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.
Earlier this week, I tuned into an episode that come out in late March on the 99% Invisible podcast about the panopticon effect. In all honesty, until this week, I pled ignorance to that second to last word — panopticon. Something that had been omitted from my anecdotal Meriam Webster. But maybe you’re less ignorant than I am and you’re already familiar with this term. Maybe we’re in the same boat.
Nevertheless, it turns out the panopticon was a relic of the late 1800s. It was a time, not too unlike today, when they were tackling the age-old problem of reforming prisons. Brought to life by Dutch architect Johan Metzelaar, the panopticon is a cylindrical prison, further defined by a single pillar at the center of it all — a guard tower. Unlike previous prison designs, this one was specifically designed so that the guards could keep their eye on every prisoner. Or at least that was the idea. For those in the prison to feel like they were always being watched, in hopes that would aid in the correction of their behavior.
And in that same episode, rewinding even further back in history, Roman Mars, the host of the 99% Invisible podcast, shared a fascinating piece of trivia. The Dutch were once again one of the first to introduce prisons as an alternative to torture, capital and/or corporal punishment. These houses of correction were meant to be opportunities for inmates to develop discipline and morality. Spoiler alert. It didn’t work out as expected. He mentions, “The goal of rehabilitating inmates was quickly lost. The houses of correction devolved into just convenient sources of very cheap labor.” Simply put, while the intentions for correctional facilities were good, the incentives led them astray.
2/ Josh brought up a great point about INTENTIONS x INCENTIVES
A lot of tech is invented perhaps with the right intentions, but financial or other incentives can get in the way, twisting outcomes to undesirable ones for society.
Nuclear was invented to harness renewable elemental power, but became a means to create weapons of mass destruction.
Social media started as a means to bring people together, but devolved into a tool for gaming eyeballs and invasive ads.
Vaping started as a way to help people quit smoking, but to create a sustainable business, the companies have started marketing “fun” flavors.
The battle between intentions and incentives is no less true in the past with prisons and empires and political beliefs as is in the present and future with technology, generative AI, deep tech, crypto and blockchain… The list goes on.
Intentions are usually about personal motivations, morality, ethics, and the greater good. The force that drives us forward. I truly believe that most people don’t start off wanting to take advantage of others. Incentives, on the other hand, are business motivations. They’re optimizations. A rationalization of decisions that conflict with goodwill for the sake of, well, insert your choice of blame and delegation of responsibility. Often times it is for the broader organization.
It reminds of a saying that I first heard in The Dark Knight. “You either die a hero or you live long enough to see yourself become the villain.” I can’t speak for every individual out there, neither is it my place to preach. That said, with the world progressing exponentially, selfishly speaking, I’d hate to see good people and good businesses overly optimize for the wrong reasons. And lose themselves in the journey up.
#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.
Earlier this week, I grabbed coffee with a founder. Let’s call him “Elijah.” He recently lost a key exec he’d been working with for two years to their incumbent competitor. The competitor’s offer happened to be too good to turn down. Triple the exec’s salary. As that exec had a family to feed and children’s education that didn’t come cheap, he made the hard decision to leave. Needless to say, Elijah was devastated. And he asked,
“David, what should I have done?”
I initially thought it was rhetorical. It seemed that way. But he paused, looked at me, and waited.
So I responded.
My response
I’ll preface by saying that the advice I shared with him was a collection of insights I learned from mentors over the years — some a lot more recently than others. I don’t hold all the keys to the castle. And every situation is, well, situational. So the last thing I wanted was for the founder to take my advice as the word of god (nor anyone reading this blogpost now). Merely a tool in the toolkit. At times, useful. Other times, just something that acts as décor in the shed.
“Elijah, it’s probably too late for that exec… for now. He’s made his decision and walked. That said, I think there are two things to be aware of here:
The fact you didn’t know about this until it happened, and
The decision itself.”
Pre-empting the ultimatum
For the former, here’s how I think about pre-empting your team’s career inflections.
In their first week, have everyone put together their personal manifesto. What is their 6 month goal? 1 year? 5 years? 10 years? Lifetime goal? What motivates them? How do they like to give and receive feedback? Of course, it’s helpful to share your own first, so they have a reference point. Don’t expect anything you’re not willing to share first. So, naturally, this requires a level of transparency, and more importantly, vulnerability.
Then within the first two weeks, you and their direct manager should review their manifesto with them for at least 30 minutes live. Really get to know them. Taking a page out of Steven Rosenblatt’s book, what drives them? What haven’t they achieved that they want to achieve? How do they do their best work? When do they feel the most motivated? Why did they want to work here? Why are they excited to do so? How does working at your company fit in their broader goal?
Then every quarter, allow every team member one day of mindfulness away from their work to revisit their manifesto. I usually recommend a Friday. What’s changed? What’s stayed the same? Does their current role still fit in their broader goal? If not, why not?
The week after, take time to sync again and be incredibly candid.
Of course, the above is easier to do if you have a company of less than 50. At some point, when your company scales past that, it’s at least helpful to do it with your direct reports and their direct reports.
Helping with the decision
For the latter, you can’t stop a river. Even if you build a dam, the flow will always find a way around. You can’t change what motivates someone else. But you can help them channel it. The best thing you can do is equip that person with the tools to make a decision they will not regret, and wish them the best.
I like to sit people down and first help them figure out why they’re considering a new role. People often conflate the three traits of a job — compensation, scope, and title — together when making a career move. But in truth, they’re similar, but all a bit different. And I want people to know that just because they’re getting paid more doesn’t necessarily mean an increase in responsibility. Just because they’re getting a new title doesn’t mean that they’ll get more money. Then I have them stack rank the three traits. From most to least important.
If they still rank compensation first, that’s fine. Maybe they’re saving to buy a new house or to pay for their child’s higher education. And there’s nothing you nor I can do there. But if it’s one of the other two that come out on top, there’s room to create a new position or set of responsibilities where the individual feels empowered. And if it’s not at your company, they’ll be equipped to think through it at their next company. If they don’t have one lined up yet, help them through your network find one that’ll fit the criteria.
The wonderful irony
The funny thing about helping people achieve their dreams — sometimes that’s actively helping them leave your company — is that the karma usually comes back in one way or another. In this case, and I’ve seen it and experienced it before, even if you lose this person at this time and place, they’ll remember the help you gave them. To which, one day, when they have an all-star friend looking for their next opportunity, they will think of you.
There’s a saying I love. ‘The best compliment an investor can get is to get deal flow from someone they passed on.’ And here, the best compliment you can get is to get talent from someone who left your team.
In closing
Shake Shack’s Danny Meyer recently said something that echoes this notion. While he uses the word “volunteering,” he defines “volunteering” as:
“I basically, to this day, treat all of our employees as if they are volunteers, which not in the real sense. You’re going to get paid. But if you’re working for me, it means you’re probably good enough to have gotten another 25 job offers at least. And so, as far as I’m concerned, you’re volunteering to share your gifts with us.”
He goes on to say, “I didn’t have any way to motivate them with money. I couldn’t give them a raise, couldn’t dock them their pay. So I learned such a crucial lesson, which is that, if someone’s volunteering, the only way to motivate them is to have a higher purpose.”
Of course, there’s more than one way to make a team member feel like they are valued and that they value their work here. Another way is to give your prospective team member a “love bomb”, as Pulley’s Yin Wucalls it.
Give the candidate a love bomb once you're in sell mode.
Offer chats with investors. Get your team to reach out.
Send cake.
Talk to the candidate's partner, sister, kid, etc. Everyone wants to feel appreciated. Do whatever you can to show the person you want them on the team. pic.twitter.com/4pgnOQIO5S
Now I’m not saying that if Elijah did all the above, he’s guaranteed to retain the exec. Who knows? He might have. Might not. For a man with a family and financial needs, it’s a hard ask. But at the minimum, this career move wouldn’t have blind-sided him. And better, he could’ve supported that exec in making that career move.
Just like with your product, your goal with your team is also to catch lightning in a bottle. How do you attract the best talent to work with you? And then, once you are able to, how do you keep them?
With the latter, a big part of it is showing you care.
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 thing is this is the first real recession I’m working in. I entered the workforce something in the midst of one of the longest bull markets in modern history. So, naturally, I had a lot of questions. One of which I asked one of my mentors in VC who’s been through a few cycles late last year. “Are there any leading indicators that foretell when we’re going to get out of a recession? Or when we truly hit rock bottom in a recession?”
And he said something that made complete sense. “When the frequency of mass layoffs, especially from some of America’s largest employers, slows to a halt.”
Since then, every month or so, I check in the number of WARN notices that come in which require companies doing a mass layoff to publicly report a layoff 60 days in advance. For instance, you can find California’s here.
As Chamath Palihapitiya puts it in his 2022 annual letter, “while we believe that most of the multiple contractions in these markets have largely worked their way through the system, we suspect there is still some more room to fall — particularly if the U.S. enters a recession in the coming year.” Since it seems layoff season is yet to pass, it seems wise to buckle in for the longer run.
While friends have asked me when the recession will end, I responded with a simple “I don’t know.” No one does. And while many may make conjectures on the timing, the one thing we can use this free fall for is to build a heat shield.
I really like this one line in Chris Neumann‘s recent blogpost on antifragility. “As great as it sounds for a startup to get stronger when unexpected events occur, I don’t actually think that’s a realistic goal for most companies (it certainly isn’t the case for VC firms). Rather, I think the goal in making antifragile startups should be to minimize the risk and distraction when unexpected events occur, such that the company can continue to make progress while its competitors are panicking and reacting.” One thing’s for sure. The world is host to a plethora of distractions. Something we won’t be in shortage of. With each black swan event, we will only be left with a surplus of attention stealers.
And I’d be presumptuous to say that the best do not get distracted. Rather the best realize when they are and have ways to get back to a focused flow state. Simply put, it’s helpful to play a game of What if? What if this unexpected shock happens? How will I react when my servers get hacked? How do I react when my cash flow is constrained due to an unpredictable event? And in each broad category of What if’s, do you have a way to hedge the risk?
Sometimes, it’s preparing for the unexpected black swan event.
That’s why code is redundant to prevent the fragility of storing it only on one server.
It’s why you should have your cash in multiple bank accounts, with at least one of them being a big 4. A few top firms, including General Catalyst, Greylock, and Redpoint, have also said, “Keep two core operating accounts, each with 3-6 months of cash. Maintain a third account for ‘excess cash’ to be invested in safe, liquid options to generate slightly more income.” All to protect against the downside risk of losing all your money when you put your eggs in one basket.
But when the black swan does hit, prioritization matters even more. When the pandemic hit and Airbnb was between a rock and a hard place, Brian Cheskydescribed it, “We realized not everything mattered. And it was like if you have to go into a house — your house is burning — and if you could only take half the things in your house, what would you take?”
Chamath went on to write in the same letter. “The most alarming consequence in startup-land has been the divide it has created between the management teams who have ‘found religion’ (i.e. made the tough decisions and managed their businesses smartly) and the rest who are trying their best to avoid reality.” And those tough decisions include, “cutting non-core projects, lowering costs, and vastly reducing G&A while getting to profitability [which] is now mandatory — otherwise you will have to face the consequences.” Those same tough decisions set teams up for success in bad times and bear markets.
In closing
Recently on the Tim Ferriss Show, David Deutsch said, “wealth is not a number. […] It is the set of all transformations that you are capable of bringing about.” Similarly, a company’s revenue is not just another number. It is a product of all the miracles that the company willed into existence. Crossing the chasm. Leaping over hurdles.
To take a line out of Nassim Taleb‘s book, “Crucially, if antifragility is the property of all those natural (and complex) systems that have survived, depriving these systems of volatility, randomness, and stressors will harm them. They will weaken, die, or blow up.” We need black swan events to create miracles. And we need miracles to create stronger, more resilient companies.
Trauma strengthens us. You need to bleed to grow scars. You need to feel pain before you grow calluses. The product of each makes one more resilient to pain and injury in the future.
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 an industry that is heavily apprenticeship-driven, the more tactical advice one gets, the faster they grow. Historically, that meant a senior partner taking you under their wing. Or maybe 2-3. While I’ve been lucky to work and learn alongside some of the world’s most exceptional minds in the funding landscape, I’ve always found it helpful to have multiple teachers. Some in the form of books. Others in the form of shorter form content. Tweets. Social posts. Podcasts. And of course, from the insightful conversations that I have weekly. At the same time, in hopes of supporting the growth of others in this industry (such a small world, but it just isn’t helpful enough), this blog has been and will continue to be my vehicle for stewarding information and insights from the best.
Just like in both of my initial pieces of 99 pieces of advice for investors and founders I wrote in April 2022, this will be a continuation and an evolution of the last. While this will cover more of the same topics as last time, like startup investing, pitching to LPs, and fund strategy, I’m personally really excited about the some new categories, like succession planning, tax, and how to think about exiting positions.
And while I do write long form posts most of the time, and have been guilty of well… longerrrrrr form essays (and maybe one day with even more r’s), like this or this… I digress. While I do enjoy long form expositions, some things are best shared without superfluousness.
Most of the advice below captures the essence of a TikTok or Instagram Reel or a YouTube short. Choose your fancy. Many of which answers the age-old podcast question: “If you were to share one piece of advice with your [insert age]-year old self, what would it be?” Or “What advice would you give someone starting their first fund today?“
And now with “new and improved UI” (don’t get too excited, just number count of soundbites in each category), each fall in one of ten categories:
1/ You can’t be in every good deal, but every deal you’re in better be good.
2/ “You’re not defined by your worst investment. All angels will have failures in their portfolio. It’s part of the process.” – Brian Rumao
3/ “The weird thing is when late stage went from the hardest part of venture to the easiest. And that should have been the flag to everybody.” – Jason Lemkin*timestamped May 2022
4/ “The older you get, the younger your mentors should be.” – Samir Kaji
5/ “Your brand is what people say about you when you’re not in the room. It’s their first reaction when they see an email from you in their inbox. You build that brand — or not — with every interaction.” – Chris Fralic
6/ “Never let a good crisis go to waste.” – Winston Churchill
7/ When there’s risk involved, don’t let the outcome determine the quality of your decision. – Andy Rachleff
Investing — Deal flow, theses, diligence
8/ When assessing startups against their incumbents, consider their incumbents’ ability to hire top talent. For instance, if the incumbents are banks that are known for slower logistical and bureaucratic procedures, it’s easy to hire the best talent out there. On the other hand, if the incumbents are Coinbase, that’s still a fairly young, sexy company that’s innovating quickly, hiring top (technical) talent is more challenging. Shared by a former executive and founder with 2 exits, turned fund manager with 2 funds.
9/ If you’re not getting a call from a founder when they’re in trouble, you’re probably not getting a call from a founder when they’re raising their next big round. – Zach Coelius
10/ Pick great market inflection points to bet on. “The founder is the surfer. The product is the surfboard. The market is the wave. The wave matters most.” If you bet on a good surfer on a bad wave, they’re not going to get you the returns you want. Some Sequoia partner.
11/ Ask for investor updates (before investing). Before you invest, ask for the most recent investor updates. Helps you understand how founders think and communicate. – Brian Rumao
12/ Align with the founders, but also employees on valuations and dilution. – Nikhil Basu Trivedi
13/ The earlier you invest and the more you care about ownership, the more active role you’re expected to take in your portfolio company. You can’t expect to take large ownerships, and not actively help anymore. If you want to be a hands-off investor, you don’t have a right to fight for ownership. In a bull market, founders get picky about who’s on their cap table (as they should be). Focus on your check size to helpfulness (CS:H) ratio. Inspired by Jason Lemkin.
14/ “We have no fear. If we could find God’s phone number, we’d call him.” – David Beirne of Benchmark Capital fame, cited in eBoys. You are never too good to cold-call.
15/ Create a list of your favorite builders (i.e. engineers, community managers, executives, etc.). Then scrape Delaware incorporation docs regularly to see if any on the former list pop up in the search. If so, reach out to them early.
16/ Ask the founders to see different versions of the pitch deck. While we always say, “investors invest in lines, not dots”, oftentimes it’s hard to measure the slope (rather than y-intercept) when you’re meeting only with a founder at the beginning of their fundraise and not sooner. But one way to see is watch how much the pitch decks changed over time (and how quickly the founders incorporated feedback).
17/ Invest in companies that will be timeless. Where there will still be customers in a recession.
18/ If the competitors of the startup are being bought by private equity firms, then it may be a lucrative space to invest into. The competitors’ innovation slows, and optimizing for profit and the balance sheet becomes a priority when PE firms come in. – David Sacks
19/ There is a superpower to be speaking the same native language as the founders you back (and for them to their customers). Try to understand them for their position of strength.
20/ “The market you’re exiting in is not the one you’re funding now.” – Ben Narasin
21/ “There’s another phenomenon that happens in a time like this: Google’s not hiring. Facebook’s not hiring. People are clamping down. Guess what happens to their most advanced projects? They go. And guess who are the best people in any large company? The best people are working on the most advanced projects. They are the ones who want to do visionary things. They’re the fodder entrepreneur for venture capitalists. So I think many more of the best people — not because they’re not getting paid huge raises in compensation — but because they’re working on less interesting projects — will leave to follow their vision.” – Vinod Khosla (timestamped Oct 28, 2022)
23/ “Funny people are really underrated. […] Charismatic leaders are pretty funny. Humor is a really important emotion for two reasons. One is if you can evoke it a lot and be funny, you can create a sense of bonding. Generally speaking, in a remote world, there is a shortage of emotions you feel. An exchange between us now as we stare at each other in our computer monitors is maybe 1/100th of what it would have been in the real world. When you think about it, why do movies succeed? Movies substitute the real world interaction with synthetic emotion. So… horror, humor, action, drama. So you want leaders who can do the same over Zoom. That’s why Peloton instructors have all the jokes that they’re saying. It’s same exact effect.
“But there is a second reason to why humor matters, which is if you were to imagine a Maslow’s Hierarchy of Needs, I at least find with myself, I’m not able to think of a joke if basic stuff isn’t right. […] You do have to be careful of the ‘court jester’ type. These are people who are so insecure that they’ll do anything to get a [cheap] laugh.” – Daniel Gross. For example, cursing or vulgar jokes or making fun of others are examples of cheap laughter.
24/ For follow-on checks, Founders Fund and Saastr invest 10% of the fund in each of their “winners”. – Jason Lemkin
25/ “Whenever a CEO blames their bad performance on the economy, I knew I had a really crappy CEO. ‘Cause it wasn’t the economy, it was a bad product-market fit. The dogs didn’t wanna eat the dogfood. Sometimes the economy can make that a little worse, but if people are desperate for your product, it doesn’t matter if the times are good or bad, they’re going to buy your product.” – Andy Rachleff
26/ “[Peter Reinhardt] would put plants in different parts of the office in order for the equilibrium of oxygen and CO2 to be the same. He would put noise machines in the perfectly placed areas and then reallocate the types of teams that needed to be by certain types of noise so that the decibel levels were consistent. What I don’t think people realize about founders is that they are maniacal about the details. They are unbelievable about the things that they see.” – Joubin Mirzadegan
Value add
27/ Everyone says they’re a value add investor or founder friendly. And every founder goes through these 10-15 moments in their founder journey from which they lose sleep over. How many of your portfolio founders call you first if shit hits the fan? Those will be who you’re remembered by. No other portfolio founders will remember you.
28/ The network you bring is table stakes. That will neither help you win deals or raise LP capital when it really matters.
29/ “Dirty secret of VC platform teams: they are more about scaling the GP than the founder.” – Sarah Tavel
30/ Are you uniquely positioned to get allocation on the cap table because you can be a value add to these companies? – Vijen Patel
31/ Sometimes the most helpful thing you can do is to say no. When founders ask for introductions, and you don’t think they’re a good fit for your investor network, “It’ll be tough for you to fundraise right now. And if you jump in a conversation now with these other investors, it’ll hurt your ability to fundraise when you finally iron out those 1-2 key metrics and get to that inflection point.”
32/ Before the term sheet is signed, sit down with them and say this. “‘Listen. The chances this company gets to the finish line – the finish line being this fantastic exit – we don’t know what they are. But what I do know is that there is a chance, a high probability, that the company will fail. And I want you to think about this as an opportunity cost. I want you to think about every day you walk in the door to this company or turn on this Zoom as an opportunity cost. If it is not working, I want you to tell me, ‘It’s not working.’ And let’s have just a dispassionate conversation about what that means, so that we don’t waste any more time trying to make it work. And I promise you I will do the same.’
“And if you can set those guidelines from the beginning, you can move onto something that might have better timing. The founder can. And I can. Be aware of what failure looks like.” – Maha Ibrahim
Pitching to LPs
33/ Don’t promise your LPs guaranteed co-investing rights to go directly on the cap table of your portfolio companies. Let the founders decide who gets to invest on their cap tables. – Samir Kaji.
34/ A typical emerging fund takes 1-2 years to raise <$10M. Plan for that timeframe. A fast raise is 6 months. – Elizabeth Yin*timestamped April 2022
35/ To LPs there are 4 main metrics that are of note. Gross and net IRR to show how cash efficient you are, as well as how your portfolio is marked up. TVPI and DPI to show your paper returns and cash you’ve returned to your LPs, respectively. – Chamath Palihapitiya
36/ When you’re pitching institutional LPs (i.e. endowments, pension funds, university investment offices, etc.), you’re bet against 10-year life cycles and portfolio strategies. When benchmarking metrics (i.e. IRRs and TVPIs/DPIs), you have to show you can outperform other asset classes (i.e. real estate) and the public market equivalent (PME). Comparing and contrasting is often the most effective.
37/ When you’re pitching individual LPs (i.e. angels, or “belief capital), largely true for Fund I’s and II’s, it’s about personality and promise. Do people like you? Do you bring in great top of funnel deals? Are you different?
38/ “Don’t run out of leads.” You want to be constantly meeting new investors, ’cause you don’t want to be in a situation where you have to go back and convince people who are clearly not sold. – Elizabeth Yin
39/ If your Fund I consists of mostly individual LPs (i.e. accredited investors, but not qualified purchasers), you’re going to have to fundraise from scratch in Fund II and III. Since they have less of a net worth than institutional LPs, they most likely don’t have the capital to: (a) re-commit for a subsequent fund, (b) and even if they do, they won’t have enough to meet the minimum check size, assuming Fund II/III is bigger than Fund I. Inspired by Elizabeth Yin.
40/ Ask LPs what they like and what they don’t like about the pitch deck, and use each conversation as a learning and refining process.
41/ Figure out how much money you’re capable of raising in Fund I, and raise 25% less. It’s much better to be oversubscribed than suffer from lack of momentum. And leverage the “oversubscription” to help you raise Fund II, III, and so on. Told me to by someone who has sat on over 6 LPACs(LP advisory committees) in his career so far.
42/ The median family office check into first-time fund managers is $750K, with over 80% of family offices investing into first-time managers.
43/ “Does the world need another VC fund?” Most LPs don’t think so, so you need to convince them why you should exist.
44/ Before wasting your time pitching to some LPs, ask “Are you actively investing in venture funds at this time?” Many take meetings, but aren’t. Your time is precious.
45/ You’re going to raise from friends and family in the beginning. Your second cohort of LPs will be people you have a substantial network to. In other words, investors who you have many duplicate warm connections with, so that they can easily qualify your ability. – Dylan Weening
46/ In a recessionary market, LPs find themselves rebalancing their asset allocations. As their public market assets go down, they find themselves overallocated into venture. As such, they’re investing in less new managers. So in order to raise as an emerging GP from these LPs, you need to replace someone they’re currently investing into. That means you need to: (a) outperform them (4x TVPI is table stakes), and (b) have one compelling story on why you, backed by numbers.
47/ When doing diligence, sophisticated LPs evaluate you based on consistency. They will evaluate fund/portfolio performance with AND without your top investment. Hence, they expect a minimum number of investments in your portfolio – usually 20 to 30.
48/ Some LPs have been burned by staying invested in yesterday’s firms for too long. The top firms a decade ago are not the same top firms today. These firms often have an emerging GP thesis.
49/ “This is not a one-trick-pony relationship. You’re a capital allocator. The cost of finding new relationships to build is significant. You need to seek long-term capital allocation partners. Have a three to five fund view – multi-decade relationships. How repeatable is your success?” Shared by an LP in 30 funds.
50/ “The best filter for this is figuring out what [an LP’s] minimum check size is. And, is that greater than 20% of your fund size? If so, it won’t be a good fit.” – Sarah Smith
51/ “There’s a thing called ’round tripping.’ If a fund in India invests in a fund that’s built in the US, then invests back into Indian startups, that’s round tripping. And unfortunately, not allowed.” – Shiva Singh Sangwan
52/ “Before you say yes to LPs, check the CFIUS rules. Under those guidelines, you may not be able to take money from certain countries and parties.” – Arjun Dev Arora
53/ “Valuations are not the way you judge a venture capitalist, or multiples of their fund. […] The way that I judge a venture capitalist is by how many companies did they back that grew into $100M revenue businesses.” – Andy Rachleff
Fund strategy/portfolio construction
54/ It’s often good practice to not lead syndicates the same time as you’re raising for a fund (outside of SPVs to maintain pro rata). It gives too much optionality to LPs. For the most part, it’s easier sell a deal than it is to sell a fund.
55/ Typical GP commits are 1-2% of the fund. If you’re unable to do so (or even if you are), good practices include recycling fees and deal warehousing. The latter is where you keep a portfolio of personal investments in storage before launching the fund. Warehousing deals de-risk the deal by allowing LPs to participate in marked-up deals at more lucrative, aka lower valuations.
56/ In a downturn, investors are still funding startups but adding in more terms in the form of side letters. The riskier the bet, the greater the liquidation preferences, anti-dilution provisions, and minimum hurdle rate expectations.*timestamped in April 2022
57/ “Bank loans for VC funds have short paybacks (90-180 days). The 2+ year paybacks relate to large PE funds. IRR boost is minimal in VC.” – Samir Kaji
58/ Don’t be scared to recycle carry early. Most funds suffer from under-deployment, which usually leads VCs to deploy the last 25% of capital either towards deals with high valuations or in difficult situations (down rounds, pay to play rounds). – Villi Iltchev
59/ While pro rata rights are technically legally binding, earn the right to invest in subsequent rounds, rather than just expect it.
60/ Liquidation preferences have little impact on fund returns, which makes sense when you actually think about it, but many VCs add these provisions to protect their downside. Data shows that only the bottom quartile funds see IRR impacted greater than 1% due to liquidation preferences. Returns are driven by the winners in your portfolio where liquidation preferences don’t matter. There’s a big difference in a strategy to win versus a strategy not to lose.
61/ IRR is a vanity metric for funds early in their life cycle. While it can be a useful metric for LPs to compare across vintages and their portfolio, overoptimizing for it gives a false sense of hope. Why? IRR values quick capital deployment. Recycling hurts IRR. Many things change over the span of a 10-15 year fund. – Seth Levine.
62/ Ownership and pro rata allocations are inversely proportional to the number of portfolio companies in a fund. Many managers can’t get 100% of their pro rata allocations, but rather only 50-75% of their allocations. Inspired by Henri Pierre-Jacques.
63/ Venture reserves make less sense in a bull market. Reserves are usually put into a fund’s winners. But in a hot market, a larger percentage of your portfolio companies get mark ups – making it harder to differentiate signal from noise. Reserves make sense in a bear market when it’s easier to differentiate signal from noise. In a bull market, it might be better to have no reserves, and spin up SPVs for a follow-on strategy.
64/ Your ability to get into later rounds, not just ’cause of pro-rata rights, should be a big determinant if you have a reserve strategy. Can you earn your allocation in later rounds? Will founders fight for you even when downstream investors want more equity? The best companies are hot commodities. Even if you have a follow-on strategy, you might not be able to get in those subsequent rounds.
65/ If you want to include more than 99 accredited investors in your fund, set up a parallel structure where you have one fund for accredited investors (<$10M) to include 249 accredited investors, and another fund for qualified purchasers (QPs).
66/ “The best way to protect yourself against the downside is to enjoy every bit of the upside.” – Bill Gurley
67/ If you have a parallel fund structure (i.e. one for accredited investors, one for qualified purchasers (QPs)) and you’re going through rolling closes, understand that your initial allocation in each deal will change as a function of each fund’s committed capital from LPs.
For example, let’s say you’re raising a hypothetical $100M fund – a $10M fund for accredited investors, and $90M for QPs. Let’s call the $10M fund Fund IA, and the $90M fund Fund I. On average, QPs take much longer to make a decision, so you’re likely to close your Fund IA before you close Fund I. As such, your first investments out of the fund might be 50-50 from each fund. But as you finish closing your Fund I, you will need to rebalance your allocation into earlier deals, like changing it from a 50-50 allocation between the two funds to 90-10. As such, in your term sheets, make sure you include the “right to transfer securities to affiliates.” And make it clear to your founders why that’s in there before everyone signs.
68/ If you’re building a concentrated portfolio, think about portfolio construction from a bottom-up perspective, rather than top-down. How many unicorns/decacorns do you need to return the fund? How often have you historically seen them in your inbox? That’ll be your deployment schedule. And subsequently, your capital call schedule.
69/ “Fund management is irrelevant unless there are winners in the portfolio.” – Laura Thompson
70/ Calculate your mark ups on priced rounds rather than valuation caps on SAFEs. Your TVPI and IRR may look nice in the short-term, and may help you raise from individual LPs. But once you start talking to institutions, you look deceitful or have no idea what you’re doing.
71/ Avoid overly large GP commits. If you invest too much of your own net worth into a fund, you’re going to make decisions that sacrifice the long game of the fund for short term personal liquidity, like selling secondaries to buy a house. Don’t go higher than 10% of your net worth. – Sheel Mohnot
72/ “For funds that are <$20MM, the GP commitment is fairly meaningless in the evaluation of a fund. Either the person is already taking a great opportunity cost by running such a small fund or has independent personal wealth where a small GP commitment is irrelevant to them.” – Samir Kaji
73/ “Most LPs allow you to reinvest returns 18-36 months after the investment period. The early wins are often small and don’t impact the returns so you are better off reinvesting to go for another unicorn. This is a game of outliers.” – Henri Pierre-Jacques
74/ “Management fee schedule adjustments: Pause or slow down fees in ’23 (with authority delegated to LPAC to avoid conflicts of interest)” – Chris Harvey (timestamped Feb 13, 2023). A way to leverage your LPAC to communicate fund decisions to the rest of your LPs
75/ “What % of companies successfully got funded from investment to the next round?
Seed —> Series A should be >35%.
Series A —> Series B should be >50%.
Series B —> Series C should be >50%.
And, Series C —> Series D+ should be >60%.” – Aman Verjee
76/ As a long-term investor, you have to generate at least three times the risk-free rate (3-month T-bonds, bank interest rates, etc.) to have an investment make sense in the long-term. – Chamath Palihapitiya, speaking when T-bonds’ rate is 6.5%, meaning a private investment must generate at least 20-25% for it to make sense
Selling positions
77/ “In consumer and consumer social, advocate more aggressively for selling along the way. The hype cycle of consumer means heat and traction do not have the sustainability of enterprise ARR and so more weight placed on selling some portion earlier there.” – Harry Stebbings
78/ “Pigs get fat but hogs get slaughtered. Even if we believe a company has tremendous longterm upside, it’s not inappropriate to take some money off the table in order to manage that risk. As we’re recently reminded, markets go down, not just up. Just be aware of the incentives, emotions, and other factors at play. It’s ok to behave one way before you hit your DPI target and another way after, but understand how those factors produce better or worse possible outcomes. This is also true with regards to recycling. If we can sell partially out of a position and put those proceeds into one that we believe has more incremental upside, that’s accretive to our results.” – Hunter Walk
79/ “Generally once a position is worth 3x the fund sell 1/3rd to return 1x the fund (if there is liquidity). […] For the hot names you will get a bunch of inbound. Negotiate to get a price you like. For less hot names, just talk to the investors leading the next round and see if they want to add to their position. A lot of times they do and don’t mind buying out earlier investors.” – Sheel Mohnot
80/ “For public shares, we’ve landed on the following model:
1/3rd immediately (either first-day lockup expires or immediate on direct listing)
1/3rd 6 months after
1/3rd up to our discretion
Here’s why — The first third books your win. If you do seed, you likely have a huge position by the time you hold public shares. The second third allows the stock price to stabilize after the market has been hit with lots of supply from VCs doing distributions. The last third allows you to have an opinion on the stock/market — however, you can choose to distribute this third anytime, including alongside or after the previous thirds.” – Chad Byers
81/ If you’re a reasonably good fund, you should return at least 1x your fund (1x DPI) within 5-7 years. – Chamath Palihapitiya and Jason Rowley
LP management
82/ Early funds generally have 30 LPs in the fund. Fund I is often an exception.
83/ A general rule of thumb is to not have any one LP contribute more than 25% of the fund, or else you might lose control when you have such a large “shareholder”.
84/ “After my LPs wire their money, I send them an intake form where I ask the question: How would you describe yourself as an LP? I have a number of statements they can select to indicate whether they are a newer or more experienced LP, if they’d like to be more active with founders, how often they’d like to communicate with me, and if they are interested in co-investment opportunities and events. I have another question following that: If you want to be more active, what are ways you enjoy helping?” – Sarah Smith
85/ “Be thoughtful about how you’re managing your time, so that you don’t turn into a full-time venture professor. You’re an investor, a GP. That’s what you’re getting paid to do.” – Arjun Dev Arora
86/ “Avoid LPs who ask you to give up economics as a GP or change your terms. LPs who want to negotiate lower management fees, a different carry structure, or they want to own 20% of the general partnership for the next three funds are best avoided if possible. They want to change the terms that everyone else has. I wouldn’t allow that. If other LPs find out (and they eventually do), it would cause my LPs to lose trust in me and rightfully be frustrated that they got worse terms.” – Sarah Smith
87/ “If someone does ask for it, and if they aren’t a large enough check, we tell them, ‘We like to reserve this spot for our largest LPs because they have the largest exposure in our fund. We’re open to you being a member in our LPAC, if you increase your check size.” That way, you can leave the ball in their court. Either, they won’t push further or they’ll commit more capital to the fund.” – Eric Bahn
88/ “If you’re in your Fund I or II, like I am, you’re still figuring shit out. You’re still testing what works and resonates and what doesn’t. I ask them, ‘what have you seen other managers do in this situation?’” – Paige Finn Doherty
89/ “The average, for a normal venture fund, is around 5-7 years to call 90% of the capital.” – Chamath Palihapitiya
SPVs/Syndicates
90/ There are two types of syndicate leads: “marketers” and “connoisseurs.” The former focuses on volume, which lead to more noise than signal. The latter focuses on quality, and as “tastemakers” lead to higher signal over noise. As LPs, quality may matter more than quantity, especially when you’re most likely diversified by being in several other syndicates already. Inspired by Julian Weisser.
91/ If you’re warehousing SPVs for your fund, do note that the number of unique LPs in your SPV(s) count towards your accredited investor limit.
92/ If you’re an LP in an SPV and agree for it to be warehoused into a fund, you are forgoing your right to the individual deal for access to the fund’s portfolio of deals.
93/ As the syndicate lead, set the minimum check size at or less than your own check size.
94/ Your GP commit into your SPV is directly proportional to your net worth. The greater your net worth, the more you’re expected to contribute. Any less, would be a negative signal. That said, the less of a net worth you have, the more you’re expected to be a great curator of deals.
Succession planning
95/ “The best way to think about succession planning is that you have to have team members at different parts of their life. Different generations. Even if they’re non-founding partners, if they all retire at the same time, you can’t build a legacy.” – An investor with 9-figure AUM
96/ Structure your fund to have a generational off-ramp for compensation. A lot of funds are structured so that payout is done through the management company, and so owning equity in the management company becomes increasingly more expensive as the firm matures and has greater AUM, etc. So the next generation, in order to succeed the firm, must buy out the previous generation’s equity. So, leadership transitions are not easy. Instead, structure your firm so that the management company doesn’t have value, where the value is at the GP. So transitions are a lot easier. – Maha Ibrahim
Tax planning
97/ When invest in a startup via SAFEs or convertible notes, your QSBS timer counts when the SAFE converts on equity round, not during the convertible round.
98/ As a GP who takes management fees through a management company, often LLC, you don’t receive W-2’s. As such, you can’t withhold taxes, so you have to be disciplined on cash management. “Outside of federal and state tax, there is a massive self-employment tax of 12.4% on up to $147,000 of earnings. And an additional 2.9% on any earnings.” – Jarrid Tingle
99/ The origin of the 1% GP commit comes from taxation laws prior to 1996. But even now, “in order for GPs to avoid their carried interest being taxed as ordinary income vs. long-term capital gains, many GPs still follow safe harbor.” – Courtney McCrea and Sara Zulkosky. While this isolates GPs who aren’t independently wealthy or are well-capitalized, in lieu of the typical cash contribution, I see a lot more emerging GPs warehouse deals and recycle carry.
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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.
