What we saw in the bubble was that capital got cheap and time got expensive.”
We’re now back at a time when capital is expensive and time is cheap.
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.
A few days ago, I caught up with an old friend from college. Amidst our conversation on how I was spending my time, he asked me, “Wouldn’t your time be more valuable helping the winners in your portfolio than the others?”
And I told him, albeit a bit more defensively than I would have liked, “Our brand is determined by our winners. Our reputation is earned by helping everyone else.” One of my better ad hoc lines, if I say so myself.
But more so, and I might be naïve in saying so, I may not get the most number of hours for sleep a night, but I will say, when I hit the bunk, I have the best sleep out of anyone you might know. And I do so because I know I’ve meaningfully touched someone else’s life. And by extension of them, indirectly, a few others.
Just because most startups fail doesn’t make each of their endeavors any less important.
Malia Obama once asked her dad, our former president what’s the point in working on climate change if the difference is so miniscule. That the world is burning. And what can one person do?
To which, Obama said, “We may not be able to cap temperature rise to two degrees Centigrade. But here’s the thing. If we work really hard, we may be able to cap it at two and a half, instead of three. Or three instead of three and a half. That extra Centigrade… that might mean the difference between whether Bangladesh is underwater. It might make the difference as to whether 100 million people have to migrate or only a few.”
In the world of startups, which isn’t exclusive to our world by any means, there’s a saying that people love quoting. Aim for the stars; land on the moon. And regardless if you hit the stars or not, aiming for it gets you the escape velocity to be extraterrestrial. In other words, it’s not always about whether you hit your goals or not, but rather… it’s the pursuit of lofty goals that gets you further than if you didn’t try in the first place.
I’m reminded of a great line by Dr. Rick Rigsby quoting his dad. “Boys, I won’t have a problem if you aim high and miss, but I’m gonna have a real issue if you aim low and hit.”
So, in this week’s short dose of optimism, don’t aim low and hit. Stay awesome!
#unfiltered is a series where I share my raw thoughts and unfiltered commentary about anything and everything. It’s not designed to go down smoothly like the best cup of cappuccino you’ve ever had (although here‘s where I found mine), more like the lonely coffee bean still struggling to find its identity (which also may one day find its way into a more thesis-driven blogpost). Who knows? The possibilities are endless.
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.
VCs win upon liquidity event. And that happens either via M&A or via going public. After that, the shares are transferred to the hands of the LPs and they choose how they’d like to liquidate or keep. To date, we have neither seen a trillion dollar acquisition nor a trillion dollar IPO. I’m not saying it’ll never happen. I’m sure it will, at some point. A combination of inflation and companies finding more liquidity when private markets are bullish.
As Charles Hudson suggests in his one of his latest posts, the venture world has been changing. What was once a cottage industry gave way to multi billion dollar funds. While there are still many small sub-$100M funds, LPs have started evaluating venture capital not as just one big industry, but segmenting it by size of fund. Small funds, sub-$100M. Medium-sized funds, $100-500M. And big funds, funds north of $500M assets under management (AUM for short). And as the Mike Maples dictum goes, your fund size is your strategy.
Returning a billion-dollar fund requires different kinds of investments and math for it to work compared to returning a $50M fund. And one day, as large funds continue to expand into multiple stages, check size, but also eventually into public markets, we might see them start to bet on trillion-dollar outcomes. Because to return a 11- or 12-figure fund, you need to do just that. But given the market we’re in now, I imagine that won’t be in the near future.
The 10,000-foot view
So the thing you have to gain conviction around, as a macroeconomist, is not how big a venture fund should be. Nor the debate on how many VC funds is too many. The number nor the size truly matter in the grand scheme of things.
For an illiquid asset class like venture, where you’re betting on the size of the home runs, not one’s batting average, what you have to gain conviction around is:
How many truly great companies are there every year
How much capital is needed to get these companies to billion dollar outcomes
For the latter, there are two main ways to get to billion dollar exits: going public or getting acquired. And while there are outliers, the best way is for these businesses to get to $100M of recurring revenue.
And everything else is downstream of that.
As an LP once told me, “In the 1990s, it took $7 million to get to first revenue. In the 2000s and into the early 2010s, it took $700K. Now it takes $70K.” With each era and each wave of technological development, founders become more capital efficient. There are less barriers to get to market. Now with AI, it might just be $7K to get to first revenue, if not sooner.
The question is how much capital is needed to get to $1M ARR. If we take a decent burn multiple of 1.5x, then we underwrite an assumption that it’ll take $1.5M to get to $1M ARR. And possibly $4.5M to get to $3M ARR. And somewhere in there, that founder will find product-market fit and turn on the growth engine. CAC (customer acquisition cost) falls. And lifetime value increases. Payback periods shorten. And if all goes well, founders may find themselves with a sub-one burn multiple. And after they hit $1M ARR, and they triple the first two years, double the next three, they’re at $100M ARR. Of course, I’m illustrating the above all in broad strokes. The best case scenario. But most things don’t go according to plan.
Then an investor has to figure out if one should only make net new investments or re-capitalize a select few of their existing investments.
Then as LPs, what is the minimum ownership percentages that can return funds at each differentiated stage and fund sizes? And due for possibly another blogpost altogether, how does a 7-8x multiple on forward-looking ARR impact round sizes and valuations across bull and bear markets?
All this admittedly is both art and science. But I will admit that larger fund sizes and playing the AUM game may not be the answer.
In closing
My friend recently sent me this letter that Sam Hinkie wrote when he retired as GM of the 76ers. In it, he quoted the great Sage of Omaha when he closed down Buffett Partnership. “I am not attuned to this environment, and I don’t want to spoil a decent record by trying to play a game I don’t understand just so I can go out a hero.” And it’s for that same reason, Sam stepped down. The same reason Jerry Seinfield turned down $110 million to do another season of Seinfeld. Even though the sequel business does quite well.
There is no shame in knowing when to hang up the cleats. And there is great power in being disciplined. In fact, it’s one of the most sought-after traits in fund managers. If not, the most sought-after.
In VC, it comes in all sizes, ranging from:
Fund size discipline. There a lot of GPs out there who have gone on to raise 9- to 10-figure early stage funds. A mathematical equation that becomes increasingly harder to prove true, given outputs need to reflect inputs. In other words, larger funds are harder to return. There are a lot of VCs who would rather play the AUM (assets under management) game than stay disciplined on returns. Not just paper returns, but real cold hard cash. In the words of my friend Chris Douvos, “moolah in da coolah.” To quote another line from Chris, “OPM (other people’s money) is like opium. It’s addicting.” Something one too many investors have gotten addicted to.
Thesis discipline. As a friend who’s been a VC across multiple economic cycles once told me, it’s much better to turn down an off-thesis hot deal led by a top tier firm than to take it.
Career discipline. To echo the words of Sam Hinkie above.
And of course, knowing that we underwrite billion dollar outcomes, rather than trillion dollar ones. Then again, that’s just a subset of fund size and portfolio construction.
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.
There was a fascinating episode on the Tim Ferriss Show recently, where we get the inside baseball on how David Maisel, founder of Marvel Studios, raised half a billion on a promise for a company who’s public market cap at the time was only a fifth of a billion. Naturally, not only was he against a lot of headwind externally, but internally as well. According to the board at the time, they would only greenlight the idea of producing their own films (as opposed to licensing their IP out) if “Marvel had no risk. Not little risk, but no risk.”
On the cusp of Captain America and Thor being licensed away, David asked the board to give him six months. The “zero risk” pitch then came in the form of external funding, huge financial upside (if things worked out), market timing, and a promise.
Financial upside for Marvel
As David puts it:
“First to my board, the argument, was if we own our own studio, it means we get the full financial upside that they understood very well.” As opposed to licensing, their traditional business model. Where Marvel only got five cents on every dollar of profit. As was the case with SONY and Spiderman.
“Number two, we decide on greenlight when the movies get made that they also understood because they only sold toys really at the time, and the toys were contingent on a movie, which they then control the timing. Now when you’re doing a public company and you’re giving guidance every year, how can you give guidance if you don’t even know what movies are going to get made? And so controlling greenlight was important, full creative control.”
Moreover, the team was able to take 5% of revenues as the producer fee AND keep all non-film revenues (i.e. toys, video games, etc.). And even if four out of the five films lost capital, they’d still make $25M in revenue each. In other words, $100M in sum. Half of Marvel’s public market cap at the time. Whose cap was only based on toy sales.
Market timing
“The bond bubble of 2004 was happening,” as David shared, “so it was a time where there was loans being made that shouldn’t have been made. And a lot of people were enamored with Hollywood as they get enamored every few years.”
Zero downside
Instead of funding the studio off balance sheet, David would go out to fundraise from others. So what was the external pitch?
“Give me four at bats, and if one of them hits, then every movie’s a sequel after that.”
On top of all the above, to me, there were some interesting terms for the investment that helped sweeten the deal:
Merrill Lynch got a 3% success fee upon the $525M closing.
David got a low interest rate loan from Merrill by getting it insured by MPAC, therefore the debt became AAA debt, which “was easy to sell to pensions and easy to sell to individual investors” in case things went awry.
Now I’m not sure if this is standard Hollywood practice. But I imagine it’s not, at least back in ’03 and ’04. I’m a venture guy after all. And as one, the above is news to me.
That said, the banks David went to fundraise from were not taking equity. It was “pure debt. So very low interest rate. And the only collateral were the film rights to ten Marvel characters of which we could make for the movies.” Which, to me, ten characters sounds like a lot for a company whose business is characters. I also imagine these were characters that had some level of historical fanbase, so they weren’t random ones from the archives.
But David clarifies. “A lot of people misunderstand that they think we pledged ten of our characters as collateral. It wasn’t that at all because in the worst case scenario, it only got collected if we lost money on those first four movies. And then those six characters, we owned all the rights besides film. And if a film was ever made by the bank, whoever collected this collateral, we got the same license fee that we get if we just license it that day to a party. So there was no opportunity cost.”
And the promise
This is history now, but at the time, was a bold claim. The idea was borne out of frustration as an entertainment investor. That:
Marvel couldn’t capture a large part of enterprise value through productions with just licensing
The first movie business was horrible. Sequels, on the other hand, were a lot more predictable. So, the focus after the first movie would not be on predicting profit, but maximizing profit margins.
So David had a thought. “What if after the first movie, every movie after that was a sequel or a quasi-sequel, which required all the characters, or a lot of the characters, to show up in multiple movies?”
The idea of sequel snowballed into what we now know as the MCU — the Marvel Cinematic Universe.
Bringing it back to venture
It’s a nice corollary to raising a Fund I, where you’re also selling a promise. A world vision. A painting of the future. Nothing’s proven yet. You’re sure as hell not selling a repeatable strategy yet, and definitely not any returns. Since there’s a good chance you haven’t returned capital to LPs before.
And this is true for not just funders, but also founders. In the words of Mike Maples, “Breakthrough builders are visitors from the future, telling us what’s coming. They seem crazy in the present but they are right about the future.
“Legendary builders, therefore, must stand in the future and pull the present from the current reality to the future of their design. People living in the present usually dislike breakthrough ideas when they first hear about them. They have no context for what will be radically different in the future. So an important additional job of the builder is to persuade early like-minded people to join a new movement.”
Dissent is a luxury
The truth is loads of people will disagree with you. You’re not looking for consensus. In fact, it’s better to be wrong and alone than right and with the crowd if you’re in the venture world. Either as a founder or an emerging GP. It’s something I recently learned from the one and only Chris Douvos. If you imagine a 2×2 matrix… On one axis, you have right and wrong. On the other, you have with the crowd and alone. You want to be in the right and alone quadrant for sure. That’s where “fortune and glory” exists. It’s where alpha exists. It is how you become an outlier and achieved outsized returns.
But the prerequisite to be there is to have the guts to start in the wrong and alone quadrant. If you start from being right and in the crowd, you’re one among many. And that doesn’t give you the liberty to have independent thinking. You’re constantly trapped in noise.
It’s as Abhiraj Bhal says. “If you are a category-defining company, you will always have a TAM question, if the category is defined by somebody else, you will not have a TAM question.” You want people to question you. And as humans, we like to fit in. But to create something transcendent, external doubt is your best friend.
As such, your promise of the future must seem bizarre.
Don’t start with the product, start with your customers
When you have a promise, admittedly, the easiest way is to start engineering it right away. Without market validation. Without stress testing. Which pigeonholes a number of founders. I forgot the origination, but there’s a great line that says, “The only difference between a hallucination and a vision is that other people can see the latter.”
And in order to test that, you need to get in front of potential users and customers first. Max, someone I had the joy of working with, once wrote the below timeless tweet:
My hot take of the day:
Most aspiring startup founders who think they should learn to code would be better off learning to write well instead.
As Elizabeth once shared: “We decided that we’d start with no product. We would not build anything. And, we just started selling ads. We manually brokered deals with publishers and advertisers and took a cut in between. We got our customers by emailing people and setting up the copy and links ourselves. People would pay me through my personal PayPal account. It was only when we realized we were onto something that we started building technology to remove bottlenecks.”
On the investor side, it’s building a thesis where great investments fall into. It’s a way of looking at the world in a perspective that may seem foreign to others, but almost obvious in retrospect. The thesis should elicit the response, “Why didn’t I think of that first?” But no matter how obvious, you are the best positioned to bring the thesis to life. That doesn’t mean you need returns yet. Although good graduation rates certainly help as a leading indicator.
In that regard, it’s quite similar to how David Maisel foretold of the Universe to come. Obvious once explained, yet still met with resistance from legacy players.
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.
This is an addendum to the blogpost I wrote back in April of this year. Catalyzed by something Seth Godin recently shared. Which led me down a rabbit hole, and eventually to this sequel.
Seth Godin shared some fascinating perspective recently. “Turnover is a good thing when we are doing human work, not a bad thing. And what I would do if I was running a real company is I would say the first thing you’ve got to do on your first day is update your LinkedIn page and keep it up to date. And we’re going to have a resume job finding seminar every two weeks here. I don’t want you to stay here because you can’t get a better job. I want you to stay here because the conditions we’ve created, the work we are doing is worth you staying here for. And then I would listen.
“If I’m not creating the conditions where the people who I need to be dancing with want to stay, I have to change the conditions, not curse the people who are leaving.”
Which reminds me of a great Jerry Colonna dictum, “How am I complicit in creating the conditions I say I don’t want?” While the line is meant to be applied to an individual’s own awareness of how their environment is partly a product of their own design, it is equally as powerful in organizational design. Have you created an environment that lends itself to turnover? Is that by intention or lack thereof?
While I’m not urging founders to be less disciplined with their burn rate, Precursor’s Charles Hudson found one interesting piece of data recently. He wrote, “You cannot save your way to success. Our portfolio companies that graduated from pre-seed to seed typically spent more per month than those that failed to graduate. This result was consistent with what I’ve observed; the companies finding product-market fit spend more to keep up with growth and customer demand.”
While the above may be true when you graduate from the pre-seed to the seed, by the time you get to the A, it’s about securing great talent.
But let’s say your star talent has left (meaning that they passed the equivalent of Netflix’s Keeper test or any of these other culture tests). The one thing you DO have to be wary of is the morale of those who stay. Has your team members leaving broken the morale of the company? How fast can you get the team to bounce back?
To set some context, Frank Slootmandefines winning as breaking the competitors’ will to fight. “In a world of software, you break the enemy’s will to fight when you are hiring their people because they have given up. They’d rather be with you than they are with the other company, because it’s too hard and too painful and they’re not making any money. So, ‘I’m going to join the winner instead of stick with delusion.'” And in Bezos’ words, “when the last person with good judgment gives up,” your team’s will has been broken.
Each team member leaving has a non-zero chance of creating this snowball effect. As the founder, maintaining culture and momentum is important. As Bob Iger once said, “[The] most important measures of success for a CEO [are] internal satisfaction, investor relations and consumer support.” In my experience, the first of the three is often far less obvious to first-time founders than the latter two.
So how does one maintain internal satisfaction?
The truth is there’s no one right answer. So, instead, I’ll share some tactics I’ve seen work well.
The last day for someone should be on Friday. It gives teammates the weekend to unwind and doesn’t affect their work ethic in the weekdays immediately after.
Set up 1:1 time with all their direct reports and who they reported to (if the latter person isn’t you) within the week after that person’s last day. While the obvious next steps may be to figure out the new chain of command and reporting structure, the first conversation you have with them should be about how they’re feeling and not about company goals. And have an honest, unfiltered conversation here. Which also means you need to share how you’re feeling as well. Don’t sugarcoat anything. Smart people see through lies very easily.
Offer each direct report to that person a mentor. Either internally in the company or externally. For the latter, there is immense value in helping your team member grow and getting an advisor or someone in your network you respect to get more involved in the company through monthly/quarterly mentorship.
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.
Surprisingly, last week was the first week I’ve gone to multiple events for a given conference. Also I’m using the word “conference” very loosely here since I’m counting a tech week as one. What started off as ‘I’m going to support just one friend,’ ended up being a slippery slope, and supporting many friends, and catching up with friends in town. I mean, c’mon, how do you not at least say hi to a friend who’s flown from NYC or Miami? Perks of being bad at saying no.
That said, for the founder focused on getting to product-market fit, or actively fundraising, or the GP fundraising, your time is better spent elsewhere. But if you’re exploring and trying to increase the surface area for luck to stick, these events are great. So many fun, interesting ideas floating around.
Eight quick takeaways, before I go back and I let you go back to the rest of your week:
For VC/founder events, most attendees are founders. Smaller VCs went to the GP events. Bigger VCs just host their own.
For LP/GP events, most attendees are GPs. Went to an event of this type, and I kid you not, only met 2 LPs out of 15 people I chatted with. The rest were GPs. The folks you would like to show up at VC/founder events would rather pitch than to be pitched.
Interestingly enough, for the events that have a good proportion of LPs, most don’t seem to be investing in emerging managers. Anecdotally, have heard three of my friends who are individual LPs get turned down from LP events during SF Tech Week.
Smaller funds seem harder to raise than larger funds.
US large family office and institutional LP market is drying up. Most have overextended to buyouts and still need therapy for being burned in 2020 and 2021. For those that haven’t, they’re resorting to intros from friendlies.
Hosting your own events gives you better bang for your time than attending events.
And as one would suspect, AI dominates 70-80% of conversation.
Investing in unsexy industries is sexy. New moniker is to invest in industries where either 1/ people have scruffy beards or unkempt hair or 2/ meetings that require suit and tie.
Stay awesome, friends!
#unfiltered is a series where I share my raw thoughts and unfiltered commentary about anything and everything. It’s not designed to go down smoothly like the best cup of cappuccino you’ve ever had (although here‘s where I found mine), more like the lonely coffee bean still struggling to find its identity (which also may one day find its way into a more thesis-driven blogpost). Who knows? The possibilities are endless.
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.
It’s not every day one gets to sit down and experience a Chinese tea ceremony under a late afternoon Los Altos sun. Sitting across from me was a gentleman in a white tee who moonlighted as a tea connoisseur. As such, he was in the middle of passionately describing to me what was some of the best tea I’ve had to date.
“David, smell this blend three times. You’ll realize that each breath you take will smell completely different from the last.”
To my bewilderment, he was right.
As I handed the teapot back to him, he continued, “Now the first pour you always pour out. Here, we are just washing the tea leaves. But we use this opportunity to also coat the insides of your teacup with the flavors of this next tea.”
True to his word, he awakened the inner mold of my cup with the smoky liquid infused by leaves that had been aged longer than I’ve been alive. Then poured the first pour back onto the teapot with the lid on, creating a wet seal around the teapot. As a result, the leaves were washed. The aromas are concentrated in the pot. And the cup has been given time to get to know the tea.
When, finally, the teacup landed back in my hands, I could taste the unfiltered, rich, smoky, yet mellow aroma of a Wu Yi Shui Xian tea.
If I didn’t know any better, I’d never have guessed his “day” job was being an investor. Specifically, a pre-seed and seed deep tech investor.
Of course, you’re smart. Given the title of this blogpost, you didn’t come here to read about the intricacies of drinking tea. But about the intricacies of deep tech, which in the process of editing this piece, I realize deep tech happens to have the same initials as drinking tea. But that’s not only stretching it, but I digress.
The fine gentleman who sat across from me in a white tee, his name is Arkady Kulik, Co-Founding Partner of rpv, a fund dedicated to backing early-stage scientifically intensive teams. In other words, deep tech. Currently, the industry itself is highly fragmented. In Arkady’s words, “it’s like investing in IT in the 80s. But they’re all ventures that can completely reshape the landscape.”
As Arkady continued, he shared something else quite fascinating. “In software, you’re looking at a high market risk and low technological risk. In deep tech, it’s the exact opposite. We have a low market risk and high technological risk. The problem is not whether they can sell this to people, but rather whether they can build it.”
Naturally, as someone who spends little time looking into the deep tech world week to week, I had to double click on that. What followed was a conversation where I found myself wishing I could take notes faster.
Smelling the tea leaves
As a non-technical person, the biggest question for me has always been: How do you evaluate a deep tech deal?
To Arkady, it’s the entry point in price as a function of Technology Readiness Level. TRL, for short.
Source: rpv’s Investor Deck (and yes, Arkady gave me permission to share this)
“TRL is actually something that the team at NASA came up with. NASA has always had a lot of internal projects, and they needed some internal tool to evaluate the readiness of those projects.
“It was developed in the 1970s, but was formalized in the decade after. One through three on the TRL scale is all theory. They’re largely funded by the government through grants and such. Seven through nine on the scale is commercial, and covered by generalist VCs. Everything in between is in some form of a product development process. That’s where we come in.
Source: rpv’s Deck, citing NASA TRL levels
“To get the graph above, we take TRL levels on the X-axis and the historical round size data on the Y-axis. Then we looked at every single company, took the lowest and highest round in each vertical within deep tech, and mapped it out.”
While every firm’s “blue box” is different — and after learning about this, I do encourage every deep tech firm to go through such an exercise, rpv’s sweet spot is companies leveraging technologies TRL 3-6 whose round is shy of $1.5 million.
The first pour: Tea meets cup
After passing through the smell test, the first question Arkady tries to answer is always: Is it BS? “I look at every deck myself. No analyst. No associate.”
After Arkady looks at the deck, he then sends it to his team. “They give me one of three scores: green, yellow, or red. If it’s positive — meaning either green or yellow, I take the first meeting. We have 12 deal breakers, ranging everything from lack of ability to protect IP (it’s why we don’t do software deals) to tech, finance, or team conflicts of interest. If any of us in diligence raise a flag, we don’t continue. If not, we ask specific questions to the team.”
When meeting with the team, the question of founder resilience always comes up. Of course, every investor measures grit differently. I ask about excellence and scar tissue, but I was deeply curious as to what Arkady asks for.
“I try to gauge it from learning about founders’ past experiences (not necessarily professional ones),” he goes on, “I dig deeper on tough situations a founder has faced. Also proposing hypothetical scenarios about their fundraising or team dynamics help a lot in understanding that facet.”
Without a beat, I follow up, “For that, do you have any go-to questions?”
“Nothing formal. I try to find an experience in someone’s past that could be good grounds for showing resilience: competitive sports, PhD, previous startups, complicated and long-term projects in the corporation or something like that.
“For the hypothetical scenarios, I ask things like ‘What if you won’t gather the round?’ Or ‘What if your co-founder absolutely had to resign, what’s your action plan in the bus factor case?’
“It’s an area where you look at how they react, not just what they say. How does their body language change when they’re answering the question. It’s about the non-verbal signals. ‘Tell us an experience in the past and things didn’t go your way, and things were dragging.’ Was it when you applied to college? Or went for your PhD? Or when you were trying to go on a date with someone you liked?’
“Resilient people usually have some kind of Plan B. People who don’t have another plan and still try the same thing again and again are stubborn. We don’t seek stubbornness in entrepreneurs. We look for their ability to be honest with themselves and other people.”
The second pour: Tasting the depth
“If there are no red flags after meeting the founders, then we move into scientific due diligence. We ask everything from deep scientific questions (on isotopes or wavelengths) to the feasibility of the product — essentially a peer review on a paper by our internal, but also external scientists and advisors. The latter to get a truly unbiased opinion.
“Then we do a deeper diligence process with a scorecard of 35 items from team composition to their stage of development to their ability to protect IP to the availability of competition, each rated twice. Once by myself, and another by our advisors and venture partners. Then we average the points out for each of the 35 items and compare against our thresholds. If it’s a green light, we make an investment decision. If yellow, we follow up with the target venture’s team to see if they have a good answer to our concerns. And if not, then we say no. If red, well, we also say no. Though we have yet to give a red final score after using the scorecard since they’ve all died during the extensive due diligence process.”
In our conversation, which eventually migrated to Zoom (with some people, you just never run out of things to ask), I postulated about the variability in venture firms using scorecards. There are strong reasons why you should or shouldn’t from both sides of the aisle. Both of which have generated great returns for their LPs.
Today, many of the top tier venture firms make outlier decisions based on gut. It’s the same reason why generational or succession planning at these top firms are so hard. Once the GP leaves or retires, the next generation have a hard time making the same investment decisions as the previous generations.
On the scorecard end of the spectrum, hedge funds are, by definition, firms who employ algorithmic discipline to generate alpha. On the venture side, you have Correlation Ventures, SignalFire, just to name a few. Seven years back, Social Capital’s Capital-as-a-Service, just to name a few. The last of which seemed to have been deprecated due to the inability to scale support for a portfolio of 500 startups, rather than the inefficacy of their “scorecard.” As you might suspect, a topic I’m quite fascinated about.
“We make our decisions based on scorecards,” Arkady reaffirmed, “And if you were to look at each one we’ve done, you’ll see that it’s rare that our team sees eye to eye. We disagree a lot. It’s an individual decision and we take it. And we never try to convince the other to change their score. We trust each other to give a score we believe in. For advisors, since we have many, we take the average of all their opinions. We also ask different advisors for each item on the scorecard. Some advisors are excellent in one area, but might not be fluent in another.
“The final thing I’ll say is that when something feels off, we say no. Even if the data shows green, but we’re unsure about the validity of the data, we still pass. One of the best pieces of advice I got around hiring is if you’re not sure about a hire, pass. It’s the same with investing.”
For Arkady, that is the weapon of their choice.
In closing
Between three calls and a tea ceremony, even then, we only touched the tip of the iceberg. One I’m likely to have many more questions for Arkady and my other friends who live and breathe in this space. It’s an exciting space. To be fair, even calling it all just one space is an understatement. It’s a permutation of many that’ll be segmented when the broader investment community starts to understand them all better. Myself included.
Looking forward to it all, and appreciate you, Arkady, for all the back and forth edits, lessons, and the tea!
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.
